Reap What You Sow

BY Tim Weinhold

Business can seem pretty complicated. But every so often circumstances conspire to reveal an elemental simplicity beneath the complexity. Which is exactly what has played out recently in the smartphone industry.

In early November BMO Capital Markets analyst Tom Long reported in a research note something quite extraordinary. He said that Apple had garnered 104% of all Q3 smartphone profits globally (the figure exceeds 100% because of the way losses affect the calculation). Long’s conclusion was widely reported by business and technology publications, precisely because it is such a remarkable event.

Think about it. In one of the largest and most aggressively competitive industries on the planet, a single company earned the entirety of the industry’s profits. And did so with only a 12% marketshare. Astounding.

Tale of Two Phones

From just these facts, we can draw a significant, even startling conclusion: Apple’s customers are willing to pay substantially more for their phones than are customers of other smartphone companies. Of course every customer who has walked into a cellular carrier’s store knows this firsthand. iPhones are never discounted, whereas most other phones come with a ‘buy one, get another one (or two, or three) free’ promotion.

In one of the largest and most aggressively competitive industries on the planet, a single company earned the entirety of the industry’s profits. And did so with only a 12% marketshare. Astounding.

We might also infer, quite correctly, that iPhone customers are decidedly more loyal than is true for customers of competing companies. Earlier this year customer surveys by 451 Research “measured a 99% customer satisfaction rate for iPhone 6S and 6S Plus . . . The survey also suggests that the loyalty rate for the iPhone is almost twice as strong as the next highest brand.” Jim Lynch, writing for the CIO website, states the case more emphatically: “Apple has long inspired an almost fanatical loyalty among its customers in a way few companies can match.”

Why? What explains such loyalty and, even more, what explains customers’ willingness to pay decidedly more for an iPhone versus its competitors? Before we tackle these questions, though, there’s another circumstance in the smartphone industry that begs our attention — one that has garnered far more press than Apple’s remarkable profits.

Samsung, the largest smartphone maker by volume, and Apple’s foremost competitor, has been embroiled in a rolling product disaster of epic proportions. Shortly after the August release of the company’s new flagship phone, the Galaxy Note 7, reports of a troubling flaw began to surface — the phone had a propensity to burst into flame. Before long, the internet was abuzz with scary reports. In one case, the phone exploded in the hands of a six-year-old child who had to be rushed to the hospital. In other instances, Note 7s set fire to a car and a home.

Samsung went into crisis mode and within a few weeks said they had identified the problem as faulty batteries coming from one particular supplier (also a Samsung company). All customers were urged to swap the original Note 7s for replacement units, the batteries for which no longer came from the problem supplier.

Unfortunately, it didn’t take long before the supposedly-safe replacement phones were also bursting into flame, including, in a widely-reported incident, on a Southwest Airlines plane that had to be evacuated moments before takeoff. Not long afterwards, the Federal Aviation Administration banned all Samsung Note 7 phones from all flights. And not long after that Samsung threw in the towel — recalling all 2.5 million Note 7s and cancelling further production. To this point, Samsung still has not identified the cause of its battery problems.

Analysts are estimating the immediate cost of the recall and lost sales at more than $5 billion. Reuters estimates, however, that the full lost-revenue cost of cancelling the Note 7 product line will likely total $17 billion. And that estimate makes no effort to assess how the considerable damage to Samsung’s reputation may dampen sales of the company’s other phones going forward.

At the very same point in time, the smartphone industry is experiencing two extraordinary events. Apple is garnering all the profits for the entire industry and Samsung, its foremost competitor, finds itself suffering through an expensive, humiliating, even epic debacle.

So at the very same point in time, the smartphone industry is experiencing two extraordinary events. Apple is garnering all the profits for the entire industry and Samsung, its foremost competitor, finds itself suffering through an expensive, humiliating, even epic debacle. And, in case you’re wondering, there is relatively little connection between Samsung’s difficulties and Apple’s exceptional profits. A year before the Note 7 disaster, Apple collected 90% of all smartphone profits, a level it has achieved rather consistently over the years.

Nevertheless, does the confluence of these two remarkable circumstances point towards a crucial lesson about business? Might there be a single, simple explanation for these polar-opposite outcomes?

