Guest Column: It's Make or Break Time for Apple

[Editor’s Note: This is a guest column by Robert Tercek. Tercek is a pioneering digital media executive and strategic advisor to media companies, and is the host of  INVENTING THE FUTURE, an online video program about the technologies that will shape society.]

Now that CES is finished, it’s time to turn our attention to the next big burning question for the tech obsessed.

What will Apple accomplish in 2013? 

Apple’s Q1 earnings call on January 23 will be the most important in a decade.   There’s a lot hanging in the balance.   The stock  slid 28% in the past three months.  Some pundits predict Apple will continue to decline,  yet several analysts still consider Apple a buy.  The technology industry is waiting to find out what breakthrough innovation will come from Cupertino this year.

If Apple pulls a rabbit out of the hat, they may win big.  Or at least reverse the decline.  If not, they will continue to slide downward. In that case, Apple could join the ranks of predecessors who reigned briefly in mobile hardware, then sank inexorably, such as  Motorola, Nokia, Ericsson, RIM.

Let’s consider three sets of observations.

1.  Rumors of Apple’s demise are greatly exaggerated
2.  In late 2012, Apple stock plummeted and the pipeline was cleared
3.  What might Apple have in the works for 2013?

1.  Rumors of Apple’s Demise Are Greatly Exaggerated
Nobody gets to be the world’s most valuable company without enduring criticism.   Some of it is fair, some is not.  In 2012 Apple’s  luster was tarnished.  There was a lot of press about Apple’s shortcomings.

Given the lemming-like stampede that substitutes for critical thinking among bloggers, once this meme hit the echo chamber of the blogosphere, it blew up to epic scale and swiftly became conventional wisdom.

Here are some examples of anti-Apple hysteria  (it’s quite easy to find more in this vein).

•     Kids no longer think Apple is cool!!
•     Apple “app dictatorship” bums out developers!!
•     Apple App Store is “a disaster” for developers!!
•     Samsung is beating Apple in high growth international markets!!
•     New Android devices are putting margin pressure on Apple!!
•     Apple sucks at cloud services!!
•     Apple software is bloated and cumbersome!
•     New Chinese manufacturers will invade the US market!
•     Apple’s aggressive patent defense is clear evidence of a company in decline!
•     Apple uses slave labor! (Hmm, not quite).
•     Apple’s boss tries to gut the retail operation!

(Okay, okay, I exaggerated some of the headlines for comic effect… but not all of them).

The whole “let’s hate on Apple!” bandwagon began rolling when reports about miserable work conditions at Foxconn plant in Chengdu began to surface a year ago.  But then the hate meme spiraled out of control, eventually morphing into a litany of complaints about Apple products, software, business practices and stores. The frenzy culminated this autumn with the Apple Maps fiasco that saw Jobs protege Scott Forsdale defenestrated.

Perhaps the most damning accusations came on November 20 from former Apple employee Patrick Gibson.  On his blog he argued that Google is getting better at design faster than Apple is getting better at web services.

There’s some truth in these reports.  I certainly can bear witness to Apple’s inelegant software from painful firsthand experience.

But diehard Apple fans resist these attacks.  They counter the negative reports by pointing to Apple’s formidable strengths:

Ecosystems matter more than platforms
The computer hardware industry has evolved from the old battle of platforms towards a new battle of ecosystems.   Apple is a master of this game.  Apple has the richest, most diverse and vibrant ecosystem of all.   By October, the Android ecosystem finally caught up to iOS, boasting an equivalent number of apps, but Apple still monetizes apps far better than any rival ecosystem.  In November iOS monthly revenues were 4x those of Google Play, according to this report.   Developers have earned $7 billion since 2008 from iOS app sales.   As long as this virtuous cycle is not disrupted, Apple will continue to attract the best content, the best apps and the best innovation.  As we learned in the game console wars in the 1990s, the platform that attracts the best developers fastest with the “mostest” tends to win the next round.  Apple App Store had the biggest December ever:  2 billion iOS apps downloaded.

