Dan and Horace talk about Apple’s quarter with an eye toward the operational commitments being made. We cover the cost of store openings, data center purchases and machinery used in manufacturing iOS devices. By tracking capital expenses we can get a clue about where Apple wants to go.
This episode is sponsored by Sourcebits, Handelabra Studio, and Shopify.
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Research #Theory · 77 comments
Last quarter I was wrong because I thought Apple would throttle production of the iPhone 4 in the fourth quarter post-launch. "The reason growth would moderate was that Apple slowed production of the old model in order to switch out to the new model--we saw the same thing happen with the slowdown in iPad 1 and transition to iPad 2."
As a result I seriously under-estimated iPhone volumes in the second quarter (FQ3). That failure led me to question whether the theory I was using in forecasting was still valid. When it came time for a new estimate I hesitated.
I had to choose whether to apply the old seasonality theory or to assume that the game had changed and that the product would now grow organically.
The first assumption would put the iPhone growth at 100%+ while the second would place it in the 60% to 80% range. I decided to dial in a figure somewhere in between at 90% but I’m not very confident in this
The result was an over-estimation by almost the same error as that of the previous quarter. Most of the other product lines were accurately predicted, but again, as a always, the whole forecast rides on the iPhone.
So where does that leave the theory?
I now believe that the iPhone behaves far more consistent with the original theory. Namely that...
The first point is not controversial. The iPhone continues to grow at triple digits rates. The second quarter's 142% growth and the first quarter's 113% growth more than makes up for the 21% of the third. Fourth quarter promises to be exceptionally strong with management clearly guiding for a blockbuster.
The point of contention was number 2. If we look at the following chart, we can observe that it still holds:
Each new iPhone launch was preceded by a quarter where units went down sequentially. The same has happened with the iPad for the one tradition we've had so far.
Regarding the third point, Balance sheet analysis shows that investment in manufacturing process equipment installation slowed in the March quarter. That was not matched by a decline in the June quarter sell-out however it does correspond with a slowing in the September quarter. Using the PP&E line is something I'm still exploring but it does seem that there is support for the theory.
I made an error in abandoning my theory. I thought I had discovered an anomaly that made it invalid. I was wrong. I read too much into the late in cycle boom. I bought into the notion that the product was in a new pattern of behavior--due to expanded channel or broader portfolio. This was a mistake.
Footnote
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Research #Theory · 165 comments
At the Open Source Business Conference in March 2004 Clayton Christensen gave a presentation. It's available as an audio file for download here: Clayton Christensen | Capturing the Upside. I strongly recommend listening to the whole thing because it's the quintessential Disruption lecture.
It has relevance in many areas of analysis, but when I was trying to think of a way to characterize the potential for Siri I recalled one particular passage that I saw as almost clairvoyant. Seven and a half years ago, Clay said:
... the next time you go to a computer superstore, go to the voice recognition software shelf and pick up a box there that’s called the IBM ViaVoice. Now don’t buy it, but just look at it! They have a picture of the customer on the box, and it’s an administrative assistant who is sitting in front of her computer wearing a headset speaking rather than word processing.
You think about the value proposition that IBM has to be making to this woman. She types 90 words a minute. She is 99% accurate. If she needs to capitalize something, she just instinctively presses shift and cruises through. And IBM has to say, “No, don’t do that anymore. I want you to put this headset on and teach yourself to speak in a slow and distinct and consistent manner in complete sentences. If you must capitalize, you must pause, speak the command “capitalize,” pause, speak the word you want to capitalize, pause, speak the command “uncapitalize,” pause, please be patient, we are 70% accurate, this will get better we promise.”
This is not an attractive proposition to this customer. And IBM has -- I’ve not worked with them at all, but as I understand it -- they’ve spent maybe $700 million trying to make voice recognition technology good enough that it can be used in that market. This is a very difficult technical hurdle to surmount. Meanwhile, while they are investing that aggressively, Lego comes up with these robots that recognize “stop,” “go,” “left,” “right,” and the kids are thrilled with the four word vocabulary, and then "press -- or -- say -- one" kinds of applications take root, and now directory assistants ask you to say the city and state and so on, and much simpler, and an interesting market is emerging.
