The Apple Powerhouse

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It's no surprise that Apple (Nasdaq: AAPL  ) crushed its fourth-quarter earnings estimate. The company delivered earnings of $1.67 billion, up 47% from last year on an earnings-per-share basis. To understand why Apple's crushed earnings predictions were no shock, take a look at the business model that telegraphed the punches behind what Apple called its most profitable quarter ever.

Think different
Apple's core competency is innovative design and technology. That's the spirit behind its famous "Think Different" ad campaign. Apple introduces products that truly wow the market. Think back to the Macintosh in 1984 -- the first affordable computer with a graphical user interface (GUI). Today, the iPhone challenges the definition of a phone, by combining a portable digital media player, Internet client, GPS navigator, camera, and ... um ... oh yeah, a phone. Not only does Apple wow consumers, but it changes the way we think about consumer electronics.

Buy different
Apple doesn't just want you to think differently about their products. It wants you to redefine the buying experience. Visit an Apple store, and you'd almost think that it was designed more to create a clubhouse for Apple enthusiasts than to actually sell the company's products. Consumers enter a store, check out Apple's new products, attend a workshop, and sit in on a presentation or in-store concert. Get immersed in the Apple culture, and when you're ready, Apple will sell you a piece of the experience to take with you. Microsoft (Nasdaq: MSFT  ) wants to create a similar experience with its own chain of stores. Good luck with that, Mr. Softy.

Lower the entry barrier
The real innovation of Apple's business model exposed itself when the company focused its core competencies on lower-priced products. Introductory Apple products like the iPod series have had great mass-market appeal, which directly addressed the perception that Apple only catered to high-end markets. Instead of cannibalizing its high-end products with lower-cost product offerings, Apple is capitalizing on an inverse effect.

The cash machine
Apple sold 3.05 million Macs this quarter, an increase of 17% year over year. This increase can be attributed in part to the halo effect, and partly to customer switching costs associated with Apple's iPod and iPhone customer base. Brand loyalty will keep growing as Apple continues to suck in the mass market through its introductory products.

In addition, more and more customers continue to purchase proprietary digital media and apps for Apple's products. As of September, Apple has sold more than 8.5 billion songs through its iTunes Store. On its latest conference call, the company also announced that users have downloaded 2 billion iPhone apps. How likely do you think these customers would be to ditch their proprietary Apple digital media and apps for a competitor's product?

Apple's business model is as innovative as its products. The company is a dominant force in the consumer electronics industry, but it still hasn't established a firm grip in global mobile market share. With competitors like Research in Motion (Nasdaq: RIMM  ) looking to strengthen their foothold against Apple, and Verizon (NYSE: VZ  ) and Motorola (NYSE: MOT  ) on the attack with their anticipated launch of the cryptic Droid smartphone, Apple will need to quickly increase its presence domestically and abroad to keep up its lofty growth rates. However, recent announcements that mobile carriers like Vodafone (NYSE: VOD  ) , Orange, and China Mobile (NYSE: CHL  ) will start carrying the iPhone are a good indication that Apple is priming its business for the rest of the world. If Apple's iPhone can succeed beyond the U.S., you can be sure that any market-share gains will spill over to fuel continuing growth in its Macintosh line as well.

At this point, I'm not betting against Apple. Let me know what you think by chiming in with a comment.

Nate McMahon does not own shares of any of the companies mentioned. Apple is a Motley Fool Stock Advisor selection. Microsoft is a Motley Fool Inside Value selection. Try any of our Foolish newsletter services free for 30 days.The Motley Fool has a disclosure policy.

Read/Post Comments (17) | Recommend This Article (22)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 26, 2009, at 3:10 PM, buhlenhoff wrote:

    I wouldn't bet against Apple either. They have products that people want, the operational discipline to build and deliver them profitably and loads of untapped markets. I expect another good year for Apple even with all the attention they are getting from the likes of Microsoft. In fact, I think all the Microsoft efforts only help Apple look better. The Windows Phone ads bring more attention to the category, but the Windows offering simply doesn't stack up. I don't blame Microsoft for trying, but they haven't proven to be innovators over the past 5 years.

  • Report this Comment On October 26, 2009, at 3:12 PM, joeyuknas wrote:

    The Apple powerhouse will again exceed estimates next quarter. The Christmas Season is coming and besides the likely gift buying of ipods/iphones, I'm fairly confident that there are many people like myself that will be buying the new Apple desktops and laptops. I have never owned an Apple computer so instead of dealing with Windows 7, I intend to switch to Apple.

  • Report this Comment On October 26, 2009, at 3:25 PM, magnym wrote:

    @ joeyuknas,

    I made the switch in 2003 and have never looked back--likely never will. Apple delivers in every way imaginable, from fashion to function. I have only known one person in my life who switched to Mac then switched back. Most people who switch to Macs are like me, lifetime converts.

