Apple isn't a hardware company. Nevertheless, hardware's importance to Apple continues to grow. Apple is now overseeing a supply chain and manufacturing apparatus responsible for producing more than 300M gadgets per year. As Silicon Valley increasingly bets on services and intelligent assistants, many are making a critical mistake in downplaying hardware. As Alan Kay, a tech industry pioneer, once said, “People who are really serious about software should make their own hardware." Apple is betting that Kay's advice will remain relevant in the future. Apple is doubling down on hardware in order to become the most powerful software provider in the wearables era.

Hardware Strategy

The vast majority of Apple's products are assembled by contract manufacturers in Asia. This wasn't always the case. In the 1990s, Apple owned its own factories. However, the company was imploding financially from a bloated product line and a costly manufacturing apparatus. Apple's supply chain and network of factories just weren't efficient. In March 1998, Steve Jobs hired Tim Cook as SVP of Operations to save Apple, literally. Cook's initial tasks included quickly drawing down excess Mac inventory in addition to laying the groundwork for Apple's outsourcing strategy.

Cook began to rethink Apple's supply chain, going so far as to get suppliers to move closer to Apple's new assemblers. Apple soon discovered that manufacturers and assemblers in China were capable of meeting the company's high standards like no other. It was around this time that Apple began its long-standing partnership with Foxconn, the company's largest product assembler. Cook also instituted a just-in-time inventory production system which addressed excess inventory issues that nearly crippled Apple.

While much attention has been placed on Apple's contract manufacturers, little is reported on the degree to which Apple works with its suppliers and assemblers. It is not uncommon for Apple designers to spend weeks, or even months, at factories in China. Apple does not design a product in California and just send final manufacturing instructions to its assemblers. The amount of collaboration that occurs between Apple and its various suppliers and manufacturers would surprise most outsiders.

Even though Apple doesn't own factories, the company does own a significant amount of equipment and machines housed in third-party factories. As of the end of September, Apple held $54B of machinery, equipment and internal-use software on its balance sheet. A significant portion of this total is machinery used in the production of Apple's products.

Expanding the Bet on Hardware

Apple's bet on hardware continues to grow. In the past, controlling hardware still amounted to Apple being dependent on others to provide the core technology and components. Apple began to see the value in controlling its own destiny by owning the core technology powering its devices.

In 2010, Apple unveiled the iPad. The device was powered by an A4 processor, the first Apple-designed chip. The A4 was made possible by Apple's P.A. Semi acquisition two years earlier. Jumping ahead seven years, Apple now has a range of processors:

A Series: iPhone and iPad

S Series: Apple Watch

W Series: AirPods, Beats, and Apple Watch

T Series: Mac

Back in September, Apple introduced the A11 Bionic chip in iPhone 8, 8 Plus, and X. The chip includes the first Apple-designed GPU solution. There is now an increasing amount of evidence that Apple is moving into modem design and power management chips. Apple's end goal is to create a system-on-a-chip (SoC) that includes Apple Ax processors, GPUs, and LTE modem chips.

Apple's current hardware strategy is all about controlling the experience found with its products. In the past, differentiation came from simply doing both hardware and software. Differentiation is now found when there is tighter control over the core components powering products.

Scale

It's easy to think of Apple as just an iPhone maker. More than 210M iPhones are sold per year, and no other Apple product comes close to surpassing iPhone in terms of unit sales. However, iPhone is only one piece of Apple's hardware story.

According to my estimates, Apple sold 322M gadgets in FY2017. This total includes unit sales from every major product category and accessory powered by Apple software (iPhones, iPads, Macs, Apple Watches, AirPods, iPods, Apple Pencils, Beats headphones, and Apple TVs). After a down year in 2016, when Apple shipped 8% fewer devices than in 2015, the company returned to unit sales growth in 2017. In fact, Apple shipped 7% more devices in 2017 than in 2016.

Exhibit 1: Apple Gadget Unit Sales