Bernstein's Toni Sacconaghi looks at Apple's pace of innovation and wonders where $12.7 billion in annual R&D spending is going.
From a note to clients that landed in my inbox Friday:
Seven years ago, when Tim Cook became CEO, Apple was spending just 2.2% of its revenue on R&D, a percentage that was dramatically lower than its peers. Since FY12, the company's R&D spending has outstripped revenue growth each year, and total annual R&D spending has jumped from $3.4B to $12.7B. Apple now spends 5.1% of its revenue on R&D...
While some companies acquire new technologies via [mergers and acquisitions] M&A rather than R&D spend, we note that Apple's M&A spending has also lagged peers. Apple has deployed just 2% of its [free cash flow] FCF towards M&A – dramatically lower than peers at ~25%. Collectively, the combination of low R&D spending and low M&A suggests that Apple may be "underinvesting" in innovation.
Perhaps most importantly, despite R&D spending more than quintupling over the last 6.5 years, Apple's pace of new product/services introductions does not appear to have accelerated. We note that Apple cumulatively spent $11.5B between 1998 and 2011, a period in which it introduced the iPod, iPad, and iPhone – last year alone, Apple spent a similar amount. We believe that Apple's R&D productivity has declined (which is not uncommon as companies scale, but may also be attributable to the loss of Steve Jobs). That said, it is also possible that the recent surge in R&D spending could translate into accelerated product and services announcements in the near to medium term.
Maintains Market Perform rating and $190 price target.
Below: Three Bernstein charts:
My take: The efficiency with which Apple under Steve Jobs turned R&D dollars into cash-generating product was once the envy of the industry. To quote Horace Dediu:
Creating products is very cash efficient. For example, the iPhone–the most successful product of all time–cost almost nothing to develop; certainly nothing that required Apple to dip into its cash. Funding for the type of product development Apple does comes from existing cash flows and mostly consists of salaries for their employees.
I'm with Sacconaghi on this one. Either that efficiency has suffered greatly under Cook & company, or something great is coming.
See also: Toni Sacconaghi sees the light
Neither is a matter of investing this quarter, or indeed year, and expecting results this quarter or this year.
Even the incremental stuff like improvements in current products is on a two or three year developmental cycle.
I would have thought that the glimpse behind the curtain they allowed for the development process for the MacPro would have made this apparent.
It would be apparent if your work experience was more than manipulating spread sheets, or getting your onscreen makeup right. Unfortunately that excludes most of Wall Street and the talking heads on CNBC.
I just couldn’t get this statement out of my head. It has been driving me crazy since reading it.
Now I know why. Apple isn’t going to be testing components and/or designs (or manufacturer’s ability to meet quality and volume points) three months prior to launch. Those development issues were settled long before then. ERGO, production rumors involving component constraints in the weeks before a product’s launch are, by their very timing, BOGUS.
Thanks again George.
Jobs and his ”consumer friendly” vision did. One of his first acts was to streamline Apple’s product line, taking it from wildly complex (and expensive to maintain) to understandable (and less expensive to maintain). From there he began looking at the future. The result was the original iMac, the iPod, MacOSX, the iPhone and the iPad.
Most of the technology to make these products already existed when Steve returned. All Apple did create the binding agent to bring them together. R&D cost was minimal.
These products were truly revolutionary vs evolutionary, but they all LOW HANGING fruit.
Since then Apple has had to create the technologies to make breakthrough products possible. That costs much , much more than relying on third parties, AND the results aren’t as splashy as the four mentioned above.
Why? Two reasons, first there had been a dearth of new, exciting products introduced (since the desktop computer) by technology’s “leaders” (see list above) so when the iMac, iPod, IPhone and iPad were introduced they were introduced to a market hungry for the breakthroughs they represented. Second, so many breakthroughs were introduced, so quickly, that the market grew to expect more of the same as routine.
But future breakthroughs don’t occur on a schedule, they occur after tons of hard work and billions (in today’s dollars) of expenditures. Their introduction is random and unpredictable. Like John Wayne used to say, “life is hard, it’s even harder if you’re stupid”. Well, paraphrasing Wayne’s saying, “innovation is hard, it’s even harder without a vision”
Who out there has a CORPORATE vision greater than Apple’s? Who has created smart watches superior to and easier to use (or more dominate) than the Apple Watch, who has created earbuds superior to Apple’s AirPods (or more dominate) or HomePod (soon to be dominate), or even the A-Series of processors (or more dominate), or iOS (or more dominate)? Nobody. In the absence of Apple breakthrough innovation who has taken the lead? No one.
Apple is investing heavily into health technologies for the Apple Watch, Artificial Intelligence, Machine Learning, Autonomous Vehicles, and original content. Apple’s original content is going to exploit Apple TV, iTunes, HomePod, AR and other Apple initiatives in ways NO ONE else can.
