Car Wars – II: Why Is Apple Interested In Cars?

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So it appears that Apple (NASDAQ:AAPL) is really serious about making an electric car. The Wall Street Journal reports, citing people familiar with the matter, that Apple intends to significantly ramp-up the size of the team working on its automotive project, targeting a “shipment date” as early as 2019. [1] Now, Apple does have the financial wherewithal to pursue a car project aggressively, but there remain several unanswered questions. Why is Apple looking to enter the market? Is it really possible for a company with little experience in automotive design to break into the electric car market? Would a project make financial sense? In our analysis below we will try to figure out why Apple might be interested in the car industry.

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The Quest For The Next Big Thing

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Apple has seen a stellar run over the last several years, with revenues growing by a staggering 31% CAGR since the launch of the iPhone (2007) and the broader iOS juggernaut, which allowed the company to disrupt several high-value industries. Apple is now the world’s most profitable and valuable corporation, by far. However, growth is projected to slowdown in the near-term. While the bread-and-butter iPhone business is currently experiencing a growth spurt, riding on the large-screen form factors that Apple held off on for many years, the longer term growth prospects could be mixed, given the increasingly saturated smartphone market and elongating upgrade cycles. The iPad has actually been seeing a decline sales, while the Apple Watch isn’t expected to really move the needle in terms of earnings. Now, finding similarly large and profitable markets for expansion within Apple’s core domain of consumer electronics and computing isn’t going to be easy, and its likely that the company will have to pursue other industry verticals where it could apply its expertise in software, industrial design and user experience.

Is It Possible To Build A Car Business From Ground Up? 

In our previous article, we discussed how cars and technology are colliding in a manner similar to how mobile phones and technology collided around seven to eight years ago. The success of Tesla Motors has shown that it is now possible to build a successful car company from the ground up with the right combination of human and financial capital. Their success also indicates that the barriers to entry into the automotive market are not as high as they used to be. Moreover, it appears that the barriers to entry might be lowered even further. The shift to all electric cars from internal combustion engine cars means that the mechanical complexity of cars will be reduced significantly. This means that what goes into the making of a car will change and the supply chain involved in the making of cars could become simpler. The key hardware components involved in electric cars — drive trains and batteries — could be standardized and outsourced in a manner similar to the white box manufacturing process employed in the manufacture of smart phones. Companies will then be able to add their own software, design, marketing and distribution capabilities to differentiate themselves. Apple could have what it takes to succeed in the changing market.

Does It Make Financial Sense?

Apple’s core consumer electronics business is a high-margins, high-volume game. However, Apple will face a trade-off in this regard in the automotive market. While the auto business offers tremendous potential in terms of market size (high volumes and prices), it raises many red flags in terms of profitability. There are cars that have the gross margins of an iPhone (roughly 50%, by our estimates), but they sell fewer units in a year than the number of iPhones sold in a day. Even if one only considers the premium car segment — that includes BMW, Audi, Lexus and Mercedes-Benz — this amounts to a market of around $220 billion in revenue and 5-6 million in terms of units. In a good year, this segment will report gross margins of around 25%, implying gross profits of around $55 billion. According to our estimates, the gross profits for the iPhone alone last year stood at $58 billion. Considering these figures and the capital expenditure required in order to build the manufacturing capacity for such cars, the automotive market as we know it doesn’t look all that attractive from an earnings standpoint for Apple. So if Apple wants to make an electric car that can really move its earnings needle, it will have to be truly disruptive and not just an incremental improvement over what’s available in the market.

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Notes:
  1. Apple Targets Electric-Car Shipping Date for 2019, WSJ, September 2015 []