Apple is generating obscene amounts of cash. The company recently reported nearly $6 billion of free cash flow during what is typically its weakest quarter of the year. Over the last 12 months, Apple earned $51B of free cash flow. This is more than any other company earned. It is easy to chalk up Apple's financial success to the iPhone and call it a day. However, upon closer examination, Apple's business model predisposes the company to cash generation unlike any other firm in Silicon Valley. In fact, Apple currently possesses the best business model in the world when it comes to generating cash.

The Numbers

Apple is in a financial league of its own. As seen in Exhibit 1, Apple's $224B of trailing twelve month (TTM) revenue was nearly as much as that of Amazon ($143B), Alphabet ($95B), and Facebook ($33B) put together.

Exhibit 1: Revenue (TTM)

The numbers become more daunting when moving down the income statement. As seen in Exhibit 2, Apple's $60B of TTM operating income was nearly 50% more than the combined operating income of Alphabet ($24B), Facebook ($15), and Amazon ($3B).

Exhibit 2: Operating Income (TTM)

Turning to the cash flow statement, Apple's numbers are just as remarkable. Apple's $64B of operating cash flow was nearly as much as that of Alphabet ($36B), Facebook ($19B), and Amazon ($17B) combined. In essence, Amazon is doing as well financially as Facebook. Google is generating as much cash as Amazon and Facebook put together. Apple is generating nearly as much cash as Amazon, Facebook, and Google combined.

Not only is Apple generating significant operating cash flow, but the company is also kicking off free cash flow at rates not seen elsewhere in Silicon Valley - or the world for that matter. Free cash flow is a measure of how much cash is generated after taking into account capital expenditures and other costs associated with running the business. Apple's $51B of TTM free cash flow is $3B more than the free cash flow produced by Alphabet, Facebook, and Amazon combined. In what may come as a surprise, Apple is bringing in 70% more free cash flow than Microsoft, who is still considered to possess one for the more lucrative business models in existence.

Exhibit 3: Free Cash Flow (TTM)

Superior free cash flow generation has played a major role in Apple's ballooning cash hoard, which now stands at $154B of net cash (excludes $108B of debt). Despite spending $216B on share buyback and dividends since 2012, Apple's net cash level has increased by $33B over the same time period. The company is generating so much cash, management can't spend it fast enough.

Exhibit 4: Net Cash

Profit Extraction

Most of the discussions involving Apple's finances position the iPhone as being responsible for the company's good fortune. While the iPhone accounts for approximately 60 percent of Apple's revenue, the device doesn't tell the full story.

Consider Apple's current product line:

The most profitable smartphone
The most profitable tablet
The most profitable laptop
The most profitable desktop
The most profitable smartwatch
The most profitable pair of wireless headphones
The most profitable streaming TV box

Few hardware manufacturers make money selling smartphones and tablets. The money found in the components business doesn't come close to Apple-like profitability. The best-selling laptop and desktop manufacturers can only dream of Mac margins. Apple is the most profitable wearables company. Even minor Apple products from a sales perspective, like Apple TV, are grabbing profit in an otherwise profitless industry.

It may be easy to look at these products and conclude that Apple must be overcharging its customers. How else can Apple sell so many profit leaders? However:

Apple Watch and AirPods are underpriced versus the competition.
MacBook is priced competitively with laptops with similar specs.
iPhone is priced competitively with Samsung's flagship Galaxy smartphones.

Apple's product line shows that there is more than just pricing behind management's ability to extract profit from an industry. Apple's entire business model predisposes the company to superior free cash flow generation.

Core Tenets

The best way to begin dissecting the Apple cash machine is to take a closer look at Apple's business model. There are three tenets, or beliefs, underpinning Apple's business model.

Placing the product above all else. Apple's superior cash generation begins all the way back in the R&D labs. Management is motivated by coming up with great products, not making massive profits. While Apple executives use every opportunity to reiterate this point, most outside observers think it's just talk or PR. However, Apple's financial performance backs up management's claim. Apple doesn't design and sell products to drive revenue. If Apple is able to make great products, management is confident that consumers will like the product and profit will follow. This motivation results in a much more unique product strategy than that of other companies.
Staying focused. Apple values the art of focusing, saying no to great ideas in order to concentrate the entire company on a few really great ideas. This intense level of focus extends all the way down to Apple's R&D efforts. The amount of money Apple spends on R&D as a percent of revenue is well below that of its peers. In addition, Apple's M&A strategy follows a similar protocol as management is very deliberate in its purchases, focusing on technology and people purchases capable of plugging holes in the asset base.
Relying on contract manufacturers. Apple is a product company that relies on others to assemble its products. While Apple brings in significant amounts of cash from hardware sales, the company's free cash flow generation receives a big boost from using contract manufacturers. Instead of owning an extensive web of factories around the world, Apple invests in equipment and machinery located in other companies' factories. This results in Apple spending much less on capital expenditures as a percent of revenue. Apple is on track to spend $15B on capital expenditures this year. Alphabet and Amazon spend nearly as much on expenditures despite having a much smaller revenue base. This means that a significant portion of Apple's operating cash flow ends up as free cash flow and can be considered truly "excess" cash.

