Apple: Game over or room to grow?

  @FortuneMagazine July 15, 2013: 6:22 AM ET
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(Fortune)

FIRST: THE BEAR CASE

Watching Apple stumble is a little like witnessing a just-over-the-hill prizefighter wobbling on his feet or a once-eloquent orator stammering for the right word. But there's no question: Apple has lost a step since the death of Steve Jobs. That this observation is as inevitable as the effects of gravity doesn't make it any less shocking or lamentable.

How has Apple fallen? Let us count the ways. It has been three years since the release of the iPad, the company's last breakthrough product. The latest version of its mobile software reminds design critics more of the edgier features of Google's Android or Microsoft's Windows Phone than anything associated with Apple's penchant for leapfrogging-the-competition boldness. Apple's management is defensive, its people are less committed, and its competitors are resurgent. Apple's ferocious profit growth has stalled, and investors have lost faith in its ability to restart that engine. Apple's stock price is deflated, sure, but that's merely a symptom, not the disease.

No, the real problem with Apple (AAPL, Fortune 500) is that this company, long the arbiter of cool, the corporate trendsetter on all matters from design to marketing to operational excellence, has gone from being insanely great to merely great. Let's not lose sight of the fact that we're talking about a company that's still worth almost $400 billion and last year generated almost $42 billion in net income, making it the second-most profitable company in the world after Exxon Mobil (XOM, Fortune 500). It's also worth noting that most unfavorable comparisons about Apple are with Apple itself. Apple's relative decline is exactly what the doubters predicted would happen after its legendary leader died. As CEO for the last 15 years of his life, Steve Jobs saved the company he co-founded from oblivion, rescuing it from near bankruptcy with his singular ability to define a vision and steer the best course of action.

Indeed, though Apple's bulletproof finances and solid product lineup today bear no resemblance whatsoever to its sorry state of affairs before the iMac, iTunes, the iPod, the iPhone, and the iPad changed our lives, the image Apple is projecting of itself harks back to that troubled time. In lieu of breathtakingly new product categories to share with its customers, Apple has instead unveiled an expensive ad campaign that one can't help compare, adversely, with its iconic "Think Different" creation from 1997. The new campaign is neither attack-dog comical, like the famous "Get a Mac" spots that pilloried PCs, nor the lush product commercials that celebrate Apple's devices. Instead, it is a series of pretty pictures that barely showcase Apple's products, instead reciting the company's values. They include: "There are a thousand 'no's' for every 'yes' " and "We spend a lot of time on a few great things."

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It's as if Apple is trying to convince itself that it is still great, rather than simply peddling products to customers. Apple, one of the best marketers of modern history, is telling rather than showing.

The criticism that stings Apple the most is that it has lost its edge for innovation. The defensiveness over the frequently repeated criticism shone through during Apple's keynote presentations at its annual conference for developers in June. Introducing a new and impressively redesigned version of its Macintosh computer for professional customers, Phil Schiller, the company's senior vice president for worldwide marketing, blurted out, "Can't innovate anymore, my ass." This was a call to action in front of a friendly audience, and it drew predictably approving hoots and hollers. But it acknowledged the existence of doubt, something the Apple of old would never deign to validate. That Schiller, who played a reliable straight man to Jobs' virtuoso performance in days gone by, was calling out a product that very few Apple customers will ever buy only accentuated the lack of fresh thinking in other, more visible areas.

Is Apple making a comeback?

The best Apple has to offer these days is a new look and feel -- a fresh coat of paint, the critics sneered -- for its updated mobile software, iOS 7. "You expected something novel from Jony," says a Silicon Valley venture capitalist who follows Apple closely, referring to Jonathan Ive, Apple's longtime hardware designer, whom CEO Tim Cook recently appointed to head software design as well. "It sure doesn't look novel. It looks like a mishmash of Android and a Windows Phone." What's more, most of Apple's latest product releases have been iterations on existing gadgets. "It's hard to argue with the bears," says Katy Huberty, the Morgan Stanley analyst who follows Apple. "The iPad Mini is just a smaller iPad. You need something new to really hit investors over the head to prove that innovation isn't dead at Apple." (From a stock price perspective, Huberty counts herself a bull, predicting that Apple's shares will hit $540, compared with a recent $400, nearly a 52-week low.)

