Will Slowing Growth Take a Bite out of Apple?

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David Hsu and Murillo Campello discuss Apple's future.

Apple’s slowing growth in the sales of its flagship iPhone and similar projections for its revenues and profitability have riveted focus on the company’s fundamental drivers. The top concern is whether the loyalty of Apple’s customers and their allegiance to its “ecosystem” — or its so-called “walled garden” of products and services — are being tested by lower-priced competitors and more flexible technology platforms like Android. According to experts, the Cupertino, Calif.-based company needs to recast its global strategies, especially those for emerging-economy markets, become less risk averse in innovation, and accept the reality that maturing corporations cannot sustain high growth rates and market domination forever.

In the latest quarterly results that Apple announced on January 26, the company reported the slowest growth in sales of its flagship iPhones since their launch in 2007. Sales of iPhones, which account for about two-thirds of the firm’s revenue, grew 0.4% to 74.77 million phones compared with the same period a year ago, missing analyst estimates of 76.54 million phones. It also projected the slowest revenue growth in 13 years for the current quarter to between $50 billion and $53 billion, against analysts’ estimates of $55.6 billion. Profitability is also weakening, with gross margins pegged lower than analyst estimates of 39.97%.

Threats from ‘All Directions’

“New adapters coming to the market are not [all] going to Apple; if anything, [they are] switching away from Apple,” said Murillo Campello, management and finance professor at Cornell University’s Samuel Curtis Johnson Graduate School of Management. Competition from Apple’s rivals “is global; it’s coming from all directions,” he said. For example, consumers in South America are switching to Samsung’s phones, and in China, where Apple makes most of its sales, people are switching to cheaper domestic smartphones.

“Maybe [Apple is] failing to understand that local markets … have their own needs, and Apple may not be able to be this one-size-fits-all product in all markets,” Campello noted. The company “needs to think deeply about what [it wants] to achieve in the new economy,” he added.

Sales of Apple Watch, the company’s smart watch, are also below expectations, according to market reports, although Apple has not released those numbers. That indicates a threat to Apple’s ecosystem, according to Wharton management professor David Hsu. “The bet is that once you get users on one part of the ecosystem, they will be friendly to the remainder of the Apple ecosystem,” he said. “[That has] not played out as nicely as the company would have wanted.”

Hsu and Campello discussed Apple’s challenges on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

The threat to Apple’s dominance “is global; it’s coming from all directions.”–Murillo Campello

Wharton marketing professor Peter Fader, who is also co-director of the Wharton Customer Analytics Initiative, does not perceive a threat to Apple’s ecosystem – as yet. “I wish there were a serious threat to the Apple walled ecosystem — in general, it’s bad for consumers,” he said. “But consumers don’t realize this, and they seem happier than ever to have their choices limited by what a handful of people in Cupertino tell them. So, I don’t put much weight in the warning signs that seem to be emerging.”

Unsustainable Growth

Apple has to come to terms with the reality that its high growth rates are unsustainable, according to Wharton adjunct finance professor John Percival. “The basic problem is a lack of willingness to accept the mathematical and economic inevitability of a slowing in the rate of growth as entities get large,” he said. “They can continue to grow, but the rate will slow down.”

Percival said Apple was “superb” at staying a step ahead of competitors who would inevitably clone its products, by constantly innovating. “However … to maintain the same rates of growth meant that each innovation would have to be bigger than the one before,” he added. “That could not continue forever.”

Apple is a victim of its own success, suggested Wharton professor of legal studies and business ethics Kevin Werbach. “Apple’s challenge is the law of large numbers Twitter ,” he said. “How do you keep growing and raising profits when you’re already by some measures the most successful company in the history of capitalism?”

Werbach said it is striking that Apple’s future is being questioned after it posted a quarter with $18 billion in net profits and continued domination of the smartphone market. “Only 10 countries in the world have foreign exchange reserves greater than Apple’s cash on the books,” he added. Apple had more than $215 billion in cash reserved at last count.

“No company can grow and dominate forever, especially in fast-changing technology markets,” said Werbach. He noted that Apple’s “hyper growth” in recent years has also been inextricably tied to China, both as a manufacturing source and as a massive consumer market. “The current instability in China, and concerns about its sustained growth, are bound to affect Apple’s prospects in the short and medium term,” he added. “Even if China disappeared, however, Apple would still have a fantastic business.”

New Threats

Hsu said the slowing growth of iPhone sales and Apple’s inability to gain traction for the Apple Watch is causing concern in the investor community. “Much lower-priced Android devices can achieve the same functionality [as Apple devices],” he added. “Consumers are looking at that stark difference.”

Hsu noted that such a situation is problematic for a company that counts on customer loyalty and premium pricing. Investors may be looking at the decline in iPhone sales growth “as a prelude to a possible tipping point downward for the company.”

“Consumers … seem happier than ever to have their choices limited by what a handful of people in Cupertino tell them.”–Peter Fader

Against that backdrop, Hsu said he expected Apple to think more broadly about its global strategy and its positioning vis-à-vis much lower-priced handsets and platforms. Campello added that Apple also needs to revise its strategies especially for the Chinese market. “It is likely that six months from now, [Apple’s sales in China] won’t be as good, just because of [problems facing the] economy and the strength of the dollar. You can’t produce magic with the same phone, unless they come with a disruptive innovation, which they have failed to deliver.”

