Why Apple Is Ready For the Future
Trouble in China ≠ Trouble With Apple
For the first time in years, the media narrative might actually be true: Apple is having some real trouble. Well, not “real trouble” in absolute terms, considering that Apple has more cash on hand than Amazon, Microsoft, and Google combined. But after Apple released an unusual letter to investors downgrading their expected earnings for the 4th quarter of 2018 from $89-$93 billion to $84 billion due to lower than expected iPhone sales, the “Apple is doomed” crowd finally has proof from Apple itself that the gravy train might be off the tracks. After all, if iPhone growth has stopped, Apple’s overall growth — as well as its dominance in the tech world — has surely stopped along with it.
And Apple is definitely facing some serious obstacles. In their downgraded earnings estimate to investors, Apple cited low iPhone adoption in China as a major reason why they would miss their original 2018 4th quarter estimates. This should come as no surprise considering Trump’s idiotic trade war, which threatens Apple both through tariffs on its products manufactured in China as well as from the effects of China’s slowing economy, which makes a pricey smartphone a lot less attractive. In addition, the nationalist dimension of Trump’s trade war has made Chinese consumers feel that buying a smartphone from Chinese competitors like Huawei, Vivo, or Oppo is an act of patriotism, especially with the recent arrest of Huawei’s CFO in Canada at America’s behest.
But as a longtime Apple watcher and shareholder, I don’t feel that Apple’s troubles in China mean that the company is in a major decline. I haven’t sold any of my AAPL stock, and even bought some more (though I wish I’d waited until the stock’s price had fully bottomed out). That’s because even if we’ve reached peak iPhone, I firmly believe that Apple is ready and well-positioned for the future. Here’s why.
Apple Is More Than the iPhone
Before the iPhone, the iPod was Apple’s dominating product and the source of the vast majority of its profits. During that time, people spoke of the “halo” effect, where people’s fondness for their iPods and its terrific user experience made them more open to and likely to buy a Macintosh. The same “halo” happened with the iPhone, and was strengthened by the fact that iPhones and Macs truly worked in conjunction with each other by (mostly) seamlessly syncing photos, music, messages, contacts, etc. over the air.
During the iPod era and the early years of the iPhone, the halo effect could really only extend to buying a Mac. These days, the iPhone’s halo makes you more likely to not only buy a Mac, but AirPods, an iPad, an Apple TV, Beats headphones, or an Apple Watch, as well as services like Apple Music, iCloud, and maybe an AppleCare plan to insure your investments. That’s why the current mix for Apple’s revenue as of November 2018 looks like this.
The iPhone is still dominant, but less so than it’s been in past years, especially as the Services (Apple Music, iCloud, AppleCare) and Other (AirPods, Apple Watch, etc.) categories continue to show strong growth, providing evidence that they will likely be a major source of Apple’s future growth even as the iPhone market reaches saturation (when virtually everyone who wants an iPhone has one) and sales of new iPhones remain flat. There are hundreds of millions of iPhone users in the world, but many of those users don’t own other Apple products, and even fewer pay for services like Apple Music or iCloud.
If Apple was a pyramid, iPhones would make up the base. While that base might not be getting any wider, Apple’s brand loyalty means that it isn’t shrinking. Meanwhile, the height of that pyramid — which is comprised of more and more Apple hardware products and services — is getting taller. The pyramid is still gaining volume.
Perhaps a better analogy is the Brad Pitt/Jonah Hill baseball movie Moneyball. In the film, the Oakland A’s lose their best player Jason Giambi to the New York Yankees, who offer him a contract way beyond the budget of the small-market A’s. So instead of pining for a star player of Giambi’s skill who the A’s could never afford, the team uses advanced statistical analysis to find and sign several lower-priced players who can make up Giambi’s most important stats — how often he gets on base and drives home runs — in the aggregate instead of trying to find one player who can do it all. In the case of Apple, the growth in iPhone profits/revenue is Giambi, and the players replacing him are the other non-iPhone Apple products and services that must make up iPhone growth between them if Apple is to keep growing.
Apple Already Has the Next Big Thing(s)
For better and for worse, Apple more than any other company has been saddled with the expectation and responsibility of bringing the world “the next big thing” when it comes to technology. And not for nothing — they pioneered personal computers with the Macintosh, revolutionized music with the iPod and the iTunes Store, and brought the internet to our pockets with the iPhone and App Store. But with the rise of the smartphone seemingly being a once-in-a-lifetime phenomenon, and with iPhone sales plateauing, what Apple device(s) will define the post-smartphone era?
