There was a time when clever individuals could sustain themselves by exploiting people’s ignorance and anxiety. Augurs studied the flight of birds to explain the will of the gods; haruspices practiced divination by inspecting the entrails of sacrificed animals. For fear of bursting into uncontrollable laughter, so the joke goes, the fortune tellers studiously avoided making eye contact with one another in chance street encounters.
Not much has changed.
Our modern-day haruspices, the Wall Street anal-ists, must struggle mightily to keep a straight face (although perhaps not so mightily–they’ve had a lot of practice).
Profit margins on hardware are very difficult to sustain over 10% for long periods of time. Someone always comes after you and this is not going to be an exception to that rule. But that in turn means that you either must cut your own prices (and margins) to compete or watch your market share get diced up into little tiny pieces by a bunch of guys wielding machetes.
Colorful. And with a disclosure of his own AAPL posture:
Lightly short and more likely to add to that position over time than cover it, eyeing major support in the $400 area.
The entire longish post is enlightening, in a “special” way, as is his September 2010 Seeking Alpha post where he predicted serious trouble for Apple’s new tablet (for which he uses a nickname that, we’ll assume, elicited schoolyard snickers from his cohort in the Tea Party, a group he helped found. New age male sensitivity be damned.) And what was the trouble he saw when he fondled the sheep’s liver? RIMM was “coming after” Apple; they had just announced the QNX-based BlackBerry PlayBook. Don’t laugh.
The idea, here, is that Everything Becomes a Commodity. It’s a common fallacy among the Street watchers, a meme, “a unit for carrying cultural ideas”, in Wikipedia’s words. It’s built on the idea that market forces—competition—will erase all advantages at a “molecular” level. Yesterday, customers were paying more for product A because of some unique feature or service. Tomorrow, a competitor will provide the same (more or less) at a lower price. Commoditization always wins, say the sages. QNX is better than iOS so the PlayBook will, clearly, murder the iPad.
Fun aside, Mr. Denninger is but a member, if that’s the right word, of a class of ideologists who seem to be curiously unaware of their surroundings. Where is the ineluctable commoditization they predict?
It isn’t a new idea. When I landed in Cupertino in 1985, the Pepsi and Playtex marketeers that tagged along with the new CEO insisted that the tech game was over, personal computers are now commodities, marketing would have to do for Apple what the Leo Burnett ad agency had done for Philip Morris with its Marlboro Man campaign.
True, the Marlboro Man was an exemplary marketing success that made a huge monetary difference for an otherwise commodity product. Marlboro didn’t make a “superior” product–blonde non-mentholated 100mm filtered cigarettes are all the same. The only pieces tobacco companies could move across the chess board were imaginary and romanticized.
But high tech isn’t a commodity market. In very French words I told the young commoditizing Turks how wrong they were: Moore’s Law and good software would create the opportunities that make a difference. Commoditization isn’t ineluctable.
Are clothes all the same? Tube socks at Costco, perhaps. But for the rest of our wardrobe, material and cut (and brand) matters.
Food? Do we buy commoditized calories, or do we care for the difference that the quality of ingredients and preparation make? Fresh string beans and asparagus, lightly fried in butter and properly salted—you can’t get that from canned vegetables packed in a margarine sludge, ready to pop into the microwave.
Do we buy cars because they go fast and the wheels are (most of the time) round? I can hear the young Turks claiming that people don’t buy cars, they buy transportation (all while jumping into their BMWs). But when Detroit began putting accountants at the head of car companies, they rode the steep downhill slope of commoditization. That Audi is now one of the most profitable car companies on the planet tells us something about the importance of technology, design, manufacturing, and quality.
I used to refer to BMW as a good example for Apple: Don’t worry too much about market share. A well-made, well-marketed product will see its difference rewarded by the marketplace. And, indeed, BMW became larger than Mercedes Benz. And now we have Audi.
Quality shows, and Apple continues to show quality. Last quarter they enjoyed an incredible 47.4% Gross Margin. Higher than expected and very unusual for a hardware company.
As an ex-entrepreneur and a venture investor, I’m a fan of Gross Margin—it’s what you can spend. Revenue is nice, but it doesn’t tell you when and how much you can eat. Because Apple’s Operating Expenses have become such a small percentage (8.1%) of revenue, Apple’s Operating Margin approaches 40%. As Horace Dediu notes in his Which is best: hardware, software or services? comparison of Apple to Microsoft and Google, this is unusual for a hardware company:
Can this growth continue unabated? Probably not, both Microsoft and Google have shown that there’s a plateau, a margin level that can’t be exceeded. But their examples also show sustainability.
Of course, Apple execs are cautious forecasters. Their much second-guessed guidance for the next quarter calls for “only” 41% Gross Margin, significantly less than last quarter’s. But the commoditization predicted 27 years ago isn’t about to happen.
I’ll quote Horace Dediu’s May 1st post once again:
Apple is the most valuable company in technology (and indeed in the world) because it integrates hardware, software and services. It’s the first, and only, company to do all these three well in service of jobs that the vast majority of consumers want done.
A mere matter of execution…
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