Apple: Market Share Is Key

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) is engaged in a bitter war for market share with a host of competitors including the hardware/software combination of Samsung (OTC:SSNLF)/Google (NASDAQ:GOOG), and Apple's old nemesis, Microsoft (NASDAQ:MSFT). It is possible, even likely, that a single major winner will emerge from this struggle. Victory for Apple means continued strong growth for many years and a rising stock price. Defeat means stagnation and a permanently reduced share price.

Apple has numerous advantages in this struggle and should easily dominate its competition. But Apple is burdened by a collection of corporate dogmas that may keep the company from deploying its advantages in an optimal fashion: Maintain high margins. Keep the number of products small. Offer few options. Make products lighter and thinner (and harder to manufacture) than the competition. And, most damaging of all, don't fret about market share, quality products will eventually win out.

These dogmas are the legacy of Apple's legendary founder, Steven Jobs and served Apple well in its decade long climb from also-ran to dominant tech company. Unfortunately for Apple this is a new day, a new set of circumstances, a new struggle. Were Jobs still alive he would probably adapt to the altered competitive landscape. But Jobs' legacy, his almost godlike status, and the effectiveness of Apple's strategy over the past decade might cause current Apple management to stay their present course and miss the vast opportunity which lays before them.

Before I explain why winning the market share war is so crucial to Apple's continuing success, and what the company must do to win this war, let's take a step back in time to the beginning of the 1980's.

Apple was an upstart company. The Apple II was the largest selling product in a nascent market. But not for long. In 1981 the dominant tech company of the time, IBM (NYSE:IBM), entered the fray with the IBM PC running Microsoft's MS-DOS operating system. Because IBM hurried their device to market it lacked a certain level of security and was easily copied. Soon a new company, Compaq, brought out a cheaper PC clone. Followed soon thereafter by other companies selling cheap PC clones, all running MS-DOS. Despite the launch of the superior Macintosh computer in 1984, Apple struggled to compete with the forces arrayed against them. Their walled garden approach, general hostility to third party applications and third party peripherals, IBM's market clout and Microsoft's deft maneuvering gradually pushed Apple to the sidelines during the historic growth spurt of the personal computer. By the early nineties the Mac had become a boutique product with a minuscule share of the vast and growing worldwide market for personal computers.

The ultimate winner of this war was neither IBM, Apple, Compaq nor other PC manufacturers. It was Microsoft, the owner of the PC operating system and beneficiary of a networking effect so powerful, that by the mid nineties Microsoft had become a virtual monopoly. Dubbed the 'evil empire', Microsoft had gained such a stranglehold on the personal computer business that governments stepped in to try to split up the company.

But nothing lasts forever. Jobs returned to Apple and led a renaissance, spearheaded by the disruptive iPod portable music player. It was a modest renaissance at first. Despite the so-called halo effect and the stylish iMac personal computer released in 1998, Apple made only modest headway in its primary business -- the selling of personal computers. Then around 2005, someone at Apple had a brilliant idea. An idea which ran counter to Apple corporate dogma, counter to the way the corporation had run its business for almost thirty years. The idea was simple. Something which Microsoft had understood from the beginning. Outside application developers are our friends, not our enemies.

Voila!! The App Store is born. The insanely wondrous iPod touch is released. The mobile revolution is about to begin and Microsoft's heretofore unbreakable monopoly about to be broken.

In 2007 the iPhone comes to market. In concert with the App Store and an enthusiastic, worldwide hurrah from the developer community, Apple's new product permanently and radically disrupts the mobile phone business. IOS Apps proliferate like snowflakes in a blizzard. The first iPad is released in 2010, sells like crazy and begins to replace PC's as the primary computer for a growing cohort of ordinary people. Soon PC sales begin to decline.

Like a Phoenix risen from the dead Apple is back and with a vengeance. But in some ways, it's the same old Apple. Willing to sacrifice market share for margin and some kind of holy grail of design excellence.

The exclusive iPhone deal Apple makes with AT&T leaves the door open for Google and their hastily concocted mobile operating system, Android. If Apple had been less greedy, willing to make a less favorable deal with both AT&T and Verizon, there probably would never have been an Android, and Apple would, today, probably be in complete control of both the smartphone and tablet business worldwide.

Instead Android becomes a lifeline to flailing mobile phone makers, and by the end of 2011 Android has overtaken IOS in mobile market share. Android devices, which most agree are inferior to their IOS counterparts, are marketed by many companies and fill many market niches which Apple leaves empty. No matter how much Apple and its adoring fans go on about the superiority of Apple products, there are many folks who simply like the larger screens of Samsung's Galaxy series, and many, many, many folks who can't afford Apple's products, especially in markets where no carrier subsidy is offered.

Today the combined market for computer devices (servers, desktops, laptops, tablets, smart phones and, increasingly, TV's and automobile user interfaces) is fragmented among operating systems. Windows, Linux, Android, IOS and Mac OS divide up most of it. Microsoft's share is slowly shrinking. Android's growing rapidly while Apple's share is holding steady. Of all the players Apple is clearly best positioned to gain the kind of operating system dominance Microsoft enjoyed for twenty years. But Apple is also in danger of losing the market share war by continuing to fight the previous war.

