The Bet

Two Bites of the Apple

Three years into Tim Cook’s reign, are we bullish or bearish on the house Steve Jobs built?

Tim Cook
Apple Inc CEO Tim Cook speaks on stage during an Apple event in San Francisco, California October 22, 2013.

Photo by Robert Galbraith/Reuters

On June 2, Tim Cook will likely deliver the keynote address at Apple’s Worldwide Developers Conference. Held every year around this time, WWDC is Apple’s big show—and not just for the company. The tech press whips itself into a fine froth in the run-up to the event. Every journalist, blogger, and fan on the Apple beat tries to scoop the other with the latest gossip and wildest predictions. Is this the year of the iWatch? An Apple television? Something else altogether?

Here’s what I can predict: the Apple of 2014 isn’t going to be made or broken by the sex appeal of whatever Cook demos on stage. Pundits love to trot out super bullish or über-ursine predictions every year around WWDC, as if the fate of the company hangs in the balance. But that’s hardly the case. Apple is a sober, mature company, with a $600 billion market cap, $45.6 billion in quarterly revenue, and a 39.3 percent gross margin. It’s increasingly catering to shareholders: raising its dividend and increasing its stock buybacks. It’s even been issuing bonds—a $17 billion offering last year, followed by a $12 billion offering the other week—to take advantage of low Treasury interest rates, and to offset the tax bill on the 88 percent of its $151 billion in overseas holdings. It’s the kind of company that makes sizeable acquisitions—like its rumored $3.2 billion Beats deal—to secure brands and perspectives outside of its own, but that are complementary to its objectives.

People talk about Apple as if, after all these years, it’s still a startup. It’s not. Nevertheless, it’s a growth-oriented company, and that growth is at a crossroads. Most of it is coming from a single product, the iPhone. That product is approaching its eighth generation. On the other hand, the iOS platform has lots of room for expansion—into every device imaginable.

Here are two competing assessments of the company’s health.

The Pessimistic Analysis

Apple is in a dangerous position. It’s a hardware company, dependent on high margins and frequent customer replacement. Most of its hardware lines are long in the tooth, and customers aren’t fetishizing them like they used to.

The iPod, for example, is not entirely dead, but it’s dying quickly—sales are down 51 percent year-over-year, as the feature-richness of the other iDevices has rendered a single-purpose media player largely obsolete.

Then there’s the iPad. The fastest-growing product in Apple’s history has stopped growing. Sales are down 16 percent year over year, per Apple’s quarterly reports. Apple moved 16.4 million iPads in Q2 of 2014, down from 20 million in Q2 of 2013. Engadget’s Chris Velazco thinks the iPad may be a victim of its own adequacy:

Some have also argued that the iPad’s main market consists of high-income consumers, and they’ve already got their iPads. After all, we nerds may upgrade at the slightest provocation, but the iPad isn’t bound by a mobile contract that promises you a good deal on a new one in two years. It’s more fixed than that, so it shouldn’t be surprising that people tend to hold onto them.

On Apple’s most recent earnings call, Tim Cook offered a rebuttal to iPad bears. He emphasized that 210 million iPads have been sold so far, and that the iPad has grown at twice the speed of the iPhone since its launch. But these are lagging statements, and they don’t satisfy. Yes, the iPad has been a phenomenal success to date. In all likelihood, the iPad will remain a big seller for Apple for many years to come—but it won’t be the growth engine it has been. It seems everyone in America who wants an iPad already has one, while the iPad’s position in China is an unsettled question.

Apple could break out a big new product line in the wearables market. But that market’s been a tough nut to crack. Wearables like the Nike FuelBand and the Samsung Galaxy Gear have failed to impress the general public. The more ambitious Google Glass has yet to launch big—and many of its early testers aren’t quite sure it’s ready to. If Apple is getting into the wearables game, it’ll have to take a different approach. Furthermore, it’ll risk a confrontation between its new device (iWatch or otherwise) and the iPhone, its flagship product. The iPhone is quite good at almost everything these days. The iWatch will need to carve out exciting new use cases to set itself apart—but those use cases can’t be too specific, or they’ll limit the size of the market for the device.

