Welcome to the 11 of you who joined us last week, we have officially crossed 100 sign-ups. The beginning of a new journey is always the hardest, thanks so much for your support! Here’s to more milestones. Cheers.
If you have not signed up yet, Join +100 smart, curious, and critical people by subscribing here:
Hi there 👋 ,
This is the third letter from Disrupted, I am new to newsletters, there is so much to learn, and I gotta do it in a cost-effective way right from the beginning, so I am taking inspiration from my favorite writers when it comes to newsletter best practices. My writings have traditionally leaned towards a mass-market appeal with YouTube, which emphasizes visual impact and algorithmic sensationalism, so it will take me some time, I imagine, to adapt to the newsletter medium which needs structured rigor & depth in analysis. Fortunately, I have many writers to learn from. As for the content itself, I promise to make them fun.
Without further ado, let’s dive in.
Apple, control = success🤑
When you think of Apple, the company, what comes to your mind? Its annual launch events? Its iconic celebration of new iPhones? Or the beautiful landmarks at Apple Park? Those, of course, are branding activities backed by Apple’s incredible products and ecosystems.
I think we can all agree that Apple is a great company. It invented modern computers in the 70s, changed the way we consume music, and with the iPhones, it changed our interface with the world in the most fundamental way. The Smartphone is an extension of our brain much like what bikes are for our legs. We now have virtually instantaneous access to information. All you need is to take a subway to see how addicted people are to their smartphones. But Apple’s secret is how it gets to, year after year, outcompete its rivals and capture 66% of the entire smartphone industry profit. Apple announced that its profits more than doubled to $21.7 billion in the most recent quarter and its revenue soared by 36% to 81.4 billion. With now over 1 billion active iPhone users around the world, Apple has firmly captured the most affluent user segment in the developed and developing countries, so how does Apple keep 1 billion people happy🔥?
I have not seen anyone who has decoded the playbook to Apple’s success, so let me make my attempt today. Spoiler alert, from a company standpoint, Apple is quite unstoppable.
I will cover the following topics,
Steve Jobs’ Apple - A brief history
Apple’s business under Tim Cook
Where does Apple's business stand strategically? Invincible
Apple’s remarkable profit
How did Samsung Survive Apple
Elaborating on Apple’s Pyramid of Control
Quick takeaways
Let’s start.
Steve Jobs’ Apple
It is hard to separate the brand of Apple from Steve Jobs. As a startup founder, he built much of his personality into the company.
At Apple’s founding in 1976, Jobs was only 21 years old and his partner Steve Wozniak was 26. For founders in his generation in the US, they had two great advantages going for them, it’s hard to tell which one is more important.
They had, first of all, the backing of a tech and manufacturing superpower. They grew up in a post-war America where the whole world was in tatters and was dependent on the US. In a report by the United Nations in 1948, shown in the chart below, the US’s production as a percentage of world manufacturing grew from around 25% in 1938 to about 50% in the late 40s.
In addtion, the world’s first transistor, which is the foundation of any computer technology, was also invented in the famous Bell Labs in the US. This means for the millions of little Steve Jobs in the 1960s’ China, Europe, and Japan. They are out. I’m sure there are entrepreneurs equally brilliant and inventive like Steve Jobs elsewhere, but no other country had both the tech know-how and the production power to bring computers into the mass market. (USSR had the potential, but they made two fatal mistakes. First, they alienated the world’s biggest consumer market, China; and second, USSR’s system was not built to produce consumer goods anyways).
For Americans born in Jobs’ generation, super boosted by manufacturing dominance of the US, anything was possible. (US politicians were foolish to give this up in the 90s with NAFTA and then with accepting China in to WTO)
Another advantage for Jobs’ generation was psychological. In the 1970s, America just has a decade of space endeavors that culminated in the moon landing. When Jobs was 14 and Wozniak was 19, the famous Moon landing happened and the Americans took the “giant leap” for mankind. Their generation of Americans dream big, if landing on the Moon is achievable, what isn’t?
With these two advantages, the conditions for Apple Computer were ripe.
In 1947, John Bardeen, William Shockley, and Walter Brattain developed the bipolar point-contact transistor.
In 1959, metal–oxide–semiconductor field-effect transistor (MOSFET or MOS transistor) was invented. This was the beginning of the semiconductor revolution.
In 1970, Intel 4004 became the first commercially produced microprocessor, without these inventions, none of Apple computers would be possible.
