We start with Mini’s plans to sell 100,000 cars in the States by 2020, nearly double today’s pace and remember how Cadillac destroyed their brand and how Mercedes, Porsche, Ferrari et. al. can’t wait to do the same.
Also, might retail power in the form of strong dealer regulation limit brand’s ability to improve or address customer experiences? What motivated Warren Buffet to enter the American car dealer business? (With a long aside on what Buffett investment logic is all about and why it’s not contradictory to a growth investor).
When the Apple Watch was launched, all eyes turned to the Swiss watch industry. Analysts measured it and asked if it's big enough to be interesting. Industry observers questioned the competitiveness of an entrant vis-à-vis the ancien régime. Marketers weighed in with segmentation hypotheses and how Apple's queer new device might best fit.
These are all mistakes in analysis.
The market for Apple Watch is not the Swiss (or Chinese) watch market. The market for Apple Watch is the number of wrists in the world. To the extent that those wrists will be covered with Apple hardware will determine whether it is successful or not.
Measuring the existing market is a mistake because the existing products are hired for different jobs. Those measurements will yield only an answer to how big that job is.
Assessing competitiveness vs. incumbents is a mistake because incumbents have perfected solving the problems of wrist-worn timekeeping devices over a century. Apple's watch is not a wrist-worn timekeeping device any more than the iPhone is a phone or the iPad is a pad.
Segmenting the market by whatever means are convenient today is irrelevant because the segments are currently positioned on the current jobs to be done. It's no more relevant than classifying the iPhone along the segments defined for phones in 2007. ((e.g. keyboard phones, flip phones, and feature phones))
Some have tried to wedge the Apple Watch among the "fitness tracker" market. This is no more plausible given that fitness tracking is no more interesting than timekeeping is to Watch.
The best way to measure the opportunity is to quantify the "wrist-space-time" continuum and deciding what is and what isn't addressable. The wrist is an interesting place to put a computer and Apple makes computers. The rest is left as an exercise to the reader.
Samsung's smartphone ascent was breathtaking. From having essentially zero market share in the category in late 2010 to becoming the largest vendor took less than two years. In doing so it grew to become the largest phone vendor, smart or not--a goal which eluded them during the previous decade of effort. Samsung went on to capture not only the lion's share of unit volumes, they also took almost all the profits in the Android mobile phone market.
And in a market filled with competitors. Literally hundreds of vendors and thousands of products were available at every conceivable price point. Samsung did away with HTC, LG, and Motorola. HTC, the first Android vendor (and first to market with Windows Mobile), Motorola, Google's launch partner in the US and "Droid" brand partner (and future owner). Google's own Nexus products. Samsung Galaxy ruled them all.
Galaxy swamped the Chinese market and the Indian market, the largest in the world. They were so powerful that they were singled out both by Microsoft and Apple for IP royalties.
All within two years or the average life-span of one smartphone.
But something went wrong in 2014. Growth in shipments suddenly stopped. This was not a problem with the overall market, which kept growing. The slowdown did not affect other vendors, especially the up-and-coming Lenovo and Xiaomi and the second and third tier vendors whose names are known only in the local markets they serve.
The result of this slowdown is shown in the following graphs:
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Note how the wobble in units shipped was foretold by slowing revenues and an even more profound effect in profits. Peak revenues and profit occurred in Q3 2013 while volumes continued to grow until Q1 2014. Even in the last quarter, shipments are at near year-ago levels. Profits however have dropped to 2011 levels.
At the same time, Apple shipments continue to grow as do those of Lenovo, Huawei and Xiaomi. Xiaomi in fact is growing in a trajectory eerily parallel to that of Samsung from 2010. It just hit the same level of volume that Samsung had in Q2 2011. And Samsung had been making phones for decades while Xiaomi is barely two years old.
Having seen a boom/bust rise/fall pattern with other vendors (e.g. Nokia and Blackberry) it should behoove us to ask what are the causes of success and failure in this business. Samsung management suggests that they perceive speed of action, product mix/portfolio choices and hardware experimentation are the keys to their success.
