Strategy 101: A Lesson From Apple
 

Last Friday, 26th of July 2019, Apple has announced that it will acquire Intel’s smartphone modem business for $1 billion. Let’s try to understand the reasons behind this acquisition.

Why is Apple buying Intel’s smartphone modem business?

Whether or not you are a fan of Apple’s products, it is undeniable that the Cupertino company has always designed innovative products and brought new features into the market before its competitors. The company invests heavily ($14.2 billion in 2018 [1]) in R&D, to keep its products, especially the iPhone, ahead of the competition.

All the critical components within an iPhone are designed internally, and this seems to be a winning strategy. All but one: the modem. This exception represents for Apple a big headache that jeopardizes its smartphone business, and this happens during the infancy of the most advanced telecom breakthrough, the 5G.

Reduce the risk of over-dependence on suppliers

In 1979, a professor from Harvard, Michael Porter, defined a framework, where he identified five forces that can impact the profitability of a company [2]: 1) competitive rivalry, 2) threats of new entrants, 3) threats of substitutes, 4) bargaining power of customers and 5) bargaining power of suppliers. This last force is crucial in understanding Apple’s latest move: the supplier’s dependency represents, in fact, a significant issue for the company since it has always relied on external suppliers for this specific part of the phone which connects the handset to the world: first Infineon, then Qualcomm and, more recently, Intel. This reliance has caused troubles and costed money.

For instance, starting from the iPhone 4S model, Qualcomm’s modem equipped iPhones, but the partnership has always been challenging and wrecked among several litigations that mainly orbited around the licensing policy [3] of Qualcomm (see below for details). For its latest smartphones, Apple turned to Intel, but, even in this case, the delayed development of the Intel’s 5G modem chip (XMM 8160) forced the Cupertino company to settle earlier this year the long-standing royalties dispute with Qualcomm. The agreement to pay $4.5 billion, which does not include future royalties [4], was indeed the result of a FOMO effect (fear-of-missing-out): Apple feared of missing the 5G train by delivering the next iPhone below expectations. This could have impacted Apple’s brand negatively and the company would have subsequently lost ground to its competitors (competitive rivalry and threats of substitute).

Qualcomm business Model

The company generates revenues through two businesses:

          1 - QTC, Qualcomm CDMA Technologies, i.e. selling chips;

          2 - QTL, Qualcomm Technology Licensing, i.e. charging royalties (fix or variable on the phone selling price, for instance 3.25% of the selling price of branded multi-mode 3G/4G/5G handsets).

While the former impacts more the top lines of Qualcomm, the latter weights more on bottom lines, having an operating margin between 68% to 80%, as opposed to 17% of chip sales.

Getting the last piece of the puzzle

Therefore, the acquisition goes into the direction of diminishing the pressure generated by exogenous factors, such as suppliers, Qualcomm in this case. Rumors have been around since September 2018, but it is the Apple-Qualcomm settlement mentioned earlier that induced Intel to abandon its 5G smartphone modem, having de facto lost its largest customer, Apple. We believe that this deal would accelerate the design of Apple’s custom modem, initially expected for 2025 [5], to 2021 [6]. The acquisition includes a patent portfolio on wireless technologies, 2’200 workers, equipment, and lease. 

Conclusion

The strategy deployed by Apple is straightforward and easy, as it ticks all the boxes of a Strategy 101 exam: on the short term, it copes with lack of a top-notch modem for the next iPhone model, by settling its dispute with Qualcomm, which has, as of today, the best performing 5G modem (see table for other models and players). This move has pushed Intel to abandon its smartphone modem business definitively.  At this point, Apple made public all the rumors about its interest in this business, as this acquisition accelerates the deployment of its long-term strategy: the development of its chip to reduce its reliance on Qualcomm.  The Qualcomm settling that seemed an Apple defeat was indeed a lost strategic battle to win the smartphone 5G war.