Apple exercises unmatched control over its supply chain
According to the fickle press, Tim Cook is an operational genius.    As Hal Varian notes, the magic of Apple is a design process that combines commodity parts into a valuable finished product…and that’s why Apple captures so much of the value in its products.  Starting with the return of Steve in 1997 Apple began to focus on supply chain optimization for potential competitive advantage.  The company jumped seized every opportunity to build a sustainable defense, even purchasing equipment which it then lends to suppliers.  For instance, read this tale about Apple’s drive to  stockpile a hoard of lasers to etch holes in aluminum cases.   For years, Cook has used Apple’s cash pile to lock up exclusive capacity at a number of manufacturing plants around the world.  le #1 in its ranking of the Supply Chain Top 25.    By 2012 Apple was able to release new products day and date in massive quantities around the world, instead of flowing them out market-by-market.   Gartner placed Apple #1 in its ranking of the Supply Chain Top 25. Apple now operates at a scale that many would-be rivals may not be able to reach (Samsung excluded!).    Yet even this strategic advantage is not without doubters:  In 2012 some reports began to cast doubt on Apple’s vaunted supply-chain prowess.  See this one from Forbes.   Another writer observes that Apple’s dependency on sole source suppliers may leave it more vulnerable to disruption.

Apple faces an army of rivals, not a single giant
Who would usurp Apple? The competitive landscape is deeply fractured.  No single company challenges Apple.  It’s an army.  Would-be rivals still suffer from hardware-and-software-fragmentation, clumsy UI, small user install base, smaller ecosystems, etc.  Most of this is  the result of “closed ecosystem” strategies that deliver increasing returns to market leaders.

It’s tempting to call Samsung the usurper, but only in mobile:  Samsung does not command an equivalent ecosystem spanning all devices.  Microsoft still has strength in enterprise and the desktop but they are nowhere in mobile and just getting started in tablet computing.  Amazon dominates books and is chiseling away market share in tablets.  Only Google has a product in every category, barely.  Yet even the many devices sporting Google’s Android operating system don’t really form a single unified ecosystem.  It’s more like a loose alliance of squabbling tribes who have banded together briefly to fend off an invader.  If Apple recovers its mojo, they can hold their own against this lineup.

2.  At the end of 2012, Apple stock plummeted and the pipeline was cleared
What happened in December?   Predictably, Investors dumped AAPL.   Some of this selloff can be attributed to year-end tax planning by investors, and some of it has to do with a reaction to the relentless tide of negative reports.

The slide continued into January. On the 14th, the stock dipped below $500 for the first time since last February after a flurry of rumors following a WSJ report that Apple cut orders for iPhone 5 parts.  The report seemed to telegraph soft demand.    But later, analyst Tero Kuiitinen pointed out that there is some doubt about the accuracy of these rumors.   Too late.  Damage done, the stock closed at $501.

Now all eyes are on Apple’s first quarter earnings report on January 23, viewed as the most important conference call for the company in the past decade.   Investors are worried about Apple’s growth potential and margin pressure.   The faithful expect Apple to report a massively successful holiday season.

Analysts have not lost faith.  Piper Jaffray’s Analyst Gene Munster remains bullish on Apple.  On the 14th, he shaved his Apple price target from $910 to $875 per share, but that still represents 70% upside to the current share price.     Separately, UBS has a “buy” rating with a stock price target of $700  a share.  And Barclays cut their target from $800 to $740.  Deutsche Bank believes that the margin pressure on Apple is entirely cyclical, citing the 2010 ramp in iPhone 4 sales as evidence that iPhone 5 will eventually reach volume.   Morningstar’s fair value of Apple stock is $770.

