[2014] Apple Is Still the Most Profitable Tech Company, but It Has Grown Slow to React

Top 15 Year in Review: Apple

Regular article

The most valuable, highest-grossing and most profitable tech company

In January 2011, Tim Cook took over Apple from the gravely ill Steve Jobs. People have doubted Apple's future ever since. This year a former Wall Street Journal reporter even wrote a book, Haunted Empire, questioning Cook's record as CEO.

Some of the doubts hit the mark, especially the worry that Apple has stopped noticing change and can no longer lead the industry. When Samsung started the move to bigger phone screens, and when digital music shifted from paid downloads to online streaming, Apple was plainly slow to respond.

Still, Apple's results remain outstanding. The supply chain it spent years building, its scale and its brand have kept it growing. While Samsung, HP and Dell gave ground step by step to cheap Chinese rivals, the experience built in the Jobs era, with hardware, operating system and app store working as one, has kept Apple's products above the price war.

Apple is still the most valuable, highest-grossing and most profitable tech company. In fiscal 2014, which ended in late September, Apple's sales reached US$182.8 billion and its profit US$39.51 billion. On November 26 this year, Apple's market value passed US$700 billion for the first time; in Cook's third year in charge, the company's value had doubled.

And the hundreds of millions of iPhones and iPads, along with the technologies Apple made mainstream, above all touch interaction and the app store, still shape our daily lives.

The iPad has begun to decline; the iPhone is still the pillar

Apple's revival since the 2000s has rested almost entirely on its devices: the iMac, the iPod and the iPhone each lifted the company to a new peak in turn.

Apple's challenge is to find and seize the next opportunity. But the iPad line, which was supposed to become the next iPhone, began to run out of steam in its fourth year.

The chart makes it clear: over 18 quarters, iPhone sales rose year after year. Building on the ground the iPhone had broken three years earlier, the iPad did well from the start, but its growth has kept slowing, and in three recent quarters sales have fallen from the same quarter a year earlier. At the same stage, the iPhone was still growing at triple-digit rates.

Four years after its launch, the iPad still faces the charge that "it's just a big iPhone." As smartphone screens grow larger, the iPad's prospects look more and more doubtful.

In response, Apple announced a partnership with IBM this year to build business apps, and the first batch was unveiled just this month. Whether repositioning the iPad can revive sales will depend on how the market responds next year.

Problem one: slower to sense change, Apple was a year late with the iPhone 6 Plus

At the end of 2011, Samsung launched the first phone in its large-screen Galaxy Note line. Critics panned it at first, arguing that nobody would want such a monster in their bag. But the market is the only real test of a product, and the phone sold extremely well.

At the end of 2013, according to J.K. Shin, head of Samsung's mobile communications business, the Galaxy Note had sold nearly 10 million units, and that year's flagship, the Galaxy Note 2, nearly 30 million. Over the same period, sales of the 4-inch iPhone 5 and 5s took a heavy hit: in every quarter of 2013, iPhone sales grew less than 20% year on year.

Average screen size of Samsung phones compared with the iPhone

Only this year did Apple finally launch large-screen phones, the iPhone 6 and iPhone 6 Plus, a full three years after the first Samsung Galaxy Note. Even allowing for development time, Apple should have responded last year.

Problem two: less able to create new industries, as the iPod and digital music show

In September, Apple pulled the iPod classic from its online store, and the iPod nano and iPod touch will likely be retired within a few years too. The first hero of Apple's march back to the throne has finally met the thing that displaces it.

Launched in 2001, the iPod ruled the entire digital music market for the next 10 years. iTunes Music freed music from tapes and discs and brought the music industry back to life. By its 2007 peak, iTunes had sold 2 billion songs.

But in the internet age, loading songs onto an iPod through a computer became a chore. The smartphone revolution set off by its younger sibling, the iPhone, born in 2007, hastened the iPod's death. iPod revenue has fallen every year since 2009 and now makes up just 1% of Apple's total revenue.

Today, with Wi-Fi and 3G/4G networks everywhere, streaming music online has become the norm:

Streaming services led by Pandora and Spotify have grown fast in recent years. Pay a monthly fee and you can listen to anything in the catalog that month. No more counting what each song costs, no more picking songs carefully, no more worrying that the player will run out of space, so the streaming model spread quickly.

Apple was slow to react to this upheaval in how music is sold. Pandora's revenue took off in 2009, growing more than fivefold in a single year. Apple did not launch a similar service, iTunes Radio, until 2013. In mid-2014, Apple spent US$3 billion to buy Beats, the well-known American headphone maker, bringing its streaming service, Beats Music, into Apple as well.

