The Importance of Innovation: Why despite strong numbers, Apple is in trouble

This is the third part of the three part series on Innovation. The first part talked about the role of Innovation in organizations, the second described how Apple has recently regressed in its innovative output. This piece talks about how Apple has used other tactics to compensate for its lack of innovation and why their current business model is not sustainable.

I’m not sure where the old adage, “If you’re not growing, you’re dying” came from, but it illustrates my message so I’m going to do as Steve Jobs would have, and steal it.

The primary goal of any company is to generate profitable growth, or simply to grow. A company has to grow to meet financial obligations to its shareholders and maintain a place in the competitive marketplace. Each quarter, companies project how much they will sell and how much money they will earn. How the company performs relative to these projections dictates the price of their stock and therefore, the value of the company.

Companies that miss their projected earnings tend to have their stock price tumble. Companies that beat their projected earnings tend to have their stock price rise. When Tesla Motors announced in May that it had grown well faster than expected and it was profitable for the first time, the stock price quadrupled in a mere four months.

If a company does not meet their projected growth mark, it is interpreted as a sign of distress or failure within the company and the stock price, and therefore company value, tumbles dramatically. Recent examples of that would be BlackBerry and J.C. Penney. In both of those cases, the dramatic miss of earnings illustrated the inner turmoil of the company and led to a crippling loss of value.

On the high end, the stock market grows at about 7% a year. This means that on average, you can expect companies to grow by 7% annually. Since financial markets and stock prices of companies tend to rise over time, if a company merely stays the same it is underperforming the market and therefore is declining relative to its peers. So as a company, if you’re not growing, you’re dying.

An organization can grow in two ways. The first is organically. Organic growth is a result of innovation. It is developing new to world or new to market technology that changes the competitive landscape. Apple had a great stretch of developing new to world or new to market products including the iPod, iPhone, iTunes, and iPad. These innovations were developed internally and transformed Apple from a computer company into the most recognizable technology company on the planet.

The second way organizations grow is through mergers and acquisitions. Companies can purchase other companies or technologies that will expand their overall sales numbers for a given year. Over the past several years as the world entered and now has started to recover from the global recession, companies had to do more mergers and acquisitions to meet their growth numbers. A company that did $10B in sales in 2011, but due to the slowdown was only projected to do $9B in 2012 would have to acquire businesses totaling over $1B to meet their objectives and continue to grow as a whole. Additionally, companies can find synergistic technologies that will support current offerings and purchase the company that developed and owns them. This is an alternative to developing new technology internally and a strategy that Apple has increasingly employed. The incremental innovations such as the fingerprint scanner and Siri featured on the newest iPhone and software were technologies acquired when in acquisitions. Sure, those are now Apple technologies, but they are not Apple innovations.

In addition to using mergers and acquisitions to compensate for a lack of organic innovation, Apple is also entering new markets. Apple has entered the iPhone into three large new markets. The first is China. After first entering China last year, China Mobile, China’s largest mobile provider, is now planning to partner with Apple to sell the iPhone. The second is Japan. Apple’s new partnership with Docomo, Japan’s largest mobile carrier, is further expanding the consumer base. This strategy has been successful as people lined up in stores to buy as many iPhones as they could in the Asian markets. Sales ended up being limited to two per person for fear of the high rate of resale.

Apple also put out a new product called the iPhone 5C to target a market of lower middle class individuals who otherwise couldn’t afford the iPhone 5S’s steep price tag. Calling the iPhone 5C a “new product” may be a bit of a stretch as it has recently been called, “Garbage” and “Nothing more than an iPhone 5 with a colorful jacket.”

Nevertheless, these plans to enter into new markets are very effective at generating profitable growth. This release was considered, “The most successful product launch of all time.” The company sold nine million units, far outpacing previous launches. This success led them to raise their quarterly growth projections, but investors should be cautioned before jumping at these numbers. For the first time, Apple released two iPhones and entered into new markets.  Japan is getting an iPhone for the first time and this is the first time China has been able to get the most modern model at the launch. Sales in these countries counted towards the launch weekend numbers for the first time. Controlling for these new factors to compare each launch on equal terms, this one was nothing special for Apple’s flagship product.

The iPhone now accounts for about half of Apple’s revenue. Steve Jobs, like other effective leaders, cut poor performing products to focus the efforts of the company on a its most viable ideas. However, having one product account for 50% of all revenue is a dangerous business model, especially if that product is losing market share to competitors.

In fact, Apple has been losing market share to rivals as a result of having lost its innovative touch. Samsung recently became the world’s largest maker of smartphones by offering a wider variety of designs and prices than Apple. Google’s Android operating software accounted for 79% of smartphone shipments last quarter and Apple’s iOS only made up 13%.

These numbers are disconcerting for Apple and its shareholders because as this trend continues, App developers may focus more of their efforts on Google’s Android operating systems, which would eventually cause Apple users to defect further limiting sales and growth.

The growth strategy of most successful companies relies on a balanced approach, but with the majority of its profitable growth coming from organic innovation. After tapping the lower middle class market in North America and the large Asian markets, there isn’t much more Apple can do to grow except to innovate.

We have seen giant companies fail before, and while Apple is not in any danger of bankruptcy as it currently has $147B in cash on hand, which accounts for 10% of all corporate cash held by nonfinancial companies, this recent trend is disturbing for long term investors in the company. (Note: If Apple’s cash reserves were a country, it would have the 58th largest GDP). Remember the story of Wolworth’s? They created the modern retail business model and were once the world’s largest retailer. It didn’t innovate, so it declined and eventually went bankrupt. Apple, take note and please don’t be the Wolworth’s of my generation.

Check out the first part of the series here and the second part of the series here.