Apple (NASDAQ:AAPL) is a very special business. However, even though the company attracts a lot of attention from Wall Street analysts and the media, the true nature of Apple's business model is usually misunderstood. Apple is not in the business of selling iPhones or iPads. The company sells experiences, and it delivers those experiences with products such as the iPhone. The distinction has major implications for investors in Apple stock.
Wall Street doesn't get Apple
Wall Street tends to think of Apple as a company that sells hardware, software, apps, and services in an integrated fashion. However, the combination of all those elements, coupled with Apple's differentiated brand power and unique cultural footprint, creates a very particular user experience, and that's at the core of Apple's business model.
Analysts usually tend to compare Apple products with those of the competition using quantifiable variables related to product specifications and price competitiveness. Looking at these factors alone, it's hard to understand how Apple gets away with selling its products for such a big pricing premium over those of the competition.
This has always been a big misconception regarding Apple. Back when the company launched the iPod in 2001, a popular joke was that iPod meant "idiots price our devices," since the product seemed clearly overpriced in comparison with other digital music players in the market. It turns out the iPod was quite different from the competition, and it revolutionized the music industry in just a few years.
The same happened with the iPhone. In a 2007 interview with USA Today, Steve Ballmer, who back then was the CEO of Microsoft (NASDAQ:MSFT) said of the product: "There's no chance that the iPhone is going to get any significant market share. No chance. It's a $500 subsidized item."
It's easy to fall on Ballmer with the benefit of hindsight. He was spectacularly wrong, but he was far from the only one saying the iPhone was an egregiously overpriced product. An opinion piece in Bloomberg in January 2007 said: "The iPhone is nothing more than a luxury bauble that will appeal to a few gadget freaks. In terms of its impact on the industry, the iPhone is less relevant."
Eight years later, the iPhone 6 and iPhone 6 Plus models are a booming success, and sales momentum is truly mind-blowing. Apple sold 74.5 million devices during the past quarter, a 46% year-over-year increase. In U.S. dollar terms, iPhone sales jumped by a whopping 57% to $51.2 billion.
What this means for investors
When consumers are willing to pay significantly more for an Apple product than for a device with similar specifications coming from the competition, they're saying there's something different about Apple -- something that can't be explained in terms of hard variables such as memory capacity or display definition. Customer experience may not be a tangible factor, but it's a very real one, and it has massive implications for investors in terms of profitability.
A superior customer experience creates product differentiation, and that means higher prices for Apple products and bigger profit margins for the company. According to data from the Consumer Electronics Association, average smartphone prices have declined from $440 in 2010 to an estimated average price of $275 in 2015. However, Apple managed to increase the average selling price in the iPhone segment by $50 during the past year, reaching $687 per unit in the past quarter.
This trend has enormous implications in terms of profitability. Apple delivered an operating margin of more than 32.5% of sales during the last quarter, far above Samsung's (NASDAQOTH: SSNLF) operating margin, which came in just under 15% in recent quarters. Most industry competitors are doing even worse, as many of them are losing money at this operating level. According to a recent research report from Canaccord Genuity, Apple captured a gargantuan 93% of all operating profits in the mobile industry during the fourth quarter of 2014.
Apple doesn't simply sell tech devices. The company is in the business of providing a differentiated customer experience that consumers value and are willing to pay for. That means extraordinary competitive strength and sky-high profitability for the company, which has big positive implications for investors in Apple stock now and in the future.