Apple Will Destroy It's Greatest Product

A Motley Fool Special Report

9/2/13 1:18 PM

Apple Will Destroy Its Greatest Product
Truly revolutionary products are rare. Products of this caliber create history, push industries forward, signal paradigm shifts, and redefine the way we live.
Apple (NASDAQ: AAPL) has brought not just one, but several products of this magnitude to market over the decades. When Steve Jobs introduced the iPhone in 2007, here's how he put it:
Every once in a while, a revolutionary product comes along that changes everything. One is very fortunate if you get to work on just one of these in your career. Apple has been very fortunate; it's been able to introduce a few of these into the world. In 1984, we introduced the Macintosh. It didn't just change Apple -- it changed the whole computer industry. In 2001, we introduced the first iPod, and it didn't just change the way we all listened to music -- it changed the entire music industry.
Over the coming years, the product unveiled that fateful day would indeed proceed to change the entire smartphone industry. A few years after that, the iPad would jumpstart the tablet renaissance, after the first tablet movement fell flat because the segmented value chain failed to deliver a compelling product.
As unique as Apple has been in its ability to create so many revolutionary products throughout its turbulent history, it's also unlike other companies in that Apple shows no fear whatsoever in actively destroying its greatest successes of the past. For this reason, Apple will again predictably destroy its greatest product when the time is right. But to really illustrate this point, we have to go all the way back to 1984...

Back to the Mac
In the early days of computing, arguably before computers were really considered "personal" on a mainstream level, interfaces were largely text-based command lines. Back then, computers used operating systems like DOS, which required users to be familiar with specific command prompts or risk running into the dreaded syntax error. Even the Apple II used a textual interface.
Needless to say, this computing paradigm was far from approachable for the average consumer, which is why personal computers were largely a niche product at the time. Apple would soon develop and launch the Macintosh in 1984, with its revolutionary graphical user interface, or GUI, heralding a new era of truly personal computing with a user-friendly interface that the average consumer could learn to use.
Original Macintosh GUI. Source: Wikimedia.
GUIs had already been implemented in industrial computers (such as at Xerox PARC, where Jobs first saw a
GUI), but this was the first time a company put a lot of weight into widespread consumer commercialization. A few years later, Microsoft would release Windows, which featured a GUI. The rest, as they say, is history.
Of course, Microsoft's rise to ubiquity is well-documented, as is Apple's flirtation with bankruptcy, despite the revolutionary impacts of the original Mac. However, after Steve Jobs returned to Apple in 1997 and reinvigorated the company with the iMac, things began to turn around. The Mac became a great product again, even though it was relegated to single-digit market share figures and the company was in the midst of a multiyear turnaround http://www.fool.com/free-report/stock-advisor/apple-will-destroy-its…tmail.com&iid=42051843&repeatecap=n&vsaid=5478&src=isaeditxt0900025 Page 1 of 9

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under Jobs' second tenure.
In many ways, the Mac was the first modern PC with a GUI, and has always defined what a PC should be. Only in relatively recent years has Apple's PC market share begun to climb meaningfully. The company is now into double-digit territory in the U.S. market. Yet Apple is the biggest champion of the
"Post-PC" era, a term widely popularized by Steve Jobs. Although that hasn't stopped
Apple from continued development and innovation in Macs, even though its importance to overall financial results continues to decline.
Source: SEC filings. Fiscal quarters shown.
As Apple expanded into music players, smartphones, and tablets, the Mac has not only taken a back seat to those product categories, but it has become a clear victim of a secular trend that Apple is largely responsible for catalyzing. The smartphone and tablet markets are only where they are today because of Apple, and combined they exert incredible downward pressure on PC sales through the form of lengthened upgrade cycles and outright cannibalization.
With current CEO Tim Cook's predictions that the tablet market will soon eclipse the
PC market, the Mac's future prospects are muted. Apple was fully aware that the mobile revolution would add to Mac cannibalization, yet it has no qualms contributing to its downfall.
The Mac isn't the only victim of Apple's self-cannibalization...

The Rise and Fall of the iPod
Apple's second big breakthrough product was the iPod, which revolutionized the portable music player market.
Much of this success can also be attributed to launching the iTunes Music Store, which allowed users an easy way to legally purchase digital music, an important distinction since piracy was rampant at the time. http://www.fool.com/free-report/stock-advisor/apple-will-destroy-its…tmail.com&iid=42051843&repeatecap=n&vsaid=5478&src=isaeditxt0900025 Page 2 of 9

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The iPod became another category-defining product that helped catapult Apple's brand image just four years after Jobs' return during the company's darkest days. The device proved Apple's capability to design a product that consumers didn't know they wanted but would eventually find it hard to live without, cementing Jobs' status as a visionary leader.
Since Apple was able to quickly grab and maintain more than 70% market share of music players, Apple's brand became synonymous with music devices and even Apple's iconic headphones became a pop culture phenomenon.
Apple has long described the "halo" effect that it observed after launching the iPod. Since the iPod and Mac were integrated so seamlessly, iPod sales helped boost Mac unit sales as consumers prefer devices that work well together. iPods and Macs are complementary products, and as such they helped sell each other. There was simply no threat of cannibalization here.
The iPod was absolutely a great product that shifted the broader music industry by setting the standard for digital distribution and demonstrating that music player interfaces didn't have to be overly complicated. It spurred a string of entrants into the music player market hoping to grab a piece of Apple's success, including Microsoft's
Zune, among many, many others.
Source: SEC filings. Fiscal quarters shown.
The iPod's financial importance was steadily rising and peaked at 40% of TTM sales.
This was coming from a product category that had previously lacked leadership and all of this revenue was entirely incremental upside. However, that all changed with the iPhone, and then later with the iPad. You could even argue that the iPod is the perfect example of Apple's self-cannibalization, since the iPhone and iPad are definitive substitutes for the music player. By incorporating iPod functionalities directly into iPhones and iPads, declining iPod sales were simply inevitable. Source: SEC filings. Fiscal quarters shown.
If we consider the iPod business in dollar terms, it's not surprising that iPod revenue peaked just six quarters after the iPhone's launch. Revenue pulled back and began to stagnate, and then plunged shortly after the iPad's launch. Yet, despite the fact that the iPod is now merely 3% of sales, Apple continues to innovate and introduce new designs for its iPod subfamilies. The iPod Touch and iPod Nano recently received complete (and expensive from manufacturing and cost curve standpoints) industrial redesigns. When it comes to internal resource allocation, http://www.fool.com/free-report/stock-advisor/apple-will-destroy-its…tmail.com&iid=42051843&repeatecap=n&vsaid=5478&src=isaeditxt0900025 Page 3 of 9

