• Elon Musk isn't threatened by Apple's "open secret" to build a rival car.
• With Apple's strong operating margins and effective sales strategy, car manufacturing has more risk than reward.
• I am not optimistic about Apple entering car manufacturing and hope they outsource the hardware and focus on vehicle software technology.

Tesla (Nasdaq:TSLA) founder Elon Musk has said Apple's plans to make a competing electric car is an "open secret." He cites how Apple (Nasdaq:AAPL) has hired over a thousand engineers, making it difficult to keep their plan under wraps. However, Elon Musk isn't threatened by the most valuable company in the world, and perhaps for the same reasons I am not as optimistic about the future of Apple entering the automotive market.

First Concern - It doesn't seem worth the risk

Not everybody invests in Apple just for growth, but they invest because the company turns big cash flow, and we can thank Apple's incredible 30.5% operating margin for that. Tesla, a likely competitor, has a double digit negative operating margin. Honda's (HMC) margin is 4.9%, Ford's (F) is 4.1%, and GM's (GM) is 2.9%. It's difficult to imagine how Apple would be able to compete with the auto manufacturing industry, which has an operating margin average of 6.5%, or at least any time soon. Apple would be entering the car market late, even electric car manufacturing. This means a significant amount of money would need to be invested to build and distinguish themselves from competitors. And what that equates to is a lot of negative cash flow from their car manufacturing business for a long time.

Now let's pretend the business model works in the long-term. Let's say that Apple is able to turn a massive operating margin like that of other established luxury car manufacturers, such as Ferrari (NYSE:RACE) who has an Operating Margin of 17.7%. But Ferrari's sales are a little low, so let's use Tesla's sales of $3.788 billion for the TTM. Applying Ferrari's Operating Margin to Tesla's sales would create operating income of $670 million. Now $670 million would be amazing for Tesla or Ferrari, but for Apple it equates to less than 1% of their current operating income, making an insignificant impact on their bottom line given the risk.

Second Concern - It's a new sales strategy

Apple isn't just known for a loyal base of customers, but the consistency at which those customers will continually open their pockets for newer Apple products. A loyal Apple consumer might upgrade their iPhone after 2 years when the newer edition is available, but they won't upgrade their cars after 2 years. Apple customers are not going to pay a premium for a car and then subject themselves to tens of thousands of dollars in lost depreciation expense just to upgrade to the newest model. This has been an extremely successful part of Apple's business plan; on-boarding customers and reselling products with updated hardware and software. With Apple's premium pricing strategy and the average age of vehicles on the road in the United States being 11.5 years, this presents a concern to Apple's traditional sales strategy.

Concern 3 - The car needs to be an industry game changer

I don't care how much cash you have, car manufacturing is extremely competitive. If Apple is coming to the market with a car then there better be more than just a brand behind it. Brand loyally already exists in the automotive industry and Apple is coming to the market late, which means they have to come with something new. The only way I can see this working is if Apple sets themselves apart from the rest with significantly better technology, which would support future sales to exceed $50 billion annually. To go head to head with the likes of Tesla means big spending on innovative technology that surpasses what exists in the industry.

The Solution

To me, I think partnering with a car manufacturer makes the most sense. Let Apple focus on technology and how they can improve software technology in vehicles, which is becoming more and more important, while they outsource the hardware components. It could be an American company, but likely a Chinese manufacturer, which makes all too much sense given Tim Cook's operational history in supply chain management. I think this makes the most sense as it reduces Apple's risk and still maintains a fair reward.

Conclusion

An Apple car on its own just doesn't make sense to me. The only way Apple should enter this market is if they are bringing new technology to the auto manufacturing industry beyond software, such as a better battery. Regardless, I feel if Apple enters this market they are going to need something more innovative than an electric self-driving vehicle. I would like to see Apple go back to their tech roots and focus on vehicle software technology and leave the manufacturing alone. Car manufacturing would be a big risk and I feel Apple might be too far behind the curve this time.