These three factors play a big role in Apple selling highly profitable hardware that stands out from the competition.

Apple Is Different

The next item to investigate when dissecting the Apple cash machine is to see how the preceding core tenets come together to make the company's business model stand out from that of its peers.

In some cases, Apple hardware has gone on to hold monopoly-like market share in its respective product category (iPod, iPad, Apple Watch). For other products, Apple hardware remains the small player in town in terms of sales share (iPhone, Mac, Apple TV). However, in nearly every example, Apple ends up being the profit leader because management looks at scale differently than other companies view it. Apple doesn't view scale as a requirement to achieve success. This has major implications on Apple's pricing strategy in addition to how the company thinks about monetization.

Facebook and Google approach scale very differently. For both companies, scale is needed in order to reach as many people (and their data) as possible. The additional data enhances and improves their free services. Amazon's business model is also dependent on scale, albeit a different kind. Much of the company's ongoing investments (transportation, logistics, cloud, and artificial intelligence) are designed to get you to buy more and more goods through Amazon. This significant level of investment will likely be needed for the foreseeable future.

In summary:

Apple is a design company focused on selling tools capable of fostering superior experiences. Scale is considered a byproduct of a properly functioning business model.
Facebook and Google are service companies focused on offering free, data-capturing services to as many people as possible. The business models are dependent on achieving scale in order to access as much data as possible.
Amazon is a retail platform company focused on getting you to buy more stuff over time. Scale in terms of purchase volume is needed in order for the cash flow/reinvestment cycle to continue.

There are exceptions to these underlying themes such as Apple Music needing scale in order to become a better music streaming service. In addition, Apple Pay needs widespread retailer adoption to make sense for consumers. However, these examples only reinforce the uniqueness found with Apple's primary business model. Instead of being key revenue or profit drivers, Apple Music and Apple Pay are services meant to increase the value found with Apple hardware.

Putting It Together

Apple possesses the best business model for generating cash because the company is capable of monetizing premium experiences much more effectively and efficiently than anyone else. Instead of chasing scale with the goal of monetizing data or usage, Apple sells tools that management thinks people will want and are willing to pay for.

While Apple doesn't look at scale as a requirement for success, the company undoubtedly benefits from scale in a few ways. Greater economics of scale help drive down product costs over time, which both improves both product accessibility and Apple profitability. Scale also allows Apple to place larger component orders. There are a number of examples over the past decade involving Apple competitors being unable to ship competitive products due to Apple buying up all of the available component supply. These elements don't define Apple's cash machine but rather represent the lubricant that makes it run more smoothly.

Stationary Speaker Market

Apple's unique approach to the burgeoning stationary speaker market highlights how the company plans on using its business model to set the company up for cash generation. Amazon and Google currently have products in the marketplace. Apple's HomePod is scheduled to go on sale in December. Facebook is rumored to be entering the market next year with some kind of stationary screen/camera/speaker.

Amazon. The company's goal with selling Echo hardware is to get its digital voice assistant, Alexa, in as many homes as possible. Greater Alexa usage leads to more data being collected which then helps Amazon become a better, and smarter, retailer. In order to accomplish this goal, the company is willing to give away Echo hardware at cost, or even a loss. When it comes to monetization, instead of making money from Echo hardware, Amazon positions Prime subscriptions as the cash generator. While this strategy has been wildly successful for the company, it has been difficult to miss Amazon's lack of free cash flow. Unlike Apple, Amazon piles most of its operating cash flow right back into the business. Market observers have made the mistake of looking at this behavior as purely optional on Amazon's part. In reality, Amazon will likely need to maintain this high level of investment indefinitely to ward off competitors and keep people buying products from Amazon. This means that Amazon's business model, while successful in delivering valuable customer experiences, may just end up being contained when it comes to excess cash generation.

