Apple Business Model Score: 10 out of 10

In my last post ‘The Apple Growth Story – Lessons for Tech Companies’, I talked about Apple’s phenomenal growth over the last several years and the 5 lessons that Technology companies should take from Apple. Yesterday, Apple crossed yet another milestone. It became the World’s most valuable company, with its Market cap overtaking that of Exxon Mobile. Apple and Exxon Mobile are the only 2 companies in this world with Market Cap of more than $300 Billion. On 10 August 2011, Apple had Market cap of $337 Billion and Exxon Mobile had Market cap of $331 Billion. Exxon had held the Number 1 spot since 2005.

For a while now, even before Apple gained the Number 1 spot on Market valuation, people had been talking whether Apple can achieve $1 Trillion Market cap.  A recent story on Bloomberg Businessweek ‘Apple’s Earnings Power Befuddles Wall Street’ mentioned Microsoft Market cap of $607 Billion in 1999, a record for any company so far. The story concludes by saying that if Apple keeps it up, the company will soon have a shot at breaking Microsoft’s record tech company valuation. Then, $1 Trillion isn’t so absurd because “Apple is an industry, not a company.”

$1 Trillion is an interesting number. Only 15 countries in the World have GDP more than $1 Trillion. Can Apple achieve $1 Trillion Market cap? The answer may lie in its business model. Bill Gurley (VC in Silicon Valley) wrote an interesting article ‘All Revenue is not create equal – The keys to the 10x Revenue Club’ few months back. In this article, Bill talked about 10 distinguishing traits that warrant high price/revenue multiples and thus higher valuations. Let us look at Apple’s Business Model from Bill’s lens.

1. Sustainable Competitive Advantage – Here you basically need to answer “How easy is it for someone else to provide the same product or service that you provide?” Does your company have “high barriers to entry”? Apple has created a sustainable competitive advantage for itself with iTunes platform. Earlier iTunes allowed users to download songs for iPod. Now, iPhone and iPad are also integrated with iTunes for apps download. The iTunes platform and its tight integration with Apple products is so powerful that Walmart has decided to exit the digital music selling business by 29 August 2011, as per a news that came yesterday. iPhone and iPad, which didn’t even existed 5 years ago, now contribute nearly 70% of Apple’s revenues. How many companies you know who have 70% revenues coming from the products that didn’t existed 5 years before?

2. The presence of Network Effects – In economics and business, a network effect is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it. Network effects are present in two-sided markets. Example markets include credit cards, composed of cardholders and merchants; operating systems (end-users and developers), newspaper and magazines (advertisers and readers); video game consoles (gamers and game developers).

As per Tom Eisenmann (Professor at Harvard Business School who studies lean startups, entrepreneurship, platforms, and network effects), there are two types of network effects: A same-side effect, in which increasing the number of users on one side of the network makes it either more or less valuable to users on the same side; and a cross-side effect, in which increasing the number of users on one side of the network makes it either more or less valuable to the users on the other side.

With its products, Apple is able to build both the same-side and the cross-side Network effects. On one side, Apple has iPhone and iPad users. On the other side, Apple has app developers. As per Apple financial disclosures, Apple has sold nearly 29 Million iPads during last 5 quarters. The cumulative number of iPhones sold so far is 129 Million. These numbers are big enough to attract the developer community to develop apps for the users. More the users buy Apple products, more the developers will develop apps. More the apps are there in Apple App store, more the users will buy.

3. Visibility/Predictability are highly valued – Investors favor pricing models that provide a high level of predictability & consistency in the future. The business models should be less vulnerable to the “hit” risk. Apple doesn’t have a huge breadth in its product range unlike IBM or HP. This allows the analysts to easily model Apple future revenues.

4. Customer lock-in/High Switching Costs – Investor favor companies with low churn rates of customers and High switching costs. The switching costs can take many forms like Hardware lock-in, Data lock-in etc. Apple has a highly loyal customer base. Apple initially achieved Customer lock-in with Hardware, then apps, and now with upcoming iCloud offering.

5. Gross Margin Levels – As per Bill, lower gross margin companies will trade at highly discounted price/revenue multiples. Apple Gross Margins have continued to improve over last 5 years. Apple Gross Margin currently stand at 42%, up from nearly 30% 5 years ago. Apple competes primarily with HP and Dell in Desktops and Portables business and with Nokia in Phone business. HP and Dell had Gross Margins of 31% and 19% respectively in their last quarter reporting.  Apple Gross Margins are higher than Nokia as well who has Gross Margins of nearly 31%.

6. Marginal Profitability Calculation – Investors love companies with scale. Investors will value a company more if higher revenues create higher profit margins, all other things being equal. 5 years back, during Q3’06 (April-May-June 2006), Apple had revenues of $4.3 Billion and Operating Income of $566 Million. This translates to operating profit margin of 13%. Now, during Q3’11, Apple reported revenues of $28.5 Billion and Operating Income of $9.3 Billion. This translates to operating profit margin of 33%. Clearly, higher revenues resulted in higher profit margins for Apple.