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Everywhere are signs that Apple is stuck in its ways, from the superficial to the meaningful. It has dropped hints that new product categories are on the way: an iWatch or other wearable computers, a TV, a payment or billing system that leverages its industry-leading 575 million iTunes accounts. Yet those products are nowhere to be seen. Instead, there is a predictability to Apple's product launches now, with most of the features and products leaked ahead of time. At its developers conference in San Francisco, Apple announced -- but did not have ready for release -- a service called iTunes Radio. The streaming product looks a lot like Pandora (P), which has been around for years.

Certainly there have been high-profile and self-inflicted wounds under Cook's time as CEO, including the botched hire of a retail chief (John Browett, recruited from Britain's Dixons, who lasted nine months) and its launch of a mediocre and therefore embarrassing mobile mapping service. But Apple is also suffering because its competitors are innovating and experimenting, siphoning some of the buzz once reserved exclusively for Apple. Google (GOOG, Fortune 500), for example, has wowed its developers with its futuristic computer within geeky spectacles, Google Glass. The search giant also continues to push ahead in web services (think Google Now, Google Drive). A former Apple employee, now with a startup, laments his former company's "blatant disregard" for the kinds of Facebook-like social media services that are the wave of the future. "For Apple to really not have a clue about how to do social worries me," says the Apple veteran. Apple's response to surging competitors has been defensive and churlish. In March, the day before Samsung was set to unveil its latest phone, the Galaxy S4, marketing chief Schiller granted on-the-record interviews to several publications bashing Samsung and Google's Android. (This seems a good place to note that Apple declined repeated requests to make any of its executives available to comment for this article or respond to its assertions.)

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There are indications as well that the troops at Apple are getting restless. Multiple recruiters say it is easier now than at any time in recent memory to woo Apple employees to leave. Ex-employees refer to the culture inside Apple as a "grind," one with little opportunity for promotion. It is not uncommon at Apple for people to stay in the same role for years, faithfully executing plans designed by their superiors. That was fine when the stock was moving and Apple's products were shooting the lights out. "Today there's less of an element of trusting that they're going to be working on the next cool thing," says Chetta Crowley, a former Apple recruiter, now with Groupon (GRPN).

Strategically, Apple hasn't yet shown its hand. The company has long been chary of blockbuster acquisitions. It didn't snap up the crowdsourced mapping company Waze (Google bought the company for more than $1 billion), continuing an aversion to chasing after popular deals. Rather than acquire hot Silicon Valley companies like Twitter, Square, or Nest, Apple sticks to targeted purchases. It spent less than $600 million on acquisitions in the first half of its fiscal year, which began in October, according to securities filings, and more than half of that was for a fingerprint-sensor chipmaker called AuthenTec.

Wall Street seems to have grown impatient with Apple's unwillingness to use its immense balance sheet to buy young talent or upgrade its web services portfolio. There's no doubt Apple has more tricks up its sleeve. But for the world's most valuable technology company the bar is almost impossibly high: Even if it lives up to investors' pent-up expectations for a bold move, it may never live up to the standard set by Apple at its peak.

ROOM TO GROW
Apple is a different company under Steve Jobs' successor, Tim Cook -- and that's not necessarily a bad thing. Up next: the bull case

The Apple doubters are wrong. Yes, the company's profits are eroding, and its product pipeline seems dry. It would be easy to say (and many have) that Apple -- having racked up virtually every superlative in business, including, for a time, the highest market capitalization in the world -- appears to have only one direction to go. Add in that Apple needs to navigate its future without Steve Jobs, and it isn't hard to understand where the detractors are coming from.

Sorry, haters. Apple has a long way to go before it can be counted out. Look closely at what little Apple has revealed about its secretive plans for the future, and you'll see a still-dominant, still-innovative company that is intelligently regrouping for fresh battles that didn't exist when Jobs was around. In its corporate DNA, Apple is a go-for-broke company, an astounding attribute given its size. The opportunities for reinvention at Apple are many, and to underestimate the abilities or the imagination of the crew Jobs left behind would be foolish. Just because Apple hasn't indicated its road map or offered concrete examples of its upcoming breakthrough ideas doesn't mean it doesn't intend to surprise and delight its customers again, the way it has so many times before.

Apple has frequently been compared to a cult or a religion, and to some extent having confidence in its future requires a leap of faith. Yet this expectation of heroics also tends to blind Apple's critics from seeing how good it remains. "From a product as well as a financial perspective, if you took the name off the recent descriptions of Apple's business, anyone would be enthralled," says Bob Borchers, a venture capitalist and former Apple product-marketing executive. "I'm a believer. The only problem here, per se, is that Apple is being compared to itself. The key is the next revolution. It has been a while since the last one, but that isn't unusual."

