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  1. Happy Birthday iTunes Store

    Research · 16 comments

    iTunes (including software and services) revenues in Q1 topped $4 billion and were 30% higher than (re-stated) 2012 Q1 revenues. Accompanying this revenue figure were additional data points from the company:

    • Cumulative app downloads have surpassed 45 billion
    • Payments to developers reached a cumulative total of $9 billion
    • Payments to developers were $4.5 billion in most recent four quarters
    • Now paying $1 billion to developers every quarter
    • 800 apps are downloaded every second
    • iOS app revenues doubled since year-ago quarter
    • App Store accounted for 74% of all app sales in the quarter (citing Canalys)
    • App stores reach customers in 155 countries (850k Apps, 350k iPad apps)
    • iTunes music downloads are available in 119 countries (35 million songs)
    • Movies are sold in 109 countries (60k titles)
    • iBookstore is available in 155 countries (1.75 million titles)

    This data allows for a few inferences:

    • Nearly 70 million apps are downloaded every day
    • The average revenue per game is about 23 cents
    • Gross app revenues are about $16 million per day (of which 11 million is paid to developers.)
    • Gross iTunes revenues were $5.4 billion last quarter of which I estimate:
    •  …App revenues were $1.6 billion
    •  …Music revenues were $2.2 billion
    •  …Video revenues were $287 million
    •  …Book revenues were $312 million
    •  …Apple's software generated $1 billion
    • In addition, I estimate that Services generated $100 million

    Note that there is a difference between the amounts transacted through the store and what the company reports. The difference is shown in the following graph

    Screen Shot 2013-04-29 at 4-29-1.02.50 PM

    To mark it's 10th year, I wrote a segment for Billboard Magazine describing what iTunes has become. I suppose it's easy to become numb to these numbers, but there is perhaps one way to look at iTunes that is still compelling:

    Selling $20 billion a year would put iTunes in the top 20 US retailers and top 50 Global retailers.

    Screen Shot 2013-04-29 at 4-29-1.36.41 PM

    Not bad for a 10 year old.

  2. Margin call update: About those changes in service policies

    Research · 21 comments

    In the March quarter, our gross margin was 37.5%. It was at the low end of our range. We had a few items that on balance resulted in us reporting at the low end. They included mix, in particular, selling more iPads than we had planned, including getting iPad mini into our four- to six-week channel inventory range, some changes in our service policies that required us to make provisions for prior quarter sales, and we had some unfavorable adjustments.

    - Peter Oppenheimer, Apple CFO, FQ2 2013 Earnings Conference Call

    [my emphasis]

    Thanks to Philip Elmer DeWitt for bringing this quote to my attention in the comments to Margin Call 2.

    I was curious about the "changes in service policies" and what that might have meant, especially since they seem to have been retroactive (provisions for prior quarter sales).

    The 10Q offers more details:

    Accruals for product warranty for the three months ended March 30, 2013 include $414 million associated with product sales in prior fiscal periods reflecting the impact of changes to certain of the Company’s service policies and other estimated warranty costs. Of this amount, $224 million is associated with product sales in the first quarter of 2013, and the remainder is associated with product sales in 2012.

    - Apple 10Q, Note 6, Page 17, second paragraph.

    These service policy changes were made around April 1st and were in response to editorials in the People's Daily, the official paper of the Chinese Communist Party. Though seen as a PR issue, their impact goes beyond the company's image. Changes in warranty policy implies setting aside some of the revenues as an expense, increasing the cost of sales and reducing margins.

    The 10Q says that $190 million of the additional warranty set-aside was for prior quarters and that $224 million was for the March quarter.

    If we were to subtract the $190 million from the cost of sales the gross margin would increase from 37.50% to 37.93% and if we subtract the full $414 million the gross margin would increase to 38.44%.

    The calculations are shown in the following table:

    SalesCost of SalesGross margin
    Q1$43,603$27,25437.50%
    Q1 adjusted for change in service policies in 2012$43,603$27,06437.93%
    Q1 adjusted for change in service policies in 2012 and 2013$43,603$26,84038.44%

     

    If we read 2012 and 2013 as meaning fiscal years then the entire $414 amount is for prior periods (i.e. not for the current quarter) and the gross margin for Q1, excluding one-time items, would be nearly 1 percentage point higher than reported.

    The effect of the change in policy would have been very difficult to anticipate when estimating the gross margin, even for Apple's own team three months ago.

    It's also important to note that this does not say much about the supposed effect of competitive pressures on Apple's margins. 38.44% gross margin is not as good as last year's, but they're pretty good.

