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

In this final part, I would like to discuss the other long term implications of research and development. Earlier, I explored how Apple was spending lots on stock buybacks and how their most important business line, the smartphone line was stagnant.

Apple has already increased its R&D spending by a considerable amount. In fact, it has risen by a great deal over the past few years. I believe this amount is far too low given the long term prospects of the business. In fact, they have a doctrine around this idea. However, Apple is now under fire for having little to show for their increased R&D, something I strongly disagree with. R&D is inherently risky, takes time, but if a company under-invests in R&D, then the competition will eventually take over the leadership role.

The next big thing

The big reason to spend money on R&D is on the next big thing. There will be something like smartphones that booms. It will be in a field that few people initially anticipated.

Spending a lot on R&D doesn’t assure that the company that spends a lot will be there first. In many cases, history is filled with failed companies that launched products that were well before their time that later became successful. This may be because the technology was not yet mature enough, the user base that would have become revenue generating customers was not there yet, or any number of other possible reasons.

Apple has an enormous amount of cash to work with here. Although R&D is often hyped up, the brutal reality is that most spending does not lead to commercially viable products. Most spending fails. This is like most startups. We may glorify the field, but the overwhelming probability of the future startup is to fail, rather than to be the next Google. Only a handful of startups can ever hope to become the next  Google. It is literally throwing ideas onto the proverbial wall in order to determine what will stick.

With truly breakthrough technologies, there is very little that is “obvious” about them when they are introduced, even though they may seem that way later on as they take off. Very few new technologies are “obvious” when they were emerging. There have also been many high profile failures of technologies that would “obviously” succeed. An example of a high profile failure may be supersonic aircraft. They were never able to take off and truly become successful because of the inherent difficulties in supersonic flight. An aircraft that is supersonic needs to have a very particular shape to minimize drag and that is not at all conducive to a profitable venture. Other issues such as sonic booms, radiation exposure from high altitudes, etc, were never truly resolved.

Historically, a lot of the breakthroughs that we have seen have come from government spending. This role of the government has not often been acknowledged. In fact, it is often considered a case where we have socialized the profits and privatized the gains. Likewise, many of Apple’s iPhone technolgoies are the progeny of government spending. Regardless of government policy and whether or not we as a society deserve a bigger slice of private profits when we taxpayers fund research that leads to profitable companies (I believe we do), we need to consider that other companies do not spend nearly what they could on R&D. We do not have anything quite like Bell Labs or other “blue skies” research facilities in our modern day society funded by either the private sector nor the government.

Apple needs to spend because as a company, Apple needs to be in a position where it can capitalize on the next big innovation. Apple as a company is simply ill equipped to fight in a market where the products they focus on are a commodity. It must rely on product differentiation. The closest to success where Apple does succeed in a mature market is the laptop and desktop market, where it uses product differentiation, in this case, its operating system, to compete against Windows laptop manufacturers with much lower margins. In fact, there are now rumours spreading that Apple will eventually leave Intel and the x86 architecture in favor of ARM.

Apple has spent a considerable amount of money on its A series of computer chips. They originally purchased the PA Semi company and poached some of the top talent in the semiconductor industry. This is why they have managed to build a CPU that is very impressive. This took a large sum of money and is a competitive advantage for Apple even today. It has also set things in motion for the possibility of Apple leaving Intel and x86.

Smartphones, tablets, and the traditional computers are long on their way to becoming commodities. There are record declining sales and no compelling reason for consumers to upgrade as frequently as they did in the past.

As of late, Apple has been pushing on services to address the decline. The question remains, can these services possibly replace the iPhone? There are already signs that the Chinese market may not be as easy for Apple as it seems.

In the long run, the company must deliver serious value to justify its premium

As of late, Apple has been criticized for its stock being a result of financial engineering through buybacks, as opposed to value.

Many years ago, when General Electric was at its peak, it was considered an icon and nearly indomitable. It spent an enormous amount of money on share buybacks. Today there are some analysts saying that GE is in serious danger of going bankrupt in a recession. The parallels with Apple may be striking, if you consider them. Right now Apple, even with its sales, looks almost indomitable. Yet it is spending enormous sums of money on buybacks. Ultimately, a company must add real value to its customers in order to justify its price premium, both in the stock market, and for customers. That by nature requires investment in the future, which is a difficult, and at times, uncertain thing.

That does not meant that Apple will end up like GE for certain, but it remains a risk. There is never an assurance that a company spending a lot on R&D will see a return on its investment. Yet it seems that following in the path of lots of share buybacks would be a big mistake and that a path of R&D spending to innovate to the next big thing offers a far more promising possibility.

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