Does Software Development Threaten to Dethrone Apple?

A couple of months ago I wrote an article speaking to how Apple (AAPL) was the fourth largest company in the United States by market cap according to the S&P 500 (it is currently the 3rd largest), and began speculating as to whether or not the company deserved this highly coveted position. While being a tech company with no debt obligations is going to bias Apple's position upward in the S&P 500, I do think investors should re-evaluate whether Apple deserves this position in the market.

Yesterday there was a very interesting article posted in Slate (Apple Wants to Own You), and while I feel that the title is far too fear-mongering, I do think that a few of the issues raised are pertinent to Apple's ongoing success.

The biggest point raised in the article is the fact that the locking-out of third-party software that originally only pertained to the iPhone is now being included in the iPad, something at the very least controversial given that the iPad is being hailed as a tablet computer. This is to say that except by ways of the Apple marketplace for apps, you are unable to install any non-Apple endorsed piece of software on the iPad without manually unlocking the device and voiding your warranty. While this may not be a short-term concern for Apple, the Slate article identifies that one of the key draws to Apple products is the rich environment of downloadable apps.

This of course raises the question of whether software begets users, or users beget software. As it stands now, Apple gets 30% of the sales from all apps. That's a pretty lucrative business for being referee and market maker on your own devices. With Apple additionally trying to take 30% out of magazine subscriptions on the iPad as well as growing rumblings over the subjectivity and increasing conservatism of iPhone and iPad app acceptances, there is concern that Apple is starting to take more advantage of the moat of user base it has built up with the lights-out success of past products.

While the iPad currently has no side-by-side competitor, other phones such as those using the Android operating system produced by Google potentially offer users a more unfettered access to third-party software than those using the iPhone.

The story of the iPad has been a huge success thus far, with Apple reporting over 500,000 units sold. Apple's stock momentum appears to be one of maintained margins and continually growing revenue, with revenue expected to jump 47-80% from last year's second quarter. While Apple has been a very strong performer in the past, it might be worthwhile to current investors to re-weight the risks and evaluate whether the price that Apple is currently trading at is pricing in a significant amount of optimism regarding future success.

The Dangers of Anecdotal Evidence

Perhaps it's something that has been embedded in us by the process of evolution, but humans seem to really enjoy articles, snippets, and stories from real human beings rather than data.

Consider every instance you've ever heard of someone doing something that objective reason and presumably some sort of data would suggest is wrong. This could include driving very infrequently yet choosing to lease, or buying a can of Coke every day from the local corner store when one could save 50-75% of this cost by buying a twelve pack and bringing the soda from home.

Now think of when those instances match up with a story or personal experience that seems to fly in the face of data or statistics. "Well my friend blah-blah bought her car and then the engine went out and she had to pay (large sum of money), so I just lease now". Or "my sister so-and-so used to bring her sodas from home, but then one day some of the cans exploded and ruined everything in her pantry, so now I just buy my soda from the corner store on the way to work".

These stories are extremely appealing, because we can identify with them. You imagine yourself in that situation, and since it happened to your friend/family member, it seems to suggest the probability is high that it can happen to you. If you look at this person's experience as a foretelling of what will happen to you (i.e. probability of negative event = 100%), then making a choice that goes in the face of objective data makes sense. However, it could just be that the probability of the effect is fixed, and your friend or family member just happened to be on the wrong end of the probability distribution.

While citing personal experiences to show how personal anecdotes are oftentimes blatantly false is a logical absurdity in and of itself, consider the following article that was on the front page of Yahoo! Finance this Saturday. Entitled: "How My $499 iPad Purchase Became a $1,170 Credit Card Bill", by Jeff Fox from ConsumerReports.org, the article instantly grabs your attention because of the large change, as if to suggest Apple is tricking you.

The article itself is a misnomer because one of the first things Jeff says is that he decided to get the $829 64GB 3G model (because you can use it with more than just Wi-Fi) that evidently releases later in April. Right there, the article should have simply become "How a $829 purchase became $1,170", but Jeff seems to suggest that he was "lured in" with the $499 version.

The other $341 comes from a greater insurance and tech support plan and accessories, all of which Jeff had the choice to purchase. I personally resent the fact that he seems to be suggesting that Apple made him buy these additions. To make his point even more ridiculous, if you go to the Apple website and begin trying to purchase an iPad, all of the accessories are defaulted as "no", which is counter-intuitive if Jeff is right and Apple is trying to pull a fast one.

Outside of the error in trying to make Apple sound like a baddie is the justification for his splurging on additional memory. Jeff states: "As for stepping up to the 64GB iPad, my philosophy is that you can never have too much memory. I have no doubt that I will fill much of that 64GB within the next year or two. Speaking only for myself, the breathing space was worth the extra couple of hundred dollars."

I find this comment particularly hilarious, because if Jeff was most concerned about memory, why not have simply bought a net book, which for around $360 dollars can give you 290% of the memory and 60% more processing power than the 64 GB iPad? (the iPad only has a 1 GHz processor whereas most net books baseline at 1.6 GHz. The iPad beats net books in weight however by being roughly a pound lighter).

Jeff had essentially narrowed down the known universe of purchasable products to between the the higher and lower memory iPad 3G models because of prior selections he had made. When you consider the additional price he paid for the memory in the spectrum of the computing world, the extra cost/amount of memory added seems like highway robbery.

I think that Jeff speaks for a lot of Apple consumers in that his purchasing decision seems to have been driven by the presentation of the product and its ease of use. I'm personally too practical to buy a product who aside from it's touch screen and lower weight is already obsolete from a processing and memory standpoint, yet costs more than double that of competing net books. (granted tablets and net books are by definition not the same, but do accomplish similar tasks by being "mini-PCs")

This isn't the first time I've written about Apple products (see: Is Apple Really the Fourth Most Valuable Company in the United States? ), partly because I find the cult of product so fascinating with this company. If you were to ask a robot which he/she would be willing to pay more for, my guess would be the one that was the cheapest in terms of computing power/dollar (presuming the two products were made with the same quality of components). This doesn't play out the same way in the real world, and I think it's a perfect example of the impact of the "human factor": how presentation and ease of use can put value multipliers on products that are inferior from a hardware perspective.