In 1976, Apple Computers was founded in Steve Jobs’s garage, Apple I was built which was sold without a monitor. That was a terrible business decision, but who can blame them, Steve was only a 21-year-old and he was on track to become a millionaire.
In 1977, Apple II revolutionized the computer industry with the introduction of the first-ever color graphics.
And by the year 1980, Apple’s sales stood at $117 million and in the same year, Apple went public. At the time of launch, Apple’s stock was 22 dollars a share and they sold 4.6 million shares. 1000 dollars investment then would make you a millionaire today.
But being the first generation disruptor meant being ahead of time.
We, in the 3rd decade of the 21st century, know the stories of Facebook, Google, Apple too well. Backed by VC funding, founders of those startups are firm believers of the mantra “launch now, and fix later”, this means aggressive expansion and innovation in the short term and monetization later. However, this idea was alien to managers then. They had not seen the disruptions computers and the Internet could bring. If you look at the board members who ousted Steve Jobs in 1985, most of them were born before the 1930s and in the case of Henry E. Singleton, he was born in 1916. They were Great Depression era businessmen whose minds were distracted with terrible failures. To them, innovation without a promise to make money meant risks that caused depression. Therefore, under a board who can’t understand the business model of silicon valley startups, Steve Jobs’ actions were deemed too risky. John Scully (who were hired by Jobs) was a much steadier manager than Jobs, so they thought.
A coup followed and we know the rest of the story, Jobs was ousted and he sold all his Apple stocks, he left. The company went into a decade of professionally managed decline, the great irony of modern corporations.
Until 1997, Steve Jobs came back when everyone thought the company was going down the drains.
Most of us are familiar with what happened after Jobs’ return. He reinvented the company to build iTunes, iPods, Macs, and finally iPhones in 2007.
After Jobs’ passing in 2011, his long time lieutenant, Tim Cook took over. Tim turned out to be brilliant. In my opinion, he is one of the rare people who understands fully the brilliance of Jobs’ vision, he carried out Jobs’ vision perfectly and added in his flare for operational excellence.
Apple’s business under Tim Cook
As of 2020, Apple’s market cap is 2 trillion dollars and increasing, it has no sign of slowing down.
Apple presents its businesses in two sections. The product section includes iPhones, iPods, Macs, and wearable devices. The services section comprises advertising, apple care, cloud services, digital content, and payment services. But there are a lot more actions happening behind the scenes. We’ll never understand what Apple is by looking at its financial report. I see Apple’s business as a pyramid-shaped business empire, I call it “Apple’s Pyrimid of Control”.
Apple’s Pyrimid of Control
It comes with 4 offerings, the Apple brand, software & services, hardware, & a robust manufacturing, supply, & sales network.
MSS network
The manufacturing, supply, and sales network is the unsung hero of Apple’s dominance. Apple is known to plan for its long-term vision.
After Steve Jobs’ return and Tim Cook joining Apple as their operations VP in 1998, the company has built many industry pioneering products including iPhones, iPads, the updated Macs, and now the Apple Car in the works, all of them require a manufacturing and supply network with hundreds of companies, if not thousands, some replaceable some strategic. All of this should be seen together with the scale of Apple’s production. Apple sells over 200 million phones every year, over 100 million Airpods in 2020, no one gets to manufacture products at this scale and do it at such a proficient level as Apple. FoxConn for example is able to hire tens of thousands of Chinese workers on-demand for iPhone launch every year, this is a luxury that no other company has. Another example is Apple’s exclusive deal with TSMC, Apple basically reserved all of TSMC’s 5nm fab to Apple chips. So, if you wonder why Xiaomi phones are no good compared to Apple, this is it.
I also categorize the design and production of M1 chips here because it is not a final product that gets shipped to customers. Apple’s A-series chips have been industry-leading in years, and since smartphone specs are somewhat misleading, I usually look at transistor count to measure the processing speed of a chip, if you look into the CPU design in 2020 based on transistor count, only Apple’s A14, M1 and Huawei’s Kirin 9000 uses 5nm technology.
One more factor that is super important here is the high cost of R&D involved in the Foundry business, TSMC reportedly invested 25 - 28 billion dollars in Capex in 2021. What does this mean? This means TSMC’s foundry model is the only model that could work for the industry because that gives them the scale and quantity to make billions of profit, which then goes into the next-gen chips R&D investment. The traditional IDM model in the semiconductor industry no longer suits the current cutthroat business. (Semicon is a critical industry and a topic for another day) This also means that a customer like Apple is invaluable to TSMC because TSMC needs the profit for R&D to stay ahead.
