Countdown to Apple's Meltdown

morgueFile user beanworks

(MoneyWatch) COMMENTARY As the hubbub builds around Apple's (AAPL) launch tomorrow of the iPad 3, the company's string of product hits has come to make it seem invincible -- and for good reason. Apple is arguably the most effective corporation in history, transfixing investors with what Reuters refers to as a "casino stock."

Despite this remarkable performance, there is more than a hint that the good times won't last forever. That's because the "Cupertino miracle" is attributable in part to a number of conditions that are bigger than Apple. More broadly, as history shows, today's sure bet is tomorrow's losing ticket. Housing prices are guaranteed to rise "forever," until they don't. Going back further, the "big three" U.S. automakers were once considered invulnerable, until competition from abroad and their own mismanagement made it clear they weren't. The world changes, and hallowed "truths" change with it.

This year's black

And for Apple, success is largely a function of that most mercurial, and hard to recreate, quality -- fashion. Indeed, the company has as much of a fashion-oriented marketing and sales approach as any apparel business, since design is the language of style. By definition, though, styles shift, often catching companies by surprise because they assumed their previous success meant they knew how to predict and control the market.

Ironically, the more popular something becomes, the more vulnerable it becomes to being unpopular. It's the reason why luxury brands try to shut down knock-off manufacturers. Not that the people buying a cheap, shoddy faux Gucci or Coach bag would actually pay the money for the real thing, so they aren't losing direct sales in that way.

However, as people in this particular industry have explained to me in the past, wealthy consumers buy luxury brands not only for the quality, but to reinforce their sense of exclusivity. Make the trendy item ubiquitous, and the buyers who helped created the elite status in the first place look for something else that isn't so ... common.

This could easily happen to Apple. It has already started to, in a way, with smartphones, where Android phones have taken the market share lead. All those who say it couldn't happen in tablets aren't remembering that they probably said the same thing about Android smartphones. They were just poseurs that happened to become wildly successful. (As for the argument that it's an unfair comparison because Google leverages many manufacturers, so what? Microsoft (MSFT) did that successfully for years -- and Samsung alone sell roughly as many smartphones as Apple does.)

Don't let those sales evade your eyes, just subsidize

Another potential problem for Apple that the Wall Street Journal points out is the iPhone subsidy crutch. Apple -- as is true with other companies in the smartphone space -- relies heavily on carrier subsidies. They make phones relatively cheap for consumers, though not for carriers.

The practice has proved to be a big advantage for Apple, which posted a 73 percent jump in revenue in its latest quarter, at the expense of carriers such as Sprint Nextel Corp. (S), which started carrying the iPhone last fall but doesn't expect to make a profit on the device until 2015.

But this tactic doesn't work in many parts of the world, like the south of Europe, where people skip contracts and pay full freight for devices. Or, as Google director of Android partnerships John Lagerling, reportedly said, "From a sustainability standpoint, if you have very expensive devices as the only ones available to access your ecosystem, then that can come with a pretty severe hangover in the long run."

True enough. Complicating that possibility is that Apple has been able to call a lot of the shots with carriers. But telecom companies aren't known for being meek. They like the reliability of service contracts, but probably aren't happy subsidizing the enormous percentage of industry profits that Apple appears to take. Some shifts in how the carriers do business could pull the ground out from under the company.

Time ain't on their side

Most importantly, things change over time. As Ecclesiastes so eloquently puts it, to each thing there is a season. The same is true for large companies. Not that sticking around for a long time is impossible. Of the dozen original members of the Dow Jones Industrial Average, 11 are still in business, or their direct descendants are.

Can Apple stay on top forever? Absolutely not. It might for months, years, or even a decade or two. It originally was a powerhouse in PCs and then did terribly, only to crawl back from the grave to dominance in a new area of products. But eventually it will decline again. It's just common sense and a whole lot of historic precedence. And when so many competitors are gunning for you, eventually could sooner rather than later.

Image: morgueFile user beanworks

[kirkaewing]

I am not sure that Erik Sherman understands the difference between fashion and product design. Fashion is form before, or even without, function. Product design is function before form. Apple is not a fashion company, it is a product design company. Brilliantly designed products never go out of fashion, as long as they solve the problem in the best way. Ask GE, Boeing etc. Badly designed products which have poor functionality, no matter how good they look, will be unsuccessful.