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Indeed, innovation doesn't follow a predictable timetable, even at Apple. Six years passed between the launch of the iPod in 2001 and the debut of the iPhone. Three years separated the pathbreaking iPhone from the iPad, which itself built on many of its predecessor's innovations. In retrospect, there wasn't a sense during that relatively fallow period before 2007 that Apple was somehow letting down its fans -- or its investors. During that time it churned out updates to popular products, like the iPod Mini and Shuffle, and fresh approaches to notebook versions of the Macintosh computer. In that light, recent iterations like the iPad Mini, the thinner iPhone 5, and redesigned mobile software look like business as usual, presuming the habitual magic is happening behind the scenes. Despite the faithful's anxiety, it has been only three years since the release of the iPad.

In the near term Apple has plenty on its plate. Investors who have traveled to Asia, where Apple buys its components and contracts for the assembly of its devices, report that a lower-cost iPhone for developing markets is on its way. Although such a device could hurt Apple's profit margins, it represents a major growth opportunity. Students of Apple's supply chain also have a window on Apple's next innovation for its high-end iPhones: the integration of fingerprint-sensor technology from AuthenTec, the chip company Apple bought late last year. The rumor mill in Asia is devoid of chatter about an imminent iWatch or an Apple television, though fans continue to expect such devices next year.

Apple is famously tightlipped about future products, but it has repeatedly dropped hints about a service many expect. At its conference for software developers in June, CEO Tim Cook noted that Apple's iTunes service currently has 575 million accounts, giving Apple the largest collection of credit card data of any online merchant. It's a statistic Apple frequently updates publicly, provoking the widespread belief that Apple will create a payments or billing system that could incorporate the best of PayPal and Square. Payments are a true ecosystem, offering the opportunity to conduct repeated transactions with loyal customers. Of the many companies poking around in payments, none has the combined hardware and software prowess of Apple. Says Katy Huberty, a Morgan Stanley analyst: "It's so important that Apple helps the market understand how they'll monetize this 575 million-person account base."

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Another tantalizing opportunity for Apple is in automobiles. It recently announced that major car manufacturers will be integrating Apple's mobile software into their vehicles beginning next year, a move that could foreshadow new mobile offerings and bolster the company's recently announced iTunes Radio service. "People spend two hours a day in the car, and they're usually listening to music," notes BTIG Research media analyst Rich Greenfield. "Apple showed off how iTunes could be the operating system of the car. That was the first time I'd seen that." It also plays to how Apple could make strengths out of recent weaknesses. With Apple Maps and its Siri voice-activated search product, Apple hasn't shown itself to be a leader. But both are examples of software services that get better the more people use them and where Apple is making investments.

Products are a key metric, but management's confidence can also be measured in its willingness to act in un-Jobs-like ways. Cook, who had been chief operating officer since 2005, has shown a responsiveness to outside groups that Jobs dismissed. He has improved Apple's relations with critics of its Chinese contract manufacturers, for example. In granting a dividend, raising debt, and committing to considerable stock buybacks, Cook also has appeased Wall Street -- at least regarding Apple's balance sheet.

In many symbolic ways, too, Apple has embraced change. Its new mobile software, iOS 7, is notable for abandoning the so-called skeuomorphism favored by Jobs. These design tricks included images of old-fashioned card tables in its gaming app and bookshelves in its iBooks app. "We just completely ran out of green felt," said Craig Federighi, Apple's senior vice president for software engineering. "And wood. This must be good for the environment." Federighi, a rare top Apple executive who left the company and then returned, took on more responsibility last year when Cook fired mobile-software chief Scott Forstall, an acolyte of Jobs. That Federighi could cheekily joke about a design predilection so closely associated with Jobs shows the existing management team finding its own voice.

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There are even tiny signs that Apple people have begun to sally forth into the world, compared with the former Jobsian diktat that all but a chosen few stick to their knitting in Cupertino. Andy Miller, formerly head of Apple's iAd mobile advertising business and now president of a San Francisco startup, reports that a team of his former colleagues attended a major advertising conference in Cannes recently. "Steve would never let us go," he sniffs.

