Apple (AAPL)

TOP CONTRIBUTORS

Jane Jiang

Matthew Martos

William Papolis

Apple (NASDAQ:AAPL) designs, manufactures, and markets smart personal devices addressing the consumer electronics space through its online stores, its retail stores, its direct sales force, and third-party wholesalers, resellers, and value-added resellers. The company's products include the Macintosh (Mac) family of personal computers, the iconic iPod portable music player, the iPhone, and, the iPad. Additionally, Apple sells a variety accessories and peripherals including application software, printers, storage devices, speakers, and headphones^[1]. Under the leadership of Steve Jobs, Apple's co-founder who returned to head the company in 1996, Apple has demonstrated considerable acumen in implementing high-technology in product design and marketing, generating sustained enthusiasm and substantial growth.

Business Overview

[These first two paragraphs need updating - it appears to be from 2008 - two years is infinity in the Apple investment years] In the past several years, Apple has been at the forefront of innovation within consumer electronics, launching key products geared towards the high-end mobile market (the iPhone) and the home entertainment industry (Apple TV). On June 9, 2008, Apple announced the iPhone 3G, which featured increased speed, improved design, and lower pricing (although the sole US network provider, AT&T, absorbed any savings with increases in subscriber prices over the two-year contract). The iPod has grown faster than any other music player in consumer electronics history, accounting for half of the compm the sales of hardware and content. Its rising brand equity has generated a "halo effect" contributing to increases in sales of Mac desktops and laptops and the opportunity to penetrate existing markets. In fact, its popularity among consumers has turned the tech company into one of the highest revenue per square foot retailers in the world.

Unlike many other technology companies, Apple has historically not evinced as strong a commitment to increasing its presence abroad. The Americas has accounted for a hefty 48% of total revenues, while Europe rings in second, contributing just 21%. Apple is especially weak in Asia, where its Japanese revenues have dropped 10% from 4Q06 levels (the rest of Apple's Asia/Pacific sales have grown by a few percentage points.) However, strong revenue growth in Apple's retail division (nearly 42%) and its iPhone partnerships with wireless telecoms around the world offsets this imbalance and provides a framework for growing the company's worldwide presence in the future. The company's success in the mobile phone and personal media player markets may carry over into other consumer devices, with the company using its brand to gain significant market share.

Business and Financial Metrics

Apple reported $15.7 billion in revenue in 3Q10, a 61% increase over the previous year's quarter, as well as a 78% surge in its quarterly profit, buoyed by strong iPad and iPhone 4 demand^[2]. The company reported that the iPhone 4's antenna problems, a highly publicized signal algorithm glitch on the device, did not have a significant impact on demand. Additionally, it stated that the newly-released iPad, thought of as an ancillary competitor to the Macintosh computer, did not result in cannibalization, as Mac sales rose 33% quarter-over-quarter^[2].

In this quarter, Apple sold 3.47 million Macintosh computers (33% QoQ increase), 8.4 million iPhones (61% QoQ increase), 9.41 million iPods(8% QoQ decline), and 3.27 million iPads^[3]. As of late, there has been speculation that Apple's exclusivity contract with AT&T is set to expire, which would bode well for Apple as it would be allow for a more flexible distribution network and new agreements with other wireless carriers. On June 29, 2010, Bloomberg reported that two insiders disclosed non-public information that Verizon Wireless would start selling Apple's IPhone on January 2011^[4].

Perhaps the most noteworthy figure in Apple's financials is its cash balance, with cash and cash equivalents standing at more than $51 billion as of January 2011^[5]. CEO Steve Jobs has said that this cash would not be used to buy back stock or pay a dividend, but for potential future acquisitions without the need for outside financing. These vaults of cash have allowed the company to embark on an acquisition spree, which includes online music service company Lala Media in December 2009, followed a month later by the purchase of mobile advertising player Quattro Wireless ^[6].

Business Segments and Product Portfolio

After a decade of stagnant sales at Apple, co-founder Steve Jobs returned as CEO in 1997 and began a period of reinvention, resulting in the release of several highly innovative products, notably the all-in-one iMac PC (1998) and the iPod (2001). An aggressive subsequent advertising campaign put Apple squarely into the public eye, and today Apple remains known for its catchy, clever ads.

