Horace Dediu

In terms of platforms, IDC expects a relatively dramatic shift between 2011 and 2016, with the once-dominant Windows on x86 platform, consisting of PCs running the Windows operating system on any x86-compatible CPU, slipping from a leading 35.9% share in 2011 down to 25.1% in 2016. The number of Android-based devices running on ARM CPUs, on the other hand, will grow modestly from 29.4% share in 2011 to a market-leading 31.1% share in 2016. Meanwhile, iOS-based devices will grow from 14.6% share in 2011 to 17.3% in 2016.

Via: IDC - Press Release - prUS23398412

The company provides a stacked bar chart (follow link above) to illustrate their view of the market. I took the data they included and measured the implied growth rates for the product categories:

IDC is implying that in four years the tablet market will be growing at 10%, the Smartphone market will grow at 11% and the PC category will grow at 11%. In other words, five years from now the PC market is expected to grow faster than the tablet market and just as fast as the smartphone market!

What's more remarkable is that this situation is not going to happen in four years. The slowdown in growth is actually expected much sooner. The growth rates two years from now are expected to be: Tablets 17%, Smartphones 15% and PC 10%. IDC is unequivocal: by 2014 the good times will come to an end to the post-PC challengers. These growth rates would be catastrophic for share prices and the value propositions of the new platforms to developers, partners and consumers.

What's more, these growth rates are striking not only because they predict a collapse in the value of most market challengers but that they also predict a strongly resilient PC market. How can we test this forecast?

I tried to reconcile this doomsday scenario with what is known about the components making up the data. I.e. what "bottom-up" data is IDC using? In the quote above, IDC offers some insight into this market participant data. Based on the category and share data they published it's possible to infer the following:

Bearing in mind that neither iOS nor Android existed five years ago, we can observe they are bigger together than the PC market. And yet, IDC predicts a compounded average yearly growth rate of 16.7% in Android, 19.4% in iOS and 7.5% in Windows between today and 2016.

In aggregate, IDC forecasts that in the next five years Android will not manage to double and that iOS will only increase by a factor of 2.4. Is this believable?

I try to stay away from long term forecasts, but I do maintain a short term forecast based on recent growth data. My forecasts for this year and next year are shown below.

I super-imposed my short-term forecast (outline bars) on IDC's long term forecast (solid bars) and a several differences become apparent.

First, my 2013 forecast is nearly the same as IDC's 2016 forecast. To see why we need to look at each platform separately.

Perhaps we might (with difficulty) agree on Microsoft's potential. I believe Windows 8 will have a catalyzing effect and that Microsoft will begin to see its platform grow again. However, my expectations are modest. To increase Windows sales rate by 100 million units/yr between 2013 and 2016 is possible but ambitious.

The real problem is that our Android and iOS forecasts are outside any zone of possible agreement. Maybe there is a difference in what we measure. For a hint, we seem to disagree on the number of Android devices shipped in 2011. I used Google's own reports of activations to work out the yearly shipment estimates. Perhaps IDC is including versions of Android that are not Google sanctioned.

We also disagree on the 2011 iOS figures. I obtained 156 from Apple's own reports. Again, perhaps the difference is the inclusion of the iPod in my case.

Nevertheless, the difference in the long term cannot be accounted for only through these categorization differences. I would put the cause of the difference down to the methods used in forecasting. As can be seen from the first chart above, IDC's growth rate reductions are extraordinarily steep. Perhaps the approach used by IDC was to forecast the overall market growth and then assignment of shares to participants. This can be called the "top-down" approach. In contrast, my approach is to forecast growth rates based on recent growth rates and moderating these rates gradually. This can be called the "bottom-up" approach.

My experience and all the data I've ever collected about historic disruptions tell me that the entrants tend to win these types of paradigm shifts. They win through a vast expansion of consumption and the recruitment of non-consumers. Markets tend to experience vast shifts in composition. If we believe this to be true then the bottom-up approach focused on entrants is likely to be more effective vis-a-vis the top-down approach of projecting steady state markets and the implicit assumption of incumbent share preservation.

Horace talks to Mike Schneider, a feature film development executive about what development means in the context of filmmaking. We cover the changes the development process faces, the impact of technology on business models and the future role of development in a more integrated film value chain.

via 5by5 | The Critical Path #31: Greenlighting.

