Joseph Schumpeter was an economist and at times a radical economic theorist. Schumpeter identified two forms of innovation that cause a perfectly competitive market to briefly morph into a monopolistic market or a monopoly. A perfectly competitive market is difficult to fathom, except for maybe the agricultural industry; therefore Schumpeter's theory that perfect competition exists is a radical idea to many.
According to Schumpeter the perfectly competitive market can exist, however brief periods of technological advances cause one particular firm to outperform the rest. This industry leading position does not last forever. In fact, the exact opposite occurs. According to Schumpeter's innovation, smaller firms will eventually learn the same techniques and produce products that are perfect substitutes. Therefore in the long run, according to the theory, all firms will produce the same product in the same manner.
If, for instance, the firms in the same market are producing the same product for the same price, we will have perfect competition. However, in reality this seems to never happen because as the new firm/firms catch up, simultaneously one of the new firms may in fact create a better product than the previous leading product. This will inevitably lead to that firm outperforming the rest of the competition; hence voiding perfect competition. A perfect example of this is Apple (AAPL) and Microsoft (MSFT).
It is important to recognize Apple and Microsoft have followed Schumpeter's innovation because over the long term, both companies have reversed roles several times. This is important because this same trend will appear in the future. Or, perhaps, another company will develop a new product that becomes the new industry leader; similar to what Apple has done over the past decade. With that said, at this point, it is nearly impossible to foresee another firm outperform Apple. However, according to Schumpeter, this will occur at some point. Will it be Microsoft? Samsung? Motorola? HTC? An unknown?
Before moving forward it is important to review the past 30 years to trace how exactly Microsoft and Apple have switched roles as leading innovator time and time again. Microsoft was the leader, with help from IBM, throughout the early 1980s. Also, excluding Apple's first Macintosh sold in 1984, Apple was in Microsoft's shadows throughout the 1980s. Microsoft was able to dominate Apple throughout the 1980s because the company continually developed new operating systems and the like. As Schumpeter predicted, this innovation was able to set Microsoft apart from Apple, but the tide was soon to change.
Throughout the 1990s there was much of the same as the 1980s. Apple was able to produce a few top of the line products that would prove to be the backbone of market leading products years later. Nevertheless, Microsoft continued to lead the industry throughout the 1990s, but in 1997 there was a point when change was about to happen. Instead of competing with Microsoft Windows, in 1997 Apple essentially "innovated" and partnered with Microsoft to create Microsoft Windows for the Macintosh.
The tide began to leave Microsoft around 2001 when Apple introduced the iPod. During this time Microsoft continued to develop the Windows legacy, but once Apple partnered with Intel (INTC) in 2006, it was apparent the changing of the guard may have already happened. It goes without saying the number of incredible products Apple has produced over the past decade, but what can be said is Apple has became the untouchable industry leader.
To briefly recap, Microsoft was more or less the industry leader from 1980-2001 and Apple has been the leader since that time. Therefore as Schumpeter would have expected, Apple eventually learned from their mistakes and was able to use new technology to create a better product than Microsoft and all other firms in the industry. Furthermore, this dominance has allowed Apple to continually develop new products and patents that are making it difficult for other firm's to enter the market and catch up.
But, as they say, "what comes around goes around." Is it possible that another firm will produce a mind numbing product in the future? Yes, it is very likely, but when and who and how will Apple respond? Unfortunately the when is not an easy answer. In fact it is nearly impossible. Schumpeter stated innovation occurs over the long term, therefore Apple will be the market leader for the long term, and when a new firm arises that company will be the leader for the long term. What defines long term? Well, Microsoft led the industry for 20-25 years on the conservative side. If Apple leads for 25 years we will see a changing of the guard around 2025-2030.
This gives investors plenty of time to ride the Apple wave to the $1000 level. Yes, over a 13 year period it should not be surprising to see Apple's share price move to $1000. Over the last 13 years we have seen Apple's share price increase roughly 440 points. Therefore another 560 points in 13 years should not be surprising considering the past 13 years has treated equities very poorly with a dotcom bubble, two U.S. recessions, and a long lasting housing crisis.
Is there a possibility Microsoft will take back the market lead? There is always a chance of this happening according to Schumpeter. In fact, that is the beauty of the vagueness. Since there is no real way of predicting which company will innovate the next "have to have" item in a decade or more, we can only speculate. Furthermore discounting any firm does not allow for the possibility that every company has equal probability of creating an incredible product.
Assuming Apple will lead the market until at least 2025, what will come about of Microsoft? Microsoft's share price will likely continue to stay range bound. The range will likely increase as Microsoft continues to improve margins and develop new products. Also, the company's 2.7% dividend will increase over time and reward investors for believing in the company over the long term.
Is it possible Apple will break Schumpeter's rule? Obviously right now in the present it is easy to say Apple will be the market leader forever because the firm's products are spreading throughout the world with no slowdown in sight. Also, Apple is innovating new products that are keeping pace with technological advances. Three of these products are the iPad to keep pace with the tablet revolution; iCloud to keep pace with the cloud movement; and the iTV to expand into the television and streaming multimedia market.
It should be remembered, however, that Schumpeter's innovation ultimately leads to a perfectly competitive market. Therefore even though many believe this is unfeasible the truth is there may in fact be a brief moment when innovation and technological advances cause all the firms in the market to be equal. However due to innovation and different technologies to produce products, the market appears to be an oligopoly with Apple leading the charge.
With that said, Schumpeter and the characteristics of an oligopoly agree that over time the market share of one or two particular companies will diminish and smaller firms will slowly gain market share. This occurs because, in theory, the larger firms will eventually expand to a level where margins will shrink because costs reach an unsustainable level and cost cutting measures are needed to improve margins. Also, as the firm's margins decrease the price of the product may increase; which will lower demand assuming there are substitutes in the market. If demand decreases it will be likely that the firm is forced to lower production costs in order to expand margins. However while the firm's demand has decreased the smaller firms are simultaneously able to increase demand and production; which eventually lead to a more perfect market. Also, if the major firms, such as Apple, are bringing in a substantial amount of revenue, smaller firms will attempt to enter the market at an increased rate.
The economy may not work exactly how it is discussed above, but the concept is there. This concept is, according to Schumpeter, that regardless of the present, a minority firm will at some point create a new product that will cause Apple to become the minority. Perhaps in a decade or so a technology company will partner with Apple just as Apple partnered with Microsoft?
There are many possibilities, but what can be said is that in the foreseeable future Apple's share price will continue to blast off towards the $1,000 level while Microsoft will find a higher range to fluctuate between. But over the long term Schumpeter's innovation will prevail and new technological advances will cause the market to reach a perfectly competitive market; even if this only lasts one night or one day before the new firm becomes the industry leader.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