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most companies follow strict policies that send development dollars to the biggest revenue generators. Apple bucks this trend and keeps upgrading the iPod, even though the average MBA student would probably look down on the practice.
It was always inevitable that multifunction smartphones would eventually replace single-purpose music players. As the dominant music player vendor, Apple had the most to lose from this transition -- but that didn't stop it from fully embracing the smartphone. The market positioning is very different from in PCs, where Windows PCs have more to lose from rising mobile adoption.
The iPod was easily Apple's greatest product for many years, but Apple didn't even hesitate to crush one of its most successful businesses. That said, Apple doesn't always need to come up with new product categories to demonstrate its propensity to cannibalize itself...

Keeping It in the Family
Even within product families, Apple has shown it doesn't simply rest on its laurels. The company has shown a penchant for moving downmarket at times in order to broaden its appeal and user base. This is also an anomaly in many companies, since most executives and investors balk at the idea of voluntarily putting downward pressure on average selling prices and margins unless absolutely necessary.
As the iPod gained popularity, Apple subsequently introduced the iPod Mini, iPod Shuffle, and iPod Nano, all of which targeted lower price points and led to a precipitous drop in its average selling price (ASP). The iPod Touch was launched shortly after the iPhone, but by then there was no hope of the iPod's ASP ever reclaiming its former glory. Source: SEC filings. Fiscal quarters shown.
Those smaller iPods couldn't serve as complete substitutes for full-featured iPods with greater storage capacity, since this was before the days of cloud storage and streaming options. Still, there was always the risk that they could serve as sufficient alternatives to flagship iPods and some cannibalization would occur. That didn't stop
Apple.
The most recent example of the same strategy comes with the iPad Mini. Apple positions the iPad Mini as very much an iPad alternative, making sure it has all the same features of the larger model but just packed into a smaller form factor. This fact virtually guarantees a high level of cannibalization, and just one quarter after launch Apple posted a meaningful decline in iPad ASP. Apple isn't perturbed by this decline, even if Wall Street is. http://www.fool.com/free-report/stock-advisor/apple-will-destroy-its…tmail.com&iid=42051843&repeatecap=n&vsaid=5478&src=isaeditxt0900025

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Source: SEC filings. Fiscal quarters shown.
Speculation continues to swirl that Apple is preparing a similar move with the iPhone.
Thus far, Apple's iPhone strategy has been to gradually move older generation models down, but that may change this year if
Apple launches a fresh iPhone model targeting mid-range price points. This will naturally push iPhone ASP down, but the upside will be increased adoption and unit sales. Once again, some cannibalization of the flagship model is expected. Once again, this concern isn't stopping Apple, in part because the company has figured out the key to successful cannibalization...

The Key to Successful Cannibalization
Over the past few decades, Apple has demonstrated a unique willingness to selfcannibalize its greatest products, starting with the Mac and then with the iPod. Right now, the iPhone and iPad are unarguably
Apple's greatest products. The iPhone made capacitive touchscreen interfaces the norm, while the iPad continues to define and lead the tablet market.
If history repeats itself (which it has a tendency of doing), Apple will eventually crush both the iPhone and iPad. Make no mistake: This outcome is inevitable.
Mere mortals aren't privy to the details about how or when this will happen, or what product Apple will devise to do the dirty deed. The most possible new product categories that
Apple may soon enter are smart watches and smart TVs, which would seemingly be complementary devices rather than substitutes and thus not be a direct threat to the iPhone and iPad.

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However, the smart watch notion represents an entirely new frontier of technology in wearable computing, a broad category that could threaten smartphones. Eventually, the iPhone and iPad will become as financially unimportant as the Mac and iPod are today, even though that day is many years away.
The important thing for Apple is that it's been able to undermine its previous successes in a way that keeps it at the forefront of evolving trends in consumer technology. This is the key to successful cannibalization: Apple's sole focus is simply to create great products. So long as Apple is able to continue executing this task, cannibalization becomes an afterthought.
Tim Cook has said that once cannibalization becomes a determining factor in choosing which products to pursue and which not to, a company has already lost sight of what's really important: the customer. One of Steve Jobs' favorite quotes came from hockey legend Wayne Gretzky: "I skate to where the puck is going to be, not where it has been." Jobs also always said it was better for Apple to cannibalize itself instead of waiting for a rival to do so.
That's how Apple stays a great company. To learn about more quality companies like Apple, keep reading.

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All scorecard numbers as of July 31, 2013. All other figures as of March 26, 2013. The
Motley Fool owns shares of Apple and Microsoft.

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