Apple's share price has increased rapidly in the last few weeks. The rise to $600 was swift and broke the pattern of slow growth the the stock was able to obtain over the past few years. The level, however, shouldn't have been a complete surprise.

I think Apple is going to $600...It's really not that complicated. Apple has a number of key drivers in its business model which have yet to be properly priced into the stock because I think it's very cheap at this level.

-Stephen Coleman, chief investment officer at Daedalus Capital

This prediction was made October 26, 2007. On that date Apple's share price closed at $184.7. It may have seemed like a bold bet, but as Coleman noted, the reason why it would reach $600 was easy to spot.

The real story on how I get to that valuation doesn't even involve the sale of (the Leopard operating system) or the growth in the Mac business. How I get there is through the iPhone itself.

What was not easy to tell was when it would reach $600. Back in October 2007 the stock had a P/E ratio of 48. It's PEG(trailing) was 0.65, and cash per share was $17. Sales were $6.6 billion for the quarter and earnings were 98c/share. If an analyst were to take those ratios and apply a forecast of sales five years hence, the $600 price would have been reached much sooner: Sales had tripled by 2010 and earnings had tripled by 2009. In contrast, the stock took until 2012 to triple.

The delay of one or two years is perhaps reflecting the risk involved in investing. Namely, you can predict outcomes but not their timing.

But still, we have to return to the question of why the stock has rallied in the past few weeks. There has been no new information about the company since it reported earnings and any product launches (e.g. new iPad) or increased distribution (China) are completely predictable.  Curiously, the market did not react until late in the quarter. The following chart shows the phenomenon.

(Note the two scales on the left: inner is share price, outer is net sales)

It shows the share price as a line superimposed on the sales chart with stacked product revenues. The recent rise can be attributed to the rise in revenues/earnings from the fourth quarter. But why would a stock react in March to data from six months earlier (and published two months earlier).

Classical market theory suggests that markets anticipate and "discount" the future. Efficient markets supposedly react to all available information and do so instantly. If that was the case, the chart above would show the red line shifted significantly to the left.

What we are observing is market inefficiency.

Inefficiency implies that perception of reality is not the same as reality. It happens when people are reluctant to believe the truth. It's also implies that with $15 billion being "bet" on the share price every day, each one of those bets is misinformed!

The cause of this divergence between reality and perception is that disruptions are divergent from perceptions. A disruptive company always "leads" its valuation. There is cognitive delay for the vast bulk of observers. You can then argue that for those, like Mr. Coleman, that don't suffer this delay, there will be profit.

5by5 | The Critical Path #30: Jetlag.

The thirtieth Critical Path is an extended edition covering a broad sweep of topics: The new iPad and the value of filling the gaps, trip report on the Apple Investor Summit, conversations with a TV show writer, Tim Cook's attack on the cash mountain and an update on Asymconf. Horace also talks about his cure for jetlag.

As the chart below shows, the last quarter (fourth calendar 2011, first fiscal 2012) was robust with 116% earnings growth and 73% net sales growth. I've heard many superlatives used to describe it. It is certainly exceptional but it was not as good as the second calendar quarter of 2011.

Sales grew faster both in CQ1 and CQ2 of 2011 and earnings grew faster in CQ2. It was in many ways a return to normality due to the iPhone returning to 133% revenue growth after the lull of the transitional third quarter.

Now it's time to consider the current quarter. It's already quite late in the quarter to make predictions, but I waited to hear some data about the iPad. The iPad remains a difficult product to forecast. Mainly because it is a new category and the pattern of growth takes a long time to establish. We've only had three quarters where y/y growth could be measured. Sales growth has been 180%, 146% and 99%. Unit growth has been 183%, 166% and 110%.

These rates have been higher than the average iPhone growth rates (average of which was 100% in units and 108% in revenues over the calendar 2011). Indeed, the average iPad growth rate so far seems to be 150%.

Is it sustainable?

The answer from this latest launch seems to be yes. The following chart shows the launch performance of the various iOS devices whose launch performance has been announced.

The growth in launch performance between iPad 1 and iPad 3 is a factor of 28. iPad third generation had broader distribution but the volume boost from first generation is enormous. This implies a vastly improved production ramp. As the product remains supply constrained, the most important indicator of performance is production throughput.

