The latest data from comScore showed a few surprises:
New smartphone users dropped to a very low level, below the trend line.
Slightly less than 300k new smartphone users abandoned their feature phones every week during the month. Compared with the 1.5 million per week in November, it's quite a slowdown.
Penetration growth slowed as a result as well. Only 1.3 points of share were gained by smartphones.
It's still likely that the penetration will reach 50% by the end of summer this year (as was predicted in 2010).
When looking at the picture above broken out by platforms, we see signs that the slowing in smartphone growth seems to be attributable to a slowing in Android adoption:
Here are the installed bases in users over time of the different platforms:
The share of users of the platforms is shown below, first as a stacked area:
And also as a line chart:
This last chart shows the first time when Android share dipped sequentially. It should be watched closely as an indicator of a change in market dynamics. As we reach saturation, the basis of competition will change.
Finally, the last chart shows net user gains for the platforms.
Here again we see the lowest user growth for Android since 2009 (and hence since it reached mainstream distribution.)
It's perhaps too early to suggest that we're seeing a slowdown in the US for Android. Perhaps there will be a return to growth in the fall. The concern has to be that rather than seeing the net adds growing--as they have for two years with only two contiguous months of decline--Android net adds have been falling for four months.
A glance at Nokia and RIM's market values today shows that they are both valued below book. With respect to RIM,
The company's share price has collapsed in the past year, and it is now only valued at about $5.4 billion, down from $84 billion at its peak in 2008. Excluding its cash and the estimated value of its patents, RIM's device business and its 78 million subscribers around the world are in aggregate worth less than $1 billion to investors.
MKM: We are downgrading Nokia to Sell from Neutral following our U.S. retail Lumia model checks. We assume no value for the handset business and no value for the roughly four billion euros [about $5 billion] in net cash.
Three years ago the situation was dramatically different. RIM's share price was six times higher and Nokia's about four times higher. Here's what the market looked like in Q1 2010:
This summary view shows individual competitors in the phone market as well as their combined total volumes. The profitability/volumes/pricing can be visualized as well as margins and revenues.
The same visual summary is presented for the first quarters of 2011 and 2012 below:
The change may be subtle to the untrained eye, but it can be summarized as contraction for most vendors and expansion for Apple and Samsung. RIM and Nokia not only contracted in terms of revenues and volumes but also, crucially, lose money.
I've written about this before (many times.) But it's important to repeat again that this is a very short time span. Only three years separate the top chart from the bottom right. The "shape" of the market participants has not changed much but a tipping point has been crossed. This is the point where some participants are disrupted enough that they cannot recover.
Did it happen in 2010, 2011 or 2012? We're only looking at data which results from hundreds of decisions and thousands of actions. It's improbable that there was a single moment when the shift occurred or a single decision that caused it. But it's equally improbable that the disrupted could have countered any of the actions that got them to this point.
The cause (and remedy) for disruption is never found in a single act. It's a process and a way of operating and thinking. Is management to blame? That's always the answer. But how did management go from being smart to foolish so quickly and why did all managers in a firm, even an industry, conspire to become foolish at the same time?
If you study the decisions on a day-to-day basis, management consistently applies all the lessons they learned that led to success in the past. But these lessons lead to decisions that end up with exactly the worst result possible.
The crux of this dilemma is that doing the "right thing" leads to the wrong result. In a comment I questioned the possibility of management in a public company solving the dilemma.
Some have argued that public companies with professional managers entrusted with fiduciary responsibility are inherently incapable of solving the innovator's dilemma and are thus doomed to be disrupted. I'm starting to believe the argument. Whenever you as a manager try to work out the solution to the dilemma, you encounter a value destroying obstacle that cannot be surmounted while maintaining your position in the company. [As you attempt to solve it, you lose your position] Your successor won't make the same mistake and [thus] the whole enterprise collapses.
There are counter-examples however. The reason Apple should be studied is that it gives hope that they have cracked this problem.
This week, Horace follows up on his discussion of automobiles and road infrastructure by talking about how road networks were rebuilt in European countries to accommodate cycling. That leads to hints about the challenge of re-building energy infrastructure to support new power train technologies. We talk about RIM's post-trauma life expectancy. Finally He and Dan also analyze comments made by Tim Cook at the recent D10 conference about Apple TV and disruption of the entertainment industry.