I bet maybe the next place it takes route is in chatrooms because the kids don’t spellcheck or capitalize anyway, and they would rather speak than type. And maybe then the next application would be, when you see these stubby fingered executives with their BlackBerrys trying to peck out emails, and their fingers are four times the diameter of the keys, they’re only 70% accurate. If somebody gave them a voice recognition algorithm that really didn't have to be very good so that they could speak their wireless email rather than peck it out, I bet they’d be thrilled with the crummy product. And ultimately, as it takes route in these new applications, it may get good enough that we can do word processing with it, but it’ll be a long time.
The thing that strikes me about Siri is how "crummy" it is. It's trying to be an intelligent assistant but it's not nearly good enough. Many have called it "toy like". It was so uninteresting that there was minimal coverage of it after the keynote launch. One can almost forgive the cynics. It was "yet another feature".
However, it does seem to be good in a very limited set of tasks. It is something you can hire for some minor jobs that you'd rather not do. Basic calendar booking, context aware search and a few delightful surprises. But it's not trying to be much more. It's not trying to be a typist. It's not trying to be a companion. It's not trying to be smarter than you and make you redundant. It's only trying to help lubricate your life. This is what makes it so exciting.
Like the example of the toy robot that delights the child, Siri delights with simple competence. It's not profound but as Clay points out in his talk, it's a necessary first step. What must follow are many more steps. Siri must get better. And because it will have at least 200 million users, I'm betting it will. So over time it will take on more tasks and will eventually help us in ways that we cannot yet conceive possible today. This is just like the introduction of the capacitive touch screen. Popularizing the touch screen has led to experiences with phones and tablets which we did not think possible four years ago.
But it takes time. Like any truly useful breakthrough, it takes a long time to mature. And also like any disruption, the potential of Siri is rooted in four principles:
There's no magic to it. In fact it's banal. These are only the principles that every parent uses to raise a child.
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Research #Industry #Market #Theory · 88 comments
In the last two posts (How much does an Apple store cost?, The down payment on iCloud) I discussed two line items in the PP&E asset class on Apple's Balance Sheet. In isolation, the data is interesting as it gives us an idea of the cost structure of stores and facilities being developed to sustain its current business model. In aggregate, it provides insight into Apple's strategic intent.
To complete the picture, I will look at the third asset: "Machinery, equipment and internal use software." It's the yellow line in the chart below:
It's plain to see at first glance that it's the most significant asset. What does it represent and what conclusions can we draw about Apple's strategy?
Before I begin, I should make clear what this asset represents and what it does not represent. These expenditures cover equipment used in production. They do not include components used in the production nor loans to suppliers for purchasing equipment. These are fixed assets that can be depreciated on a schedule and have specific tax treatment as a result. These are, in plain language, instruments used for producing things to be sold. They are things Apple owns.[1]
Using the same method as in the other asset analyses I took a measure of the sequential change in that asset over the time period and tried to see if there is a correlation between that spending and some other measure of output from the company.
Here is the sequential change chart since the end of 2005:
I noted that the pattern seems to relate closely with the increase in shipments of iPhones. More specifically, iOS devices. To test this I overlaid the overall volumes (with estimates of product types) of iOS shipments. This is a modified version of the chart published here.
There is a broad similarity. But again, as in the other analyses, the spending on assets typically predates the "output" from that asset. As we saw in land and buildings, the operational start of a facility may happen many quarters after the purchase is made. Similarly, stores open some time after the spending on fitting them out.
So it is with Machinery and Equipment. If we time-shift the output one quarter to account for spending before production we have a better fit (note the change in the title with "Q-1" indicating that the dates for the iOS shipments are offset by 1 quarter to the left).
We can even take the analysis further by breaking the spending and output into Phases corresponding to specific product cycles and introductions.
Spending on M&E prior to the iPhone launch began two quarters in advance of sales. The following chart reflects this delay. Note that the M&E payments are marked with quarters ending six months earlier than the shipment schedule. Note also the scale (red denoting the M&E spending and black the units shipped). I also separated the two product types (iPod touch are my estimates, iPhone numbers are published by Apple).
