I recently wrote about Apple Inc.'s (NASDAQ:AAPL) growing iTunes (including App Store) and accessories segments, and their key role in Apple's future growth. In this article I take a closer look at Apple's role as market creator and regulator - a role that it already performs in the iTunes Store and the App Store, and which it hopes to perform in the "smart home" and health spaces.
As market organizer and regulator, Apple is attempting to increase the intensity of competition among third-party producers in a bid to improve the capabilities and quality of its products. It is also attempting to enhance the base capabilities of its hardware so that developers can in turn do more on the Apple platform than they could on other platforms. These new capabilities for third-party developers drive competition further by allowing developers to introduce new features and products. This in turn improves the capabilities of Apple's mobile hardware and drives their sales.
Increasing the intensity of competition in the markets that it regulates - combined with Apple's provision of a unitary high-end hardware platform - should help Apple maintain its innovative edge over the competition in the long term. Android's fragmentation is going to cost Apple competitors like Google Inc. (NASDAQ:GOOG) (NASDAQ:GOOGL) and Samsung (OTC:SSNLF) dearly on this front. Additionally, because innovation in the Apple ecosystem is becoming increasingly decentralized, it may prove more consistent and sustainable in the long run than if Apple were to rely largely on its own resource.
Apple as Market Creator and Regulator
Apple has frequently reshaped markets for third-party products in tandem with the introduction of new product categories. The iPod came with iTunes and the iTunes Store, and the iPhone and iPad came with the App Store. The latter App Store - as reported by Tim Cook during Apple's most recent earnings call - is now a giant $10b per year marketplace that is "almost doubling year-over-year."
Apple is also attempting to gain control of the market for "smart home" devices and apps through its upcoming introduction of HomeKit; and the market for health information, apps, and devices through its introduction of Health and HealthKit. It is widely believed that Apple is likely to utilize something like "Made for Apple" branding to drive partner smart home and health-related accessories sales.
I have already written about Apple's strategy for directly monetizing its role as market regulator in its iTunes and accessories segments, so I will not rehash these arguments here. Instead, I will consider Apple's moves toward further improving the competitiveness and innovation of the marketplaces that it operates.
Apple is pursuing a multi-pronged strategy toward intensifying competition in its marketplaces.
First, competition among Apple's ancillary firms grows in proportion to the size of the market in question. The larger the market, the greater the rewards of success, and the greater the impetus for innovation. In terms of offering great rewards for success, iOS far outstrips other platforms in app sales and monetization. Apple has also been taking greater control over allocation of these rewards through design awards, editor's picks, and improved ranking algorithms.
Similarly, the smart home market is poised to grow rapidly with Apple's introduction of HomeKit, which should open up new opportunities for makers of smart accessories, appliances, and home automation devices. The health information and health-related accessory markets are likewise poised to grow rapidly with the introduction of Apple's Health app and HealthKit developer framework. Investors should look to how exactly Apple regulates and monetizes these spaces, especially through partnership programs.
Second, Apple's consistent introduction of superior hardware and software capabilities in its devices permits developers to compete with each other in new ways. Apple provides extensive base platform capabilities for which developers can then create new applications, extensions, and use cases: the greater the platform's abilities, the more innovative the third-party software and hardware will be. The following are some instances of new capabilities introduced by Apple among its mobile devices during the past few years:
- Siri voice assistant (introduced iPhone 4s), and improved Siri integration in iOS.
- Desktop class 64-bit A7 processor (introduced iPhone 5s), which is bringing even console games to the iPhone and iPad.
- Touch ID fingerprint scanner (introduced iPhone 5s), which will become open to software developers with iOS 8.
- Swift programming language (to be introduced iPhone 6).
Tim Cook has also already discussed Apple's great interest in the upcoming rise of advanced sensors and the great opportunities it will create. Many of these sensors are rumored to be destined for the so-called "iWatch," but some of them should inevitably also make their way to the iPhone and iPad, where they will drive innovative new applications among developers and users.
Finally, Apple is promoting competition in its marketplaces by lowering barriers to entry and the costs of bringing products to market. Nowhere is this aspect of Apple's strategy more visible than in the introduction of its newest programming language, Swift. Among other things, Swift is meant to be easy to pick up and is designed to substantially reduce some of the tedium and difficulty of writing apps. Apple is also set to release Metal, a new framework for video game design which should similarly simplify video game development.
