All of us were reminded over and over and over during the last few days that Apple has more cash on hand than does the U.S. government. This coincidence means precisely nothing to either outfit. We won’t see President Obama asking Steve Jobs for a loan, nor will we see Steve Jobs offering one. Yes, the government is broke and yes, Apple has a lot of cash. But GE has almost $50 billion more than Apple, so where are all the GE stories?
There’s a mystery about Apple’s cash and that mystery has to do with Steve’s strategy for holding all that money. What’s it for? The predominant theory seems to be that Apple intends to make a huge acquisition and periodically there are rumors of Cupertino buying this big company or that, with Hulu being the latest supposed target. And maybe Apple will buy Hulu (actually, I don’t think so, but let’s assume they do) but that will still leave Steve with $74+ billion, so the Apple money story won’t be going away. I think Apple has raised all that money for the sole purpose of….. having a lot of money. I don’t think Steve intends to make any major acquisitions at all, though that says nothing about a post-Steve Apple.
The Silicon Valley corporate tendency to not pay dividends and instead accumulate vast quantities of cash was pioneered by Dave Packard at HP. Starting in the late 1950s, Hewlett-Packard was raking-in the dough but it was at the time also a privately-held company with just two shareholders — Bill Hewlett and Dave Packard. The founders could easily have demanded dividends or even, I suppose, stock buy-backs, but they were earning plenty of money and preferred to let it ride. Going further, Packard, as the money guy, didn’t like the Wall Street trend of taking on corporate debt to fund growth. The less you paid out to shareholders (both of them) he decided, the more growth could be funded internally. That’s not the way they do it anymore at HP, by the way — that habit having been broken by Fiorina, Hurd, and now Apotheker, though the last can’t really be blamed because the damage was mostly done before he came on watch.
What was pioneered at HP was later emulated at Intel and every other big Silicon Valley company right up through Apple and Cisco today. And since they all did it and their stockholders made plenty of money from capital gains, nobody much complained until fairly recently when some of these companies began paying small dividends.
But not Apple. Steve Jobs knew what it was like to be poor at Apple from 1976-77 and he knew what it was like to be really poor at NeXT in the early 1990s. So when he returned to power at Apple in 1997 Steve embraced very conservative financial practices that kept Apple awash with cash to pay for what he was sure would be inevitable missteps. All that money was an insurance policy against Steve’s own inevitable failure.
Only he didn’t fail.
His bets were bold in scope but modest in cost and hardly ever failed. So Apple’s cash accumulated and accumulated and accumulated until it reached the point where Jobs could no longer view it as an insurance policy. That’s when it became an acquisition fund — not because Steve had particular acquisitions in mind, but because thinking of it as being intended for acquisitions made not spending the money easier to do.
Apple could have made any number of acquisitions. Just as both John Sculley and Gil Amelio tried to sell Apple to Sun Microsystems and failed, Scott McNealy and Jonathan Schwartz tried to sell Sun Microsystems to Apple and failed. But Steve didn’t make any major acquisitions, saying the opportunities weren’t good enough but also knowing in his heart that buying his way to scale would kill the Apple he was slowly building in his own image.
Remember we’re now 14 years into what is probably a 20-year Apple strategy. Yes, it has evolved and expanded over time, but the strategy was always headed in the same direction. Where the typical Silicon Valley CEO thinks about this quarter and next quarter, Steve Jobs had the leisure to think about this decade and next.
When it finally became clear inside Apple that Steve really wasn’t going to buy a big company (Apple’s biggest-ever acquisition, remember, was the recent $2.4 billion purchase of Nortel’s patent portfolio, which got Steve the IP he wanted without the lovely Canadian engineers he didn’t want) the company had to find another plausible reason for holding all that money.
And so Apple today uses its cash to buy parts in huge quantities. Lately this has mainly meant buying flash RAM and iPhone displays in amounts that move whole markets and guarantee Apple the lowest prices anywhere. This is important: in an era where interest rates on idling cash are averaging one percent, Apple is using its cash to get 15-20 percent discounts on parts. That’s exactly like earning a 15-20 percent interest rate.
Apple not only gets the lowest prices, they also get the most reliable supply. I won’t call it anti-trust, but I think it is fair to say Apple has an effective consumption-side monopoly for certain mobile components.
IBM tried to do exactly this back in the days of the IBM PC-AT when Big Blue bought Intel’s entire supply of 80286 chips — a bold move that backfired when Intel fell back on second source agreements and quickly doubled production. IBM was stuck using the same 8 MHz 286 chips for nearly three years to blow through its supply, while Compaq, Dell and others jumped to the 386. That’s when IBM lost its PC market leadership position, compounding it by requiring OS/2 to work on those stockpiled 286 chips, too.
Apple isn’t IBM. Cupertino’s purchasing bets are bigger than IBM ever imagined and they’ve paid-off better, too, with Apple keeping an eye on the construction plans of its suppliers so it doesn’t make an IBM-type mistake.
For most Silicon Valley companies, then, holding lots of cash may increase financial flexibility and lower or eliminate short-term borrowing costs, but they also are a persistent drag on earnings just because there’s no way companies can make as much return on their cash holdings as they could make by rolling that money back into their business. Only Apple is a clear exception to this rule. Only Apple plays the game big and bold enough to never lose. But to do that you have to have a bigger pot than the house, or in this case the government.