Computers are looking more and more like a commodity with Dell Inc. (DELL) recently lowering its earnings outlook and Hewlett-Packard (HPQ) planning on spinning off its PC business. In addition, component prices for computers continue to rise, which will soon give consumer electronics companies paper-thin margins and little flexibility. Apple (AAPL) is currently an industry leader in profit margins and Apple users are willing to pay a premium for their products. In this article, I explore why Apple is able to outperform competitors and what it needs to do to keep its competitive advantage.
Apple has a remarkably short line of products given its size. Because of this, the average consumer always has a good knowledge of Apple’s product line and what new Apple products will be available for sale. I believe that competitors can replicate this, but few are willing to risk shortening their product breadth. They can provide higher product visibility and marketability and cut expenses, but this move could backfire and cause companies to lose market share and consumer reach.
Apple has a very vertical value chain. Most consumer electronics companies do not make their own components, and simply add value by assembling components from different manufacturers. Apple is historically known for producing many of its own components. Apple also has its own retail stores, which no competitor of Apple’s has. This is a very sustainable advantage since the costs of vertical acquisitions and vertical organic growth are very high. It is a very difficult process that adds value if done right, and Apple has had a vertical value chain built into its business plan for a long time. The company has obviously become less vertical over the past few years with the use of Intel chips and manufacturers for many of its products like the iPad and iPhone, but Apple leaders know the consumer electronics business at every level, which no other competitor can say.
Apple has brand loyalty. Apple users defend the brand and are proud to use Apple products. They will pay the extra money for the quality, aesthetics, and innovation that Apple offers. No other consumer electronics company can boast such a loyal following of customers. Its customer service remains unmatched and puts Apple’s customer satisfaction rating at the top.
In order for Apple to continue being a valuable company with a sustainable competitive advantage, it has to not only maintain these value-added advantages, but create new ones. It has to use its unique strategic position in the consumer electronics industry to release more innovative products that will create new markets and keep a firm hold on those markets. The company needs to keep competitors one step behind by hiring the best talent and controlling distribution channels through the retail stores and its relationships with retailers.
When Dell computers first came to the market, it was able to succeed because its supply chain management capabilities were far superior to its competitors’. Now, every consumer electronics manufacturer uses a just-in-time inventory system and Dell trades at a P/E ratio of under 8 with almost no growth potential. For Apple to avoid the same fate, it has to continue to innovate while preventing competitors from copying its strategic moves. I believe that Apple’s competitive advantage is more sustainable than Dell’s was since a company cannot generate brand loyalty in a short period of time or a vertically integrated value chain with a small investment. I believe that Apple’s value is safe for now and the stock is one of the top technology stocks to invest in. However, I advise that holders of Apple stock keep a close watch on Apple’s competitors because any one of them can be the next innovator in consumer electronics. In 2005, Apple was behind Dell in market cap, and it is not impossible for a competitor to pass Apple in market cap in a couple of years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.