In my opinion, they’ve already unveiled a big one: the Apple Watch.
Over the past few years, I’ve been amazed not only by how many people I see wearing Apple Watches — a product the tech press repeatedly tells us no one really needs — but also the kinds of people I see wearing them. While it’s not surprising to see techies and affluent people wearing a watch costing over $250, I also see tons of Apple Watches on the wrists of waiters, bartenders, groundskeepers, baristas, nurses, teachers, construction workers, store clerks, and a wide range of what I’d consider to be regular, average people who probably don’t have a lot of disposable income to spare on a pricey watch that will be outdated in a handful of years.
But as Quartz reporter Mike Murphy found by talking to a wide range of workers, the reason for this broad appeal is quite simple: for people who can’t be checking their phones while at work, the Apple Watch ensures that they don’t miss important notifications. The Watch has become indispensable to people who want to stay connected to friends and family while on the job, and with tens of millions of Americans working in the service, wholesale, and retail industries, that’s a huge market to tap. Another large demographic the Apple Watch appeals to is people who want to be healthier and lose weight, including the roughly 160 million Americans who are either overweight or obese. The Apple Watch has proven to be an exceptionally effective fitness tracker and coach — just Google “Apple Watch weight loss success stories” or search #CloseYourRings on Twitter for tons of anecdotal evidence.
By appealing to both of these demographics, Apple has managed to become the number one watchmaker in the world despite having entered the market just four years ago, selling more watches than all of the Swiss watchmakers combined. That’s an incredible accomplishment, but I feel that the story of the Apple Watch is just getting started. As I wrote in my post “With Series 4, the Apple Watch Era Begins”, the Apple Watch is quickly gaining momentum and seems to be on the brink of an explosion in terms of interest and sales, with hundreds of millions of iPhone users around the world as potential customers. Apple has reported impressive double-digit growth for each of the Apple Watch’s first three years, and I have a feeling that that growth is only going to accelerate.
Going forward, a huge engine for future Watch growth is in the related areas of health and safety. In fact, talking about Apple’s desire to enter the healthcare market, Apple CEO Tim Cook has said that the trillions spent on healthcare “may even make the smartphone market look small,” and that “in the future, you will answer that question: Apple’s most important contribution to mankind has been in health.” The Apple Watch, along with first- and third-party apps, will surely be what makes all this possible. Already, some health insurance companies are now subsidizing the cost of Watches for their customers, betting that it will make them healthier and, therefore, less in need of expensive procedures and medications. Apple is also currently in talks with private Medicare plans to help get Watches on the wrists of senior citizens, who have the most to benefit from continuous health monitoring. After all, just one trip to the emergency room could cost as much as hundreds of Watches.
While having health insurers buying Apple Watches by the crate is obviously great news for Apple, what’s even more interesting is how it indicates that the future of healthcare may already be upon us. Ever since it debuted, stories have emerged about people who have had their lives saved by their Apple Watches. In addition to being used during emergencies to call for help when a person’s iPhone is out of reach, the Watch alerts users when they have a dangerously elevated heart rate when they appear to be inactive, calling attention to previously undetected heart issues that could prove fatal.
The Series 4 Watch introduced the capability to take an electrocardiogram (ECG) which is able to detect signs of atrial fibrillation, a first for a mainstream consumer device, and stories about this new function saving lives are already being reported. And with a new accelerometer also introduced in the Series 4, the Watch can now detect if wearers have taken a hard fall and will automatically contact emergency services if the wearer is unresponsive. While a high-tech gadget like the Apple Watch seems like something that would be aimed at a younger and more tech-savvy demographic, a common sentiment from many journalists reviewing the Series 4 was that it was a product they could imagine buying for a parent or grandparent because of these new health features.
This is new territory for over-the-counter electronic devices, but it’s an area Apple has been moving towards for years, and it certainly feels like the future. I predict that in the next few years, wearable health sensors will become commonplace, especially for senior citizens and people with chronic health problems. And before too long, we will wonder how we ever got by without wearable devices that continuously monitored various aspects of our health, can call for help or alert family members in case of an emergency, and can provide doctors with a more accurate picture of how sick or healthy we actually are without using unreliable self-reporting. These sensors may someday be viewed in the same way we now see car seatbelts or helmets for motorcyclists — something you hopefully won’t ever need, but that is so life-saving when you do need one that there’s no good reason to go without it.
