- 16 Oct 2023
- The Parlor Room
Mihir Desai on Apple's Powerful Financial Model
In this debut episode of The Parlor Room, host and Harvard Business School Online Creative Director Chris Linnane sits down with HBS Professor Mihir Desai to discuss how Apple's financial model contributes to its success and illustrates a critical lesson about risk management.
Guest
Mihir Desai, Mizuho Financial Group Professor of Finance, Harvard Business School
Resources
Leading with Finance, Professor Desai's HBS Online course
Professor Desai's books:
- The Wisdom of Finance: Discovering Humanity in the World of Risk and Return
- How Finance Works: The HBR Guide to Thinking Smart About the Numbers
- International Finance: A Casebook
Related HBS Online blog posts:
- What Jane Austen and Mel Brooks Can Teach Us About Finance
- 3 Financial Principles Every Professional Should Know
- The Importance of Financial Literacy in Business
- How to Learn Finance without a Finance Background
- Which HBS Online Finance & Accounting Course Is Right for You?
Follow HBS Online
Transcript
Chris Linnane:
The Parlor Room is an official podcast of Harvard Business School Online.
Mihir Desai:
You go to a supplier, and you say “Would you like to do business with me? Here's how it's going to work. You're going to keep the inventory until I call you at midnight the day before. And I'm going to say, ‘I need 1,000 iPads at the Fifth Avenue store at 6:00 AM. And you're going to deliver them to me.’”
Chris Linnane:
Wow.
Mihir Desai:
And they say, “OK, and when are you going to pay me?”
“When I feel like it.”
Chris Linnane:
What?
Mihir Desai:
And you say, “Yes, sir. Let's do that again.”
Chris Linnane:
Welcome to The Parlor Room, where business concepts come to life. My name is Chris Linnane. I'm the creative director of Harvard Business School Online.
So, why is this show called The Parlor Room? Well, parlor rooms were meant for discussion—for telling stories—and that's what we're doing here. I invite Harvard Business School professors over to our parlor room, and we learn business concepts through real-life stories.
On this episode I'm joined by HBS Professor and business podcast royalty, Mihir Desai. Professor Desai simplifies the complex by blending intellect with storytelling.
In a moment, you'll hear him do just that.
While helping him make his HBS Online course, Leading with Finance, I saw firsthand the inaccessible become accessible. I'm no longer afraid of finance. Well, I'm no longer as afraid of finance.
We'll learn about the inner workings of one of the world's most iconic brands, and Mihir even talks me through unresolved anxiety from a high school dance. It's sort of like a “tough love” moment.
So, let's get started. Welcome to The Parlor Room.
Chris Linnane:
All right. So, I know, I know where I want to start.
Mihir Desai:
OK, let's do it.
Chris Linnane:
“Finance; finance.” What’s the difference?
Mihir Desai:
You know, I don't know, man. I should have the answer to this question.
And the reality is, I say both and I interchange them, and I don't even know what I'm using at different times. So, I have no wisdom on that.
Chris Linnane:
I had a feeling that if you said “finance,” you would know what you're talking about. And if you said “finance,” you were just trying to work with your checkbook.
Mihir Desai:
Is that right?
Chris Linnane:
That's my perception of it.
Mihir Desai:
I think “finance” sounds fancier. For sure. And it throws people. So yeah, maybe I should use it.
I honestly, I don't have control over it. I just say it.
Chris Linnane:
But both are right, you're saying.
Mihir Desai:
They are, exactly. There's no one way in finance, Chris.
Chris Linnane:
Well, that's what I've learned from you.
So, your book, Wisdom of Finance. I know we've talked about this before, but I think one of my favorite sections is the Jane Austen and the Pride and Prejudice section. Can we go into that a little bit?
Mihir Desai:
Yeah, sure.
So, I mean, the premise of the book is that these big ideas of finance that we were talking about, actually aren't just unique to finance, they're about life.
And in a way, I was trying to take finance out of some big ivory tower and put it into people's lives. And the way to do that is with the humanities: literature and religion and philosophy. So, for every big idea in finance, I was looking for these analogs in literature and history.
And so, for risk management—which is a really, really big idea in finance—it turns out Jane Austen is just, like, a spectacular guide.
So, in Pride and Prejudice—which is this classic novel about Lizzie Bennet—you know, she is basically dealing with suitors. And one of the things that Jane Austen thinks about deeply is that it's a risky world for especially, young women who are trying to make choices, in a way that it's not risky for men, because it's easy for a man to make a mistake, and it's not easy for a young woman to make a mistake in that era.
