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How Apple Built Its Biggest Rival

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Apple (NASDAQ: AAPL  ) has built an empire on selling innovative new products to the masses. But what most people don't realize is that Apple has long focused on what it makes and not how it makes them. Under the leadership of CEO Tim Cook, the company has shut down its own manufacturing and expanded outsourcing to other electronics manufacturers.

This isn't a problem when your suppliers aren't also your competitors, but Apple has actually made competitors key suppliers. The biggest is Samsung, the rival that can compete with the iPhone. We now know that Samsung can manufacture products equal or better than the iPhone. After all, it's manufacturing a lot of Apple's components today.

Handing blueprints to the competition
Most investors knows that Apple outsources iPhone and iPad production to Foxconn, a standard practice for computer, tablet, and smartphone makers. This has more to do with cheap labor in China and less expensive business practices than anything. But Foxconn is essentially an assembly house for Apple and provides little in the way of competition.

The more troubling outsourcing is the manufacture of key components like touchscreens, batteries, and chips. Apple has made a big deal about its "advanced" Retina display, it always touts innovations in battery life, and it in-house line of chips that operates smartphones and tablets more efficiently. But guess who is making those products?

Yup, it's Samsung.

Samsung has made batteries for MacBooks and iPads, flash memory for iPhones, the chips that power iPhones and iPads, and even the displays for iPhones and iPads, just to name a few. This wasn't all that big of a deal when the iPhone first came our or even with the first-generation iPad. Samsung's products were far inferior to Apple's products and Google's (NASDAQ: GOOGL  ) Android operating system wasn't as refined, either. But in the process, Samsung learned how to build a quality smartphone and put what it learned to work.

A rival is born
I don't think Apple really knew it had a problem on its hands until the Galaxy X2 came out. It was comparable to the iPhone in many ways but came with a larger screen that clearly consumers gravitated toward (see larger screen on iPhone 5). The Galaxy S3 took Samsung's knowledge to another level and came out before Apple's iPhone 5. It had 4G before Apple, a larger screen, even near-field communication, a capability Apple has yet to add. The Galaxy Note 2 is another phone that fills out Samsung's portfolio and will make for a formidable competitor to Apple.

In the tablet market, Samsung has yet to make deep inroads like Amazon (NASDAQ: AMZN  ) has with the Kindle. But like the smartphone market, Samsung will continue to improve and we know it can make tablet products. Android tablets from Samsung are improving and a partnership with Microsoft (NASDAQ: MSFT  ) to make tablets may even help the competitor.

Apple thought that it could protect itself from this barrage of competition with a number of patents that protected the design and operation of the iPhone and iPad. Oh, how wrong it was.

IP not holding up against Samsung
Apple has held an all-out IP assault on Samsung over the past two years in hopes of getting Samsung's products off store shelves and sending the company back to the drawing board. The problem is that most rulings around the world have gone in favor of Samsung. Outside of a $1.1 billion ruling in a nearby California court, which will likely be overturned, Samsung has crushed Apple in court.

The damage is done
The only step left for Apple is to stop relying on Samsung for so many components. Recent reports suggest that Apple is trying to reduce its reliance on Samsung for a number of important parts. The company has shifted display orders from Samsung's 100% owned spinoff Samsung Display to other suppliers like LG Display (NYSE: LPL  ) . Some memory chips will now come from suppliers like SK Hynix instead of Samsung. The company is also looking to Amperex Technology and Lianjin Lishen Battery to cut Samsung out of the battery equation. However, Samsung will supply some of these components and is the supplier of the A5, A5x, and A6 chips Apple designs.

The bottom line here is that the damage is done. Apple showed Samsung how to build a better smartphone and a tablet and paid for the company to expand its manufacturing capacity.

Secretive and trusting
For a company as secretive as Apple, I'm surprised it trusts so much of its manufacturing to outside companies. Earlier this year when I highlighted outsourcing as the biggest threat to Apple, I highlighted the fact that we've seen this before. In the computer industry, companies outsourced production to Asia, only to find that these suppliers eventually became full-fledged competitors.

Apple could have mitigated some of this risk by manufacturing key components in-house. It may be a more expensive plan but it can pay off in the long run. By worrying more about speed to market, the company relied on outsourcing manufacturing to key competitors like Samsung and inadvertently helped create its biggest competitor in the process. 

Is Apple still a buy?
There is absolutely no doubt that Apple is at the center of technology's largest revolution ever, and that longtime shareholders have been handsomely rewarded with over 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company (and more importantly, your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.

Read/Post Comments (8) | Recommend This Article (14)

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 November 29, 2012, at 8:01 PM, deasystems wrote:

    The author wrote, "We now know that Samsung can manufacture products equal or better than the iPhone." No, we don't know that, Travis, not at all.