So given this data on the iPad and the ongoing broadening of the iPhone distribution network, here are my first quarter estimates (with y/y growth in parentheses):

• iPhone units: 37.3 million (100%)
• Macs: 4.7 million (25%)
• iPads: 12.2 million (160%)
• iPods: 7 million (-22%)
• Music (incl. app) rev. growth: 40%
• Peripherals rev. growth: 25%
• Software rev. growth: 10%
• Total revenues: $42.7 billion (growth: 73%)
• GM: 44.7%
• EPS: $12.0 (88%)

This earnings value would imply a trailing twelve months’ EPS of about $40.7. At $600/share the P/E would be 14.7. Cash and equivalents will probably increase to $108 billion.

 

In the recent event discussing Apple's cash plans, Tim Cook stated that the primary objective of the stock repurchase program is to reduce dilution from the ongoing distribution of shares to Apple's employees and executives as part of their future compensation.

The amount allocated to this is $10 billion over a three year period.

This sets up an interesting analysis. The company is saying that they will continue to pay employees with newly issued shares (in addition to wages) but that a portion of those shares will be purchased back from the market to reduce dilution.

To understand the impact, it would make sense to look back and observe how many shares were issued in this way historically and consider how much $10 billion buys.

The following chart shows the quarterly change in shares outstanding.

The absolute number of shares outstanding grew from 874.2 million in Q4 2005 to 941.6 million last quarter. That's a net increase of 67 million shares over a six year period. The rate of growth has been accelerating. Over the last three years  40 million shares were issued.

These issuances have an effect for shareholders. They "dilute" the total shares outstanding and thus spread the earnings more thinly. You can get an instant feel for this as the EPS figure must be re-computed each quarter with a different denominator. This is a real cost.

Here is how to compute it. Last quarter there were two million shares issued at a "cost" of about $400/share. That means that shareholders lost the equivalent of $800 million (2 million x $400/share average price in Q4) of value.

Now what Apple has just promised is that they would buy back the equivalent of $833 million per quarter ($10 billion/(3 years x 4 quarters/yr)) for the next three years. Note how close this figure is to the one calculated above.

What we can also obtain is a ratio between stock-based compensation and wage-based compensation. Since we can estimate the total Apple employee wages at $3.2 billion per quarter (average R&D and SG&A over the last year), the stock compensation of $800 million amounts to a 25% bonus.

In other words, on average an employee is likely to get compensation of $X in wages and 0.25X in stock grants.

Therefore Apple's $10 billion dollar pledge is not only a commitment to shareholders that the dilution will be eliminated. It's also a signal to employees: for at least three years, Apple will continue to offer shares as compensation and will do so in a ratio of 1:4 of wages.

This seems like a good use of cash.

Today Apple announced both a dividend and a share re-purchase plan which, when combined, will consume 45% of Apple's current US cash reserves.

The dividend will be $2.65/share/quarter and the buyback will cost $10 billion over three years. The dividend will therefore cost about $2.5 billion per quarter (starting next quarter) and the re-purchase will cost about $833 million per quarter (starting next fiscal year).

However, note that Apple's cash has been growing far more quickly. It increased by $16 billion last quarter or $37 billion over the last year. This rate of increase is itself increasing.

To illustrate, I prepared the following chart. It shows historic net income, change in cash and a forecast of the costs of the new uses of cash and future net income (based on my estimates).

I made an assumption that future cash growth will equal net earnings minus costs for the new dividend and share re-purchase. What we should see is that the previously tight coupling between increase in cash and earnings will remain but that there will be a negative offset by $3.333 billion each quarter. In other words, cash will increase but at a slower rate.

This means Apple's total cash should still grow by more than $35 billion this year.

That would result in the following, more subdued, total cash trajectory (for simplicity, I assumed all added cash would be in cash and cash equivalent accounts)

We discuss the five characteristics of disruption: Net growth and value creation, inevitability, increased speed of change, necessity for macroeconomic growth, historical consequences. This and much more will form the basis of discussion for Asymconf.

via 5by5 | The Critical Path #29: The Consequences of Disruption.

@mastermmik: love how @asymco thinks of everything and everyone as being "hired" to do something. lol

via Twitter.