However, competitors which are rising rapidly (at the expense of Samsung) are not acting in the same way. Xiaomi is patterned as a Chinese Apple, offering design, brand, attention to detail and software as differentiation. Lenovo is building on its computing roots and expanding with acquisition. Huawei and ZTE leverage networking business and operator relationships.
The crisper answer to causality may be that the market is bifurcating into an "upper" market where new jobs-to-be-done are being explored with integrated offerings (Apple and Xiaomi) and a "lower" market which is in the throes of low-end disruption. Both are competing with non-consumption though the upper market is service non-consumption and the lower market is feature non-consumption.
Samsung is stuck right in the middle ((Just like Nokia was.)) It defines itself on the basis of what exists. It competes only within a defined market and positions itself agains existing products. They claim to be "better" than the competition and make the point loudly with their advertising. However, being better is never a solid foundation. At some point you'll be either good enough or someone more agile will be faster than you.
At some point the fast follower exposes themselves to being faster followed. Better to find new lands to conquer.
Based on the analysis of Capital Expenditures (as forecast by Apple in their annual 10K report) I concluded "iOS unit shipments should be between 250 million and 285 million."
The answer turned out to be 247 million. ((Including an iPod touch estimate of 9.5 million)) Including Apple TV the total would probably be around 251 million.
Since last year, I adjusted my model by observing corresponding iOS unit shipments for the calendar year corresponding to each fiscal year. Since the calendar year is offset by one quarter (FQ1 = CQ4) looking at calendar year means looking forward one quarter post-spending. I believe this is more accurate as spending generally happens in advance of production.
The resulting pattern is shown below:
The company is currently anticipating spending $12.4 billion on non-retail CapEx. The spending for last fiscal year was almost exactly what was anticipated in the previous 10K. If we calibrate production (with a 3 month shift) to the 2014 benchmark, then 2015 calendar year would see about 310 million iOS units.
The big question is whether this will include Apple Watches. To answer this we have to make many guesses:
Does the company have a deliberate production plan for Apple Watches? What is the lead time? How quickly can production be ramped given channel and demand?
Do Apple Watches require significant capital expenditures? Do Apple Watches require capital intensity similar to iPhones and iPads? How unique are the watch cases, straps and computing cores? What are the demands of the digital crown, the sapphire crystal, the display?
The capital budget of $10.5 billion in F2014 had to cover the ramping of the iPhone 6/6Plus as well as some of the new Macs, iPads and the Arizona sapphire plant ((Note that some of that would have been in 2013 and at about $0.5 billion, the plant was about 5% of CapEx)). It also had to cover some of the new campus ((The construction cost of $1billion/yr would amount to about 8% of the capital spending (non-retail) )). In previous years the capital budget also covered data center construction ((Including vast renewable energy infrastructure)) which may not be present in the future budget.
The non-retail capital budget is anticipated to increase by 18%. There are more moving pieces next year than usual, but directionally at least, CapEx remains a strong indicator of future iOS growth. Especially as it's given to us a full year in advance.
In Q3 2014 Apple's revenues were 5.3% higher than the upper end of their guidance. This is the highest error in guidance since the new range-bound reporting regime started two years ago.
The following graph shows the guidances given since 2005 and the actual revenues. The error (as a percent of upper guidance) is given in the second graph.
Note how since the newer, presumably more accurate method was introduced in 2012, the errors have decreased on average. As a result, for these two years, forecasting performance for Apple was no longer challenging. The only questions for the analyst were how to allocate the revenues among products and to guess how many shares would be retired.
Is this about to change? Could forecasting make a comeback as sport and leisure?
Assuming no error in Q4 yields the following shipment forecast:
That's about 95.5 million iOS devices in the quarter. That also means that the one billionth iOS device will have been sold sometime in the next few weeks. ((McDonalds took 23 years to serve its first billion hamburgers)) ((Over 650 million iPhones, 115 million iPods touch, 265 million iPads))
The problem with getting better is that if you're more than good enough you're actually getting worse. Improving beyond the point where your improvements can be absorbed is not only wasteful but it's also dangerous. It opens the door to competitors who compete asymmetrically.