And so, she's got a big risk management problem.
And the really fun part is, as she's seeing these suitors come, one is maybe handsome but a drunk, and another one is solid but ugly, or whatever it is. She's got to try to juggle these things.
And the really fun part is she basically gives voice to risk management strategies. Like, she gives voice to the idea of diversification. She gives voice to the variety of options. She gives voice to all these financial tools that people think are super arcane and weird and developed in the 1970s. But in fact, have been used throughout history.
It's meant to be representative of what that book tries to do, and what I like to do more generally, which is bring finance down to Earth—away from all the trappings that people associate it with and bring it down to people's lives.
Chris Linnane:
So, can I run something by you then?
Mihir Desai:
Yeah, sure.
Chris Linnane:
All right. Risk management.
Mihir Desai:
Yeah.
Chris Linnane:
You grew up in New Jersey.
Mihir Desai:
Yeah, after age eight, exactly. Yeah.
Chris Linnane:
Did you have a prom? Did you go to prom?
Mihir Desai:
I did go to prom.
Chris Linnane:
All right, first of all: “Finance; finance.” “Prom; the prom.”
I think it's “the prom.” But people just say, “I'm going to prom,” which is maddening to hear.
Mihir Desai:
Yeah, no, I use the article. Yeah, I went to “the prom.”
Chris Linnane:
So, risk management wise. So, when I was going to a prom, I think I have my own Pride and Prejudice moment here, and I want to see if this is it.
So, I had a plan to ask a girl to the prom.
Mihir Desai:
Yeah.
Chris Linnane:
Then I had heard that there was a girl that was going to ask me to the prom.
Mihir Desai:
Yeah.
Chris Linnane:
Different girl.
Mihir Desai:
Yeah.
Chris Linnane:
So, what I had to do was figure out how to not interact with that other girl while trying to ask this girl to the prom.
Mihir Desai:
Yeah.
Chris Linnane:
Turns out, that while I was trying to potentially avoid this girl, that other girl was trying to avoid me because I'm no catch.
Mihir Desai:
Right.
Chris Linnane:
So, I finally got an opportunity to ask this girl to the prom.
Mihir Desai:
Yeah.
Chris Linnane:
And there was a very long silence, to a point where I thought, “I'm going to ask again, maybe she didn't hear me.”
So, asked again, and then she said, “No, I heard you. I'm just thinking.”
So, it was followed by more silence.
Mihir Desai:
Yeah.
Chris Linnane:
But then she responded with, “I guess so.”
Mihir Desai:
Wow.
Chris Linnane:
Is that risk management?
Mihir Desai:
It's a deeply touching story. And I think we should work through it.
From her perspective, she was, I think, implicitly, Chris—and I hope I'm not breaking any news to you—but you know, she was basically deciding, “Should I settle?”
Chris Linnane:
Yeah.
Mihir Desai:
Right? Or “Should I wait?”
“Should I wait? Maybe there's a better offer coming. Or should I settle for Chris?”
And I'm sorry, Chris, this is, I know you haven't quite come to terms fully with this experience. But that's kind of what's going on, right?
And that kind of idea, which of course, is in Pride and Prejudice, as well, when Mr. Collins gives Lizzie Bennet basically an offer of marriage. And she's like, she says “No.” And her mother and father think she's crazy.
And so, this young woman in your life, basically decided, “Yeah, I'll settle.” Which is kind of like it's an optimal stopping problem, which we see in finance. And it has a lot to do with optionality.
She gave up a lot of optionality. She gave up the optionality to wait. And so, she surrendered her options.
And now of course, you're married and have three kids. And it's a great story.
Chris Linnane:
It's a great story.
Anyway, I just wanted to let that sit a little longer.
Mihir Desai:
I hate to break it to you, but it's not all about you, Chris.
Chris Linnane:
Well, I just figured that out.
Mihir Desai:
It's the greatest lesson in life, Chris.
Chris Linnane:
Yeah. So, let's change gears a little bit.
Mihir Desai:
Yeah.
Chris Linnane:
Why do people like me find finance so intimidating?
Mihir Desai:
I think many people—all too many people—find finance very intimidating.
And what the course has been about, what the books have been about, and what my pedagogic career has been about is disabusing them of that idea that finance is intimidating.
