Some fun facts about Apple’s turnaround:

• +8,524% (37.7% annualized): Stock performance since Steve Jobs’ return to Apple in 1997.
• +821% (18.6% annualized): Revenue growth since Jobs’ return.
• +5,093% (66.4% annualized): Stock performance since the launch of the iTunes Store in April, 2003. (A disruptive innovation.)
• +951% (39.9% annualized): Revenue growth since iTunes Store launch.
• In the last 8 years, revenue has grown by $60 billion (1,000%). 73% of that growth came from newly launched products.
• In the last 3 years, revenue has grown by $40 billion (165%). 60% of that growth came from iPhone sales.
• $220 billion: Amount of products sold since the release of the first iPod.
• $19 billion: Apple’s cut of all sales through the iTunes Store, plus Apple iPod accessories (currently $5 billion a year).
• 298 million: Total number of iPod units sold.
• 90 million: Total number of iPhone units sold.
• If the cash and securities on Apple’s balance sheet (~$60 billion) was turned into a hedge fund, it would be the biggest in the world.

Apple Sales/Income Timeline

Apple’s unit volume for non-Mac products:

As many have already seen, Google just posted some great third quarter figures. Both revenue and operating income were each up 23%, and Traffic Acquisition Costs (the revenue paid to AdSense partners) were at an all-time low of 25.7% of ad revenue. They also broke out some never-before-released sales figures: $2.5 billion a year for non-text display ads, and $1 billion for Google’s mobile search (driven mostly by use of their Android OS). But one part of the conference call caught my attention:

This is why we’re incredibly proud of Google Instant. Many of you guys speculated that we launched Instant to make more money. Well, let me tell you, that’s simply not the case. We launched Instant because it’s so much better for the user. In fact, from a revenue standpoint, its impact has been very minimal. And from a resource standpoint, it’s actually pretty expensive. So why did we do it? Well, we believe from a user standpoint, Instant is outstanding—and the data that we’re seeing actually bears this out.

The above was from Jonathan Rosenberg, Google’s SVP of Product Management. So, Google Instant was an expensive, non-revenue-producing upgrade to their lucrative search product. They did it, said Rosenberg, because it’s a huge improvement to the user experience. But how can that be measured? This got me thinking about what kind of metrics are truly important to Google in a broader economic sense. In Google’s financial reports they tout improvement in metrics like Traffic Acquisition Costs, Cost-Per-Click, and total number of Paid Clicks. All important to their business, but none that really capture Google’s overall business model. The most important metric to Google, I believe, is Revenue per Unit of User’s Time (or RUUT, for short).

Translating Time into Profit

Time is the ultimate scarce resource. Most businesses capture a portion of their customer’s wallets in exchange for a good or service. But businesses like Google (and TV networks, and most new media/web-based companies) capture a portion of customer’s time first, then translate that time into revenue.

Because time is scarce, when consumers choose to devote their time to a product or service, they are doing it at the exclusion of something else. So that company is literally capturing their customer’s time.  Before Google and other search engines, when people wanted to “find” something, they went about it a multitude of ways: white & yellow pages, classifieds, a library or bookstore, or just plain leaving your house and searching (hard to believe, I know). These things took up a lot of people’s time.

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Instead of further examining where Apple’s current (and future) products fit in on the “innovation scale,” in Part II I want to talk about Apple as an investment, and where its products fit in in terms of investment value.

Apple has been a fantastic investment over the past decade. In fact, since April 2003 when they launched the iTunes store (and iPod sales took off), a dollar invested in Apple would be worth over $40 today – an annualized return of almost 70%. That’s a return that would make most venture capitalists blush. Not bad for a company founded 27 years prior.

One more statistic: even if Apple stock had gone nowhere from its IPO in 1980 up to 2003, its annual return over the three decades since going public would be 13%, which still beats the S&P 500 by over 3%. In other words, almost all of Apple’s current value (~$230 billion) was created over the last seven years.

Where did that value come from? For the seven years ending 2009, sales grew from $5.7bb to $42.9bb. Over 70% of that growth came from new products: the iPod, the iPhone, media sales, and other related peripherals. On a net profit basis, even more than 70% of Apple’s growth came from new products (segment margins aren’t disclosed, but overall margins have hugely increased and most of that likely came from new products). Aside from the storied brand name, Apple is basically a startup that was funded with the cash and income from their struggling Macintosh business.

