Saturday, June 16, 2012

5 Worrying Signs For Apple

Volume 4 Issue 25: Intelligent Investing

I am not an extreme tech enthusiast. Far from it. The Worldwide Developers Conference, or better known as the WWDC, is Apple’s annual event where they launch their new gadgets, or software and fun stuff like that. But based on yesterday’s news from the WWDC, I see a big sign of worry for Apple. Especially if you are an Apple investor.

As I said, I am not a techie. So if you were to ask me to discern the functionality of the iOS 6 vs the Android Ice Cream Sandwich, the best thing that I can probably tell you is that Ice Cream Sandwich has a far more enticing name.

But I pride myself in spotting macro-trends and here are 5 worrying signs for Apple as I see it:

1. Android x (Samsung + HTC)

As recently as three years ago, there was no serious competitor in sight to Apple’s iPhone 3 and 3GS. I am a (very unproud)owner of an iPhone 3GS and the only reason I got it was because there were no close substitutes to a web-capable mobile phone.

In 2009, Google tried their hand with the NexusOne and the reception was lukewarm at best. Google fanboys swarmed to it but Apple was still the king of pop when it came to “coolness”. Apple definitely got it right with ads like these:

Fastforward to 2012. Apple is no longer just up against the likes of Nokia, or Google’s half-hearted attempt at a smartphone. Samsung and HTC have combined powers with Google and have proven to be more than a challenge to Apple’s throne in the smartphone arena.

It is easy to see why. When you are the market leader, you can be certain that every one will be gunning for your back. And technology is one of the most competitive and fast-changing industries. Case in point: Nokia’s “demise” in the smartphone industry.

In fact, it is arguable that Samsung has definitely arrived at the “coolness” stage. The Galaxy S2, the Galaxy Note, the Galaxy Nexus, and most recently, the Galaxy S3 are more than serious challengers to Apple's iPhones. How do I know this is a legitimate challenge? This brings us to point No. 2.

2. Patent suits

The amount of lawsuits filed by Apple against Samsung just keeps increasing. While others may see this as a sign that Samsung "copied" Apple, I see this as Samsung is legitimately challenging Apple. Why else would Apple take Samsung to court over the most frivolous of disputes. How frivolous? Here are some samples:
a) A spokesman for Apple told Mobilized the Galaxy line infringes the 'Trade Dress' of the iPhone and iPad by using a rectangular design with rounded edges. Apple notes the black borders that adorn the Galaxy Tab are similar to those on the iPad.
b) They also believe Samsung has copied the use of small square app icons.
c) Even the slide-to-unlock feature that was first seen on a Nokia was disputed. 
After all, you could find thousands of other copycats out there, especially in China. Even Malaysia is getting on the tablet wagon with its 1Malaysia Tablet. The reason Apple has singled out Samsung is plain and simple. It is the biggest challenger and Apple is trying to take them out of the game. Being the cynic that I am, I think the main purpose is just to delay the launch of Samsung's products so that they can catch up. Yes, you heard me right. Apple is playing catch up right now. Samsung has come up with product after product with almost no real answer from apple after the iPhone 4.

3. No New Products?!

This one is sure to strike a chord with Apple fanboys. I am claiming that Apple has not launched anything revolutionary since the iPhone 4 and iPad 2. Since those two products, Apple has come up with the iPhone 4S and the "new" iPad. The iPhone 4S is just a souped up version of the iPhone 4 and is far from game-changing. It saw the introduction of Siri, which is more of a gimmick that has an entertainment value of two weeks or so, than an actual game-changer. There is great potential for voice-command, but more still needs to be done. The 3rd generation iPad, also called "the new iPad", is also just a souped up version of the previous iPads. There was nothing "gotta-have-it" about the new iPad. One has to question, did all of Apple's creativity move on to the next world with Steve Jobs?

The latest WWDC was again a let-down of sorts. While Apple is best known for its secret-keeping, the delay of the iPhone 5 hints of Apple's impotence in trying to catch up with Samsung. They took a look at the S3 and was like, "Holy Crap!". So it is back to the drawing boards for Jonathan Ive and his team of designers. The best they could come up with at the WWDC was, "We are going to upgrade the Macbook Pro" and "We will have our own version of Apple maps, but our web-based version will link you to Google Maps". By the time they come up with the Galaxy S3 beater, Samsung would be ready to launch their next Apple killer. The iPhone 5 is probably the last bet for Apple to flex its muscle. Without any game-changer ala Jobs, it does not bode well for Apple's future.

4. Cracking China

With 1.3 billion people in China with an increasingly bulging middle class, it is already a given that China is THE consumer market. All the big brands in all industries like BMW, Volkswagen, Adidas, Nike, Louis Vuitton, Hermes and Gucci want a piece of that Chinese pancake. But Apple finds itself a stranger in a country where imitation is free game. Apple has to come to terms with the fact that as soon as they launch a new product, some smart Chinese dude is going to get his hands on one, crack it open, reverse engineer the product and launch a rip-off that is half the price of Apple's product. And point No. 5 shows why this is a huge problem.

5. Fat Margins

One of the main reasons why ripping off Apple's products is a viable business is simply because Apple prides itself in charging fat profit margins. This is probably Apple's best non-kept secret. In the given link, page 43 of Apple's 2011 annual report (Form 10-K) shows that Apple's gross profit margin is over 40% while its net profit margin is about 24%. While most people may be OK with paying Apple that kind of premium, but economics dictate that such profit margins WILL be challenged. Samsung will continue to launch cheaper and arguably better products with HTC not far behind.

In an oligopolistic market, Apple is unlikely to descend into an all-out price war with the other two Asian upstarts. This partially explains why it needs to go through the patent-trolling route. It is fighting to separate itself from Samsung and HTC products as much as possible, to generate what economists call "perceived differentiation" so that it can continue to charge the fat margins that it has been charging all this while. Given the lucrativeness of this smartphone and tablet business, you can count on the fact that the competition is not going away. To be able to keep charging the premium that it has been charging, Apple needs to come out with equally deserving products. The iPhone 4S and the "new" iPad isn't going to cut it.