I’ve long been dismissive of analysts, this article from Sacconaghi reaffirms that conviction.
Apple’s initiatives all have an end goal. Just because we can’t imagine what the goal does not translate to lack of innovation. The goal could be so monumental that is going to take a lot of time before all the pieces are in place. I think FY2020 is the year we will see Apple’s vision of the future, and I’m willing to waiting.
All four other companies are really “just” software (with maybe some dabbling in a few other things). Very different types of R&D.
It’s possible both of these are true.
But I find the notion of “R&D efficiency” to be problematic.
Assume you’re trying to compare three novelists. One produces 20 pages of manuscript in a day, one produces ten, and one produces two. It’s impossible to say who the most “efficient” writer is. Efficiency is an odd concept to try and tie to a creative endeavor. It all depends ultimately on the quality of the end product.
R&D works the same way. $2 billion spent to find out something should be shelved is better than $1 billion spent on a bad product. The $2b spend is actually better in the long run, even though there is no product to point to and say “R&D made this.”
5% of revenue seems a very reasonable amount to spend on R&D and to Apple’s benefit this rate turns out to be a very healthy $12b. You can afford a lot of “what ifs” for that kind of money. I’m not concerned about how many products that leads to as long as whatever they do make is worthy of the brand.
I just don’t see Apple building a car but I do see them building various sub-systems in someone else’s future car, a la CarPlay on a larger scale.
Bull.
— Apple is very secretive;
— The things we know Apple is working on — autonomous cars and Apple glasses, require huge expenditures;
— Lord knows what else Apple is working on. Like I said, Apple is secretive.
— No one knew the iPhone was going to be the iPhone either. Many people said Apple hadn’t done anything new since the iPod. Which was true, right up until it was no longer true.
— Just because Apple hasn’t released “it” yet, doesn’t mean they won’t. Me, I’m willing to give Apple the benefit of the doubt.
“We believe that Apple’s R&D productivity has declined”
— A belief based on absolutely nothing.
Let me put it to you this way: When was the last time Google, Facebook, Microsoft reinvented tech? People fall all over themselves praising Amazon’s Alexa, but it’s a virtual drop in the bucket compared to a product like the iPhone. The truth is that companies don’t re-invent the world very often — or ever. So I’m willing to give Apple a lot more time and a lot more spending leeway. Changing the world is hard. And expensive.
1) 5% spend on R&D is excellent, far superior to the norm for tech companies. Apple’s Gross Profit is 8 X it’s R&D spend. This is not a problem.
2) Comparing to when the the iPhone was at the steep point in the S-curve creates an unrealistic and unsustainable benchmark. While S-curves are common, big ones like the iPhone or e-commerce or on-line advertising are exceptional.
3) The cost for top talent in Silicon Valley has escalate dramatically in the last 7 years. We’re hearing 7 figure salaries in some cases.
4) The past is the past, Tim Cook is not Steve Jobs. Tim wisely has chosen not to try please people like Toni.
5) Apple may have a big surprise that neither Toni nor any of us know about yet.
Generally I like Toni. Just not this piece.
Yeah, right.
Steve Jobs was that rare human being who can look at a haystack of ideas and decide which one, if any, is a “needle”, and thus has a better chance of actually flowering into something special. He could then nurture it all the way to fruition. He had a true one-two punch that made him really unique.
You can’t “buy” a Steve Jobs. You can only luck out and end up with one. You MIGHT be able to nurture one, given the right kind of environment (which I believe Apple is).
So here’s the problem: If you spend enough money, you can generate TEN haystacks worth of ideas. The problem is, you then need ten Steve Jobs’….
BTW, Tim Cook doesn’t come across as having that particular Steve Jobs talent. That’s okay, as long as he’s open to those that do. In that regard, he has two things in his favor; he’s an open kind of guy, and he once knew the original Steve Jobs, up close and personal. He’ll know one if he sees one.
I would guess that a lot of the R&D budget goes into things we don’t see as specific products. Scratch resistant coatings, stiffer cases, more precise manufacturing technology, battery technology, A series chip designs, camera and lens technology, etc.
Just because we don’t see new families of products doesn’t mean Apple is not getting benefits from the investment.
– Dr. Scott
They R&D in $Bs for the True Next Big Things:
Safe Autonomous Vehicles
Safe AI
Safe AR
Safe Wearables
Extraordinary Silicon
Privacy and Security
So, cheer Apple Watch 4, AirPod 2, HomePod 2, iPhones, but these are just baubles which pay for the R&D to make a safe, secure, and delightful private garden in this historic moment where safe, secure, and delightful doesn’t seem to be a target for some big players.
Safe, Secure, and Delightful = Expensive and Rare R&D.