An Apple Watch (or band) that can continuously and non-invasively monitor glucose levels without needle sticks would be life-changing for the over 370 million people in the world with diabetes, especially the 187 million who don’t even know they have it. Imagine if the Watch could notify a person that the discomfort they are feeling in their chest isn’t acid reflux, but an impending heart attack, or warn a person with epilepsy that they are going to have a seizure in two minutes, giving them enough time to pull their car over or lay down on the ground to avoid a fall. When Apple unveiled the Series 4 Apple Watch, the fact that it had an FDA-cleared ECG came as a complete surprise and was beyond what most had thought a wrist-worn wearable was capable of. With the Watch still a relatively young device that is just hitting its stride, who knows what other surprises might be in store that could make the Watch even more indispensable? Something that can save or extend your life is the ultimate killer app, and the fact that Apple has such a strong stance on privacy while controlling both their hardware and software means that they will likely be more trusted and capable than other tech companies attempting to enter the healthcare market.
In addition, the smartwatch category is one that Apple essentially has to itself, capturing over 60% of the smartwatch market with nearly five times the market share of its nearest rival. While Apple has had four years to refine watchOS, redesign its case, build ever more powerful and efficient system-in-packages (SiP), and support a large ecosystem of watchbands for any occasion, Apple’s competitors are struggling to formulate a strategy and identity (Samsung), are waiting for up-to-date Qualcomm chips to power their hardware, are struggling to survive (FitBit), or are still trying to figure out what to call themselves (Google/Android). While the other companies are trying to put their shoes on, Apple is already running the marathon, and have even built a state-of-the-art fitness lab to analyze the results.
And speaking of wearables and health sensors, Apple also has the AirPods, perhaps the best first-generation product Apple has ever made which continues to be a runaway hit. On a recent trip to Chicago, I honestly saw more people wearing $159 AirPods than Apple’s free wired EarPods. In 2018, Cook revealed that its wearables category — comprised of Apple Watch, Beats headphones, and AirPods — is now the size of a Fortune 300 company. Patents Apple has filed show that future AirPods might have their own health sensors embedded within them, making them another possible piece in Apple’s health monitoring puzzle.
With hit businesses like wearables and services that still have plenty of room to grow and innovate, Apple just needs to execute and improve on products it already offers instead of betting their future on a product that doesn’t yet exist. But that doesn’t mean that another Next Big Thing isn’t being prototyped in Jony Ive’s design studio right now.
And if Apple’s bad luck continues, they still have well over $200 billion in cash they can tap into. If they get desperate enough, they can use this cash to buy themselves time, take chances, acquire companies and top talent, or make investments that might take years to pay off, or that simply add value to other products. The easiest way to make money is to have a lot of it, and Apple has plenty to get them through any rocky times.
Apple Is Not Like the Rest of FAANG
Part of the decline in Apple’s share price has followed an overall slump in the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) that have been a major success story in the stock market for the past few years. As the thinking goes, if the biggest players in tech are having trouble, why wouldn’t Apple (as the biggest one) be the same? However, this thinking totally overlooks the reasons why the FAANG stocks are in decline, and why Apple doesn’t suffer from the same issues afflicting them.
The crises Facebook and Google are facing are directly linked to their core business: collecting as much data about its users as possible and selling it to advertisers and, it seems, anyone else willing to pay for it. This has shed an unflattering light on the vast amounts of information these companies are able to collect on their users, often without their knowledge or permission, and the detailed profiles they are able to create about you, your habits, and even your location at any given moment. As users learn more about how this information can be used, abused, or left unprotected for hackers to exploit, the anger and mistrust towards these companies has grown exponentially.
However, this is not something Google and Facebook can easily change since obtaining and selling user data is at the heart of their ad-centered business models. The real paying customers for these companies aren’t the people who use “free” services like Gmail or Messenger — it’s the advertisers and others who pay Google and Facebook for those people’s data, the more detailed the better. But the more targeted these advertisements become based on our personal information, the more creepy, invasive, and unsettling they feel. People are becoming more worried about their digital privacy, and not only are Facebook and Google unable to provide that privacy, they are the main entities trying to take it away.
There are also the issues of Google and Facebook being used as propagators and amplifiers of propaganda, misinformation, harassment, and hate speech due to their reliance on algorithms. This causes a censorship/curation problem neither company seems able or willing to solve, aside from apologies, admissions that this is indeed a difficult problem, and vague assurances that artificial intelligence and machine learning will somehow figure it out. But even if they are able to do this, it may reduce the use of services which Facebook and Google need if they want to grow and collect more user data, as well as advertising dollars from companies who want to advertise to these users, no matter how unsavory they might be. It’s one reason why Facebook was so slow and reluctant to act on Russian pro-Trump propagandists — they paid for ads and increased user engagement. Add to this the recent scandal and worker walkout over Google rewarding and protecting former executives accused of sexual misconduct, and both companies appear to have culture problems that extend all the way to the executive suites.
