There was an article in the Wall Street Journal on Saturday discussing Apple’s (AAPL) newest store in Beijing – the company’s third in the city and their largest in Asia. Here’s the particular section that caught my attention for this article:
“Hundreds began lining up as early as Friday evening for the 9 a.m. grand opening and a chance to get their hands of special T-shirts commemorating the new store.
A pair of high school students, Wang Xueang and Chang Dawei, were first in line at 8:30 p.m. Friday night, bringing snacks in tow. They wanted to be among the first to see the store, they said, because they admired the 'unique' brand. 'Their goal isn’t to make money but to change the world, and it’s a culture we should learn from,” Mr. Wang said.'"
Let me start by saying the following: when Mr. Wang talks about changing the world, I would assume that he’s talking about the company’s game changing technology (or at a minimum, their ability to create products consumers love – they didn’t invent the MP3 player, but created a product in a class of its own in the eyes of millions -- while the company has stayed ahead in this regard for a decade, they don’t have a monopoly on innovation, and there are plenty of companies with huge R&D budgets and intelligent people looking to upend the lead horse.
When I first read Mr. Wang’s quote, I thought of “unique” in a different manner, and the way it has historically been thought of in terms of Apple – used by a small fraction of the world with a sense of differentiation from the masses. When thought of in this fashion, it reminds me of the luxury brands in China – and looking at that marketplace and how it has changed recently may be instructive for what’s in store for Apple (quotation from a China Daily article):
“When Sun Sisi planned to buy a new handbag, the 27-year-old Beijing office worker, who already owns some LV and Chanel handbags, turned her focus to niche brands this time.
'I am tired of the big names, and it is more important that I do not want a bag that many people on the street already have," Sun said. Sun is not the only one thinking this way in China's big cities. Luxury, but without showing off, is what Chinese luxury consumers are looking for now, especially in cities like Beijing and Shanghai.'"
The luxury consumers' new preference has helped some niche brands, which are not well-known, to grow fast in China, while some mass-market brands are seeing slower growth.
Burberry Group Plc, which recently released its trading update for the three months through June 30, said its revenue growth in the Asia-Pacific area dropped to 18 percent from 67 percent in the same quarter of 2011. Gucci brand's sales in the Chinese mainland increased by 17.2 percent in the first half of 2012 compared with the same period of 2011.
Meanwhile, leather-goods maker Bottega Veneta, which targets an elite clientele and insists on no logo, had a 62.4 percent sales growth in the mainland during the period, according to the half-year result of PPR SA, which is the parent company of both Gucci and BV.
"'Chinese luxury consumers are gradually giving up the brands, which the public is familiar with, and picking up the niche brands,' said Zhou Ting, executive director of the research center for luxury goods and services at the University of International Business and Economics in Beijing.”
This brings us to a critical question – what has made Apple so successful (with 17.1 percent U.S. market share as of August 2012) in mobile? The clear answer is innovation – when the iPhone was released in June 2007, it was literally in a class of its own, competing with products that looked dated by comparison (see here for an example). As we all know, this is no longer true – Apple faces real competition from Samsung’s Galaxy S III, and Microsoft’s (MSFT) hardware partners will release phones over the coming months that will add additional pressure to the company’s top selling product (the iPhone has accounted for more than 50 percent of Apple’s sales year to date).
This is where I believe the distinction between Apple of old and new comes into perspective; while Mr. Yang thinks the company is “unique”, I think the reality is that most consumers are only concerned with the product in their hand (they don’t have any special affinity for Apple) – and that they wouldn’t hesitate to drop their Apple products if something better came along.
Consider the case of Nokia (NOK) – the company was the industry leader, and spent the better part of the past decade at the top of “Best Global Brands” rankings; here’s what was written by Bloomberg in August of 2007:
“Given its No. 5 ranking, it may seem crazy to consider the Finnish giant a comeback story. But it is one, as evidenced by a 12% jump in brand value, which extends a rankings winning streak after faltering in 2004. Nokia realized its focus on making cheap handsets for the developing world was hurting it in the U.S. and Europe, where consumers wanted phones that played video and surfed the Web. Nokia released high-end phones aimed at both the consumer and business user and is showing strength in emerging and mature markets alike.”
With hindsight, we know that this “strength” never materialized, and that the company is fighting for its life just five years later (a time period during which the stock has fallen more than 90%); my contention is that the idea of brand equity in this segment is really a case of product equity – you are only as good as your latest innovation, and the crowd will abandon you if you’re no longer on the cutting edge. This is what happened to Nokia in the space of a few years – and I think that anybody who believes Apple is immune to this phenomenon is kidding themselves (obviously this line of logic assumes Apple won’t stay on the cutting edge, which is far from assured).
Some people think that there’s lock-in among these devices – when you buy an iPhone, you’ve got to have an iPad, a Mac, etc; while I think this argument has merit, I think that it is way overstated in the current environment (interconnectivity among devices is still in the early days, and I still think it’s unclear what role the product platform as a whole will play). I would simply point to some industry statistics that suggest switching might not be as painful as some assume: Gartner, for example, estimates that of all mobile app store downloads in 2011, nearly 90% were free downloads.
My point is this – investors who are assuming lock-in among consumers to any product or brand better have a thorough understanding of what’s driving that lock-in and how sustainable it is; I think history has shown that these “advantages” have proven to be overstated in real time, only to be correctly analyzed in retrospect – and I think that Apple may be a case where that could play out over the course of a few years without a clear sign of industry leadership in terms of game changing innovation (and an iPad mini doesn’t fit the bill).
About the author:I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.
I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over a period of many years.