The Optimistic Analysis

The future belongs to iOS, and Apple has plenty of opportunities to exploit it.

The iPhone is still growing like crazy after seven years on the market. It accounted for approximately $58.6 billion of Apple’s $103 billion in revenue in the year to date. Year-over-year revenues for the iPhone are up 17 percent so far, with much of that growth coming from international markets. In Q2 of 2014, Apple sold almost 44 million iPhones, up from 37.4 million in the same period last year.

Presumably, a lot of this growth comes from China. Apple’s deal with China Mobile puts the iPhone in theoretical reach of a staggering 700 million mobile customers. Those customers, growing more affluent by the year, have demonstrated fairly American consumer patterns. We can expect that they’ll trade up for newer, shinier iPhones in much the same way that Americans do. That’s great for Apple, because it yields a predictable business cycle, it simplifies demand forecasting, and it makes supply-chain management easier. (All of those things, we should note, are Tim Cook’s specialties.)

Impressive as the iPhone’s trajectory still is, however, it’s a single product. Apple courts a great deal of danger relying on just one line for over half of its revenues.

Or does it? We can think of the iPhone as Apple’s leading product, or we can think of iOS as Apple’s leading product. True, Apple makes its money selling hardware. But selling hardware depends on having a strong ecosystem to support it. And iOS is stronger than ever, with over 1 million apps available (and growing quickly). iPhones and iPads have delivered iOS into the hands of hundreds of millions of customers, and in so doing, they’ve creating a ready and willing customer base for any iOS-based products Apple releases in the future.

We can expect, as rumored, that Apple will give iOS a starring role at this year’s WWDC. Apple will introduce a new look and feel for iOS 8. It’ll reveal Healthbook, a total health- and fitness-tracking app that paves the way for iOS-based wearables. It’ll show off split-screen multitasking for the iPad, a productivity tool that makes iOS more suitable for business use. (The enterprise market for iOS is potentially enormous.)

If Apple launches a wearable product this year, that wearable will almost assuredly be running iOS 8. That’s enormously important. Google Glass got off to a rocky start in large part because there were only a handful of Glass apps available for the device. Apple won’t make that mistake. Its iWatch will, from day one, be backed by over a million apps already available. It’ll also have plenty of iWatch-specific apps already in development, or on the way shortly, and will be capable of integration with other iDevices.

And iOS is about more than just apps. Critics have noted that iTunes is in trouble. Many of them have ascribed its declining share of the media business to the rise of subscription services like Pandora, Spotify, and Netflix. Indeed, that’s how many of them have interpreted the need for the Beats deal. But the real story is that iOS and its App Store have supplanted iTunes. In the future, we might purchase or subscribe to shows, music, movies, and books through apps, or as apps, and not through specialized storefronts.

Neither Netflix nor Amazon, neither Microsoft nor Google have come to dominate the entertainment landscape definitively. Movies, music, television, games—all of these things are theoretically ripe for Apple’s taking. Walter Isaacson, the man who wrote the book on Steve Jobs, thinks Apple is positioning Jimmy Iovine to launch a war for the future of all media. It’s a war Apple could fight credibly, and maybe win.

The Final Analysis

Whatever happens over the next few weeks, or even the next year, Apple will be just fine. In the past, Apple needed dazzling new devices every few years to phase out the old ones, and to expand into new use cases and new markets. That’s less the case today. Apple has learned to build on previous success, not to start from scratch every time.

The iPhone and the iPad, and all the apps developers have made for them, have built a powerful ecosystem in iOS. In the coming year, and in the years beyond, Apple’s future will depend on how necessary it can make iOS to every aspect of our lives. For Apple to succeed, it’ll have to position iOS as more than just a place for games, a place for media, a place for daily distractions. It’ll need to make iOS indispensable. It’ll need to differentiate iOS from Android and other would-be competitors.

Apple will always be a hardware company, but we need to look beyond the hardware. If you want to understand Apple’s future, don’t focus on any one device. Focus on the platform that unites them all.