Apple Faces Life as a Mature Company

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Ever since Tim Cook took over as CEO of Apple in August 2011, he has faced pressure to replicate the leadership of late founder Steve Jobs in both product innovation and financial profitability. Now Cook is under renewed scrutiny: A new book on Apple due for release on March 18 explores the challenges he faces. Meanwhile, a report earlier this week from research firm Gartner showed that Apple has lost significant share in the tablet market.

Coming off a historic string of successes under Jobs, Cook and Apple are facing the harsh reality that no company can expect to continue innovating at a consistently high rate with ground-breaking new products, retain control of large market shares and provide high profit margins in the face of increasing competition. Apple, therefore, must evolve into a more mature company with realistic expectations. Cook is not Jobs: He brings different strengths to Apple including a frugal, methodical and performance-oriented style.

“Cook has been successful at keeping Apple’s profit machine going, and at the same time putting his own stamp on the company,” says Kevin Werbach, a Wharton legal studies and business ethics professor. “He’s done about as well as anyone could reasonably expect. Cook seems committed to focusing more than Jobs did on the good Apple can do for the world, without losing its intensity as an innovator and competitor. For that he deserves credit, and in the long run, that should help Apple maintain its position.”

On Wall Street, there are concerns about Apple’s slowing growth, and its potential impact on the company’s profitability and share price. Thus far, however, Cook appears to have acquitted himself well. Apple’s share price has risen from $369 (adjusted price) to around $527 between August 2011 (when Cook took over as CEO) and today — an increase of 43%. In that period, the firm’s market capitalization rose from $346 billion to $470 billion. Between 2011 and 2013, annual revenue grew from $108 billion to $171 billion, and net income grew from $26 billion to $37 billion.

Apples and Oranges

Is it really fair to compare Cook’s performance to the astronomical growth the company experienced under Jobs? “Steve Jobs is an icon, and he’s [gone]. Tim Cook cannot possibly live up to his legend,” Werbach notes, adding that after Jobs returned to Apple in December 1996 — 11 years after he was ousted from the firm he co-founded in 1976 — he took the company from the brink of bankruptcy “to the very top echelon of global firms in terms of market cap, revenues and profitability,” in just a dozen years. “Purely by the law of large numbers, Cook can’t do the same,” Werbach points out.

“Steve Jobs is an icon, and he’s [gone]. Tim Cook cannot possibly live up to his legend.” –Kevin Werbach

In the book Haunted Empire: Apple After Steve Jobs, to be released later this month, Wall Street Journal reporter Yukari Iwatani Kane wonders if Cook is up against the “sky-high expectations that Jobs had conditioned the public to have for Apple.” The company’s immense success was based on a record of delivering more than just good and reliable products, Kane writes in an excerpt from her book published earlier this week in the Wall Street Journal. The excerpt also includes the assessment that without a charismatic leader, Apple “will move from being a great company to being a good company.”

But is being a “good” company a bad thing? Did Jobs do the right thing for Apple by fostering a cult of personality around his leadership — and how will that affect the company’s long-term outlook? Kane writes that Apple is “trapped in the shadow of Jobs,” noting that the company’s management structure is unsuited for a post-Jobs environment, since it was constructed to play off Jobs’s unique strengths and compensate for his shortcomings. But Werbach is skeptical of any argument that starts with “Steve Jobs would have done [it] differently,” adding that “Because of his tragic death, there’s no way to know.” Werbach notes that one big strength Jobs had as a leader was that “he managed to get all the limelight, and still nurture a deep and exceptionally talented bench.”

Cook’s career at Apple is an example of that strength, Werbach says. “[Cook] is an extremely capable executive whom almost no one had heard of until the latter days of Jobs’s tenure, when he was groomed to be the new CEO,” he notes. “A company as massive as Apple doesn’t succeed just because of a few visionary leaders at the top; it takes great talent throughout the organization.”

Kane, too, acknowledges Cook’s strengths in her book: “Cook proved a methodical and efficient CEO. Unlike Jobs, who seemed to operate on gut, Cook demanded hard numbers on projected cost and profits. Whereas Jobs had reveled in divisiveness, Cook valued collegiality and teamwork. Cook was also more visible and transparent with investors.”

Yet Cook is leading a company that has a vastly different position in the market than it did when Jobs came back in the 1990s. “Apple’s culture is based on being the scrappy underdog,” Werbach says. “It grew up fighting big IBM and then big Microsoft, and moved on to confront big music companies, big Hollywood and big phone companies. Now it’s bigger than all of them.”

And now that Apple has reached the top, Cook is charged with keeping it there — no easy feat, according to Werbach. “It’s an unbelievably hard thing to maintain an innovative culture and execute successfully under those conditions,” he says. The markets Apple operates in are changing fast, and competitors like Google, Microsoft and Samsung “aren’t standing still, and they are all run by very talented people.” All eyes are now on Apple to see whether the company can follow its previous trajectory as a market disrupter with the expected unveiling of a new mobile payments platform, a wearable device such as a smart watch and the long-rumored “iTV” that Cook has said is no longer viewed as “a hobby” by the firm.