Apple’s P/E Ratio slid from a high of 32.77 in 2008 to 11.36 yesterday.    As Aysmco’s Horace Deidu notes, investing in Apple between 2006 and 2010 meant obtaining a payback period of less than 4.5 years on average.  That’s effectively like buying Apple at a P/E of 4.5.  In mid 2012, Forbes speculated about why Apple’s P/E is so low, citing institutional investor guidelines as a possible cause.

There’s one big reason why there is so much volatility around Apple:  nobody knows what to expect in 2013.   After all, in 2012, the company blew out every single product in the pipeline:  the company released major upgrades to the MacBook pro laptops, upgrades to the MacBook Air,  super thin desktop iMacs, the iPad 4 and the iPad Mini, an upgraded Apple TV and of course the launch of the iPhone 5.   They did not hold anything back for 2013.   What will come next?

The mystery deepens.  Apple increased R&D spending by 39 percent in 2012, nearly $1 billion, for a total of $3.4 billion.  What, exactly, are they investing in?

And that leads me to the burning question.

3.  What might Apple have in the works for 2013?
If you believe in Apple, then you must believe that it has something entirely new in the pipeline for 2013.

Historically, Apple has introduced an industry-changing product every three years.   Three years ago, it was the iPad.  In 2007, the iPhone.  Before that, video iPod and earlier, the original iPod.  And along with these products, Apple also introduced industry-changing services (iTunes, App Store, etc).    It was the seamless integration of software services with the sexy new hardware that made Apple’s products so appealing.

Will Apple do it again?   If they stick to the previous cycle, we should expect them to introduce a game-changing new product in March or April.

But the schedule may have shifted somewhat.  Apple is moving from a once-yearly product release cycle to a twice-yearly.  That might suggest an ongoing series of incremental upgrades rather than major breakthroughs.  This is a pretty ambitious move, considering the massive scale of Apple operations.   Some pundits suggest that the “S” in recent model numbers might stand for Spring.

What might we expect in 2013?

•     In March, upgrades to the iPad and the iPad mini.  Thinner, lighter, probably a faster chip.   No word on Retina display for Mini yet, but we can certainly hope.
•     This summer:  a bigger iPhone.
•     Maybe a cheaper iPhone aimed at China  (Phil Schiller made a manly effort to squelch this rumor only to see it flare up again)
•     A bigger iPad? (There were several large tablets at CES, but I somehow doubt Apple would do this)
•     A wrist watch similar to Pebble?
•     A new streaming music service, akin to Spotify?

But none of those are game-changers.  What people really want to know is whether Apple will introduce a new kind of TV.  Not the small black hockey puck Apple TV gizmo but a full fledged wall-mounted display.   Even more, they want to see Apple take down Hollywood.  Internet enthusiasts yearn for Apple to reinvent television the way they reinvented music.   Some would argue that disrupting the television industry was already built into Apple’s share price last summer.

The arguments for disrupting the TV industry go like this:

•     TV is the last bastion of Old Media that has not yet been touched by the Internet.
•     TV is a juicy $500 billion global ecosystem overripe for disruption.
•     Cable and satellite companies don’t have the stomach to disrupt themselves (although Charlie Ergen is trying his best).
•     None of the CE giants, including Samsung, have been able to launch a Smart TV that matters to consumers.
•     Consumers are eager to flee the clutches of their pay TV provider.  They demand that television channels should be unbundled and sold a la carte.
•     Consumers are fleeing to new Internet OTT gizmos like Boxee, Roku, Vudu, to watch Internet TV.
•     Consumers are already in the habit of multitasking, using smartphones and tablets during TV time.

However, not all of these assertions stand up entirely under scrutiny, and they certainly don’t make a bulletproof case for disruption.  “Cord Cutting” remains a mirage.  Consumer behavior hasn’t changed all that much.  Although many people love to complain about their lousy cable TV service, the fact remains that most people are lazy and they seem to be quite content to keep on paying.   Very few subscribers have actually cut the cord.

