Understanding Apple's Success Made Easy

Apple is an extraordinarily successful company. I have a hard drive full of spreadsheets to document it and I spend much time each calendar quarter forecasting it. But there's an easier way to understand Apple's success than pouring over news reports, financial reports and traversing the Web on a daily basis looking for insights. 

I'll use the company's most recent quarterly performance as an example. For the three-month period that ended June 26, 2010, Apple reported revenue of $15.7 billion and net income of $3.253 billion dollars. Essentially just over $.20 of every revenue dollar flowed to the company's bottom line. This is after all costs have been paid, including income taxes. Prior to income tax expense Apple reported about $.27 of every revenue dollar flowed to the operating income line. 

In the June quarter Apple reported cost of sales (costs of the products and services sold during the quarter) totaled $9.564 billion or about 61% of each revenue dollar. Conversely, about 39% of each revenue dollar was maintained by the company to apply to other costs and reward shareholders in net profits.

Here's the simple math: Apple retains roughly 40% of each revenue dollar after covering the costs of products and services sold. Of that amount roughly 50% or 20% of each revenue dollar flows to the company's bottom line. 

How Does Apple Create Such High Profits?

Market Segmentation

Apple doesn't compete for product sales, per se. Apple competes for profits. The company carefully picks and chooses its product markets and defines which segments of these markets in which to compete. This is why Apple doesn't manufacture nor sell cheap PCs, cheap phones, etc. Apple competes in select market segments such as the $1,000+ PC market because in that segment Apple has greater pricing control and thus greater opportunities to realize higher profits.

Constituent Products and Services

Products and services such as AppleCare and MobileMe are margin expanders. They increase the yield per customer and increase the gross margin averages on products sold. Apple's focus is not on unit sales of products alone. Apple's focus is on the customer. Customer satisfaction drives sales in Apple's chosen market segments far more than the appeal of a discounted price. 

Apple consolidates revenue from iPhone-related products and services in the iPhone revenue segment. While iPhone unit sales increased 61% in the June quarter versus the prior-year period, segment revenue increased by 74%. The rising revenue relative to unit sales is influenced by revenue created from constituent products and services such as iPhone accessories. 

Content Sells Devices

Sales of the Apple iPod exploded following the opening of the iTunes music store in 2003 and the release of iTunes for Windows. Availability of content drives hardware sales. The iTunes app store is an important component of the iPhone's success. The Apple iPad, a product that set sales records at the time of release, came to market with the iTunes stores providing electronic books, music, movies and apps from the start. The iPad's early success is due in large part to the availability of content for the device. 

In the June quarter Apple reported revenue from "Other Music Related Products and Services" of $1.214 Billion, representing about 7.7% of total revenue. This revenue segment includes iTunes store sales, iPod services and Apple-branded and third-party iPod accessories. Content sells devices and devices subsequently sells more content. 

Apple Retail Stores

Apple's chain of retail stores was the fastest chain to reach $1 Billion in sales in US history. Not only are the stores successful as a retail chain, according to management 50% of Mac buyers at the retail stores are new to the platform. Although we've all seen Mac, iPhone and iPad advertisements, much more would need to be spent on advertising to support product sales absent the retail store chain. In the June quarter the retail stores were the source of 677,000 Macintosh units sold representing almost 20% of all Macintosh computers sold worldwide. 

If All This Represents A Model of Success, Why Don't Competitors Replicate It?

There's an old saying, "It took a lifetime to become an overnight success." The first Apple retail stores opened in May 2001 and the iTunes music store began operations in 2003. Both the Apple retail stores and the online iTunes stores are vital components of Apple's continuing success. Competitors can attempt to match Apple's market approach. But it would require huge investments in retail and online sales infrastructures and the ability to establish and maintain product pricing control. None of those variables come easy and nothing comes cheap. It also requires a great deal of time to establish and build on these sales assets. 

Absent the time, resources and willingness to invest in a long-term strategy to achieve Apple-style success, most competitors focus on price capitulation as a means to move units. This obviously reduces profit per revenue dollar and also reduces the competitor's ability to maintain pricing control over products.

Apple jealously guards its brand image and the company obsesses over product quality and customer satisfaction. Apple's success was not achieved overnight and can not be replicated without years of effort and billions of dollars of investment. While brand value might be considered an intangible by some, brand awareness, a reputation for quality products and strategic selection of market segments to enter are all producing tangible results for the company that will soon become the most highly-valued corporate entity in America. 

Understanding Apple's success requires only simple math. But achieving that success is the culmination of many years of effort and investment. 

Robert Paul Leitao