  • Report this Comment On October 26, 2009, at 3:39 PM, RTFM2009 wrote:

    Apple Powerhouse will one day light the whole universe; its just matter of few more years and you will be able to control every thing from iphone, your cars, your home you name it.

    APPL long.

  • Report this Comment On October 26, 2009, at 3:54 PM, papamaui wrote:

    A friend encouraged me to switch to Apple when OS X was introduced ... and I've never regretted the move! I bought AAPL stock when it was $14.85 a share ... my big mistake was not mortgaging my home and buying a lot more!

  • Report this Comment On October 26, 2009, at 4:00 PM, accelerando wrote:

    Probably the strongest corporation since standard oil. If the government doesn't intervene apple will own the personal computer market, the cellphone market, the home entertainment market, the game platform market. And will have ridiculous pricing power because there will be few competitors. Does anyone honestly think that nokia or msft or dell or sony or nintendo or hp can possibly compete with apple over the long term?

    Only google has the smarts and the cash and the business model to be there with apple five years down the road.

    Look for valuations to triple or quadruple over that period.

    Trillion dollar company in 2016? Could be.

  • Report this Comment On October 26, 2009, at 4:23 PM, ztirffritz wrote:

    It is important to note that the iTunes music store no longer sells music in a proprietary format. It is in the AAC format now. It used to be protected with a proprietary copy protection mechanism, but that is no longer the case. Many players support AAC, including the Zune.

  • Report this Comment On October 26, 2009, at 4:43 PM, TMFMaynard wrote:

    Thanks for pointing that out ztirfritz. It looks like you can update your previous purchased iTune tracks to the none protected ACC format as well which I'm sure lowers the customer switching cost.

  • Report this Comment On October 26, 2009, at 7:18 PM, CMFStan8331 wrote:

    As a consumer, I'm too much of a free spirit to be willing to lock myself into Apple's proprietary world, no matter how nice and cozy it may be (I have considered the possibility of getting a Mac Mini just to play with...), but as an investor I have a great deal of respect for the company. They make sexy, gorgeous products that people really enjoy using. Steve Jobs has done an incredible job of resurrecting the company from the lowly position it had fallen to in the 90's, without compromising its original vision.

    I've been leery of Apple in terms of valuation, but given the obvious strengths of the company and the fact that it still has a vast area open to it in terms of expanding market share in the U.S. and abroad, I'm coming around to the opinion that its 32 P/E might actually be cheap...

  • Report this Comment On October 26, 2009, at 7:57 PM, gprovida wrote:

    A couple of minor points that may better inform view of Apple's competitive strategy:

    1. Apple uses the AAC voice standard developed under MPEG as an IP stable and improved codec. Any vendor of MP3 Players can use it.

    2. Apple used H.264 video codec MPEG standard [which has been adopted by BlueRay and DVD]. Apple worked hard to ensure reasonable licensing fees for streaming video from a community that is notoriously foolish in this regard.

    Apple does have a proprietary DRM Fairplay just like Microsoft, but has chosen not to license. They claim to secure the protection, but for DRM'd work e.g., movies and apps this also provides a defacto competitive advantage.

    However, I do not think Apple really thinks about it this,way, e.g., their support for DRM-free music. If a standard was adopted [and legal liability sorted out] or DRM was no longer required e.g, music, then I suspect Apple would drop DRM. I do not think they see this as their magic bullet for competitive success.

    I take Apple at their word.

    1. Identify a market where their brand of innovation can excel

    2. Bring out game changing services devices, etc. and drive costs down to provide little coverage for competitors for similar capabilities at lower price.

    3. Keep changing the goal posts so competitors are always 1-2 years behind Apple. [Ergo the interest in much complained about secrecy - copiers world wide would steal Apple's innovation before Apple can benefit.]

    It can be argued that Apple's big failure in late 80s and 90s [sans Jobs] was to forget #2 and try to milk high prices for short term gain. Upon Job's return that was turned around. Incidently, although doing better than analysts report the Apple TV remains a "hobby." Apple is not sure how to do #1 above nor anyone else.

    Regarding the "surprised" analysts just look at their track record over the last 2-3 years [or earlier] and observe that with rare exception they do not have a clue regarding Apple's basic market strategies or performance. Recall the sell MacOS like Microsoft, or iPod is doomed Nokia will do music, Apple retail Stores doomed look at Gateway, iPhone can't compete with established market leaders, and now Apple go cheap for Netbooks and get mangled like HP, Dell, and MS in bottom dwelling commodity space.