I note the "our" in "our year". This implies fiscal year (that and the fact that he spoke in the past tense before six months had passed in the calendar year.)
Given the public information we have so far, it's now possible to estimate with some confidence the sales history of Apple TV. The following chart is my estimate. It includes all the known data so far with some interpolations to fill in the gaps.
Assuming average revenues per device of $100, we can get an estimate of about $344 million in Apple TV hardware revenues for calendar 2011. This is not a large amount relative to Apple's other lines of business. It is, for example, only 14% of the overall Peripherals revenues and only 5% of the iPod.
However hardware revenues are not the whole story. The business model for the device is in many ways the polar opposite of the business model of the iPhone. Whereas the iPhone employs "break-even" iTunes App Store (and the Music and Video and Book stores) in order to sustain its high hardware margins, the Apple TV business has low hardware margins that sustain content.
The complete picture therefore has to include an assessment of the content attach rates and the agency fees that Apple gets for that content.
Let's assume that each Apple TV is used to generate $10/month in content sales. This is not a lot. It's equivalent to 5 TV shows or one movie purchased or two movie rentals per month. The model I have shows that the installed base of Apple TVs was about 10 million by the end of 2011. That means that the run rate is $1.2 billion in content sales for the Apple TVs in use.
Now Apple does not book all that. They book only about 30% as revenues as their agency fee. That means that Apple TV could be generating revenues at a run rate of $360 million (to Apple.)
If we add that to the $344 million in hardware revenues we get about $704 million for 2011. This is still not a huge business. It is about equal to the revenue from iPad Smart Covers[1]
Looking forward, if Apple TV units sell at double the rate of last year and we increase the footprint accordingly, we could see a revenue rate of $1.2 billion for 2012.
Now this is not a high margin business. The margin on the content may be less than 50%--depending on transaction costs and hosting/traffic fees. The margin on the hardware is also likely to be below 40%. So the business is not wildly profitable. But it probably is profitable. Which means it makes sense to keep it running while waiting for other pieces to fall into place.
As Tim Cook repeated, they are very interested in this space. However, any discussion of the future must include an analysis of the business model and the sustainability in terms of profit that keeps long term development focused on getting the product to be good enough for the right jobs to be done.
What we should think about however is this "polar opposite" business model. Apple is running this as a "hobby" or as an internal experiment. Sales are (relatively) tiny but it generates some profit. Volumes are small but they are growing. It's taking a heck of a long time. It's asymmetric to the prevailing model the company relies upon. It's beneath contempt from all observers. Sounds familiar?
---
Notes:
In 2011 there were about 40.5 million iPads sold. If we assume half of those purchases also resulted in a Smart Cover purchase and if the average revenue per Smart Cover was $35 then total Smart Cover revenues were $709 million.
“Clearly this stuff isn’t selling,” said Monga [an analyst at Veritas Investments Research in Toronto.]...
RIM took a $485 million pretax charge to write down the value of its PlayBook inventory in December, after shipping just 150,000 of the tablet computers in the quarter. Then in March, the company recorded a $267 million expense for BlackBerry inventory. RIM said at the time that it would stop giving sales and profit guidance because of “ongoing weakness” in the U.S.
RIM has just entered what I call the Post-traumatic period of a phone maker's life. This period is defined as beginning with a loss-making quarter and ending with the company's exit from the business. These post-traumatic periods were visualized first here and the pattern was first discussed about a year ago here.
I've updated the chart with the current data and added the bar chart below to illustrated the "post-traumatic life expectancy" for the companies shown. Companies still operating are shown with bars without color while companies that have exited are shown with solid color bars.
The pattern may be that companies either have short post-trauma lives of about two to three years or relatively long post-trauma lives lasting 4 to 5 years. What determines this life expectancy and how long do RIM, Nokia and LG have?
There is precious little data, but perhaps one hypothesis I could offer could be that the bigger the commitment to the industry (in terms of having no fall-back options) the longer the post-traumatic period lasts. In other words, as there is no easy way out, the fight lasts longer.
This can also be interpreted using Porter's "barriers to exit" force analysis where companies which can liquidate a division see it as a low cost of exit whereas companies that need to restructure (usually more than once) and then seek either a buyout or rescue may interpret exit as a very costly endeavor.