Why does this matter? Apple continues earn the lion's share of profit in the mobile space, even as Android takes market share. Macs continue to take market share from PC's. The prospects for iTV's, iWatches and maybe even iCars seem bright. What could be the problem?

There are two primary reasons why market share is crucial. First, because eco-systems are sticky. If someone starts out as an Android user it is not easy to switch them to IOS. If someone starts out an IOS user it is even more difficult to get them to switch to Android. So it is critically important to get new users corralled into one's eco-system. Second application developers are in business to make money. At the moment developers still favor IOS, even with Android's larger market share, because of a variety of well documented factors. But if the seesaw tilts further it might be a different story. If Android gains, say, a 60% share while IOS has only a 15% share, many developers will create apps for Android first with IOS being an afterthought. Once that starts to happen IOS market share may decline further as Android will have the newer and cooler apps, causeing more developers to favor Android which will cause Apple's market share to decline further and so forth. This is known as a networking effect and at some point this networking effect may seriously impact Apple's growth and profitability unless current trends are reversed.

So there is a war for market share. Apple is losing, or at best holding its own. There are networking effects at work which may accelerate Android's market share gains. Fortunately, if you are an Apple shareholder, the company has more than enough firepower to dominate its competition, if they have the will and the wit to use their advantages in time:

  1. One hundred and thirty seven billion dollars in the bank.
  2. Worldwide brand power.
  3. Full integration of hardware, software, cloud services and app/iTunes store creates a stronger, stickier and more powerful eco-system.
  4. Unparalleled customer service.
  5. Tremendous customer loyalty.
  6. Full line of products including laptops and desktops.
  7. Possibility of new disruptive, innovative products.
  8. Significant price advantage based on:
    • Supply chain strength.
    • Full integration of software and hardware.
    • The inherent efficiency of IOS when compared to Android. Android/Java use of virtual machines and interpreted (rather than compiled into machine) code, forces hardware built around Android to incorporate faster, more expensive and more power hungry processors to run the same apps as efficiently as IOS runs them on cheaper hardware.

Unfortunately for Apple shareholders, winning the market share war is not a sure thing. Many of the steps which need to be taken run counter to Apple's corporate DNA. Time is running short. If Android market share grows much larger, the advantages Apple now enjoys may not make much difference.

What does Apple needs to do to win the market share war and grow and prosper on into the indefinite future?

  1. Build a cheaper iPhone. Soon. Perhaps in the $300 price range. Without this product the game is likely lost.
  2. Build a Phablet -- a phone larger than the current iPhone but smaller than the iPad mini. Folks love the larger screen. Sometimes you have to cater to the market rather than make the market cater to you -- even if you are Apple.
  3. Sign a deal with China Mobile. Don't hold out for the best possible terms. The time is now. If you have to give in a bit on subsidy, do it.
  4. Ensure that all Apple products come with a full complement of options. Including (oh blasphemy, blasphemy) a keyboard option for the tablets.
  5. Lower prices. Forgo some margin to gain market share. Apple can afford to make less money. Hell, they can afford to make no money for the next five years. Wall Street will understand. Or if they don't who cares? The game is not won or lost in next quarters earnings report.
  6. Advertise. Advertise. Advertise. $137 billion buys an awful lot of media space. The great Samsung commercial from the fall with the cool kids touching phones, watching the posers waiting in line for the iPhone 5 was probably the single biggest negative for Apple through all the negativity of the past few months. Apple needs to regain the initiative. It needs to use some of its absurdly large war chest to blanket the world's media with ads. Perhaps Apple needs a better ad agency. Perhaps Apple needs to steal Samsung's. Imagine if Coke had $137 billion in the bank and Pepsi was kicking its butt in the PR war. What would Coke do?

What might happen if Apple does none of the above, or takes years to fill the empty product niches? Android will continue to collect the lion's share of new users, especially in less developed countries. Little by little developers will begin to favor Android. A killer, "must have" app or two or three or four will only be available on Android. Causing many folks to switch from IOS to Android. Android will start to gain market share in developed countries. Microsoft will hold its own in the traditional PC business as Apple refuses to lower prices on laptops. By 2015 or 2016 Apple's sales will begin to decline and the stock price head to $300 or lower.

What might happen if Apple quickly comes out with a cheap iPhone, a phablet, lowers prices all around by 20 or 30% and advertises like crazy? Apple will begin to overwhelm Android in developed markets and gain its share of new customers in developing markets, especially China and India. Developers will favor IOS even more than they do now, with many ceasing to bother at all about Android, which will rapidly increase IOS lead in quality apps. By 2015 Android will start to lose market share everywhere. Price competitive Macs will eat into Microsoft's domination of the PC business. By 2017 Windows will have become mostly a legacy system and Android will be headed for the dustbin of history. By 2019 Apple will totally dominate the computer device industry and it's market cap might well be approaching 2 trillion dollars.

The spoils of victory are immense, but the clock is ticking. Apple needs to begin fighting the current war of market share, rather than worrying about the last war of design excellence and profit margin, or be doomed to stagnant sales and a perpetually depressed stock price.

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.

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