  3. Margin Call 2

    Research · 159 comments

    I expected Apple's margins to improve  last quarter. They didn't and so the question I needed to answer is why. Here is a history of Apple's gross margin and operating margin as reported since late 2005:

    Screen Shot 2013-04-25 at 4-25-9.26.53 AM

    For a company selling hardware these are extraordinarily high margins. They are higher than those of Google and have narrowed the gap with Microsoft,  neither of which has a high proportion of hardware sales:

    Screen Shot 2013-04-25 at 4-25-10.06.04 AM

    But they are not growing and the reason is to be found in the reason they grew in the first place: because of proportion of iPhones making up the total sales.

    As a reminder, the iPhone is a uniquely profitable product. I estimate that it obtains about 50% gross margins. The history of these estimates is shown below:

    Screen Shot 2013-04-25 at 4-25-9.32.34 AM

    It remains in stark contrast to the margins Apple obtains for its other products. Much of that is due to the pricing power of the product as shown below:

    Screen Shot 2013-04-25 at 4-25-9.33.13 AM

    Notice that even after the launch of the iPhone 5 and the persistence of two previous generations of iPhones (and their lowered pricing) has barely put pressure on pricing.

    Contrast that with the iPad. As its breadth of offerings increases, it causes a lower price per unit.  The iPhone is now at $613 per unit, even with two older generation products available. (The lowest price was in Q2 2012 when the average price was $608.) The iPad is at $449 per unit, down from $662 at launch three years earlier.

    So overall, margin is a function of three things:

    1. Price changes: iPhone had a small reduction (from $635 to $613) but the iPad has had a moderate reduction in price (from $531 to $449).
    2. Cost of components: This is reflected in product-line gross margins which can only be estimated. Compared to last year I estimate that iPhone gross margin dropped from 58% to 48%. iPad margins also fell from about 38% to 27%. The reasons were given by management as "Last year, our business benefited from …a more favorable foreign currency environment, and historically low costs."
    3. Mix of high and low margin products. The iPhone units grew at 7% but the iPad units grew by 65%. A year ago iPhones were 58% of revenues and this year they were 53%. The iPads were 17% and now they are 20%.

    The result is seen in this one graph showing the allocation of revenues and margins by product:

    Screen Shot 2013-04-25 at 4-25-8.46.04 AM

     

    So what is surprising? My expectations were met in terms of iPhone units (and exceeded in terms of iPad units). The mix was also something that falls out of the unit expectations. The pricing is also not  surprising.

    My guess is that the largest contribution to the "reduction of margin" is the increased cost of components. Note that the graph implies that even though iPhone revenues were nearly flat at 3% growth, the cost of those revenues went up by 29%! In addition, the iPad revenues grew 40% while costs went up 65%.

    Unit pricing (and implicitly competitive pressure) is still not the primary cause of the reduction in Apple's margins. Indeed, the curious thing is that margins are now at levels seen for most of 2009 and 2010, a time when the iPhone (and iPad) were seen as near monopolies in their respective categories.

  4. Asymco Workshops Australia 2013

    Research · 18 comments

    Screen Shot 2013-04-24 at 4-24-6.38.35 PM

    I will be in Australia in May and thought to invite local readers to join me for a few hours of in-depth discussion on the future of our industry.

    I plan to have an event in Sydney on the 3rd in the morning (9:00 to noon at the Radisson Blu 27 O’Connell. Press Room) and in Melbourne on the 6th in the afternoon (1:30 to 4:30 PM at Victoria University City Flinders Campus: Level 12, Function Room 4, 300 Flinders Street, Melbourne, VIC, 3000).

    Nominally, the topic will be: The history and future of computing using disruptive analysis.

    I will present recent material (including the latest data from Apple) and we will have a few hours of Q&A.

    Tickets are $120 and seating will be limited to 100.

    You can register here: Asymco Workshops Australia 2013.

  5. The job the iPhone is hired to do, part II

    Research · 52 comments

    I repeat what I’ve mentioned before: The iPhone is primarily hired as a premium network service salesman. It receives a “commission” for selling a premium service in the form of a premium price. Because it’s so good at it, the premium is quite high.

    The job the iPhone is hired to do 

    The original post on the hiring of the iPhone by operators was anchored in data about the revenue per unit (or price) that the product was able to obtain. The remarkable resilience in the exceptionally high average price showed that the iPhone was still getting a premium for moving users to higher levels of spending on network services.

    The evidence was circumstantial however: By knowing the price and knowing it was far higher than competing products and knowing that much of it was paid by the operator and not the consumer (at least not up-front) implied that it was the iPhone, and only the iPhone, that was hired as a network service sales tool.

    Now we have more evidence thanks to Ben Thompson (@monkbent). I illustrate the data here as an x-y scatterplot.

    Screen Shot 2013-04-23 at 4-23-11.21.37 AM

    The data consists of ARPU (Average Revenue per User) ITU data from 2010 for 60 countries combined with browser share data on a country-level from the current period (sourced from StatCounter).