Younger customers want flexibility along with low prices, according to both Hsu and Campello. “The idea of being able to customize, tinker, build their own [device] tailored to their interests and tastes [appeals to] the younger generation,” said Hsu. “There, the value proposition, or the brand image, of Apple is less compelling, especially if it is priced at such a premium.” Added Campello: “The new generation wants more customization and lower price — Apple is not in a position to offer any of that.”

Overstated Fears?

Fader agreed that Apple needs to reshape its innovation strategies to cater to lower-priced smartphone markets, especially in China and India. “But this isn’t the first time that Apple appears to have reached a plateau in [its] innovation efforts — and we’ve generally been wrong,” he pointed out.

Apple CEO Tim Cook certainly sees needless alarm over the latest results. “We don’t live in 90-day quarters, and we don’t invest in 90-day quarters,” he told the Wall Street Journal after the results announcement. “I’m so convinced that the things we are doing are right and the assets we have are enormous.”

Werbach said it is natural for questions about Apple’s continued growth to arise as the smartphone and tablet markets mature, and with the continued uncertainty about the scale of newer market categories, such as the smart watch and connected TV.

Yet, Apple happens to be phenomenally successful, Werbach noted. “There’s no Steve Jobs anymore as the magical wizard orchestrating everything, but it’s important to realize that Tim Cook heads a company far more powerful and dominant than Jobs ever did,” he said. “Apple under Steve Jobs had an impact far beyond its financial scale, but Apple today has financial scale that only a handful of corporations in the world can match.”

“How do you keep growing and raising profits when you’re already by some measures the most successful company in the history of capitalism?”–Kevin Werbach

What Should Apple Do Next?

The big long-term challenge for Apple is “the gradual migration from hardware to software and services,” according to Werbach. “Apple has so far been the one extraordinary exception that proves the rule of hardware commoditization in IT and communications,” he said. “Its operating system software is extraordinary, but its application software isn’t at the same level. As it moves into unfamiliar markets such as cars and virtual reality, where it may not have a natural advantage as a hardware designer, software innovation will become increasingly critical.”

Growing too big could bring its own set of problems, Werbach noted. “Apple’s scale now becomes one of its biggest advantages but also potentially an albatross. Apple may be the only company that can put 800 people to work on a smartphone camera, as it reportedly does for the iPhone, but the story of the tech industry has always been one in which nimble upstarts overcome incumbents with far greater resources.”

According to Fader, “Apple should start to shift — gradually and cautiously — away from its purely product-centric mentality towards a more customer-centric strategy.” While there might be some upside in doing so, “it’s not something that should happen overnight or even in the foreseeable future,” he said. “For now, they’re doing just fine — even with young people – but they should not be too complacent.”

“As with IBM, Microsoft, Google and other dominant tech titans, Apple perennially faces the question of whether it has a next act,” Werbach said. “The iPhone business took Apple into the stratosphere of global corporations, and it’s incredibly difficult to find another opportunity of that scale.”

Hsu said the time is opportune for Apple to unshackle its innovation approach. “You need to branch out and take some bets,” he said. “It is a good time to do that — not in a moment of severe crisis, but one in which you have the latitude to finance these different experiments, whether it is internal to the company or through partnerships.”

Apple could also benefit by becoming less risk-averse in innovation, according to Hsu. “Apple has [$215 billion] in the bank and it doesn’t have to be so conservative and controlling,” he said. He observed that Facebook and Google parent company Alphabet are “much more forward-looking in experimentation” on future drivers of growth. “Apple has to be willing to dial back a little bit on the control aspect, which is the legacy of Steve Jobs … [and] not be so afraid of experimentation.”

As for Apple’s famed secrecy over the work underway in its labs, Fader noted: “When it comes to innovation, per se, it’s OK to keep it quiet. But there’s a separate issue: Apple is pretty bad at using its customer-level data effectively. That’s why they push for strong privacy laws, etc. — so that they can try to limit the tremendous advantages that the other members of the “Big Five” (Google, Facebook, Microsoft, and Amazon) have over them. This disadvantage for Apple could really hurt them.”

“[Apple] has to be willing to dial back a little bit on the control aspect, which is the legacy of Steve Jobs … [and] not be so afraid of experimentation.”–David Hsu

Maturing with Grace

Percival pointed to a broader question in the debate over why Apple’s growth slowed down. “The question is how did they keep it going as long as they did? I think that part of their problem will be the culture of Silicon Valley,” he said. “The strength of Silicon Valley, which is a passion for innovation, produced incredible growth companies but can become a problem when maturity sets in.”

“Apple and Silicon Valley have had a disdain for companies such as Microsoft and IBM who have tried with some success to gracefully manage maturity through an increased focus on good strategy execution,” Percival continued. “Apple has a disdain for Samsung because their success has not been primarily innovation but rather strong execution. Silicon Valley companies such as Hewlett-Packard have not gracefully managed the transition.” He added that large companies “must accept the inevitability of maturity, but they can postpone decline by a strong focus on execution.”

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