Tim Cook’s financial high-wire act

Apple’s trillion-dollar valuation has been largely financed on the backs of its suppliers, says Harvard’s Mihir Desei. Less well-managed companies imitate Apple at their peril.

From Why Apple Is the Future of Capitalism” in Tuesday’s New York Times.

Apple’s financial model emphasizes cash flow over profits. Apple is not simply immensely profitable; in 2017, it generated $16 billion more in operating cash flow than profits. It does that in part by running its day-to-day operations in a distinctive way. Typically, a company has to use external funds to fund the process of stocking goods and collecting revenue from customers.

Apple’s model turns this upside down. Its retail stores collect cash from customers quickly, it is ruthless on keeping inventory low, and it takes forever to pay suppliers. In the process, Apple’s operations are extremely effective cash generators. This is no coincidence. It is the result of the canny supply chain that Tim Cook built. In effect, Apple has largely been financed on the backs of its suppliers, who are willing to hold their inventory and wait more than 100 days to get paid, just for the pleasure of doing business with Apple…

Apple is the epitome of an “asset light” company: It owns very few hard assets and therefore needs almost zero outside capital to run its business. As of mid-2018, Apple has $105 billion of operating assets and $120 billion of operating liabilities. What does that mean? Miraculously, its operations rely on no capital from outside financiers.

How does one achieve this apotheosis of the asset-light strategy? First, create a supply chain in Asia run by companies willing to invest in low-return projects that create your products. Second, hold those suppliers under your thumb. Idolizing asset-light strategies, however, can also lead to underinvestment, an excessive reliance on outsourcing and the artificial division of companies to avoid hard assets…

The financial archetype defined by Apple — asset-light strategy, leveraged share buybacks and cash flow above all — is a high-wire act. Boards should guard against the temptation to follow Apple’s path blindly.

My take: Desei nails it, although with more sympathy for the supply chain than we’re used to seeing. He’s something of a character at Harvard Business School. Paul Solman profiled him for the PBS NewsHour last year, borrowing heavily from Hollywood and the BBC. Lots of fun:

 

10 Comments

  1. Richard Wanderman said:

    I thought his piece in the Times was spot on. I’d forgotten the Soloman/NewsHour piece although I did see it (I try to never miss Paul’s creative segments).

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    August 7, 2018
  2. Peter Kropf said:

    “First, create a supply chain in Asia run by companies willing to invest in low-return projects that create your products. Second, hold those suppliers under your thumb.”

    OK. Sounds reasonable from Apple’s POV.

    But, why would other companies do business under Apple’s thumb?

    Maybe, it has something to do with opportunities to scale and an opportunities to innovate.

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    August 7, 2018
    • David Drinkwater said:

      If their factories are like my Fab, they are immensely more profitable running at volume. Apple is a pretty good guarantee of volume. So the suppliers dance with the Devil they know….

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      August 7, 2018
      • Exactly. During the ‘50s and ‘60s the Japanese destroyed American manufacturerers by pricing their product assuming two shifts of operation. The second shift reduces plant and amortization dramatically. They did this even though they weren’t producing enough to warrant a second shift. But, because of the lower price their products sold for it wasn’t long before the second shift was buzzing with activity.

        Compaq computer was hailed as the best run computer manufacturer because operating overhead was limited to 20% of revenue. Today, even with the amount spent on R&D, Apple’s OpEx runs at 10% to 11% of revenue

        There is nothing more expensive than idle capacity.

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        August 7, 2018
  3. Gianfranco Pedron said:

    Wait, doesn’t Apple’s CapEx fund most of the tooling and manufacturing infrastructure for its suppliers? Didn’t see that mentioned anywhere.

    Waiting 100 days to get paid is no big deal if you know those are the terms going into the contract and there is virtually zero risk of default. In my experience, the problem with getting paid in 100 or more days when Net 30 day payment terms are originally negotiated is that, in general, the risk of default increases exponentially with ageing.

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    August 7, 2018
    • Fred Stein said:

      Thanks David and Gregg, and adding:

      Some Apple suppliers are crying all the way to the bank. Case in point, TSMC: With Apple giving them massive volume, they can afford $B’s in Capex to build the most advanced chip making facilities. Their stock has more than doubled in the last 3 years. That said there are big risks and failures being an Apple suppliers.

      It is in Apple’s long term interest to have a healthy supply chain. Indeed the true genius of Tim Cook’s way of doing business is not about inventory, but about getting the world’s most advanced manufacturing companies (not just chip makers) invest continually and massively. That’s win/win.

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      August 7, 2018
  4. Since 2004 I have been debt free (bankruptcy). I took on a project I was not qualified to manage and it sucked all the oxygen from my, to then, very successful business.

    Since then I amassed a collection of 27 collectible pre-war luxury cars, bought a home built in 1907, stocked it with period antiques and travelled, all without debt. Financing was provided by my options trading (started with $500).

    Last Friday, after recovering from the giddiness brought on by AAPL’s dramatic post earning pop, I sold my $195/$197.50 AUG Wk2 Call Spreads for $1.00 more than I expected ($1.45) generating an extra $20,000 profit (leaving $1,000 on the table).

    That investment was predicated on AAPL’s Historic Trend which showed the high probability of a 3% bump after earnings. It also showed that AAPL would peak today or tomorrow and decline about $6.00 by August expiry. It looks like today is the day.

    Because I’m uncomfortable going short AAPL I am investing a much smaller portion of my cash this time, and will be buying $210/$207.50 Put Spreads, hopefully at $0.80, expecting to cash out at $1.25 (half their potential value).

    2
    August 7, 2018
  5. Ken Cheng said:

    A quibble: “Six years ago, the company owed no debt and had never undertaken a share buyback or paid dividends. Pressured by a shareholder revolt in 2013”

    Unfortunately he’s wrong. Apple did pay dividends before 1996. Also, there was no “shareholder revolt in 2013”, that was Einhorn complaining about the pace of dividends and buybacks, after Apple had already announced a cash return program.

    If one were paying attention back in those days, you would have gotten the strong impression that Steve and Apple were waiting to pass the landmark figure of $100B in cash. One so that they wouldn’t have to worry about any near-death experiences like the company experienced in the mid to late 90s, and two, Steve liked large round numbers he could throw up on the screen at presentations. Unfortunately, Steve passed away before Apple passed $100B, so we will constantly see stories about Steve not wanting to return cash to the shareholders, but it was literally, the quarter after passing $100B in cash that it was announced that Apple would start returning cash.

    As for the gist of the Opinion piece, I thought it made sense, but lacked any examples of companies actually aping Apple’s approach.

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    August 7, 2018

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