This Phase corresponds to the first "bump" in the expenditure chart but offers more detail. There is an evident relationship between the "input" expense and the "output" of units shipped.
The cost of Phase I was $408 million.
Phase II covers spending from the quarter ending March '08 to December '09 and production from September '08 to March '10.
For this Phase the time shift is only one quarter but there is a quarter's worth of spending that is initiated prior to any shipments. I chose to demarcate this Phase to cover production for both the 3G and 3GS as they probably shared a lot of common equipment. Some spending on new production lines however still had to happen as volumes increased during 3GS production.
Note the scale change from the first Phase. Whereas the maximum in Phase I spending was around $150 million per quarter, the peak is nearly twice as much in the second Phase. The peak output is 5x higher.
The cost of Phase II was $1 billion.
[I had to guess whether the Sep 09 and Dec 09 M&E spending was for 3GS or whether it was to prepare for the ramps in the new products about to be launched in the third Phase.]
Phase III begins with spending prior to the launch of the iPad 1 (March '10) to the last quarter (ending June 2011). Coupled to this is production starting in quarter ending June '10 and ending in the last quarter.
Note that due to the time offsetting on production, the output from the spending on the quarter just ended will not be known until Apple publishes their shipments for the June quarter (scheduled for October 18th).
The relationship between pre-dated spending and production one quarter later holds quite well. There is a "surplus" of spending in December 2010 but that could be seen as the ramp being prepared for the second iPad.
Phase III cost is $3.7 billion so far.
Note again the change in scale from the previous two Phases. Peak M&E expenditures are around $900 million per quarter while production peaks at around 35 million units. This is a tripling of spending coupled to about a doubling of output.
The data suggests spending on equipment is correlated with the volume of production of its iOS devices. However, Apple is understood to be a company that outsources its production and does not "own" its own factories. Claiming that it keeps equipment used in the production of iOS devices on its books is an extraordinary claim.
I make a further claim that the scope of spending itself is extraordinary.
The following chart shows the three asset classes discussed in the three latest posts relative to each other (quarterly change in asset value).
In How much does an Apple store cost? I noted that the spending on leasehold improvements of $2 billion over a few years is significant and sustaining and largely asymmetric to competitors. You can see that spending in the grey bars above.
In The down payment on iCloud I noted that spending on Land and Buildings is significant and sustaining to iOS but not on a scale many can match. Those costs are shown in the blue bars above.
If, as I claim here, the yellow bars show the spending on Machinery and Equipment used in the production of iOS devices, then the commitment Apple has made to controlling production is even higher. In December 2010, M&E expenses were 50% higher than the spending on the data center and the new Cupertino campus put together.
The M&E assets have cost a total of $6 billion. The Apple stores have cost $2.3 billion and land and buildings $2 billion. In other words, Apple's machinery and equipment is worth much more than all its buildings and stores put together.
Compared with what Apple spends on other fixed assets, M&E is spectacularly significant.
In the twelve months ended June, Apple will have spent $2.9 billion in M&E to manufacture 118 million iOS devices. To put that in perspective, Nokia, which manufacturers a large (if not majority) of the 340 million phones it sells, expects full year 2011 capital expenditures of $1.1 billion.
Correcting for amortization and depreciation and deducting some spending on Mac M&E, it's very likely that Apple spent twice as much as Nokia on the instruments of production for one third the number of devices.
It may be too early to draw conclusions from this analysis. The claims should be debated and the claims should be tested, but I can suggest some tentative strategic implications.
Last December I wrote that I thought Apple should use its capital to own the means of production for iOS. I reasoned that device supply was its biggest deficiency and that perhaps ownership would allow them to become better at it.
Indeed, Apple has used capital to ensure it has better control over the supply of components and to also perhaps ensure capacity of production of those components.
But this analysis shows that Apple has gone much further toward integrating its value chain. It suggests that a large part of the tooling in its supply chain is owned by Apple. It suggests that those tools are put out of reach of its competitors.
The implications could be profound but given the length of this post, I'll leave that discussion for another day.