Love Your Customer

As a way into that exploration, let’s turn back to the questions posed earlier: what explains the incredible loyalty of iPhone customers, and their willingness to pay decidedly more for an iPhone versus its competitors? It’s hard to resist the temptation to offer a glib but obvious answer — that customers likely feel it’s worth quite a bit not to have to worry whether one’s phone might explode in your hands, or burn down your house or car, much less the airplane on which you’re flying.

But because that answer is both glib and obvious, let’s look, instead, at why any of us ever pay noticeably more for a particular product than for its competitors. Almost always, when we do that we do so for one reason — we believe that specific product offers us considerably more value than do the others. In some way, maybe in several ways, we simply believe that product is better, enough better, in fact, to be worth the extra cost. We may believe the product works better, or will last longer, or is safer, or reflects superior design, or is better for the environment, or any number of other assessments we might make about quality and value. For some combination of factors like these, we conclude that we get meaningfully more value from the more expensive product.

As Apple’s experience with the iPhone attests, having one’s customers come to these sorts of conclusions about superior quality and value is decidedly beneficial. In fact, if customers perceive the difference in quality between your product and that of your competitors to be sufficiently great, you just might walk away with all the profit in your entire industry.

Of course, pulling that off is terrifically difficult. It requires a laser-like, even maniacal commitment to building great products — or as Steve Jobs liked to say, a total devotion to “insanely great” products. Which sort of begs the question, exactly what makes a product “insanely great?” It’s not enough that a company’s engineers believe they’ve come up with a terrific product, or even that a CEO as gifted as Steve Jobs believes a new product is marvelous. After all, Jobs believed the Mac Cube was extraordinary. Customers did not.

Steve Jobs knew, better than most, that customers alone determine whether a product is “insanely great,” whether it delivers such compelling value that it’s worth a premium price and unwavering loyalty.

Steve Jobs knew, better than most, that customers alone determine whether a product is “insanely great,” whether it delivers such compelling value that it’s worth a premium price and unwavering loyalty. Which means that a commitment to “insanely great” products is, first and foremost, a commitment to deliver extraordinary value to customers, made possible only when a company makes that its ultimate and unrivaled objective. In other words, a company must subordinate all other objectives — maximized profit, share price, market share, etc. — in pursuit of the holy grail of customer value. And that requires a corporation to decide that serving others (customers) takes absolute precedence over serving itself. Unfortunately, many companies find that a choice they are unwilling to make.

“Gotta Serve Somebody”

Which brings us back to the Galaxy Note 7. By all accounts the phone sported several attractive new features — ones intended to delight customers. But attractive features, by themselves, don’t prove a first-priority commitment to customers. That takes more.

In early November, Bloomberg was the first to shed light on what went wrong with the Note 7 phones. Not what went wrong technically, mind you, but what went wrong managerially:

Few things motivate Samsung employees like the opportunity to take advantage of weakness at Apple Inc. Earlier this year, managers at the South Korean company began hearing the next iPhone wouldn’t have any eye-popping innovations. The device would look just like the previous two models too. It sounded like a potential opening for Samsung to leap ahead. So the top brass at Samsung Electronics Co., including phone chief D.J. Koh, decided to accelerate the launch of a new phone they were confident would dazzle consumers and capitalize on the opportunity, according to people familiar with the matter. They pushed suppliers to meet tighter deadlines, despite loads of new features [including] a more powerful, faster-charging battery . . .

The Bloomberg piece then details how the decision to move up the Note 7 launch fatefully shrank the time for suppliers to perfect their work and, just as seriously, the time available for product testing. And then highlights the unsurprising result:

Then it all backfired. Just days after Samsung introduced the Note 7 in August, reports surfaced online that the phone’s batteries were bursting into flame. By the end of the month, there were dozens of fires and Samsung was rushing to understand what went wrong. On Sept. 2, Koh held a grim press conference in Seoul where he announced Samsung would replace all 2.5 million phones shipped so far. What was supposed to be triumph had turned into a fiasco.

Stating the obvious, nothing in the description of what motivated Samsung to accelerate the Note 7 launch was about what would be best for customers.

Stating the obvious, nothing in the description of what motivated Samsung to accelerate the Note 7 launch was about what would be best for customers. No, the motivations were entirely self-serving. Samsung wanted to show up its primary rival and, in the process, no doubt grow sales, market share, profits, and share price — sort of a grand slam for self-interested corporate success.