It's not surprising that people find it intimidating, because people in finance like to intimidate other people. Like that's their source of power.
And so, what this course does and what all of these efforts do is try to make it clear that finance is fully accessible. And, actually, is just a wonderful body of ideas.
If you don't understand it, it's hard to be an investor. It's hard to be an employee. It's hard to be a manager. It's hard to succeed unless one goes under the hood and starts to understand the underlying financial engine of all these businesses.
Chris Linnane:
Can we take a look under the hood of a big brand?
Mihir Desai:
I like to think about Apple a little bit, which is obviously a company that many people love.
It's arguably the most successful company of our generation. The market cap is now a remarkable $2.8 trillion. It's almost hard to fathom.
People think about their products. People think about their strategy. People think about all kinds of things about Apple.
What they don't realize is that they have just this remarkable financial model. And it's been absolutely critical to their success. But if you look under the hood, they’ve got a real financial machine.
So just as one example—and this is a little nitty gritty, but it's useful to think about—obviously they're profitable, but Apple's model is much more powerful than just being profitable.
They actually generate a ton of cash, which has allowed them to build themselves in a remarkable way, without ever getting outside funding.
So where does all that cash come from? So, it turns out that you have to look deep inside Apple to figure this out.
But what Tim Cook built is a machine. To give you a sense of what that machine is, Chris, try to guess the following.
So, Apple is a retail store. You can go to Back Bay or Fifth Avenue and you can go into an Apple retail store. And they own those stores. In retail, one of the most important things is inventory. If you want to run a good store, maybe you worked in a store as a kid. I did, and it was all about moving inventory, right?
So, in the Apple Store, guess how long inventory hangs around?
Chris Linnane:
A month, two months?
Mihir Desai:
Yeah, so at a lot of retailers that would be right.
So, for Apple, it's about five days.
Chris Linnane:
Wow.
Mihir Desai:
Which is crazy.
Now you might ask, “Wait, why? And why is that powerful?”
Well, let's put it together with two other pieces.
It turns out because they are also now a retailer—and by the way, this was not true 20 years ago; they were not a retailer—they also collect from their customers pretty quickly. Right? Because when you go to an Apple store, you pay.
And they collect really quickly, as opposed to using a distribution channel.
Chris Linnane:
Yeah.
Mihir Desai:
So, they're collecting pretty quickly, they don't hang on to inventory very long, and then the final piece is, guess how long they take to pay their suppliers?
Chris Linnane:
60 days.
Mihir Desai:
Apple has averaged as long as 150 days.
Chris Linnane:
How do they do that?
Mihir Desai:
Well, because they're Apple.
So, that little virtuous machine, which is what, wait a second, they keep inventory for a really short period. They get paid really fast. And they pay their suppliers, like, when they feel like it.
Chris Linnane:
Wow.
Mihir Desai:
What does that mean?
Well, what that means is that their operations actually generate cash. Because it's not tied up in inventory, they're getting paid pretty quick.
And then they pay their suppliers when they feel like it.
Chris Linnane:
Wow.
Mihir Desai:
And that means they have a cash flow machine that drives their operations.
Now, how do they get away with it?
Chris Linnane:
Yeah.
Mihir Desai:
The answer is, well, you go to a supplier, and you say “Would you like to do business with me? Here's how it's going to work. You're going to keep the inventory until I call you at midnight the day before. And I'm going to say, ‘I need 1,000 iPads at the Fifth Avenue store at 6:00 AM. And you're going to deliver them to me.’”
Chris Linnane:
Wow.
Mihir Desai:
And they say, “OK and when are you going to pay me?”
And Apple says, “When I feel like it.”
Chris Linnane:
What?
Mihir Desai:
And you say, “Yes, sir. Let's do that again.” Because they're Apple.
Apple has been accused at different times of bankrupting their suppliers.
Chris Linnane:
I'd imagine, yeah.
Mihir Desai:
I mean because they are turning the screws. And this machine doesn't get built easily.
But you can see how powerful it is, because effectively, who financed all their growth? Those suppliers.
So, that's the economic model that is underneath Apple. And if you don't understand that, it's hard to fully appreciate Apple as a company. And it's hard to appreciate how strong and resilient they can be.
Chris Linnane:
That's fascinating. I knew that they had the ability to do what they wanted in a lot of situations.
Mihir Desai:
Indeed.
Chris Linnane:
But that's extreme. If someone just doesn't want to meet those terms, they move on to the next person who's willing to meet those terms.