Long exits compile larger costs of distress and can cause more pain for stakeholders, especially if the end is inevitable.
Given this hypothesis, as both Nokia and RIM depend largely on mobile phone sales, it's likely that they will not exit quickly. (Ironically perhaps, LG has a better shot at a quick exit given its diversified conglomerate status.) It might imply that there are at least two more years before Nokia and RIM call it quits.
Markets are difficult to measure. Mainly because the information is not easy to obtain and that which is obtained is not made public. Collecting, analyzing and filling in the gaps is big business with many firms involved in selling it.
However, with all the analysts and companies selling and promoting their "numbers" it's important to understand the difference between the methods used. There are for instance at least the following measurements:
Units sold to end users. For example NPD or GfK data of retail transactions. Also Gartner's estimates for phone units sold.
Units sold to the channel. For example units recognized on income statements usually reported by companies. Also IDC's estimates for phone units sold.
Units in use. For example comScore and Nielsen survey data.
Units "activated". The measurement Google uses to describe Android performance.
Intent to buy. For example ChangeWave surveys of early adopters.
Utilization rate. For example browser statistics.
Each measurement tells a different story about the market but the best story is told when all data is analyzed in a combined integrated market review.
Before diving into that it's important to understand the difference between the first and second measurements or the difference between shipped and sold.
What does "Sold" mean?
Let’s say that you sell a phone to another party. What constitutes a sale? The sales agreement? That you shipped it? That he wanted it? That you were paid for it?
What if he changes his mind and returns it? Is it still a sale? What if a manager's bonus depends on these sales? What if the company’s share price depends on these sales? Is there a way to rig the accounting?
As it turns out, yes there are; many ways. Unethical and fraudulent practices happen surprisingly often. A classic instance would be: A customer is shipped ten phones, though he only wants one, and he gets paid to ship the other nine back, after the close of the year.
The sales manager records ten times the sales he actually made, making ten times the commission and the company’s stock price rises. To compound the offense, the manager could also tip his friends to short the stock at the end of the year, leaving investors “holding the bag” when the inevitable correction follows.
There have been so many cases of this kind of accounting fraud that the FASB (GAAP), SEC, and IFRS have placed a very stringent definition on “revenue recognition”. This means that although you can sell all you want, the company can only recognize the proceeds and profit in the financial statements according to strict rules.
In the case of hardware (Sales of Goods), the customer must receive it (“delivery has occurred”), and like it enough to not return it (“amount to be refunded”), and be able to pay for it (“collection is probable”). If some are projected to be returned or unpaid, that percent is subtracted from total revenue. In the case of software (Sales of Services), it is generally accounted for over a time period. And because it is customary to send the customer upgrades, the revenue must be spread out over the time the service is provided. (“upgrade rights … 24 to 48 months.”)
It gets complicated when a piece of hardware has upgradeable software. The rules used to stipulate that the hardware, in its entirety, must be accounted for as a service and have subscription accounting. This is how Apple had to report sales during the first few years of the iPhone. It still defers some revenues for its hardware, mainly on account of iCloud, but the vast bulk of hardware revenue (96%) is now accounted upfront, recognized upon the product's acceptance by customers. 4% is for software upgrades and is accounted for over a specific lifetime of the product (24 months in the case of the iPhone).
What does "Shipped" mean?
The discussion so far implies that if a product that is accounted for as "Sold" on an income statement does not mean that it's in the hands of an end user. These "revenue recognized" products are sold to a distributor, typically for a phone that's an operator.
These sales satisfy the requirements for financial reporting as revenues booked. But they are not in the hands of users. Nor are they "activated" and they don't generate page views that are measured by web analytics companies. Most analysts and companies now use the phrase "Shipped" to describe these revenue-recognized units though it's also common to hear "sold".
When a product sells to end users it's sometimes called "sell-through". It's counterpart is "sell-in" which is sales to the channel distributors.
A big gap between sell-in and sell-through might imply large amounts of in-channel inventory. This is product that is sitting either in stores or in warehouses or on trucks in transit. If sales are steady, the inventory is measured in time as in "weeks of inventory". This means that the excess is expected to be sold within a fixed time frame if shipments were to end. The smaller this amount, the better or "tighter" the operations are. Inventory, as Tim Cooks says, is fundamentally evil. It eats capital and erodes profitability.
