Apple Inc.’s (AAPL, Financial) strategy provides a solid foundation for future growth. The company could benefit from further vertical integration, with it already having provided the business with a dominant position in the lucrative music streaming segment. Changes to its HomePod product in what is a fast-growing smart speaker market alongside changes to its iPad may also improve its financial performance.
Although there are concerns about the sustainability of its iPhone pricing strategy, the recently-launched XS and XS Max products are performing well in terms of sales. After rising 47% in the last year, versus a gain of 16% for the S&P 500, further outperformance could be ahead.
Vertical integration
One area in which Apple could enjoy a competitive advantage versus its peers is vertical integration. For example, in the paid music streaming service segment, the company recently overtook Spotify (SPOT, Financial) to become the dominant operator in the U.S. It now has 21 million Apple Music subscribers in the U.S., versus 20 million for Spotify. The company’s conversion rate of users to paying subscribers is relatively high at 0.6% versus 0.2% for Spotify. A music experience which is better integrated into its operating system is a key reason for this, with the company more easily able to encourage users to upgrade to paid services.
A focus on creating a seamless user experience and better integration of its products could allow the company to grow a wider range of services. For example, it is aiming to double revenue from its services business from its 2016 level by 2020. The potential release of a premium news subscription offering could prove to be relatively successful as a result of its ability to upgrade existing customers from free to premium services. Apple Pay and the forthcoming video streaming service are further examples of segments which may also be beneficiaries of the company’s vertical integration potential.
Product potential
Apple’s Homepod smart speaker has a 16% share by wholesale revenue of the wider market following its release. Its share of the premium-price market (above $200) is 70%. The smart speaker industry is expected to rise in value from $4.4 billion in 2017 to $17.4 billion in 2022. Therefore, the changes the company is making to its HomePod could provide it with a larger slice of the fast-growing market.
For example, it is seeking to improve its virtual assistant, Siri. It is also considering the release of a smaller and cheaper version of the HomePod. This could allow the company to reach a broader range of customers. While it may cannibalize sales of its higher-end device to some extent, the net effect could be a larger share of the overall market.
Alongside product developments for the HomePod, new releases of the iPad are expected to launch later this year. New features such as a more advanced chip and support for Face ID have been rumored. More aesthetically pleasing designs have also been mooted for the upcoming iPad releases. Given that they contribute over 8% of the company’s revenue, changes made to their operational performance and design could help to arrest the decline in sales which has occurred over the last four years. In 2013, Apple shipped 71 million iPads, with this figure declining to 44 million units in 2017.
Pricing power
In Apple’s most recent quarter, iPhone revenue increased 20% year over year. Unit sales of the iPhone, though, increased by just 1%. The reason for the increase in revenue was a higher average selling price, which was raised from $606 to $724. Since iPhone sales account for 62% of the company’s revenue, they remain the most important product. It is, therefore, responding to an increasing length of phone upgrade cycles with higher prices. Further price increases may be possible for future iPhones, but the strategy is unlikely to be sustainable at its current rate of growth in the long run.
The company argues that iPhones are continuing to replace a broad range of product categories, such as music players and cameras. Smartphones are also an essential part of consumers’ daily lives, with them becoming increasingly price inelastic. Installment payment plans are favored by most consumers, which helps to make even higher-priced phones more affordable. The recently launched iPhone XS Max is also seeing better-than-expected sales. So far, it is outselling the iPhone XS by three or four times, with shipments set to grow steadily in the next quarter.
Outlook
Apple's stock price could continue to outperform the S&P 500. The company has vertical integration potential, with its business model being conducive to users upgrading to paid services across a range of products, including music streaming. Changes to its HomePod smart speaker could provide it with a larger share of what is set to be a fast-growing market, while upgrades to its upcoming iPad could further boost sales.
Although there is a potential risk to Apple’s long-term outlook from aggressive iPhone pricing, recent sales of the XS and XS Max have been stronger than expected. Therefore, the stock could have investment appeal for the long term.
