Is Microsoft taking a bite out of Apple?

In the fast changing world of technology, it is important to sometimes take a step back and consider what is taking place before our very eyes. Arguably, the most influential piece of technology that will come from this decade is the modern tablet device. Although Microsoft were first to coin the tablet PC with their pen-enabled personal computer back in 2001, Apple’s release of its iPad 1 on 3 April 2010 can be regarded as the start of the post-PC era. Now, less than three years on, we think it’s time to switch our investment to Microsoft.

Turning to history

Let’s turn our attention to the history of the personalised computer (PC). Despite commercial computers being in use for many years earlier, a major breakthrough, which led to the personalised computer (PC), came about in 1980 when hardware giant IBM approached Microsoft about a project code-named “Chess”.

Microsoft was tasked with developing an operating system that would bridge the gap between computer hardware and programs developed years earlier. Since then, numerous PC hardware manufacturers have emerged including Compaq, Dell, Intel and Apple Inc. A common feature of all these hardware producers is that they nearly exclusively use Microsoft Windows as their operating system. The exception, of course, is Apple.

During the nearly 30 year period, during which competition in the hardware market has become more and more fierce, Microsoft faced very little competition operating in an almost monopoly-like environment – its only serious competitor, being Apple’s operating system.

The results of such fierce competition in technology can also be seen amongst the television producers. Not so long ago, Japanese electronics producers Sony, Sharp and Panasonic were considered amongst the best in the world.

Competition from the likes of Samsung and numerous others has seen these Japanese giants quickly losing favour amongst consumers. In a recent press statement, Sharp’s CEO stated the following: “Perhaps it will not fail within this year, but I don’t think Sharp has a viable business in the next 3-5 years. The company hasn’t got much time left and they need to cut off businesses that they can, conserve cash and … produce something that’s really competitive.”

In fact, if one goes back in history, similar patterns can be found from traditional Swiss watchmakers, facing competition from their Japanese counterparts, to gaming producer Nintendo losing its edge to Sony’s “Playstation”. When last did you see a Sony Walkman or cassette tape?

What can we deduce from this?

Firstly, whilst any new exciting hardware development in technology is initially met with strong demand from the consumer and supernormal profits, competition eventually intensifies and profits slow down. Secondly, as quickly as the consumer is willing

to take up new technology, they are just as quick to move onto the new “best thing”. Brand loyalty is fickle when it comes to technology. How quickly did we all substitute our Nokia cellular telephones for other brands such as Blackberry?

Is history repeating itself?

Since Apple’s launch of the iPad, it has gone on to sell over 84 million units. iPad sales together with popular iPhone sales have also seen profits rise from USD3.39 to USD8.75, an increase of 158% and an increase in Apple’s share price of 182%.

Apple share price
Apple share price

It’s not surprising then that competitors have started to move in. Devices such as Research in Motion’s Playbook, Amazon’s Kindle, Lenovo’s IdeaTab, Google’s Nexus and Samsung’s Galaxy have entered the market. Competition has started to intensify, particularly between Samsung’s Galaxy and Apple’s iPad, raising the question amongst many investors as to whether it is the start of a long decline in Apple’s margins, while patent disputes between the two companies have become common occurrence.

What about Microsoft?

Has the software giant Microsoft ‘come and gone’, or are they positioning themselves for the next round of post PC growth?

Microsoft during the PC era

After Microsoft’s phenomenal share price performance of the 1980’s and 1990’s, the Company has been a non-performer. In fact, since its high on 31 December 1999, its share price has declined by over 50%. However, knowingly or unknowingly, two strategic decisions taken by Microsoft in the 1980s and 1990s could prove to be major factors in Microsoft’s return to growth in the post PC era.

The decision to write a graphical user interface and the decision to integrate their word processor, spreadsheet, and e-mail software (Word, Excel, and Outlook) into a bundled product (MS Office), integrated with Windows. Our reasoning is that these two strategic decisions alone created an operating system familiar to nearly every person who has ever used a PC. There have certainly been rivals to Microsoft’s Windows, including: Linux, Apple OS X and Google Chrome OS, but the operating system most familiar to users around the world remains Windows.

The point we are making here is that whilst consumers tend to be fickle when it comes to hardware, once a user becomes familiar with the more complex psychology of software, he or she is likely to remain loyal to the brand. Also, the Windows operating system is the standard operating system across most corporations. A switch to a new operating system and the time needed familiarizing oneself with it could be disastrous to many corporations.

The question you may be asking is, “then why has Microsoft performed so poorly since the 1990’s?” A plausible answer is that Microsoft has simply moved into its mature stage of its industry life cycle, no longer achieving supernormal profits but slowing towards more moderate global growth trends. Microsoft has tried to find new avenues of growth, including: Xbox (to rival Sony’s Playstation), the launch of Windows Bing (a competitor to Google search); cloud services and Hotmail. Unfortunately, these products have all been responses to already introduced innovations by competitors.

Microsoft share price
Microsoft share price

Microsoft during the first few years of the post PC era

The introduction of smartphones and tablet devices has changed the way the consumer thinks about technology. Access to technology is now far more convenient as technology is much closer at hand. Tablet computers and smart phones have made our lives easier.

Apple’s release of the iPad has seen huge demand for its product. As an alternative to laptop or desktop, many consumers have chosen to substitute their traditional computers for tablet technology at the cost of losing the familiar Windows operating system.

