The 3 Biggest Challenges Facing Apple

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Apple (NASDAQ: AAPL) has remained very profitable when compared to its performance since the early 80s. In particular, five years for Apple, 2004 to 2008, have been phenomenal, with 300% revenue growth, and profit increasing by 500 times. From 2009 to 2011, revenues, again, increased three fold. Much of its spectacular growth has been driven by the incredible success of the iPod, which was launched in 2001 and by 2007 had captured 70% of the US market for portable music players. In 2007, revenue from iPods and iTunes ($10.8 billion) exceeded that of Apple's traditional PC product offerings ($10.3 billion) for the first time, with all iOS device sales exceeding all Mac sales over the past 28 years in 2012.

Computer sales continue to remain important to Apple. In 2007, Mac sales grew at approximately 3 times the overall PC market and Apple improved their US market share to 8.5% (but worldwide share was still only 2.3%). Mac market share has continued to rise, while PC shipments have actually declined through 2011.

Nonetheless, Apple faces considerable challenges in each of its product categories and must make significant strategic initiatives, both in the short and long term, if it is to avoid a recurrence of challenges that it has faced in the past. Upon analyzing Apple's product strategy since inception, two notable issues stand out:

  1. Reliance on proprietary designs as opposed to relatively open systems that other manufacturers can clone, enhance or interface to. For example, in 1980 Apple lost significant market share to IBM's (NYSE: IBM) simpler PC with Microsoft's (NASDAQ: MSFT) MS DOS compatible software. Again, currently the bundling of Mac OS X operating system with Apple hardware, a combination that only Apple can offer. In contrast, the top three PC manufactures, Dell (NASDAQ: DELL)Hewlett-Packard (HPQ), and Lenovo all exclusively offer Windows and Intel (Wintel) based PCs that account for 80% of the worldwide PC sales.
  2. An excessive focus on styling and design at the expense of neglecting actual performance. For example, the Macintosh's slow processor in 1984 that led to IBM PCs dominance and then again Apple's decision to switch from PowerPC chips to Intel chips in 2006 due to poor processor performance. Further, the chips Apple is developing for its latest generation of iPods & iPhones do not compare favorably with Intel's x-86 micro-architecture.

The Macintosh Range:

A significant disadvantage that Apple faces by developing both the Mac hardware and operating system (OS) is that it competes with both PC manufacturers/assemblers including unbranded assemblers and an operating system developer - Microsoft that combined sell over 80% of all PCs. All major PC vendors such as Dell, HP, Acer, Lenovo offer PCs that run on a version of MS Windows.

Apple manufactures the Mac hardware and writes its own operating system - the latest version being the Lion OS X - and for the large part writes its own applications. Microsoft has over the past two decades focused on developing software; particularly operating systems, development tools, and cutting edge productivity applications such as Microsoft Office with newer versions of its major offerings every fewer years. The sophistication of its applications has kept pace with the increase in computing power offered by microprocessors developed by Intel over this same period. This situation, of late, has been somewhat offset with Apple introducing a Mac Apps store on similar lines as an app store for the iPhone, iPad, and iPod that permits independent developers to offer applications for sale.

Apple has focused on offering users a high-quality PC with an attractive hardware design and user interface, ease of use, relatively virus-free software and in-house applications. However, Apple Macs had a performance disadvantage until 2006 when it finally moved away from the PowerPC chip line to an Intel chip set that offered superior performance and reliability and was similar to what was used on the majority of the PCs sold worldwide.

Further, Apple is dependent on key Independent Software Vendors (ISVs) such as Microsoft for applications such as Microsoft Office. MS Office remains critical to its Mac offering and while it has received assurances by Microsoft to develop the Office for the Mac for another 5 years, Apple does not have a comparable Office suite in development yet. Further, there is a general lack of Mac software or apps available when compared to the plethora of software available for a Windows based PC.

iPhone:

The iPhone, though clearly cutting-edge, has seen its competition catching up with offerings such as the Samsung Galaxy, Blackberry Torch, HTC One X, & Nokia Lumia. Each of these offer advanced touch-screen capability similar to the iPhone and some utilize the latest 3G and now 4G network like the iPhone. These competitor phones run on closed platforms such as Windows Mobile OS or Nokia's Symbian OS as well as the Android open source platform. While iPhone's OS is considered to have advanced user interface technology compared to these other operating systems, one potential rival in the making may be Google's Android open source mobile platform. This platform does not differentiate between applications and the operating system. The implication being that it is completely free of charge, may be modified or improved upon or customized by any potential mobile handset maker, and unlike Apple's Appstore that charges for many applications, the applications developed and downloadable for an Android powered phone are entirely free. That said, Android operating systems do have significant security vulnerabilities that give Apple a distinct advantage for now.

Apple has core competencies in attractive product design, user-interface design, software design, development of horizontally integrated solutions and marketing. It gains its competitive advantage through product differentiation and often achieves this by developing "closed" proprietary solutions. Apple also tends to horizontally integrate to try and provide all associated products and services. This approach allows Apple to charge a premium for the integrated solution but it also limits the functionality of the product and forces Apple to provide solutions in wide ranging areas - some that are not their core competency. This approach, while profitable in the short-term, is likely to result in Apple struggling to compete against more open product solutions that can help to achieve lower unit costs and improved functionality.

Perhaps, more importantly, it remains to be seen whether Apple can replace Steve Jobs with someone as passionate, creative, and innovative as the late founder and CEO who can continue to keep it on the path of innovation that so characterizes Apple.


StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, International Business Machines, and Microsoft. Motley Fool newsletter services recommend Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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