Why Has Apple’s R&D Efficiency Been Declining?

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Apple‘s (NASDAQ:AAPL) research and development expenses have been trending steadily upwards in recent years, growing at a compound annual rate of roughly 30% between FY2012 and FY2016. However, this growth is not translating into higher profitability for Apple, as the firm’s RORC – a  measure of gross profit is generated for every dollar of R&D spent in the previous year – has been trending lower. For instance, while Apple earned close to $19 in gross profits per R&D dollar in fiscal 2013, the metric slipped to just about $10 in 2016. Below we take a look at some of the factors behind Apple’s declining R&D efficiency.

We have a $133 price estimate for Apple, which is in line with the current market price.

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Diminishing Marginal Returns On The iPhone Franchise

The surge in Apple’s profitability between 2007 and 2015 was driven primarily by the iPhone, which accounts for around 75% of Apple’s profits, per our estimates. The device allowed Apple to disrupt several high-value industries, creating significant returns on Apple’s R&D investments. Additionally, the company’s ability to extend the iPhone template to other products such as the iPad further boosted returns. However, innovation in the smartphone space has plateaued, with low-cost Android alternatives offering similar functionality as the iPhone, causing Apple to invest in developing more advanced technologies and proprietary components (such as 3D-Touch and Taptic engines), without being able to boost revenues as meaningfully.

Apple May Be Betting On Longer Term Projects

Apple is also likely to be increasingly making R&D investments that have a multi-year horizon, the most notable of which could be in the automotive space. Apple is believed to be working on autonomous vehicles, potentially producing a self-driving car platform that it could license to auto makers or eventually use to build its own automobile. The company is also investing in technologies such as artificial intelligence and argument reality. Apple could also start investing in more so-called “moonshots,” much like its rival Google, betting on experimental projects where the payoff could be distant or even non-existent.

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