This is the perverse and pervasive threat hanging over all system vendors. The temptation to "get better" is not coming from incentives and human nature. It's always there as Moore's Law offers an exponential increase in power. People don't naturally have exponentially increasing needs. For them to absorb this new power, it has to be couched in new uses.
What has permitted the absorption of improvements in semiconductor performance (and production) have been other aspects of the system: the software, communications and services innovations have been positioned on more demanding jobs to be done which, once hired for those jobs, saturate the available processing and storage.
This is most easily evident in how digital photography has advanced. The constraints on sensors meant that quality was initially poor and as cameras were unconnected, they were relatively under-utilized. But once software and communications were added (by inclusion in smartphones) digital photo creation exploded. This, in turn, led to more storage needs both on the device and the servers. In a virtuous cycle, more processing power meant video was possible, then high definition video, then slow motion high definition video. The previous storage limits on mobile devices were quickly overwhelmed. Megabytes of storage became gigabytes and then hundreds of gigabytes. Video editing meant processing power was suddenly in demand again. Cores multiplied.
Third party media (music and videos) storage and playback used to be the main job that storage was hired to do ((Which was far more demanding than office-like documents)) but as cameras got better, user-generated content suddenly bellied up to the bar.
That is now the story for phones, which are gobbling up all the storage and bandwidth we can throw at them. But what about the larger form factors? Are iPads (and laptops) growing in their demands? Paradoxically, it would seem that the smaller devices are hungrier than their larger cousins.
The answer lies with the jobs to be done. If highly portable devices are more usable, they will be used more. Large devices are left behind, literally, because their jobs are not as pervasive in place and time. For a large screen like the iPad to increase its attractiveness, it has to be the stage for a set of jobs that only it can perform.
The new iPad has the horsepower. It has more portability (thinner, lighter) and it has the touch ID convenience. It even has a better camera. But for it to succeed it needs to be hired for a set of jobs as expansive in usage as the user-generated photo/video jobs that the iPhone has been called to do.
I hire my iPad for one such job: to persuade audiences small and large. I use it across a dining table and across an auditorium to appeal with a visual language. I use Perspective to create stories that have to be seen to be believed and once seen, create belief.
The tool is demanding however. As the stories are fed by data and the visualizations are rendered algorithmically and not as stored images it is hungry for processing power. I also need it to record performances which taxes storage. I need to transmit those performances both in real-time and as recordings, tasking the WiFi and cellular bandwidth. I need as much screen as I can get to be able to interact with the elements on screen, of which there may be hundreds. I need to export video versions of performances and thus I need a video studio with all its extravagance. I need it to run for all-day workshops connected to a projector, sometimes through AirPlay, under stage lights, which pushes the battery.
Consider my last padcast. It was recorded in one take lasting 18 minutes. I then exported the results to a video that was uploaded to Vimeo and viewed by thousands. However it took over one hour to render it and due to that constraint I did not have the luxury of editing it. I could not easily add, subtract or annotate the video production. This was done on an iPad Air and I was happy to get it done at all.
But if I had an iPad Air 2, not only would production time be shrunk ((To about half the time)) the things I could attempt to do with a presentation suddenly expand. It's not just about more efficiency but an expansion of scope. More power means more work I choose to do.
So is the new iPad better? As far as the jobs I hire it do do, the new iPad is better. It is in fact not good enough. Which is the best thing to be.
On the eve of earnings and the "It's been way too long" special event, it's time to look back a few years and forward a few quarters. The instrument chosen is Apple's income statement viewed in Perspective flows.
1. Do you foresee any hope for a turnaround for Samsung? If so, where do its best opportunities lie?
The smartphone business was a huge opportunity for Samsung and they took full advantage of it. Unfortunately, it’s a difficult business to stay on top of. The list of victims in that industry is quite long and there have been no long-term winners. Samsung’s operating model seems to be to invest as a ‘fast follower’ filling in the market after it’s established while leveraging capital intensive components synergies. That has also worked for them in consumer electronics (at the expense of Sony and other Japanese vendors). If the modus operandi does not change then their turnaround will depend on the creation of new opportunities/categories. Wearables may be such an opportunity but it may not be as big as the phone business. ((The graph shows estimates of smartphone shipments for a select number of vendors.))
