Horace Dediu

John Sculley:

"I think they're going through a very significant change now in terms of product cycles," Sculley explains. "Traditionally Apple introduces products once a year; now it's really introducing products twice a year. The complexity of that from a supply chain is immense, and Apple seems to be doing it well. So, I think that people are underestimating just how well Apple is run, and just how successful the company can be when it gets to that twice-a-year product introduction cycle."

Former Apple CEO John Sculley: Apple is well-run | TUAW - The Unofficial Apple Weblog

Suggesting that Apple is moving to a semi-annual cycle is a very provocative thing to say, but it's something I've also speculated is happening during a Critical Path podcast.  Sculley's comments prompted me to weigh the possible evidence that this is happening:

1. All of the major products which Apple sells have been updated in the Fall. This is unprecedented. Not only were product launches scheduled in the spring, historically they had been spread throughout the year. The odds that they happen to coincide by accident are nil. Not only that but the move of iPad and iPhone and iPod and MacBook and iMac to launch all within Fall (once a year) seems risky because it leaves a vast gap for competitors to fill six months hence. Indeed, given the iPhone's launch predictability, many (most?) competing products already target launching in the Spring.
2. Launch ramp for iPhone steeper than ever. The number of countries and operators launching the product in the launch quarter is nearly the entire distribution list. This is also the first time this has happened. Not only does it imply a very steep ramp, it indicates no channel fill will be happening past Q1. There will not be incremental sales to unserved customers as the fiscal year wears on. 
3. Consumer anticipation. This year saw two quarters where sales were soft due to "product transitions" as awareness among the mass market of new product rumors caused growth to dry up. Too many potential buyers are now conditioned to wait for fall to buy iPhones thus sapping demand for half the year. Apple ends up with an inability to meet demand for half the year and a sales lull for the other half. Clearly this is suboptimal.
4. Hon Hai production has shifted to locations closer to the sources of labor. This may not seem to be relevant but we have to appreciate that Apple makes up nearly half of Hon Hai's sales volume and hence labor demands. Until this shift, Hon Hai's production has depended on migrant labor which is difficult to manage. Moving production so that the labor is local means a steadier workforce with better economies from learning curves. However it also requires a more stable order book. Production for Apple has tended to be "bursty" with breakneck round-the-clock crush followed by periods of idle time and re-tooling. This is not only inefficient but it also creates strain and stress and lowers morale.
5. Capital Expenditures de-coupled from volumes. This is a weak signal at this time and needs confirmation, but capital expenditures seem to be outpacing production. The recent bursts in CapEx may be transient or may have to do with tooling-up Samsung's replacements but it may also imply a move to a more rapid product cycle. A transition to a new operating model would require significant over-spending in advance of the shift.
6. Rumors of 5S products in pre-production. This is the least valuable piece of evidence but it might indicate that the "S" variant is targeting spring launch. I should point out that the "facelift" model change is common practice at many phone companies. At Nokia the convention was to launch an "i" variant to a model before a bigger update. Even at Apple, the iPod was going through a re-fresh during February with a "Valentine's Day" variant being released. Then there's the case of the white iPhone 4 which seemed to take forever to launch but finally did so into an April time frame. Finally we just saw the iPad retina product go through a six month cycle.

Admittedly, these are circumstantial pieces of evidence but they do corroborate Sculley's claim of a six month product cycle.  Put another way, if Apple is not switching to a six month cycle then there seems to be a lot of stress for no benefit.

I would also add that this change in cycle time is an enormous undertaking. Since Apple is an integrated company, not only production but marketing, design, hardware and software engineering must be re-configured. To put it in perspective, when Ford changed its operating mode from producing one model to a flexible mass production method pioneered by General Motors, the company had to shut down for production for six months.

The operational aspects are daunting and would affect almost all employees in the company. Therefore if it is happening it's also possible that there is some knowledge of this change dissipating outside the company, perhaps explaining Sculley's confidence in the claim.