Sometimes miscalculation of sell-through could result in vast amounts of inventory that has to be returned by distributors. That inventory is either written off or sold at fire sale prices resulting in a "write-down". This happened recently with both the HP TouchPad and with the RIM PlayBook. This special charge against income is a one-time (usually) incident but it can also affect a firm's reputation with channel partners for a long time. This type of failure is very costly.
Therefore what matters most is to keep the difference between Sell-in and Sell-through as small as possible. However, it can't be too small. Sometimes if Sell-through is too fast, you get stock-outs which means that there is more demand than supply and sales opportunities are missed. This has happened many times with iPhones and iPads. This is also an unwanted situation (unless there was too much inventory in the channel during the previous period and thus it was being drained in the current period.)
The chart to the left shows how the phone market looked for various vendors last quarter. I compiled the data based on Gartner's "sales to end users" and IDC's "shipments" data. Two vendors had higher sell-through than sell-in (Nokia and LG) probably because they were draining excess inventory. The others had channel inventory of between 5% and 10% of units shipped.
This ratio is shown below in a chart comparing the largest phone vendors.
Management is often rated for performance on this metric, as they should be, since it's a measure of operational skill. However, there are many factors that affect overall performance.
New product launches, windows of opportunity related to seasonal buying patterns, anticipating macroeconomic slowdowns, even natural disasters and legal challenges can affect this metric.
Understanding the overall market requires an appreciation of this distinction but also an understanding of all the other metrics listed above and what stories they tell.
---
Notes: My thanks to Michael Dediu for input on this discussion.
Dan and Horace take a nostalgic trip through the automotive industry. Horace asks why should a 20 year old car (which he happens to own) be replaced? Why are cars built to be disposed of and why aren't they meaningfully improved based on new jobs to be done? In this episode we look at the auto industry as a proxy for other "network-based" industries which reach plateaus of innovation and can go no further. Plus, Horace challenges readers to guess what car he drives.
In terms of units Windows-based computers made up 78% of all PCs sold in Q1. That was an increase from the 74% in the previous quarter but a decline from 90% a year ago. OS X based computers were about 3.7%, a decline in share both q/q and y/y, something the company attributed to a transition quarter.
The following chart shows the composition of vendor volumes with tablet and traditional form factor computers included:
iOS computers (i.e iPad) were 11% of the market, declining from 13% last quarter but increasing from Q1 '11's 4.2% share. Apple reported that the iPad was not at supply/demand balance and thus could have sold more units.
Amazon's shipments went down significantly though sell-through was perhaps twice sell-in due to inventory build-up during the previous quarter. Overall, about 5 million Amazon Fire tablets were sold since the product's launch.
The third significant tablet vendor was Samsung, which sold about 1.6 million tablets, down sequentially but up y/y. Other Android tablets may have shipped another 5 million units.
Overall, Apple remained the top vendor with 14.6% share, followed by HP with 14.1% and Lenovo in third at 10.7%. Dell just barely managed to beat Acer with 9% vs. 8.9%.
The impact of the tablet (aka iPad) market is being described in the response to a significant earnings miss by Dell:
Sterne Agee, which admits it probably shouldn't have upgraded DELL from underperform last week, says it's notable that the PC maker acknowledged competition from Apple and Google for the first time as part of Tuesday's dour F1Q report and forecast. Meanwhile, Mizuho calls DELL a "show-me-story for now" in cutting it to neutral and cutting its price target 25% to $15. And ISI snarks "everything is bigger in Texas--including the misses." It adds while the company "is making the right business-model changes...results will remain 'chained' for years (not quarters) to commodity desktops/notebooks, which comprise over half of sales."
- Dow Jones Newswires (Kevin Kingsbury)
And so, two years later, the impact of the iPad is becoming abundantly clear, even to the incumbents. The resistance and denial was profound. Even on this blog, the agitation and anxiety when the subject of the iPad as disruptor came up was palpable.
Perhaps that is the greatest testament to the disruptive potential of a product.
During my talk at the first Apple Investor Conference in January I said that I would pay very close attention to the Machinery, equipment and internal use software line item from its PP&E during the next quarterly report (it appears on Page 13 in the latest report).
