Former Apple CEO John Sculley and Erik Gordon from the University of Michigan discuss Apple's $1 trillion market capitalization.

Consumer electronics giant Apple is finding itself in a whole new race after last Thursday, when its share price rose to $207, making it the first U.S. company to cross $1 trillion in market capitalization.

As Apple and its CEO, Tim Cook, set their sights on the future, experts from Wharton and elsewhere point out that the company does face some challenges: Apple’s smartphone sales have slowed (although margins have gone up); it has no big-bang product around the corner, notably in augmented reality or artificial intelligence (AI); its R&D investments are lagging; and its next big leap may take place under a different CEO.

Meanwhile, other tech giants such as Amazon, Google’s parent Alphabet and Microsoft are close runners-up in the trillion-dollar race, heralding a new era of large, cash-rich companies. Platforms and ecosystems are critical to success in the next round, and some predict that Amazon looks poised to become the first $2 trillion company, especially with its ability to seemingly enter any industry it chooses to.

Credit Where It’s Due

At least the first $500 billion of Apple’s market cap should be credited to the firm’s previous CEO, the late Steve Jobs, according to John Sculley, who was CEO of Apple from 1983 to 1993. During a recent interview with the Knowledge at Wharton show on SiriusXM, Sculley recalled his first meeting with Jobs at Apple in 1982: “[He] was thinking about something that nobody else in the high tech world thought was even important — he wanted to build a personal computer, because he thought the future of computing was going to be for non-technical people to be able to have something easy to use [to] do all kinds of amazing, creative things…. Those foundational principles that Steve created way back in the early 1980s are still the foundational principles that Apple sits on today.”

He then gave Cook “a lot of credit for the next $500 billion,” and explained why: “He came up with a strategy for loyalty with shareholders that is incredibly powerful, just like Steve came up with a strategy for loyalty with consumers.”

That said, “Apple doesn’t have a next act that we’re aware of after the iPhone,” said Sculley. “Steve Jobs had the brilliance to realize that you could do photography in an entirely different way with a handheld device, and that you could send photos to another device. And that led to all the things we [have today]. The question is, what comes next?”

“If we believe that design is not going to be enough, and deep tech is going to be a differentiator … Apple should speed up its investment in R&D.”–Gad Allon

According to Sculley, Cook is probably right when he said in an earnings call last year that augmented reality will be the next big area of action in consumer technology. He noted that from the standpoint of shareholder value, Apple may not need a blockbuster product anytime soon, “but it is going to need it in maybe five or seven years” — when AI, augmented reality and “other foundational things that will probably be part of what comes next after iPhone will happen….”

At present, Apple lacks “a significant depth or innovation in the areas that are going to be significant in the future,” noted Wharton professor of operations, information and decisions Gad Allon. Apple is lagging in AI and AI-based products such as Siri, and sales of its HomePod speakers are slow, he added. “If we believe home and TV are the next battle, Apple has not figured out these, and if we believe mobility — or car as a platform — is the next battle, Apple is losing there as well.”

Apple has been lagging in its R&D investments as a percentage of revenues, behind its competitors including Amazon, Google and Samsung, said Allon, who is also director of the Jerome Fisher Program in Management & Technology at the University of Pennsylvania. This is notwithstanding the fact that Apple has increased its R&D investments significantly over the last few years, he added. “If we believe that design is not going to be enough, and deep tech is going to be a differentiator in some of these key areas, Apple should speed up its investment in R&D.”

Erik Gordon, a professor at the University of Michigan’s Ross School of Business who joined Sculley on the Knowledge at Wharton radio show, agreed that augmented reality will be the arena for the future of consumer technology. “It’s going to be fabulous, and it’s going to be very cool, but I don’t think it’s in Apple’s next product cycle,” he said. “But keep in mind that Apple has good technology capabilities and they have more cash probably than the U.S. government to invest. They can keep shareholders happy over the next four or five years – they can just keep them happy with stock buybacks; they have so much cash.”

A Wartime CEO

Gordon said that he sees Apple as a contender in the markets where AI and augmented reality will reign. “Apple will be a player in the next round,” he predicted. “But it might be a new CEO because it’s not Tim Cook’s strong point.”

Tim Cook is a “peacetime CEO,” according to Allon. “He got the firm in very good shape with a deep, innovative product line, and his main role has been executing the plan. He has a great user base that is absolutely addicted to Apple’s products. Tim Cook has done pretty much what he needed to do to deliver on this.” That said, Apple’s next CEO “will have to be a wartime CEO — one that is getting a few depleted cash cows with the need to recreate the next innovation.”

“[Augmented reality is] going to be fabulous … but I don’t think it’s in Apple’s next product cycle.” –Erik Gordon

The task for Apple’s next CEO would be significant, Sculley said. “I wouldn’t want to be the next CEO coming in after Tim Cook, because the next CEO is probably going to have a very challenging strategic set of issues over the next four, five, six or seven years —  eventually this model will be a challenge because there [will need to be] innovation.”