Hiring products to do jobs for us is not a difficult cognitive leap to make. But can we extend the metaphor to "everything and everyone?" Aren't there parts of the human experience that are outside the realm of the implied trade that hiring suggests?

Of course there are.

There is an implied rationality to the practice of hiring. Commerce itself is implicitly, at least partially if not totally, rational. Buying and selling depends on a mix of instinct and calculation. And yet much of what drives human activity is not motivated through the calculus of rational thought. It could even be argued that, as we are all gifted with emotions, instinct and passion, we are anything but rational beings.

The epitome of the triumph of the emotional over the rational is the practice of making art. Art is created to stimulate or cause appreciation. The appreciation is the reward. There is no calculation.

However, during the last century the arts have become industrialized. That is to say that works of art are produced for profit on a grand scale. The technologies of communication and media have meant that the appreciation of art has turned into the entertainment of the masses. And since these creations are made for commercial gain then it is not only fair but fitting that entertainment should be analyzed as product.

The industry resists analysis not just because it's difficult to define the product but because it's difficult to define why it's consumed. The 'job-to-be-done" framework that leads to insight about which products to build and how to design them seems to fail when we look at a product that seems to exist only to be appreciated.

To suggest that appreciation can be categorized sounds presumptuous. Human perception is infinitely nuanced and every person can perceive differently from another.

And yet, for resources to be allocated (aka. financing) or for development decisions (production) or promotion (marketing) a theory has to exist about who buys and why they do it.

The theory that seems to be in common use in the industry is that a few experts have the knack for knowing how to allocate the resources for what is created. These persons are entrusted with an increasingly large influence. There are only a few major studios for deciding what most of the world consumes in the form of either visual (cinematic) or audio (music) productions. The concentration of power is a result of the distribution model of physical media or broadcast networks. These are artifacts of a technological infrastructure that was built in the last century. An infrastructure whose replacement is unavoidable.

Its replacement will enable creation and distribuion of art to be democratized[1].

It's important to understand the jobs entertainment is hired to do. Not because the creative process can be synthesized. It's important because those creators need to learn how to allocate their own resources. A framework is needed to help dis-intermediate the resources allocators--the central planners, if you will.

In other words, learning how to create commercially valuable appreciable products should be a skill all creative people possess.

These are not complicated ideas. They don't require powers of deduction beyond the reach of the average person. What they require is perspective.

The dialogue on this topic will begin in Amsterdam on April 13th 2012, at Asymconf. I look forward to seeing you there.

—

Notes:

1. The proof of this is left to the reader.
2. This is the material accompanying the first case discussion at Asymconf. Participants are encouraged to read it before the show.

The phenomenon we call business disruption could benefit from a different name. Although it signifies a disturbance or an interruption in an industry, it's much more than that.

The nominal definition I work with is that disruption is the "transfer of wealth in an industry from dominant incumbents to disadvantaged entrants." It's a convenient definition because it's brief, it puts the emphasis on economic value and because it alludes to a reversal of fortune and the implied extraordinariness.

However, there are several nuances lost and contradictions ignored in this definition. I want to enumerate them here and now:

1. Although in a disruption there is a transfer of wealth, that wealth is not necessarily conserved. An industry that undergoes a disruption often emerges larger, more productive or more influential. Disruption typically creates net growth.
2. Although extraordinary and spectacular it is also very commonplace. Disruption is not rare. In fact, it rarely fails to happen. One could even say that if it does fail to happen, it's a symptom of an industry in crisis.
3. Being so common, it can be seen as a regular occurrence. But if the regularity of disruption can be considered to have a clock cycle, its frequency is increasing.
4. Disruption in the literal sense implies discomfort, displacement and even destruction. But it's necessary to the health of any economy. The analogy to biology is that death is the most important thing in life.
5. Although only recently characterized and studied in cases set in the past century, the pattern is evident throughout history.

I've offered examples of these consequences or side-effects of disruption but I'll emphasize once more the example I'm most familiar with. To illustrate the primary definition, the AMP index is a measure of the success of one company relative to a set of peers in the mobile phone industry. It's the average of four market shares: mobile phone units, smartphone units, revenues and operating profits.