Besides, the bundle of cable channels that you pay for today turns out to be a pretty good value compared to,.. well… just about any other form of entertainment if you compare it on a dollar-per-hour basis.   Depending upon your cable TV package, you are paying about $2 or $3 a day for television, and you are probably watching about 4 hours a day.  Compare that to a movie (at $15 a ticket for two hours) or a video game ($40 for maybe 40 hours of fun).   The pay TV bundle turns out to be a pretty good deal.   Some analysts predict that monthly fees could rise another 20% before triggering a consumer exodus.

Disruption only occurs when newcomers can supply an acceptable substitute at a radically lower price.  That hasn’t happened yet.  YouTube channels are nice but they are no substitute for HBO.

As much as I believe that the TV business is due for a big change, it won’t necessarily happen in 2013.  Television is not the music industry.  TV doesn’t have the music industry’s problems. It is not suffering the way the music industry was when Steve Jobs’ introduced iTunes.  It doesn’t need a savior, and besides, Steve is gone.  Sure, the TV industry sells lots of DVDs and BluRay disks, and those are declining fast, but TV is nowhere near as dependent upon revenue from fixed media as the music industry was in 2001.   Which means TV is far less vulnerable to digital disruption.

In 1999 nearly every digital pundit was advising the music industry to “make services, not products.”   But it took the music industry a full decade to finally launch music as a digital service.    Today television doesn’t heed that advice because TV is already a digital service.  It happens to be a hugely profitable service that consumers really enjoy.

Moreover, it’s not at all clear that the TV programming will improve significantly if the service migrates to the Internet.    Paradoxically, TV will probably get more expensive if channels are sold on an a la carte basis.

Today, cord-cutting is a pain in the butt.  Not all of the content is available online.  You can’t get sports programming easily, and the various shows from various providers are not available on all the SVOD services.  This scenario is not likely to change any time soon, especially since a whole bunch  of TV sports deals and channel deals just got renewed for up to ten years.     If you want to replicate your cable TV experience on the Internet, you need to subscribe to Hulu, Netflix, Aereo, MLB.com and a few more services… which means you won’t be paying much less than you were with cable, and you’ll spend your evening logging in and out of various services instead of simply flipping to another channel.

TV industry executives know this.  They are in no rush to make their wares uniformly accessible on digital devices.   They have no incentive to make this transition easy for the consumer. The friction diminishes the appeal of Internet alternatives to TV.  Each network, channel, studio and MVPD will roll out an arbitrary selection of content on the devices that they choose at a time of their choosing.   Initiatives like TV Everywhere and UltraViolet are not designed to make life easier or better for consumers:  they are designed to offer consumers the minimum to scratch their OTT itch while preserving the status quo of pay TV.   So far, this strategy is working.

And yet, Apple has no choice.  They need to make a play in this space.  Now.  Investors demand that Apple improve its cloud services.   The cloud represents the next big battleground in this war of ecosystems, and for the first time in a decade, Apple is not winning.   Google trounced Apple with a suite of integrated apps that shine on Android and work better than Apple’s own iOS apps.   Amazon also offers superb cloud services that span a multitude of devices.   Startups like Dropbox, Sugar Sync and Evernote operate cloud services that are superior to Apple’s.  And iTunes offers nothing like cloud video services like Netflix, Amazon Prime, Hulu, Aereo, Redbox/Verizon, or Comcast Streampix.

In short, investors are going to hold back until Apple demonstrates that it can win in the next round of cloud combat, and that battleground will include television.

So, what will it be?   An upgraded little black hockey puck (the current Apple TV) or a supersized iPad that you hang on your wall like a television?

I am personally somewhat skeptical about Apple’s chances if they decide to build a full sized TV set.   Here’s why:

1)  TV sets have a long life span.  TV sets are very different from the rest of Apple’s product lineup because they don’t get purchased very frequently.  Consumers tend to replace their cell phones every two years.   The TV set? Once every seven or eight years.  If Apple wants customers to upgrade routinely, they will be better off focusing on turning the little black hockey puck version of Apple TV into the digital hub of your living room.  At $99 customers will gladly upgrade.