If Apple fails to seize the moment and gain leadership in augmented reality or another new technology, some other company will, Sculley said. “As AI and machine learning become more and more integrated into everything, [the next leader] will be [a company] like Google, which has clearly invested incredible amounts [into] R&D and great talent. Will they be able to productize it better than Apple? The next CEO who follows Tim Cook is going to have to focus on those kinds of issues.”

Amazon Closing In

Gordon pointed out that Amazon has performed better than Apple on the stock markets. “Amazon actually in some ways has a better market cap growth story; its market cap now is somewhere around $890 billion, which is about 90% of Apple’s,” he said. Seven years ago, Amazon’s market capitalization was only a third the size of Apple’s market cap. The pace at which that has grown clearly makes it “the rocket ship” in market cap growth, he added. Other large technology companies are close, such as Alphabet with a market cap of nearly $870 billion, and Microsoft with $830 billion, he noted. “So we have a group of really large new-generation companies.”

Gordon did not see any natural limit to how large those companies could become. “They have their fate in their hands,” he said. “As long as they creatively reach out and do new things, I don’t know why [$1 trillion] would be a ceiling. For example, Amazon, which seems to be willing to try almost anything — how to put a cap on them?”

Amazon is Sculley’s pick for the next big winner. “Apple may be the first $1 trillion company, [but] Amazon probably is a more likely candidate to be the first $2 trillion company,” he said. “I would agree with [Gordon] that Amazon has been able to invent line of business after line of business after the line of business. I think Jeff Bezos is the most competent CEO in the world right now, and it doesn’t look like he has any intentions of slowing down.”

“Jeff Bezos is the most competent CEO in the world right now, and it doesn’t look like he has any intentions of slowing down.”–John Sculley

Apple’s Strengths

Apple put up a strong show in its latest fiscal 2018 third-quarter earnings report last week, posting a 40% growth in earnings per share and a 17% growth in revenues, year-over-year. Gordon parsed those to highlight some trends that underscore Cook’s contributions. For example, he noted that revenues have grown smartly although smartphone sales growth was almost flat in the third quarter. “Their success has been getting people to buy more expensive phones, so the average selling price has gone up,” he said. He noted that the ability to sell $1,000 phones may have seemed far-fetched five years ago.

Apple has also been vastly more profitable than others in its industry, Sculley said. “Apple only has 15% of the physical smartphone market, but it’s got about 95% of the profits in the smartphone ecosystem,” he said. “Apple is leveraging its ecosystem — a consumer experience so good between the different devices — and leveraging that service revenue.” At the same time, smartphone users have slowed down their pace of upgrading their devices, said Sculley. “We haven’t seen the replacement cycle [being] as rapid as it’s been in the past.”

According to Sculley, Cook has done “a very good job” building shareholder loyalty. “He does it because he has 10 times as much cash ($285 billion as of December 2017) as Amazon does. He’s buying back stock — about $100 billion this year. They give a big dividend. They don’t try to be the innovator of what’s coming next and take risks. They trail innovation by a couple of years. So the iPhones don’t necessarily have the latest new technology, but they do a really good job when they deploy it and they do it at scale.”

Apple has also in recent quarters increased its emphasis on services, said Gordon. Although services form a small part of its revenues and profit, they tend to have high profit margins, he noted. In recent earnings calls, the company has encouraged equity analysts to focus also on that part of its business. He pointed to one survey, which showed that 38% of a sample of 1,000 iPhone users had additional iCloud storage; about 18% stream Apple Music — about the same number of iPhone users that stream Spotify — and about 23% buy AppleCare protection plans for their devices. However, Gordon did not expect the services push to compensate for the next blockbuster product. “They will need something else to regenerate growth after they’ve bought back all the stock they want to buy back,” he said.

Allon is convinced that “Apple has been, and will be, a product firm.” He said the services are used to help and sell more products, and gain a bigger share of the wallet from existing customers. “But Apple makes money by selling better products than any other firm,” he said.

“The big question is: What’s the next category of products — Home? Car? Augmented reality? Apple is trying to play in all of these, but we have not seen a game-changing product yet….”–Gad Allon

According to Allon, Apple’s “only truly innovative product” in recent years was the Apple Watch; the HomePod was “too late to the market,” and although the iPhone is doing well, that is not where growth will come from. “The big question is: What’s the next category of products — Home? Car? Augmented reality? Apple is trying to play in all of these, but we have not seen a game-changing product yet there from Apple, and it is definitely losing ground.”

Platforms over Products

Platforms will be more important than products for the next tech leader, according to Sculley. “[It’s] being driven by all kinds of new innovations — in drones, in precision medicine and robotics. All of these are opening up huge opportunities to completely re-imagine what industries will be like. The most fundamental to all of them are the business architectural platforms. Apple obviously has an important platform, but so do a lot of other companies.” With more and more innovation occurring in the platform space, he saw “the opportunity for more Apples, more Amazons, more Microsofts over the next decade.”

Scanning the future for the smartphone market, Sculley said he expected the industry to become more and more commoditized. Chinese companies are likely to have an edge in that scenario, because of the speed at which they are able to scale production, he added. “We don’t know how to scale a business that fast in the U.S. So there are going to be different ground rules for creating these extraordinary, successful companies in the future that are different than the models that we’ve used in Silicon Valley up until now.”