Apple is a marketing and technology company focused on the design of consumer communications products. This Apple Business Quality Report explains the Excellent Quality ranking that Apple received under my quality ranking system. A full list of companies ranked by the quality of their business is available for exclusive access by DIY Investing members. Sign up here for the DIY Investing Membership program.
Basic Company Information
- Company Name: Apple
- Ticker: AAPL
- Quality Ranking: Excellent (5)
- Primary Reason: Brand / Oligopoly
- Size: Mega-Cap
- Last Updated: 11/30/2019
- Apple’s luxury brand creates pricing power.
- Their secure ecosystem creates high customer retention due to high switching costs.
- Low Competition (Oligopoly)
- Services business provides low-cost sustainable growth.
Apple Business Quality Description
Apple operates a hardware and software ecosystem centered around smartphones in a market where they only have one true competitor: Samsung. Samsung and Apple combined account for the supermajority of the market. Apple earns a supermajority of the net profit in the smartphone market as well.
The smartphone market has stabilized meaning that the current leading providers no longer need to heavily innovate to retain customers. Smartphones are now “good enough” that customers are unlikely to switch from one provider to another.
Apple is a luxury brand
The Apple brand name is a luxury brand in the minds of consumers. When customers buy an Apple product they are buying the Apple name, the Apple ecosystem, AND a piece of useful technology. As a result, Apple has pricing power: the ability to charge a higher price for their goods than their competitors.
Apple’s pricing power shows up in their retail sales. Apple’s retail sales per square foot in its stores is comparable to other luxury brands like Tiffany and Co.
Apple’s Ecosystem = High Customer Retention
Apple’s secure ecosystem is a set of hardware and software integrations that allow customers to receive a surplus of benefits by owning more than a single Apple device. Apple iPhones integrate with an Apple Watch, an iPad, an iMac, a MacBook, etc…
With Apple, the ecosystem is truly greater than the sum of its individual parts. The subsequent consumer surplus increases Apple’s pricing power and customer retention rate.
If a customer owns an iPhone, an iPad tablet, and a MacBook laptop, they are highly likely to buy an Apple product again if any of the three products need to be replaced. Apple’s core users tend to start and end their product search by only comparing between various Apple products.
Apple operates in an Oligopoly (Low Competition)
Apple operates in multiple market segments, including Smartphones, Tablets, Laptops, Desktops, Wearables, and Services. However, a majority of Apple’s market power and revenue is earned from their Smartphone business segment. Therefore, my focus in this business quality report is an analysis of the smartphone business and related revenues like services.
There are numerous smartphone and ‘dumb’ phone manufacturers worldwide. Yet, only three companies compete in the global high-end smartphone marketplace. Apple, Samsung, and Google are the only producers currently attempting to win the high-end smartphone market.
Three manufacturers are enough to classify the market as an oligopoly but this overstates the influence of Google’s Pixel phone on the market. Google’s Pixel has a fairly low market share and an even lower profit share in the smartphone market.
Apple and Samsung represent a supermajority of the high-end smartphone revenues and Apple alone is secure in earning a profit selling smartphones. This lack of serious competition in the high-end market segment has allowed Apple to stabilize its earnings and revenues at a high rate that ensures high returns on equity.
Apple’s Services Segment is a Gold Mine
Apple’s management knows that its ecosystem is its greatest competitive advantage. By locking customers into their ecosystem they ensure a high retention rate, but also the ability to up-sell their customers on high-margin value-added services.
These services include Apple’s 30% upfront or 15% recurring revenue cut on App Store purchases. In addition, Apple sells subscription services like Apple News, Apple Music, and Apple TV+. Each of these services increases their average revenue per user (RPU) and deepens the Apple moat against competitors.
All a customer has to do to remain in the Apple Ecosystem is consider any one product or service as indispensable to their daily lives.
Why Apple doesn’t deserve a lower quality rating
The next lowest tier in my business quality ranking system is a “high quality” business. The key differentiator between a high-quality and excellent is the presence of an unassailable competitive advantage.
In this case, Apple’s position as profit leader in an oligopoly provides it with that unassailable competitive advantage which creates durable profits. In addition, their ecosystem is a key differentiation between your typical high-quality company.
I would downgrade Apple’s quality rating to “high quality” if I felt that their ecosystem or the lack of competitors no longer provided a large enough moat. This is quite possible as the lifecycle of technology products is shorter than most other consumer discretionary products.
Why Apple doesn’t deserve a higher quality rating
The next highest tier in my business quality ranking system is a “generational” business. The key differentiator between an excellent and generational business is the long-term durability of after-tax after-inflation cash flows.
Apple’s business as a technology-focused consumer discretionary prevents Apple from ever being granted such a generational quality rating. In order to add Apple to the ranks of a “generational quality” business, I would need to feel comfortable projecting Apple’s future cash flows out 10, 20, or more years into the future.
New technology could quickly obsolete Apple’s entire business model. While this seems unlikely today, I think that many would have said the same about Nokia or Blackberry less than two decades ago.
I believe that Apple is unlikely to ever achieve a generational quality ranking for this reason.
- Personal experience owning numerous Apple products.
- Apple’s corporate investor website
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