It’s been reported that Apple’s main iPhone manufacturing contractor is planning to fully automate their assembly plants. This is great news for the iPhone on the cost front because Apple/Foxconn would never invest in this new machinery if there wasn’t a clear cut financial benefit to the bottom line. But on the other hand, it’s investments like this that further push companies like Apple to spend more and more focus on their high-volume products to the detriment of their smaller ones.
People have a hard time understanding why large companies generally ignore niche markets whereas small companies seem to specialize in them. It’s an unintended result of the way that capital is structured.
Let me put this in a way that may be more relatable to the average tech consumer. Let’s say that you are a young person living at home, working a part time job at Arby's, and you drive an old beater. One day you decide you want to buy a new brand new Chevrolet Camaro that is going to cost you $550 per month. Now to handle that monthly payment, you decide that you need to get a new full-time job that will bring in a higher monthly income. You can’t afford that low-income job any more, even though you liked how much time it allowed you to pursue your hobbies.
It’s the same way with large corporations. Only instead of car payments, they deal with monthly depreciation charges. Let’s say that Apple decides to invest in a highly automated plant with self-driving material handler robots, robot welders, robot assemblers, etc. The cost for all that automated equipment is paid up front but is spread over the next few years. Just like a car payment. Even if they pay cash with no debt, they will still have to deal with the monthly depreciation charges on their income statement for years. So an unwise investment in machinery could result in years of red ink. That’s because their accountants are trying to match the expense of the capital against the sales it produces over its lifetime.
If a corporation invests in an expensive new plant with state-of-the-art equipment, they want to run as much product through as possible in order to spread the cost over all those products. In a way, they need to increase their income to match their higher expenses.
Let’s say that a corporation has two different product ideas to add to that plant. One million dollars is the amount of depreciation that will be spread over either product regardless of the volume. If Product A has a potential market of 100 thousand units, it will “absorb” $10 per unit. But if Product B has a potential market of 1 million units, its per unit charge will only be $1 per unit. Guess which product is going to be wildly more profitable?
Low-volume products don’t make a lot of sense for large, high-capital companies. This means that small companies don’t have to worry about competition from the big boys if they want to serve a niche market. Because of the sheer fact that small companies don’t generally invest in expensive capital, they don’t need to rely on volume to carry all that cost. They can usually either do something manually using people-power or hire a third party for special machine work.
But this is going to cost a lot. Whatever they are making is going to cost much more than if a large company was churning out millions of them. So the relatively small market has to want this niche product bad enough to pay a premium.
To go back to my previous analogy, a small company without a lot of expensive capital is like a young person still living at home and not a lot of bills. They don’t have to absorb expensive monthly depreciation charges and are free to experiment with various markets. And large companies are like a middle-aged adult with a big mortgage, a boat, and summer home to pay for. They can’t afford to backpack in Europe while they find themselves.
Now all of this doesn't mean that a company blindly manages by the numbers. It’s the role of a good CEO to make the case to his board and his employees why they need to invest in a new direction with no guarantee of success. Sometimes this is by necessity, due to impending challenges in their current product roadmap. Or it’s motivated by the desire to usher in a game-changing technology that could allow them to have a competitive advantage. But even in these cases, there’s a well-developed financial model which would outline the future profits that would outweigh the near-term sacrifice.
Let me put this in a way that may be more relatable to the average tech consumer. Let’s say that you are a young person living at home, working a part time job at Arby's, and you drive an old beater. One day you decide you want to buy a new brand new Chevrolet Camaro that is going to cost you $550 per month. Now to handle that monthly payment, you decide that you need to get a new full-time job that will bring in a higher monthly income. You can’t afford that low-income job any more, even though you liked how much time it allowed you to pursue your hobbies.
It’s the same way with large corporations. Only instead of car payments, they deal with monthly depreciation charges. Let’s say that Apple decides to invest in a highly automated plant with self-driving material handler robots, robot welders, robot assemblers, etc. The cost for all that automated equipment is paid up front but is spread over the next few years. Just like a car payment. Even if they pay cash with no debt, they will still have to deal with the monthly depreciation charges on their income statement for years. So an unwise investment in machinery could result in years of red ink. That’s because their accountants are trying to match the expense of the capital against the sales it produces over its lifetime.
If a corporation invests in an expensive new plant with state-of-the-art equipment, they want to run as much product through as possible in order to spread the cost over all those products. In a way, they need to increase their income to match their higher expenses.
Let’s say that a corporation has two different product ideas to add to that plant. One million dollars is the amount of depreciation that will be spread over either product regardless of the volume. If Product A has a potential market of 100 thousand units, it will “absorb” $10 per unit. But if Product B has a potential market of 1 million units, its per unit charge will only be $1 per unit. Guess which product is going to be wildly more profitable?
Low-volume products don’t make a lot of sense for large, high-capital companies. This means that small companies don’t have to worry about competition from the big boys if they want to serve a niche market. Because of the sheer fact that small companies don’t generally invest in expensive capital, they don’t need to rely on volume to carry all that cost. They can usually either do something manually using people-power or hire a third party for special machine work.
But this is going to cost a lot. Whatever they are making is going to cost much more than if a large company was churning out millions of them. So the relatively small market has to want this niche product bad enough to pay a premium.
To go back to my previous analogy, a small company without a lot of expensive capital is like a young person still living at home and not a lot of bills. They don’t have to absorb expensive monthly depreciation charges and are free to experiment with various markets. And large companies are like a middle-aged adult with a big mortgage, a boat, and summer home to pay for. They can’t afford to backpack in Europe while they find themselves.
Now all of this doesn't mean that a company blindly manages by the numbers. It’s the role of a good CEO to make the case to his board and his employees why they need to invest in a new direction with no guarantee of success. Sometimes this is by necessity, due to impending challenges in their current product roadmap. Or it’s motivated by the desire to usher in a game-changing technology that could allow them to have a competitive advantage. But even in these cases, there’s a well-developed financial model which would outline the future profits that would outweigh the near-term sacrifice.
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