Why Apple will remain the tablet king with the iPad
An Apple employee shows an iPad to a person at the Apple store on Fifth Ave. in New York, on Saturday, April 3, 2010. (AP / Diane Bondareff)
Published Saturday, October 9, 2010 7:43AM EDT
The only real way to invest with confidence is to evaluate companies first on sustainability of the long-term growth rate. The Apple iPad is the market leader; leadership creates increasing returns. Even at these levels, Apple remains a buy.
A plethora of tablet devices will flood the market at the beginning of 2011 leaving a lengthy first-to-market advantage to Apple and creating yet more consumer confusion over the devices. Both of these serve to drive more consumers to the iPad and, maybe, a lower-priced distant second will emerge. But even that is a long shot, unless the competitors change their approaches. Consider these points:
First, too many choices result in consumer paralysis and will generally just drive the consumer back to what they already know, that is, the market leader. The Apple iPad not only pioneered the category but it set the standards to which all other competitors are trying to match or beat. When customers are faced with more and more products, they become overwhelmed and find it is just easier to go back to the market leader than sift through all the combinations.
Second, the only knocks on the Apple iPad so far are the lack of certain features like a camera, a video camera and voice capabilities or its price. But all these will come in carefully orchestrated product upgrades and launches probably already on the Apple corporate calendar. Just because these features are not in the first generation Apple iPad does not mean they are not ready in the stables.
Third, a cost-competitive strategy is very challenging in consumer electronics because the spread of features-to-price-point compresses very quickly. Generally within about 18 months, the spread is so narrow that consumers are happy to pay just that slight bit more for more features. Over the past eight years, consumers have become accustomed to quickly dropping prices on the features they aspire to, so rather they either hold off purchasing for what they really want or just splurge now.
All this will drive consumers to the Apple iPad. We've seen this play before. Think digital music players and the iPod--iPod still has over 70 per cent market share.
What is Apple's "secret" to success? What Apple has delivered in the iPad and has consistently delivered in all of their products is a "user experience." Somewhere around 1967, our culture began to focus on experiences, not attributes, and ever since then marketers have made millions selling books on branding, emotional branding, rethinking design, conventions of experience, et cetera. Yet, technology companies fall into the same old trap of touting attributes (GB, RAM, 4G, et cetera) instead of the experience.
Ease of use. Simplicity. Elegance. All of these equate to brand loyalty and market leadership. Consumers are willing to pay more, accept prescribed functionality and even switch carriers to adopt Apple products. Most critically to an investor, this market leadership generates increasing returns. This is why it matters to us investors.
Market leadership creates increasing returns. Michael Walkley of Canaccord recently calculated that Apple earns roughly 40 per cent of the profits with less than 3% of the overall handset market. Theoretically, in the book Eating the Big Fish, Adam Morgan illustrates this phenomenon across industries. Once established like Apple is, the market leader has to spend less to maintain leadership and can maintain higher margins. In mobility, Apple maintains this position unchallenged currently.
Increasing returns creates sustainability, which in turn translates into long-term growth rates. This is very important as investors consider what stocks they want to own at a time where the market is uncertain and individual stock prices are whipped up and down 2 per cent daily. The greatest returns in the market came from the companies that offered a new and differentiated user experience. Consider the stock movements over the past five years. Winners, in this category, are Apple $52 to $284; Hewlett-Packard $27 to $42; Research In Motion $22 to $48 and Google $313 to $525. Losers in this category are Nokia $17 to $10; Motorola $20 to $9; and Dell $33 to $13. This brings us back to the top. If the competition just tries to compete with Apple on functions, they will not be well served. The tablet category is just beginning. Apple has emerged as the clear mind-share leader and the only way to compete is to focus on user experience (usefulness, simplicity, elegance, consistency) not the product attributes.
It will be particularly difficult for the Google Android devices to differentiate from each other because they will all offer a similar experience. Research in Motion set up its own challenge with the Playbook. Research in Motion had its day by providing a function -- e-mail -- to a business user. It was never an "experience," but it did deliver increased business functionality to a business user. Contrast that to the PlayBook's press release describing it is a great "gaming" device. Enough said.
There are two wild cards in the tablet category, namely because it is not clear what they are going to do. The first is HP because it has an original user-experience DNA with their acquisition of Palm. Recent announcements suggest HP will embrace Palm's webOS and Jon Rubinstein is publicly speaking and portending product releases. HP has the war chest to support Palm in ways Palm could not have done as a stand-alone company and Palm understands the user experience and how to deliver it in ways HP did not as well (remember the iPAQ in 2000?) If the Palm culture can integrate with HP (for example, will Todd Bradley be the next CEO?), then a differentiated user experience could emerge from HP.The second is Nokia because, despite numerous missteps, it has an incredible technology war chest and has signaled to the market a change with Steven Elop from Microsoft and Peter Skillman out of Palm and IDEO. It just needs to step back and package technologies in a useful simple way. With recent management changes, Nokia is signaling a willingness to do things differently. Nokia has enormous challenges. The first and most critical is to deliver a unified consistent branding message.
"Connecting People" is a great start. Now leverage that into a user experience.How should we value sustainability? Currently, Apple trades at a 14.7 times forward multiple (excluding cash) and boasts a 21.5 per cent growth rate, resulting in a price-to-earnings growth ratio of 0.68. The growth rate appears sustainable as Apple stock has delivered twice that, a 42 per cent compounded annual growth rate over five years. Using the earnings estimates out there and the 21.5 per cent growth rate, Apple should be a $342 stock in 12 months. In this rate and stock environment, it still remains a buy.There are no other market contenders yet. That said, I am keeping my eyes on Hewlett-Packard to see if the Palm DNA comes through either in the new CEO or product announcements. Its price-to-earnings growth of 0.77 times is attractive if it can differentiate in this category. I am also watching Nokia to see if it will leverage its technology into a fresh compelling user connection. With a price-to-earnings growth of 0.58, Nokia has the most upside to offer if it can unify its global footprint, technology, new leadership and connect with its users across the markets.