The Biggest Threat to Apple

Tim Cook has been celebrated as the supply chain genius who built the foundation on which Apple (Nasdaq: AAPL  ) can build its innovative products. His guidance has cut down lead times, locked in suppliers, and made sure Apple's innovative products remain on shelves even in the face of extremely high demand.

Cook has done this, primarily, by outsourcing most of Apple's production to overseas companies, notably Foxconn, and closing down Apple's manufacturing plants. This does a few things for Apple. It allows the company to preserve capital, which would have to be used to buy equipment and hire workers if it did its own manufacturing. It also leaves most of the manufacturing details to these suppliers, allowing Apple to focus on what to build and less on how to build it.

Therein lies the problem
Building your supply chain in this way can be extremely effective for a lot of companies and is used for most of the electronics we use today. But the problems it creates are starting to rear its ugly head.

When you send manufacturing to other companies, you have to teach them how to make what you make. If you want to build a great competitor, there's no better way than to have your competitor build your products.

This week, it came out that Samsung was the only supplier that has been qualified to make screens for the new iPad. That has been disputed, and LG Display (NYSE: LPL  ) may be a supplier as well. The point is, this is the same Samsung that is actually stealing market share from Apple in the Chinese smartphone market and makes arguably the best competitor here in the U.S. Since the third quarter, the gap in Chinese market share between Apple and Samsung has grown to 26.8 points, with Samsung commanding 24.3% of the market and Apple holding 7.5%.

What's to keep Foxconn or even a few employees from Foxconn from taking all that they've learned building iPhones and iPads and starting their own companies? That's how Lenovo and ASUS, two of the largest PC makers, got started.

We've seen it before
Remember when Gateway, Compaq, HP (NYSE: HPQ  ) , Dell, and IBM (NYSE: IBM  ) dominated the PC landscape? One of the reasons they lost control of manufacturing was that U.S. companies began outsourcing production to companies abroad, teaching them how to make their products. The more production that moved over there, the more those companies learned how to manufacture computers on their own.

ASUS was founded by four ex-computer engineers at Acer, and one of Lenovo's first successes was a circuit board made for IBM. Less than 20 years later, Lenovo would purchase IBM's PC business when the company decided it no longer wanted to compete in the low-cost PC business that China was starting to take over.

As a result, two of the top five PC companies today are Chinese, and most PC makers outsource at least some manufacturing to China.

Keep it in-house
When I worked as an engineer at 3M (NYSE: MMM  ) , this transfer of intellectual property to suppliers -- and even other countries -- was a major concern. It's one of the main reasons manufacturing for some of 3M's most valuable films remains within a short drive of 3M's headquarters to this day. Instead of moving product manufacturing to China, Singapore, or Malaysia -- where costs are lower -- the company recognizes the value of keeping it in-house and in-country.

Apple took a different approach, outsourcing its production and transferring that intellectual property to competitors and countries that have a history of stealing good ideas.

What this means for Apple
You could argue that Apple's biggest competitive advantage is its products' ease of use and how seamlessly they work together. This isn't something competitors will be able to steal by making Apple's products, but their devices may improve by learning a few things from Apple. Samsung has clearly become a major competitor in both the smartphone and tablet spaces, while also manufacturing Apple's key devices in the same categories. Many argue that Samsung's own products are probably equal in quality.

The threat to Apple may not be imminent. It took 15 to 20 years for the PC market to turn itself over to China. But it is a cautionary tale. Now that Apple is such a big target, competitors will be doing everything they can to replicate its success. If those same competitors are the ones actually making Apple's product, you know they're not far behind.

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Fool contributor Travis Hoium manages an account that owns shares of Apple. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple and 3M; creating a bull call spread position in Apple; writing covered calls on Dell; and creating a diagonal call position in 3M. 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.


Read/Post Comments (9) | Recommend This Article (25)

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  • Report this Comment On March 15, 2012, at 3:48 PM, bsimpsen wrote:

    I think you underestimate the value of Apple's software and ecosystem. Samsung may find itself switching operating systems for both tablets and phones in the next year, while Apple continues fleshing out Mac/iOS.

    Samsung is unlikely to gain Apple's traction in content and delivery, as they don't have as much leverage in negotiations. If they negotiate access to content exclusively for Samsung devices, they'll have further fragmented the Android ecosystem on which they depend.

    Samsung is indeed a very capable follower. It'll be a big step to start leading. Let's compare Chinese phone penetration when Apple finally produces a phone for China Mobile. Apple has 15 million phones on their network, even though it's NOT available on their network.

