Apple: The Potato Chip Effect Outweighs the Cannibalization Effect

By BA McKenna - July 13, 2012 | Tickers: AMZN, AAPL, GOOG, MSFT | 0 Comments

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You might be familiar with the saying, “You can’t eat just one potato chip.” Well, Apple (NASDAQ: AAPL) is the potato chip (or fill in your addictive food) of the consumer technology menu. Its competitors might leave consumers content, but most don’t delight or leave them craving more. Microsoft (NASDAQ: MSFT) and the others might be spuds, perhaps.

The results of this survey illustrate how Apple delights, the others not so much:

But before I focus on one key element of Apple’s success, let’s first look at the big picture.

Core of Apple’s Success

There are three core reasons, in my mind, for Apple’s domination:

1. Its innovative, best-in-class and aesthetically-pleasing products.

2. Its superior user-experience, from its products to its customer service.

3. Its willingness to cannibalize (or risk doing so) its own successful products.  

Our focus is on #3.

Eat or be Eaten

Steve Jobs, as per Walter Isaacson’s recent biography, has been quoted as saying:

“If you don’t cannibalize yourself, someone else will.”

Apple: Anatomy of An Eater

Apple's willingness to cannibalize (or risk doing so) its own successful products has been a huge factor in its success. 

Let's jump back in time. Apple is ticking along as a slow-growth company with just one notable product line, its Macs, for many years before it introduces the iPod in late 2001. In late 2004, the iPod becomes the dominant digital music player in the U.S., with its market share increasing from 31% in January 2004 to 65% in January 2005. Its market share continues to rise and hits 72.7% in January 2007.

iPod: Please don't eat me, iPhone!

By 2004-2005, Apple knows it has a winning digital music product on its hands, so what does it do? Unlike other companies that would try to ride the iPod wave for as long as possible (and/or perhaps expand into similar music-related products), Apple decides to enter the ultra-competitive cell phone market and -- at the same time -- risk cannibalizing sales from its iPod line by building a music player into its phone. 

The iPhone is released in June 2007. It's an instant hit, selling more than both Apple and analysts expect. Its market share in the U.S. and European markets steadily increases, while the market for smartphones themselves is also quickly expanding. So it's getting a growing share of a growing pie. 

Mac: Please don't eat me, iPad!

Not only is the iPhone riding high, but the success of it and the iPod have turned erstwhile PC users onto Apple products and spurred sales of Macs. So what does Apple do? Rather than just concentrate on continuing to penetrate the smartphone market and further stimulate sales of the Mac, Apple decides to enter -- heck, "create" -- the tablet market. Its iPad not only aims at the e-Reader market, created by Amazon's (NASDAQ: AMZN) Kindle, but also expands on that market by creating a product "between" a smartphone and laptop. So, Apple risks cannibalizing its MacBook. 

iPad: I know my baby won't eat me, well, maybe just a bite or two!

Now there is buzz about Apple's plans to release a smaller-screened iPad this fall. Surely, this mini iPad will take some sales away from the current iPad, but Apple is willing to risk doing so in order to compete head-on with smaller and less expensive tablets such as the Kindle Fire, Google's (NASDAQ: GOOG) new Nexus 7, and Microsoft's planned Surface. 

All bets are for this product to do what Apple products do best -- dwarf any cannibalization from an existing product by greatly expanding the market.

Cannibalization Can't Be Accurately Measured

It's impossible for a company such as Apple to accurately measure the extent of the cannibalization, primarily because its (likely) cannibalized lines were still growing. Who can know how many of those people who bought an iPhone would have bought a first -- or upgraded -- iPod had they not bought the iPhone? Consumer "what-if scenario" surveys are not very reliable. Surely, some cannibalization -- especially of the iPod -- occurred, but likely little. The iPad is almost an entirely different animal than a laptop, so cannibalization has likely been extremely small.

Big Chip, Little Cannibal

The market shares captured by iPods and iPhones led to no doubt that many iPod owners gobbled up iPhones. In chip terms, they couldn't eat just one. And there's no doubt that people watching the chip eaters eat started craving -- and munching on -- chips.

The extent of the cannibalization is just academic. The bottom line is the Potato Chip Effect has been much greater than the Cannibalization Effect. Hence, Apple's soaring revenue and earnings -- and stock price.

Kodak: Anatomy of an Eaten

Everyone's familiar with the once behemoth, now bankrupt, Kodak. And many know the King of Photography fell because it was slow to aggressively enter the digital camera revolution. It was complacent as the bulk of its profits came from film, not camera, sales. 

But I'd guess that many don't realize that Kodak actually invented the digital camera! Yup -- way back in 1975; over a decade before the first mega-pixel (high resolution) digital cameras for consumers were commercially available (1987); a decade-and-a-half before they became truly pocket-size (2000); and over two decades before the first cell phone with a camera was introduced (1997).

And get this kicker: Kodak actually manufactured Apple's (yup, Apple) digital camera entrée, which was early in the game (1994)!

Talk about   S      L      O      W.

Granted Kodak isn't an apples-to-apples comparison with Apple. Significantly, Kodak dwarfed Apple in size when the "Risk Cannibalization?" likely came up, among other factors. Nonetheless, Kodak's experience is still a good example of what happens when a company doesn't risk cannibalizing its own products.

Anatomy of the Eaten: The Visual

It looks like there was the 1997-1999 one-two punch, and then the final death knell, dealt by the iPhone (and perhaps other smartphones) in 2007.

 Bottom Line

• Buy stock in companies that are willing to cannibalize their own products.
• Sell your stock in companies that aren't willing to do so *as soon or very soon after* that becomes obvious. Had investors in Kodak, and Research in Motion, for that matter, done so, they'd have bailed while the stock price was at or near a high. 

Pass me a chip...or two or three.

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