Apple’s iOS Dominance Warrants a Wide Economic Moat

Sector Director

Brian Colello

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Apple’s consumer hardware dominance stems from its ability to package hardware, software, services, semiconductors, and third-party applications into sleek, intuitive, and appealing devices. This expertise, coupled with its walled garden approach for its unique iOS ecosystem, enables the firm to capture a premium on its devices, unlike most of its peers that rely on open operating systems, Windows and Android, in particular. We see no other technology titan with comparable expertise across consumer hardware, software, services, and chip design. In turn, we believe this integration allows Apple to build premium devices that command industry-leading average selling prices and margins, most notably the firm’s crown jewel: the iPhone.

We think high customer switching costs, intangible assets, and network effects support Apple's wide economic moat. Switching costs from iOS are as strong as ever thanks to more auxiliary products and services that make switching away from iOS more difficult over time, while a non-Apple iOS experience does not exist, unlike computing platforms for the Windows or Android ecosystems that boast devices from a multitude of firms. Regarding intangible assets, Apple’s differentiated user experience via iOS, coupled with its broad design expertise, allows the firm to build vertically integrated products more seamlessly. We also see network effects around iOS and its 1 billion-plus installed base with new app development favoring iOS.

We view the iPhone as a revolutionary product that created the smartphone ecosystem and transitioned computing habits away from the PC. The robust app store helped foster iPhone adoption and grow Apple’s user base, with applications ranging from productivity, social media, shopping, gaming, music, and so on. Going forward, we expect Apple to better monetize its captive user base via supplemental products and services (Apple Watch, Apple Music, Apple TV+, AirPods, iCloud, Apple Pay, and so on) that will evolve into a more robust recurring revenue stream.

Business Strategy & Outlook

We assign a wide economic moat rating for Apple that stems from the combination of switching costs, intangible assets, and network effects associated with its iOS ecosystem. Combined with an asset light business model, we think it is nearly certain that Apple will generate excess returns on capital over the next decade and more likely than not over the next 20 years.

We think the firm's primary moat source stems from high customer switching costs, based on a variety of aspects of Apple’s hardware, software, and services. First, we think about the risk of customers moving away from today’s electronic devices, such as smartphones. We view the smartphone as the most essential computing device for users, and despite innovations in other types of electronic devices like smart speakers, AR/VR headsets, and the Internet of Things, we don’t see the smartphone going away anytime soon. The smartphone has already replaced a host of standalone electronics devices (standalone cameras, MP3 players, portable game consoles, and so on) while emerging as the primary portal with an intuitive interface for many other digital services (email, books, web browsing, shopping, social media, videos, and more) in a pocket-sized form factor. Apple’s iPhone fostered the industry, has maintained its position as the premier smartphone, and we expect the firm to increasingly monetize its valuable installed base with the iPhone as the catalyst.

Beyond the iPhone, Apple’s other key hardware products such as the iPad, Mac, Watch, and AirPods each fill a computing niche that enhances the experience of the user. We do not foresee Apple’s primary electronic devices (smartphones, tablets, PCs, wearables, hearables) becoming irrelevant. Concerning the risk of iOS losing ground to new and existing operating systems, most notably Google’s Android, the world’s largest mobile operating system in terms of users, we view Apple’s market position as secure.

Perhaps the stickiest aspect of the Apple iPhone is the integration of iOS across multiple devices. Users of ancillary products (including the iPad, Mac, Watch, and AirPods) lose significant functionality when paired with a smartphone other than the iPhone. For example, an iMessage will show up on an iPhone, iPad, Mac, and Watch if all are owned by a customer. We do not believe these other hardware products (iPad, Mac, Watch, AirPods) are wide-moat businesses in and of themselves, but together with the iPhone they create a formidable customer lock-in as the experience between multiple devices diminishes if one is not on iOS. Wearables such as AirPods and the Apple Watch have also disrupted their respective predecessor industries and have created another expensive hook to keep customers tied to Apple’s ecosystem. Apple’s active installed base (iPhone, Mac, and iPad) reached 1.8 billion at the end of 2021, up 9% from a year prior, highlighting the growing adoption of multiple iOS products by individuals.

Furthermore, if an iPhone user were to switch away to an Android device, they would lose significant functionality with other iOS users (that is iMessage texts from Android OS turning green or lack of AirDrop to share files conveniently). iMessage, FaceTime, Apple Pay, Apple Music, and Apple TV+ are just some of Apple’s services which, to varying degrees, provide users with a seamless experience that ties them to iOS. As Apple adds more software and services to its iOS ecosystem over time, the risk of disruption here for each user only intensifies.