2. What has contributed most to Samsung's decline? Which competitors are posing the greatest threat?
The fast follower strategy belies its own limitations: it implies a transience or impermanence in strategy. In a fast follower strategy it’s only a matter of time before late followers eat into the business, similar to the way that the fast follower ate into the innovator. Chinese vendors are poised to take more share. The way I said it in 2011 was that I saw in Huawei ((I did not anticipate the Xiaomi and Lenovo entrants which are also doing very well.)) what Samsung was five years earlier. It’s easier for the low-end providers to move up-market and not at all easy (in terms of loss of margin) for the higher end to move down.
3. You mentioned the pattern of commoditization in all of Samsung's markets -- what would be the best way around this?
Commoditization is largely unavoidable. The way to survive as a business is to ensure you create new businesses or solve new problems. One hope that springs eternal is that through a “brand” a maker can ensure long-term margin survival. That did not help Nokia, Sony, or Microsoft. Brand is only valuable if it carries meaning and often that meaning becomes a fading product. So the short answer is that Samsung needs to create new categories or businesses. The challenge for them is that they need to control the platform and service infrastructure. These are currently out of their control and I’m not quite sure how they can regain that control.
I was wondering if you had any followup comments you could offer about Samsung in light of the announcement today that it's developed a faster 60 GHz wifi technology -- do you think this kind of technology, if it's everything Samsung says it is, could provide the kind of corporate turnaround momentum Samsung needs?
Certainly not. This is a sustaining improvement in a technology. What Samsung needs is a disruptive improvement. A disruptive improvement implies a new business model. Put another way, it means that Samsung needs to invent a new way of making money.
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Postscript: One problem with this prescription is that it's considered impossible to execute and those who try to operate as repeatable innovation companies are punished with deep discounts and condemned as being "hits driven" rather than annuities. Woe befalls the manager who seeks this route.
Samsung Electronics warned Tuesday that its third-quarter earnings would fall below market expectations. It did not cite a decrease in shipments but an increase in marketing expenses coupled with an unfavorable mix (i.e. more low-end units and fewer high-end units).
The headlines reporting the news emphasized the 60% forecast drop in operating income but the company also provided sales figures. Adjusting for exchange rates, the forecast revenues are shown in the following diagram:
Note that I also included Apple's revenue history and forecast. Samsung's revenues are shown on the right and Apple's on the left using the same scale (each horizontal gridline represents $10 billion/quarter.
The explicit cause for the drop is a decline in prices and "increased competition". ((Though one can't be sure when there was ever decreased competition in its markets.)) However a few more questions need to be answered regarding long-term success in the markets Samsung competes in.
Namely:
The absence of a software platform fully within its control
The absence of control over an ecosystem of content and apps
The absence of services
The lack of integration of software, services and hardware
The absence of differentiation vis-a-vis other vendors
The indefensibility of its low end offerings from low end disruptors
The pattern of commoditization in all its markets
Samsung is a very big company but many very big companies came to become small companies. They all followed similar roads.
In order to do this I need to understand at least two concepts:
The process of theory building
Disruptive innovation theory
I'm more comfortable with the latter--having been a student (and victim) of it for more than a decade--but the the process of theory building is a new concept. At least to me but also, I believe, to many. The belief that a theory is fully cooked when first conceived is not the way science developed and the idea that business management theories are singular ideas rather than processes is symptomatic of an immaturity in the field.
So here are the basics of theory building as put forward by Clay Christensen and David Sundahl:
Definition: A theory is a statement of what causes what, and why, and under what circumstances. A theory can be a contingent statement or a proven statement. That is all.
Many managers shy away from using the word "theory" because it is associated with the term theoretical which suggests impractical. But managers use theory every day. They make decisions on some basis of cause and effect, often without being specific about their reasoning.
Process: First comes observation. Second, description. Third categorization. Fourth comes analysis and a statement of what causes what and why. This analysis can be simply an observation of a pattern or a more rigorous correlation analysis.
But that's not the end of the process. The causal statement needs to be tested by predictions whose validity is tested with further observations and confirmation or denial of the statement. If the statement is denied we need to decide if it's an anomaly that expands the theory or whether it contradicts the theory making it less useful.