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Looking for more information on the renaissance of production and its the effect on the technology industries? Then come to Asymconf and take part in the debate.

Samsung Electronics' SG&A expenses are curiously high. Consider the following graph:

It shows SG&A as reported by Samsung and Apple over the periods 2010, 2011 and the sum of the first three calendar quarters of 2012. Note that Samsung appears to be spending three times as much as Apple on sales and administration.

The company offers a break-down of these SG&A costs and they are also shown (Apple does not provide a break-down except for advertising in its yearly report). The suspicion that something is not right comes from looking not only at the overall picture but the notion that Transportation, Warranty and "Other" for Samsung are higher than overall SG&A for Apple.

Note that Apple's SG&A includes the cost to operate its retail stores. This includes the salaries and operating costs of over 300 stores.

Considering that many of these costs are borne in the sale of products for consumers (and not borne in the sale of components such as semiconductors,)  the percent of sales of some of these expenses are:

• Advertising: 3% of consumer sales
• Sales promotion: 5%
• Transportation: 4%
• Warranties: 3%
• Public relations: 0.5%

Excluding wages and commissions shows a total of 15.5% of consumer sales paid in SG&A expenses. Apple's total cost for SG&A was only 6.5% overall. Advertising was 0.78%.

I also added to the graph data for 2012 (through first three quarters.) It looks like Samsung SG&A will easily reach $30 billion this year, staying at three times Apple for another year.

I don't have any explanation for this disparity.

9:00 to 10:15 Being Back. How California came to disrupt

The disruptive history of California is remarkable. Whereas few nations can claim credit to one, California is home to at least four major disruptions: Semiconductors, recorded entertainment, venture capital and personal computing. And it did all this in less than one century. If any one place can vie for the title of "serial disruptor" it's California. One success can be seen as luck, but many successes imply a system is at work. In this case session we discuss California's disruptive history and put forward hypotheses on the what causal mechanisms are at work. We ask further whether California can still be the home of future disruptions or whether the system has broken down.

• The effect of "frontier mentality" on unforeseen growth
• The effect of migration and diaspora on innovation and counter-effect of the absence of either.
• Applying these causal themes to the management of innovation in institutions

10:15 to 10:30 Break

10:30 to 12:00 Designed in California, Assembled in China

Geographically and culturally, California is closer to Asia than any other western market. It has always faced west more than it has faced east. Is there a symbiosis between California and Asia? Are its institutions adapting to a new center of economic mass? Is California leading in thinking or culture or is it being disrupted by a new frontier as growth moves east?

• The growth in Asia and China in particular is in many ways a reflection of rapid industrialization. But it can also be seen as a low-end disruption.
• What can be learned about business model innovation in the contrast between Californian and Asian approaches to business?
• Does culture play a part in an innovation mentality?

12:00 to 1:00 Lunch

1:00 to 2:15 Guest presentations and Panel session

Guests are invited to debate or discuss points raised during the morning sessions. A chance for panelists to challenge or refute points made as well as for the provision of anecdotal evidence.

Potential panelists:

• Ben Bajarin
• Michael Lopp (aka @Rands)
• Jean-Louis Gassée
• Om Malik
• Charlie Kindel
• Dan Benjamin
• Philip Elmer-DeWitt
• Tim Bradshaw

2:15 to 2:30 Break

2:30 to 4:00 North vs. South

Does the tension between industries of Northern California and Southern California reflect an opportunity or a crisis? We will re-visit the narrative of what Entertainment is hired to do. We will review the differences and similarities of the technological creative process vs. the artistic creative process. We will see whether industrialized, commercialized art is subject to disruptive forces or whether there is persistent exceptionalism at work.

• Is the intersection of "liberal arts" and "engineering" more than a metaphor?
• What can be learned by cross-pollination of the creative processes of engineers and artists.
• What's the future of technology-based entertainment? Are North and South closer and have more in common than the war talk lets on?

4:00 to 6:00 Reception

Please register here.

