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Will Apple’s Focus on Profits Let Its Rivals Jump Ahead?

Pocketing profits instead of investing in innovation is how market leaders turn into has-beens.
September 11, 2012

As golden geese go, it’s pretty hard to beat the iPhone. In the five years since Apple introduced the first model, the company has enjoyed booming sales and ever-increasing profit margins. Revenues this year will top $150 billion, six times what they were in 2007. Apple’s profit margin over the past nine months (the first three quarters in its 2012 fiscal year) was an astounding 28 percent, double its level in 2007.

But the real miracle is that Apple has kept growing, and widening its profit margins, even as it has been eclipsed by its biggest rival, Google’s Android operating system. In 2010, the two platforms were about even in terms of market share. But today Android holds four times as much share as Apple.

Last quarter, Android’s smartphone share surged to 68 percent globally, up from 47 percent a year before, while Apple slid to 17 percent, down from 19 percent a year before, according to IDC. Worse yet, in the June quarter, Apple’s smartphone unit sales grew 27.5 percent, while the overall market grew 42.2 percent and Android grew 106.5 percent.

That’s right. Apple, the “market leader,” is growing slower than the market, and has one-fourth the market share of its biggest rival.

So how do you lose ground in a market but still turn in barnburner financial results?

Easy. Sell the same damn phone for five years, but keep charging a premium for it. Since 2007, Apple has produced five models of the iPhone. Squint your eyes and it’s hard to tell them apart. They’re all roughly the same size, with roughly the same user interface. The display size hasn’t changed at all. The shell of the iPhone 4S was the same as the iPhone 4. The iPhone 3GS was the same as the iPhone 3. Sticking with the same shell for two-year stretches lets Apple save money (read: milk profit) by not having to retool its production line.

Did you know that Apple spends far less than its rivals on research and development? Despite all its bluster about “innovation,” Apple devotes a paltry 2 percent of revenue to R&D, versus 14 percent at Google and Microsoft and 6 percent at Samsung. In terms of absolute dollars, Google spends twice as much as Apple on R&D, though it has one-third the revenues. Microsoft spends three times as much as Apple, but has half as much revenues. Samsung’s revenues are about the same as Apple, but the Korean company spends 3.5 times as much on R&D.

No wonder Apple makes such an amazing profit. The overall net margin may be 28 percent, but on phones, Apple makes 38 to 42 percent, says Tim Bajarin, head of Creative Strategies, a Campbell, California-based research firm.

But others have kept pushing ahead, and today, the iPhone lags behind Android phones in terms of functionality, as top-tier Android phones like the HTC One X and Samsung Galaxy S3 have shipped with bigger screens, better batteries, voice navigation, and support for speedy 4G LTE networks. In recent years, Apple’s big “breakthroughs” have been things like the high-resolution retina display (yawn) and Siri, a voice assistant that works great in TV ads, but in real life? Not so much.

On Wednesday, Apple will unveil the sixth version of the iPhone, which apparently will be called the iPhone 5, and it seems that Apple is sticking to incremental improvements rather than radical changes. Rumor has it the new iPhone will be slimmer, with a better battery and support for 4G LTE networks. And Apple will stretch the phone so the screen will be four inches (diagonal) instead of 3.5 inches.

That seems a bit underwhelming. Nevertheless, Apple no doubt will produce one of its classic new-product videos where design chief Jonathan Ive and marketing boss Phil Schiller explain the Nobel-worthy research required to add that half-inch of glass and better battery. And people will go for it. Gene Munster of Piper Jaffray, one of the best analysts covering Apple on Wall Street, reckons that Apple could move 10 million units in its first week of sales.

But how long can Apple keep this up? How long can it sell me-too products at premium prices? At some point you would imagine that the onslaught of Android phone makers, particularly Samsung, would start to take its toll. Eventually the strategy of pocketing profits instead of investing in innovation is what turns market leaders into has-beens. The fact that Apple has resorted to lawsuits rather than competing in the marketplace is another worrisome sign.

For now, however, Apple still gobbles up 66 percent of the profits in the overall mobile phone market, according to Asymco, a research firm. That’s down from 75 percent last year, but still—good grief. A single company, selling three smartphone models, grabs two-thirds of all the profit. That’s amazing, and maybe even a little bit obscene.

Just remember, if you’re one of those people who stands in line to buy the latest, greatest, overpriced iPhone 5, there’s a reason why Apple employees clap and cheer for you when you check out. Now you know.

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