7. Customer concentration – Investor prefer a highly fragmented customer base versus a highly concentrated one. This is because concentrated customers have “market power” that can result in pricing, feature, service demands over time. The ideal situation is tons of very small customers who are essentially “price takers” in the market. Since Apple is focused on Consumer Market than the Enterprise Market, the customer base of Apple is highly fragmented. This allowed Apple to grow much faster than enterprise-focused companies, even during a “consumer-driven” recession. Apple was least affected by the freeze in IT budgets or discretionary spends of Global 2000 companies.

8. Major Partner Dependencies – Investors will discount price/revenue valuations of any company that is highly dependent on another partner in some way or another. One of the key reasons for Apple success is that they own both Hardware and Software. Apple controls the complete user experience. They are not dependent on their partners for any technical breakthroughs. They innovate at their own pace. Apple does outsource mass-scale manufacturing to vendors like Foxconn, but it is not dependent upon them for value proposition development or customer reach-out.

9. Organic vs Heavy Marketing Spend – Investors love companies where the products/service sales are achieved through “word of mouth” process and the cost of acquiring a new customer is low. Lower the marketing spend, the better it is. In case of Apple, Gross Margins improved by 12% during last 5 years, whereas Operating Margins improved by 20% during the same time. Sales and Marketing Expenses are usually captured as Operating expenses. Clearly, higher operating margin growth implies low spend on Marketing to acquire new customers.

10. Growth – The faster you are growing, the larger and larger future revenues and cash flows will be. As per Bill, High growth also implies a company has tapped into a powerful new market opportunity, where customer demand is seemingly insatiable. Apple announced its Q3’11 (April-May-June 2011) results on 19 July 2011. Apple crossed the $100 Billion TTM revenues (Trailing-Twelve months) milestone in Q2. This translates to nearly 4x revenue growth in 4 years. Apple had less than $25 Billion TTM revenues 4 years back. During last 12 months, Apple had nearly twice the incremental revenues than HP, IBM, Microsoft, Dell combined.

* FY ending June.

** HP and Dell AMJ’11 quarter revenues are as per Analyst estimates.

Now let us summarize the aforementioned parameters.

Clearly, Apple Business model scores 10 of 10. I am aware of very few companies who would score 10 of 10. Which companies are you aware of? Do their numbers speak for themselves? Are you aware of other methodologies to analyze the business model robustness of different companies? Please let me know. You can connect with me on Twitter at!/jitendermiglani (@jitendermiglani).


The Apple Growth Story – Lessons for Tech Companies

Year 2004: Apple had $7 Billion revenues and $172 Million Net Income. Apple was ranked 301 in Fortune 500 list. Year 2011: Apple has $87 Billion revenues and $20 Billion Net Income. Apple is ranked 35 in Fortune 500 list. During a short-span of just 7 years, Apple revenues have grown 12-fold, Net Income has grown 116-times, and Fortune rank improved from 301 to 35. Though Apple has been growing its revenues steadily over the last 7 years, they had remarkable revenue growth over the last 12 months.

This article provides a deep dive analysis into Apple’s recent growth so as to understand the reasons behind it and to provide learning for other companies. For the purposes of the analysis below, FY ends March (See Note at the bottom). So, FY10 represents the 12-months period from April’09 to March’10. Similarly, FY11 represents the 12-months period from April’10 to March’11. An analysis with FY ending March also helps because the analysis can be done with latest reported numbers of different companies.

As per 2011 Fortune 500 list, the top 5 Technology companies (Hardware, Software, Services, or their combinations) in the World are HP, IBM, Apple, Microsoft, and Dell with Fortune rankings of 11, 18, 35, 38, and 41 respectively.  For FY11, HP, IBM, Apple, Microsoft, and Dell had revenues of $128, $102, $87, $69, and $62 Billion respectively. During FY10, Apple had $51 Billion revenues. During FY11, Apple registered phenomenal YoY growth of 71% to take revenues to $87 Billion. Apple added $36 Billion incremental revenues – 4-times more than its nearest competitor. Apple crossed Microsoft and Dell to the 3rd largest technology company. Not only did Apple register a strong growth in Revenues, but also even stronger growth in Profits. Apple Net Income grew by 81% YoY to reach $20 Billion in FY11.

Apple is currently trailing behind IBM and HP by $15 Billion and $41 Billion respectively in total revenues. As per Analyst estimates, Apple will cross IBM in TTM (Trailing Twelve Months) revenues over next 3 quarters to gain the Number 2 spot. Over the next 3 years, Apple is estimated to even cross HP to become the Number 1 Company in the Technology Industry.

Apple derives 63% of its revenues from Americas and Europe and about 22% from Asia Pacific and Japan. During FY11, Asia Pacific has shown nearly 3-times faster growth than Americas and Europe. Apple revenues from Asia Pacific grew at 162% YoY from $5 Billion in FY10 to $14 Billion in FY11.

Apple Revenues from its 3 core products-lines  – iPhone, iPad, and iPod – in FY11 were $57 Billion (66% of company Total revenues). iPhone Sales grew at 98% YoY from $19 Billion in FY10 to $37 Billion in FY11. iPad Sales grew from zero to $12 Billion in the first 12 months.

