The "Unexciting" Upgrades of the iPhone: Where Apple's Hundreds of Billions Are Spent

Published:September 14, 2023

Prof. David Reynolds stands as a luminary in the field of electrical engineering, renowned for his expertise in integrated circuits. Holding a distinguished position as a Professor of Electrical Engineering, Prof. Reynolds earned his acclaim through decades of research, teaching, and industry collaboration.

For many users, the number that follows "iPhone" after each annual Apple product launch no longer signifies any visible upgrades but simply represents the passage of another year.

Last night's event was no exception. Following the footsteps of the iPad and Apple Watch, Apple has also forsaken innovation in the iPhone's appearance. The iPhone 15 series continues the same design introduced with the iPhone 12 series four years ago, with minor adjustments: a slightly curved titanium alloy frame, a larger camera module, and a 20g reduction in weight (for the Pro and Pro Max versions).

However, in areas that are hardly visible even under a microscope, Apple, along with its suppliers, has spent hundreds of billions of dollars.

By next weekend, the first batch of consumers who have pre-ordered the iPhone 15 Pro/Pro Max will be using chips built on a 3-nanometer process, with the smallest components in this chip measuring just 12 silicon atoms wide—smaller than even the new coronavirus by at least 30 times.

As chip feature sizes approach the atomic scale, the capital investment required for each generation of advancement increases exponentially. Moving from a 4-nanometer to a 3-nanometer process, Taiwan Semiconductor Manufacturing Company (TSMC) alone invested over $20 billion.

During the presentation, Apple mentioned terms like "chips," "silicon," "sensors," "CPU," and "GPU" more than 50 times. Today, the computing power of a smartphone is millions of times stronger than the navigation computers used during the moon landing over 50 years ago.

Consumers may not perceive significant changes because, on a daily basis, we use our phones to perform complex calculations that Alan Turing and John von Neumann could not have predicted—on average, spending 2 hours watching short videos, 1.5 hours on WeChat, 30 minutes on news apps, 30 minutes watching movies or TV shows, and 21 minutes shopping online.

Today, most people replace their phones not for performance improvements but due to cracked screens, aging batteries, and insatiable consumer desires.

Upgrading the chip by just one or two generations only results in a marginal improvement in battery life. However, a decade of continuous effort has allowed chip manufacturing processes to shrink from 28 nanometers to 3 nanometers. This is a significant enough change to make artificial intelligence and autonomous driving move beyond science fiction.

Since the inception of smartphones, they have been at the forefront of technology, especially in chip development. Chip manufacturing is incredibly capital-intensive, and the scale created by selling over a billion smartphones a year allows for economies of scale that enable industries like Tesla and Nvidia to adopt the latest technology.

Previously, Apple, Samsung, and Huawei fiercely competed in the high-end smartphone market, each striving to incorporate the most advanced chips, ensuring that the chip industry had the necessary investments to drive technological progress. However, the smartphone industry has faced a downturn for several years, and Huawei has faced obstacles due to non-commercial factors. This year, there may not be another smartphone company that can afford 3-nanometer chips. "The profit margins in the Android phone camp are thinning, and they are increasingly unable to afford the latest chips right away."

To continue advancing chip manufacturing processes, metal fabrication techniques, and display technology, and to convince consumers to continue spending, Apple spent $26.3 billion on research and development and $10.7 billion on custom equipment procurement last year. The suppliers who collaborate with Apple contribute ten times more in capital investment.

 

Tenfold Leverage: A $300 Billion Tech Investment Machine

When Apple CEO Tim Cook hosted his first earnings call in 2009, he was asked how Apple would operate without Steve Jobs. His response was, "We believe that we need to own and control the primary technologies behind the products we make, and participate only in markets where we can make a significant contribution."

Cook officially took over Apple two years later, rigorously following this investment approach. While he lacked the legendary taste and inspiration of his predecessor, he was willing to spend enough money to ensure that the company always had access to, and often drove, the latest technologies.

According to estimates by organizations such as IHS Markit and Counterpoint Research, from the time Cook took over Apple until the release of the iPhone 14 Pro Max last year, the component cost of Apple's flagship iPhone models increased 1.5 times to $464—surpassing the average selling price of smartphones from competitors like Samsung and Huawei.

The iPhone has reached nearly luxury pricing levels, but Apple's allocation of expenditures resembles that of a manufacturing company. Each year, this company without factories uses 63% of its hardware revenue to purchase parts and produce products, allocating over 13% of its revenue to research new technologies and procure production equipment. Only a small portion of expenses is used for advertising and product distribution.

According to the International Business Strategies (IBS), designing a 3-nanometer chip alone costs $590 million, more than twice the cost of designing a 7-nanometer chip. In the past year, Apple's research and development expenses, along with capital expenditures, totaled $37 billion.

