The Failure That May Derail Apple's And Google's Momentum

 |  Includes: AAPL, GOOG, MSFT
by: BubbleBustInvesting

Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) seem to have everything going their way these days. Apple enjoys a leadership position in mobile devices, while Google enjoys a leadership position in Internet search engines-though their paths cross in the smartphones devices, where they have both gained market shares against Nokia (NYSE:NOK) and Research in Motion (RIMM). Recently, however, the two stocks have corrected sharply from all time highs. Is that just a correction, or something more serious?

Hard to say, as it is hard to distinguish a correction from a secular decline associated with a momentum shift, as was the case with Cisco Systems (NASDAQ:CSCO), Hewlett-Packard (NYSE:HPQ), and other technology companies. The crucial question, therefore, isn't whether the correction is over, but what can derail the momentum of these companies?

Answer: Social failure, problems with government regulators, and legal challenges from competitors.

In every society, firms perform three functions - the social function, the managerial function, and the entrepreneurial function. The social function defines the very existence of the firm as a social institution: the serving of consumer and social needs; the provision of employment and income for labor; the contribution of funds the support of the local and national community; and compliance with government rules and regulations. The managerial function of the firm determines how economic resources should be allocated to alternative uses, and how different tasks are to be performed. The entrepreneurial function accommodates the discovery and exploitation of new business opportunities-the most important function, as it keeps the firm alive for decades, even centuries to come.

The three functions are not independent of each other. The social function, for instance, imposes different constraints on the entrepreneurial and managerial functions, while the entrepreneurial and the managerial functions impose their own constraints on the social function. This means that problems with any of the three functions undermine the other two functions.

A failure of a corporation, for instance, to comply with government rules and regulations and acceptable business practices can cause legal woes that impair its ability to innovate and keep up with its competitors, as has been the case with Microsoft (NASDAQ:MSFT) in the 1990s. Its leadership spent too much time addressing regulatory issues and ended up missing out, relative to Apple, on mobile devices.

It took, for instance, four years (1997-2001) for the company to move from Windows CE 2.0 to Windows XP. In the meantime, Apple introduced a host of new products, iBook (1999), iBook Fire Wire (2000), and iPod (2001). Microsoft's stock has yet to regain its momentum--the company is trading close to 50 percent below its 2000 all-time highs.

Now, Apple has its own problems with government regulators over e-book pricing in the US and iPad trademark in China; so does Google, over its search engine dominance and acquisitions, and Android system with Oracle (NYSE:ORCL). While it has yet to be proven whether the two companies have done anything wrong, their leadership will certainly be distracted until these problems are resolved. This means that investors must keep a close eye on the entrepreneurial and managerial activities of these firms, especially the pace of new product introductions before they buy shares of the two companies.

Disclosure: I am long AAPL, MSFT.