Why Apple's iPhone Will Continue To Be Successful

| About: Apple Inc. (AAPL)

It's a familiar story: Apple (NASDAQ:AAPL) launches new iPhone, breaks previous revenue records, stock price continues to rise. Now that the iPhone 5 has been released and sales records are being broken left and right, the question is, can Apple keep it up?

On the surface, to expect Apple to continuously innovate its iPhones every year for several years in a row is a lot to ask, and downright irrational to expect (especially since the death of Steve Jobs). True, if it were solely up to Apple to make its products better on its own, the assumption that it would succeed every year without fail would be preposterous. Think about trying to innovate a hot dog - it's just not gonna happen. However, the smartphone and the smartphone industry itself are continuously evolving, and we haven't yet seen the beginnings of any decline for the industry. And Apple, along with app developers, telecom companies, cable companies, content providers, and component manufacturers enjoy a feedback loop in which continuous innovation in one area spills over into another area. Apple is positioned in an envious space because, when telecom companies inevitably find a way to develop faster networks, that improvement will immediately render all previous smartphones obsolete (or at least inferior), and Apple will need to manufacture a phone that is compatible with that network. When component manufacturers find the ability to make smaller components, which allow for a thinner phone, Apple will gladly produce another iteration of the iPhone that is thinner. When the manufacturers make a better battery, Apple will be there; and so on and so on. In this way, the iPhone is riding the wave of industry innovation, in addition to improving itself along the way. A fellow Seeking Alpha contributor wrote an article about Apple's incremental innovation recently.

This line of thinking makes sense. Consider the following incremental improvements Apple has made to its iPhone: the 3G obviously improved upon the original iPhone's cellular network capabilities. The 3GS was faster and added a video camera, the 4 included retina display and a rear-facing camera, the 4S introduced Siri, an 8MP camera and 1080p video recording, and the 5 has a faster processor, bigger screen, turn-by-turn GPS navigation, a panoramic camera, and other improvements. Is there room to grow? Of course! The screen, camera, processor and operating system are continuously being incrementally improved upon each and every year. And the improvements are nothing to balk at; I remember just two years ago how much of a vast improvement the iPhone 4 was over the 3GS. I compared the two side by side. The difference in speed and screen resolution was amazing. Processor speed and connection speed are two improvements that seem to make leaps and bounds every year, irrespective of what Apple does or doesn't do. And we've really only seen the beginning of these technological improvements. How fast will connection speeds be in five years? How fast will smartphone processors be? Answer: a lot faster than they are now. Do you remember Edge? That was only five years ago. 'Nuff said. All Apple needs to do is make these small adjustments needed on the iPhone so that it benefits from the new technology the industry is experiencing, and it'll sell another 20-30 million units.

Again, this is not like trying to re-imagine the hotdog. Ten years from now, the hotdog will remain unchanged, while there is little doubt that the smartphone will be thinner, faster (both in processing speed and connection speeds), more intelligent, more useful, more ubiquitous and cheaper. Apple is positioned to garner more than its fair share of this growth coming from these technological improvements because it has the management team (not Steve Jobs, but Cook and several others have been there and gotten the T-shirt), the industry experience and know-how, the ecosystem (iTunes and App Store), the supply chain, the legally-protected intellectual property (as seen by the recent Samsung legal battle), the army of third-party app developers, and the cold, hard cash - probably around $130 billion right now, give or take $20 billion. Let's keep in mind that this mountain of cash can really come in handy and make up for any lack of mental ingenuity from Apple's headquarters now that Steve Jobs is gone. Case in point: Siri. Siri, Inc. started off as an app developer that made an app that was available for sale in the App Store. It was planning to develop apps for Blackberry and Android as well, but Apple liked the platform so much that the company acquired Siri in 2010. And the rest is history. Two points can be made here: 1) Apple had the cash to buy Siri. $130 billion can buy a lot more Siris. 2) The feedback loop mentioned earlier, which contains Apple on one end, manufacturing the device, and the app developers on the other end, creating better apps, was present here and working its magic. The fostered creativity between the two companies gave birth to Siri. And now we see Siri leveraged into the auto industry as a vehicle telematics solution in the near future. Who knows where she'll go next.

This type of creativity remains alive and well between Apple and its suppliers. Essentially, Apple has its own legion of companies trying to develop apps that make the iPhone better and better. There's no telling what the next big thing some app developer out there is creating right now that will be in iPhone 6 or beyond.

From the consumer's point of view, the iPhone will continue to be a success. Why? One word: subsidy. Because you and I and most other consumers pretty much expect to be tethered to a cell phone contract for the foreseeable future (if not a contract, at least a monthly payment plan), the subsidy model is protected for a while. I, like a lot of other smartphone users, am on a two-year contract with my wireless carrier. At the end of the two years, I look at my cellular plan and my smartphone needs (wants) and ask myself if the iPhone has been improved upon in the last two years enough to warrant a $199 purchase. For the last five years, the answer from most Apple customers has been a resounding yes. On top of that, because of the iPhone's quality and market value retention, you can sell your old iPhone on eBay (NASDAQ:EBAY) or directly to a host of other companies (GameStop (NYSE:GME), Gazelle, and even Apple itself) for a good portion of what you initially paid for it up front. This lessens the blow of a new purchase. Up till now, this value proposition has been a no-brainer for most people. For the consumer, it's a great deal because you can buy a brand new upgraded version for a subsidized cost of $199. For Apple, it's a great deal, because when you purchase your next phone, it gets the full $620 for it (from the cell phone company, that is). If, sometime in the future, the answer to this value proposition becomes a "No, it's not worth the $199," then waiting another year for the next iPhone upgrade is not a big deal. When the 4S was released last year, there were already articles out telling people to wait for the iPhone 5. So, this year, a lot of the people purchasing an iPhone 5 are upgrading from the 4 (released two years ago), or even the 3GS (released three years ago). Going from the 3GS to the 5 is like moving from a Mississippi trailer park to Martha's Vineyard (well maybe not quite, but you get the gist). So, what happens is you've got a wave of anywhere from two to four years of pent-up demand being unleashed on the market with every annual iPhone upgrade. And remember, Apple only has to come up with a portion of that innovation on its own, as already discussed.

One more point on the success of the iPhone and its future. There is a tidal wave of demand waiting in the wings in China, with 600 million China Mobile subscribers just waiting to get their hands on a version of the iPhone that is licensed for the China Mobile network. A China Mobile-approved iPhone has not yet been released, however, that event is expected any time now, and is on the radar screens of many Apple investors who consider this virtually untapped market the last geographic frontier for Apple's iPhone. The evidence of that demand is seen in the 15 million China Mobile subscribers who own iPhones, yet don't even have access to China Mobile's network. These users are perfectly happy using their Wifi connection, or slower 2G connections with unlocked iPhones. How much more utility will come to the user when 3G, or even 4G is enabled on a China Mobile-approved iPhone? Don't be surprised to see another wave of anywhere from 15-30 million units sold for that specific location when this happens.

As long as this catalyst remains untapped, the iPhone has an ace in the hole and the stock price has room to move. But even on the other side of a China Mobile announcement, Apple's iPhone should be well-protected from oncoming marauders by a deep moat of cash, patent protection, superior management, brand loyalty and collaborative innovation not only within the confines of Apple's Cupertino headquarters, but between its mutually beneficial relationships with its app developers and suppliers. Hopefully I'll have a chance soon to quantify what all this means for Apple, and its intrinsic valuation as a whole.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.