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Apple and the iConomy's Long Road Ahead

By Daniel Segundo - Jan 27, 2014 at 10:30PM

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An in-depth look at Apple's long term game plan.

Apple (AAPL 0.35%) has emerged as a leader in the smartphone and technology industry, and has developed a narrow economic moat through switching costs. However, competition in the smartphone industry is heating up, and the environment is becoming crowded as the battle for market share continues. Google (GOOGL -0.50%) and Samsung are taking market share from the iPhone maker; while Apple's iOS global market share has remained stagnant, Google's Android OS has increased nearly 50%.

So What?
Unfortunately, that is a negative sign for the company's moat, as its long-term success is dependent solely upon innovation. For Apple to establish once again itself as a complete leader in the smartphone industry and maintain its competitive position, the company doesn't just need to simply innovate, but rather to revolutionize. 

Apple's introduction of the iPad Air and its latest smartphone line is certainly a game-changer for the company's prospects, as the new 64-bit architecture now used in both the latest iPad and iPhone 5s should certainly help drive sales. One thing that sticks out, however, is the degree of innovation that has occurred under Tim Cook's reign, compared to that of Steve Jobs. Under Jobs' control, Apple not only improved its preexisting devices, but also managed to form completely new categories. Granted, Cook has a lot on his plate, as investors are looking for Jobs-like actions, but the reality is that Apple, today, isn't the same as it once was.

In addition, the iCloud service is an important aspect of the company's switching-cost-based moat, as it makes customers who own a variety of iOS products far more reluctant to purchase a new device that doesn't sync with the Apple ecosystem. iCloud and iOS won't burden Apple users with tremendous switching costs, but they are important to future iPhone growth, as it is likely to come from repeat purchases in the years ahead. 

From an international perspective, a large catalyst for Apple is the deal with China Mobile (CHL) that allows Apple's products to penetrate the Chinese ecosystem much further ever before. The Chinese ecosystem is important because growth in Apple's largest segment, the U.S., has been slowing, and Apple's infiltration into the developed Chinese marketplace would result in a noteworthy boost to international growth efforts. In a joint statement, Apple and China Mobile said the iPhone 5s and 5c models went on sale in Apple and China Mobile stores beginning on Friday, Jan. 17

While Apple has managed to achieve some entrance to the Chinese market, it will need the assistance of the world's largest wireless carrier to reach the bulk of the Chinese populace. China Mobile, with an astronomical 750 million mobile subscribers, controls almost 65% of the Chinese wireless market. Although the deal will almost certainly be less profitable than Apple's prior arrangements, it would open up opportunities for huge iPhone and iPad sales in China. 

The question that remains is, where does Apple's economic moat go from here? More importantly, how sustainable is Apple's competitive advantage? Undoubtedly, Apple is a remarkable company, but long-term-oriented investors are truly interested in Apple's competitive advantage. Although the stock probably won't experience drastic declines any time soon, a wavering competitive advantage won't prevent competitors from eating into Apple's profits.

Now What?
Especially at a time where Apple's size has truly become a limiting factor to annualized growth on both the top and bottom line, the last thing Apple needs is competition gnawing at its profitability. Simply put, if Apple continues finding innovative ways to attract consumers into the "iConomy," the company's competitive advantage will continue to expand. Altogether, this leads to high returns on invested capital that should continue to return money to shareholders for years to come.

Ultimately, Apple will need to continuously develop new products that revolutionize the playing field across all of the markets in which the company competes. Despite apparent lackluster performance in the U.S., a deal with China Mobile could be a key catalyst the tech giant needs, providing a huge boom in China. Apple's software should remain one of the two dominant ecosystems alongside Google's Android. Despite the nice revenue streams iTunes has provided, Apple's future profitability won't come from add-on purchases, but rather the sale of its hardware.

To maintain this position, however, Apple needs to regain its luster and avoid missteps along the way. Apple will continue to enrich shareholder value with both brilliant ideas and managerial decisions. All the story needs, now, is patience. With consumer sentiment still slightly negative, but recovering, an investment in Apple appears to be a potentially lucrative one.

Fool contributor Daniel Segundo has a position in Apple and Microsoft. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, China Mobile, Google, and Microsoft. 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.

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