The reason I consider this important is because capital spending has provided reliable foreshadowing of iOS device production. This is itself because Apple invests in the equipment used in the manufacturing processes for its devices. The more spending on equipment, the more production capacity is brought to bear and the more units are produced. Since iOS devices tend to be supply constrained, the more units are produced then the more are sold.
The first quarter of the fiscal year saw a very small increase in CapEx which caused me to "backload" spending later in the year. By watching this spending, we can assess approximately when and for which products is investment allocated. If the spending happens early then we can anticipate an early update to the iPhone. If it happens late then we can anticipate a late release. So has the ramp-up begun as of the second quarter (first calendar quarter)?
The following chart begins to give us the answer. It tells the story of spending by tracking the change in asset values:
Stripping out the Machinery and Equipment portion (in yellow above) and overlaying the following quarter's iOS shipments yield the following composite graph:
It would appear that there is significant acceleration into the second quarter. Is it something significant?
The increase in M&E is the highest for any quarter to date. Some of that is undoubtedly in service of the new iPad but some must also be the initial ramp-up for the new iPhone.
To gauge it further however, we need to look at overall expectations. The company also signals future production plans though its yearly report. As I concluded from October's 10K, fiscal 2012 production should double from the year before (as it did from the year before that and the year before that, etc.)
At $1.3 billion, the spending is substantial and a new record, but it does not make a big dent in the overall budget for the fiscal year. Half-way through the year, the total spending on M&E and Real Estate is still only 26% of the budgeted $7.1 billion. You can see the gap in the following chart. The yellow line needs to match or exceed the blue line after the next two quarters.
In order to reach its own expectations, the spending therefore needs to double from the current rate to at least $2.5 billion/quarter over the next two quarters.
Such numbers are hard to grasp. They are unprecedented not only for Apple but for almost any comparable company. Just as a reference point, they will have to exceed the historic average CapEx rate for Google by more than 100%.
Regular readers will note that there is nothing new in this analysis. This is only an update in a continuing story. The pieces are in place for continuing the existing rate of growth.
My thanks to Bruno Ferrari of Exame magazine Brazil for asking the following questions. My answers were written two weeks ago on April 2nd.
Based on financial data of the first fiscal quarter, it is possible to confirm that 2012 will be the best year in Apple's history?
Actually, it's possible to confirm without looking at first quarter data. Every business line Apple has except the iPod is growing and is likely to keep growing during this year. That means that sales will increase over 2011, which was Apple's biggest year. You can see historic sales growth data here:
What are your predictions for the second fiscal quarter?
The iPhone number seems to be higher than consensus. It's aggressive but I'm basing my opinion on the launch of the iPhone 4S in China and the Chinese New Year and new carrier agreement there. Also the iPad will do quite well.
Do you think Apple will hold the iPhone 5 launch to September in order to open 2013 with an extraordinary result?
The next iPhone will launch between June and September. It might be earlier due to the 4S being the "wide end of the egg". Think of the iPhone as an egg rolling down the hill. There is a sharp end and a wide end and the speed of rolling depends on which end is down.
Besides the iPhone 5, which products that Apple could announce in 2012 you think may help them to maintain this extraordinary growth?
I think the iPhone is becoming more predictable. What I'm more curious about is what they will do with the iPod. Apple takes its brands seriously. I am watching the iMac, MacBook and iPod for clues of a re-fresh or replacement as they have aged.
Do you think we will see the “iTv”? Do you think it could be “the next iPad” of technology market?
Apple TV is in waiting mode. It's like an airplane circling, waiting to land. Something will happen but not sure when. Fundamentally, the opportunities are still there but the entertainment industry is very complex. The more complicated it is the more necessary for an entrant is to create a parallel version of it. That takes time.
The building blocks are all there however. See additional thoughts here.
If we analyze the growth of Apple in recent years, it is supported by the launch of new products, especially the iPhone and the iPad. Do you think Apple can lower your rate of growth in coming years since we don’t see in its roadmap new innovative products like a new smartphone or a new iPad?
New products created new growth but iterations of those products also created and will continue to create growth. Of all of Apple's products only one product is not growing today, the iPod. And that is after 10 years in the market and with a "dominant" market share. In addition, Apple has a lot of room to expand internationally and into enterprise and professional sectors.
