Apple's Cycle of Abuse

 | Oct 12, 2012 | 4:00 PM EDT  | Comments
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This commentary originally appeared at 12:35 p.m. EDT on Oct. 12 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

Part of me wishes that Apple had not been so kind of arrogant and feeling we're the only one with the right clue.... I wish they had made a small and a large version of the iPhone; that would have been great for me. Keep the aspect ratio the same, horizontal and vertical the same, but just grow it in the other way.... I think Apple tricked itself and said, "Oh you could reach everything with one thumb," and I don't see anybody having any trouble using the larger screens. Apple said that as a defensive move because when the other phones came out, they all had larger screens. Apple is now trying to run with that defense, saying "We are right," and really there's a mix of people. Not all people want the same thing and a lot of people really like the big screens.

-- Steve Wozniak (Apple co-founder), TalkCentral interview

With so much discussion of Apple (AAPL) over the past few weeks, I thought it appropriate to end the week with some additional comments and concerns.

Arrogance has been the subject of some of my criticism recently on Apple. (It is also often the downfall of many companies.) It seems this is also a concern to Apple Co-founder Steve Wozniak.

Wozniak's view (above) raises some more issues.

Did Apple not deliver a larger-screen phone because:

A. there is an issue with the OS or existing apps or cost that prevents the company from doing so (any of these are or will be a problem);

B. the company actually believes that the current form factor is better than existing large-screen phones, in contrast with what many consumers think (Wozniak's point about arrogance);

C. the company purposely did not do a larger screen, following its pattern of lagging the market on common features to capture a one-year upgrade cycle with the next release of the phone, in this case the big difference in the next phone for all intents and purposes would be the larger screen.

If point C is the answer, then perhaps the company has purposely left common features out of its phones to incentivize annual upgrades when that feature is released in the next phone. In the past, this practice has worked for Apple -- even though customer-unfriendly, the company has gotten away with it and captured extra revenue and hugely incremental margin by doing so.

I guess then my key question would be, Is this strategy, which has been good in the past, now starting to backfire on Apple for the following two reasons?:

  1. Apple may be losing more sales by not having these features now that competitors have caught up and passed the company in some instances -- in which case, Apple will gain by increasing churn when the company finally releases the device a year behind the market.
  2. Even worse, Apple might be doing more damage to its brand, market position and customer position by losing the perception as the market leader and the company with the coolest product on the market (see Samsung Galaxy ad that mocks Apple).

Also, if you believe the current Apple form factor is the best answer and Apple won't or can't do a larger-screen device (and will stick to one phone at a time for cost reasons), what is the next iPhone going to have that will really matter and get customers excited to buy it and help the company gain additional share? Is the bulk of the innovation done? And, yes, I know it's easy to say that Apple always thinks of something new, but the reality is that the last few iterations of iPhone have been evolutionary and not revolutionary -- and, arguably, they now lag the market.

If there is no larger screen and it's just better hardware features (it will run faster or the camera is a bit better), well, then in addition to being generally unexciting, more importantly, this is, again, a radical change in the investment hypothesis.

In essence, Apple will have gone from a disruptive innovator and category creator with unique and different products to a company competing on the basis of run-of-the-mill hardware features. This is not much different than the low-margin handset industry before Apple entered it and disrupted it.

Another issue I would raise is how unfriendly Apple's suppliers have been to their employees. The problems at Foxconn and other companies have been well-chronicled (labor walkouts, worker suicides, etc.). These stringent working conditions lower the cost of goods to Apple and thereby increase Apple's profit margins. In fact, I suspect Apple continues to bid suppliers aggressively based on price, as opposed to reforming their labor practices. By continuing to use suppliers with these policies in place, Apple can be viewed as directly guilty of these practices as well, in my opinion.

Let's compare Apple to another high-profile company: Wal-Mart (WMT).

Suppose a Wal-Mart supplier was accused of these conditions. Many Wal-Mart customers would protest Wal-Mart for use of these suppliers, refuse to buy the products or even shop at Wal-Mart. And all sorts of scathing editorials would follow, the combination of which would force Wal-Mart to change its practices. Some Apple customers who would likely take these actions against Wal-Mart hypocritically line up days in advance to buy the latest Apple products. How does that make sense?

In my opinion, Apple is hypocritical -- the company is every bit the abusive monopolist that it once accused Microsoft (MSFT) of being (including the latest iteration of foisting a bundled inferior map product on its customers, which is ultimately what got Microsoft in trouble for being a monopolist, when it started bundling Internet Explorer with Windows as Netscape was gaining traction); it is also an incredibly greedy corporate entity, as opposed to the socially responsible company that it positions itself as (again, see what goes on at its suppliers with which it continues to do business).

And Apple's customers are also hypocritical by continuing to buy Apple's products and thereby supporting this abusive behavior.

At the end of the day, Apple has proven that, left to its own devices, the company will not change the abusive labor practices at its suppliers, so Apple's customers are the only ones who can pressure the company to do so. Again, as a thought exercise, these customers should think about what they would do if a Wal-Mart supplier was accused of the same practices.

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