In 2001 Apple (NASDAQ:AAPL) launched its iconic iPod brand of portable media player. Now Apple itself is iconic because of the tragic death of Steve Jobs. In terms of business model and strategic leadership Apple is Numero Uno. The only problem Apple faces now is whether it can keep its dominant market position.
Apple’s successful business model includes two key benefits for which customers are willing to pay a price premium. One is an owner appearing “cool” or “savvy,” as the company’s products offer among the most elegant looks on the market for technology products (for most products, as a matter of fact). But a key driver of Apple’s financial success has been growing adoption of Apple products for business (as opposed to school or home) use.
Sustainable Competitive Advantage
Apple has created a sustainable competitive advantage for itself with the iTunes platform. Earlier iTunes allowed users to download songs for iPod. Now, iPhone and iPad are also integrated with iTunes for apps download. The iTunes platform and its tight integration with Apple products is so powerful that Walmart (NYSE:WMT) has decided to exit the digital music. iPhone and iPad, which didn’t even exist 5 years ago, now contribute nearly 70% of Apple’s revenue. How many companies do you know that have 70% revenue coming from products that didn’t exist 5 years before?
The potent combination of device, software, and online store quickly disrupted the music industry and gave Apple a dominant market position.
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Investors prefer a highly fragmented customer base versus a highly concentrated one. This is because concentrated customers have “market power” that can result in pricing, feature, service demands over time. The ideal situation is tons of very small customers who are essentially “price takers” in the market. Since Apple is more focused on the consumer market than the enterprise Market, the customer base of Apple is highly fragmented. This allowed Apple to grow much faster than enterprise-focused companies, even during a “consumer-driven” recession.
Major Partner Dependencies
Investors will discount price/revenue valuations of any company that is highly dependent on another partner in some way or another. One of the key reasons for Apple success is that it owns both hardware and software. Apple controls the complete user experience. The company is not dependent on partners for any technical breakthroughs. It innovates at its own pace. Apple does outsource mass-scale manufacturing to vendors like Foxconn, but it is not dependent upon vendors for value proposition development or customer reach-out.
Organic vs Heavy Marketing Spend
Investors love companies where the products/service sales are achieved through “word of mouth” process and the cost of acquiring a new customer is low. The lower the marketing spend, the better it is. In case of Apple, gross margins improved by 12% during the last 5 years, whereas operating margins improved by 20% during the same time. Sales and marketing expenses are usually captured as operating expenses. Clearly, higher operating margin growth implies low spend on marketing to acquire new customers.
The faster you are growing, the larger and larger future revenue and cash flows will be. High growth also implies a company has tapped into a powerful new market opportunity, where customer demand is seemingly insatiable. Apple announced its Q3 2011 (April-May-June 2011) results on July 19, 2011. Apple crossed the $100 Billion TTM revenues (Trailing-Twelve months) milestone in Q2. This translates to nearly 4x revenue growth in 4 years. Apple had less than $25 Billion TTM revenue 4 years back. During last 12 months, Apple had nearly twice the incremental revenue of Hewlett-Packard (NYSE:HP), IBM, Microsoft (NASDAQ:MSFT) and DELL combined.
Disclosure: I am long AAPL.