I do agree that 100% growth is hard to maintain without new products. I believe there might be a few products still waiting for launch. TV is one area (along with game-based entertainment). New user interfaces might be enabling new categories of products. Intelligent assistance and companionship are open problems that software can solve but which have not been productized.
When do you think we’ll stop to see Job’s legacy in Apple new products. And what then?
Jobs' legacy is not in specific products but in how products are built. He also taught the importance of putting products first and markets second (this is, at its base, an artistic principle, not a commercial one). I think that legacy can last forever, if managed properly.
How do you analyze the dividends pay and the buyback made this month?
I wrote some thoughts about it here. I believe the impact will be mostly psychological for investors.
And finally, I was reading at Asymco some analysis of Apple’s share price. Do you think $600 is enough? Do you think in a 1 trillion dollars company in 2014 as some analysts are saying?
The share price depends on the psychology of people. I like to say that Apple is the same exact company today as the one that was priced at $78/share three years ago. When I look out the window of my office I see the same view year-to-year. When I look on my computer screen at Apple's financials I also see the same view year-to-year. I don't know how people can see Apple differently one year to the next. To me it's like looking out the window and seeing mountains instead of the sea.
But this is how markets behave. I can't say what the price will be. It may be $1000 or it may be zero. But the company will not change in either case. It won't change because it does not need to change.
Chris Brennan asked a few important questions regarding potential saturation of the iPhone market.
Is the iPhone anywhere near saturation? Can Apple continue to shift iPhones in ever increasing numbers or is a sales plateau realistically on the horizon?
The market for mobile phones is approximately 5.5 billion connections, perhaps 5 billion users. The iPhone has approximately 300 million installed base. I consider a base of 1 billion users to be a minimum for continuing participation in this market long term. Licensed platforms will reach this in no more than two years. I don't know what Apple's ambitions are but if they don't triple their base I don't see a strong future for the company in mobile phones. In order to triple the base the company will need to sell substantially more than an additional 700 million iPhones. The retirement rate can be as high as 50% of installed base. Apple will need to sell at least 1 billion iPhones in the next few years. Seen another way, Apple has a market share of about 9% on a quarterly basis. This needs a lot of improvement. Chinese vendors are not standing still.
Can the Mac also continue to outperform the rest of the PC market for long?
The PC market is in decline. It will continue to decline as its disruption continues. The PC market will still exist 10 years from now but, similar to the mainframe market, it will be hard to notice. Apple is doing a fine job carving out a large portion of that market for itself but overall it's an increasing portion of a decreasing pie. It would be better to track the share of profits captured or even share of value rather than units. The reason units were important 20 years ago was because platform dynamics determined whether a marginal platform could survive. Would a 5% share be enough to attract developers? That is no longer an interesting discussion. Applications for PCs are not an area of investment for any significant pool of capital. Development has moved almost entirely into mobile or web. Therefore, as the PC is now a commodity product, the best performers are those who can capture a larger margin. Those margins should be subsequently be invested in new platforms. PC vendors who neither capture margin, nor invest in new platforms are strategically insolvent.
Finally, this exponential growth of Apple products has to end some time soon doesn't it? How many high-income buyers for expensive products can there be left for Apple to target?
Trying to calculate the limits to growth is futile. There are limits but they are not calculable and inaccurate estimates don't offer any useful information.
In 1939 a total of 921 military aircraft were built in the United States. Five years later, in 1944, annual production was 96,318. A question could have been asked by an aviation analyst in 1939 about whether the American aircraft industry could grow. Aircraft, especially multi-engined ones used by the military were _extremely_ expensive. The reason an industry grew exponentially making extraordinarily expensive products was not because of organic demand but because the primary buyers engaged in a cataclysmic global war. In other words, there was a will to buy and hence there came a way to build. Therefore the answer to the question of sustainable growth comes not from an analysis of demand but from an analysis of the consequences of not growing. Not growing would have meant the end of many nation states.
Your question was framed by an implied market categorization: that buyers are either high-income or, presumably, low-income. This is a false dichotomy. Buyers are either needful of a job to be done or not. If the job is important enough, money will be found to hire a product. Sellers of products will also find ways to meet the demand through lower prices and increased capacity. Every product Apple makes used to be out of the reach of all consumers. Whether computers (portable or not), music players and professional grade software, voice recognizing personal assistant cellular phones and tablets are all luxuries or necessities is only a question of timing.