Market Adjustments

Some of those pressures to perform are evident in the latest Gartner data for the tablet market in 2013. The market share of tablets using Apple’s iOS operating system fell from 53% in 2012 to 36% last year, while the share of Android tablets rose from 46% to 62%. However, Apple was the biggest seller of tablets in 2013 at 70.4 million, up from 61.6 million units in 2012. Samsung posted the biggest growth in market share from 2012 to 2013, rising from 7.4% to 19.1%.

“Apple started with near-100% market share in tablets when it launched the iPad, so there’s only one direction it could go,” Werbach notes. “Over the long haul, market share isn’t the most important metric for Apple.” He says Apple’s iPhone is “far more profitable now,” even though it now trails Android in market share. “The market is far bigger, and Apple is able to maintain far higher margins than virtually all of its competitors.”

“It’s not that easy to run a great company, especially at the scale and in the markets where Apple operates.” –Kevin Werbach

While Apple has come under the scrutiny of shareholders who want the company to relax its premium pricing strategies to capture more market share in lower-priced segments, especially in emerging markets, Werbach takes the opposite view. “Apple could build a cheaper tablet, but why should it?” he asks. “Just look at what happened when it tried to create a cheaper iPhone with the 5c — it was one of Apple’s least successful products in years.”

Critics have panned the iPhone 5c for its reduced features compared to the higher-priced iPhone 5s. The iPhone 5s in the U.S. is priced at $199 when purchased with a contract from a cell phone service provider and $649 when purchased alone, compared to the 5c price of $99 on-contract and $549 off-contract. Walmart this week discounted the devices further, offering the 5s at $119 with a two-year contract with AT&T or Verizon and the 5c for $29 with a contract.

Exploring emerging markets is another key strategy for the company under Cook. Apple recently struck a multi-year agreement with China Mobile, the world’s largest cell phone services network with more 750 million customers. Since January, China Mobile has been selling iPhones through its network of stores. “China is an incredibly important market to Apple, and iOS devices already account for 57% of all mobile web browsing in China,” Cook said in his January call with analysts.

But Cook also stressed that Apple is not aggressively pursuing market share at all costs. “Our objective has always been to make the best, not the most, and we feel that we are doing that,” he said during the call.

John Percival, an adjunct finance professor at Wharton, advocates Apple taking a fresh look at its pricing strategies. “With the benefit of hindsight, their mistake was being too greedy in their pricing,” he says. “The margins were so high that they invited competition to spend whatever was necessary to clone Apple products because they could still undercut Apple on price and be profitable. Apple was able to
get away with it because they were able to come out with new products at the point where earlier products had been successfully cloned. Perhaps that was a combination of good new product development and luck.”

“With the benefit of hindsight, [Apple’s] mistake was being too greedy in their pricing.” –John Percival

Apple had to ensure that each new product was “even more spectacular than the one before” to maintain its growth rate, but that was not sustainable, Percival notes. He says the company probably should have priced its products “more conservatively to keep competition at bay and give themselves more time for new product development.” As companies become larger, it is impossible to maintain the same growth rate, he adds.

Growing Up

In the scenario that unfolded, Apple continued to be successful, but it was also maturing around the time Cook took over, Percival points out. Now, the company “needs to act more like a mature company.” One way Apple could do that would be to realize that it cannot use up all of its cash reserves, and that it “should be distributing more aggressively to shareholders,” Percival adds.

For shareholders looking to estimate the future value of their investments in Apple, the company’s much-hyped secrecy does not help. A news vacuum fueled by a multitude of rumors about Apple’s next move has further confounded attempts at accurately valuing the company. “We’re working on some things that are extensions of things you can see and some that you can’t see,” Cook told shareholders in January, according to a Reuters report. He added that he did not want to talk about Apple’s innovation pipeline for fear of alerting competitors. “You can see we’re getting ripped off left, right and sideways,” he said.

According to Wharton accounting professor Wayne Guay, Apple should be valued according to conventional metrics. “Share price and profitability are the key performance measures for Mr. Cook, or any CEO of a publicly traded firm,” he says. “Regarding a specific valuation for Apple, there is no real mystery. Certainly the current market capitalization as determined by market participants is the most obvious candidate for a reasonable valuation.” That valuation is based on the same thing as with every other company — the present value of expected future cash flows, he notes.

However, Guay recognizes the difficulties there. “The question then becomes one of constructing an accurate forecast of expected future cash flows. On that question, if you ask 100 people, you will get 100 different answers,” he says. “Those 100 answers — or in reality thousands of answers — get aggregated by the capital markets to determine Apple’s current valuation.”

According to Werbach, “Apple was just a great, but normal, company for most of the time Jobs was there, especially during his first stint.” He points out that few companies in history have done what Apple did over the decade in which it launched the iPod, the iPhone and the iPad. “It’s not that easy to run a great company, especially at the scale and in the markets where Apple operates.”

 

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