Why I wouldn’t invest in Apple

Apple is the most valuable company, a status which it achieved first in August 2011 but was quickly surpassed by Exxon Mobile, again. Since then Apple has become even more valuable and managed to take the pole position for the near future. It grew approximately 100% since last year and is now worth a staggering USD 560bn. And it still has a lot going for it. However, I also think there are some major risks which are too often overlooked.

 

The smartphone opportunity

Arguably, Apple still produces the best or at least one of the very best smart phones in the world. Gobal smart phone penetration is still merely 28% which leaves plenty of room to grow.

Source: It’s still a feature phone world – Techcrunch

While the market is starting to get saturated in the US, there is still good growth potential in Europe. The emerging markets are just starting to adopt the next generation mobile technology and offer even more exciting opportunities.

 

Apple is THE world beating innovation engine

Apple is arguably the most innovative company of the last decade. Part of their magic comes from transferring of product management approaches from the IT sector to the consumer electronics sector: Apple had to learn the hard way during the early nineties that the computer industry is an incredibly competitive environment where strong network effects often prevail. It lost the operating system war against Microsoft and became a niche supplier for the creative industry.

Apple applied its learnings about platforms and ecosystems to the consumer electronics market. A market where replacement cycles are often between 2 years phones and 10 years for home stereo equipment. And even in those two years innovation is of the incremental sort and by no means disruptive.

Here Apple, which is used to product cycles in the IT of often only 6 months, and where concepts like continuous deployment are all the rave, had an easy play against slow moving giants like Sony (iPod vs MiniDisc players) or Nokia (iOS vs Symbian).

And there is still ample room for more products: The iPad contributes approximately 20% to revenues and is a product line which has not existed just 2 years ago. Or iTV…

 

Financial perspective

From a financial perspective, Apple is quite strong as well: They are highly profitable, making approximately USD 25bn revenues a quarter. They have USD 100bn in the bank which allows them to take long term bets and make acquisitions if needed. And most interestingly they are even fairly priced at around 17 P/E for the last 12 months.

 

However, Apple’s approach to innovation works until you have to diversify

While you can’t copy Apple’s product design and marketing genius, competitors which are equally dynamic have entered into the market of transforming consumer electronics. Apple is no longer fighting Nokia in the Smartphone sector but Google which knows how to address a vertically integrated company: with an open eco system and platform approach. While it is more complicated to coordinate a network of independent companies, you can clearly see how the advantage of Apple’s products over the competitors is shrinking. And you can even see how the competitors are ever faster at adapting the next product category: It took 5 or 6 years to catch up with the iPod, 3 to 4 years to catch up with the iPhone and I would expect that we will see tablets which are comparable to the iPad coming on the market within this year.

 

The market growth potential requires a diversified product portfolio

To successfully address the growth potential in the emerging markets, Apple will have to launch devices which cost considerably less than USD 700 for a phone. This is probably even valid for the remainders of the US and European markets. The untapped market potential most likely belongs to the late majority and laggard market segments. These customers buy a device because they have to and do it for purely pragmatic reasons.

Now Apple’s organizational set-up does not lend itself too well for churning out a wide variety of products. It automatically means you can pay less attention to the launch of a single product and ultimately, that’s what they excel at. So this market dynamic is actually more in favor of Google’s ecosystem approach.

 

Software as a Service removes lock-in by Apple

The last decade brought us a mature and diversified web services market. This initially helped to make smartphones possible because you did not need to store all of Google Maps locally. You just used the power of the cloud.
Now that the cloud is a mature and diverse eco system, there is much less value in designing a product end to end. Cloud services enable you to switch a device such as a tablet, smartphone or PC without the need to re-install or configure any software. As long as the operating system gets the infrastructure layer right like good battery life, good look and feel and reliable connectivity it doesn’t really matter that much whether I am running iOS, Android or Windows Mobile.
Apple’s lock-in in that regard is vanishing fast. Some web services like Spotify are even better than Apple’s iPod App on the iPhone in the meantime.

 

Financial success will make it more difficult to maintain growth

Apple is so big in the meantime, that portfolio managers are starting to take a look at the US stock market with shares excluding Apple. Heck, Apple’s worth 1% of equities world wide:

See also: iRational – The Economist

In my eyes, this means two things:

  1. Anybody who thinks Apple is a great investment has it
  2. Anybody who has to match in index has it; the risk of not having it and underperforming the index is way too large.

There will be incredible pressure to find market opportunities which are big enough to move the needle: if Apple want’s to grow revenues by 30% (they have done 50% – 70% historically), they need to create USD 20bn in additional sales. This will become even harder in the coming years.

