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Apple and Microsoft – Enjoying Sticky Business

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Apple and Microsoft are companies that enjoy a sticky business model. “Sticky” means that it’s difficult or costly for customers to change the products or services they use for another vendor. High switching costs/complexity is one type of economic moat that protects companies like Apple and Microsoft.

If half of your home is connected to an Apple product (air pod, iPhone, Mac book, Apple TV, and no doubt others in due time), changing your iPhone to an Android would be difficult. The connectivity of Apple’s product ecosystem is convenient, but it’s also a product prison; you can’t escape without a steep learning curve and significant costs. So, you “stick” with the vendor you know and love.

Microsoft suite iconsMicrosoft’s suite of products (Windows OS, Office) is deeply embedded in individual and corporate workflows. Imagine a corporation wanting to move away from Microsoft products…the training, the lost productivity during and after the switch, and employee resistance to change are all costly!

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Sticky business models

This sticky business model, or switching cost advantage, exists for many technology companies, but it’s not exclusive to them. Companies in other industries also enjoy this advantage.

Fastenal (FAST)’s strong bond with its industrial customers stems from having its vending machines and even stores on-site at the customers’ manufacturing facilities. Fastenal can provide unmatched speed of service, making it unlikely that customers will sever that relationship. A similar example is Air Products & Chemicals (APD)’s on-site hydrogen connections.

Business models can be sticky due to specialization. Magna International (MGA / MG.TO) builds custom parts to automakers’ specifications. The significant set-up costs incurred, and the long-term relationships built with Magna mean customers don’t walk away easily.  Same thing with Equinix (EQIX), the data center REIT and digital infrastructure company. Its co-location services for customers who do business together make its customers stick around.

Apple and Microsoft

Apple and Microsoft are successful in part because of their sticky business models.  While both have low yields, they’re superstars for dividend growth investors. Why? They have both offered solid total returns, meaning dividends and stock price appreciation over the years; I feel they are poised to keep on doing so for years.

Dividend growth investing is not centered on high-yield stocks, but rather on strong dividend growers: companies with solid business models, growth vectors, and positive trends for revenue, profit, and dividend growth.

The goal is to create enough income for yourself in retirement. That income doesn’t have to come from dividends exclusively. Dividend growth and stock price appreciation will do just as well. Apple and Microsoft both fit the bill. To learn how to create retirement income for yourself, download our Dividend Income for Life guide.

Now, let’s learn more about Apple and Microsoft’s stickiness.

Apple (AAPL)

The strength of Apple’s business model could be summed up like this: quality products that integrate easily into a user-friendly ecosystem, backed with unrivaled brand loyalty from its customers.

Apple created a tightly integrated ecosystem where devices (iPhone, iPad, Mac, Apple Watch) and services (iCloud, Apple Music, Apple Pay) work seamlessly together. The wide array of applications in its App Store creates more reasons for users to stay within the Apple ecosystem to enjoy the full benefits.

Its high-quality hardware and well-designed software that offers a consistent and reliable user experience across devices are very appealing to its customers. Through its effective marketing, a reputation for innovation, and a premium brand image, Apple has cultivated strong brand loyalty. Loyal customers are less likely to switch to competitors.

If all that wasn’t enough, Apple also provides features and content, like iMessage and iCloud backups, that are exclusive to its devices, creating a barrier for users to move to other ecosystems without losing these functionalities. You see how difficult it is for customers to leave Apple’s ecosystem once they are part of it.

Apple dividend triangle

Below is the 10-year evolution of Apple’s stock price, revenue, earnings per share (EPS), and dividend payments. The last three metrics make up what I call the dividend triangle.

Apple dividend triangle graphs as of May 2024

We see steady and strong growth over the years that has slowed down since 2022 due mostly to the economic slowdown and falling revenue in China. AAPL’s first growth vector remains its iPhone. It’s also seeing double-digit growth for its services, which generate higher margins. The company posts solid cash flow generation. Short-term, the concern relates to the technology sector performance as a whole. However, continued interest from consumers of premium products means Apple should continue to perform well long-term.

Don’t be fooled by the low yield; AAPL should double its dividend every 8 years going forward. Both payout and cash payout ratios are very low. The last three dividend increases were more modest (4.2 to 4.5%), but management approved a $100B share buyback program instead of purely increasing its dividends.

Microsoft (MSFT)

Microsoft has made itself indispensable and hard for businesses to switch. It too provides an integrated suite of products (Windows, Office 365, Azure, and Dynamics 365). This makes it convenient for businesses to stay within the Microsoft ecosystem rather than adopting disparate solutions. It has become a leading cloud service provider, and the natural choice for businesses already using Microsoft software.

Through its flexible and attractive licensing agreements, which often include discounts, extended support, and bundled services, Microsoft locks in customers for long periods.

Customers benefit from solutions and specialized applications built and supported by its vast network of developers and partners on Microsoft platforms. The company provides robust enterprise-grade security and compliance solutions that meet industry standards, which is critical for many corporations.

Through its commitment to innovation and continuous improvement, Microsoft ensures its products evolve with the latest technological advancements. This keeps their offerings competitive and appealing to corporations.

All this creates a strong dependence on Microsoft’s ecosystem, making it challenging for corporations to switch to alternative providers without significant disruption and cost.

Microsoft dividend triangle

Microsoft has increased its dividend yearly since 2004. Its yield used to be at ~3%, but the hype surrounding the stock has made it low-yield (~1%). Even a double-digit dividend growth rate wasn’t enough to compensate for the stock price surge since 2015. As you see below, Microsoft shows a perfect dividend triangle. Investors can expect high-single-digit dividend increases for a while.

Microsoft's dividend triangle graphs as of May 2024

Can any company enjoy sticky business?

Not really. Industries with many competitors, or whose products are seen as commodities with little differentiation, don’t have high switching costs or strong loyalty from customers. For example, even a loyalty card at a grocery chain store won’t keep me from going to a local butcher shop or to a different grocery.

Building switching costs through a loyalty program can increase stickiness, but it’s limited. These businesses compete on price, operational efficiency, and perhaps convenience of locations.

The post Apple and Microsoft – Enjoying Sticky Business appeared first on Dividend Monk.


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