Apple's 2 Core Problems

Reports of questionable repute are constantly being released about Apple's  (NASDAQ: AAPL  )  latest product, but after reading "5 Rumors on the Next iPhone: Fact or Fiction?," consumers should expect a cheaper iPhone this fall. Unfortunately, if this rumor holds true, investors should expect an Apple with two problems at its core. 

Innovation

"Innovation distinguishes between a leader and a follower" -Steve Jobs

At the core of Apple's business lies innovation. But the company known for revolutionary inventions hasn't released a new product to consumers since the iPad in 2010. Consumers and investors alike are getting antsy. If Apple wants to return to the glory days of a $700 stock price, it needs to share its innovations with consumers. Ironically, Apple should take note from the inventor of the dual core: Intel  (NASDAQ: INTC  ) .

Phone and tablet producers Apple and Google are stealing customers from the PC market at an alarming rate. The PC market has long been Intel's private cash cow, and a smaller market means lower profits. Intel's earnings in the second quarter fell 29% to $2 billion, down from $2.83 billion a year earlier.

The company has to innovate in order to right its ship. Intel released a new line of micro-processors (Haswell) for the growing tablet market, and has made a dedicated effort to appear in the newest smart phones. The latest product you can find its chip in is the new Samsung Galaxy Tab 3.

Intel has learned its lesson from the tablet/smartphone takeover and wants to be ready for the next big market trend. CEO Brian Krzanich believes that the future lies in wearable products. Whether it's Google Glass, or the "iWatch," Mr. Krzanich has made it clear that the company is ready to be a part of that future.

A cheaper iPhone is not an innovation; it's a sign that creativity is running dry at Apple. Apple needs to return to its roots and release a new product.

Margins

Apple's lack of innovation is only half the problem. While a cheaper iPhone doesn't necessarily mean that Apple won't release a new innovative product, it does point to lower margins.

Selling an in-demand product, like the iPhone, allowed Apple to sell it at a high price, which supported margins. Just one year ago, Apple had a gross margin of 42%. In the company's most recent annual filing, Apple revealed that number has fallen to 36%.

The smartphone market is quickly becoming saturated. Almost two thirds of Americans now own a smartphone, and unless Apple keeps their products in demand, consumers will not pay a premium. Apple's current iPhone 5 is made of anodized aluminum and ceramic glass. Even if Apple can lower its cost by making new iPhones out of plastic, the crowded smartphone market is full of low cost competitors that can afford lower margins.

While Apple has been the standard for high margins in years past, it appears they have lent their high margins strategy to fellow technology stalwart, Oracle (NYSE: ORCL  ) . In its last earnings report, CEO Larry Ellison explained that the company has, and would continue to expand its "cloud" services. The company's "cloud" offerings have proved profitable in the past and are high margin products. Oracle’s gross margin has risen from 76% three years ago; to 83% in the most recent quarter as "cloud" computing becomes more important to corporate clients. In line with a higher gross margin, Oracle's net income rose 10% year-over-year. Higher margins mean higher profits. A lesson that Apple once taught, it must relearn.

Two problems, one solution

The solution for Apple is simple: release a new product. If it's as good the company's past innovations, consumers won't have a problem paying a premium and boosting Apple's gross margin. A cheaper iPhone will only display the company's lack of innovation and lower margins. I don't like rumors, and I won't like Apple if they release a cheaper iPhone.


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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 August 26, 2013, at 10:14 AM, rhvonlehe wrote:

    "The solution for Apple is simple: release a new product."

    I'd probably argue with you about the definition of simple.

  • Report this Comment On August 26, 2013, at 10:36 AM, techy46 wrote:

    Apple's two problems are 1) overpriced products with high margins that 2) competitors can now beat on function, price and performance handily.

  • Report this Comment On August 26, 2013, at 11:05 AM, skyisfalling wrote:

    New Product, gross margin we are hear of this two problems from the time iphone5 made its appearance. Say something new. If the "world market wants more of the same iphone it is common business idea to release new iphone 5c or whatever you call it before all corners of the worlds has seen it before you launch a "innovative" product. What Apple is doing makes lots of good sense! The new product - it can come later.

  • Report this Comment On August 26, 2013, at 11:05 AM, skyisfalling wrote:

    New Product, gross margin we are hear of this two problems from the time iphone5 made its appearance. Say something new. If the "world market wants more of the same iphone it is common business idea to release new iphone 5c or whatever you call it before all corners of the worlds has seen it before you launch a "innovative" product. What Apple is doing makes lots of good sense! The new product - it can come later.

  • Report this Comment On August 26, 2013, at 11:09 AM, FoolSolo wrote:

    Innovation doesn't just have to come in brand new product lines, it could also be some breakthrough features in existing products that make those products effectively new again.

    Abandoning the iPhone, especially when there is still so much of the market yet untapped would be suicide.

  • Report this Comment On August 26, 2013, at 11:19 AM, FoolishLonghorn wrote:

    "Ironically, Apple should take note from the inventor of the dual core: Intel "

    IBM shipped the first dual core processor, the Power 4 , in 2001.

    AMD shipped a dual core in 2004

    Intel shipped its first dual core in 2005.

  • Report this Comment On August 26, 2013, at 12:10 PM, tkell31 wrote:

    Apple's in trouble unless they can make money off their operating system. If they can do that a cheaper phone is not only a good idea, but a great money maker as people with Apple products tend to buy other Apple products and get more immersed into the eco-system.

  • Report this Comment On August 26, 2013, at 12:44 PM, wildeweasel wrote:

    I would disagree with the assertion that smart phones and tablets are taking away from PC sales as well.

    The main driving force for PC upgrades has alway been software, just as it is for phones and tablets. When the new content cannot be run on a device that is when people will upgrade to a more powerful device. Right now the development cycle for a AAA PC game is 3 years, at that they will barely slow down a 3 year old computer. 6 months of development on a tablet game would bring any current gen device to its knees. The incentive to buy the next faster device is much higher with handheld units. just like people will not adopt 4k TV's without content neither will they buy PC's until there is a reason. For the most part I don't see PC or GPU sales coming back to the levels they were in the past there will be a slow upgrade/replacement cycle most of the sales growth will be in smaller mobile sector. small screens will not likely replace desktops anytime soon.

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