On The Future Of Apple's Growth

| About: Apple Inc. (AAPL)

Apple Inc. (NASDAQ:AAPL) is much in the news, with alternating sources discussing Apple's latest surprise in growth, or explaining why the gravy train is over - a prediction frequently laid at the feet of some alleged law of mathematics. This article briefly reviews Apple's position in some key markets to examine the evidence Apple hasn't suddenly peaked but is in the swing of a prolonged growth phase.


Although no longer called "Apple Computer", the company's products are in fact computers. Airport? It's a router. AppleTV? It's a streaming multimedia client capable of displaying iPad video on the big screen just as easily as it displays Netflix (NASDAQ:NFLX) content or media in an iTunes library anywhere within wireless range. Time Capsule? It's a multi-terabyte file server. Even the smartphones and tablets are Unix machines underneath the glossy finish. In this era of attention to mobile devices, it's easy to forget that all those devices are using a Unix operating system acquired when Apple bought NeXT (and regained Steve Jobs) in the late '90s.

And of course, the company makes "computers" -- especially notebook computers. Globally, Apple cracked the top 5 rankings for notebook computers with a notebook share of 8.3% (if tablets are counted, Apple is the global leader).

Apple doesn't make loss-leaders, and it's been able to grow PC unit sales (excluding iPads) - even while markets like France or the UK (Apple is not even in the top 5 by unit sales share in Europe overall) or the United States actually shrank in some quarters. In China, where the PC market grew 6% from the beginning of 2011 to the beginning of 2012, Apple enjoyed Mac growth of 60%. And Apple is still working to add points of sale to its China sales operations.

Apple may not sell as many PCs as other vendors ship machines preloaded with Microsoft's (NASDAQ:MSFT) operating systems - but it's certainly growing its unit sales faster. What's more, Apple makes more money per sale. Unlike Dell (NASDAQ:DELL) - a commodity vendor forced to compete on price because its products have no other distinguishing feature - Apple's ownership of the software that makes the computers run is both a production cost advantage (it doesn't need to license an OS from Redmond) and a qualitative differentiator to quality-conscious users. Even if it sold the same products at the same prices, Apple would earn more income. Apple's sustainable competitive advantage in software differentiates it from the bulk of commodity box makers, who must defend their business without the advantage of a moat.


Fully 25% of iPad buyers have never owned an Apple product. Tablets help Apple reach customers that previously had no reason to visit an Apple Store - and in doing do, help Apple market everything else Apple offers to people who enjoy the Apple experience. If one counts tablets, Apple is the #1 mobile computer vendor on the planet.

Mainland China has not yet seen the new iPad.

The growing importance of tablets to Apple's financial success indicates that this market segment - not to be confused too readily with the market for e-readers - is important to Apple and indicates strongly more near-term growth. Claims that Apple is about to be clobbered by competition now that the world has seen and can copy the product flies in the face of Apple's experience selling three different generations of iPads. Apple holds the high ground in tablets,and seems set to defend it.


Remember Motorola, scoffing in the wake of the iPhone launch that Apple would learn the hard way how hard it was to make a phone? Yeah. Apple's come a long way, baby.

In the last quarter of 2011, Gartner estimated that 149 million smartphone handsets were sold. The smartphone market grew 47.3% from its size in the last quarter of 2010. Apple - riding the launch of a new iPhone model - sold 35.5 million of those phones, to take 23.8% of the unit sales share that quarter. The smartphone market is itself a small fraction of the global cell phone market - a market that is steadily being overtaken by smartphones. In this larger cell phone market, Apple grew its share from the last quarter of 2010 to the last quarter of 2011 by more than 100%, from 3.5% to 7.4%. To enjoy substantial share growth in a dramatically-growing market is a wonderful place to be.

Yet, that global number gives the illusion that Apple has nearly a quarter of the smartphone market anyplace one would go. In fact, Apple's market share varies greatly by geographic market. Hardly anywhere is Apple's share so small, or so fast-growing, as in the world's largest smartphone market: China. While share of Google's (NASDAQ:GOOG) Android platform approximately doubled in China during 2011 to reach unit sales share of 68.4%, Apple ended the year with but 5.7% market share. Nokia's (NYSE:NOK) Symbian platform beat iOS soundly in China with 18.7%.

