Apple (1)

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Apple: What’s Next? APPLE IS THE first company whose stock market valua- tion crossed the $1 trillion threshold (in 2018). Some 20 years earlier, however, Applewouldlikely: have gone bankrupt if archrival Microsoft (which enjoyed a valua- tion of $615 billion in December 1999)" had not in- Eested $150 million invAppie, Under investigation by the Department of Justice at the time for alleged abuse of monopoly power, Microsoft'was eager tonot have The Apple Ecosystem Apple achieved its success over two decades by imple- menting a potent competitive strategy. That strategy, conceptualized by co-founder Steve Jobs, combined in- novation in products, services, and business models. In 1997, Apple was near bankruptcy. Butifi 20015 its revi- talization took off with the introduction of the iPod, a prtable digital music player; this was the same year Appleopenedits firstretail stores)(see Exhibit MC1.1). Today, Apple’s stores earn some of the highest sales per square foot of any retail outlets, including Tiffany & Co., a luxury jeweler, and LVMH, a purveyor of fine handbags and other high-end goods. In 2003, Apple soared even higher when it launched its digital store iTunes. And it didn’t stop there. In 2007, the California tech company revolu- tionized the smartphone market with the introduction of the iPhone. Just three years later, Apple re-created the tablet segment by introducing the iPad. For each of its iPod, iPhone, and iPad lines of businesses, Ap- ple followed up with incremental product innovations that extended each product category. In 2017, Apple launched the 10th anniversary edition of the iPhone 10 and in 2018 it introduced the iPhone XS Max. Globally, Apple has also sold more than 1 billion Frank T. Rothaermel prepared this MiniCase from public sources. This Mini- Case is developed for the purpose of class discussion. It is not intended to be used for any kind of endorsement, source of data, or depiction of efficient or inefficient management. All opinions expressed, all errors and omissions are entirely the author’s. Revised and updated: June 18, 2019. © Frank T. Rothaermel. e Apple’s category-defining products (iPhone, iPad, iMac, and Apple Watch) are critical building blocks for its ecosystem anchored around its proprietary i0S operating system. Studio Monkey/Shutterstock iPhones. (The classic iPod was discontinued in 2014; the intent was always that the iPhone would subsume the MP3 capability. In 2019, Apple phased out iTunes and replaced it with three apps: Apple Music, Pod- casts, and Apple TV.) Also, in 2019, Apple intro- duced the iPhone 11 and Apple TV+, its new streaming service. By combining tremendous brainpower, intellectual property, and iconic brand value, Apple has enjoyed dramatic increases in revenues, profits, and stock mar- ket valuation. By 2019, it was one of the most profit- able companies ever, with $225 billion in cash holdings alone. A Good Strategy Why was Apple so successful? Why did ApPpI&’sicomn- petitors, such as Sony, Dell, Hewlett-Packard (HP), @okja, and BlackBerry,‘struggle or go out of business? The short answer is: Apple had a better strategy. But this raises the question: What is a good strategy? A good strategy is more than a mere goal or a company slogan. A good strategy defines the competitive chal- lenges facing an organization through a critical and an

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honest assessment of the status quo. A good strategy also provides an overarching approach (policy) on how to deal with the competitive challenges identified. Last, a good strategy requires effective implementation through a coherent set of actions. A good strategy, therefore, consists of three elements:2 1. A diagnosis of the competitive challenge. 2. A guiding policy to address the competitive chal- lenge. 3. A set of coherent actions to implement the firm’s guiding policy. THE COMPETITIVE CHALLENGE. First, consider the diagnosis of the competitive challenge. Above, we briefly traced Apple’s renewal from the year 2001, when it hit upon the product and business-model innovations of the iPod/iTunes combination. Before that, Apple was merely a niche player in the desktop- computing industry and struggling financially. Steve Jobs turned the sinking company around by focusing on only two computer models (one laptop and one desktop) in each of two market segments (the professional market and the consumer market) as opposed to dozens of non-differentiated products within each segment. This streamlining of its product lineup enhanced Apple’s strategic focus. Even so, the outlook for Apple was grim. Jobs believed that Apple, with less than 5 percent market share, could not win in the personal computer industry where desktops and laptops had become commoditized gray boxes. In that world, Microsoft, Intel, and Dell were the star performers; Jobs knew that he needed to create the “next big thing.” A GUIDING POLICY. Second, Apple shifted its com- petitive focus away from personal computers to mobile devices. In doing so, Apple disrupted several industries through its product and business-model innovations. Combining hardware (i.e., the iPod) with a comple- mentary service product (i.e., the iTunes Store) en- abled Apple to devise a new business model. Users could download individual songs legally (at 99 cents) rather than buying an entire CD or downloading the songs illegally using Napster and other file-sharing ser- vices. The availability of the iTunes Store drove sales of iPods. Along with rising sales for the new iPod and iTunes products, demand rose for iMacs. The new products helped disrupt the existing personal computer market because people wanted to manage their music MINICASE1 Apple: What's Next? 473 and photos on a computer that worked seamlessly with their mobile device. Apple then leveraged the success of the iPod/iTunes business-model innovation, follow- ing up with product-category-defining innovations when launching the iPhone (in 2007) and the iPad (in 2010). COHERENT ACTIONS. Third, Apple implemented its guiding policy with a set of coherent actions. Apple’s coherent actions took a two-pronged approach: It dras- tically streamlined its product lineup through a simple rule—"we will make only one laptop and one desktop model for each of the two markets we serve, profes- sional and consumer.” It also disrupted the industry status quo through a potent combination of product and business-model innovations, executed at planned intervals. These actions allowed Apple to create a string of temporary competitive advantages (see Ex- hibit MC1.1). Taken together, this enabled Apple to sustain its superior performance for over a decade. Peak iPhone: What’s Next? Past performance, however, is no guarantee of future performance. Although Microsoft struggled to keep up with Apple, by spring 2019 it surpassed Apple to be- come the world’s most valuable company once again with its renewed focus on cloud and mobile computing. In the same fashion, Amazon has also surpassed Apple in stock market valuation, while Alphabet is closing in. At the same time, Apple continues to face stiff compe- tition from such non-U.S. rivals as Samsung (a Sotith Korean firm) and Huawei, Xiaomi, and Oppo (all Chi- nese firms). The trillion-dollar question today is whether Apple can continue to maintain a competitive advantage in the face of increasingly strong competition and rapidly changing industry environments. One big issue that Apple faces is “what’s next?” after the iPhone. The situ- ation in 2019 is akin to that of 2005 when Apple faced peak sales with the iPod, and competitors were starting to offer flip phones with MP3 player capabilities. As a response Apple launched the iPhone in 2007. The iPhone was a complete game changer. Although it made the iPod as a product category obsolete, Apple dominated the smartphone market for the decade to come. The problem is that the global smartphone market has peaked. After reaching double-digit growth rates in 2013 and 2014, in 2017 and 2018 growth in sales of new

