Apple Inc.'s Brilliant Cellular Modem Strategy

Apple's (NASDAQ: AAPL) iPhone 7 series of smartphones, as well as its new iPhone 8, 8 Plus, and iPhone X smartphones, all use cellular modems sourced from either market leader Qualcomm (NASDAQ: QCOM) or fast follower Intel (NASDAQ: INTC). It's well known that Apple's decision to source modem chips from both companies has forced the company to be about a generation behind in cellular capabilities, since Qualcomm's current best standalone modems are at least a generation ahead of Intel's in terms of advertised feature sets.

Apple's decision to multi-source modems has drawn criticism. For example, Ryan Shrout, head of Shrout Research and the owner of tech review site PCPerspective, said in a recent opinion piece that Apple's new iPhone 8 and iPhone X suffer "a performance deficit that has real-world impact in comparison to many flagship-class devices that use Alphabet Inc.'s (NASDAQ: GOOG) (NASDAQ: GOOGL) Android operating system."

That's probably true, though I doubt that more than a small fraction of iPhone 8 or iPhone X buyers will care. And from a long-term supply-chain management perspective, Apple is absolutely doing the right thing.

Intel's strategic importance to Apple

Cellular modems are critical components in smartphones. Without them, a phone can't make calls, nor can it access high-speed data when the device is away from a Wi-Fi hotspot. To borrow a phrase from Intel executive Aicha Evans, who formerly ran Intel's mobile and communications group, a smartphone without connectivity is "a brick."

It's in Apple's best interest, then, to ensure a reliable supply of cellular modems. And it's less than ideal for Apple to be dependent on a single supplier for such a critical component, especially a supplier with whom Apple is in a bitter legal dispute and that actively arms its competitors with key chip and other platform components.

Apple has a competent management team that understands it's best to have at least two viable suppliers of cellular modem chips over the long term. By buying substantial quantities of chips from Intel, Apple does two things. It gives Intel a compelling financial incentive to continue to invest in future modem technologies, and reduces the amount of money it sends Qualcomm's way.

If Apple waited to use Intel's modem technology only when Intel's technology was up to par with Qualcomm's, then I'd imagine Intel would give up long before that aspiration was met. After all, without hope of significant revenue, what incentive does Intel have to keep investing in future modem technology? Apple surely recognized that and, despite the negative commentary that it's getting for the move, agreed to bring Intel onboard as a modem supplier.

Now that Intel knows that it'll sell millions upon millions of modem chips, there's a clear incentive for the company to keep its foot on the gas to try to build modems comparable to Qualcomm's in features and real-world performance. That's good for Apple, as, over time, it should have two capable vendors of cellular modems to buy from for future iPhones. That means less risk and better bargaining power, which will probably translate into lower component costs down the line.

Getting to that point won't be easy, and it'll mean compromises, such as missing out on gigabit LTE for the iPhone 8 and iPhone X this year. But the long-term gain will almost certainly be worth any short-term pain.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Ashraf Eassa owns shares of Intel and Qualcomm. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool owns shares of Qualcomm. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.