People who are in the first group above will probably have made a nice return and cash in if the run is becoming more difficult. People in the second group actually should never have invested in the first place and will run to the exit when things get difficult.

 

Final thoughts

Finally, out of a pure investment perspective: What’s the upside?

It would be a hell of a feat to be the company which gets to USD 1 trillion market capitalization first. So that’s 2x if everything works out great.

I would strongly argue, that e.g. Salesforce can become the next SAP or Oracle. Now compare the upside of Salesforce which has a market cap of USD 21bn and could grow – if everything works out – to USD 80 – 140 bn (SAP and Oracle’s market cap, respectively).

Apple’s done it – they are legend. But I’m not convinced it’s a good investment.

Building a product for a consumer web business

There is always a lot of buzz around innovative businesses on the web. Various investors and startups prefer different variations of models:

  • Incubators such as Rocket Internet prefer businesses where the customer need has been validated in the US and where they shift the geographic focus to Europe
  • Then there are business models which worked in an offline world and get shifted to the web as more and more consumers, time and ecomomic activity is on the web. Examples here are mobile payments, ecommerce or advertisements
  • Lastly there are businesses and innovations which are true, radical innovations such as a search engine or Bittorrent

A business in its entirety is more complex, though, and there is good literature on how to assess and decompose business models. Alexander Osterwalder’s Business Modell Generation for example is in one of the best recent books on this topic.

In a nutshell the book argues, that you can look at a business as a combination of the following components:

 Approaches to creating a good value proposition

The difficult part is often the value proposition. From my experience, consumer businesses usually cater to at least one but usually a combination of the following use cases:

  • Discovery
  • Transaction
  • After Sales & Loyalty
  • Content
  • Sharing / Peer-to-Peer

Discovery

Discovery helps to find something. This is usually achieved in two ways:

  • Algorithmic search, where a ranking algorithm determines the relevancy of an object to the search. Google, Bing or Wolfram Alpha are good examples of business built on this
  • Curated search, here the content is hand selected by individuals. Early Yahoo was good example of curated search until the growth of web content outgrew the ability of Yahoo to curate. Other examples would be reddit or StumbleUpon

Transaction

Transaction means to exchange goods or services e.g. through e-Commerce stores or market places. Also I would put payment providers into this category. Examples are Amazon, Ebay or Paypal for the respective sub-segments

After Sales & Loyalty

Here the focus is to recommend further products, provide re-targeting ads for aborted shopping sessions and generally customer care.

Content

Written content is provided in the form of news sites and blogs. But are also use cases for (streaming) media, such as Spotify or Netflix and crowd sourcing content platforms such as Soundcloud or Youtube

Sharing / P2P

These are the traditional p2p file sharing networks started by Napster in the late 90s or Bittorrent. In my eyes more modern forms of this are social networks such as Facebook or Pinterest where you share status updates or other interesting things found on the web.

Final thoughts

Interestingly, when you look at most businesses they combine several of the use cases.

A P2P / sharing use case for example gets more interesting when you also have content and methods for discovery. Another example would be content which can be helped to provide information around products like the reviews of products on Amazon.

Most great startups that we admire really nailed one of these use cases and combine it with several other ones where they either partner with the best solution out there or achieve similar functionality to other sites without being extremely superior. The reason for this is that you simply can’t do everything in an excellent way. My favorite example for a failed attempt to do everything is when Apple tried to introduce Ping as a music social network as opposed to Spotify which clearly differentiated on superior content and chose to partner with the leading social network Facebook.

It’s time for the market place 2.0

Floating Market Thailand

 
 
 
 
 
 
… and it will look distinctively different from Amazon Marketplace and eBay…

 
 
 
 
 
 
 
 
 
 
 

In recent weeks I had several really cool discussions about attractiveness of marketplaces as a business model.  In summary I would say that we agreed on the following:

  • High margin
  • Relatively easy to implement technically
  • Critical is to overcome chicken and egg problem

 However, there are also a couple of challenges:

  • Combination of high margins which attract competition and low market entry barriers
  • The larger your platform grows the more you are in danger that a competitor re-segments the market and focuses on one specific niche: eBay as all-purpose platform for example has been challenged in the German speaking market by Chrono24 for watches, mobile.de for cars, immobilienscout.de for real estate etc

As a result this seems to put a limit on how big eBay as the most successful marketplace company can become. The entire company is currently valued at USD 43bn on the stock market. However, a substantial part of current and especially future business belongs to the PayPal business line:

Without going into too much detail, I would suggest it’s fair to assume that 50% of the business value is actually contributed by marketplaces which would put the current market valuation at roughly USD 20bn. Not bad right? Well, compared to the valuations of businesses with other business models this does seem to leave some room for improvement:

  • Amazon, e-commerce: USD 81bn
  • Apple, high end consumer hardware & software: USD 460bn
  • Google, search & advertisements: USD 196bn
  • Microsoft, b2b and b2c software: USD 257bn
  • Oracle, b2b software: USD 142bn

So how could the marketplace business model evolve?