Hardware
Hardware is Apple’s absolute bread and butter since its inception. Apple I, Apple II, Macintosh, iPods, iPads, iPhone, Airpods, and the upcoming Apple car. Apple dominates in almost all categories of products it’s selling. Apple shipped 100 million iPhone 12 according to counterpoint research, Airpods were also sold 100 million units in 2020.
Most of us see Apple products in our local shopping malls, they are always high quality and are always sold at a premium too. There are two exciting developments in the hardware department, the first one in my opinion is the launch of the Apple M1 chip, an arm-based CPU for computer usage. If you’re not aware of this, the M1 chip pretty much doubles the speed and halves the energy usage compared with competitive chips from Intel, thanks to Apple’s fabless capability and its supply network that was mentioned above.
The second exciting development is the building of the Apple car, this is a clear sign of an industry-level disruption happening at a global stage. China is trying hard to take the crown in the EV space, but Apple has 1 billion smartphone users who might leap to a new Apple car if they see a clear “ecosystem” benefit.
I have advocated for EV since 2017 on my YouTube channel so I don’t want to elaborate here. The gist is, EV is the future, Tesla has the first-mover advantage, and Chinese companies control the supply chain of EV components. Apple joining the market is consequential, but we will only see the fight happening in 2024 when the Apple car is launched. This is a big challenge for traditional carmakers, when Apple launched iPhone, the other phone brand died within 5 years except for Samsung. Most car makers now adopt an OEM model where production is highly outsourced, its very early to say, but I think they are in big trouble in the next 10 years.
Software & Services
This is Apple’s soft power, and its killer advantage. If you look at the 4 layers of offerings, software and services are a major problem for Apple’s competitors who adopted the android system. Samsung, Xiaomi, Oppo, and Vivo, all of them are great at making phones, Samsung can even make great chips, but users tend to easily change from each brand, I call this low exit cost. Xiaomi users have little ‘exit cost’ when switching to Samsung, but Apple users cannot easily leave Apple’s ecosystem because of the high exit cost. iMessage, Apple Music, Facetime, Appstore, etc. These make it hard for people to leave the Apple ecosystem. On top of that, controlling software, hardware, and chip design means that Apple could optimize performance for all three components, this is quite obvious in India where the iPhone 6s is still sold as a new phone.
The Apple Brand
The Apple brand ties everything together. Because of Apple’s control over software, hardware, and components manufacturing and supply. Apple has built a closed ecosystem. This ecosystem is then marketed as Apple’s brand ethos which is “power to the people through technology”. Apple’s brand is associated with creative disruption, perfection, and endless creativity, all of this is backed by the first three layers of offering that is controlled by Apple.
This brand is then cared for and cultivated year over year with now over 1 billion active iPhone users around the world, that is 1 in 7 of humans on the planet using an iPhone. This means tremendous network effect, with Apple capturing the customers through the closed system and building a powerful exit barrier. Apple sucks out the high-end premium users from Xiaomi and through the closed system, making sure this process is one way.
So, where does Apple's business stand strategically? Invincible
These four offerings form a feedback loop that sustains Apple’s capital-intensive business, and enhances Apple’s negotiation & pricing power. This means a higher competition barrier for competitors, and a higher exit cost for users, which is the “ecosystem”.
Putting consultant hats on for Apple’s competitors, their biggest strategic failure was their decision to adopt the Android system. Samsung is Apple’s strongest competitor since the early days, and it has control over only 2 out of 4 layers of offerings (hardware, & the MSS network), it lacks the software and brand control, its users could easily change to Huawei or Xiaomi because of the similar Android system underneath. Samsung over the years attempted to build its own software ecosystem without success. Xiaomi, Oppo, and Vivo are doing well, but they are stuck. Because of their inability to make their own chips & operating system, they will not be able to compete with Apple & Samsung in the long term. TSMC’s 5nm chips fab will always prioritize Apple products and Samsung’s fab, of course, is reserved for their Samsung branded smartphone lineups. Xiaomi, Vivo, and Oppo, therefore, often find themselves in an awkward position with lots of enthusiastic fans but not able to move up the value chain and compete with the big boys.
I will elaborate on Apple’s pyramid of control and why the four factors are important below.