It is a complete fallacious argument to compare the success of Apple to a bubble market such as housing. One is built on the economic fundamentals of selling more products in more markets, the other temporarily ignores the economic fundamentals of markets. To the comparison with auto makers, the big three US automakers just made inferior products. Look at the switch-gear, the materials used in the interiors and the gearboxes of a 1990-2010 Ford, GM or Chrysler and compare them to a VW or even a Euro Ford or GM car and you understand the failure of these companies was inevitable.

Apple is better at product design than other companies. They create new products which solve latent demands that others have been unable to solve. This is the essence of good product design, not fashion. They also solve them in a way that all their products form a contiguous ecosystem with a contiguous design philosophy (cough! Microsoft try it some time).

Apple is also amazing at connecting products to comprehensive, industry changing business models (iPod and iTunes, iPhone and App Store). Many issues with markets can only be solved by changing the industry's business landscape before designing the products to release into the market.

If you look at Apple TV it fits beautifully within Apple's Eco-system but it still doesn't solve some of the fundamental problems of TV. As a result Apple describe it as a hobby.

When looked at broadly, the current TV product available is extremely limited. The distribution channels currently only buy packaged content (real-time TV channels) and this product is so limited that opportunities for innovation are minimal. A display device, such as Tivo or a Windows Media Edition PC, can improve the user interface but cannot solve the underlying, fundamental problems. Consumers want to watch the content they like, when they want to and want to easily be able to finds new shows they would also like. Consumers don't really care about channels and they want to be able to view all their content on-demand, in any location using a single interface design (both device interface and commercial subscription). A display device could not possibly solve these inherent problems.

There are definitely opportunities for Apple to revolutionize new markets though the entrenched players are more and more likely to behave like the TV players are currently behaving. They will resist change and innovation the more successful Apple is in their current markets and other markets they enter. Apple's ecosystem is a threat to all other players in that Apple owns the most valuable asset; the customer relationship. This is the limiting factor on the "rise and rise" of Apple. The more successful they are, the less likely that entrenched industry players will want them to innovate in their industry. The result of Apple entering an industry is that the customer relationships become inherently Apple-centric as AT&T and Verizon can tell you.

The problem is that the single contiguous ecosystem is the best solution to the problem. The rise of the only valid competitor to the iPhone in Android and their creation of a mini-ecosystem validates this. As a consumer I want to minimize the number of relationships I have to manage. If Apple ecosystem can provide all the solutions to my digital needs there is an inherent appeal to that as this decreases the cognitive load of these products. That is something consumers are willing to pay for.

It is a shame the author's analysis misses the fundamentals of Apple's situation and that he relied on arguments that could, at best, be described as logically inconsistent. Also the financial fundamentals of Apple's stock price suggest it is undervalued not overvalued.

Here is a quote from the Reuters article he links to:
"Despite the high price, Apple look like a value stock. It trades at 15 times earnings, close to the 14 earnings multiple of the broad S&P 500 index, even though its earnings per share grew nearly 83 percent last year, nearly four times that of the broad index."

I believe the author is fundamentally wrong though I also believe Apple will need to change its tactical approach to entering new markets. They need to become a better partner and less of a bully if it hopes to continue to grow at its current rate.

[eriksherman]

Sorry, but it's not a fallacious argument. Apple is great at product design, but it also relies on many of the tools of fashion - which, after all, is about product design that must meet customer tastes. And consumers aren't perfectly rational, looking only for products that fit their needs. Fashion also doesn't exist separate from products.

There was a time that Braun was known for top design. It didn't last forever. Yes, there are *potentially* opportunities for Apple to do more in more markets, but that's a far cry from saying that it will always be able to do so. You've mistakenly taken Apple to be an entity rather than a collection of people that will change and make mistakes.

Then there's the issue of the subsidies that make the profile levels possible. Those also won't last forever because the carriers will tire of giving up that level of profit.

[kirkaewing]

Erik,
Again you missed the point of what I wrote.

I only said that comparing Apple to the housing market was fallacious. Your other points I never said were fallacious, I just do not find them very compelling.