Mihir Desai:
Exactly. And of course, everyone's falling over themselves to do business with Apple.
You can draw a parallel to the way Dell pioneered this. Amazon has done this. Obviously, software as a service is about this. It runs throughout the economy in really interesting ways.
Chris Linnane:
So those suppliers, this is kind of like their risk management for them.
Mihir Desai:
And it's also for Apple, right?
So, you can't be too dependent on any supplier. So, you're managing multiple suppliers, and yet, you're also pressuring them in this way.
And then, of course, for Foxconn or Hon Hai, the question is, “What do I do if I don't do business with Apple?”
Chris Linnane:
Yeah.
Mihir Desai:
“What can I do if I don't do business with Apple?”
Chris Linnane:
Because then they're marrying the good-looking guy who's a drunk.
Mihir Desai:
Or they're going to the prom with Chris.
Chris Linnane:
Oh, Wow.
Mihir Desai:
I'm sorry.
Chris Linnane:
It's OK.
Mihir Desai:
Yeah.
Chris Linnane:
Tied it all back together nicely.
Mihir Desai:
There you go.
Chris Linnane:
So, I've got some questions.
Mihir Desai:
Yeah.
Chris Linnane:
Our first question is Matteas in Brazil.
Mihir Desai:
Wonderful.
Chris Linnane:
What skills or qualities are crucial for success in today's financial landscape?
Mihir Desai:
Yeah, that's a great question.
And let me say what I think is not the right answer, which is it's tempting today to think that the right answer is more familiarity with data science and understanding artificial intelligence and knowing how to prompt ChatGPT.
I think those are relatively cheap skills. I think what is really lacking in finance and what distinguishes people who do really well is judgment. And is really thinking hard about value.
So, what the traits are that really matter today are the same traits that have always mattered in finance, which are judgment, character, and its consistency.
And, in some sense, that sounds like very old-fashioned advice. And I think it is very old-fashioned advice. But that's what mattered 100 years ago; I think that's what matters today. And I think it matters in most fields, but it matters, particularly in finance.
Chris Linnane:
With judgment, is that something someone can develop over time?
Mihir Desai:
It takes a long time. And judgment—
Chris Linnane:
How do they develop that?
Mihir Desai:
Well, so the wonderful thing about finance is, you just keep investing in it and it keeps getting better and better.
So, judgment matters, particularly in finance because it's a very fast-changing world. Markets are quickly moving. And you have to make sense of tons and tons of information.
And that's if you're a CFO, that's if you're an investor, that's if you're whatever you are in finance. Because you're going to be embedded in financial markets perhaps at a corporation.
But there's going to be just tons and tons of data coming. And you have to learn how to respond to that data. And you have to do it in a consistent way. And the great news about it is, you learn. And you get better and better at it, because judgment comes, by and large, from experience.
And so, with that experience, you learn what you're doing right, what you're doing wrong, and then maybe, over time, you get better.
It's a very, very challenging field, because most people don't have the patience to try to develop that judgment. But that judgment is what really, really matters.
Chris Linnane:
Great. OK, so Rachel in Chicago: “What are your thoughts on the future of finance in the light of technology and digital currencies?”
Mihir Desai:
I'm going to give you a little bit of a cranky old man answer to that.
Chris Linnane:
OK.
Mihir Desai:
On digital currencies, I think they're really interesting. And I think when we have the Federal Reserve or central banks around the world adopt them fully and start to develop them, that'll be really, really powerful. I'm not a big fan of other digital currencies or cryptocurrencies. And, in fact, I think they're pretty pernicious.
I wrote a piece for the Times about five months ago about the magical thinking that has infected finance. And I think of a lot of cryptocurrencies as manifesting that. That somehow we need to tear up everything and start anew. And I don't think that's really true. So digital currencies, and especially central bank digital currencies, will be really powerful and really interesting.
Technology will be at the forefront of finance for all kinds of reasons, because of the power of computing, because of all that information that are in these markets, there's always going to be technology that is going to be driving financial markets. And financial institutions adopt technology really fast. And they spend on technology a lot, because of that fundamental nature of all that information they're trying to aggregate. And it will only become more and more important. And so, that's a great intersection to be at.
Ultimately, as we discussed before, I think judgment is the more precious asset than kind of technology. But being very secure in your understanding of that technology is a great way to build a career in finance.
Chris Linnane:
All right. Elizabeth in Boston asks, “How can we improve financial education and empower individuals to make informed financial decisions?”