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Notes:
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Research #Industry · 76 comments
Apple loves to talk about its stores. They do it in every conference call, keynote event and SEC filing. There is a monotony with the repetition of how many they have and how many they are building and how pretty they are. They start to seem like commodities.
But if they were commodities why aren't there any other networks of successful "vendor stores"?
The answer is partly in the odd integrated business model Apple maintains asymmetric to every other modular technology provider. Apple seems to want to control the relationship with the buyer. It's also partly in the uniqueness of design, an obsession with the brand. But still, that does not explain why can't it be copied.
The answer is in the economics.
To understand the cost of developing an Apple store, we turn again to the balance sheet. Fortunately for us, Apple reports details of a particular asset called "Leasehold Improvements." It's a substantial asset worth over $2.3 billion in the last statement. It represents "alterations made to rental premises in order to customize it for the specific needs of a tenant."
The following chart shows the change in that figure quarter-over-quarter.
Can we tie these expenditures directly to stores? I overlaid the number of stores opened in the same quarters as the expenses in the following chart:
There does not seem to be much correlation. But if we consider that spending happens before a store opens and shift the openings forward relative to expense by one quarter we have the following:
This is a very consistent pattern. The rise and fall in expenses is matched by the subsequent rise and fall in store openings. We can even see how stores seem to be getting more expensive with the amplitude of the waves increasing relative to the amplitude of the openings.
So if we are looking at store costs, just how much does one cost?
Over the time period illustrated, Apple opened 220 stores and spent $1.9 billion in fitting them out. That's about $8.5 million per store. It's been increasing so it's probably closer to $10 million lately.
That's an interesting figure by itself, evidence of how profitable they must be. But I turn the question again to competitiveness and the lack of response in kind.
The data shows that if a company wanted to duplicate this effort they would need to commit to spending at least $2 billion. And that's just for "fixing up" the sites. This figure does not include the lease itself, the cost to operate (including the tens of thousands of employees) or the inventory within. It also does not include the value of choosing the right locations (though maybe a follower could simply choose to locate in the near proximity to an Apple store.)
So assuming a competitor (e.g. Microsoft) did commit to this spending, how would they recover it? I'll keep this question rhetorical, but the hint must be in the unique way Apple is integrated as a business.
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Balance Sheets are not typical targets of focus in software or services or "high tech" companies. Except for Cash, there are usually not much in terms of assets for analysts to contemplate. With outsourced manufacturing, even hardware companies don't maintain depreciable assets on their books.
Apple, as usual, is different. It turns out there is a lot there and there's a lot to learn from what's there. I've looked at the Cash and Long Term Securities in the past but in the next few posts I'll dive into fixed (non-current) assets. Specifically Apple's Property, Plant and Equipment.
Apple Inc. has selected North Carolina as the location for a new data center and will invest more than $1 billion in the project over nine years, Gov. Bev Perdue announced
via It's Official: Apple iDataCenter to North Carolina » Data Center Knowledge.
When Apple committed to the North Carolina data center in mid-2009 the iPhone was two years old. Only 26 million iPhones had been sold to date (about as many as Apple now sells every quarter.) Clearly if the commitment was on such a scale there must have been a plan. A big plan.
We don't know for sure if NC was used last week or whether it was handling only part of the load, but let's assume it was. What I want to think about is how much iCloud would thus cost and hence what would be the cost for alternative providers of such a service. That analysis might let us determine if "cloud" forms a substantial barrier to entry for competitors.
Beside the public statement above (which may have been designed for political benefit) can we find any evidence of what Apple spent on data centers? That's where the PP&E line comes in.
The following chart shows the Property, Plant and Equipment asset in Apple's Balance Sheet.
Each line represents a particular type of asset and its value at a particular point in time. I will now pay attention to the blue line, Land and Buildings. I'll look at the other lines separately.
Note that each line represent current value so it does not say directly what was happening in the quarter. However, if we look at the change q/q for a particular line we get how much new spending occurred in the quarter for that particular asset.