Note: this puts Huawei in an interesting spot. Due to geopolitics, it is now forced into a stealth mode, but far from going away due to its telco business and its Chinese domestic market. Now that Huawei is banned from using Google’s android and started building its own OS, coupled with its world’s leading fabless HiSilicon, Huawei could make itself a tiny Apple in China building on a highly controlled ecosystem that one day could challenge Apple.
This is a long-term possibility (a decade), but under my analysis framework for Apple focuses on the benefits control. Huawei is now cornered to innovate and drop android. Let’s see how it works out in the next 5 years. What I know is, if Huawei’s smartphone business survives in 5 years, it might become an even tougher challenger for Apple without the shackles of Android.
Apple’s remarkable profit
The advantage of control is reflected in its financial report, one number that gets casually thrown into the mix is Apple’s gross margin, it says right here that Apple’s margin is at 31.5% for its devices and 66% for its online business. This is quite interesting from the industry’s perspective. In comparison, in Xiaomi’s annual report laying out their financial numbers for the year, they made 245 Billion YUAN in revenue and 36 billion in gross profit, meaning, Xiaomi’s gross margin is at 15%.
This is why Apple’s control over the 4 factors is important, Apple is able to profit considerably higher than its competitors because of its higher level of operational control & excellence.
Counterpoint research shows that Apple’s business accounted for around 32% of the overall smartphone industry revenue, and 66% of the overall profit. This is the typical story of the smartphone industry, Apple eating everyone else’s lunch. Tracing the history of the mobile market, something remarkable has happened over the last 15 years.
Apple’s success comes with casualties, it has annihilated all of its competitors since 2005. Look at the market share numbers above, Motorola, Sony Ericsson, Nokia, LG, are the dominant names in the early 2000s. But aside from Samsung, none of these brands survived Apple’s onslaught, they either moved out of the market like LG or died like Nokia (almost). This makes Samsung's survival really interesting.
How did Samsung Survive Apple?
Here is the big picture. The time was 2005 and the biggest players in the mobile market were Nokia, Samsung, Motorola, LG, and Sony Ericsson. They were doing fine until 2007 when Steve Jobs introduced the new iPhone. At first, people did not understand what this meant, some even laughed at the original iPhone. Then they scrambled for survival when their market share numbers started dropping in a free fall.
But here’s when things got interesting, Samsung, unlike everyone else, improved its market share. So what was the secret? It turns out, Samsung has a tremendous hardware and supply chain advantage for critical smartphone components like LCD screens, RAMs, and processors. If you look at the original iPhone, you’d be surprised to find that all three of these critical components were supplied by Samsung. None of the other players like Nokia had a combination of capabilities.
I remember buying my first Nokia in the mid-2000s, and my first iPod in 2010. Since then, I’ve picked up 2 iPhones, 2 pairs of Airpods, and a few iPads. I’m in the ecosystem. So in my personal case, Apple won.
Coming back to the question, Samsung survived primarily because of its dominance in the supply chain for chips, rams, and LCD screens. Until 2012, Apple cornered all smartphone competitors by partnering with Samsung. And because Apple was the leader from the beginning, it did not play by anyone else’s rules, it defined them. To stay competitive, Apple also committed to continued long-term investment in key supply partners. That’s when Apple got very protective about its supply chain. As Samsung became more powerful in the smartphone market, Apple took three years to invest in TSMC’s chip production capability, and it dropped Samsung eventually in 2014. Many lawsuits were involved.
TSMC did not let down Apple. With the help of Apple, TSMC became the top foundry capable of producing 5-nanometer chips today. Its stock price increased 10 fold from 50 billion to 500 billion during the same period. This Wiki page shows clearly how important Apple’s partnership is for TSMC. UMC was TSMC’s biggest competitor in the 2000s and its revenue growth is relatively flat for 3 to 5 billion over the past decade, whereas TSMC’s revenue skyrocketed from 9 billion in 2009 to now over 45 billion in 2020. As I mentioned, in the semiconductor industry, only high production volume and profits can sustain high investment in R&D, and in turn, industry leadership. TSMC’s market cap is now similar to that of Samsung. (There is a foundry/fabless model vs. IDM model story, I will talk about this in future posts)
What was Apple’s lesson for TSMC & Samsung? If you stay in our supply chain and work with us, we will prosper together, I will invest in you and help you make world-class technology. But if you defy my control, you will lose the customer and be prepared for tough competition and lawsuits.