In my eyes the best way to start is by expanding the value chain.

  • This allows  you to capture more of the value generated for your customers which essentially means increased revenue potential
  • It increases market entry barriers because you are more entrenched

This is especially interesting in a b2b context where complex workflows exist. Here, there is a great opportunity in integrating directly into the workflow of your customers.

Let me make an example:  A marketplace like 99 designs which allows to get e.g. a logo design done, could offer a SaaS product extension for quotations of design tasks. A project manager could then use this to decide whether to make the logo in house or externally via the 99 designs.

And there are countless of extensions that you can think of! On the supply side for example, you could offer a SaaS solution for printing companies which allows them to fill “empty space” when they are going to run a print job. Taken to the extreme this extensibility can evolve into a full blown platform where apps serve special use cases on top of the marketplace.

Besides of increased revenue potential due to more “products” that you offer you also have the advantage of increased market entry barriers because once you are integrated into corporate processes you will be much harder to be replaced. Also you can truly differentiate yourself and can compete on a innovation / premium product strategy as opposed to a commodity marketplace functionality.

If you re-segment a market by price you better be sure it’s big enough

The Red Hat Challenge

Innovations which allow drastic cheaper prices by e.g. delivering digital media files instead of physical DVDs or harnessing the power of open source software have huge impact on the market these innovations disrupt.
Take the market penetration of Linux systems as an example. Linux replaced Sun Solaris in many webservers because you could achieve more or less the same for a fraction of the price. While this seems like an obvious observation, this has a very important implication: In order to make 100 million in revenues, e.g. Red Hat had to capture 1 billion in market size of the Solaris / Unix market.

If you can’t expand your market, take somebody elses’s

The alternative to shrinking the market is that the new price allows tapping into new customer segments which were previously not buying because of a high price. There are many markets like books or TV, however, which already have a pricing affordable by nearly everyone. So any price reduction will directly affect the market size and the amount/size of companies the market can sustain.

If Netflix streaming subscriptions or Amazon e-books are going bring us cheaper prices, which I think they have to because otherwise somebody else will, this means that they are forced to cannibalize themselves. When they start scaling through the early majority the correspondingly large increases in subscription numbers will needed to sustain growth on a base of already significant revenues as well as making up the decrease in subscription rates. So, after a successful market introduction revenue growth will be difficult to maintain. Amazon chose to expand their role in the value chain and to take over the role of a publisher to make up for the drop in prices. I wonder how Netflix will react to this threat because I think it will be much more difficult to act as a publisher in the movie industry.

Spotify going „Music as a Service”

Negotiating contracts in the music industry is hard. Spotify was founded 2006 and only managed to enter the US market in 2011. It’s still lacking licenses for Germany, Italy or Canada to name just a few.  As a result, a major business activity for Spotify is to negotiate and manage contracts. Once these have been established they act as a market entry barrier for innovative new music services.

These contracts have also major impact on the economics of the business model. Costs for content and delivery rise as user numbers keep growing. As a result it’s pretty hard to earn healthy profits as pure streaming provider, despite that some artists complain about low royalty payments. Obviously, Spotify is currently also doing major investments in product development which impact profitability on the short term but this is to be expected from a startup. However, the long term implications of record labels as gatekeepers to content, their reluctance to innovate, and the ability to squeeze margins for streaming providers as well as artists are a major concern.

Spotify’s recent announcement that it’s turning its service into a platform is great news: It reduces the difficulty to experiment with innovative concepts and enables a whole new level of innovation fueled by the creativity and drive of a developer community. Besides karma points, Spotify is benefitting by the ability to offer more functionality and use cases which cater to specific audiences on its platform.
In terms of profits this is great, too: Similar to Facebook and the social graph, Spotify provides a service to app developers by making music content legally and easily accessible. For this it can charge a fee and tap new revenue streams.

There’s only one thing which I just don’t get, though: Enabling legal access to a music catalog and charging fees for that is the core business model of a record label. Why did record labels wait for Spotify to get this done?!?

The age of entrepreneurship

A lot has been written on whether here comes another bubble (great vid – check it out if you haven’t seen it). Most of the discussion has been based on examples of rising valuations in certain stages and some hot areas where market traction and technical innovation did not really justify the invested capital (Color, anyone?). Business and innovation management theory suggests there is no bubble but at least a decade of great startups ahead of us.