This change in Land and Building asset value is shown in the following chart:
Going back to 2005, there were minimal changes. Perhaps there is some significance in the $250 million spend in early 2006 or the nearly $78 million spent in Q4 2008, but there is a definite significance to the massive spending that occurred right after the NC commitment was made.[1] Some of that payment also included the old HP campus in Cupertino. "Local real estate experts said HP’s asking price may have been $300 million or more, but they also said the final amount may have been less."
There is also a clear cut-off on that spending at the end of 2010.
The total spending during this time adds up to nearly exactly $1 billion. If we subtract $250 million for the Cupertino expansion we still have $750 million that must have gone into NC.
Note that the original statement quoted above was $1 billion over nine years. We can see that Apple spent $0.75 billion in one year. On the building alone. This is why I consider this a down payment. It does not include any of the equipment in the plant. It does not include the cost of operation (incl. labor) or any development costs (R&D). In fact, it does not include any of the funds that would be part of the nine year commitment.
What this level of spending implies is that iCloud (and Siri and iTunes) are expensive. They may seem ephemeral and even trivial as services, but they require a staggering commitment few can make. Apple made that commitment and they made it early on, before the first quarter billion users were even on the horizon.
If platforms are moving from local to distributed and if value moves from selling things to "getting to know you" and if that knowledge requires infrastructure control then the number of companies that can participate in the market shrinks dramatically. Not only in terms of who has the capabilities, but who could even afford to acquire them.
The invoices Apple pays are shown above.
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Notes:
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Research #Market · 66 comments
The iPad is still only slightly more than a year and a half old. Forecasting unit volumes has proven very difficult. But more than that it's proven very difficult to appreciate the impact on the market it's disrupting, PCs.
For some people this is obvious, but what if you don't live and breathe disruptive theory? What if you don't watch every data source like a hawk for hints of change? What if you are not even a technologist. How would you form an opinion on the effect of the iPad on PCs?
There are many industries and sectors about which I know nothing. If you asked me to analyze a market like industrial lubricants, I'd probably start by reading the consensus opinion put forward by the leading market analyst, an expert in that particular sector. That would form the baseline.
In the PC sector, that opinion is formed by Gartner (and IDC and Forrester perhaps). Gartner will get a lot of citations and its stats and opinion forms the baseline view. It may not be right, but we can expect it to be the "consensus". This is because Gartner surveys a lot of data and interacts with a lot of insiders in the industry. They collect and weigh these inputs and put out what is likely to balance them all.
If Gartner says that the iPad is a "media tablet" that is not a PC they may be wrong. But they are also repeating what the PC industry is saying. So I value Gartner as a reflection of the consensus. If there is a significant gap between Gartner and what I conclude to be reality then there is an interesting opportunity as well as evidence of incumbent ignorance.
Let's then look back on how Gartner has been reporting the iPad's rise and the PC's decline.[1]
"The consumer PC market registered double-digit shipment growth, but consumer mobile shipment growth slowed. This was due in part to slower growth of mini-notebooks," Ms. Kitagawa said. "Surging popularity of Apple's iPad temporarily cannibalized mini-notebooks, as well as consumer notebook sales to some degree. It is not certain at this stage if the cannibalization will continue with the current price point of media tablets."
"Media tablet hype around devices such as the iPad has also affected consumer notebook growth by delaying some PC purchases, especially in the U.S. consumer market. Media tablets don't replace primary PCs, but they affect PC purchases in many ways," Ms. Kitagawa said. "At this stage, hype around media tablets has led consumers and the channels to take a 'wait and see' approach to buying a new device."
“U.S. holiday sales were not fantastic for most PC vendors, but the professional market did show healthy growth during the quarter,” Ms. Kitagawa said. “Media tablets undoubtedly intensified the competition in the consumer market. These devices do not replace primary PCs, but they are viewed as good enough devices for these who want to have a second and third connected device for content consumption usage. Mini-notebook shipments were hit the most by the success of media tablets.”
"Weak demand for consumer PCs was the biggest inhibitor of growth," said Mikako Kitagawa, principal analyst at Gartner. "Low prices for consumer PCs, which had long stimulated growth, no longer attracted buyers. Instead, consumers turned their attention to media tablets and other consumer electronics. With the launch of the iPad 2 in February, more consumers either switched to buying an alternative device, or simply held back from buying PCs. We're investigating whether this trend is likely to have a long-term effect on the PC market."