  • Report this Comment On October 26, 2009, at 9:28 PM, superintelligent wrote:

    All that said, no stock is worth 35 times its earnings. This bubble shall burst too!

  • Report this Comment On October 27, 2009, at 8:11 AM, swwil2000 wrote:

    Misinformed article... Apple rolled the iphone out in international markets several months ago. Also, as the previous commenters rightly point out, Apple does not utilize proprietary technology for their digital media.

  • Report this Comment On October 27, 2009, at 9:09 AM, hembreeder wrote:

    Stan says he doesn't want to be locked in to the Apple system.

    First, there are no locks. You can buy music anywhere for your iPhone or iPod. You can unlock your phone or buy an unlocked one. The Mac OS is more interoperable with other OSs than vice-versa. Windows does everything possible to lock you into non-standard programs and operations. Apple tends to adopt industrywide standards. Dozens of them.

    However, if you still feel locked in, being locked in to heaven wouldn't be so bad. It might keep you out of hell.

  • Report this Comment On October 27, 2009, at 10:20 AM, BodoBunce wrote:

    People need to stand back and really look at Apple as a company and what it's competitors are doing.

    Apple is strong, but they are not as far ahead as many think.

    Windows 7 is as good, if not better then any Mac OS that has ever existed. Speedtests done on various techsites show Windows 7 is not only faster in many day-to-day aspects of computing, but it manages it's resources better the greater the resources become. It's a fantastic OS.

    In the cellphone market you have Android. Android has matured a tremendous amount since it's inception. Almost all non-Apple companies are releasing, or testing phones using the Android mobile OS.

    The HTC Hero for example is arguably a superior phone to the Iphone, and it uses Android. The Motorola Droid, which also uses Android, from early impressions is superior to the Iphone as well, and has many features the Iphone simply lacks.

    When you look at Mobile computing, it is heading towards Netbooks. Something Apple still does not have. Netbook sales grew 250 percent last year, and dominated that of all Laptops, including those by Apple.

    What Apple does have is marketing. Their market campaign has paid off huge, and has started to convince the public their products are superior.

    When you actually get down to the bones of it, they aren't. The Iphone is dated, can't even run Multi-app. Their Laptops and desktops are half the performance of equivalent priced PC's. Windows 7 is every bit as good as Mac Os. They are not jumping into the Netbook market any time soon. The Ipod will eventually be replaced by cellphones and their other products such as Apple TV, and Time Capsule are complete failures.

    Apple is a fantastic company, but I urge people to look beyond the marketing at what everyone else is doing. Apple is over-valued right now.

  • Report this Comment On October 27, 2009, at 11:16 AM, JoeandChuckP wrote:

    Bodobunce - sure new and shiny may have things the iphone doesn't, but that doesn't mean it's better.

    Market acceptance picks the winners and losers, not spec sheets. Windows owns computing, even if Apple continues to grow. OSX won't be 50% marketshare, ever.

    Apple marketing shows its products and their value. sure, they have a premium brand, but that's because they have managed the ecosystem of their products. MS can't, nor can Google at this point.

    Further, Apple has been doing their own planned obsolesence with iPod for years. They will continue to do the same with other products.

    Last, you can't convince me Apple is overvalues. they have a rediculous amount of cash on their books. Strip that out, and their premium is a lot smaller than the PE would suggest. And this is in the middle of a horrible economy, and before Xmas.

  • Report this Comment On October 27, 2009, at 4:33 PM, Turfscape wrote:

    BodoBunce said:

    "Windows 7 is as good, if not better then any Mac OS that has ever existed."

    But, any competitor now needs to do much, much more than just 'catch up' to Apple. Apple is tops in customer satisfaction. People on a Mac or iPhone are not going to switch off Apple products just because Microsoft or Google now have something just as good or even better.

    Apple gained market share through innovation and focusing on the user experience. They are holding that market share by making that experience valuable and satisfactory for the user. So much so that they don't need to look for alternatives.

    So, even IF Windows 7 outperforms OS X.6, even IF Android does a little bit more than iPhone, it will most likely not be enough to cause people to change platforms. In the meantime, Apple continues to gain momentum and convert people who have been frustrated by their User experience with other devices and platforms.

    And, netbooks may be a hot topic around the watercooler...but who's raking in the profits with them? Why compete in a realm of such thin margin? Again, Apple will look to define what the user really needs in that arena and IF a need exists, they'll look to provide a tool that bests the others through user interface. That's their competitive advantage.

  • Report this Comment On November 05, 2009, at 12:15 PM, XMFHRFool wrote:

    Does anyone wonder what will become of APPL post Steve Jobs? He seems to be the force behind the magic and I just wonder what will happen to the company when that force leaves (again).

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