As first introduced last week, Samsung's revenues have grown primarily due to the expanding volumes of smartphones. In today's post I convert the revenues and operating incomes to US Dollars and compare them to a set of companies.

First, I should note that Samsung has changed both the designation of its divisions and the way it reports revenue. Broadly speaking, Samsung Electronics has four major divisions:

1. Semiconductors. This includes memory products as well as systems such as CPUs.
2. Display products. This used to be called "LCD" but has been re-named Display Products.
3. Telecom. This is mainly mobile phones but includes additional products and services for telecom operators and PCs. The division has recently been re-named IM (IT and Mobile communications).
4. Consumer Electronics. This group has changed names from Digital Media and Appliances to CE. The majority of sales value comes from televisions but also includes consumer electronics and appliances.

The company further combines Semiconductors and Display Products into a group called DS (Device Solutions) and Consumer Electronics and IM into DMC (Digital Media & Communications).

I tried to reconcile these various nomenclatures with color coding in the following graph. Semiconductors are blue, Display components are red, Consumer Electronics are Yellow and Mobile are grey.

Each gridline represents $10 billion.

One more point to note about revenue recognition: Relatively recently the company has switched from reporting consolidated revenues to gross revenues. This means that current sales include inter-segment sales. So, as much as it is possible, the data above shows sales from division to division as well to external customers.

When it comes to reporting operating income, the company offers four segment values: Consumer Electronics (Appliances, TV, "Digital Media"), IT and Mobile (including mobile phones), Display Panel (formerly LCD), and Semiconductor.

I used the same color coding to show the income values in the same scale as the graph showing income:

It's now possible to compare Samsung Electronics with Google, Microsoft and Apple in terms of divisional (as a proxy for product-line) revenue and profitability over a five year period.

At this time, a portion (majority?) of Samsung's grey area in the operating income graph represents the vast majority of profits obtained from Android across the entire ecosystem.

In the post "Google vs. Samsung" I compared the profits of Google and Samsung Electronics' mobile (aka Telecoms) division. It showed how Samsung has grown its mobile business to such a degree that, if sustained, could conceivably influence the way Android is controlled.

However, we should not analyze Samsung's mobile group in isolation of the entire company. Samsung relies on internal transfer of technology and capacities of production which are quite unique for device vendors today. In other words, Samsung is a relatively integrated enterprise. Understanding the whole is necessary before understanding the part.

The following graph shows the sales and operating profit for  Samsung Electronics as a composite of its divisions since early 2008.

As one would expect, the mobile group (Telecom) is the source of both top and bottom line growth. The group has also been leading in terms of margins and increasing those margins steadily. 

The margins averaged 11% during 2007 and 17% during the trailing four quarters. This 54% increase in margin has been matched by a 55% increase in average selling price (from $151 in 2007 to $234 in the latest quarter).

One could argue however that a 17% operating margin from a group that is now leading in volume and price is still a bit weak. At its peak Nokia enjoyed a 25% operating margin, RIM 30% and HTC 27%. Apple's iPhone operating margin is around 45%.

I think a large part of the margin story is a relatively high level of spending on SG&A (Sales, General and Administrative) which includes advertising, sales promotion and commissions. In the case of Samsung Electronics, as sales has grown these expenses have grown in proportion. As a percent of sales SG&A have held relatively steady at around 17%.

Note that as Apple's sales have grown its SG&A has grown less rapidly resulting in a smaller percent over time. We might see Apple's SG&A drop to 5% during the present quarter, an all-time low.

So one of the more remarkable aspects of Samsung's success has been their willingness to increase promotional spending. Considering that their other divisions don't require as much "marketing expense" (semiconductors, LCD certainly, and TVs and Appliances to a lesser degree due to a smaller sales growth) we can imagine that the vast majority of this promotional spending has been in support of their mobile brands, Galaxy in particular.

In fact, we can obtain advertising spend data from annual reports.

