If I were to meet with its third largest institutional shareholder, Warren Buffett, I'd tell him that he's made a bad bet on Apple (in which I have no financial interest).
The reason, I'd argue, is that just because the name of the company is the same, its strategy has changed for the worse under Tim Cook. And that shift in strategy translates into a low chance that Apple will be able to grow faster than investors expect.
I'd agree with Buffett that Apple has plenty of customers who like its products. Sadly for Buffett, Apple does not have a strategy for turning that "stickiness" into faster-than-expected revenue growth.
And that, after all, is what sends stock prices up. Conversely, the failure to do so sends stock prices down -- indeed that explains why Apple has lost $380 billion in stock market value since October 3 -- costing Buffett $19 billion, according to YahooFinance.
Before getting into that, let's review Buffett's Apple holdings. Berkshire Hathaway owns 5.32% of Apple shares -- behind Vanguard (7.14%) and Blackrock (6.23%). While Apple constitutes less than 3% of their holdings, it's a whopping 25.79% of Berkshire Hathaway's portfolio, according to Morningstar.
Why is Buffett's concentrated wager on Apple a bad idea? Tim Cook is replacing Apple's strategy of innovating its way to success with a strategy of milking a dying product.
Old Strategy: Innovating Your Way To Success
When I started my consulting firm 25 years ago, one of my first clients was a huge Asian telecommunications firm that asked me to investigate why some U.S. technology companies were able to survive waves of new technology and most were not.
Out of that project came my first book, The Technology Leaders: How America's Most Successful High-Tech Companies Innovate Their Way to Success. That subtitle was inspired by Steve Jobs who said "innovation distinguishes between a leader and a follower."
While that is a nice aphorism, investors care about how that idea gets translated into faster-than-expected revenue growth. The way Apple innovated its way to success was easy to describe and difficult to do.
Jobs targeted a large existing market and invented a product that consumers liked much better than the ones incumbents were offering. Jobs did this with MP3 players (iPod), cell phones (the iPhone), and tablets (the iPad).
Jobs also recognized that a killer application was an essential prerequisite to making hungry to buy the hardware.
To that end, he transformed the market for music and video by creating the iTunes store in collaboration with content products. And he did the same thing with developers of iPhone apps through the App Store. Apple sold that content at a very low price, gave most of the proceeds to the content providers, leaving minimal profit for the company.
Thanks to great marketing, Jobs was able to convince people to pay a premium price for the hardware. Through its world-class supply chain, created by Tim Cook, Apple was able to make that premium-priced hardware for a very low cost -- yielding gross margins north of 70%.
Jobs recognized that these industries went through life cycles. He would target mature industries and enjoy rapid growth in the Apple hardware he sold. Yet, he knew that this growth would slow as the market matured.
And he recognized that to maintain ite leadership, Apple would need to repeat this strategy of innovating its way to success.
New Strategy: Milking a Dying Product
Apple has stopped innovating at the same scale -- depending too heavily on the Chinese market for iPhones (now a 12 year old product).
To be fair to Cook, Apple has milked an extraordinary amount of growth from that product. Since taking over as CEO in August 2011, Apple has added $469 billion to its stock market capitalization -- up 187%.
While he has offered lip-service to the idea that Apple's next great innovation is right around the corner, most recently in this Jan. 2 letter to shareholders, Cook has taken abandoned Jobs's idea that Apple needs to innovate its way to success.
Here are the three most recent signs that Apple has lost its innovation mojo.
1. Playing Catch Up With iPhone Rivals
Apple's iPhone success attracted rivals. And those rivals are now ahead of Apple which is trying to play catchup.
At the Consumer Electronics Show in Las Vegas, Apple announced that it would develop an iPhone with three rear-facing cameras.
But that's not innovation -- Apple is just trying to catch up to rivals. In 2018, Samsung released the Galaxy A9 with four rear cameras and Huawei’s 2018 Mate 20 Pro and P20 Pro have three rear cameras, according to the Wall Street Journal.
What's more damaging to Apple's brand is that Apple is trying to copy a feature that doesn't matter much to consumers. Atsushi Osanai, a professor at Waseda University in Tokyo told the Journal
What we want from Apple is something that makes us emotional, even unconsciously—say, truly beautiful and sophisticated design that we can’t resist. Beefing up functional value, like expanding camera features, isn’t attractive because everyone else is doing the exact same thing.
2. Giving Away Its Killer App
Apple is abandoning its strategy of offering proprietary killer apps at cost to sell more of its highly profitable hardware.
To that end, Apple is partnering with other hardware makers to bring iTunes and Apple Music to competing gadgets, according to CNBC.
After failing to win market share with the HomePod -- its own version of Amazon's Echo smart speaker -- in November Apple announced a partnership to "bring Apple Music to Echo devices and let users control playback using Alexa," according to CNBC.
Samsung has convinced Apple to write an iTunes TV app based on Samsung's Tizen operating system. And Sony's new TVs run on Android -- enabling Siri to control Google software.
To be sure, Microsoft abandoned its walled garden strategy when Satya Nadella took over as CEO. In so doing, Microsoft was able to expand business demand for its Azure cloud services which have considerably boosted its revenue growth and stock price.
Can Apple really hope to make up for declining iPhone sales by selling more services? I don't think so.
In fiscal 2017, Apple generated about $141 billion in iPhone sales and nearly $30 billion in services revenue -- up 3% and 23%, respectively from the year before. If those growth rates continue unchanged, by 2026, services will surpass iPhone sales -- with $193 billion to $184 billion in 2026 revenues, respectively.
But I think this scenario is overly optimistic.
3. Suffering China iPhone Price Cuts
If Cook's strategy for milking the iPhone was right, you would expect Apple to be able to sustain its higher prices.
This matters most for investors is China where in the past, Apple derived a significant amount of profit from selling iPhones. But Apple is not holding its high price point -- consumers there can get more of what they want from Apple rivals at a much lower price.
So Chinese retailers are discounting Apple products. As CNBC reported, Chinese retailer Suning cut the price of the 128GB version of the iPhone XR 17% from $1,036 to $858.
That discounting is pervasive. "Sunion, an Apple re-seller, was advertising 700 yuan off for both the 128GB and 256GB versions of the iPhone XR. E-commerce site Pinduoduo, which allows third-parties to sell products, also had hefty discounts across all of the latest iPhone models," noted CNBC.
Jobs was right. Apple has to innovate its way to success. Cook can't. Buffett should take his lumps on Apple before it rots further.