The anomaly allows a new categorization to take shape. Getting the categories right is the key to the usefulness of the theory. The discovery of anomalies can thus make a theory stronger. The discovery of anomalous phenomena is the pivotal element in the process of building an improved theory.
This iteration between prediction/confirmation/anomaly handling can go for quite some time. As anomalies are accounted for on a regular basis then they can either be exhausted or depleted enough that a robust enough categorization emerges and the predictive power is nearly complete.
Example: In my reading of Apple's financial statements I observed that Capital Expenditures were rising dramatically after the company began to sell iPhones. The observations were made over a few years. The pattern observed showed some correlation between spending and shipments of units.
The company's spending was then compared with a group of other technology companies. These observations suggested that spending varied according to business model and strategy and that Apple seemed to be transitioning from one type of spending (on infrastructure) to another (on manufacturing equipment.)
Then a statement was made that Apple was using capital expenditures to not only ensure supply of components but also of component manufacturing equipment. This was borne of necessity but had the side effect of creating competitive advantage as its unibody devices and Macs were unique and differentiated.
As the more data came in, by the prediction was made that capital expenditures-- which are incurred before production starts and which are pre-announced on a fiscal year basis -- indicate new product ramps or new product introductions.
A few anomalies were experienced when spending increased but production didn't and vice versa. These were studied and explained by shifts in technology (mainly screens) which required "out-of-phase" investment. Additionally, the companies in the cohort also varied their spending on the basis of opportunities in the short term.
As it stands, the theory that Apple uses capital investment in tooling to manage its quality and quantity of production and that in doing so it integrates deeply into its supply chain creating competitive lock-outs is holding up. It is not sufficiently precise to forecast actual production volumes for individual product lines but the growth in the business is broadly foretold by the growth in capital expenditures.
Indeed the share price generally reflects this:
Proposition: At a basic (micro) level, the process of theory building is something we do instinctively. We observe patterns, make statements that A causes B and carry on with the theory as an assumption. The challenge is more on a macro level. Few theories are built rigorously about the causes of success or failure of business systems. This includes understanding why large, powerful firms fail when confronted with small, weak competitors. Why, how and when industries disappear. How resources are allocated and how priorities are set. It's as if individuals behave with far more intuitive insight than firms.
That is what must change.
Because firms are increasingly determining the prosperity and sustainability of nations and the world. We can't afford mismanagement.
The counter-point to this quest is that large systems are intractable and business is inherently chaotic, unpredictable. It may be, but much of what we know as science today was once thought of as impossibly mysterious and unknowable. I have faith that as the physical universe, the affairs of men have laws which govern them.
When the iPhone 4S launched, one million units were pre-ordered and 4 million units were sold during its opening weekend. That made the daily rate during the 4S weekend 1.3 million units/day or one third faster than the pre-order rate of 1 million units/day.
When the iPhone 5 launched, 2 million were pre-ordered and "over" 5 million were sold during during the opening weekend. That made the daily rate during the launch weekend about 1.7 million which was about 15% slower than the pre-order rate. However, a few months later the 5 launched in China setting an opening rate of 2 million in three days or about 666k/day. Adding China's rate to the Rest of World rate yields about 2.4 million/day or about 20% faster than the pre-order rate.
When the iPhone 6/6Plus launched, 4 million were pre-ordered and 10 million were sold during the opening weekend. That made a daily rate during the launch weekend about 3.3 million, again lower than the 4 million/day in pre-orders. However, just like the 5, the 6 launch excluded China. If we assume that a China launch would have run 30% faster than the 5 launch ((Considering that this year China distribution includes China Mobile a 30% increase from two years ago is, in my opinion, conservative)) then my estimate of launch performance for the iPhone range is shown in the graph below:
I included in the graph the various other launch volume data we have available.
I also included lines showing how pre-order volumes relate to weekend values for the products where we know both.
It therefore does not seem improbable that had China been available (and at the time when it will be) the iPhone launch weekend rate for the 6/6Plus combo would have been about 4 million/day. A rate consistent with the history for the product.
