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Monday July 18, 2011 6:42 pm

Here’s how Apple uses its massive amount of cash to its advantage

Apple MacBook Air

Over the last few years, Apple has stockpiled cash in such huge amounts that investors often question Apple about its strategy of keeping so much money around. When asked about it, Steve Jobs and team always points out that the market is unstable and they need to have cash in place for good times and bad, as well as have money available for major acquisitions, as part of its growth strategy.

And even though this answer normally keeps its investors at bay, as Apple continues to grow its cash reserves, which currently sits somewhere around $70 billion, investors and media alike continue to tell Apple that perhaps it's time to release a dividend to shareholders. But Apple is steadfast about its position. An interesting post from an anonymous writer on Quora recently shared a fascinating view of why Apple keeps so much cash around.

Here is how "anonymous" explains it:

Apple actually uses its cash hoard in a very interesting way to maintain a decisive advantage over its rivals:

When new component technologies (touchscreens, chips, LED displays) first come out, they are very expensive to produce, and building a factory that can produce them in mass quantities is even more expensive. Oftentimes, the upfront capital expenditure can be so huge and the margins are small enough (and shrink over time as the component is rapidly commoditized) that the companies who would build these factories cannot raise sufficient investment capital to cover the costs.

What Apple does is use its cash hoard to pay for the construction cost (or a significant fraction of it) of the factory in exchange for exclusive rights to the output production of the factory for a set period of time (maybe 6 - 36 months), and then for a discounted rate afterwards. This yields two advantages:

1. Apple has access to new component technology months or years before its rivals. This allows it to release groundbreaking products that are actually impossible to duplicate. Remember how for up to a year or so after the introduction of the iPhone, none of the would-be iPhone clones could even get a capacitive touchscreen to work as well as the iPhone's? It wasn't just the software - Apple simply has access to new components earlier, before anyone else in the world can gain access to it in mass quantities to make a consumer device. One extraordinary example of this is the aluminum machining technology used to make Apple's laptops - this remains a trade secret that Apple continues to have exclusive access to and allows them to make laptops with (for now) unsurpassed strength and lightness.

2. Eventually its competitors catch up in component production technology, but by then Apple has their arrangement in place whereby it can source those parts at a lower cost due to the discounted rate they have negotiated with the (now) most-experienced and skilled provider of those parts - who has probably also brought his production costs down too. This discount is also potentially subsidized by its competitors buying those same parts from that provider - the part is now commoditized so the factory is allowed to produce them for all buyers, but Apple gets special pricing.

Apple is not just crushing its rivals through superiority in design, Steve Jobs's deep experience with mass production of hardware(early Apple, NeXT) has enabled it to create an unrivaled, exclusive, supply chain of advanced technology that's literally years ahead of everyone else. If it feels like new Apple products appear futuristic, it's because Apple really is sending back technology from the future.

Once those technologies (or, more accurately, its mass-production techniques) become sufficiently commoditized, Apple is then able to compete effectively on cost and undercut its rivals. It's a myth that Apple only makes premium products. It makes them all right, but that's because its products are literally more advanced than anything else available (i.e. the price premium is not just for design), and then once the product line is no longer premium, the products are more cheaply produced than competitor equivalents, yielding higher margins and more cash, which results in an ability to continue the cycle.

Now, I don't know who anonymous is, but he or she appears to have an incredibly deep understanding of how Apple works and why it stays so far ahead of its competitors. People I know who have left Apple have shared similar viewpoints with me over the years, and they make a point of stating that this is part of Apple's "secret sauce" and one that makes it very difficult for competitors to keep up with it.

In multiple columns in the past, I have pointed out that [Apple also uses this cash reserve to buy components in huge numbers. One great example of this was when the company purchased 60 percent of all touch screens in the 9.7- to 10.1-inch range last fall. It virtually took most of the existing stock off the market for competitors. Apple probably bought these screens at a ten million unit price discount, compared with other tablets vendor, who—at best—probably could only afford to order 500,000 to 750,000 screens for its tablets at prices at least double of what Apple paid. That alone is a good reason to keep extra cash on hand.

But as "anonymous" points out in this Quora post, if the technology or manufacturing process does not exist, Apple fronts the cost for the development of the plant and these processes and then uses it to its ultimate advantage.

In fact, in January, Apple COO Tim Cook pointed to the $3.9 billion Apple prepaid last summer to three unnamed suppliers for new process equipment and tooling as "an absolutely fantastic use of Apple's cash." This is a very important strategy for Apple, and in fact, it serves as a strategic weapon that it uses against its competitors.

This is so different from the way any other vendors approach this market, and it really does make it hard for anyone trying to compete with Apple to keep up. Apple feels that if it uses strategies like this, along with inventing new devices that plug into its ecosystem, it can stay at least two years ahead of the competition at all times. And so far, this seems to be working.

This is why Apple gets so upset when vendors, such as Samsung, just copy it, instead of innovating on their own. As you perhaps know, Apple has at least [two major suits against Samsung around patent infringement issues and the fact that many of Samsung's products look so much like the iPhone and the iPad. But given the amount of money Apple puts into its products, you can at least see why Apple feels it needs to protect them and keep vendors from just copying them without real R&D investment of their own.

With Apple making so much money on products these days, it is likely that Apple will keep adding to its cash pile while also using it in strategic ways to keep competitors from gaining much ground on its company. And in doing so, as "anonymous" suggests, Apple seems to keep inventing futuristic products and "sending technology back from the future."

This article, written by Tim Bajarin, originally appeared on PCMag.com and is republished on Gear Live with the permission of Ziff Davis, Inc.

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