Room to imagine: Apple Pay

Apple's new product with the biggest impact on the industry this year may be Apple Pay. With its push, mobile payments, which had stalled, are finally gaining some ground.

Apple Pay makes paying extremely simple. The phone becomes a wallet of credit cards: swipe it over a device that accepts NFC, and the payment goes through instantly. Beyond in-store purchases, Apple Pay may also lift online sales on iOS, which would benefit a whole range of mobile shopping apps.

Apple has no serious rival here yet. Google Wallet, an earlier service of the same kind, has gone nowhere after years on the market, and a good number of Android makers have even dropped NFC from their new phones.

Apple Pay could be a billion-dollar business for Apple. That is small change for a company of Apple's size, and it does not solve Apple's big problem: finding its next breakthrough source of profit growth. But for Apple's app ecosystem, easy payment will certainly open new room for innovation in areas such as mobile commerce.

Room to imagine: Apple Watch

The Apple Watch, expected to go on sale in the first half of next year, is the first product since Cook took the helm to carry the ambition of becoming "the next iPhone."

The Apple Watch is not the first smartwatch, but next to the bulky, overly geeky Moto 360, Pebble and Sony SmartWatch, Apple's watch offers a wider range of looks closer to a traditional watch: 2 sizes, 3 case finishes, 4 clasps and 6 straps.

The Apple Watch is without doubt the most appealing smartwatch on the market. But that may not be enough. As a new device, it asks a lot of its users:

• Spending several thousand yuan to upgrade every 1-2 years;
• Charging it every 1-2 days;
• Getting used to wearing something on the wrist.

What extra value must the Apple Watch offer to persuade people to put up with all this? Apple's launch event gave no answer. As "the next iPhone," the Apple Watch still leaves too many questions open.

Apple's year in key events

March 2014: Launched CarPlay, bringing iPhone services to in-car entertainment systems.

April 2014: Upgraded the MacBook Air's specifications, but did not release a MacBook Air with a high-resolution screen.

May 2014: Bought Beats Music and Beats Electronics for US$3 billion, the most expensive acquisition in Apple's history.

June 2014: Released iOS 8 and OS X 10.10 Yosemite, which work together more closely. Also overhauled its programming language and launched iCloud Drive, putting the emphasis on cloud services.

July 2014: Announced an exclusive partnership with IBM, aimed mainly at pushing the iPad into business use.

July 2014: Updated the MacBook Pro and cut the price of the 15-inch model.

September 2014: Nude photos of a number of Hollywood actresses, including Jennifer Lawrence, were leaked through iCloud.

September 2014: Released the 4.7-inch iPhone 6 and the 5.5-inch iPhone 6 Plus, entering the large-screen phone market; announced the Apple Watch, an entirely new product line; and moved into mobile payments with Apple Pay.

October 2014: Released an iMac desktop with a 5K Retina display; released the iPad Air 2 and iPad mini 3, with better performance and fingerprint recognition.

November 2014: Added UnionPay payments to the App Store in China, along with a special 1-yuan price tier for promotions.

The most important question: a new ecosystem

Apple is a hardware company, and the great majority of its revenue comes from selling hardware. But from the iPod to the iPhone and iPad, what has let Apple keep prices and margins high is not good hardware design alone. An easy-to-use operating system, and the ecosystem of third-party digital content around it, are the main reasons Apple can charge more than anyone else.

The Apple Watch does more than Android Wear, but judging from the launch event and the developer tools released since, it is still mainly an accessory. If Apple keeps Apple Watch apps as mere add-ons to the iPhone app ecosystem, the watch will probably struggle to become the next iPhone.

The App Store model, launched in 2008, was Apple's greatest innovation of the past decade. From 500 apps at the start to millions today, the App Store has not only built up users' habits step by step but has changed our world completely.

But today, the disruptive power of the App Store ecosystem is no secret. Chinese companies have already built on it a new business model in which cheap hardware drives software distribution.

With its new large-screen iPhones, Apple will no doubt do very well, as the Christmas-season numbers show. Its mature supply chain and its integrated hardware, operating system and app store will also help it stay clear of low-price competition from Chinese Android makers. But to become once again the Apple that leads the industry, it needs fresh ideas within the App Store ecosystem it made mainstream, especially on wearable devices with small screens. That is Apple's biggest challenge next year.

The Top 15 are: Apple, Google, Baidu, Alibaba, Tencent, Amazon, Disney, McDonald's, Starbucks, Nike, Xiaomi, IKEA, Uniqlo, Wanda and Vanke. The list will change as the companies, their markets and trends change. We will keep watching them, and their competitors and partners too.

For why we set up the Top 15 reporting project, click here for an article we think is rather good.