2)  TV sets are low margin.  Currently, TV manufacturers make razor-thin profits on their high definition TVs.  It’s a brutally competitive business.  Already, CE giants Sony, Panasonic, Sharp and Hitachi are getting choked by Samsung and Vizio.  And now a host of Chinese manufacturers are threatening to enter the TV market and undercut everybody.    Apple prioritizes high margins.    Apple was able to enter the smart phone business in 2007 because they could extract a percentage of the data revenue from AT&T and other exclusive wireless network operators.  Though this practice was later abandoned, it helped Apple offset their massive investment in iPhone during the first two years as the device gained traction.   No such carrier subsidy exists in the TV industry.  No way are cable operators going to give Apple a piece of their revenue stream.

3)  TV sets take up a lot of floor space in a showroom.  The Apple store is already in turmoil.   They don’t need more trouble.  For years, Apple Stores boasted the highest revenue per square foot of any retail shop including Tiffany.   That’s because they sold small expensive gadgets that consumers could carry.   Selling TV sets will mess up the formula.   TVs require a huge footprint in the store, which means that overall revenue per square foot will diminish.  And the back of the store will be filled with huge packing crates of TVs.   A low margin product crowding out high margin products?  Not cool.

4)  TV sets require delivery and installation.  Apple doesn’t do house calls.  Best Buy’s GeekSquad does.  Some people are capable of installing their own high definition TVs, but many others require help just to lift the thing and hang it on a wall.  And then they may also need help to install the sound system and the rest of the peripherals.   Maybe Apple will streamline this process in their characteristic way, marking the set up process smooth and easy.   But they will still need a delivery and installation option.

5)  Japanese and Korean CE manufacturers are already rolling out 4K Ultra High Definition TVs.  These ultra TVs cost a staggering $38,000.   Prices will come down eventually and probably then we will all upgrade to Ultra HD.   But that won’t help Apple in 2013.   Apple is not a player in the 4K sweepstakes.

That said, there is an interesting opportunity for Apple right now in the transition to Ultra HD.  Think back to 2007 when Apple introduced the iPhone.  At the time, the entire mobile industry was preoccupied with the transition to 3G.   But the first iPhone wasn’t 3G.  It was 2G.   It was the greatest 2G phone ever invented.   To veterans in the mobile industry, this looked like a huge blunder by a Silicon Valley rookie.  My friends at Nokia laughed derisively at the first iPhone… to their everlasting regret.  It turned out that Apple was pretty clever to cater to the audience that wanted something that works well today, not something for tomorrow’s network.   The big CE giants might be repeating this exact same mistake by focusing on 4K which is at least five years away in the future.   That could give Apple an opportunity to reinvent TV today, rather than improve the picture tomorrow.  But to pull this trick off on a flat screen TV, Apple will need to rely on component suppliers who currently supply today’s TV makers… and many of them are deadly rivals to Apple.

Let’s consider a different scenario.  It’s possible the rumor of an Apple TV set is a red herring designed to throw rivals off the scent.  The biggest issue facing television today is not the number of pixels on the screen.  It’s discovery.   The TV viewing experience is fragmented across TV and Internet, across myriad competing apps and web sites, even across competing “TV Everywhere” apps from channels and cable operators.

This is the real opportunity for Apple to do something remarkable.  How might Apple cut through this cluttered landscape?

The big opportunity for Apple in discovery is to introduce a single unified interface that searches for content across all of your services:  cable TV, VOD, SVOD (Netflix, Amazon, etc), YouTube, Aereo, your local storage, iTunes and the web.   To pull this off, Apple will need to obtain the APIs from cable TV and satellite TV companies:  that may be possible provided they pledge not to undermine pay TV (yet).

