Bloomberg published a report at the end of 2021 that Apple (AAPL 0.88%) intended to hire people right in Broadcom’s (AVGO 0.04%) and Skyworks Solutions’ (SWKS 0.95%) backyard of Irvine, California, to design wireless communication chips. Nevertheless, investors were still shocked when a recent report suggested Apple intends to replace Broadcom’s Wi-Fi and Bluetooth chips as soon as 2025.
While there are many benefits that Apple could gain by designing proprietary components and transitioning away from third-party providers like Broadcom, the strategy also comes fraught with risk.
Let’s look at the risks and rewards of the company’s strategy to eliminate its component suppliers.
Why Apple wants to design proprietary components
There are three advantages Apple gains by bringing component production in-house. First, the strategy gives it more control over component production, ensuring that it has enough parts for manufacturing the final product — a significant benefit considering the many supply chain problems interrupting output over the last several years.
Second, one of the more significant problems that Apple faced over the last several years is the increasingly smaller differentiation between an iPhone and a high-end Android phone. For Apple to justify its premium status and charge customers more, it needs to create and maintain better features than its competitors.
Its solution is that by developing more control over its components’ development and production processes, the company can substantially improve innovation and differentiation.
For instance, when Apple replaced Intel’s laptop processors in 2020 with its internally developed M1 chip, it improved its laptop battery life. Most laptops used for home, school, or office work have batteries that last around eight to 10 hours. But according to Tom’s Guide, a review site, MacBook Air equipped with the M-1 lasted 14 hours and 41 minutes when first tested. And with the new M-2 chip, Apple claims users get 18 hours of battery life, just one factor differentiating a MacBook Air from a run-of-the-mill laptop with “Intel Inside.”
In contrast, when a third-party component manufacturer creates new features, all of that company’s hardware customers instantly have the same access to the new capabilities, which goes into creating products that quickly become commoditized.
Last, bringing component production in-house eliminates costs like sales and marketing between companies that own separate production stages. Removing excess charges can boost profit margins. Or a company can pass along the savings to consumers by maintaining steady-state pricing or even lowering pricing.
For example, some theorize that Apple’s “Far Out” product launch in September 2022 lacked iPhone and Apple Watch price hikes due to its ability to control costs through its in-house strategy.
Bringing production in-house might be challenging
Apple may be unsuccessful in bringing one or more components in-house, or these goals might take far longer to achieve than initially planned.
For example, for quite some time, Apple has sought to displace Qualcomm’s (QCOM 0.03%) modems from the iPhone. In 2019, it bought Intel’s (INTC -1.69%) modem operations to jump-start its efforts to establish an in-house modem business. And its original plan was to introduce these in-house modems to the iPhone in 2023. But unfortunately, management has pushed back the Apple modem introduction to 2024, showing the difficulty of building a viable third-party wireless component from scratch.
There is also more risk than the technical difficulty of building sophisticated device components. For Apple to produce cost-competitive parts against third-party suppliers like Broadcom, Qualcomm, or Skyworks, it must manufacture the parts at an adequate scale. And the minimum efficient scale needed for manufacturing a component could be more than the volume required for efficiently manufacturing the final product. This is a mismatch that could upset the apple cart for achieving substantial financial benefits from bringing component production in-house.
A competitive advantage
Bringing component production in-house has a very high cost and complexity. However, Apple is one of the few companies with pockets deep enough to execute the strategy successfully. At the end of the third quarter of 2022, it had $48.3 billion in cash and marketable securities and produced $111.4 billion in trailing-12-month free cash flow.
Its competitors, with fewer resources, will likely continue using third-party suppliers.
If Apple successfully supplants component manufacturers like Broadcom, Skyworks, Qualcomm, and others over the next five years, it could benefit significantly from having in-house component suppliers that its competitors lack and would be hard-pressed to copy.
Rob Starks Jr has positions in Skyworks Solutions. The Motley Fool has positions in and recommends Apple, Intel, and Qualcomm. The Motley Fool recommends Broadcom and Skyworks Solutions and recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, long March 2023 $120 calls on Apple, short January 2025 $45 puts on Intel, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.