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Apple stock’s greatest enemy is its own products

What’s behind Apple’s stock plunge? Contrary to popular belief, it’s not necessarily anything the company is or isn’t doing – it’s mostly the product of accelerating commoditization, a historical force that no hardware-making company can resist.

Apple shares dipped below $400 this week for the first time since December 2011, after a report from parts supplier Cirrus Logic showed weak demand from an unnamed customer. Given that Apple, which uses the company’s parts in iPhones and iPads, makes up 90 per cent or more of its business … well, it doesn’t take a rocket scientist to work out the math.

Apple shares were again below $400 in mid-Thursday trade – more than 40 per cent off their 52-week high – signalling investors are increasingly worried about the company’s ability to compete against a raft of competing Android smartphones. Expectations of a cheaper iPhone have been circulating for months, while most industry analysts also agree that Apple’s one-new-smartphone-a-year release schedule no longer cuts it in a market marked by fast and regular upgrades from rivals.

That means Apple is under increasing pressure to innovate, but also to cut margins on iPhones, its single biggest source of revenue. Both are indubitably having an effect on the company’s shares.

Cheaper phones, cheaper wireless bills?

The fact that smartphone margins have been so high for so long – court documents in Apple’s patent battle with Samsung revealed them to be as high as 58 per cent, or double what they were on the iPad – has been a function of how the wireless market works. Phone makers sell their devices primarily to wireless carriers, who then subsidize them by locking consumers into contracts.

A strong argument can be made that if the phones themselves were cheaper, wireless customers’ monthly bills would be lower. The carriers, after all, have to recoup what they paid for the phones in the first place, so they pass on some of that cost to subscribers in the form of higher rates.

Apple has had it good since the first iPhone came out in 2007. The base model of that initial device was around $599 for the first 10 weeks, before Apple quickly re-priced it to $399. The current basic iPhone 5, meanwhile, retails for $699. Sure, the latest device is much more powerful than the first one, but how often does a piece of technological hardware go up in price?

Moore’s Law – which originally dictated that the number of transistors on a chip doubles every two years, but which has been expanded over the years to include the price-performance on virtually all technology – suggests the answer to that question is “never.”

The phenomenon holds in just about every other category of product, from computers to televisions to GPS devices to e-readers. Or, at least in every category where there is unfettered competition, which hasn’t been the case in the wireless market. With carriers playing the middle man between phone makers and consumers, the market – and therefore prices and margins – have so far been distorted.

The proof is in tablets. Apple debuted the iPad in 2010 at a basic price point of about $500. Although consumers could buy the devices subsidized through carriers, the majority were sold unencumbered without contracts. Competitors such as Amazon and Google wasted no time in commoditizing the category, releasing decent tablets for $200 to $300.

Apple itself was forced to cannibalize its own category with the iPad Mini last year, with the average price of an iPad in early 2013 coming down to $467, the first time it registered below $500 since the device’s launch. Chief executive Tim Cook admitted as much in January, although he wisely added that if Apple wasn’t going to cannibalize itself, someone else would.

The speed at which tablet prices have come down may seem remarkable, but they’re actually a reflection of Moore’s Law. Virtually every aspect and every part of every gadget is advancing amazingly quickly, with prices dropping just as fast as a result.

Being a company that is primarily in the hardware business – which Apple is – is thus becoming increasingly difficult. Such companies are under incredible pressure to innovate and keep coming up with new, category-making products. Apple has had an incredible and unprecedented run in doing just that, but no one can keep up such a pace indefinitely.

The good news is Apple posted $3.6 billion in revenue from iTunes, software and services in its most recent quarter, up 22 per cent from a year earlier. The bad news is, that still accounted for only 6 per cent of its total $54 billion in revenue, with the rest coming from hardware.

Until the company is able to start transitioning more of its business toward segments that aren’t as vulnerable to commoditization, there’s no reason to believe its shares won’t continue to be hammered by Moore’s Law.

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