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Amazon (AMZN) reports disappointing revenues and profits and its stock soars 10%. But when Apple (AAPL) meets revenue targets and beats profit forecasts, its shares plunge by 12%. Why does Wall Street seem to love Amazon, but flee Apple? Amazon's low cost producer strategy is paying off; while Apple's differentiation strategy is losing ground.
On Tuesday, Amazon reported a 22% rise in revenue and a 45% plunge in earnings per share. On both measures, Amazon disappointed -- its fourth quarter revenues of $21.27 billion were $500 million below expectations and its EPS of 21 cents a share were six cents less than forecast, according to the New York Times.
So why did Amazon stock soar 10% in after-hours trading? It could be related to the increase in Amazon's profit margin. After all, its ratio of operating margins to consolidated sales rose from 2.7% to 3.2%.
And this increase gave investors a reason to believe that Amazon would finally realize the promise of generating a flood of profits from all the market share that it's been grabbing. Amazon's recent price/earnings ratio of 150 reflects investors love of this kind of story.
Meanwhile, Apple reported results that on the surface appeared better relative to expectations. After all, Wall Street expected a 2% profit decline and profit was flat at $13.1 billion while revenue grew as expected by 18% to $54.5 billion.
But Wall Street punished Apple shares. One reason could be that Apple sold fewer iPhones than expected -- 47.8 million iPhones compared to over 50 million that analysts had forecast, according to the BBC. Another could be that Apple's margins fell five percentage points to 38.6% as many customers opted for the less pricey older iPhone models and shunned the iPhone 5 introduced last September.
The underlying dynamics of Amazon and Apple have to do with what investors expect out of two opposite generic strategies. The two generic strategies are low cost producer (LCP) -- selling a product at the lowest price in the industry and squeezing costs below that level -- and differentiation -- selling a product at a higher-than-industry-average price and profiting by holding costs lower.
Amazon is a low cost producer. For example, it sold the Kindle Fire for $199 and it cost about $202 to make. Thus Amazon was losing money on the Kindle -- likely with the idea that this low price would help encourage people to buy its e-reader -- yielding higher market share for a platform on which Amazon might be able to deliver content and commerce to consumers.
Meanwhile Apple has been a differentiator. For example, last September, the iPhone’s price was 44% higher than the Nokia (NOK) Lumia. And this yielded Apple a whopping 71% gross margin — compared to Nokia’s 54%.
Consider the comparison of the prices and bill of materials cost for the iPhone 4S and the Nokia Lumia 900. According to iMore, the iPhone’s price was $649 while the total cost of all its components — an incomplete cost measure — was $190; whereas the Lumia 900 sold for $450 and its parts cost $209.
How does this help explain why Wall Street loves Amazon and not Apple? Investors buy Amazon stock because they know that its LCP strategy will help it gain market share despite the thin margins. And they hope that someday, Amazon will start to use its market dominance to take more profits. Amazon's higher operating margin in Tuesday's report suggests that this dream could come true.
By contrast, Apple proved in the past that it could reap huge hardware profits by attacking a big market with a new product for which customers would pay a price premium. Apple did this with the iPod in MP3 players, the iPhone in cell phones, and the iPad in tablets.
But Apple's January 23 results demonstrated that Apple is losing its grip on the high margins that its differentiation strategy formerly yielded. That's evidenced in the willingness of more customers to pay less for older iPhone models because the iPhone 5 was not enough of an improvement.
Moreover, it's been about three years since Apple introduced a new category killing product for which millions of people were willing to pay a price premium. If Apple does this again, its stock should soar.
But for now, Amazon is the one that's starting to deliver on the profit promise of a successful LCP strategy while Apple's differentiation strategy is showing signs of losing its luster.
And as long as that's the case, Amazon stock will rise; whereas Apple's will fall.
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