I would disagree that, as you put it, Apple using the "tools of fashion" logically dictates that they "rel(y)" on them. I see them as clearly having a core competency in creating beautiful objects. This is clearly one of their skills that has contributed to their success and is likely to continue to do so. My point is that the most important factor to their long-term success is in creating products and business models that are functionally superior than their competitors especially in their fundamental approach to solving problems.

I do believe there is a stark difference between aspects of design that you misrepresent. The fundamentals of fashion design (your term which I think is misleading), where a product is differentiated from other products, not by it's functional differences, but by it's aesthetic design, is fundamentally different to functional design where a product is differentiated principally by it functional abilities. These are different concepts and need to be thought of and treated as such.

Of course all product has both aspects of design and are differentiated by both but one is always more important than others. Your Braun example is where it is more about aesthetics. The functional differentiation between shavers is more smoke and mirrors than reality. In this instance I completely agree that these products, companies and markets are vulnerable to the winds of fashion. As the technology behind the functionality of a product matures an becomes commoditized then functional differentiation becomes less critical and aesthetic differentiation becomes more important.

I totally agree that potential opportunities for Apple do not suggest that it will be able to do so. That was my whole point about the TV industry players and them successfully holding Apple out of their market so far.

The comment that I have "mistakenly taken Apple to be an entity rather than a collection of people" I find condescending as well as logically invalid. Apple is clearly an entity, one that has a personality and behaves as a whole. It is also obviously made up of a collection of people that change and make mistakes. One does not preclude the other. This does not refute or even comment on any of my points.

The issue of how customers pay for Apple's products is a moot point. Yes the carriers currently pay subsidies to Apple but they pass this charge onto customers. the iPad is not subsidized at all and they sold 15 million of those in Q4 2011 alone. Customers are willing to pay for value. The iPhone has clearly shown that distribution channels such as carriers have little or no power in the face of segment changing products such as the iPhone. Just ask Verizon.

Sorry Erik. Your arguments aren't very persuasive.

[2old4fun]

Why does CNET not employ editors? Did anyone read this article prior to posting? Autocorrect is not an editor.

[Mwrigley]

The write makes us out to be stupid and apple to be stupid look we all know everything is for a season that is why apple is always trying to reinvent themselves. They stopped making iBooks and now only make mac book air this is for the future and they will do the same with all things we all know that one day there will not be cell phone because there will be nationwide WIFI and there will be just phones that use wifi and there will be no contracts this was told to us in 2008 by Obama. It is a government mandate so apple will adapt like all good companies do so lay off on the apple hate for was just because your not as successful as other does not make it right to hate.

[benfromchicago2698]

This author has been negative against Apple for a long time. This is another of his rant that Apple is going to fail sooner or later. Well, as Keynes famously said, in the long run we are all dead. So I really don't see any wisdom from this article.

There are a lot of Apple bulls in the investment community. If this author has something new to say, I would like to hear it. I would like to know exactly when Apple will fail (next quarter? next year?) and why it will fail then (iPhone failure? New technology overtaking Apple?).

That will be a much more useful article than this piece of junk journalism calling for Apple's failure just based on some vague prediction and the author's emotional bias.

[eriksherman]

Not an emotional bias - an observation of history. But it's a point that many forget when discussing Apple.

[Henri_Rochard]

Call me simple-minded, but my Android phone (purchased by me for $180 with $30/month service) looks to me pretty much just like an iPhone with pretty much the same apps.

[venusvegasvada]

It is already slipping.

Compare OSX Lion and Lion Server to Snow Leopard and SL Server-

Lion and Lion Server were two steps backwards (That's putting in nicely). I was blown away how BAD they are. Even today, I want to throw my Lion iMac out the @#@@#ing window every time I turn it on. I find myself constantly leaving it off and using my Snow Leopard laptop.

I have the suspicion that Lion and Lion Server where the first things out the gate at Apple without Steve Jobs' input (due to his illness). If so, it doesn't bode well for Apple.

From what I've seen so far, the new Mountain Lion doesn't fix much of what was screwed over on Lion and Lion Server. We'll see. I'm not buying or upgrading anything Apple at this point.

By the way, Apple made it impossible to install Snow Leopard on a machine that came with Lion (SSD's- no drivers for Snow Leopard).

Thanks @#$$##$%!