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474 MINICASE1 Apple: What's Next? phones contracted. This implies that most purchases are replacements of existing phones, while consumers hold on to their phones for longer as the cost of the phones has increased. Moreover, subsequent models offer mere incremental improvements over current models, often not worth the price differential. For in- stance, the introductory price of Apple’s iPhone XS Max was $1,349 in the United States and nearly $1,800 in China! The “peak iPhone” situation is a huge prob- lem for Apple because two-thirds of Apple’s revenues in 2015 came directly from iPhone sales. By 2018, iPhone sales made up 50 percent of total revenues ($265 billion). With declining sales of iPhone units, Apple’s revenues fell in 2016 and 2017, but rebounded in 2018, in part due to higher-priced iPhones. In other words, fewer units were sold, but the price increase made up for the unit fall in sales. In early 2019, Apple’s market cap dropped again by 40 percent from its peak of $1.1 trillion in the fall of 2018 to $672 billion, but recovered to stand at $900 billion in summer 2019. In recent years, sales in China made up 20 percent of Apple’s revenues. However, Apple’s popularity in China is declining rapidly in the face of local competi- tion and trade tensions. The:Chinese'smartphonemak- ers Huawei, Xiaomi, and Oppo offer phones of similar capabilities and user-friendliness for one-half the price or less. Moreover, given the trade tensions between the United States and China, Apple can expect more head- windsvinrChinamFor example, a consumer boycott could be instigated, or a stiff tax could be levied on Apple products by the Chinese authorities. In 2019, Huawei was facing several U.S. charges, among them misleading the U.S. government about its busi: ness dealings with Iran (while it was under U.S. eco- nomic sanctions) and allegations of bank fraud and technology theft (Huawei has denied both claims). Will Apple introduce another game changer like the iPhone? In 2015, it introduced the Apple Watch, the first new product category launched since the iPad in 2010. Despite the unfulfilled potential of AirPower, which would have disrupted the charging industry and redefined the way consumers charge their Apple prod- ucts, the Apple Watch is gaining more traction and has become the most popular smartwatch. In mobile pay- ment systems (Apple Pay launched in 2014), music streaming (Apple Music launched in 2015), smart speaker systems (Apple’s HomePod launched in 2018), and streaming services (Apple TV+ launched in 2019), Apple was a late mover. Going forward, Apple CEO Tim Cook has ex- plained that Apple will focus on services to make up for losses resulting from declining iPhone sales. In 2019, Apple had more than 1 billion users in its ecosystem, which comprises mobile devices (iPhone, iPad, iMac, or Apple Watch) combined with services such as iTunes, iCloud, and ApplePay. The Apple eco- system is centered around its proprietary iOS operat- ing system, which anchors a family of Apple products with its accompanying, co-dependent services. This al- lows the firm to benefit from customer lock-in and net- work effects. In other words, if a user is embedded in the Apple ecosystem, that makes it much harder for that user to switch to a mobile phone that relies on Google’s Android operating system. DISCUSSION QUESTIONS 1. How did Apple’s introduction of the iPhone in 2007 lead to its success over its main competitors? Think about which industries it has disrupted and how. 2. What are some of the challenges facing Apple to- day? What should Apple do to address them? Be specific. 3. Apply the three-step process for developing a good strategy (diagnose the competitive challenge, derive a guiding policy, and implement a set of coherent actions) to Apple’s current situation. What recom- mendations would you offer Apple to outperform its competitors in the future? Be specific. Endnotes 1. Inflation adjusted, Microsoft’s 1999 stock market valuation of $615 billion is about $940 billion in today’s dollars. 2. This discussion is based on Rumelt, R. (2011), Good Strategy, Bad Strategy (New York: Crown Business). 3. Rumelt, R. (2011), Good Strategy, Bad Strategy (New York: Crown Business). 4. Ibid. Sources: Apple Inc. annual reports (various years); Sull, D., and K.E. Eisen- hardt (2015), Simple Rules: How to Thrive in a Complex World (New York: Houghton Mifflin Harcourt); Sull, D., and K.E. Eisenhardt (2012, Septem- ber), “Simple rules for a complex world,” Harvard Business Review; Isaacson, W. (2011), Steve Jobs (New York: Simon & Schuster); and Rumelt, R. (2011), Good Strategy, Bad Strategy (New York: Crown Business).

Apple (1)

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