Other companies have higher annualized capital spending or research and development budgets than Apple. For example, in 2019, Samsung, Volkswagen, and even Huawei had higher capital expenditures. However, Apple, with its near tenfold leverage, inadvertently built a massive technology investment alliance. Factoring in inflation, Apple and its suppliers' investments last year were enough for Oppenheimer to develop atomic bombs from scratch at least eight times.

 

Inequalities in Investment Relationships and Unavoidable Customers

Tech research and development can't compare to selling in-game skins; constant investment is necessary to maintain a competitive edge. Apple's suppliers can't afford to fail because they may be redirected or lose supply contracts simply for failing to keep up with Apple's production pace.

In 2013, sapphire glass company GT Advanced Technologies (GTAT) signed an almost $600 million agreement with Apple, invested $900 million in equipment, and built the world's largest sapphire glass factory. However, the final product did not meet Apple's expectations, and they did not receive orders. GTAT subsequently filed for bankruptcy and liquidated, selling the equipment to pay off its debts.

At the end of last year, Goertek, which had been cooperating with Apple for over a decade, lost Apple's AirPods Pro 2 headphone orders due to production problems. Within a month, the company's market value decreased by 15 billion yuan, and annual profits were halved.

Even the world's largest and most technologically advanced semiconductor manufacturer, TSMC, can't stop investing and has to allocate more and more resources to keep up with Apple's production pace and meet its manufacturing process requirements. During their 10-year partnership with Apple, TSMC's revenue doubled, but the investment in chip manufacturing process research and development expanded at nearly the same rate. Last year's research and development spending and capital expenditures together exceeded $40 billion, close to the revenue for the entire year of 2020.

TSMC's 3-nanometer manufacturing process didn't achieve ideal yields, leading to the disposal of some chips. Under normal circumstances, customers would bear the cost of scrapped chips, paying higher fees for each usable chip. However, TSMC bore losses of several billion dollars to ensure that Apple could use the new technology this year.

While chip technology is approaching the limits, the same investment logic is appearing in more areas.

For most users, the computing power in their phones is redundant. In recent years, smartphone manufacturers have been trying to create demand for increasingly advanced chips.

"Over the past decade, our problem was whether we had chips powerful enough to fulfill our ambitions," said Jeff Williams, who has since become Apple's COO, in 2017 at a TSMC event. He noted that Apple wasn't concerned about the slowdown in semiconductor performance redundancy, believing in tremendous future potential. "There will be more and more applications processed on local devices. This is the best way to ensure responsiveness, without sacrificing privacy and security."

Williams cited Apple's photo feature at the time, where users press the shutter, and the iPhone takes hundreds of photos, then calculates and provides a result. Many people believed they had a steadier hand when taking photos because of this. With the growing interest in artificial intelligence, Williams believed that the world was at a turning point, and with the development of device-based computing power and artificial intelligence, it would genuinely change the world.

To convince consumers to continue spending on products with better computing power, Apple mainly showcased two features: offline, on-device AI processing, and improved gaming graphics, including ray tracing that was previously only possible on gaming consoles and dedicated gaming graphics cards.

However, Apple is not confident that most iPhone users are willing to pay extra for these features.

This year, Apple can only install 3-nanometer chips in the iPhone 15 Pro and iPhone 15 Pro Max. The relatively cheaper iPhone 15 and 15 Plus use last year's 4-nanometer chips. Even the new Apple Watch is using technology from two years ago. A $300 smartwatch cannot afford the latest chips.

Just three years ago, 5-nanometer chips were just entering mass production and were considered the cutting-edge chip manufacturing process. In the same year, Apple released the entire iPhone 12 series, Mac computers, and iPad Pro, all equipped with 5-nanometer chips. Only the Apple Watch remained on the 7-nanometer process from 2018.

As manufacturing difficulty increases, the return on investment for developing and producing chips with more advanced processes significantly diminishes. Now even Apple only uses these investments in products with the most substantial profit margins. It's challenging to predict how much of a premium consumers are willing to pay for these year-over-year improvements, which ultimately determines how long such investment can be sustained.

Consumerism has reshaped our world over the past 80 years. When Silicon Valley was just emerging, customers were clear and singular, and chips could only be sold for lunar and military programs. Now, the world's largest customers for advanced manufacturing are consumers, from smartphone chips to Tesla's electric vehicles and the battery maker CATL, to the biopharmaceutical industry amid the pandemic.

New technologies and solutions often emerge from challenges and difficulties. But the driving force behind these innovations is often quite simple: consumers who desire better experiences and companies willing to invest in new technologies.

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