Clearly, Apple had a phenomenal growth over last 12 months when the global economy has just started to come out of recession. Here are 5 lessons that Tech companies should take from Apple.

1. Think “World-class”. Apple is one of the World’s most admired companies for Innovation. Apple has a maniacal focus on perfection and strives for excellence in user experience. Not only do they create beautiful & artistic products, but also they try to bring world-class experience in whatever they do. Apple tries to create the best buying experience in the world through their Apple Retail stores.  Apple has plans to build the best office campus in the world in the city of Cupertino, which looks like a space shuttle and will house over 12,000 employees by 2015.

2. Think “total user experience”. One of the key reasons for Apple success is that they own both Hardware and Software. They control the complete user experience. They are not dependent on their partners for any technical breakthroughs. They innovate at their own pace.

3. Think “beyond Enterprise”. Apple is focused on Consumer market than the Enterprise Market. Apple has sold 200 Million iOS devices to date. 25 Million iPads have been sold in the first 14 months. Because of the pull-factor towards its products, Apple has delivered World’s best growth numbers despite recession. Apple showed the world that Volume and Margin games can be played together. As the global economic activity shifts East, Apple is taking full advantage as seen from 162% YoY growth of Asia Pacific revenues.

4. Think “Sustainable Competitive Advantage”. Apple has built a strong competitive advantage for themselves with products like iOS and iTunes. iOS is one of the World’s most advanced Mobile Operating System (used in iPhone and iPad) with 44% of the market share. Google’s Android is its closest competitor. Just as iTunes virtually locks-in the customers, App store virtually locks-in the developer community. Apple has 225 Million iTunes accounts (with credit card details). Apple paid $2.5 Billion to developers building apps for the App store.

5. Think “New Business Models”. Tech companies need to start preparing for the “Post-PC” era, where Mobility and Cloud will be the key themes. Sun Microsystems used to say “Network is the Computer”. Apple goes even further and says “Your Data is the Computer”. That is why iCloud demotes the PC to be just a device like iPhone or iPad and moves the digital hub online. Apple developed Ecosystems with Telecom Carriers and Music companies. Apple has sold over 15 billion songs via iTunes. In less than 3 years, 14 Billion apps have been downloaded from the Apple App Store. These have further contributed to Apple revenues.

And one more thing. Think Different. 

Note – Every company has their Financial Year (FY) ending during different months of a year. Microsoft FY ends June. Apple FY ends September.  IBM FY ends December. HP FY ends October. Dell FY ends January. In order to do a like-to-like comparison, the Quarterly data for individual companies was taken and then aggregated to arrive at FY ending March data. For Dell and HP, Feb-Apr quarter is compared to Jan-Mar quarter of others.

Mega Trends that will impact the future of IT Industry

IT Industry is at an Inflection Point right now. There are three major disruptive forces that will change the way how IT will be procured and consumed and how business will engage with its stakeholders.

  1. Digital experience with Smartphones and Tablet is changing the way IT is consumed.
  2. Cloud Computing is changing the way IT is procured and delivered.
  3. Social Media is changing the way Business engages with the stakeholders.

These have important implications for the CIO office. These trends will drive a rebalance within the RTB/CTB (Run-The-Business/Change-The-Business) spend. The CTB spend will get more share of CIO’s IT Budget. This is because:

  1. Traditional PC replacement cycle is undergoing a change.
  2. Virtualization is making underlying hardware (and its ownership) non-strategic.
  3. Cloud-enabled services are becoming increasingly viable. The attraction is scalability, pay-as-you-go, and freedom from infrastructure build-out and less capex sensitivity.
  4. Application development will focus more on Mobile/Tablets than Desktops/Notebooks.
  5. Companies will spend money to create total product experience for consumers on multiple devices and operating systems.

Building a World-class Market Intelligence Function

If you were asked to build a world-class Market Intelligence (MI) function within your organization, then, you need to understand the 6 key dimensions of a MI program and its associated elements first.

The first dimension is the Scope. It is not possible to do everything for everybody in the organization. Scope attempts to define the stakeholders – the Corporate or the individual Business Units? Which User groups you will serve – Sales, Pre-sales, Operations, Marketing, or HR? Where are your users in the organization hierarchy? What decision making powers do they have? How many companies are to be tracked and analyzed? How much detailed intelligence is required on the different companies and the topics of interest? How much focus the program should put on the anticipated future developments against an analysis of the past developments and the current market situation? A clear definition of these elements will help you say a clear ‘YES’ or ‘NO’. It will help you say ‘What you will do’ and ‘what you won’t do’.

The second dimension is the Process. The processes need to be defined for Reactive Research requests and Proactive Research inputs. The processes need to be defined for collection, analysis, documentation, and communication of information and insights. The processes need to be defined for identification of new information sources, managing relationships with existing vendors, procuring ad-hoc research reports, and dealing with the research vendors for primary research. The processes need to be defined to know the effective utilization of research output and to collect the feedback on the different projects and the MI program as a whole. While the Scope will help you address the ‘What’ question, Process will help you address the ‘How’ question.

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