Why Apple Co-opts Adjacent Component Businesses

Apple has a history of moving into adjacent component supply businesses.  It now owns or has control over mobile chips (with the A7 and M7 chips in the iPhone 5s) and fingerprint sensors (purchasing this business from AuthenTec), and recently entered a $578 million production contract with GT Advanced Technologies, a manufacturer of sapphire glass.  Sapphire is supposed to be the second-hardest stone in the world after diamonds.  Under the sapphire contract, GT will produce sapphire glass at Apple’s recently announced production facility in Arizona.  So the question is, when and why does Apple get more directly involved in adjacent component supply businesses?

In a January, 2009 earnings call with analysts, Tim Cook stated:  "We believe that we need to own and control the primary technologies behind the products that we make.”  This line seems to explain Apple’s forays into mobile chips, fingerprint sensors, and now glass.  But interestingly, Apple has not asserted more ownership/control with respect to components like Intel chips in the MacBook Pro or flash memory in its phones, tablets, and PC’s.  Apple has made block purchases of flash memory in the past (insuring an adequate supply of flash memory), but it’s only asserted component ownership or more direct component control in certain areas (like mobile chips, fingerprint sensors, and now glass).

Apple seems to pursue component ownership, or direct control over component manufacturing, when the component isn’t yet functionally good enough.  Intel’s PC chips are good enough for many people, so Apple leaves this component to Intel.  Mobile chips are still improving in a meaningful way (impacting things like battery life, performance, shape, and size), and new mobile devices are still being invented.  Mobile chips aren’t yet functionally good enough, so Apple brings mobile chips in-house.  Similarly, mobile security isn’t yet functionally good enough, so Apple purchases AuthenTec and puts a fingerprint sensor in the iPhone 5s.  Gorilla Glass may not be functionally good enough because it can still break.  Apple therefore enters into a contractual partnership with GT Advanced to produce sapphire glass, which is harder to break and may be a meaningful functional improvement over Gorilla Glass.

When the adjacent component is a “good enough” commodity (or is approaching the point where it's close to good enough), Apple leaves production to the supplier.  When the adjacent component is not yet functionally good enough, Apple pursues ownership and/or direct control of the supplier’s component business, knowing that components that aren’t commodities — like smartphone/tablet glass, mobile chips, and fingerprint sensors -- provide a functional difference that distinguishes Apple's products from products sold by competitors (which obviously helps Apple’s profit margins).

And this approach is consistent with Christensen’s recommendations.  Christensen says end manufacturers should look for opportunities to enter adjacent component businesses when the component involves a product attribute that isn’t yet good enough (like glass breakability or mobile security).  See Concepts page and discussion of Clayton Christensen.  It’s a way for manufacturers to extract more profit from the product.  Apple co-opts adjacent components that aren’t yet good enough in order to differentiate its products, which allows Apple to extract greater profits.

The author owns stock shares of Apple Inc.