Apple supplier advantage studied, analyzed

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Date: Tuesday, October 13th, 2015, 14:00
Category: Hardware, News, Processors


There’s been some astonishment as to the new iPhone and its A9 processor that people are trying to get to the bottom of.

Namely, the iPhone 6s and its 3D Touch screen, which has been commented as feeling “like magic” and outsiders realizing that Apple as a platform company is so far above the competition it’s hard to fully grasp.

That being said, one wonders why pushing down on a 3D Touch screen feels so responsive and whether the hardware or the software is to credit for this? Following up on this is the question as to how Samsung and TSMC, which both produce A9 processor variants for Apple, were able to optimize the chip using a different process and library, were able to get this exactly right?

Just as there are many misunderstood reasons for Apple’s overall success, justification as to how Apple produces superior products isn’t superficially visible.

Which begs the point of Apple’s leverage over its industry, especially since Apple was able to vertically integrate chip development back in 2010.

In the past five years since this change, Apple appears to have given itself an almost insurmountable advantage. The iOS platform has done incredibly well, developers make unprecedented money off of it, consumers have responded well to it, and Apple owns an entire market’s profits in a non-monopolistic way—unlike platforms past.

This also comes at a time when device makers (Samsung et al) and OS makers (Google, Microsoft) are not making money off smartphones.2 This is simply staggering to fully comprehend, and foretells ramifications few can see.

One of Steve Jobs’ biggest legacies was his decision to stop relying on 3rd party semiconductor companies and create an internal silicon design team.

In 2007, when Steve Ballmer famously declared “There’s no chance that the iPhone is going to get any significant market share. No chance”, Jobs was off creating a chip design team. If you study unit economics of semiconductors, it doesn’t really make sense to design chips and compete with companies like Intel unless you can make it up in volume. Consider the audacity back in 2007 for Apple to believe it could pull this off. How would they ever make back the R&D to build out a team and pay for expensive silicon designs over the long run, never mind design comparative performing chips? Today, the answer speaks for itself, as Apple makes nearly 100 percent of the profit in the entire smartphone space.

It is – in fact – these chip making capabilities, which Jobs brought in-house shortly after the launch of the original iPhone, that have helped Apple create a massive moat between itself and an entire industry.

Ultimately this chip advantage is one of the little spoken, but critical elements in Apple’s vertically integrated approach. Android OEMs can copy the fingerprint sensor or the 3D Touch mechanism. They just go to the supplier that Apple buys it from. But they can’t copy the underlying software powering these ‘commodity’ chips.

Another way to look at this which helps put things in perspective is to study Apple’s buyer/supplier bargaining power. Because of Apple’s scale in smartphones, and re-use of chips in other device categories like the watch and TV, Apple has massive influence with suppliers. They can plan 3-5 years out and decide what to license, build, invest in, or buy. This has also has allowed Apple to decouple control. e.g. in producing two ‘different’ A9 chips, Apple thwarts abilities of TSMC and Samsung to hike prices or walk away.

As a result, producing chips serves as the moat around untold strategic advantages: development secrecy, hyper optimization, supplier negotiating power, etc. And all the while smartphone market volume serves as ‘R&D lead gen’ for new products in entirely new industries (tablet, watch, TV, car). By owning its own silicon design team, Apple is able to leap into other markets which will be eaten by software running on cheap silicon.

Another interesting point is that Apple’s having gone with two different suppliers for the A9 processor was both risky and brilliant. In most cases, companies use ‘merchant’ chips, these are general purpose chips which anyone can buy. Most of the time, the merchant vendor wins because they can spread the costs of designing that chip across many customers. Apple’s A-Series and other internal chips, must cost several hundred million dollars a year to maintain, possibly as high as US$1 billion, something which very few companies can afford.

Where Apple can afford this, this advantage allows them to build chips custom suited to what they want, which means they are faster and more power efficient. By some metrics, Apple is now 3 years ahead of the competition who rely on merchant silicon. Three years in silicon terms is two generations, a huge competitive moat.

The other element worth considering is this: When Apple chose to dual source this production, this put both suppliers immense leverage when it comes to pricing negotiation. This is very common among all electronics companies, but Apple is taking it to a whole new level. Apple is known for being incredibly un-sentimental in the way it treats its suppliers, which can be seen as a bit mean-spirited, but often gives Apple the advantage.

In certain cases, though, the loss of an Apple fabrication plant has emptied towns dependent on this business. As such, TSMC will be in a difficult bargaining position when it comes time to negotiate pricing for the A10 processor. If they lose Apple, they will have a an empty US$5 billion building. Apple knows that, and will use this fact when it comes time to talk about price.

This brings about the fact that Apple, especially in terms of supply, demand and scale, is now the big kid on the playground and companies will need their business more than ever to survive. It may not be balanced, it may not be fair, but Apple has found a way to hold just about all the marbles as well as make the suppliers dance to its tune when negotiations come about.

As always, let us know what you think of this in the comments.

Via and Digits to Dollars

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