The secret behind some of the sales share enjoyed by Android and Symbian is that they can run on cheap hardware. Apple, as described above, sells a differentiated product at high margins. China, unlike the United States, does not predominantly offer customers subsidized phones. The Chinese market is largely prepaid, eliminating the opportunity to conceal hardware payments in post-sales subscription fees. So, Apple is doomed in China, no?

No. The first quarter of 2012 saw the mainland China launch of iPhone 4S, to "mind-boggling" results. Phone sales quintupled, as Apple added China Telecom as an official iPhone carrier the last month of the quarter. China now accounts for 20% of Apple's global sales. With the United States accounting for a third of Apple's revenue, the growth in China suggests that the country will soon replace the United States as Apple's top region for revenue. The fact that about $76 billion of Apple's $110.2 billion in cash is offshore is easy to understand in light of Apple's dramatic success offshore.

Apple is still a minority producer in a dramatically growing market. It is itself growing strongly both its unit sales and its unit sales share, indicating continued strong overall growth not yet at a peak. Given the proportion of Apple revenues associated with its phone business, this circumstance is a material indicator of Apple's capacity for more near-term growth.

The Development Platform

Apple's "Cocoa" development environment descends directly from NeXT-developed object-oriented technology which is in full display on every Macintosh because the developer tools are free. Sure, you can learn to program "for free" on a machine running some version of Microsoft's Windows, but not using the programming interfaces designed by the operating system's developer to leverage the benefits of the development environment. To learn "for free" on Microsoft's platform, one has to pick a development environment that isn't Microsoft's - and in many cases, doesn't even target Microsoft's programming interfaces.

While it's also possible to get professional-grade Linux development tools without charge, many new developers want to deliver graphically-controlled applications to end-users and are attracted to platforms on which customers want applications with a graphical user interface. Yes, one can develop X-Windows applications, but who will you reach as a market with those? Developers for Apple's platforms benefit from having a ready market for their applications. The App Store and Mac App Store allow iOS and Mac developers to publish to every user - with Apple handling transaction overhead for 30% of any price a developer may select, down to and including free. Yes, this means Apple takes a loss on some transactions to add value to the platform. Apple frees mobile and desktop developers from having to figure out how to process purchases and obtain payment globally - and how to comply with applicable taxes on transactions or profits earned in whatever jurisdictions might govern a buyer's purchase. Developers sell to Apple, which sells the product everywhere Apple does business. Developers only have to do business with Apple in their home country to sell globally.

While Microsoft keeps promising security, speed, and ease of use, Apple has actually delivered better on each of these for years. And from the sales figures, it's evident users have noticed.


Sure, Apple will face competition from Research In Motion's (RIMM) new BlackBerry v.10 software later in the year - just as it will face competition from Microsoft's Windows 8. But as described here, RIM faces strong headwinds from Microsoft, Google, and even Apple. RIM has finally joined Microsoft's new smartphone partner Nokia in negative quarterly earnings, and though it can certainly survive for the near term the jury is out on whether its products will remain competitive in a world in which push email and instant messaging are no longer unique. Meanwhile, Microsoft has yet to show it can be relevant in the mobile market. It has only showed that it's willing to pay to play - a strategy that can be expensive.

And that's just phones. The competition in computers is as tough as it can be, yet Apple takes share. Tablets, anyone? We don't even know what "normal" tablet market sizes are, as the market is still being developed. With web standards freeing more and more users from platform lock-in, more businesses and individuals are free to try Macs than ever before - just as Apple's margins are set to benefit from economies of scale superior to those it ever had in the past.

Apple's durable competitive advantage in software serves it well in every market in which it competes. So well, in fact, that its share of profits far outstrips its share in units in smartphones, tablets, and computers. And as the recent >90% year-over-year profit comparison showed last quarter, Apple is still growing where it counts.

Disclosure: I am long AAPL.

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