Apple should be spending a lot more on research and development (Part Two)

Earlier, in part one of my post, I discussed how the smartphone market was beginning to saturate. In this post, I would like to explore in greater depth the consequences for Apple.

Since that publication, the research firm Gartner has noted declines in Q4 of 2018 and that Apple had the largest decline among the top five smartphone vendors. Huawei appears to be making gains. This is consistent with the idea that as a market becomes more and more mature, the market will become more difficult for the top end vendors to compete on features and consumers will become more price-sensitive. Huawei has heavily relied on affordable pricing, against both Apple and its Android competition, such as Samsung, which dominates the Android mobile space.

In other words, smartphones have become like desktop and laptop computers, only a bit younger than in the traditional product cycle.

 

 

While it is true that there is some innovation in the desktop and laptop space, it is not nearly as fast. Examples of innovation:

  1. Smaller process nodes for semiconductors may very well lead to faster and more efficiency in the space, but as discussed in the previous post, these will be subject to heavy limitations someday in how small transistors can get.
  2. We can expect OLED and other display technology to advance, perhaps resulting displays someday with near perfect contrast being affordable.
  3. CPUs, although they are using multicores and perhaps soon, chiplets, continue to advance in both single threaded performance, along with multi-threaded performance, albeit with limitations that prevent them from reaching the levels of improvement with each generation that they did in their heyday.
  4. GPUs continue to advance, and although the pace of improvement has declined, continue to improve at a rate faster than CPUs. They too with be limited by semiconductor scaling.
  5. Memory technology and storage technology also advance, with new memory and storage types (such as Resistive RAM) under development.

Smartphones are very similar in that regard. It is just that they are at the “peak of inflated” expectations” and on their way down to the through. There will continue to be advancements with each generation, although at a slower and slower rate.  In fact, smartphones rely on pretty much the same underlying technology that desktops rely on, only of course designed for a far lower level of power consumption. Note how many times I said there were limitations as to how good desktops could get.

Barring a major advancement, such as carbon nanotube transistors or room temperature “super semiconductors”, or the like, this is expected to continue for the foreseeable future.

So what are the implications for Apple?

Smartphones in that regard will become more like your refrigerator. There are small, incremental improvements of course, but the rate of improvement is far lower and well, you might just replace it when it dies, rather than say, when the next generation of model comes out.

For a company like Apple, which relies on its high margins and status symbol, that will be bad news. Apple is the classic case of a company that relies on its product differentiation. Apple controls the hardware, the software, and pretty much the entire experience of owning an iPhone, locked in with tight DRM.

Apple has resorted to planned obsolescence in an attempt to boost its sales and has aggressively lobbied governments against right to repair, in many cases, stopping such legislation outright. The primary reason of course is that they feel it hurts their sales, rather than for the benefit of the consumer, to whom this lobbying against right to repair is really hurting. A common example of this, which I have criticized in the past is the removable batteries in smartphones becoming extinct. Effectively, this means that Apple is resorting to planned obsolescence because they know that their next year’s iPhone simply lacks the appeal to entice the numbers of consumers that would in the past upgrade. They are also unable to mount a price war effectively against companies such as Huawei, who are willing to settle for far lower margins.

In the long run though, this is not going to work. The biggest reason why people won’t upgrade is because the latest version of the smartphone is simply not a good enough improvement to be worth upgrading for. This is not a problem that would be solved by planned obsolescence. Actually, it could backfire badly. Right now it is only a few geeks such as myself who have made this a big issue. If this becomes more publicly known, this could cost Apple a good deal of its reputation. The horde of fanatical Apple fans is one of the greatest assets that Apple has. If this becomes publicly known, Apple might see its reputation fall like other industries. They would likely be better off embracing right to repair in the long run.

The only other option would be to compete on price, which is something that Apple has historically avoided. Apple is in a position where it might be able to do this and in fact, Apple has already cut prices and resorted to incentives on the latest generation of iPhones, at time of this writing. On Apple’s side, they do have enormous economies of scale and their suppliers, most importantly Foxconn, do not make very high margins. In that regard, Apple is actually well equipped to compete more aggressively on price if they wanted to. Earlier I noted that Apple could not mount a price war. The main barrier is not ability, it is a question of, is Apple willing to settle for lower margins, and right now, that does not appear to be the case.

While true that Apple might be able to compete on the price front, and they have already began cutting prices, this would not result in the type of high margins that one would expect from a hyped company such as Apple. Lower margins would mean less available funds for future R&D and other projects. It would also mean that the stock, although it has already undergone a correction, is actually overvalued in that margins will actually decline going forward, rather than increase, as will the number of iPhones, along with the average revenue per unit.

Is there a way out?

Possibly, and I will  be exploring this in later parts of my series, so stay tuned.

The key conclusion though that one must draw from the existing market is that the status quo could very well lead to a painful correction for Apple. Smartphones now make up a very high percentage of total revenues and have matured. In the eyes of the public, it is no longer new and hot anymore. The improvements within each generation are shrinking and that gives less incentive to upgrade. For a company reliant on high margin product differentiation, this presents challenges that could lead to lower margins going forward.

Leave a Comment

Your email address will not be published. Required fields are marked *