A major wildcard for the future of Apple is its CEO, Cook. He generally suffers in head-to-head comparisons with Jobs. Who wouldn't? Cook isn't the storyteller or product visionary that Jobs was. But it's altogether possible that Apple was ready for a CEO like Cook. He shows little patience for public relations -- Apple declined to make him or any other executive available to comment for this article -- but perhaps that, too, is prudent, given his low-key personality and the heaping pile of responsibilities he confronts. Where it counts, Cook has shone, including by improving Apple's reputation on labor conditions and the environment as well as on Capitol Hill, where he wowed the Senate with his command of tax policy.

A few years before his death, Jobs hired away the dean of the Yale School of Management, Joel Podolny, to start Apple University. The idea was to create an in-house curriculum that would instill in Apple's future managers the lessons Jobs had learned in building the company. Podolny has taught a course at Apple U. called What Makes Apple Apple. He discusses, among other things, the unusually functional nature of Apple's corporate structure, so much so that no one person was ever in charge of the iPhone, for example. One small team handled the user interface, another the operating software, a third the hardware design, and so on. Joshua Cohen, a Stanford University political philosopher now on the faculty at Apple University, teaches a course called The Intersection, meant to explore the places where science and liberal arts meet in the creation of great products. He uses New York's Central Park as an example that is completely outside the realm of consumer electronics and all the better for gaining an understanding of Apple's unique approach.

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With Apple U. the company is trying to get its people to understand how they do what they do. The norm at Apple hasn't always been so philosophical: It's the kind of place where people do what they're told without asking why.

In its most critical sense, Apple is still set up for greatness. It is, in the words of a recently departed executive, "set up to force itself to keep innovating." Because Apple focuses its efforts on a relatively few initiatives, those initiatives must be amazing. "So will they come up with something fundamentally different?" asks this former executive. "If so, it remains Apple. If not, it dies a slow, painful death."

The conventional wisdom in the media, on Wall Street, and by lovers of schadenfreude everywhere is that dull normality will weigh down Apple in years to come. Some canny observers of Apple's past and future, however, see something different altogether: renewed greatness.

THE VERDICT
Even Apple fans think the company needs to act fast.

The task at first seemed impossible: Determine if Apple's best days are behind it or if it's merely taking a break from breakneck growth and world-beating innovation. After all, how do you figure out the trajectory of a company that is so tightlipped with its plans and prohibits its people from talking freely, even among themselves -- a company whose CEO speaks rarely and when he does, only in crisp, measured sentences designed to reveal as little as possible?

The solution to an undoable assignment ultimately was not to choose, or, rather, to take both sides in separate arguments. There's an equally valid case to be made here, and each argument has passionate adherents among the techno-elite. Even among Apple veterans, opinions are split, with some believing the excellence of the organization will enable it to win again and others seeing too many signs of decay to keep the faith.

But you can't really have it both ways in life. So what do I think?

The preponderance of the evidence, common sense, and gut instinct all suggest that the Apple-has-peaked argument is the stronger of the two. It is jarring to see Apple as a follower, but that's what it looks like with its iTunes Radio service, with its flat mobile software design, with its still suboptimal online maps. Apple isn't supposed to follow anyone on anything. If Apple makes a cheaper phone, it will boost revenues. But a premium brand that attacks the low end does so at its peril. If Apple moves into wearable computers, it will do so only after Google, Jawbone, and its own partner Nike (NKE, Fortune 500) have already shown the way. Ditto television, where rival Samsung has a stronghold.

Elsewhere there's the concern that Apple can't allow for fresh thinking. Because its top managers are all middle-aged, it's no surprise they're a step behind when it comes to social, web-based applications. Apple walks right into teasing by competitors that the iPhone is for oldsters. It's even easy to mock the music at Apple's recent developers conference. As one Apple veteran says, "They didn't do themselves any favors by playing Led Zeppelin."

Perhaps the most stinging comment from an ex-Apple executive regards how the company's employees are adjusting under the regime of Tim Cook. "They're learning to work under an operator," this executive says. Apple, in its greatest moments, is a product company. Operations help make products great, but the company thrives from the attention of someone steeped in product design and development. That in its essence was the greatness of Steve Jobs the businessman. He was willing to sacrifice anything at the altar of product greatness. That included placing an emphasis on marketing. Indeed, many thought Apple's product marketing, directly overseen by Jobs, was its greatest product.

Previously Apple did some of its best work with its back against the wall. The fear is that Apple's best won't be good enough.

This story is from the July 22, 2013 issue of Fortune. To top of page



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