This is the eigth segment in an 8-part series on Unlocking the Value in AAPL.
- Introduction
- The Irrational Market Theory
- The Law of Large Numbers
- Market Share
- Apple's History
- Business Model
- A Dollar A Day
- Epilogue
*Disclosure: The author owns AAPL.
Apple's model of vertically integrated hardware, software and services with a majority of revenue coming from relatively infrequent hardware sales is still very new. Apple introduced the iPod and iTunes just over a decade ago. iOS and iPhone are only 6 years old. The App Store is only 5 years old. The iPad, only 3 1/2 years old. Notable competition has only been around for two or three years.
The Apple ecosystem is extremely healthy and has a very bright future. However, having a bright future and proving this future is reliable to investors is not at all the same thing. When investors are looking for reliability in a business model they are looking for a track record with a history of at least five to ten years and a demonstrated ability to thrive in the face of competition.
I believe this means that the next few years will be extremely important for Apple's relationship with the investment community. Their challenge is to demonstrate that the iOS ecosystem continues to succeed and grow despite competition from other platforms and to expand this ecosystem into new product categories. It is to demonstrate that they are able to maintain customer loyalty over time and through product transitions. And of course they also need to demonstrate the ability to maintain reasonable margins1 and average revenue per user in the process.
Perhaps most importantly, if they are successful in this they will have demonstrated the ability to do all of this without Steve Jobs.
By the time the iPhone is 10 years old I believe Apple's business model, strategy, and leadership will have a long enough and steady enough track record to convince investors that their success is not an anomaly and does not rely on Steve Jobs. Investors will begin to view Apple as the stable, mature business it has become and not the hit-drive flash in the pan many of them see today. When this happens Apple's valuation will reflect the reality of their business rather than the fear of a sudden collapse.
- Apple has maintained gross margins of over 30% for more than a decade. This is also the magic number for iTunes, iBooks and App Store sales. They may not be able to maintain the extraordinary gross margins that were possible during the first few years of iPhone sales but it is a safe bet that gross margins will remain above 30%. The modern Apple has and will always refuse to make hardware that isn't profitable (or even marginally profitable).