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People are focusing on the wrong thing when analyzing Apple's path forward in the face of slowing iPhone sales. Instead of debating how much Apple will try to monetize the iPhone user base with services (not as much as consensus thinks), the company is instead planning its largest pivot yet. There are only a handful of logical explanations for Apple's current R&D expense trajectory, and all of them result in a radically different Apple. In a few years, we are no longer going to refer to Apple as the iPhone company.
As I pointed out last May, Apple's R&D expense saw a significant bump up beginning in mid-2014. It was clear Apple was up to something big. However, after looking at Apple's 2Q16 results, it appears I underestimated the situation. As depicted in Exhibit 1, Apple is now on track to spend more than $10 billion on R&D in 2016, up nearly 30% from 2015 and ahead of even my aggressive estimate. This is a remarkable feat considering that Apple was spending a little over $3 billion per year on R&D just four years ago.
One of the more interesting aspects of Apple's R&D expense trajectory in recent years is that the increase has been outpacing revenue growth. As seen in Exhibit 2, given my current iPhone sales expectations for FY16 and FY17, Apple is on track to approach a multi-decade record in terms of amount spent on R&D as a percent of revenue.
Unusual R&D Perceptions
The most shocking aspect about the amount of money Apple is spending on R&D is how little attention it has garnered in Silicon Valley and on Wall Street. Other than my R&D post last year, there is rarely any mention of Apple's R&D, and this doesn't seem to make much sense.
I suspect most of this has been due to the fact that Apple does not draw attention to its product pipeline and long-term strategy, choosing instead to embrace secrecy and mystery. Now compare this to Mark Zuckerberg laying out his 10-year plan for Facebook. It is easy and natural for people to then label Facebook as innovative and focused on the future. The same principle applies to Larry Page reorganizing Google to make it easier for investors to see how much is being spent on various moonshot projects. Jeff Bezos is famous for his attitude towards failing often and in public view, giving Amazon an aura of being a place of curiosity and boldness when it comes to future projects and risk taking.
Meanwhile, Tim Cook has remained very tight-lipped about Apple's future, which gives the impression that Apple isn't working on ground-breaking ideas or products that can move the company beyond the iPhone. Instead of labeling this as a mistake or misstep, Apple's product secrecy is a key ingredient of its success. People like to be surprised. Another reason Apple takes a much different approach to product secrecy and R&D is its business model. Being open about future product plans will likely have a negative impact on near-term Apple hardware sales. Companies like Facebook and Google don't suffer from a similar risk. The end result is that there is a legitimate disconnect between Apple's R&D trends and the consensus view of the company's product pipeline. Apple is telling us that they are working on something very big, and yet no one seems to notice or care. I find that intriguing.
Logical Explanations for Apple R&D
Even though Apple remains tight-lipped about its dramatic increase in R&D expense, there are three logical explanations for what may be happening.
1) Apple's expanded product line requires additional R&D. This theory represents the most straightforward explanation. Essentially, because Apple has grown significantly over the years, the company needs to spend more on R&D just to keep up with its more expansive product line and greater competition. The company is now invested in four hardware categories (iPhone, iPad, Mac and Apple Watch), not to mention various software and services initiatives.
2) Apple plans on doing more. Keeping with another simple explanation, Apple's increased R&D spend could signal that the company is willing to try its hand at more things. The expectation would be that Apple will begin releasing a greater number of products in terms of hardware, software and services.
3) Apple is looking to pivot. Apple is ramping up R&D because they have a few big bets that require a massive increase in investment. The two most logical areas for these bets are wearables and personal transport initiatives. In both cases, Apple is moving well beyond its comfort zone of selling pieces of glass that can be held in one's hand. Instead, Apple is literally building a new company with additional capabilities and strengths.
Apple Pivot, Will We Care
Agree. Apple is looking for another disruption not looking to milk iPhone / iPad sales. And this is an understatement:
"I suspect most of this has been due to the fact that Apple does not draw attention to its product pipeline and long-term strategy, choosing instead to embrace secrecy and mystery. "
Open vs. Closed
The bigger question, for us, is the OPEN vs. CLOSED question. Apple hasn't made friends in the developer community. Sure we bend, scrape, plead and cry to have apps accepted, but the taste left with us is sour and painful.
Android is trying to tighten standards having played, "Come One, Come All" a tad too loudly, but Apple is fickle and a pain. Yes it is good to be KING, but no one is KING of anything lasting that doesn't also inspire loyalty, trust and love.
Most of the developers I know, even the ones who are rich thanks to Apple's app store, don't look forward to wrestling with Apple again. Some have achieved "trusted" status now, but they remember the blood and tears it took to get there.
So note to Google, never tighten to the point where your tightening feels or seems capricious and mean. Apple has seemed capricious and mean to several developer friends who requested to remain nameless. Were they scared Apple might make a horrible process even harder? You bet.
Apple is testimony to the power of "insanely great". NO ONE jumps through the seemingly arbitrary hoops Apple is known for unless "insanely great" is attached. I'm a huge Apple fan and have been since buying the Apple II back in the day.
Lately I've caught myself wondering if the OVER (what I gain by being an Apple supporter) is worth the UNDER (what it takes to remain loyal). That is a conversation NO BRAND wants their customers to begin EVER since all the negative things leaving brings follows.
The watch left me cold. I rarely wear watches anymore, but when I do I want something from MoMA and their tiny phone on your wrist looked more Dick Tracy than cool watch (to me). I'm wearing a watch to dinner tonight and it won't be an Apple Watch.
My updated AIR is nothing but a pain. It doesn't fit my hands, the keyword is impossible to tune, and the screen too small. I never use it preferring my old Air (from 6 years ago). I love my iMac with the huge screen (what I'm writing on now), but it too was a failure.
We tried moving my 83-year-old father over to the big Mac screen but accessibility features were a torture and he is a Windows guy and will remain one. My Macbook I like, but it is getting long in the tooth and clunky. My iPad Pro I LOVE and that is taking the place of the new AIR (that I hate) and my MacBook.
Long diatribe, but I share my journey as a note of growing Apple frustration. My new EXPENSIVE Air was a disaster I should have sent back, but I kept thinking it was me. I don't think that way anymore and that can't be good for Apple.