• Mac Hardware Products

Macintosh (Mac) brand desktops, laptops and related hardware/software are traditional mainstays of Apple's business. Mac hardware products include the iMac, MacBook and MacBook Air notebook computers, and a number of peripherals. Its software offerings include its OS X operating system, built on top of a UNIX-based platform which can also be directly accessed. OS X is known for its ease of use and sleek, intuitive design. In January 2011, Apple introduced the Mac App Store, releasing more than a thousand applications suited for Mac products^[8].

• Music Products and Services

Apple's music offerings include the iPod and its variations (i.e., Nano, Shuffle, Touch) as well as the iTunes media player and distribution system. iTunes has been a great success for Apple, controlling 70% of the online music market and boasting more than 160 million accounts tied to credit cards as of September 2010^[9][10]. In its tenth iteration of the ITunes media player, Apple embedded a social network titled Ping, the company's first attempt at leveraging its content to enter the social networking space^[11]. Ping had over a million registered users within two days of its release^[9].

• iPhone

Apple launched its iPhone in June 2007. Touted as a device converging communications and media playback, the iPhone combines EDGE mobile technology, a touch-screen system, wireless Internet browsing capability, and iPod functionality. Three models have been launched since its original debut: the iPhone 3G, the iPhone 3GS, and most recently, the iPhone 4. The performance of each release highlights the brand loyalty of iPhone users and the quality of the phone: Piper Jaffray estimates that 77% of iPhone 4 purchasers were previous iPhone owners, compared to 56% and 38% for the 3G S and 3G, respectively^[12].

The new iPhone 4 is powered by Apple's iOS 4 operating system, and features many improvements over the iPhone 3GS. Since its release in June 2010, it sold over 1.7 million iPhone 4 handsets within the first three days of its release, powered by a preorder count that grew tenfold from that of the iPhone 3GS^[13]. However, Consumer Reports did not endorse the handset, amid criticism that a certain grip of the iPhone, known as the "Death Grip", results in considerable signal loss^[14]. On July 17th, 2010, CEO Steve Jobs admitted the root cause of the dropped calls was a mistake with the signal algorithm, and offered a free protective case to all users who have bought a case before September 30 as a remedy for the antenna defect^[15][16].

• Peripheral Products

In 2007, Apple introduced its Apple TV product for the home entertainment center. Apple TV allows digital media from a user's computer to be played on entertainment systems and digital televisions such as high-definition LCDs and plasmas. The device is constrained by Apple’s video selection availability, and unlike its other products, lacks portability. Movies, music, and TV shows may be rented or purchased via the Apple TV using the infrared remote and an iTunes account. When the user runs the iTunes application on his/her PC, content bought and downloaded to the Apple TV is synced to the PC. Given its extensive content universe, it has been rumored that Apple may attempt to compete with Netflix and through a cloud computing-based system offering movie and TV rentals for a nominal fee (i.e. 99 cents) in the next iteration of the Apple TV^[17].

• iPad

On April 3rd, 2010, Apple unleashed the iPad as part of an effort to transform the way consumers approach personal computing and experience media. At only 1.5 pounds and 0.5-inch thin, the iPad boasts a 9.7 inch high-resolution multi-touch screen with 10 hours of battery life and a relatively simple interface, meant to run more PC-like software than the smaller screen iPhone^[18]. A lack of multiprocessing, webcam, HD screen, telephone connectivity, and other features have drawn some criticism^[19] but allow Apple to strategically roll out these sorts of features in future generations of the device. The device offers browsing, email, media, gaming, and eBook functions and also features downloadable apps through the iTunes store^[20].

The iPad comes in 16GB, 32GB, and 64B, all of them also functioning in 3G. The iPad is compatible with most of the 200,000 apps in the App Store, as well as those already purchased by iPhone and iPod Touch users. According to Steve Jobs, 1 million iPads were sold within 28 days of its April 3, 2010 release, accompanied by the download of over 12 million apps from the App Store and over 1.5 million ebooks from the new iBookstore^[21]. In June 2010, Apple declared that it had sold three million iPads within the first eighty days of its release, or about "an iPad every two seconds^[22]." The company also added that as of June 2010, developers had created more than 11,000 apps specifically for the tablet^[22].