The chart above shows comparable ad spending from a cohort of technology companies as well as Coca Cola and Samsung Electronics.

It might be surprising to note that Samsung spends considerably more than Apple and Microsoft. But it also spends more than Coca Cola, a company whose primary cost of sales is advertising.

However, advertising is not the only form of promotional spending. Samsung also pays commissions and "sales promotion". The following chart shows the value of these sales promotions relative to the ad spending budgets above.

 

We don't have data on the current year since that is released after year's end, but it's interesting to note that promotions cost more than ads, which themselves are substantial relative to other companies.

The company also reports "Marketing Expenses" every quarter[1]. These figures appear to be the sum of Ad spending, Sales Promotions, Public Relations and a portion of "other" expenses as a part of SG&A.

When considering all marketing expenses, Samsung Electronics' sales efforts begin to look quite astonishing.

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Notes:

1. The data used in the latter three charts are available as a Google spreadsheet here.

An update on Asymconf California, a discussion of engagement and why Android does not get enough of it, why Amazon likes giving away Fires and the causal hypothesis of Samsung's success in smartphones. That plus announcing a new 5by5 show: High Density.

via 5by5 | The Critical Path #65: The Shoe Seller's Dilemma.

Asymconf is developing well. Workshops are at 75% 90% capacity. I'm also delighted to also announce some of our distinguished guests:

• Ben Bajarin
• Michael Lopp (aka @Rands)
• Jean-Louis Gassée
• Om Malik
• Charlie Kindel
• Dan Benjamin
• Philip Elmer-DeWitt
• Tim Bradshaw

More to come.

Following yesterday's IBM data, Monetate released a new study showing similar data related to retail browsing but covering a period of dates from Q3 2011 to Q3 2012.

This data also shows an acceleration of mobile shopping, from 7.7% of online in Q3 2011 to 18.8% in Q3 2012.

It also shows tablets growing to take about half of mobile traffic in a very short time frame.

The data also shows the iPad taking the vast bulk of traffic among tablets (88.9% vs. 88.3% from IBM).

The data also shows the iPhone taking 61% of phone traffic (67% from IBM) with the rest being Android.

The data shows the share of iOS being 74% in Q3 while IBM reports 77% for Black Friday.

The data also shows a very small participation from Kindle and Android tablets.

Finally, by using the install base data from ComScore, the data shows an absolute and relative decline in Android engagement. Android phones went from 0.47 of iPhone engagement to 0.4 in one year.

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If you'd like to learn more about the Asymco method, come to Asymconf. The next Asymconf will be at the end of January near San Jose. Not only will you learn about how mobile is disrupting computing, you will also get to hobnob with the likes of Om Malik, Jean-Louis Gassée and Michael Lopp.

 

IBM's Digital Analytics Benchmark reported US Black Friday sales and the news is reasonably good. Overall online sales grew by 17.4% while mobile grew to make up 24% of traffic.

The data goes further to show the split between device types. I illustrate this split with the following graphs:

Of the 24% of traffic made up by mobile devices, phones contributed 13% and tablets 11% (or 54% and 46% of mobile respectively). Of the phone traffic, iOS devices were about two thirds of traffic and Android one third. Of tablet traffic, iPad was 88%, Kindle and Nook were 5.5% Galaxy Tab was 1.8% and other tablets were 4.4%.

Overall, iOS was 77% generated mobile traffic and Android (excl. Kindle, Nook) was 23%.

That's an interesting snapshot of the consumption of mobile devices, but is there a pattern here? I also took a look at the same data from 2011 and 2010.

Besides the pattern of significant mobile growth (from 5.2% to 24% of online in two years) there is the curious effect of iOS growth outpacing Android growth. Android went from 1.43% of Black Friday shopping traffic in 2010 to 4.92% in 2012. In same time iOS went from 3.85% to 18.46%. In other words, while Android is up by a factor of 3.4, iOS is up by a factor of 4.8.

