Oh, how the mighty have fallen! Apple (NASDAQ: AAPL ) , widely regarded as the most popular company on the planet -- and it's hard to argue that point, given the cult following the company boasts -- missed revenue estimates slightly when it reported its first-quarter earnings results last week, and the stock was subsequently pummeled.
Since that report, we've seen statistical analysis out the wazoo of what's wrong or right with Apple: "Gross margins are down"; "iPhone sales dominated Christmas-quarter sales in the U.S. for the two biggest telecoms, AT&T and Verizon Wireless"; "it has $137 billion in cash."
Today, I intend to brush these statistics aside and break this down to the absolute basics of what's wrong with Apple. The way I see it, Apple's problems can be explained by three factors:
- It outgrew its supply chain.
- Competitors are copying its operational model with success.
- Our expectations as investors are flawed.
It outgrew its supply chain
How can the formerly biggest company in the world fail if iPhone 5 preorders were off the charts? Very easily, if the supply chain isn't prepared to meet a monstrous increase in demand.
Back in September I labeled Apple's supply chain as the biggest threat to the iPhone 5 and, while it may not be apparent, I feel Apple has grown so large that it's been cannibalizing its own production capacity. Apple has tried, unsuccessfully, to persuade Taiwan Semiconductor (NYSE: TSM ) to give it more production capacity. Now here's the interesting part: Taiwan Semi's two primary customers are Apple and Qualcomm (NASDAQ: QCOM ) . Qualcomm is the sole supplier of Apple's cellular baseband processors in the iPhone 5. Without a back-up for this component, Apple's sort of stuck in a nasty catch-22: stymie current production, or risk a shortage of Qualcomm's baseband processors if it can persuade Taiwan Semi to boost production.
In other areas, it isn't just a supply chain-sharing issue, it's a capacity issue. Hon Hai Precision, the parent company of Foxconn, the exclusive assembler of Apple's iPhone 5, admitted in November that the iPhone 5 was a very complex and time-consuming device to put together. This could be a reason why there were iPhone 5 supply shortages shortly after its launch. Sharp, one of Apple's three LCD display manufacturers, had manufacturing issues prior to the iPhone 5's launch, which made meeting Apple's demands nearly impossible.
Simply put, there's only so large Apple can grow without supply chain issues becoming a repetitive problem. The more suppliers it attempts to add in order to boost potential parts supply, the less control it'll have over the manufacturing process and, worse yet, the less consistent the finished product could become.
Competitors are copying its operational model with success
"Monkey see, monkey do" is the oldest form of legal business thievery around. We see it in the food sector with Burger King Worldwide mimicking McDonald's menu of healthier food options and smoothies. We see it in merchant services where eBay introduced PayPal Here, a triangular shaped on-the-go card-swiping device that's modeled almost entirely after Square's credit-swiping device. And now, we see it from Microsoft (NASDAQ: MSFT ) which has taken a page right out of Apple's own book and has been opening brick-and-mortar stores in high volume malls around the U.S. with notable success.
Let's remember that Apple is just as much as software company as it is a hardware company, and Microsoft is looking for ways to find the bridge between the two. For Apple, that balance has been hit through its highly successful Apple stores which boast the highest sales per square footage in the United States. Microsoft is looking to hit that stride as well by burning the Microsoft brand into consumers' minds and allowing them closer access to its products than ever before. Between 2011 and 2014, Microsoft has planned to open 75 brick-and-mortar locations.
During the holiday season you'll see that Apple stores still trounced Microsoft when it came to both foot traffic and sales -- at least according to a side-by-side comparison done by Forbes. Keep in mind that Apple had more than a fair running start when it comes to getting its stores up and running. However, as Microsoft's technologies become more pervasive, we might see this gap begin to close.
The lesson here is that other technology companies can emulate Apple just as Burger King and eBay are emulating peers in their sector. With less operational differentiation than in years past, Apple's share price is having a hard time heading higher.
Our expectations as investors are flawed
Finally, our expectations of Apple as investors aren't realistic. We can recall how much Apple's devices have changed the way we operate, but we falsely assume that'll it'll be the only innovating company in existence and punish it for not succeeding at every venture.
Facebook (NASDAQ: FB ) is another great example where investor expectations were unrealistic. We'd seen examples of Facebook's dominance and its user growth prior to its public debut, but we somehow didn't connect the dots that at some point top-line subscriber growth would level off as domestic markets became saturated. Most investors also failed to see that Internet usage was shifting from PCs and laptops to smartphones and tablets. When Facebook's growth targets didn't cut it shortly after its IPO, the stock was pulverized.
Apple's scenario is very similar to Facebook. We knew a tapering of its top-line growth was coming but somehow appear shocked by the fact that revenue "only" grew by 18% in the first quarter. We're also unnerved by the fact that Apple's competitors, as I mentioned above, are successful emulating its platform to sell their own products. Based on this, we assumed that Apple's operational model is broken, when in fact it's not!
In short, Apple is a victim of investors' lofty and unrealistic expectations.
What now, Apple?
Now that you better understand what's wrong, how does Apple make it right?
Believe it or not, the answer to this question is it "does nothing." That's right, nothing! Apple is still the tech company emulated by others and, as such, is still in the driver's seat when it comes to introducing new products and controlling the tech evolution cycle. Apple stores are by far the most lucrative retail operations in the U.S., its sales growth is still phenomenal, and its cash hoard could rival the total GDP of numerous countries. If it isn't broke, don't fix it, Apple!
About the only thing that does need fixing around here is our own unrealistic expectations as investors.
Your one stop for everything Apple
There's 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 your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.