• iAd

Apple's 2010 launch of the iAd mobile advertisement platform allows developers to incorporate advertisements into their applications. The technology became available in 2010 after Apple acquired Quattro Wireless, which held 9% of the mobile advertising market at the time^[23]. and incorporated it into its mobile phones. Through iAd, Apple receives 40% of the advertising revenue, leaving the rest to the app developers. Since its launch, the firm has forged large ad contracts with firms such as Unilever and Nissan^[24]. Research firm IDC believes that Apple may end up capturing 21% of the mobile wireless market by the end of 2010, despite not being an active player in mobile advertising in 2009^[23].

Trends and Forces

Apple's current primary strategy is a shift away from computers towards diversified consumer electronics. The company's intention to move from a Mac/iPod-driven business model to one that includes many different product lines puts a spotlight on Apple's forays into several new markets.

Product Cannibalization

Since the establishment of the iPod as the leading MP3 player in the market, each new addition to Apple's product portfolio has included and expanded upon the features of the previous generation. For example, the IPod Touch offered the same features as the original IPod but with a larger display, WiFi, PDA applications, and a virtual QWERTY keyboard to enhance functionality. Although the evolution of the iPod line creates the possibility that an iPod owner would want more than one model, the coexistence of these products allows for the possibility of cannibalization across the portfolio. Since the iPad is arguably a hybrid of Apple's Mac and iPod products, many feared that its introduction would cannibalize the rest of Apple's product portfolio; however, according to market research firm NPD Macs were up 39% YoY in April 2010 while iPod sales were down 17% during the same span, meeting expectations given consumer substitution towards the more versatile iPhone^[25].

Dependence on new products

Apple's maintains an aggressive product innovation cycle which permits the company to maintain its unusual but highly profitable system of product pricing (not lowering prices until a new version is released). The company is notoriously tight-lipped about new products, carefully controlling the release of new product announcements.

Among the new products released at the 2009 Macworld conference, is the new MacBook Pro that Apple claims is the thinnest and lightest 17-inch notebook computer available. Its new battery can run for up to eight hours on a charge and can be recharged up to 1,000 times, the company said^[26]. However, being the first Mac laptop with a non-user serviceable battery, when the battery eventually fails, users will be submitted to a service intervention. While inconvenient, the cost is comparable to previous battery replacements.

Contrary to expectations, no news of an upgrade or a replacement for the MacMini, Apple's only headless consumer model (sold without a monitor, as opposed to the traditional Apple concept of 'all-in-one' computers); the extremely powerful 8-core MacPro is designed exclusively for the professional user, and Apple shows no signs of intending to bridge this gap.

The "Apple Halo"

Apple's self-reinforcing virtuous business model takes advantage of the technological integration of its products to transform new buyers into loyal Apple fans across the broader product line. End-to-end control over the design and manufacture of hardware, software, and peripherals alike makes high compatibility between products possible, and high-quality customer support ensures satisfaction and loyalty. Apple's differentiation between product designs and the secrecy surrounding new product launches also reinforces the Apple mystique. These factors combine to create the Apple "halo effect," where a buyer of one Apple product has a high probability of returning to Apple for other products as well.

