Fellow Collegiant Ramster doubts Baruch, and writes:
So if the iPhone is such a gamble for Apple, what’s the alternative? Stay out of the phone business entirely?
Ramster also questions whether Apple really needs to go mass market. There’ll be enough fanboys out there, he opines, to create
. . . a pretty decent sized niche…which leads to the question of scale that you mention. It strikes me that when a few hundred million handsets are being sold per year, a niche market can still hit numbers that would be considered mass market in any other space (e.g. 10s of millions of units/yr).
Well, Ramster, for your first question, there IS no alternative to iPhone for Apple, is there? Other than sitting on the iPod franchise and milking it for cash and managing its decline. But of course that would be a bit of a multiple shrinker.
In that sense I guess is not strictly speaking a gamble, or at least one with any optionality. It just proves that Apple may not have been in quite as strong a position as we thought.
But your second question goes to the heart of the Apple thesis I propound, and is why answering your question is deserving of a post by itself. I fear there is much misunderstanding here.
Let’s do a thought experiment. Let’s say Apple flogs “10s of millions of units/year”: 20m iPhones at USD500 a pop wholesale, which is USD 2 bn in revenues. Say Apple makes a 50% GM (I’m being generous), but has to pay 500m in R&D and 300m in SG&A (these totals may not be enough, they are just illustrative). That means Apple makes USD 200m in EBIT, a 10% margin for Apple. Oh dear. Wailing and gnashing of teeth.
But just sell 5m more units and you make 450m in EBIT, a 22.5% margin. Got that? 20% more units gives you over 100% your profit. Once you cover your cost it drops straight through to the bottom line. Or you can keep the same margin and spend more in R&D or have a cooler ad campaign or build a distribution network in Mongolia or wherever. This is what we call operational leverage. It comes from scale.
Without scale, other people with scale can come in and eat your lunch. Let’s ignore SG&A, even though it’s equally important, and just concentrate on R&D instead. Nokia spends 12 BILLION fricking dollars on R&D per year. And still has a 20% margin. If its R&D was only half as efficient they could outspend Apple’s illustrative business model above by diverting just 10% of that. Not straight away, but over 6 months, over 12 months, you’d see Nokia start to have better features than Apple, in iPhone-like models that are released before Apple’s. Moreover, Nokia would start to offer more variants to fit different tastes and budgets, and extend the business into new customer segments.
Soon Nokia will be selling more units and making more money, free EBIT to spend more on R&D. The advantage thus becomes self supporting, a virtuous circle for Nokia, a more vicious one for Apple. Eventually they have to drop out of the handset market. This is not a fanciful example. This is exactly what Nokia did to Panasonic, Ericsson, Sony, BenQ, Siemens, and Motorola. It’s why they have a 45%+ share, 3x more than anyone else.
And that’s why Apple needs to go mass market.