Not a single day can go nowadays without the media elating about the skyrocketing trajectory of Apple’s stock price. The Cupertino, CA-based company seems to be breaking record over record. TV anchors get giddy when they report how the tech giant’s market cap has surpassed the GDPs of most developed countries on Earth. Many people realize that this rise has become a bubble. Some even dare to predict “doom’s day” when Apple’s stock will crash. However, not too many pundits have really tried to explain what drives Apple’s dominance, why it may be nearing its end (and why this is something completely normal to observe as part of any company’s business cycle). In this post, I’ll borrow from business theory to offer my slightly non-conventional perspective on Apple’s future.
Please note that this post is part 2 in my September 2012 trilogy, which also includes the following:
I hope you’ll read the other two posts, as well. But since you’re already here, why don’t you first learn how the “most valuable” company may also be very, very vulnerable.
The Bass model is a very useful tool for forecasting the adoption (first purchase) of an innovation (more generally, a new product) for which no closely competing alternatives exist in the marketplace. An important corollary of this model is that any product follows a life cycle. Even the most successful products reach their peaks at a certain point and then start declining in their appeal. Companies use this model not only to predict their future sales, but as an early warning of when they need to innovate in order to move on to the next Bass curve. For more information on this model, you can read this informative technical note posted on University of Washington’s web site.
I am going to borrow from the main premises of this model to show why I think Apple may be reaching an important milestone — i.e., the tipping point where the iPhone would reach its peak in terms of market appeal and will start its sun-setting trajectory.
Without diving into unnecessary technical detail, the Bass model stipulates that each product follows a predefined trajectory of adoption. Some products have very long lives — mainly because they are staples and related to needs that do not change very often. Other products are very dynamic and short-lived. As Prof. Ashwath Damodaran from New York University — one of the most prominent academics in Finance — states in one of his recent blog posts:
The iPhone has a short life cycle. […] Since the iPhone 4 came out in June 2010 and the iPhone 4S was introduced in October 2011, that puts about a two-year life cycle on the product. […] With a short product life cycle, a company is faced with two challenges. First, it has to come up with innovations to its product to retain its customers when the cycle is renewed, and that will require investment, especially during the later parts of each cycle. Second, even with these innovations, there will be customers who switch to competitors’ products (either because they are cheaper or because their innovations are more attractive) and for a company to maintain it’s market share, it has to get more of it’s [sic] competitors’ customers to switch to its products.
In short, the iPhone is no different from any other product out there. It has a life cycle. And its life cycle is relatively short — by dint of the dynamic industry that it represents. Apple has been employing two classic ways to “stretch” the Bass curve further out into the future. It releases iterations of the iPhone on a regular and relatively frequent basis, and it flexes its powerful marketing muscle to squeeze as much juice out of each iPhone version as possible.
Take a look at the illustrative graph below:
Through creative product versioning and aggressive marketing, a company can extend the life of a product. Eventually, however, a company needs to move on to a new Bass curve; otherwise, it risks losing revenue and thus shareholder value.
This is important for Apple because the iPhone has been the flagship product for the company. The iPhone accounted for 43% of all Apple sales in 2011, and its share is trending even higher YTD (as of the company’s third fiscal quarter in 2012).
One can argue that the release of the iPad in 2010 was an attempt to break out of the iPhone Bass curve and move on to a new one. However, despite all the hype surrounding the iPad, it accounts for only approximately 20% of the company’s sales. What is more important — three years into its product life cycle, the iPad represents only 50-60% of the slice of the pie that the iPhone commanded in its third year.
Moreover, the iPad’s average order value (as crudely measured by dividing total dollar sales by total number of units) has already fallen below the AOV for the iPhone.
Having shown that the iPad may not be (at least as of yet) providing a new Bass curve for Apple, let’s get back to the iPhone. Bass curve calculations can be fairly complex and require extensive research. Rather than spending too much time constructing a Bass curve on my own, I have decided to highlight one that a site, called Strategy Questions, has put together. Below is one of the Bass curves that the site proposes. For the full analysis, please visit the actual post.
Please keep in mind that that site’s analysis was done in late 2011 and long before the release of the iPhone 5. I don’t recommend blindly drawing conclusions based on this site’s analysis — the iPhone hegemony may be shorter or longer than the site predicts. I am just using this as an example of how even the “most valuable” company in the world has to follow the basic rules of product life cycles.
The two big questions that remain are:
Only time will tell us the answers of these two questions. On one end, Apple had demonstrated in the past that it can rise from the ashes like the proverbial Phoenix. On the other end, Apple had fallen in the Bass curve “trap” before — just remember the first Macintosh computer in the 1980s and how the company was on a precipitous trajectory to the cliff until Steve Jobs came back to the rescue and moved the company to the iMac Bass curve.
What is your take on this? I’ll appreciate your thoughts in the Comments section.
Quick Disclosure: At the time of writing this post, I do not own stock in Apple (and at its current price and given the Bass curve analysis, I do not intend to buy in the foreseeable future).