The only fly in the ointment — i.e., the only thing put at risk by the decision — was customer safety. Of course, if doing what’s best for customers is one’s ultimate priority, that’s a tradeoff you simply don’t make. Instead, you necessarily give your suppliers, and your testers, sufficient time to make sure your product is safe. And just as obviously, having failed the customer safety test once, you don’t release a “safe” replacement phone when, in fact, you have no idea whether it’s safe or not.

And there we have it. Two companies, competing in the very same arena, each making (over and over again) the single, simple choice at the heart of business — whether, first and foremost, to serve oneself or others. Not coincidentally, this watershed choice between service and selfishness is also a choice to fulfill or violate the Golden Rule foundation for human morality throughout the ages. And, at least in this case, it’s a choice which, made one way, led to extraordinary success and, made the other way, to extraordinary failure. Which leads, in turn, to a clear takeaway for business people and their investors: Choose wisely whom you will serve. Much rides on your decision.


Unless otherwise noted, Eventide is not an investor in companies discussed in this or other of our ‘faith and business’ columns, nor is there meant to be an endorsement, explicit or implied, of the entirety of any company’s business model, much less of all of a company’s business practices. Rather, aspects of the business model or practices of particular companies are discussed only to help illustrate contemporary examples of larger ‘faith and business’ topics.

The material provided herein has been provided by Eventide Asset Management, LLC and is for informational purposes only. Eventide Asset Management, LLC serves as investment adviser to one or more mutual funds distributed by Northern Lights Distributors, LLC, member FINRA. Northern Lights Distributors, LLC and Eventide Asset Management are not affiliated entities.

Download the print version of this article.

Blog › Reap What You Sow

Mutual Funds involve risk including the possible loss of principal. Past performance does not guarantee future results.The Funds’ ethical values screening criteria could cause it to under-perform similar funds that do not have such screening criteria. The Funds can have risk related to option investing. There are special risks associated with investments in foreign companies including exposure to currency fluctuations, less efficient trading markets, political instability and differing auditing and legal standards. Because of ongoing market volatility, the Funds performance may be subject to substantial short-term changes.

The Eventide Gilead Fund & Eventide Healthcare & Life Sciences Fund can invest in smaller-sized companies which may experience higher failure rates than larger companies and they normally have a lower trading volume than larger companies. The Funds can also have risk associated with the biotechnology and pharmaceutical industry in which these companies may be heavily dependent on clinical trials with uncertain outcomes and decisions made by the U.S. Food and Drug Administration. The Funds can invest in private companies. Private investments include various risks including but not limited to lack of liquidity, capital commitment risk, and valuation risk. Private companies may not be financially profitable and have uncertain futures, thus subject to additional risks. Investors in the Gilead Fund should be aware that companies in the technology industries have different risks including but not limited to products becoming obsolete, and entrance of competing products.

Investors in the Eventide Multi-Asset Income Fund should be aware that interest rates are at historic lows and may change at any time based on government policy. In general, the price of a fixed income security falls when interest rates rise. A rise in interest rates may result in volatility and increased redemptions, which in turn could result in the fund being forced to liquidate portfolio securities at disadvantageous prices. Longer-term securities may be more sensitive to changes in interest rates. The intermediate-term bond portion of the Fund’s portfolio may represent 0% to 100% of the Fund’s portfolio with an average duration of between two and eight years.

The Eventide Multi-Asset Income Fund may invest in other funds. If other funds are utilized, such underlying funds are subject to investment advisory and other expenses, which will be indirectly paid by the Fund. As a result, your cost of investing in the Fund will be higher than the cost of investing directly in underlying funds and may be higher than other mutual funds that do not invest in underlying funds. The Fund may invest, directly or indirectly, in “junk bonds.” Such securities are speculative investments that carry greater risks than higher quality debt securities. There are unique risks associated with REITs, MLPs, preferred stocks, convertible bonds, BDCs, and yieldcos that are covered in the Fund's prospectus and SAI. The Fund is a new mutual fund and has a limited history of operations for investors to evaluate.

An investor should consider a fund's investment objectives, risks, charges and expenses carefully before investing or sending money. This and other important information can be found in the prospectus, which can be obtained at www.eventidefunds.com or by calling 1-877-771-EVEN (3836). Please read the prospectus carefully before investing. Eventide Mutual Funds are distributed by Northern Lights Distributors, LLC, Member FINRA, which is not affiliated with Eventide Asset Management, LLC.

4779-NLD-11/10/2016