We also see other areas where the time, effort, expense, and risk of switching away from iOS precludes most users from switching. We believe this inertia is driven by a disinclination for learning a new user interface, re-downloading apps, risking data loss, re-logging into accounts, and other headaches of disrupting an essential device like a smartphone. 

For all these reasons, we think existing iPhone users are relatively locked in to the iOS ecosystem. We have seen little evidence of disruption to iOS stickiness on the services front in recent years, and we see no signs of this dynamic changing. A variety of survey data shows that iPhone customers are not even contemplating switching brands today. In a 2021 survey by Consumer Intelligence Research Partners, over 90% of U.S.-based iPhone users said they planned to remain loyal to future Apple devices. An October 2022 survey from 451 Research indicated iPhone customer satisfaction of 98%.

Beyond switching costs, we believe Apple's expertise in hardware, software, semiconductors, and services represents an intangible asset that even the strongest of tech firms have struggled to replicate. While the Android cohort has replicated a similar feel of apps, app stores, and integrated experience, we have not seen third parties within the Android ecosystem work well enough together to deliver devices and services that are clearly superior to Apple. Competitors such as Samsung (Galaxy smartphone) and Google (Android OS) specialize in hardware and software, respectively, with Samsung boasting leadership in mobile device units and Google’s Android OS serving as the pervasive smartphone OS. However, neither Samsung nor Google has been able to offer a comprehensive and integrated product like the iPhone on its own, though both have attempted to develop software/operating systems (Samsung’s Tizen OS) and hardware (Google’s Pixel smartphone), with subpar results.

We view Apple’s chip design expertise and tightknit partnership with TSMC as another intangible asset instrumental to its success. Powering all its devices are Apple’s internally designed processors (A-series in iPhone and iPad and M-series in Mac). Apple has an ARM architecture license and designs the CPUs found in its devices from the ground up. Given Apple has a tighter product lineup compared with its peers, we believe it can design more powerful chips to better handle the demands of iOS and MacOS, in contrast to chips from Qualcomm or Intel that must address a wider array of devices and operating systems. Perhaps even more critical to Apple’s performance leadership in chip benchmarks is its close relationship with foundry leader TSMC. Apple’s scale enables it to demand dedicated capacity in TSMC’s most advanced fabs while its large chip orders enable TSMC to ramp production of its leading-edge process technology more economically. For example, Apple’s iPhone 15 will be the first device to feature chips made on TSMC’s 3-nanometer process technology in 2023. Apple’s chip design efforts aren’t limited to the CPU either, as the firm also designs its own GPU, dedicated AI neural engine chip, and is attempting to develop its own cellular modem, Bluetooth, and Wi-Fi chips in-house.

Finally, Apple’s intangible assets in hardware, software, services, and chip design give us confidence that the company is unlikely to be left too far behind if any revolutionary technology were to emerge. In smartphones, we have often seen innovative features arise in the Android ecosystem before Apple (foldable screens is a recent example) and we would never bet on a single firm (even one as large as Apple) being the only firm to come to market with new technologies. Although recent Android innovations have not led to massive share loss for Apple, we think Apple has seemingly perfected the fast follower strategy in which others come first-to-market before Apple addresses the weaknesses in the new technology and comes to market with a superior implementation.

In other types of technologies, others may come to market first, but only once Apple introduces its own flavor of a product or feature does a market inflect upwards (none of the Mac, iPhone, iPad, Apple Watch, or AirPods were the first of their kind). We may see this play out in the years ahead in AR/VR headsets (of which there are many existing products but none that have reached an inflection point of adoption).

Network effects represent another source of Apple's wide moat. As iOS users gravitate to the App Store to purchase new applications, the increasing size of Apple's installed base attracts developers to build new apps for iOS. Apple's integration of hardware and software also supports its developer networks, as Apple knows that iOS will be loaded on to only a handful of screen sizes or iPhone models, versus the hundreds of devices and manufacturers that support Android. This leads to a more fragmented Android ecosystem, which we believe is relatively harder for developers to support. Apple consistently touts when the majority of its user base is on the latest operating system, which in turn allows developers to build for the latest version of iOS and know that their apps are optimized for most of Apple's user base.