But Apple isn’t the only company working on this strategy.  It’s a footrace.  Already plenty of rivals are hard at work on new TV interfaces.  At CES, Samsung demonstrated its latest version of Smart TV which is supposed to solve the discovery problem.  In my view, Samsung’s Smart TV is not quite ready for prime time.  The voice navigation worked sometimes, but the gesture navigation didn’t, and the menu system was pretty complicated with five separate rotating screens for shows, movies, apps and… I forget what else.  Meanwhile Microsoft has made great progress in turning the Xbox game console into a media hub for the digital living room.  The next Xbox will be prioritize media over games.   Sony may attempt something similar with the PlayStation whenever it manages to hit the market.  In sum, every company will make their play to control the digital living room in 2013.

How can Apple win?  Think software, not hardware.  The solution might lie in Airplay, Apple’s software that links the Apple TV to other iOS devices.  One way for Apple to cut the Gordian knot of TV UI is to turn to their developers.  Open up Airplay to third party apps. Let pioneers like Frequency.com design the UI for the future of TV on top of the Apple devices.    Web developers have already begun to experiment with novel interfaces that use a combination of channels and social recommendations.   Apple could buy one of these companies (maybe they should) or they could open up their ecosystem to all of them.  Or they could do both.

The ideal scenario is to use Airplay as the glue that binds the TV set to the Apple ecosystem of devices, content and apps.  In this scenario, it doesn’t matter whether I buy a full sized TV from Apple, or merely plug my $100 Apple TV hockey puck gizmo into a flat screen from any vendor.   Siri will provide viewing recommendations via voice navigation.   ITunes will serve up the content.  The iPhone will be the remote control.   My iPad will be the place where I set up playlists and tweak my preferences.  In other words, all of the gnarly interactive stuff doesn’t have to happen on the TV screen.   It can happen on devices that we already own and have already personalized.

That’s why so much is riding on Apple’s ability to get its act together in cloud services.  To win big, Apple doesn’t need new hardware in 2013 as much as it needs an overhaul of its deeply flawed software.

In the end, solving the TV “problem” has nothing to do with pixels and screen resolution.  It has much more to do with unbundling and rebundling the channels into something that is more personalized and local.   That will take time.  Apple is unlikely to unbundle TV in 2013.  For that, you must keep an eye on Intel who is purportedly working on a new set top box designed to offer a la carte channels… but again I am skeptical because the six mega-media giants who control most TV channels would be crazy to unbundle their wares.  That would be like the record labels voluntarily killing albums in favor of singles.   They will only make this move under extreme duress… and TV just isn’t there yet.

Some Wild Cards for Apple in 2013:

•     Moving to a twice-yearly product release cycle from an annual product release cycle could be a huge risk, but it’s necessary to fend off the constant flow of rival tablets and smartphones.
•     Moving some manufacturing capacity to the US could disrupt Apple’s vaunted supply chain or, alternatively, it could increase stability and reduce dependence upon foreign suppliers.
•     turmoil in retail stores could harm Apple perception among consumers (maybe it already has)
•     Losing Samsung as a component supplier might cast doubt upon Tim Cook’s legendary supply chain prowess.
•     Dumping Samsung as a semiconductor supplier will force Apple to turn to several suppliers of varying quality and capacity.
•     The looming battle to turn the automobile into the next mobile computing platform could present Apple with some good news in an unexpected front in 2013.  Google is well ahead with robot cars but commercial deployment will be delayed by a decade of lawsuits and revisions to laws.  In the short term, there will be a struggle to integrate IOS and Android in the automobile dash board.  In June 2012, Apple announced that it had already struck partnerships with nine auto manufacturers, including BMW, Mercedes, GM and Jaguar, for integration with Siri supposedly in the next 12 months.  Read more here.

Photo by Flickr user alistair_israel, used under Creative Commons license.