More Vertical Integration Coming for Apple Inc.

By Markets Fool.com

Image source: Apple.

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Over the past several years, Apple (NASDAQ: AAPL) has increased the number of technologies it develops in-house. The company now designs its own processors, fingerprint sensors, and other critical components that go into its iPhones and iPads.

Bringing key technologies in-house can allow Apple to develop differentiated products, something that's especially evident in the company's best-in-class applications processors.

However, product differentiation isn't the onlyreason that a relatively high degree of vertical integration could be attractive to the iDevice maker. Designing these technologies internally allows the company to maintain an element of secrecy about its future product plans that it potentially couldn't otherwise. The fewer companies involved, after all, the fewer potential sources for leaks.

According to a report from Digitimes, the iDevice maker is planning to bring another key technology in-house beginning with its 2017 iPhone.

A custom display driver chip

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Apple has traditionally sourced display driver chips for its iPhone from Renesas SP Drivers, which Synaptics (NASDAQ: SYNA) acquired back in 2014.

Back in 2015, Digitimes reported that the 2016 iPhones would continue to use display driver chips from Synaptics, as Apple's "in-house developed touch and display driver integration (TDDI) single-chip solutions" wouldn't be ready.

However, according to a newer report from Digitimes, Apple's next-generation smartphones -- which are expected to feature OLED displays -- will use "in-house developed OLED driver [integrated circuits]."

Implications for Apple

By building its own display driver chips, Apple may be able to provide some level of differentiation relative to what an off-the-shelf chip from Synaptics might offer -- although at this point, this is speculation.

Perhaps more importantly, though, by bringing this technology in-house, Apple incurs the research-and-development expense associated with designing these chips but should reap a reasonable amount unit cost savings by not having to pay Synaptics' margin dollars.

Although it might not seem like saving a relatively small amount of money per chip is worth all of this effort, the lower unit cost on this component can either lead to better margins for Apple or more freedom for Apple to use costlier components elsewhere in the design to enhance the user experience.

How about for Synaptics?

Although Apple should be able to reap the benefits of bringing this technology in house, especially since it ships so many iPhones and can spread the fixed research-and-development costs across many millions of units, Synaptics may not be so lucky.

If Apple manages to replace Synaptics' display drivers with an in-house chip, then Synaptics stands to see its Apple-related display driver chip business eventually trend to zero. It wouldn't go to zero right away because Apple will continue to sell the iPhone 7 as a mid-range offering even when the flagship 2017 iPhones arrive.

The silver lining to such a development should it materialize is that, according to Synaptics' most recent form 10-K filing, Apple wasn't listed as a customer that made up at least 10% of the company's revenue in its most recent fiscal year. This suggests that even if Synaptics' Apple-related revenue were to eventually go to zero, the company would lose less than 10% of its revenue.

Indeed, Synaptics has fairly broad exposure to the smartphone market, with many product lines beyond display drivers, such as fingerprint sensors and touch controllers. So it should be able to weather the loss of Apple's display driver chip business without too much of an issue.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.