Although the Google Play store that supports the Android user base also achieves a similar network effect, we think the iOS user base is more valuable from a developer perspective given this user base skews to richer consumers (the iPhone unit market share is in the midteens globally but about 50% in the U.S.), making them more likely to spend money on in-app purchases. According to data from SensorTower, global consumer spending on mobile games per download was about $6 on iOS versus $0.70 on Android OS in 2022.

We concede Apple’s competitive advantages are not insurmountable, illustrated by the rise and fall of former mobile device titans such as Nokia, Motorola, and BlackBerry, all of which failed to keep up with smartphone innovation (though we argue the iPhone has become materially more vital to users than the preceding mobile devices). The short product cycles for phones and the inability of these firms to sufficiently innovate left each one struggling after the debut of Apple’s iPhone and its subsequent proliferation. Apple is not immune to these pitfalls, as consumer sentiment for technology gadgets can be unforgiving, with one buggy or subpar product potentially driving customers to other companies’ offerings, which have been increasingly competitive.

Based on these three moat sources, we don’t foresee Apple’s captive user base scaling its walled garden anytime soon. We believe switching costs from iOS are as strong as ever thanks to more auxiliary products and services and greater inertia for users, making switching away from iOS more difficult over time. Regarding intangible assets, Apple’s differentiated user experience via iOS coupled with its expertise in hardware, software, and now semiconductor design allows the firm to build vertically integrated products more seamlessly. We also see network effects around iOS and its 1 billion-plus installed base with new app development favoring iOS. Going forward, we expect Apple to better monetize its captive user base via supplemental products and services that will evolve into a more robust recurring revenue stream. We see no other technology titan with comparable expertise across consumer hardware, software, services, and chip design.

In turn, we believe this integration allows Apple to build premium devices that command industry-leading average selling prices and margins, most notably the firm’s crown jewel: the iPhone. Although Apple’s midteens market share in the smartphone space doesn’t seem excessive, the firm does enjoy the lion’s share of industry profits (we estimate 25% operating margins for the iPhone versus about 10% for Samsung’s mobile device segment). In an industry where the greatest concern a decade ago was commoditization of the smartphone, we’ve actually seen Apple lift its iPhone average selling prices, or ASPs, in recent years much higher than ASPs within the Android device space.

Wide

Economic Moat

Apple

Apple Music is a music and video streaming service developed by Apple Inc. Users select music to stream to their device on-demand, or they can listen to existing, curated playlists. The service also includes the Internet radio station Beats 1, that broadcasts live to over 100 countries 24 hours a day. The service was announced on June 8, 2015, and launched on June 30, 2015 in over 100 countries worldwide. New subscribers get a three-month free trial period before the service becomes paid-only.

Apple Music

Apple Watch is a line of smartwatches designed, developed, and marketed by Apple Inc. It incorporates fitness tracking and health-oriented capabilities with integration with iOS and other Apple products and services.

Apple Watch

Apple TV is a digital media player and microconsole developed and sold by Apple Inc. It is a small network appliance and entertainment device that can receive digital data from a number of sources and stream it to a capable television.

Apple TV

Beats by Dr. Dre (Beats) is a leading audio brand founded in 2006 by Dr. Dre and Jimmy Iovine. Through its family of premium consumer headphones, earphones and speakers, Beats has introduced an entirely new generation to the possibilities of premium sound entertainment. The brand’s continued success helps bring the energy, emotion and excitement of playback in the recording studio back to the listening experience for music lovers worldwide. Beats was acquired by Apple Inc. in July 2014.

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Shazam

Apple, Inc. engages in the design, manufacture, and sale of smartphones, personal computers, tablets, wearables and accessories, and other varieties of related services. It operates through the following geographical segments: Americas, Europe, Greater China, Japan, and Rest of Asia Pacific. The Americas segment includes North and South America. The Europe segment consists of European countries, as well as India, the Middle East, and Africa. The Greater China segment comprises China, Hong Kong, and Taiwan. The Rest of Asia Pacific segment includes Australia and Asian countries. Its products and services include iPhone, Mac, iPad, AirPods, Apple TV, Apple Watch, Beats products, AppleCare, iCloud, digital content stores, streaming, and licensing services. The company was founded by Steven Paul Jobs, Ronald Gerald Wayne, and Stephen G. Wozniak in April 1976 and is headquartered in Cupertino, CA.

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