This chart shows the shift in AMP index values for the competitors whose data is public and which make up the vast majority of units sold:

The reversal of fortunes, though not complete, is clearly evident. Motorola and Sony-Ericsson, two of the brands that were a significant part of the mobile phone landscape for more than a decade, have ceased to exist as independent companies. A third, LG, is likely to follow. Nokia, the most successful phone vendor for the decade of the 2000's is in severe distress at this time, valued barely above book. RIM, a pioneer, is priced below book value and HTC, another pioneer is also looking for a way to remain relevant.

But we have to appreciate that as these valuations evaporated, the market grew both in value and in volume. The overall spending on phones has never been higher. The total profits captured is also growing. By any standard, smartphones are a booming business. Queues form for the latest versions, there are supply constraints and media coverage is almost universal.

We also have to appreciate that the Nokia that is faltering today was itself disruptive when it gained its prominence. In the 1990s the mobile phone market was dominated by Motorola, then by Ericsson. Nokia was a relative latecomer and succeeded by being better in some regards (e.g. the ease of use of text messaging on its phones) but also by being asymmetric. Using logistics and a portfolio approach to the market allowed it to build scale while maintaining margins. Process innovation led to component shortages for competitors and allowed Nokia to build massive distribution. It also allowed it to invest in software which gave it a unique selling point for several years.

Looking into the even more distant past, the mobile phone market has seen several waves of disruption. Going from analog to digital was such a turnover. The companies which were successful with analog (mainly Motorola which supplied not just handsets but infrastructure) were sidelined when global digital standards took root. Integrated European vendors dominated a period when 2G GSM was becoming predominant. Isolated pockets of integrated innovation like iMode in Japan also had mini-booms but were swamped by standardization and the Galapagos syndrome.

And let's not forget that mobile itself has been disruptive to fixed line telephony. Looking at all telecom, the transitions from fixed to mobile, analog to digital and most recently feature-based to computing-based platforms have all been disruptive, bringing a new set of companies to lead while incumbents fretted.

It should also be noted that these changes are happening more rapidly. The chart above has a five year period. The change from analog to digital took longer. Over 10 years since its inception analog was still dominant. If we look how long it took for mobile to take consumption away from fixed, that process is still ongoing, several decades later. The speed is so slow that some countries have skipped over fixed networks altogether.

With software-defined devices and cloud-based distributed computing the changes will become even more rapid. Even though the user base is expanding to cover nearly the entire global population, the replacement rate of devices means that change in the tools and services people use are limited by supply rather than demand. Supply-based innovation or "the new manufacturing" will probably be the dominance-defining asymmetry of the next decade.

The disruption of mobile phones that Apple has foisted on the world through iOS has caused it to reach a point where it dwarves the values of other companies, not just in the sectors it competes, but in all sectors. Some suggest that Apple is an anomaly and does not reflect the economy. To truly understand the state of the economy, they say, means to subtract Apple from it. But I feel this is exactly wrong. Apple is, through the iPhone and iOS ecosystems, defining this era. Just like Microsoft defined an era of increased productivity through the creation of the "knowledge worker", or like GM re-defined transportation and the notion of the brand in the 50's, or like IBM re-defined business process efficiency with automation in the 60's and 70's, these companies were not anomalies of their era. They were the eras. They were the locomotives of growth that taught other companies how to operate and the contemporary managers how to manage.

Companies that study Apple today will benefit by understanding how it re-wrote the rules. The anomaly is the norm. The exception is the rule. The times they are indeed a-changin'.

Finally, to put disruption in a historical perspective. I wrote a retrospective on the history of the telegraph as a parable of how disruption could be interpreted to have happened even a century ago. What I hope to do now is to show how, given this set of spectacles, we can see how the fate of nations was determined, in part at least, by the ability of leadership to accommodate disruption.

The case of growth or limits to that growth, the question of integration vs. modularity and the evolution of value chains all have application for regulators, policy makers and political leaders.

The dialogue on this topic will begin in Amsterdam on April 13th 2012, at Asymconf. I look forward to seeing you there.

---

Notes:

1. This is the material accompanying the first case discussion at Asymconf. Participants are encouraged to read it before the show.

Regarding the recently proposed Reception and workshop at the Apple Investor Summit, registration is now open.

You can purchase tickets here: asymco-workshop

Details and venue:

Time: 6:30 PM Thursday, March 15th
Location: Room 511, Los Angeles Convention Center, West Hall (across from the Ballroom).