Meanwhile, Apple has made protecting user privacy a key selling point and differentiator, even defying the FBI and the US government over their calls for Apple to weaken encryption and build backdoors into their operating systems for law enforcement. Apple’s pro-privacy stance comes easily for them because harvesting and selling user data has never been part of their business model, making it unnecessary and possibly risky for them to gather and store more user data than they absolutely need. And since Apple doesn’t do search or manage a social network, they don’t have to worry about policing bad actors or people scamming their algorithms. Their executives have also stayed notably scandal-free.
Netflix, which continues to bleed money despite its growth and popularity, is also facing existential threats that they may be unable to avoid. Their most-watched programming is made up of movies and TV shows that Netflix doesn’t own and must lease from other companies who increasingly see Netflix as a competitor. This is why Netflix was forced to pay a staggering $100 million to WarnerMedia for the rights to stream the TV show Friends for just a single year. As Netflix’s second most popular offering, they couldn’t afford to lose it and had little to bargain with.
Studios and major content owners who are planning to start their own competing streaming services — which is basically all of them — have even more reason not to lease their most popular properties to Netflix, or at least force Netflix to pay out the nose for them. The Office is the most-watched show on Netflix, and in a recent interview with Deadline, NBCUniversal CEO Steve Burke said it was a “safe assumption” that they would try to take The Office back for the streaming service they plan to launch in 2020. Netflix is currently streaming popular Marvel/Disney movies like Black Panther, the Avengers: Infinity War, and Guardians of the Galaxy Vol. 2. But with Disney planning to launch its own streaming service in 2019, they are incentivized to pull these films from Netflix so Disney can say that their service is the only place where you can stream Marvel movies, as well as anything made by Disney or 20th Century Fox. Netflix’s loss will be Disney’s gain unless Netflix ponies up vast sums of money to stream Disney’s content, which is still a win for Disney. Netflix is feverishly trying to develop and produce its own must-see content that they can own in perpetuity and would only be viewable on Netflix, but could Netflix really survive as a streaming service if it only hosted Netflix-produced content?
On the other hand, the problems Apple is facing have nothing to do with their business model and identity as a company that makes high-end hardware bolstered by its own software, services, and best-in-class customer support. The saturation and maturation of the smartphone market, the lengthening of the smartphone replacement cycle, China’s economic slowdown, and Chinese customers opting for cheaper phones from Chinese vendors won’t change who Apple is, won’t stop them from selling tens of millions of iPhones a year, and are bound to be equally or more harmful to other smartphone makers that don’t enjoy Apple’s sky-high customer loyalty and ecosystem lock-in. Apple is adjusting their mix of profit generators by leaning more on services and other product categories, are offering more incentives to encourage people to upgrade their iPhones sooner, and are probably taking another look at their iPhone pricing strategy, but none of these things require abandoning their current business model or reinventing their identity.
Apple nearly went under in 1997, outsold by cheap Windows PCs on one end and wasting money on a bloated lineup of failing products on the other. With the return of a chastened and more mature Steve Jobs, Apple tightened its belt, refocused on a dramatically reduced set of products, and embarked on perhaps the greatest corporate comeback in the history of business, creating, reinventing, and decimating dozens of industries along the way. But during that whole time, there were always journalists, analysts, and competitors predicting their demise. Something was always evidence that Apple was “doomed”, some product was always poised to be the iPod or iPhone “killer”, and Apple would always be lost without their visionary leader, doomed to repeatedly commit supposedly fatal errors that would “never happen under Steve Jobs”. But every year, Apple’s revenue and profits smashed records, leaving the prognosticators quietly scratching their heads until their next set of doomsday predictions.
Apple learned a lot from that near-death experience, and having truly faced their own mortality, have taken steps to make sure it won’t happen again by socking away cash and diversifying their portfolio in preparation for the end of the iPhone’s explosive growth. And having proven every naysayer wrong for decades, they know that now is not the time to start believing them. Apple just needs to keep doing what they’ve done ever since their renaissance began. Focus on the user experience. Block out the noise. Make great products that improve users’ lives. Sweat the details. Care.
The rest will take care of itself.
