Apple (AAPL) CEO Tim Cook is “uninspiring” and making Apple “more like most other companies,” or so two recent profiles suggest. And Cook’s biggest challenge is to find a new product that can “move the needle” and increase Apple’s $171 billion of revenue significantly, both articles agree.
But although the two profiles contain a ton of fascinating detail and news tidbits (such as Cook’s search for new board members), neither captures what Cook is actually doing – or needs to do -- to boost Apple’s business and share price.
In reality, Cook is taking Apple in new strategic directions, making it more difficult for competitors to follow. He is also focusing on areas that will boost profits – the key to Apple’s share price trends, both up and down – as much as revenue. And while new products may be important, Cook is pursuing just the sort of steady improvements that have historically been the key to Apple’s biggest gains.
It helps to start by analyzing just how Cook and his predecessor, Steve Jobs, got Apple’s business booming – and its share price to the record high $100.72 (adjusted for the recent split; in pre-split dollars, the stock topped out at $705). The key wasn’t a new product at all. It was the fabulously profitable iterations of the iPhone, the 4 and the 4S, released in 2010 and 2011 (Jobs stepped down from Apple in August 2011 and died less than two months later).
Apple’s crazy iPhone-fueled stock rise – from a split-adjusted $12 a share at the beginning of 2007 to over $100 five years later – came not from higher sales alone but from relentless improvements in the iPhone and a resulting increase in profitability.
Apple’s gross profit margin, the difference between the cost of making products and the revenue brought in from selling them, increased in each of those five years, from a starting point of 29% to a peak of 44% in 2012. Such steady increases are extremely rare for a hardware maker. As a point of comparison, Hewlett-Packard’s (HPQ) gross profit margin declined from 24% to 22% over the same period, and Cisco Systems (CSCO) dropped from 65% to 60%.
But Apple’s stock price peak was also the profit margin peak. Revenue continued to grow in 2013 but Apple’s product mix changed. The iPhone 5 and iPad mini, particularly, carried lower profit margins than older models whose sales they displaced. As a result, Apple’s gross profit margin slumped to 37% in 2013, erasing three years of gains and marking the first actual decline since 2006. The stock slumped to a low of $55 last April.
But Cook and his team were already hard at work on the answers Apple needed to fix the profit margin shortfalls. New products arriving at the end of 2013, especially the iPad Air and iPhone 5S and 5C, were more profitable than the models they displaced. And Apple’s quarterly gross profit margin has ticked up the past three quarters in a row. In the first quarter of 2014, the gross margin exceeded 39% for the first time since the third quarter of 2012 – back when Apple’s stock hit its all-time peak.
While most analysts were bemoaning the lack of exciting new products, Apple shares were set up for a strong rally. Since reporting the stronger-than-expected first quarter results on April 23, Apple shares have gained 27%.
Even higher margins could be on the horizon with upcoming iterations of the iPhone, according to rumors leaking out of Apple’s Asian manufacturers. Apple may be planning an iPhone with a slightly larger screen and a significantly higher price. The larger screen, higher profit margin phone would help doubly – grabbing back market share from larger-screened Google (GOOGL) Android phones and boosting margins over smaller-screened iPhones as well. And viewed through the lens of profitability, a new product like the rumored iWatch could help Apple more than a slender overall revenue increase might imply if it, too, carried high profit margins.
Cook is also taking Apple in directions that will be hard for any of its rivals, including Google, Microsoft (MSFT) and Samsung (005930.KS), to follow. At the company’s recent developer conference, Apple focused on improving integration among its various devices, with everything from photos to text messages flowing seamlessly from iPhone to iPad to Mac. Health and home automation features will link customers' lives even more deeply with Apple devices. And new software features and tools will make it somewhat harder for app developers to replicate their offerings on other platforms.
No other company controls the software and hardware on its customers’ devices like Apple. Samsung's difficulty in fending off cheaper products from Chinese rivals, evident in its weak second quarter sales, only highlights the problem of controlling just one half of the total package.
Even the $3 billion acquisition of Beats Electronics strengthens Apple’s efforts to differentiate itself by warding off a threat to its industry-leading media ecosystem. The iTunes store has been the top music retailer for years, and helps entice Apple customers to buy more Apple devices. The Beats acquisition makes Apple quickly competitive in music streaming, which is displacing digital music sales and threatening iTunes' hegemony. And those high-profit headphone sales don’t hurt either.
It appears to be true that Cook has made Apple a friendlier place to work, along with being more in touch with its community. He even joined a large contingent of Apple employees marching in San Francisco’s gay pride parade last week, posing with many for selfies. To that extent, Apple is becoming more like other companies, and rightly so.
But in the highly competitive market of smartphones, tablets and whatever wearable devices come next, Cook is taking Apple down a more solitary path than ever. And that’s just what Apple’s stock needs.