The reason is evident in the graphs above: the iPad is now the predominant mobile shopping device. You can observe the pattern in the following graph:

Two years ago the iPad was trailing Android usage but this year it was more than twice Android usage. Curiously, the iPhone seems to also be pulling ahead of Android.

Curiously because the number of Android users in the US has gone the other way. That data is available from ComScore, though only for phones. (ComScore data for periods ending November each year, Nov 2012 is my estimate):

Having the number of users and the traffic allows us to measure consumption per capita, so to speak. That is, the percent of traffic per device user:

The ratio shown is basis points of usage (1/100 of 1% of shopping traffic) per million users of smartphones. iPhone users are about three times more engaged in shopping with their devices than Android users. Two years ago the ratio was two to one.

Overall iPad is changing shopping habits, but it has a near monopoly in its form factor at this point. The bigger question is what is causing phone users to behave differently based on the devices they own. The phone market is more mature and has had several years of competition to be able to discern differences in platforms. The pattern is pretty clear with respect to Android: engagement is down as ownership is up. This pattern has not exhibited itself with iPhone, even though it has had a longer time in market.

Of course, one would expect that later adopters would engage less, but I find it surprising that US Android users would behave so differently only two years after the platform began to be widely adopted. That pattern is not happening with iOS even after five years and certainly not with the iPad which is about as old as most Android brands.

This I consider to be a paradox: Why is Android attracting late adopters (or at least late adopter behavior) when the market is still emergent? We've become accustomed to thinking that platforms that look similar are used in a similar fashion. But this is clearly not the case. The shopping data is only one proxy but there are others: developers and publishers have been reporting distinct differences in consumption on iOS vs. Android and, although anecdotal, the examples continue to pile up.

And engagement is not a frivolous platform attribute. It is highly causal to success because it correlates with all cash flows associated with ecosystem value creation. Especially when a platform like Android depends more on engagement than "monetizing hardware."

I'm not satisfied with the explanation that Android users are demographically different because the Android user pool is now so vast and because the most popular devices are not exactly cheap. There is something else at play. It might be explained by design considerations or by user experience flaws or integration but something is different.

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If you'd like to learn more about the Asymco method, come to Asymconf. The next Asymconf will be at the end of January near San Jose. Not only will you learn about how mobile is disrupting computing, you will also get to hobnob with the likes of Om Malik, Jean-Louis Gassée and Michael Lopp.

A dialogue with Benedict Evans, mobile analyst. Benedict has observed not only the technology and telecommunications industries as an equities analyst but also worked for an operator and a major media company. We take a look at mobile strategy and what the media industry will evolve into.

via 5by5 | The Critical Path #64: Mano a Mano.

The iPhone is a severely constrained product. We're used to thinking that it's production constrained—and it is, but it's also distribution constrained. It has a business model that is almost completely dependent on operator subsidy. Few end users pay the $650 average price that Apple obtains and that price point has held for a remarkably long time. This price point is largely invisible to the user.

In this regard it's very different from all the other products Apple sells. Historically, the company has preferred having its customers to also be its users and maintained a direct relationship with them, strengthening that relationship through its own retail channel for the last decade. Pricing is used by Apple as a signal to clearly illustrate value to the user and pricing is part of the communication about the product that Apple makes very explicit. This has been true for the iPod and Mac and is still true of the iPad. But this is not so for the iPhone. The entire marketing strategy for the iPhone (and hence the entire product concept itself) is "off message".

Why is this?

Before we get into causes, let's try to measure the distribution channel for the iPhone. Apple occasionally reports the total number of carriers it has relationships with. The last update was in the summer when Peter Oppenheimer, Apple CFO discussed the quarter ending June:

We added several small regional carriers during the quarter and now have iPhone distribution through over 250 carriers in over 100 countries.…

We added China Telecom as the second [Chinese] carrier in March…

We also don’t expect to add any significant new country or carrier additions in the September quarter…

In addition, Apple publishes the list of operators it sells through on its web site. The last time I counted I got 227 listed operators.

