So what does Apple do after their iPhone market matures? The same thing everyone else does.
- Steal market share
- Look for complementary businesses to expand to
Stealing market share doesn’t require much explanation. It means shifting their crosshairs at the Android market as opposed to those with no smartphone at all. But choosing a complementary market is more of an art than a science. If Apple chooses wisely they could continue their torrid success but if they choose poorly it could be a huge cost both in terms of profit and opportunity cost. I say opportunity because time invested in a poor choice will be time not spent on something else that they are probably now behind in.
A complementary business is one that allows Apple to leverage its fixed costs and build on it’s strengths.
What is “Leveraging Fixed Costs”?
If you’ve heard this phrase bandied about and always wondered what it meant. Here it is. It means that you’ve already invested in some kind of asset or resource and you are looking at how to maximize your use of it. Also, the cost of your asset is fixed. Whether you sell a hundred units or a thousand it doesn’t change how much you pay for the asset on a monthly basis. You can either increase your sales revenue through selling more of what you are currently selling or you can expand into a new product that also requires the asset you already own.
For example. Let’s say that you ran a donut shop that catered to walk-in customers. One day you decide to increase revenue by delivering donuts to gas stations and restaurants. So you invest in a new delivery truck. Great, sales are up and everything is good. However, after you have sold donuts to every gas station possible you still have a lot of space left on your truck. What do you do? Try offering fresh baked bread and rolls. You can place these on the truck right next to the donuts and most of your customers will be the same.
You’ve picked a complementary market that allows you to use raw materials that you are already purchasing and the cost of the delivery trunk is already sunk. It won’t increase with your volume. You’ve increased your sales revenue faster than you’ve increased your costs. You’ve successfully leveraged your fixed costs.
Apple’s Analysis
This is basically what the team at Apple wants to do. They want to find another large market that allows them to increase revenue while not increasing costs at the same rate.
I have no idea what Apple is going to do next. However, I do have some idea on how they will evaluate their options at a financial level. Ultimately, each direction in which they contemplate moving towards has a calculated return on investment. Most companies have a strategy group that does nothing but vets new ideas and attaches price tags and financial models to them. These options will be presented to the management team who then has the tough job of deciding what the company needs to look like in the future.
Evaluating Complementary Markets
The financial model attached to each potential new market will play a huge role. Let’s say that Apple is considering offering a new service which will bring in an additional $50 billion in annual revenue. In my hypothetical example, let’s say that Apple has no experience in this proposed new market and won’t be able to leverage much of their fixed costs. Also, this market is full of competition so there will be downward price pressure.
If this proposed service is compared to the financial model for offering a new hardware device in which Apple is able to utilize existing assets guess which proposal is going to look more profitable? For a company like Apple which has already has millions upon millions already invested in the infrastructure to manufacture on a large scale, any proposed new service is going to have a hard time beating hardware proposals. The pricing and profit potential on a new proposed service needs to be huge to overcome its lack of advantage in leveraging fixed costs.
Does Apple have to leverage fixed costs when they expand into new markets? No, but if they don’t, their pricing power had better be pretty good in order to match the return on investment of a hardware proposal. Simply increasing revenue doesn’t necessarily do investors any good. It’s increasing the profits that will drive share price growth.
Evaluating Your Strengths
Besides wanting to leverage your fixed costs companies also try to capitalize upon what they are good at. That could be anything from negotiating raw material prices to advertising. Apple watchers trying to guess where Apple will go next next need to answer the question on what do they think Apple is good at today. This will be a big clue on where Apple will go next.
It’s probably worth noting that people within a company may disagree on what their strengths are. When I was working with Gateway Computers there was a huge debate internally on whether or not manufacturing was one of our core competencies. The management team finally decided that it wasn’t and shut down every manufacturing facility and outsourced everything.
I’m sure that as Apple decides which direction they need to move that different camps will be advocating for different directions based upon what they feel are Apple’s strengths. There are probably groups within Apple that feel their strengths are more software related versus hardware and vice versa. It’ll be up to the management team to decide who is right and make a decision.
Changing Times
For those who like Apple devices the iPhone reaching maturity could be the best thing to ever happen. As long as the iPhone was growing at double digit rates with 40% margins that meant the entire company was consumed by how to keep that going and making plans to support untold growth. It is extremely difficult to run a department knowing that you may have to double your work load in the next year or two. These department managers now have the freedom to get more involved in new product projects.
