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Assessing Apple Inc. (AAPL)’s Innovation Capability

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Coco Chanel once said: “In order to be irreplaceable one must always be different.” Coco was talking about clothes and fashion, but still, I cannot think of a better notion that can fully capture the importance of creativity and originality in today’s tech world. There is no doubt that for a tech company the key to staying at the top of the heap is innovation.

But how does a company become a champion innovator? More specifically, in Apple Inc. (NASDAQ:AAPL)’s case, what is the secret to unlocking creativity and translating it into juicy profits?

Apple Inc. (AAPL)

It takes money to achieve innovation?

Most people associate successful innovation with excessive spending on research and development. However, unless you are a big pharmaceutical jockeying for the next blockbuster drug, you probably don’t need to spend all your cold, hard cash on research activities.

Every year, the Boston Consulting Group publishes a report revealing the 50 most innovative companies worldwide. Last year, Google Inc. (NASDAQ:GOOG) and Apple Inc. (NASDAQ:AAPL) made it to the top ten with Apple taking the lead, once again. So, how much did they spent on R&D?

If we take a look at the chart below, which illustrates the revenues that these companies generated, as well as their R&D expenses
over the past five years , we see that the intensity at which they invested in research and development was pretty soft:

AAPL Revenue TTM data by YCharts

Yet, this relatively low reliance on research and development didn’t keep them from achieving stellar top-line growth and enhancing shareholder value. Hence, using R&D intensity to gauge a company’s effectiveness in delivering innovation is, more or less, misleading. It doesn’t say anything about how beneficial these investments are, and it most definitely does not serve as a guide for the future.

Measuring successful innovation

Overall, since a company’s ability to innovate derives primarily from its intangible assets, measuring innovation can be quite a fuzzy business. Nevertheless, we can evaluate the returns on innovation investment (ROII) by comparing the net profits from the sale of new products or services to the direct research expenditures generated in creating these new products or services.

As we can’t know precisely how much money Apple Inc. (NASDAQ:AAPL) bet on creating the iPad, we can take a look at its gross profit margin instead. At the end of the day, if a company can generate gross margin then we know that its innovation engines are working. The chart below is worth a thousand words:

AAPL Gross Profit Margin Quarterly data by YCharts

As we can see, Apple Inc. (NASDAQ:AAPL) did a bang-up job unlocking value from relatively low R&D expenses. But how? If heavy research and development spending is not a prerequisite for delivering successful innovation then what is it?

Apple’s capability around innovation

A breakthrough product may be a real money-spinner, and even capture sales that might have otherwise gone to a competitor. But
if a company truly intends to compete on innovation, a more reliable source of competitive advantage is that company’s capability around innovation; and Apple Inc. (NASDAQ:AAPL) is the epitome of successful innovation capability.

Apple, under Steve Jobs‘s supervision, chose a set of core competencies and invested in aligning those competencies to its overall growth strategy in a sustainable and inimitable way. It bet on things like its strong brand, sleek and unique design, ability to meet unmet needs, and it wooed its customers with superior ease-of-use integrated solutions. Most importantly, it knew that in order to avoid obsolescence it had to cannibalize its own products. This way, it prevented its peers from replicating its ideas, while at the same time it continued dominating the market.

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