If we contrast this with the total number of global operators (excluding MVNOs) there might be a way to measure distribution penetration. I compiled a list of all such operators based on information available in Wikipedia. You can browse the list here (Google Docs [1]).

This global list includes 802 operators. The list is not current, being mostly based on 2009 data but it's pretty close. I've read that a more recent (non-public) estimate is 816.

By this measure we can say that Apple has distribution through about 30% of the total operators. Consider also that RIM reports that it sells BlackBerry through 565 wireless carriers in over 175 countries. By this metric alone BlackBerry has twice the addressable market of the iPhone.

But we can do better than counting operators. We should account for the fact that some operators have more subscribers than others.

Using the same database, I measured the subscriber count of iPhone distributing carriers vs. overall subscriber count. The ratio was about 50%.

iPhone "addresses" about 2.8 billion connections whereas there are about 5.7 billion available connections. Note that this is not users but subscriptions—essentially SIM cards.

The ratios vary by region:

• Middle-east/Africa has 29%
• Asia/Pacific is at 39%
• Europe 73%
• The Americas 83%

 

We can take it a step further and identify which countries hold the highest opportunity for iPhone distribution. The top 5 are:

1. India: 658 million
2. China: 622 million
3. Pakistan: 116 million
4. Russia: 102 million
5. Nigeria: 89 million

But the opportunity is not only in emerging markets. Japan is a 69 million subs opportunity and even the US has 80 million subs without direct (i.e. subsidized) access to the iPhone.

So we can now return to the question of why the iPhone is sold the way it is.

First I should point out that the addressable market of Samsung or Android in general is larger than that of the iPhone. Samsung has relationships with far more operators, at least on the scale of RIM or Nokia, perhaps even more. It might be safe to assume that Android is completely unconstrained in distribution and therefore its addressable market is the entire subscriber space (meaning that Android has twice the addressable market of the iPhone.) For Apple to compete on the basis of volume or market share it would make sense to broaden this network. So what's holding it back?

I think the answer is the other constraint mentioned: production. The company is still iterating the product on a yearly basis and needs to ramp production to reach all its carrier partners in a timely fashion. The carriers use the iPhone as differentiation and a way to uplift their core business. Therefore they want the latest version as quickly as possible. To satisfy this, Apple needs to manufacture the latest variant very quickly. But that's not easy. Peak production is one thing but getting there quickly is another. This is the problem which Apple's vast capital expenditures is trying to solve.

So far the production capacity has been increasing at nearly 100% per annum. This is an astonishing achievement but it's still not enough. The product is supply constrained during much of the launch quarter. Therefore, to summarize, the entire business model for the iPhone revolves around this question:

Can enough units be shipped in a sufficiently short time frame to allow a limited (but large) subset of operators to create competitive advantage which sustains a generous up-front subsidy.

At this time the answer seems to be that the model can work for about 30% of operators serving 50% of subscribers. The crucial question for the business is how much higher can these numbers get?

Note that this is not a debate about market share or consumer preference but about delivering a particular value proposition to network operators, (which sustains a premium price point.) The iPhone is built around this business model and to alter it would alter the very essence of what the product is. The addressable market is one piece of the product but it interconnects with the price, margin, design, production and breadth of offering. You cannot change one without changing the others. It's a product whose distribution model is part and parcel of its design.

I believe that the particular way this product translates into a business is very rigid, which is why it has not changed much during the life of the product. This is in contrast to Apple's other products which exhibit more market flexibility. Inter-dependency is not a new concept for Apple products (e.g. iPod/iTunes, Mac/MacOS) but the iPhone shows a level of inter-dependency with distribution and production the likes of which has never been seen.

This topic will be further discussed at Asymconf in January as the fourth quarter data will then be available and there will be an opportunity to debate it live with an august audience.

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Notes:

1. The database is neither current nor complete. If you would like to help maintain the data based on local (public) information, please get in touch and I can grant access to edit it.