One key trend that Apple (NASDAQ: AAPL) investors have taken note of recently is the company's precipitous rise in research and development spending. As a percentage of revenue, Apple's R&D expenditures would historically stay within a 2% to 4% range, but in recent years this has climbed to 4% to 6%. That translates into an awful lot of spending in dollar terms when you factor in Apple's growing top line (2016 notwithstanding).
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The most obvious explanation is that Apple is investing in future products that it won't talk about yet, which it certainly is doing. But that's just one of four different reasons why Apple's R&D investments have grown. CFO Luca Maestri spoke at the Goldman Sachs Technology and Internet Conference 2017 earlier this week, and he laid out why this line item on the income statement continues to grow.
Image source: Apple.
1. A growing product portfolio
Apple has always prioritized product depth over product breadth, which has historically helped contribute to R&D cost discipline. Even as the company still only offers a handful of devices within each product family, far fewer than some of its more prolific rivals, the portfolio is still expanding:
The first one is the fact that our product portfolio today is much larger than it used to be. We now develop three iPhones. We used to develop one. We develop multiple iPads. We used to develop one. We now have the Watch. We've got AirPods. We have Beats. So the product portfolio is larger, and obviously, we need more R&D to develop those programs.
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2. Investing in services
The Mac maker has grand ambitions of doubling its services business over the next four years. But even now, the current growth that the services business is enjoying requires a lot of investment in order to scale across Apple's massive user base.
The second element is that the Services business has grown a lot. And to grow the business, we need to make engineering investments in services like iCloud, like Siri, like Maps. And so clearly, the spend -- R&D spend that we have on services is significantly higher than we used to have.
3. More in-house development
This is perhaps the most important: Apple has in-sourced the development of many core technologies. The most meaningful of which being its A-series of processors, and designing processors is incredibly expensive. But doing so gives Apple greater control over its product roadmaps, instead of being at the mercy of suppliers' roadmaps. For instance, the Mac is still very much dependent on Intel's roadmap.
The third reason, I think, is a very strategic one and a very important one that allows us to keep our differentiation from the rest of the industry, and it's the fact that today, we do much more in-house development of some fundamental technologies than we used to do a few years ago, when we were leaving more of that to the supplier base. Think of the work that we do around processors or sensors, right? Much more work than we're doing today in-house than we used to. It's very important for us because we can push the envelope on innovation. We have better control over timing, over cost, over quality. And so we look at that as a great strategic investment for us, right?
4. Future products
And of course, as mentioned above, Apple is investing in future products that aren't contributing to the top line quite yet.
And then finally, it's the point of view we're making around the fact that, yes, we're also working on things that do not generate revenue today. And those expenses are meaningful, and the products, being of things that are not very large, but obviously, they add up over time. And hopefully, those are good bets that we're making for the future of the company.
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Evan Niu, CFA owns shares of Apple. 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. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.