Everybody Has Been Underestimating Apple

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Robert Galbraith / REUTERS

Apple CEO Tim Cook

Apple’s innovation machine is broken, critics said. Look no further than the latest iPhones, which they complained lack the pizzazz to become blockbusters.

Once again, Apple has proved the critics wrong.

The company announced that it sold 9 million new iPhones — the 5s and 5c — in their first three days on sale after premiering in stores last Friday. The results are a new sales record for the device, easily surpassing the 5 million units sold last year when the iPhone 5 launched.

Strong iPhone sales are likely to ease some of the pressure on Tim Cook, Apple’s chief executive, who had faced growing doubts about the company’s trajectory. Investors wondered whether Apple had lost its edge after a decade of increasing dominance. (His predecessor, after all, was named CEO of the decade and was already a legend before he died in 2011.) Many questions remain, but Cook has succeeded in putting off talk of Apple’s decline for at least the time being. “People have said that Apple lost its magic,” says Daniel Ernst, an analyst with Hudson Square Research. “What Apple demonstrated with their customers on Friday is that they have a long-term future.”

Apple’s health depends, in large part, on whether it can continue building products with a wow factor. Anything less risks being a bust with consumers, who can instead buy from rivals like Samsung and Google. With the iPhone, Apple’s challenge is to reinvent the device every year by coming up with new impressive features. But in recent years, the new iPhones seemed more evolutionary than revolutionary, with only minor tweaks distinguishing one generation from the next.

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That is true of the latest iPhones, the 5s and the 5c. During a recent unveiling, Apple executives lavished them with their usual praise. But Wall Street reacted coolly by sending Apple’s shares down more than 10%. Investors didn’t think the phones were innovative enough to lure new buyers or entice existing customers to upgrade. The high-end 5s features an improved camera, speedier microchips and, most important, a fingerprint sensor. Instead of typing a passcode, users can unlock their phone by placing a finger on the home button, where a scanner is located, to have their identity verified.

Apple also introduced the 5c, its first phone made with a plastic cover. Many people expected the phone, essentially a repackaged iPhone 5, to be aimed at more cost-conscious shoppers in developing nations like China. But the price — $549 without a contract — isn’t exactly cheap. A number of rivals sell phones for far less.

But a funny thing happened when the new iPhones finally went on sale last week in nine countries including the U.S. Shoppers defied the conventional wisdom by lining up at Apple stores and by going online at midnight to buy the new devices. They didn’t seem so concerned about whether the phones were evolutionary or revolutionary. They simply wanted them, and they bought so many that the higher-end version is now out of stock. “The demand for the new iPhones has been incredible, and while we’ve sold out of our initial supply of iPhone 5s, stores continue to receive new iPhone shipments regularly,” Cook said in a statement on Monday. “We appreciate everyone’s patience and are working hard to build enough new iPhones for everyone.”

Encouraged by the strong iPhone sales, Apple raised its quarterly revenue guidance to the higher end of its previously announced range of $34 billion to $37 billion. In response, investors sent Apple’s shares up 5% Monday to $490.64.

But Apple’s strong weekend iPhone sales come with some disclaimers. Comparing the data with previous years isn’t entirely fair. For example, this is the first time that China got the iPhone at the same time as other big markets. By including China, Apple virtually guaranteed record sales in its weekend sales report.

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And even with record sales, Cook and Apple aren’t home free, of course. They face many more longer-term challenges than one successful iPhone upgrade can solve. For one thing, Samsung and Google are formidable rivals with deep pockets and compelling products. They match almost everything Apple does, often at a lower price.

Furthermore, Apple must come up with the next big thing if it hopes to lift its slowing growth. Smartphones and tablets are increasingly mature markets. What Apple may decide is to sell entirely new products like interactive television sets or smart watches, both of which the company is said to be working on. But both products may be difficult sells. People buy televisions less often than smartphones. And consumers increasingly prefer to check the time on their smartphone screen than wear a watch. “New categories are important, but increasingly, it’s difficult to find opportunities that are as large as the smartphone,” says Ross Rubin, principal analyst with Reticle Research.

Apple has a proven track record of branching out into unexpected areas. No one could have predicted that the company would expand its original desktop-computing business into digital music players and then mobile phones and tablets. To be sure, there have been a few missteps along the way. But they have been minor compared with the successes. “They’ve been adept at extending their brand into new spheres,” Rubin adds. “The product that Apple has been best at revising is … itself.”