Overall shipments of media tablets took place late this quarter and volumes remained low, minimizing any impact of the media tablets for PC substitutions in the second quarter of 2011
"The main contributor to the weak consumer PC market in the U.S. was intensified competition for consumers' money," Kitagawa said "Media tablets and smartphones took center stage in the U.S. retail sector, and the expectation is for continuing demand for these devices throughout the holiday season."
I've added emphasis for the key words describing the impact of the iPad (referred to as "media tablets").
Note how the message changed over time. At first the effect was thought to be temporary (presumably due to "hype"). Three months later the "hype" was leading to "hesitation" in the channel. Three more months and there was "a hit" on Mini-notebooks but only for those needing a second or third device for "consumption". In the fourth report it seems that "consumers" (vs. business users) are really interested in this. The fifth report suggests that the effect is "minimal". The latest report suggests that this is a "localized effect".
An external observer (or paying customer) reading this must conclude that five quarters in, these media tablets are having some effect but most probably a transient one. By keeping tablets separate from PC's Gartner is implicitly stating that the two products do not compete. If they have an effect it's on the discretionary spending by consumers. Similar to the effect game consoles or consumer electronics may be having on PCs.
However, if tablets were added to notebook totals the chart for 2011 would look like this:[2]
Notes:
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Research #Nostalgia · 15 comments
Dennis Ritchie created C and co-created Unix. One of the unsung heroes of the modern world. He died yesterday.
His "The C Programming Language" was my bible during a formative period of my life.
In his memory I re-link a post I wrote a little over a year ago.
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Research #Market · 103 comments
Windows Phone is in limbo. The company acknowledged that it has performed below expectations. During the last quarter for which we have data (ending June) I have an estimate that Windows Phone sold only 1.4 million units (Gartner's sell-through analysis suggests 1.7 million). That gives Microsoft a 1.3% share of units sold (Gartner 1.6%), a new low.
At the same time, comScore data shows that user erosion in the US and EU5 has slowed and is holding at about 2.2% of all users.
For its part Microsoft has lain low during the last few months. It released version 7.5 (Mango) last month to manufacturers. It has a number of Windows Phone SKUs in the market or recently announced (27 with version 7 and eleven with version 7.5)
It also sued Android vendors successfully and obtained royalties from the largest Android licensees Samsung and HTC. Patent royalties from Android are probably going to be higher than license revenues from Windows Phone for quite some time.
Something is missing from this analysis. Clearly Microsoft has a plan. It's always had a plan. The plan is not easily perceived because the market Microsoft addresses itself to is not directly to the consumer--we cannot read the message. Microsoft needs to work through partners. Device vendors and operators mainly. In order to persuade them Microsoft deploys its check book.
Put another way, the plan is that Microsoft intends to buy market share. Before we get into exactly how, we need to understand the most important but least discussed contributor to device sales: channel incentives.
Before a phone is sold it needs to get through a mine field of obstacles: it needs to appeal to operator or distributor priorities; it needs to fill a slot in a portfolio of products for the manufacturer and the channel; it needs to acquire shelf space; it needs to appeal to some end users and, unless it has a blindingly strong brand, it needs to offer incentives to the retailer.
This last piece of the puzzle is something of a mystery. Although not a universal practice, in many cases retail staff are paid commissions directly or indirectly by the device vendor. This relationship between the retailer and the vendor is not transparent. A buyer typically does not know what incentives are attached to a given device. Stories of salespeople steering people to and away from certain devices abound.
Microsoft acknowledges this:
Both Samsung and HTC Corp. have committed to increasing marketing budgets for the phones, said Andy Lees, president of Microsoft’s mobile unit, in an interview. While manufacturers will determine how the money is spent, some of it will probably go toward spurring retail staff to tout Windows Phone models, he said.
Microsoft Phones to Get More Marketing, Sales Incentives - Bloomberg.