Now that the iPhone appears to finally be settling down, this will allow Apple to start branching out into other markets and expending energy into trying new things. And unlike recent history, they will have the financial incentive to do so.
A complementary business is one that allows Apple to leverage its fixed costs and build on it’s strengths.
What is “Leveraging Fixed Costs”?
If you’ve heard this phrase bandied about and always wondered what it meant. Here it is. It means that you’ve already invested in some kind of asset or resource and you are looking at how to maximize your use of it. Also, the cost of your asset is fixed. Whether you sell a hundred units or a thousand it doesn’t change how much you pay for the asset on a monthly basis. You can either increase your sales revenue through selling more of what you are currently selling or you can expand into a new product that also requires the asset you already own.
For example. Let’s say that you ran a donut shop that catered to walk-in customers. One day you decide to increase revenue by delivering donuts to gas stations and restaurants. So you invest in a new delivery truck. Great, sales are up and everything is good. However, after you have sold donuts to every gas station possible you still have a lot of space left on your truck. What do you do? Try offering fresh baked bread and rolls. You can place these on the truck right next to the donuts and most of your customers will be the same.
You’ve picked a complementary market that allows you to use raw materials that you are already purchasing and the cost of the delivery trunk is already sunk. It won’t increase with your volume. You’ve increased your sales revenue faster than you’ve increased your costs. You’ve successfully leveraged your fixed costs.
Apple’s Analysis
This is basically what the team at Apple wants to do. They want to find another large market that allows them to increase revenue while not increasing costs at the same rate.
I have no idea what Apple is going to do next. However, I do have some idea on how they will evaluate their options at a financial level. Ultimately, each direction in which they contemplate moving towards has a calculated return on investment. Most companies have a strategy group that does nothing but vets new ideas and attaches price tags and financial models to them. These options will be presented to the management team who then has the tough job of deciding what the company needs to look like in the future.
Evaluating Complementary Markets
The financial model attached to each potential new market will play a huge role. Let’s say that Apple is considering offering a new service which will bring in an additional $50 billion in annual revenue. In my hypothetical example, let’s say that Apple has no experience in this proposed new market and won’t be able to leverage much of their fixed costs. Also, this market is full of competition so there will be downward price pressure.
If this proposed service is compared to the financial model for offering a new hardware device in which Apple is able to utilize existing assets guess which proposal is going to look more profitable? For a company like Apple which has already has millions upon millions already invested in the infrastructure to manufacture on a large scale, any proposed new service is going to have a hard time beating hardware proposals. The pricing and profit potential on a new proposed service needs to be huge to overcome its lack of advantage in leveraging fixed costs.
Does Apple have to leverage fixed costs when they expand into new markets? No, but if they don’t, their pricing power had better be pretty good in order to match the return on investment of a hardware proposal. Simply increasing revenue doesn’t necessarily do investors any good. It’s increasing the profits that will drive share price growth.
Evaluating Your Strengths
Besides wanting to leverage your fixed costs companies also try to capitalize upon what they are good at. That could be anything from negotiating raw material prices to advertising. Apple watchers trying to guess where Apple will go next next need to answer the question on what do they think Apple is good at today. This will be a big clue on where Apple will go next.
It’s probably worth noting that people within a company may disagree on what their strengths are. When I was working with Gateway Computers there was a huge debate internally on whether or not manufacturing was one of our core competencies. The management team finally decided that it wasn’t and shut down every manufacturing facility and outsourced everything.
I’m sure that as Apple decides which direction they need to move that different camps will be advocating for different directions based upon what they feel are Apple’s strengths. There are probably groups within Apple that feel their strengths are more software related versus hardware and vice versa. It’ll be up to the management team to decide who is right and make a decision.
Changing Times
For those who like Apple devices the iPhone reaching maturity could be the best thing to ever happen. As long as the iPhone was growing at double digit rates with 40% margins that meant the entire company was consumed by how to keep that going and making plans to support untold growth. It is extremely difficult to run a department knowing that you may have to double your work load in the next year or two. These department managers now have the freedom to get more involved in new product projects.
Now that the iPhone appears to finally be settling down, this will allow Apple to start branching out into other markets and expending energy into trying new things. And unlike recent history, they will have the financial incentive to do so.
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