    The first observation is that there is a modest correlation between iOS usage and ARPU. It may not be particularly interesting by itself but it is interesting when compared with the lack of correlation between Android usage and ARPU.

    The presumption behind smartphone usage is that it leads to more browsing which leads to more network usage which in turn, leads to more network revenues and, finally, more network investment. If there is no additional browsing then there is a far smaller economic incentive to network operators to invest in infrastructure. It is this link between usage and revenues which I hypothesize drives operators to carry, subsidize and promote the iPhone. And the resilience of this link indicates that it still works.

    The ASP data seems to support this hypothesis and so does the ARPU data. The more iOS is in relative use, the higher the network revenue per user. Correlation is not causation, but when combined with data about Android, we can also say that the presence of the primary iOS alternative does not lead to more revenue. In other words, if a lot of iOS is present then revenues are higher and if there is little iOS present then revenues are not higher.

    I'm not suggesting that Android users use less bandwidth—the share data is after all relative—but rather that Android use itself does not seem coupled to paying more (or less) for service.

    If there is something to be concluded it's that not all usage is created equal. The data regarding how apps and ads are consumed is consistent with a qualitative difference between iOS and Android. This data is more of the same.

    It's something of a cliché to say that audiences vary in terms of quality, but that does not make it less true. Indeed, network operators depend on it being true.  And so does Apple.

     

  6. Interview with Chosun Daily of Korea about Apple

    Research · 65 comments

    The following interview took place by email on April 15th, 2013.

    1. What are the truth and false about the 'Apple shock' currently? In what perspective should we see this?

    First, I'd point out that during Steve Jobs' time the company suffered many such shocks. The stock fell many times far further than it just did for trivial and irrational reasons. Recently Warren Buffett himself pointed out that his own company had 50% drops in value four times in the past. Share prices are not always good indicators of potential and markets are not always efficient. I catalogued the dramatic share price declines in Apple during the last decade here.

    Second, I'd point out that the number of people watching and commenting on Apple has grown almost as fast as its sales and earnings. When Apple was small the people who studied Apple were few. (You could see this today for other, modest tech companies. There aren't 50 analysts writing reports every day and 2000 bloggers tweeting about Lenovo even though it's a successful and growing PC company.) Because of this growth, I would guess 80% of the observers have not observed Apple's prior painful episodes first hand. For them this is the first time a "dominant" Apple has slowed. The amplification of so many voices raising alarm makes it seem truer, but it isn't.

    Third, the failures being cited are not significant. In terms of increased competition, before Samsung there was Nokia and Motorola and the mobile Operators and Microsoft and Dell and many others long forgotten. They were all about to "defeat" Apple. As a quick example when Apple was "the iPod company," iTunes was considered vulnerable and fragile due to DRM concerns or the Beatles not being on it. Microsoft was launching "Plays for Sure" and Zune and Creative was suing Apple over patents. These battles are long forgotten. Before those there were concerns about the viability of the Mac that go back decades. At the time those were actually very valid concerns. At the time Apple did not have half a billion users. It depended on one product. But what saved them was a process of development of new products not the products themselves. iPod faded, Mac faded. What mattered is that they created new things to replace them.

    Finally, what is not commonly understood is that the mechanism for creating things at Apple is unchanged. Its functional organization is inherently unstable and chaotic, sometimes looking like it will derail. But that's the way it was designed to be. You just have to have faith that it's a system that works. Those who did in the past were well rewarded.

    2. What possibilities out of 1~10, do you think, Apple will suffer the same downfall as Steve jobs has left the company in the past in current?

    The threat is negligible. During the first departure of Jobs, the intention of management was to make the company into "a proper company." The plan was, essentially, to remove the chaotic model that Jobs had put in place and replace it with something more "rational" and "grown up." After he returned he set about not just returning the company to the way it was but to also codifying and identifying exactly what that was so that it did not happen again. You have to appreciate that the greatest thing Jobs ever created was not a product but Apple itself.

    Note that Apple managers stay in their roles the whole time they are there, sometimes for decades. There is no "general purpose" manager and the whole company has been organized along these functional lines. The way to think about it is that during his first departure the new management tried to undo what Jobs had built which is why it became dysfunctional: the DNA did not match the body it was operating. His return re-aligned the culture and operations to what was originally developed. As long as new management does not try to undo that, they'll be all right.

    3. Apple is now defined by some people, as 'the company who modifies well', not 'the company who innovates' well. What they made was ipad, ipod, iphone, apple tv and all the modifiers of the original products. Do you agree? If you do why?

    Innovation is not invention. Innovation is the application of invention in ways that solve new needs. I'm always amazed at how misunderstood this term is even though the definition is easy to understand:

    ("Innovation differs from invention in that innovation refers to the use of a better and, as a result, novel idea or method, whereas invention refers more directly to the creation of the idea or method itself.")