In another interview:
Q: It seems like one of the challenges is getting the salesperson in the store to push the phone.
A: Absolutely. I think that's a number of things:
One — they get influenced by how good the product is. The reviewers have influence with that and also their own experience.
The second thing is the alignment with the operator. I think we're already pretty aligned and over the life of this release, we'll get even more aligned.
Much more here: Business & Technology | Windows Phone chief Andy Lees sees time ripe for Mango | Seattle Times Newspaper.
What's more, Microsoft and Nokia have a deal whereby at least one billion dollars from Microsoft are earmarked for the promotion of Nokia Windows Phones.
Even prior to the launch of the Nokia relationship, with the original Windows Phone launch exactly a year ago, Microsoft made clear that it had a budget for promoting Windows Phones ($400 million in fact). In the event, the money seems to not have been spent, or spent sparingly because LG made public its disappointment. The coded language can be interpreted as a snub to Microsoft for withholding promised funds.
Perhaps the funding was withdrawn because by the time the launch was scheduled, the Nokia deal was being negotiated. Perhaps Microsoft felt it better to put more effort behind the re-launch of the platform with Nokia on board. A re-launch which has yet to happen but seems to have already had $127 million allocated to it by Nokia alone.
Microsoft is proud of what it has accomplished with Windows Phone because they were able to update the OS in 11 months and took only about two years to completely rebuild Windows Mobile into Windows Phone.
But the dependence on a complex value network means that products do not reach users quickly enough and when they do the marketing message is weak, even when backed by large budgets. The real problem with Microsoft's approach is that it's neither viral like Android (because it has a price and a contract associated with it) nor is it focused and agile like Apple's. It seems to suffer from the worst aspects of modularity (market lag) without benefiting from the control over the ecosystem and end user experience that differentiates it.
Microsoft will muddle through but the 20% share that it says is "conservative" seems anything but.
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Research #Market · 70 comments
Last week I proposed that there were two significant markets for the new iPhone: 1) the existing iPhone user base 2) smartphone "non-consumers". Today I want to dig a bit deeper into the first market to get an idea of what it amounts to.
The following chart shows the total iPhone shipments over time with an estimate for the mix of models during the last two years.
The way I calibrated the mix is by taking into account the statement that Tim Cook made that half of all iPhones shipped were iPhone 4. I first estimated that this past quarter (ending September) included about 22.3 million units. That makes the total iPhones to end of Sept 151.3 million. Half would be about 75 million. Therefore the red area needs to add up to that total. The remainder must therefore be the yellow, 3GS volume.
This mix implies that the following shipments by variant (through end of Sept 2011):
I also highlighted in grey the most likely target market for upgrades during the next 12 months. What I'm assuming is that recent buyers will not be likely to upgrade but those having purchased an iPhone two years hence will probably be looking to replace it. The naive approach is to assume all the iPhones beyond a certain age will be automatically upgraded. That would give almost 70 million units. However, not all those phones are in use and many of those phones may have already been upgraded to iPhone 4s. 70 million is a theoretical maximum. We have to be more specific.
In order to get a better figure for this I created a probability distribution (PD) which suggests the likelihood that the phones purchased in that quarter get upgraded in the next 12 months. I created two such PDs illustrated in the inset chart below:
PD 1 is the simplest. It assumes that 90% of two year old iPhones will always be upgraded. PD 2 is a bit more nuanced where it assumes that there is a range of probabilities over a wider period, but with a peak in the 2 year old zone. These PDs are guesses but consider them starting points for debate.
By multiplying the probability in the line chart (PD1) with the area below it (the units it covers) we get get the shaded area indicating which phones (and variant) will be upgraded next year.
The areas not shaded are either left un-upgraded or represent phones which were already upgraded to iPhone 4's last year. The PD1 assumption yields 36 million units.
Doing the same with PD2 yields a different upgrade set shown below:
This assumption leads to about 36.2 million units upgraded in the next 12 months. Very similar to PD1 but approached from a different angle. Are these figures credible? I don't know. The real PD may be quite different but I think these are pretty conservative figures. They are about half of the theoretical maximum.
This is interesting because of two reasons.