Business theory knows 3 types of business cycles:

  1. 4 year cycles driven by stock over and under capacity
  2. 7-10 year cycles driven by investments into production capacity
  3. 50 year cycles driven by new technology

The 50 year cycles can be broken into 2 parts. In the first period a new disruptive technology is introduced. The second period brings a clearer understanding of the applications and the technology diffuses into the wider economy and society. Between the two parts is usually a financial crises caused by overrated application and market penetration assumptions. In short: after getting drunk on the new kool-aid everybody wakes up with a really bad headache.

Characteristic for the second period is a fast paced and more stable expansion and growth until the markets are largely saturated. Following this logic, we would not head to another bubble. Before that a new technological 50 year wave would need to be kicked off, probably in the areas of nano technology or clean tech.

Due to different durations and time frames (the numbers are more approximations than exact values), overlaps can occur. Additionally, 50 years cycles are triggered by technological innovation which can cause additional overlaps between 50 years cycles. This doesn’t make it easy to get a picture of where we currently are.

The last 3 cycles were marked by the invention of steal & electricity; oil, cars & mass production; and computers & semiconductors. Everybody pretty much agrees on that. Usually the internet is attributed to the computers & semiconductors age, too. But business theory after all has a great track record of getting things right AFTER the fact ;-). So I’d say the jury is still out.

In my eyes there is an important difference in the internet: all previous cycles still depended to a large degree on physical resources which limit how often a given good can be produced. The internet brought us a technology by which another unit can be created without incurring considerable costs (the music industry had to learn that the hard way). This innovation enables entrepreneurs to turn their visions into reality with minimal resources. Facebook, for example, has conquered the world with just 2,000 employees.

This is the age of entrepreneurship. I think we will get smarter and fluctations of company values will be less extreme because we understand value added better. Of course there will always be ups and downs but these should not really matter as long as we focus on killer products which address real issues.

Quo vadis Twitter – is Twitter going mainstream?

Failwhale

 

Twitter is an awesome service. It’s one my regular sites which I always login to as soon as I start a browser. But I have doubts that it will be in its current form a mass communication tool such as Email.

 

 

 
I think Twitter has three main use cases:

a)    For broadcasting: because you don’t have to mutually agree on friendship the resulting graph is more similar to the media industry where it is possible to publicize a news and opinions in a one to many approach
b)    For trends/analytics: if you really want to know what people are thinking about your product create a Twitter search. You will find out quickly what’s wrong and can engage directly with you customers
c)    Hand curated discovery: Yahoo ultimately declined in search because the web grew faster than Yahoo’s ability to hand curate search results. Twitter kind of brings that back in a crowed sourced way. They’re taking it from a slightly different angle because you d on’t have to search, the information “finds” you. Of course you can manually maintain an RSS feed use TechMeme, StumpleUpon or good old browser bookmarks, but Twitter allows to filter news by the interests of the people who you follow. As a consequence it is also able deal with news which is normally not in one’s core interest areas would pretty quickly come through if it’s important enough like a natural disaster.

 

Why media and tech love Twitter

Many argue about how similar or different Twitter is to Facebook by pointing out the use cases implied by the underlying 1 to many graph. Few doubt that Twitter will become a universally used service (in the way that email, Facebook or Amazon are used).

I am not so sure to be honest. I see why the media, tech enthusiasts and Venture Capitalists love Twitter. Most Top 20 users on Twitter are from the media industry or politics.

And the tech community is always hunting for the next big trend, so for them it is a fantastic long tail analytics and curation tool (as well as a very promising investment opportunity). See here or here.

 

But what’s with scaling to “” people?

In my eyes Twitter faces a classic crossing the chasm problem. Twitter has successfully scaled through the innovators and early adopters, but the majority are pragmatists. If I look at the use cases above and at the non-tech group of family and friends, I don’t see that they find the same things equally appealing.

This group values opinions and updates by friends and the ability of instant delivery of messages and that’s why Email and Facebook are tools appealing to huge masses. These friends may read some journals which provide job related information and get general news from the big news sites on the web or TV. In my understanding this satisfies their need for information. They don’t have a “customer problem” in terms of that they don’t get enough news.

 

So what could Twitter do? 

  • voting up/down for posts to improve the signal/noise ratio?
  • allowing more than 140chars so it doesn’t feel like a 1990 style mobile text anymore? You don’t need to go for the other extreme, but how about 50 words?
  • the above would require a more powerful and easier to use tagging system to foster better categorization?
  • use an app store approach to centralize all twitter add ons and make them easily accessible for main stream audiences?

Unfortunately, I think it would involve adding features (it’s pretty hard to remove anything – that’s for sure) and I am sure that this has been intensely discussed internally. However, I have never heard of an innovative market leader who stayed in that spot by moving nowhere.