Investors should look for Apple to work toward further simplifying ancillary software and hardware development over the next few years, especially through HomeKit and HealthKit.
The Apple Edge
So far, Apple has been quite successful in being the platform of choice for developers. This has in turn enabled Apple's ecosystem to innovate rapidly and thus stay ahead of the competitors like Google, Samsung, and Microsoft. There are three primary reasons for Apple's success at nurturing an extensive ancillary industry around itself:
- Uniform Software and Hardware. Apple has been touting the fact that iOS is much less fragmented than Android, largely due to Apple's direct control over the operating system and its updates. Similarly, Apple's hardware is also significantly less fragmented, with only a few models of iPhones and iPads in existence. Software and hardware uniformity in iOS makes it substantially easier for developers to reach a great number of users with a single version of an app. Apple will be looking to further capitalize on this uniformity of design through HomeKit and HealthKit, especially once they have been refined over a few iterations.
- Advanced Capabilities. The iPhone and iPad also offers advanced features not available on other platforms. For instance, it does not seem to me that any smartphone besides the iPhone 5s - including the Galaxy S5 - has been able to implement a consistent and seamless fingerprint scanner. Similarly, Apple's desktop class A7 processor also remains unmatched by any other smartphone manufacturer. These advanced hardware capabilities attract developers to Apple.
- High Monetization. Finally, as I have already mentioned, iOS users spend much more on apps than non-iOS users. This great opportunity also attracts a great many developers.
The Sustainability of Apple's Position
Apple has grown through radical innovation and become a symbol for it. I have argued that Apple has been able in recent years to foster a thriving and highly competitive ancillary industry around itself, which it is working to make even more competitive and innovative. I believe that Apple's moves toward making its marketplaces more competitive and better-designed could even now greatly increase the innovativeness of the Apple ecosystem.
This decentralization of innovation away from Apple should improve the ecosystem's ability to innovate consistently in the long term, especially in those adverse situations when some of Apple's own projects do not meet with the hoped for success. Decentralization of some research, development, and innovation to a competitive ancillary industry is good for the Apple ecosystem, good for Apple and good for Apple investors, and could sustainably maintain - and perhaps even extend - Apple's competitive advantages for many years to come.
Developers are likely to continue flocking to Apple as long as it can retain its large and lucrative user base, software uniformity, and top-of-the-line hardware. Of these, software uniformity is unlikely to decline because Apple almost completely controls iOS (Google's Android is also unlikely to become as unfragmented as iOS, and Microsoft's (NASDAQ:MSFT) Windows phone has little traction). Similarly, Apple may see a decline in user base eventually, but we will very much know if and when that begins to happen. It also seems unlikely to me that competitors will catch up with some of Apple's hardware-related accomplishments - like the A7 processor and Swift - any time soon either, especially as Apple's research and development balloons to unprecedented levels ($1.6b for the June quarter).
One of the primary concerns about Apple in recent years has been the sustainability of its profits in the long term. This has been reflected most clearly in the relatively low price-to-earnings ratio attached to Apple shares, especially once we take into account Apple's incredible book value of $123b.
Similarly, investors have worried a great deal over Apple's ability to innovate after Steve Jobs. Uncertainty over sustainability for radically innovative companies is only to be expected. However, I believe that the decentralization of innovation in the Apple ecosystem - away from Apple and into the hands of ancillary firms - will ultimately help Apple retain its innovative edge in the long term, especially in the smart home and health-related applications and accessories markets. An Apple that adeptly guides the innovative capacities of its ancillary firms may well sit atop one of the most innovative ecosystems in the world for many years to come.
The many industries that Apple has created or transformed have become much greater than Apple itself, despite the latter's meteoric rise over the past decade. This is inevitable, and one of the consequences of a thriving technology sector. Even then, Apple's significant role as market creator and regulator should permit it to accelerate, guide, and monetize its ecosystem. Apple's success on this front will be central to its financial stability and growth in the years to come, and investors should take solace in the fact that Apple is taking an increasingly active approach with respect to its ancillary industries.
Disclosure: The author is long AAPL.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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