This decline in PC sales for tablet devices has obviously impacted Microsoft as they have not been represented in this post PC movement. However, as the consumer has attempted to integrate their tablet devices and smartphones with their working lives, certain problems have arisen. And this is where we see the opportunity for Microsoft!

With the majority of the corporate world still heavily dependent on Windows as the chosen operating system, using MS Office as a daily part of our lives, the forced integration of tablets into the workplace has been far from perfect. The ineffective use of Word or Excel has been frustrating for many users.

What has Microsoft been doing to address this?

Having missed this sudden shift in technology, we think Microsoft has been smart to take its time in entering the market. Realizing the need to integrate technology, Microsoft has acquired some

strategically smart assets. The agreement with Nokia, whereby Windows 8 for smart phones has been installed on the new Nokia Lumia, provides a solution to fully integrate the smart phone with other devices. Microsoft has also realized that traditional forms of communication via telephones and sms’s have quickly changed. Consumers now choose to use technology such as Blackberry Messenger, WhatsApp and Voxer. Skype, which incorporates both voice and visual communication, may be a very intelligent purchase by Microsoft.

We believe however, that the ‘crown jewel’ lies in Microsoft’s creation of Windows 8 – the much needed jump into the post PC era. The Windows 8 interface has been designed for full integration between smart phones, touch devices, PCs and cloud-based applications. Its developers have taken the time to create a tile-based layout that neatly packages all applications used both in our private and work lives together. Not being satisfied with the tablets made by its traditional hardware makers, Windows has also created its own tablet device, the Windows Surface.

Its clever design of incorporating a keyboard with touch screen technology is the closest thing to bridging the gap between PCs and tablet devices.

Overall, we think that Microsoft has quietly gone about business over the past three years creating what now is a very exciting product offering. The ability to fully integrate all your devices, using the familiar Windows operating system will be welcomed by many.

What about Apple?

Over the past few years we have been a huge fan of Apple. Their ability to create new and exciting products, coupled with attractive designs and excellent customer service, has captured the world’s imagination, making Apple Inc. now the largest company in the world. Having its own operating system Apple IOS, it has also been in a position to dictate the terms to consumers with many of them choosing to convert other devices such as laptops and smartphones.

Microsoft has undoubtedly lost many of its customers to Apple, many of whom will be lost forever. Having made the changeover to Apple’s software, they are happy to remain users of Apple software rather than going through the hassle of changing over to Windows again. It is therefore not difficult to understand why Apple has seen such a huge demand for its products in recent years with strong demand for not only its iPhones and iPads, but also its Macbooks, iPods and accessory products.

Apple’s superior ‘app’ offering has also attracted many consumers. At a 3rd quarter earnings call earlier this year; Apple announced it now had over 650,000 apps in the Apple App Store, 250,000 of which were developed specifically for the iPad. Android, in comparison, offers only 400,000 apps. Apple Inc.’s share price recently peaked at USD705.07, a return of nearly 200% since it launched its first iPad, with strong growth across all its product ranges.

The problem Apple now faces is the beginnings of stiff competition from Samsung and others alike. Consumers, who have become frustrated by Apple dictating the terms of usage as a result of an operating system that is incompatible with other hardware, has begun to surface. Apple recently reported slightly weaker margins compared to the preceding eight quarters. After the initial euphoria of the tablet, consumers now want to optimally use programs such as Microsoft Outlook, Excel, Word and Adobe and integrate them across all their electronic devices – something that is proving to be difficult with Apple products.

Looking ahead – Apple vs. Microsoft

It’s not to say that we don’t think Apple’s products are impressive, we just think Microsoft’s new Windows 8 operating system and the integration that it allows its users is even better. The migration back to Windows may prove to be slow but we believe that the familiarity of Windows and MS Office will eventually prevail. With this assumption in mind, we could very well see a drastic slowdown in the demand for Apple’s products whilst we see a rejuvenation of Microsoft. It is estimated that around 84% of users worldwide use various editions of Windows whilst only 9% make use of a Macbook.

So where are we putting our money?

Having profited from our investment in Apple over the past few years, after purchasing our first shares at a price of USD250.00, we believe that Apple’s appeal may finally be at risk.

Increased competition along with an incompatible operating system and some questionable decisions taken by the new management team raises Apple’s risk profile. Its recent Siri application has been unsuccessful while faulty mapping software and other errors have had consumers upset and confused. These mistakes are uncharacteristic of the Apple we’ve come to know over the past few years. Are they dropping the ball?

That’s not to say that Microsoft is without risk. Microsoft faces its own challenges. It will need to successfully entice the consumer back to a Windows-type environment while overcoming the obstacles of Apple’s impressive stores, extensive number of apps and reputation for strong customer service. Furthermore, the president of Microsoft’s Windows division, Steven Sinofsky unexpectedly recently resigned due to personal reasons.

In summary, we consider Microsoft to be an exciting investment opportunity. History has proven that shifts in the technology arena can happen extremely fast and we are witnessing the first signs of executives transitioning back from Apple to Microsoft. We are of the opinion that the overall upside potential now lies with Microsoft whilst the risk lies with Apple Inc. As a result, the time has come to sell our Apple shares and replace them with ownership in Microsoft.

* This report was prepared by Robert Enslin, Portfolio Manager at Efficient Select.

Source: Moneyweb

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Is Microsoft taking a bite out of Apple?