Firstly, it lets us calibrate our forecast for iPhone sales next few quarters. My own estimate stood at 140 million prior to this analysis. Is it reasonable? Remember that the target market includes non-consumption or non-iPhone, non-Smartphone users. Given the "guaranteed" market above at least 36 million, it makes the non-consumption target about 104 million. Does it sound reasonable?[1]
Yes. Primarily because most iPhones sold during the last 12 months were sold to non-consumers. And there were 76 million of them. Apple's distribution has increased since and will continue to increase[2]. That means that Apple does not need to stretch much more than it already has to get the additional growth from un-penetrated markets. We know that this market is still measured in the billions of users. The demand is there.
Secondly, this is interesting from a competitive point of view. When competitors like Microsoft claim that Apple left open an opportunity by not launching a new iPhone "5" they are not looking at the world through the lenses shown above. From their point of view each new phone sold must come from their installed base or non-consumption.
But they don't have any installed bases over 2 years old looking to upgrade. There are few Galaxy users who are yearning to upgrade since they just bought their first units. There are no Windows Phone users (and no Windows Mobile users) who are ready to upgrade to Mango. Since they don't don't see the world through upgrade "lenses" they see their marginal buyer as somebody who might have bought an iPhone 5 because it was the latest and the greatest in terms of specs or novelty.
However they cannot be hopeful that any existing iPhone buyer will switch because they know the satisfaction scores are above 90%. They also know the legendary Apple brand loyalty that keeps Mac and iPad and iPod users glued to their devices. They are also aware of the moats of iTunes, iCloud, hundreds of installed Apps and iMessage all designed to preserve Apple's customer base.
Competitors have none of these things. They don't have upgraders, or switchers to target. They can only target non-consumers. There their odds are better but Apple's are at least as good.
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Research #Market · 74 comments
The iPhone portfolio is now larger than ever. It's arguable that, for the first time, we can actually call it a portfolio vs. the [n, n-1] pair of products that's been available to date. A year ago I even argued that the n-1 variant of iPhone was more of a cognitive illusion than a real alternative.
But that all changed last week. For the first time since launch, there is a real portfolio. The iPhone is now available as five different variants with 10 different price points. Prices and options may vary by country, but I took the US portfolio as the baseline and illustrated it:
Including all the pricing options It's a very regular pattern. It reminds me of the iPod which, at one time was sold at every $50 increment point from $50 to $500. The logic behind this pattern is that "there is now an iPhone for every budget". Of course, as with any purchase decision, each of these price points has trade-offs. Considering product performance or in terms of option value, the buyer has many things to weigh.
To simplify, I divided the options into two subsets: Locked and Unlocked.
We can now see the premium for unlocking (or, the discount for losing the freedom to use the phone on another network, as the case may be). We can also compare unlocked prices to unlocked prices for competing products.
To assess it further, I combined the two charts above into one, superimposing the unlocked price onto the locked price.
In this last chart it becomes clear that buyers who purchase an unlocked phone are paying $450 more (the white areas), regardless of the phone's spec (except for the 3GS where the difference is only $375). For locked phones, the $450 discount is, presumably, the value of the change of carrier (GSM only) option for a buyer.
But there is more to this picture. The unlocked price is also the price that Apple sells its product direct to consumers, many of which will be traded in secondary markets world-wide. Many will be sold in countries where Apple does not have distribution agreements with any operators. Because Apple needs to avoid channel conflict, they cannot price the unlocked product lower than they sell it to their channel. As a result, the unlocked price must be very nearly the price that operators themselves pay (excluding any volume discount).
We can actually confirm this because Apple publishes the average selling price (ASP) that Apple obtains from the iPhone. I made a line in the last chart at the price Apple got in the last quarter. It falls very nearly around the mid-point in the portfolio (and thus assuming the mode equals the mean and median in the distribution of sales.)
There is one further implication in this. I think it's a safe assumption that the ASP for the new portfolio will be largely unchanged. Although Apple introduced the lower price for the 3GS ($375), it also added a more expensive 64G option. The lowering of ASP with the 3GS may be offset by the additional high-end sales, especially early on.