Google and Facebook. Both companies are interested in capturing customer data in order to power their free services. This will lead to the companies selling hardware at cost or even at a loss, similar to the way Amazon does. Instead of making money on hardware, Google and Facebook will look to monetize the data obtained via microphones and cameras through advertising. We have seen this model's profitability over time. Facebook and Google serve more customers than Apple, but the companies generate cash on a much smaller scale than Apple. Their business models just don't throw off the same kind of free cash flow as Apple. While the home will present different dynamics than mobile and there is room for each to grow the advertising pie, there is little reason to think the overall profitability picture will be much different in the near term.

Apple. Apple is positioning HomePod, its new stationary speaker, as the best sounding speaker people have ever owned. Apple is betting that controlling both the hardware and software while having the product work closely with Apple services such as Apple Music will lead people to want to own and use HomePod. Apple plans on making money from HomePod through hardware sales. Priced at $349, the device very likely contains a profit margin equivalent to that of other Apple hardware. It is worth pointing out how the device is aggressively priced compared to speakers with equivalent speaker quality. Over time, HomePod usage will help drive Apple services such as Apple Music and Siri. These services will then go on to add greater value to future Apple hardware. Apple's strategy will be to use HomePod to extract most of the profit from the standalone stationary speaker market. Additional profit will come from Apple expanding the speaker pie (i.e. bringing more people into the stationary speaker fold).

Even though it may seem counterintuitive, Apple stands to earn more cash through hardware sales at a smaller scale than companies giving away hardware at cost but looking to monetization in other ways. This is why the initial exhibits up above comparing Apple's financial picture to the leading consumer-oriented tech companies are so surprising.

The Big Question

Apple has built a spectacular cash machine kicking off remarkable amounts of free cash flow. There does not seem to be any other company that is close to copying this machine. Amazon, Google, and Facebook look at hardware as a way of improving data capturing services. Microsoft's hardware success in consumer markets is fading. This leaves companies such as Samsung, Huawei, Oppo, Vivo, and Xiaomi as the only large companies trying to make money from consumer hardware. Each is seeing various levels of mediocre success.

There is no question that the smartphone wave has been a good one for Apple to ride. As iPhone sales have stabilized, Apple's revenue, operating income, and free cash flow growth has also stabilized. Meanwhile, Facebook, Amazon, and Alphabet are seeing stronger growth trends.

The big question going forward isn't if Apple will find another product as profitable as iPhone to drive growth, but rather if Apple will need to find another business model in order to enter new industries. Will there come a time when Apple's business model will need to evolve into something else?

Growing Pessimism

It's been hard to miss the growing amount of pessimism surrounding Apple's cash machine. There is a large chorus in Silicon Valley that views Apple's business model as a liability given how artificial intelligence (AI) will infiltrate literally all aspects of our lives. Do Amazon, Facebook, Google, Microsoft, Tencent (WeChat), and Baidu actually possess early versions of the business models of tomorrow? Is Amazon's Echo strategy the more attractive way to handle hardware? Many people now think companies chasing scale and collecting as much data as possible are much better positioned for the future than Apple.

In some ways, concerns regarding Apple's cash machine are genuine. For example, it's not clear if Apple's current business model would do well in tomorrow's transportation industry without some modifications. Is the future of transportation based on people buying or leasing cars? A good case can be made that the future is found with ridesharing. The answer would likely impact the way Apple monetizes transportation tools.

However, there is also evidence that fears of Apple's cash machine imploding are overblown. Unlike the unknown found with the transportation question, the idea that AI will make Apple's business model irrelevant looks to be based on faulty logic. The entire thesis assumes the world is headed in a different direction that it actually is.

Over the past decade, one of the biggest revelations in technology has been design's increased role in how we consume and value technology. The mass market has bought into Apple's view of personal technology. There is nothing about AI that changes this reality. Instead, we have non-hardware companies pontificate how hardware won't matter in the future. In reality, the opposite will likely occur. Hardware will matter more going forward. The wearables industry represents a good example of this in practice. Meanwhile, the way smartphone and tablet components are mattering more now than ever to AR and AI is another hole in the "hardware won't matter" thesis.

Some Things Won't Change

As it stands today, Apple's business model is producing more excess cash flow than every other business model. Even assuming competitors see stronger growth than Apple over the next few years, it's not clear how any company will match Apple in terms of cash generation. There is also evidence to suggest Apple will continue to rely on its current cash machine in the wearables industry (Apple Glasses, Apple Watch, AirPods) as these products fit within Apple's current business model extremely well. In fact, the way Apple Glasses seems to match perfectly with Apple's current business model may end up elevating that product to likely be the next product category Apple enters.

However, even in a world that requires Apple to modify its cash machine, some things won't change. The core tenets that underpin Apple's business model will remain, and those are the key ingredients that make the cash machine tick.

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