If you’re ever forced to read a public company’s annual report, turn first to the “risk factors” section, which is always the most entertaining. This is where companies are required to disclose all of the things that could go terribly wrong with their businesses. It’s a Wall Street version version of Edward Gorey’s Gashlycrumb Tinies (“A is for Amy, who couldn’t pay debt, B is for Basil, by unions beset”).
Take Apple’s most recent annual report. The 11-page risk factors section lists every imaginable hazard, from recession and natural disasters to the fluctuating dollar, supply chain snafus, flubbed product launches, product quality problems, lawsuits, the loss of key people, and competition from Windows and Android.
But there’s one major pitfall you won’t see described in Apple’s report—or anyone else’s, for that matter. It’s the risk of gradual decline if managers don’t sense customer dissatisfaction and respond appropriately. To my mind, this is one of the most common yet underestimated dangers faced by big, successful companies, and it’s one of the main ways they end up ceding their leadership positions to competitors. It’s what happened to Microsoft, it’s happening right now to companies like Comcast and AT&T, and it could easily happen to Apple.
Why pick on Apple in this regard, at a time when the company is generally performing well? Two reasons. First, I’m a loyal Apple customer. I get a lot of value out of my Apple devices—an iPhone, an Apple TV, a company-owned MacBook Pro, a brand-new iPad Air—and I’d like to believe that there are many generations of great Apple hardware yet to come. So it’s useful to lay out the worst-case scenarios now, in the hope that doing so will help prevent them from coming about.
Second, I’m concerned about signs that Apple is inattentive to its base. It often seems that the company would rather have buyers than actual customers. By speaking up now, I hope to do my small part to call attention to the problem before it gets out of hand.
The truth is that Apple (NASDAQ: AAPL) is in an extremely competitive business; whatever laurels it has, it can’t afford to rest on them. While Apple’s smartphone business continues to grow—it shipped 33.8 million iPhones in the third quarter of 2013, up 26 percent from the same quarter of 2012—it’s now dwarfed in this market by Samsung, which shipped more than 88 million Android-based smartphones in the same period.
The Korean electronics giant is also poised to surpass Apple in tablet shipments by the end of the year. And judging from the presentations I saw at a recent developer summit in San Francisco, Samsung has a lot of ambitious ideas about how to stitch together devices in the home, particularly phones, tablets, and TVs.
Investors seem to have a growing appreciation of the challenges Apple faces. From 2009 to early 2012—as the iPhone and iPad gained ground against a range of relatively feeble competitors—the company’s share price was on a steady upward march, quadrupling in value from $100 to about $400.
In a fit of enthusiasm in early 2012, investors then bid the price rapidly upward, driving it to a peak of $700 by September 2012. Since then, as Samsung has surged, Apple shares have settled back into the $500 range, suggesting that whatever special optimism investors were feeling about the company a year or two ago has dissipated. I think they’re right to be a little more cautious.
My vague but longstanding worries about Apple took firmer shape this week as I read a classic economics text called Exit, Voice, and Loyalty, by the late Albert Hirschman. Published in 1970, the book is about the choices available to a firm’s customers when its products or services decline in quality or increase in price. In a robust market, quality-conscious customers can express their dissatisfaction by switching to a competing product—that is, exiting. But if there aren’t any high-quality alternatives, or if the switching cost would be too high, they may decide to make some noise, in the hope of getting the company to change course. That’s voice.
One of the questions that interested Hirschman was whether loyalty—which he defined as “a considerable attachment to a product or organization”—can nudge customers toward using voice instead of exit, leaving an ailing firm more time to fix things.
I couldn’t help thinking about Apple as I read Hirschman’s analysis. The company isn’t ailing, but it certainly has a large number of highly quality-conscious customers, who are willing to pay a premium for products that they believe to be superior. As Hirschman points out, this group is often the first to protest or defect if they think quality is decreasing. And Apple, despite its reputation for perfectionism, doesn’t have a spotless quality record.
You don’t have to reach back to ancient flops like the Lisa computer and the Newton handheld for examples of missteps. The two most public cases in recent years were Antennagate in 2010 and … Next Page »
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