Earlier this week I wrote about the psychological challenges that Apple shareholders face. I also discussed the evolution of Apple’s “i” gadgets — the iPod, iPhone and iPad — and how they have created an ecosystem unlike those of other technology companies.
Apple’s ecosystem is an important and durable competitive advantage; it creates a tangible switching cost (or, an inconvenience) after Apple has locked you into the i-ecosystem. It takes time to build an ecosystem that consists of speakers and accessories that will connect only via Apple systems: Apple TV, which easily recreates an iPhone or iPad screen on a TV set; the music collection on iTunes (competition from Spotify and Google Play lessens this advantage); a multitude of great apps (in all honesty, gaming apps have a half-life of only a few weeks, but productivity apps and my $60 TomTom GPS have a much longer half-life); and, last, the underrated Photo Stream, a feature in iOS 6 that allows you to share photos with your close friends and relatives with incredible ease. My family and friends share pictures from our daily lives (kids growing up, ski trips, get-togethers), but that, of course, only works when we’re all on Apple products.(This is why Facebook bought Instagram for $1 billion. Photo Stream is a real competitive threat to Facebook, especially if you want to share pictures with a limited group of close friends.)
The i-ecosystem makes switching from the iPhone to a competitor’s device an unpleasant undertaking, something you won’t do unless you are really significantly dissatisfied with your i-device (or you are simply very bored). How much extra are you willing to pay for your Apple goodies? Brand is more than just prestige; it is the amalgamation of intangible things like perceptions and tangible things like getting incredible phone and e-mail customer service (I’ve been blown away by how great it is!) or having your problems resolved by a genius at the Apple store.
Of course, as the phone and tablet categories mature, Apple’s hardware premium will deflate and its margins will decline. The only question is, by how much? Let me try to answer that.
From 2003 to 2012, Apple’s net margins rose from 1.1 per cent to 25 per cent. In 2003 they were too low; today they are too high. Let’s look at why the margins went up. Gross margins increased from 27.5 per cent to 44 per cent: Apple is making 16.5 cents more for every dollar of product sold today than it did in 2001. Looking back at Nokia Corp. in its heyday, in 2003 the Finnish cell phone maker was able to command a 41.5 per cent margin, which has gradually drifted down to 28 per cent. Today, Nokia is Microsoft’s bitch, completely dependent on the success of the Windows operating system, which is far from certain. Nokia is a sorry shell of what used to be a great company, while Apple, despite its universal hatred by growth managers, is still, well, Apple. Its gross margins will decline, but they won’t approach those of 2003 or Nokia’s current level.