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Is Apple Getting Sloppy With Its Software?

By Chris Kuiper, CFA – Feb 19, 2016 at 4:27PM

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The world is driven by changes at the margin, so investors should be aware of potential quality problems in Apple’s core software.

A number of prominent tech journalists have started to question whether some cracks in Apple's (AAPL -1.51%) mobile and desktop software are going unnoticed, or even getting worse. Although none of these writers say they're ditching their Apple devices, investors need to be aware of these developments given that the company's software and brand image are the foundation of its success.

What's the problem?
The criticism of Apple's software was recently kicked off by veteran tech journalist Walt Mossberg. In a piece for re/code, Mossberg says over the last couple of years he has noticed a gradual degradation in the quality and reliability of Apple's core apps for both the mobile and desktop versions.

Specifically, he singles out iTunes for the desktop, which he now dreads opening due to how bloated and slow the software has become, as well as Mail, Photos, and iCloud. One of the themes in Mossberg's review of these apps is the failure to properly sync email and photos across devices, as well as the inability to properly back-up data in iCloud.

Another prominent Apple blogger, John Gruber, chimed in as well, detailing his latest problems uploading and syncing photos. This is especially concerning because the appeal to Apple users is everything should "just work." Finally, Jim Dalrymple piled on with his view on the matter, especially noting how Apple Music has been plagued since the initial release, and has finally been improved up to the point where it should have been from day one of the release.

He offers his guess as to why this happened, concluding it is probably because they were given a rushed time frame for the product. Personally, I also wonder if the size of the company and the number of employees can lead to more bureaucratic and communication friction.

The economic concept of margins
I can already hear the howls from Apple investors, so let me make a few things clear. First, this kind of observation and speculation does not mean Apple is going down the tubes and investors need to sell their Apple stock today. The point instead is that investors need to understand the concept of change at the margin.

When talking about the economic concept of marginal change or choice, it doesn't refer to the way financial practitioners use the term -- which is either to refer to profit margins (although the two are related), or the use of debt, such as trading on margin.

Margin in this context means "additional," or thinking of the very next step forward. The first glass of water in the desert has a very high value, but each additional glass is worth less as your thirst is quenched. We face marginal choices constantly in life. We don't choose whether or not to sleep, we choose how many hours we want to sleep -- perhaps that extra hour of reading is more valuable than an hour of sleep.

What does this have to do with Apple? When people decide whether or not to buy an Apple phone or an Android phone, they similarly make choices at the margin. Apple smartphones are, on average, much more expensive than Android smartphones, even though they both perform the same basic functions.

However, people are willing to pay the additional $100 to $300 or more for the Apple phone due to its superior hardware and software. But if Apple's software becomes more buggy, prone to errors, or malfunctions, this changes a consumer's marginal choice.

Of course, not everyone is going to stop buying iPhones tomorrow. Yet this is the point of marginal thinking -- if quality declines enough, there will be some on the fence that may now say the additional benefit of an iPhone is not worth the additional cost.

What should investors do with this information?
As Mossberg correctly points out, Apple products are not premium products just because of the high-end hardware and materials such as metal and glass. Rather, Apple demands a premium because it is the only way to get access to its wonderfully designed software and ecosystem that is supposed to work seamlessly across all devices.

The marriage of hardware and software was a bedrock principle of Steve Jobs and has made the company what it is today. Apple phones have the highest margins in the industry because of the software content and integration.

Again, this news doesn't mean that investors should react by selling Apple stock, but they should be aware of a potential change in the company's product quality. This could be monitored through a couple ways. If the value of the software declines, and people are not willing to pay as much for Apple products, then this should eventually show up through lower sales and increased share gains for Android or other manufacturers. It could also show up in lower gross margins.

So far it appears Apple is holding its own in terms of market share, but may be losing a bit at the high-end to Samsung Electronics. Although revenue is expected to decline next quarter, it is not yet clear how much of this is due simply to the slowing smartphone market in general. Finally, Apple's total gross margins and estimated margins on the iPhone have not been weakening yet.

In short, this news is something investors need to be aware of and continue to monitor, but it's not a five-alarm fire. It has actually been brewing for some time, as Mossberg stated he has noticed the degradation over multiple years, and Engadget raised similar points in late 2014. Apple has top-notch talent, and perhaps the additional press will spur them to clean up this software sooner rather than later. In the meantime, we as investors will continue to stay vigilant.


Chris Kuiper has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. 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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