Mihir Desai:
It's a great question and something close to my heart. My efforts so far, including TheWisdom of Finance and How Finance Works and this online course that we worked on together, are really to basically demystify it.
And to make it clear that the ideas are totally accessible to anyone. And so, that's the first step in doing it. But the bigger step that we need to do as a society, is do it at a younger age. And if we really are serious about financial literacy—and we should be—then we need to start at a younger age.
It's actually quite remarkable data. People exposed to financial literacy at younger ages, end up amassing more wealth. Like, there's good empirical research on that now.
Chris Linnane:
Yeah.
Mihir Desai:
And so, just like you might think of health issues in K through 12 being taught, we should be thinking about financial health. We should be thinking about exposing people to those ideas at a very young age.
That's the real key to getting people to understand finance better.
Chris Linnane:
If I look back at growing up, I never learned anything until around 16, 17, 18 when you get your first job. And you think, “Oh, what do I do with this money now?”
Mihir Desai:
Yeah.
Chris Linnane:
That's the first time I had to think about it. And that seems crazy.
Mihir Desai:
It is. I think it is a little bit crazy.
With the retail investing, in a way, it's wonderful. Because a lot of young people are investing. And that's fantastic. But it's also concerning, because what they're learning is a lot closer to gambling than investing.
Chris Linnane:
Yeah.
Mihir Desai:
It's a mixed bag, in some sense, right? Like you’ve got to feel good about people investing in stocks and learning about finance at a younger age. That's got to be nice and good.
But it has this a little bit weird, weird twist today.
Chris Linnane:
There are the apps, but then they also have now, especially in Massachusetts, they have the sports betting apps.
And it's the same thing with a different cover.
Mihir Desai:
Exactly, right.
Chris Linnane:
And I think most people are going to be more comfortable in the gambling environment of that, because they have this feeling of “I know this team.”
Mihir Desai:
Sure.
Chris Linnane:
I can make an estimate of how much is going to happen in this game. Where when you say, “Well, think about investing in this company,” it's more of a black hole for most people.
Mihir Desai:
Right.
Well, what they've successfully done for many of these folks have done, is gamify finance. Which again, is wonderful if you want to get people into finance.
Chris Linnane:
Yeah.
Mihir Desai:
But it's also really problematic, if that gamification is happening in a way that is not really tethered to reality. Then it's really problematic.
Chris Linnane:
All right. This is Alex in Beijing: “How do finance and taxation intersect, and what impact do they have on business and economies?”
Mihir Desai:
That's a great question.
So, my two areas are finance and tax. And I love them. They are really the lifeblood of the capitalistic endeavor and of the state. And the way in which the state and capitalism intersects is taxation. So they're hugely influential. They're only rising in importance. And they are about, in some very deep sense, who gets what and why.
So, in the finance side it's about who gets capital, why they get capital, and who should get capital, and how do we get returns from those investments in capital?
And in taxation, it's about why does the state get to take my stuff, and how much of my stuff do they get to take? Think about capital gains taxation or dividend taxation or even income taxation. Think about how it changes an entrepreneur's willingness to invest in new businesses. Think about how it might impact a founder who has to get rid of some shares. It just runs through everything.
And the wonderful thing is, I think people understand that it's important, but they don't like to think about it too much. And it's really fun to be somebody who actually enjoys thinking about those topics.
Chris Linnane:
Well, I'm glad you understand it. Because sometimes it can overwhelm a lot of people.
Mihir Desai:
And it's overwhelming. Both those topics are overwhelming. That's exactly right; they're both overwhelming. Which is also why demystification is so important. Because people being overwhelmed by these things is not good for anyone. It's not good for us as a society. And the choices we make, especially on the tax side.
But in finance, they're really going to be important in the next decade or two. And they're going to be big decisions. And if people do it without sufficient knowledge, I think that's really a problem.
Chris Linnane:
Thank you, Mihir.
Mihir Desai:
Oh, it's great to see you again.
Chris Linnane:
I hope you had an OK time. I had a great time.
Mihir Desai:
It was really great.
Chris Linnane:
If you'd like to learn more about finance, or Professor Desai, you can pick up one of his outstanding books or check out his HBS online course, Leading with Finance, at theparlorroompodcast.com.
Don't forget to follow us on LinkedIn, Facebook, Instagram, TikTok, and X for more exclusive content.
I'm Chris Linnane. Thanks for listening.