Public image

• Apple's reception in the marketplace (more sales = higher profits) has always been closely intertwined with its perception as user-friendly, sleek, and simply "cool." Apple enjoys copious amounts of free advertising from staunch loyalists and media buzz that generate "word of mouth". Apple's customer satisfaction ratings repeatedly top the charts. This is beneficial since many highly satisfied users, in effect, become quasi-Apple salespeople as they recommend products to friends. If this level of high customer satisfaction and/or Apple's brand image start to suffer, it would unquestionably dramatically undermine sales.
• In the public eye, Steve Jobs' role in Apple is absolutely integral. This means that if Jobs is no longer available to lead the company, is implicated in legal proceedings, or even experiences substantial health issues, Apple would in all likelihood be negatively impacted. Certainly that would be the initial effect on the stock price. On January 14, 2009, Apple announce that Mr Jobs was taking a medical leave of absence until June to deal with health issues which were more complex than originally described. He plans to remain involved in major strategic decisions as CEO. How this all plays out is problematic, given Mr Jobs reputation as a hands-on manager as well as the real possibility of serious health complications.
• To the extent that it is a part of his overall public personality, Steve Jobs' perceived reputation as a "competitive deal-broker" may also prove to be a company liability, however. Many of Apple's previous partners are increasingly reluctant to sign on, often holding out for a better deal (if any) or, like Universal Music Group, are seeking alterations to agreed terms. The Motorola partnership to develop the flopped ROKR is perhaps the most notorious example of Apple's questionable partnering behavior--critics accuse Apple of burying ROKR's launch to reduce cannibalization of iPod sales, and worse yet, using the ROKR collaboration as a front to gain much of the technology now used in the iPhone.
• It is worth noting that these very factors which have the potential to hurt Apple fortunes, exist precisely because the company has been so successful in differentiating themselves in the marketplace in precisely these ways, having brilliantly translated these dynamics to market share and bottom line profitability as no other technology company in recent memory.

Competition

Mac:

Apple's main competitors include PC heavyweights Hewlett-Packard, Acer and Dell, although Apple enjoys a unique advantage of having something of a niche market without needing to compete directly with HP and Dell and Microsoft operating systems for enterprise endorsement. Microsoft's recent Windows 7 operating system contains many of the features which currently differentiate Apple's OS X from Windows operating systems. While some of the hand gestures may be replicated in the new Windows system and other screen presentation features from Apple may also be borrowed, Apple's underlying operating system, built upon a version of Unix, may still prove considerably superior. The superior physical and electrical design of the Apple products must also be given consideration.

IPod:

Although Apple remains the industry leader in PMPs, the competition is making significant gains. The popularity of flash-based PMPs is problematic for Apple, which has much stronger market presence in hard-drive based (HDD) players. To combat this, Apple may release a new flash-based line of players, in addition to a souped-up and rehauled version of HDD iPods. Apple's main competitors in this area include:

• SanDisk's Sansa players, one model of which beat the Nano to market, with more GB and a lower price point.
• Creative's Zen, which has a strong grounding in flash-based players--including the first true widescreen video PMP with the Zen Vision W.

iTunes/Apple TV:

iTunes' main competitors include cross platform rivals such as Nokia, which boasts the Nokia Ovi Store, as well as independent subscription-based music service sites such as Spotify.

Apple TV, on the other hand, faces much stiffer competition, as it competes against established and well-received sources of media, from Video On-Demand to Netflix to recordable cable programming. All three of these distribution channels offer significantly higher image quality than much of what is available on Apple TV.

iPhone:

Apple's iPhone must compete with established mobile phone and PDA companies, including the likes of Samsung , Motorola, Nokia, and Sony, many of which have significantly larger R&D budgets than Apple. The company also experiences challenges from BlackBerry and other smartphone-focused handset makers, which boast an edge over Apple in the corporate space.

Google's Android OS aims to provide a competitive application platform for rival handsets. Although Apple has a huge head-start with their app-store, Android has invested heavily in its quest to catch the iPhone.

iPad:

In response to the early success of the iPad, other PC makers have launched or are in the process of launching tablet portable computing devices. Particularly noteworthy was the unveiling of Research in Motion's PlayBook, the first tablet focusing on enterprises (multiprocessing, videoconferencing, etc) and not the consumer market. The PlayBook was built with a simpler, more web-based operating system different than that in its BlackBerry phones to facilitate app development^[27]. Dell's Streak, HP's Slate, Cisco's Cius, and Samsung's Galaxy Tab have also been released, and tablets by Sony, Toshiba, Acer and LG have been announced ^[28].

Relative to its competitors, the iPad benefits from well-established distribution channels and first mover advantage^[29]. However, competitors could offer attractive products in the form of smaller tablets with added features and at a lower price (like the pocket-sized Galaxy Tab, which has two cameras)^[29]. Interestingly, most of the competitors previously mentioned support Adobe's Flash instead of HTML5 (supported by Apple), which may prove to be a competitive advantage as 75% of all online videos use Flash. Although Apple does not support Flash in its webpages, but allows mobile app developers to code using Flash ^[30].