  • Report this Comment On March 15, 2012, at 4:10 PM, ConsiderThis1 wrote:

    The first foreign laptops looked terrible, were of low quality and were generally sneered at when compared to Dell, IBM, HP, Gateway's. But these companies forget that low-end doesn't stay static. The low end folks salivate at improving just a little bit at their margin; to grab at the next juicy (from their perspective) bit of profitable segment.

    But the improvement from bottom-up is a lot faster and easier than any improvement you can do from the top as a leader.

    In other words, the competitors slowly chipped away at bottom market segments you would think as marginal and negligable to lose; but if you cannot grow your top-market segments you end up in a situation known as "pinned to the ceiling". Where you become structurally unable and unwilling to compete at the low end, yet the next high end to reach for becomes so niche and out of reach of mainstream that your market reach shrinks. Over time, you become irrelevant.

    The key to avoid that is to keep coming up with new ways to expand your market; so you get to redefine the "ceiling". It's to truly innovate. It's the Steve Jobs secret sauce.

    When Tablets become mainstream and are "yesterday's glamor" what is Apple going to come up with that somehow open a brand new innovation path; that will prevent it from being trapped in the ceiling in an ever competitive landscape?

    As investor, it's usually a good idea to figure out what your company's story is in 5 or 10 years from now. It's not hard to describe a "5/10 year story" for banks, pharma company, software companies, etc. What is Apple's 5 year story after ipads?

  • Report this Comment On March 15, 2012, at 4:28 PM, ConsiderThis1 wrote:

    And the "pinned to the ceiling" already happened before. Steve just managed to innovate ahead of the slump and let Apple escape it each time:

    1. Where is the music player device industry now? If Apple had stayed static as an iPod oriented company, it would've been in a lot of trouble.

    2. In a lot of cases, esp foreign countries, iPhone is already not the majority of the market. With harder and harder penetration as everyone has a smartphone, if Apple is purely a iPhone company, without expanding to iPad when it did, would its financials survive as well as it did? This battle is yet to be played out in China, where the battle is still being waged (hence the Samsung numbers above.)

    Pinned to the ceiling is a real threat. Apple better be spending gobs of $ to innovate and not sit on it's cash pile; or it may find the table turned when the same manufacturers and "lessor competitors" catch up with them and do a "Lenovo buy IBM PC division" on them.

  • Report this Comment On March 15, 2012, at 6:39 PM, Risky88 wrote:

    I think you make a lot of great points

    It seems everyone says.Oooh that couldn't possibly happen to apple, but reality is, its happened to many others. Kinda like the drunk driver that says ill never get caught but then sees red lights behind him.

    Everyone knows the idea of being stabbed in the back at one point or another in their life

    especially since it was probably someone close to you.....

    But i do think that if companies stay vigilant and not complacent they will pretty much do fine.

  • Report this Comment On March 15, 2012, at 7:29 PM, beetlebug62 wrote:

    Apple has been in the computer business as long as anyone, so they are well aware of any competitive threat from copycats like Samsung.

    As for the Chinese PC makers, I looked at Lenovo a while back, and they make about $10 a PC. With those kinds of thin margins, Lenovo is more of a threat to follow ProView into bankruptcy than it is to disrupt Apple's Mac business.

    As for replicating Apple's success, other companies have been trying to do it ever since the success of the iPod a decade ago. It hasn't happened yet.

  • Report this Comment On March 15, 2012, at 9:58 PM, Frisia wrote:

    IPad1, iPad2, iPad3,........

    iPhone, iPhone3, iPhone 4, iPhone4S......

    Those products are now Apple's cash cows and will continue for some more years with the newest updates.

    The only way to be successfull over time, is to come up with some new, revolutionairy products on time.

    Will they be able to do so?

    I think that Samsung will continue to battle for market share as a quality follower, but I think, longterm, ASUS is more dangerous because they are more inventive than Samsung.

  • Report this Comment On March 15, 2012, at 10:15 PM, lowmaple wrote:

    This article to me indicates why Steve Jobs wanted a humungous cash hoard.

  • Report this Comment On March 16, 2012, at 2:42 PM, mauser96 wrote:

    Samsung doesn't need any help at manufacturing quality electronic components. It has been doing that for years. When it comes to manufacturing Samsung could give Apple lessons. Putting these components together in a innovative consumer friendly way plus software that leverages the experience is Apple's strong point. The more static devices become, the less the Apple edge. But they can coexist, just as designer blue jeans are not displaced by those from Wal Mart.

  • Report this Comment On March 16, 2012, at 6:48 PM, jdwelch62 wrote:

    But the question remains, "Can Apple innovate on their own, without Steve Jobs?", or will they get "pinned to the ceiling?"... Again...

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