Apple and the Red Queen Run the Hedonic Treadmill

“…it takes all the running you can do, to keep in the same place.” – The Red Queen, Lewis Carroll’s “Through the Looking-Glass”

So, clearly, the law of large numbers comes into effect when looking at Apple’s future growth prospects. To double revenues, Apple would have to sell an extra $43 billion a year in products – that’s over 68 million iPhones or 32 million Macs every year.

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Apple is an incredibly creative, innovative company, and is usually at the top of people’s minds when it comes to new consumer technologies. So for the rest of this post, I’ll examine if and why Apple’s products are disruptive.

Disruptive Portable Music?

Before MP3 players, the only real option for portable music was a CD player. The first MP3 players were introduced in 1998, and had very low capacities. They could hold at most one or two CDs worth of music. In 2000, Creative released its NOMAD Jukebox, which had a capacity of around 1,200 songs. However, it was expensive and had limited usability.

The first generation iPod (5GB) was released in 2001 and could hold an average of 1,000 songs, or about 79 CDs at an equivalent quality. The cost of music (content) was low at first: consumers who already had a CD collection could transfer their songs to the iPod, or download them from the (usually illegal) filesharing programs on the internet.

The total cost per portable song for an iPod 1G was $1.48 or $0.39 if users converted old songs. This compares favorably to a CD player’s $1.95 cost per song (assuming someone can carry around a maximum of 10 CDs without it becoming too much of a burden – see notes for details). Despite this ability to carry more music for an incrementally cheaper cost, like earlier players the high total cost of the device—and the lack of convenience to use its capacity—confined sales to “fist adopters” and high-end users who were willing to convert their old music collection.

So at first, the iPod was a sustaining innovation relative to other portable music devices. Although it wasn’t made by a current industry leader, it was a breakthrough improvement upon other portable music devices and the performance metrics that customers valued (quality, capacity, cost per portable song, etc.).

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Although the phrase disruptive innovation is used often, it is best described by Clayton Christensen in his books “The Innovator’s Dilemma” and “The Innovator’s Solution.” Most new technologies are sustaining—they improve the performance of current products along dimensions that the market already values. Rarer disruptive innovations result in products that are worse than current offerings in the near-term, but offer a different value proposition and are directed toward a different set of customers.

There are two types of disruptive innovations: new-market and low-end. New-market disruptions create a new value network (the context in which customers and firms within an industry define what attributes are most important), with different performance attributes. They usually serve customers who would normally not be using the product at all (i.e. personal computers, Bloomberg terminals). Low-end disruptions attack the least-profitable and most overserved customers along attributes that the market currently values (i.e. discount retailing, steel minimills). Both types of disruption eventually end up overtaking or completely replacing current offerings as their performance improves.

There are also two types of sustaining innovations: incremental and breakthrough. Most sustaining innovations are simple, incremental year-to-year improvements. Others are dramatic, breakthrough advances that surpass all current offerings (i.e. contact lenses replacing glasses, airliners replacing other long-distance travel). Many people confuse the terms disruptive and breakthrough. Christensen further distinguishes them by pointing out that disruptive innovations usually do not entail technological breakthroughs. Instead, they package current technologies into a disruptive business model.

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Just going through the book “The Innovator’s Dilemma” by Clayton Christensen. I have a few posts I’ll likely write that relate to the book — this is one of them.

The Innovators Dilemma talks a lot about a company’s culture, and why incumbent leaders of a certain technology are restrained from participating in a disruptive technology’s upside. Christensen names these attributes as the incumbent’s downfall: (1) Current customers aren’t served by new market; (2) New market is too small for large companies; (3) Use of new technology isn’t fully known yet; (4) Processes that help them with current business hurt them with new business; and (5) New technology isn’t good enough yet to meet higher-end market demand.

One solution to the above issues is to acquire another company that can take advantage of the disruptive technology. If done correctly, this can solve numbers 1, 2, 4, and 5 above.

Christensen breaks down the factors that affect what a company can and cannot do into Resources, Processes, and Values. Resources are people, equipment, brands, technology, customers, etc. Processes are how companies transform those resources into products or services of greater value. Values are standards by which employees make and prioritize decisions (think of a company’s “Core Values” of the Jim Collins variety).

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