    The author then claimed that the "...Retina display, ...innovations in battery life, and it in-house line of chips" are made by Samsung. That is both incorrect and misleading.

    First, according to iSuppli and other hardware teardown analysts, Samsung supplies only a small portion of the components in current Apple products. Second, Apple's market-leading battery life achievements are a direct result of Apple's own in-house research in power control circuitry. Further, Apple's world-beating mobile processors are fully designed and engineered in-house. Samsung is--or used to be--just the chip fab. Expect TSMC to take over that job shortly...

  • Report this Comment On November 30, 2012, at 11:50 AM, TheRealRacc wrote:

    ^ ^ Apple processors will never win out over Intel. R&D goes a long way. Check out the balance sheets.

    Everyone will catch up to Apple. It is a market share battle. Components and suppliers are, for argument's sake, irrelevant to winning a market share battle.

    They design good products, and the last I hear is they are trying to master the "perfect headphones." I will leave processors and supplies to the manufacturers and the design up to Apple. They will never use 100% Apple parts. Now I am more confused than ever. What point were you trying to make?

  • Report this Comment On November 30, 2012, at 1:29 PM, TMFFlushDraw wrote:


    We know that Samsung was a supplier for the iPad 3's display because it was the first one qualified and the only source of supply for a short time. We also know that Samsung has provided batteries and chips to Apple. Maybe they're being phased out, which I pointed out in the article, but the fact is that Samsung was once a supplier and is now the biggest competitor to Apple.

    The point is that is that if Samsung can make the products it doesn't matter if Apple designed them. Companies steal from each other all the time and a few tweaks here and there and Samsung could make a product just as good, if not better than Apple if it has Apple's designs.

    I have yet to buy into the assertion that Apple has "world-beating" mobile processors. Tests have shown GS3 to be comparable to slightly slower than the iPhone 5 and the Note 2 being faster. There's no "world-beating" advantage by Apple.

    Travis Hoium

  • Report this Comment On November 30, 2012, at 5:48 PM, earthmabus wrote:

    This is one of the big problems associated with outsourcing... eventually the people you outsource to become sophisticated enough to compete against you.

    The scary thing is that this is happening at a macro level. China, which probably never saw an electrical device prior to the 1970s, is now fully capable of manufacturing and engineering everything that the world needs -- from the basics (like shoes, clothing, furniture, etc.) to the advanced (like computers, lasers, medical devices, etc.). China has learned how to do this in an astonishingly quick amount of time because we have provided our technology and knowledge to their companies. Some of these technologies has taken the US Government and American companies several decades of R&D to develop.

    With the export of all this technology and information, I believe we have made China our biggest economic, military, etc. rival... They are now capable of creating an infrastructure and military that will rival our own within a few more years. This is ability would have been much further out if they had to learn these technologies on their own time with their own scientists...

    I guess the US Government and Corporate America found this to be an acceptable sacrifice for cheaper products...

  • Report this Comment On December 01, 2012, at 12:52 PM, haysdb wrote:

    "which will likely be overturned"

    We shall see.

    "most rulings around the world have gone in favor of Samsung."

    Samsung has successfully defended themselves in many of the suits, but not all, and have failed to score any points on offense. Meanwhile Apple has forced them to change their products to avoid infringement. To say that Samsung has "crushed" Apple in court is just trash talk not supported by the evidence.

  • Report this Comment On December 01, 2012, at 3:09 PM, xetn wrote:

    So, how would the Apple/Smsung suit gone if the following had been disclosed?

  • Report this Comment On December 08, 2012, at 9:55 PM, MCCrockett wrote:

    @xetn, what relevance does the fact that a juror is being sued have to the suit involving Apple and Samsung?

    Both the Apple and Samsung legal teams had the right to reject a potential juror during voire dire (jury selection).

    It seems a wee dodgy and more like fee padding for a legal team to ask the court to overturn its decision because a juror that they accepted might have been pre-disposed to rule against their client.

  • Report this Comment On December 10, 2012, at 1:37 AM, kingkaiser01 wrote:

    Couple of incorrect statements. Market leading battery life? The Samsung S3, which has a horrible battery life, lasts *longer* than the iphone 5 (whcih has a smaller screen).

    Superior processors? As TMFFlushDraw pointed out, thats just not true.

    Samsung got the court to force Apple to apologize for misleading statements on their own (ie: Apple's) website in the UK. Sounds like a win to me, given that Samsung was the one on the defensive from Apple's absurd patent trolling.

    Apple was until earlier this year my largest personal holding. I saw the Samsung S3 and HTC One, and realized that for the first time in years, Apple now has to play catch-up. Then I see some fairly divisive patent actions (seriously? Patenting a shape that equipment in the 1950s had?; hell that my tub has, when seen from above), and decide to sell my holdings (luckily so, as it would turn out). Recently moved on to an S3, don't regret it one bit.

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