The iPad also competes in the e-reader market, which includes the black-and-white screened Amazon's Kindle and the Barnes & Noble Nook. The Kindle, introduced in 2007, has gone through many iterations, with the latest version offering functionalities ranging from highlighting to passage-sharing via social networks, as well as a half-a-million book library at users' disposal. The Nook, only available since October 2009, offers 3G and Wi-Fi connectivity, a color touchscreen with improved contrast, more font colors, and the ability to lend an ebook to a friend for up to two weeks^[31].

References

1. ↑ "Apple (AAPL): Description," Google Finance
2. ↑ ^{2.0 2.1} "New Gadgets Power Apple Sales," Wall Street Journal, 07/21/2010
3. ↑ "Apple Reports Third Quarter Results," 07/20/10
4. ↑ "Verizon Wireless Said to Start Offering IPhone in January ," Bloomberg, 06/29/10
5. ↑ "Apple: Actually, $50 Billion Isn’t Cool Either. You Know What’s Cool? $300 Billion," TechCrunch, January 3, 2011
6. ↑ "Apple’s Jobs Prefers Having Cash to Paying Dividends,' Bloomberg, 02/25/09
7. ↑ "Apple," Morningstar Investment Research
8. ↑ "Apple’s Mac App Store Opens With More Than 1,000 Apps," 01/06/2010
9. ↑ ^{9.0 9.1} "Apple’s Ping tops 1M users in two days, but it’s no Google Buzz," SocialBeat, 09/03/2010
10. ↑ "Can Google Challenge iTunes?" Trefis Investment Research, 9/13/2010
11. ↑ "Why Apple’s Ping is about cutting out the social middleman," VentureBeat, 09/01/2010
12. ↑ "First day iPhone 4 sales estimate: 1.5 million," CNET News, 06/25/2010
13. ↑ "Apple sells 1.7 million iPhone 4 units," MarketWatch, 06/28/2010
14. ↑ "Hedge Funds Hoping for an Apple ‘Slingshot’?," New York Times, 06/14/2010
15. ↑ "Apple to Give Away iPhone Case," Wall Street Journal, 07/16/2010
16. ↑ "Antennagate Likely Won’t Impact Apple Stock," Trefis Investment Research, 09/15/2010
17. ↑ "Apple TV isn’t dead yet: $99 version to run iPhone OS," MediaBeat, 05/28/2010
18. ↑ "Laptop Killer? Pretty Close," Walter Mossberg, Wall Street Journal, 04/01/2010
19. ↑ Shilov, Anton (January 28, 2010). Apple iPad Is Here, Apple iPad 2 Incoming – Speculations.. Xbit laboratories.
20. ↑ "Apple Sets April 3 iPad Debut," Wall Street Journal, 03/06/10
21. ↑ "Apple Sold 1 Million Total iPads, Estimated 300K 3G Models Just This Weekend," CrunchGear, 05/03/2010
22. ↑ ^{22.0 22.1} "Apple Sells An iPad Every Two Seconds," InformationWeek, 06/22/2010
23. ↑ ^{23.0 23.1} "Apple Threatens Search Giants' Mobile Ad Shares," BloombergvBusinessWeek, 09/26/2010
24. ↑ "iAd Platform Could Drive 5% Upside for Apple Stock," Trefis, 09/20/2010
25. ↑ "Is the iPad Cannibalizing Other Apple Products?" Wall Street Journal 05/17/2010
26. ↑ [www.bizjournals.com/albuquerque/stories/2009/01/05/daily24.html "Apple updates iTunes, iLife, unveils 17-inch MacBook," New Mexico Business Weekly, 1/7/09]
27. ↑ "Can RIM's PlayBook Compete with the iPad?" Wall Street Journal, 09/29/2010
28. ↑ "Acer, Sony Rev E-Reader Race," Wall Street Journal, 05/27/2010
29. ↑ ^{29.0 29.1} "iPad’s Challenge for Next Year," Trefis Investment Research, November 22, 2010
30. ↑ "Adobe's Creative Suite Sells Despite Threat of HTML5," 06/25/2010
31. ↑ "Nook vs. Kindle: The e-Reader Battle Joined," BrandChannel, 08/03/2010