I am not surprised at Apple’s supply chain obsession either. After all, this was what Tim Cook, the CEO of Apple was hired to do, he headed Apple’s supply chain, oversaw Apple’s investment into supply chain partners before becoming the chief operating officer and then CEO. He absolutely cannot tolerate a partner like Samsung who is both a critical component supplier and a competitor.
Elaborating on Apple’s Pyramid of Control
Now we’ve established that Apple’s success was based on its first-mover advantage, driving out its competitors, and its incredible emphasis on its supply chain. That emphasis doesn’t stop there, Apple in fact is obsessed with every aspect of its product. Since Apple gets to define the rules of the industry, it also never fails to abuse this power. For example, FaceID was not invented by Apple, in fact, Samsung and others launched similar features in 2012. Apple then showed the world TouchID is more “secure”, and when Apple’s competitor finally catches up and innovates to place TouchID at the back of a phone. Apple responds with FaceID.
It’s impossible to compete with someone who gets to change the rules, Apple is one such competitor.
If we look at what Apple has done in recent years, it launched the ARM-based M1 chip to standardize its entire product lineup, and Apple is now openly working on Apple Car which of course will be running the same hardware and software.
What does this mean? This means Apple is telling all of its competitors, if you want to compete with me, you must create your own chips, and by the way, you might want to start building a car too. (Lei: Good luck with that!)
But of course, Apple is likely to have started working on the M1 chip 5 years ago, and when it comes to the Apple car, the project was started in 2014. So good luck catching up with Apple on short notice. This is a document/map that covers 200 top suppliers for Apple’s supply chain. It tells a more intimate story of Apple’s businesses. From Apple’s assembly plant in China to its manufacturing facilities in Japan, and to its testing centers in the US. They work in concert to produce Apple devices.
Combining Apple's software ecosystem, Apple hires directly and indirectly over 2 million people in the US, 5 million in China, 2 million in the EU, and over 1 million in Korea and Japan. When an iPhone gets to our hands, it has gone through hundreds of processes and years of planning and shipping. This is the hardship that goes uncelebrated. Remember the profit margin we discussed earlier? It was the result of Apple’s care and effort spent on its ecosystems. 10 million people have worked on the product before it reaches our hands, and 1 billion of us use an iPhone per day.
Tim Cook joined the company 10 years before the launch of the iPhone in 1998, he is the principal architect of Apple’s supply chain, and it’s safe to say without him, Apple would be a different company. Tim Cook has built an incredibly efficient business. When looking into this subject of what helps Apple stay dominant in the smartphone industry. A question that puzzles me was that no matter how hard Xiaomi, Huawei, or Oppo tries, they always seem to be miles away from Apple. Apple is like the kid in school who tops every class. When tracing through Apple’s history for this video, I suddenly realized, Apple is not the student who competes to get the top spot, Apple is the teacher who sets the exam! And literally, Apple is the company that pioneered the smartphone industry and the idea of a hardware-software ecosystem. Every step of the way, Apple made the right decisions, investing early in its industry partners, keeping its ecosystem closed, and building the Apple car. As long as Apple is the one setting the rules rather than following them, Apple will never fall behind.
Quick Takeaways from Apple’s business
The two worlds dichotomy. The market has fragmented into two worlds with different philosophies. It’s about the intangibles for the affluent, and competitive prices for the less affluent. For the category Apple is in, it does not matter if the phone is 1000 dollars or 800 dollars, people want the product to be great. Chinese smartphone brands struggle to enter the premium market.
Highly controlled ecosystem is the future. In the 70s and 80s, Toyota pioneered the manufacturing outsource model, but we are seeing a reversal in philosophy because users no longer want high-quality generic products. They want a product with a personality such as the One Plus’ “never settle”
Commoditization of smartphones. With the semiconductor industry’s Fabless + Foundry model, and the Chinese manufacturing explosion, smartphones are becoming a commodity. Brands, therefore, need to compete on the intangibles to differentiate. (or to compete on price)
Semiconductor is the critical point of competition for all smartphone companies. A geopolitical contest is happening in this field as well.
EV is the next strategic high ground for smartphone makers. Chinese brands have a distinctive supply advantage; Tesla has the first-mover advantage and Apple is the most formidable entrant. Traditional car companies have about a decade to radically adjust, my outlook for ICE automakers is grim.