    Apple is an innovation machine. It does invent but that's not valuable in itself. Not all inventions are applied and not all innovations depend on internal inventions. Innovation is applied invention just like engineering is applied science. A better way to think about Apple is to think about Pixar. It's a blockbuster manufacturer. It makes blockbusters and nothing else. That means it does not make many of them and not always regularly and that the ideas may not be original, but the results are always very popular. Pixar is not like any other studio that makes some hits and some flops. Pixar is also a functional organization. It's not an accident that they were both built by the same person and that they are both successful after he left.

    4. Google is forecasted to release lots of products this year, but Apple isn't really looking forward to so many innovations. Inside Apple, is the innovation team really making a new innovative product? what are their longterm plans to fight with Google, or Samsung and the rest of the competitors?

    People outside of engineering organizations, especially large ones, don't appreciate the time scales involved. Products you see today were designed, planned and developed many years ago. We see plenty of evidence of this but we tend to ignore it. Consider that some prototypes end up on ebay showing they were built years before launch. It is the same with evidence presented in trials proving work on the product 4 to 5 years before it was launched. This is not the case just for Apple but all other technology companies.

    For this reason, what is happening in the market and what is happening inside the company are two completely different universes. The tendency is to assume a direct relationship between market momentum and current management decisions. These are connected but with many years in-between.

    For example, globally accurate Maps require a minimum of five years of development. Decisions on what ended up being Apple Maps had to have been made by Jobs himself. Namely, he must have decided whether to buy or build Maps. Contrast with Nokia's decision in 2007 to buy maps for a cost of $8 billion; instead Apple licensed and then decided to build later. In 2007 Jobs decided that it was more important to work on the product itself, meaning the iPhone (while Nokia didn't prioritize product innovation.) The results are visible today: Apple is behind and needs to accelerate with Maps and Nokia with its great maps must find a way of staying in business.

    Apple is not only working on the next product but probably 15 new products, of which 14 will be discarded. Again, I cite Pixar. Each movie is produced with multiple stories, multiple character decisions and different plots in parallel. Much ends up being thrown away. We don't see any of that.

    Apple is extremely "myopic" in that it is very concerned with execution and there is no visible "strategy plan".  That's by design. The product comes first and then comes the market and then comes strategy. To create great products you need to tune out almost everything else. However, they do have a "strategy" and that has to do with which problems they should attack and which they shouldn't. Usually they are successful because what they can attack nobody else can. That is due to their integrated, functional approach.

    5. Isn't Apple, relying too much on semiconductor manufacturers? Meaning, isn't Apple only try to be 'stable company' to supply their products on time? sometimes when companies have disruptive technologies, they have hard time supplying products.

    You're touching on the question of the problems of integration. Yes, there are vulnerabilities but that's the way it has to be. To mitigate this Apple is increasing its integration of the value chains. For example developing its own chip design and owning a lot of capital equipment.

    6. If you were Tim Cook, what would you do?

    I'd buy Intel and turn them into Apple's microprocessor design and manufacturing group. They won't have much to do in a few years and they'll be cheap.

    7. what are the reasons that Apple try to make a 'apple watch', 'apple bicycle'? How do you define these products, since, watchs and bicycles are a total different paradigm which is a totally different industries? Is Apple realizing that smartphone industry is hard for them to innovate?

    Computers are becoming more personal, intimate. It's a natural evolution from large to mini to micro to portable to handheld. I don't see this slowing and Apple should re-define the user experience during every such shift. Here again integration is essential.

    8. what are some of the stuff that we don't know about Tim Cook?

    I can't help you there. Only thing I can say is that people who know him have told me he's not soft and gentle as a manager. He's tough.

    9. How will Samsung and Apples patent fight come to conclusion?

    Again, I can't add much to this. Litigation is often a decision made outside of market conditions so it can be arbitrary.

    10. how does employees or executives inside apple think about their company?

    It's hard to describe this without sounding soft, but the employees at Apple tend to love the brand. You can't measure that but I can think of one proxy: the number of applicants to retail jobs are in the hundreds for each opening.

    [Update: Bono made an important observation regarding Jony Ive which was published after this interview: What the competitors don’t seem to understand is you cannot get people this smart to work this hard just for money. Jony is Obi-Wan. His team are Jedi whose nobility depends on the pursuit of greatness over profit, believing the latter will always follow the former, stubbornly passing up near-term good opportunities to pursue great ones in the distance]

  7. Lumia: Is the light visible?

    Research · 64 comments

    The following graph shows the history of smartphone volume shipments from Nokia.

    Screen Shot 2013-04-18 at 4-18-1.48.21 PM

     

    Lumia sales have increased to 5.6 million units last quarter. Up from 4.4 during the previous quarter. Symbian devices have nearly disappeared from the market with only 0.5 million shipped.

    This puts an end to Symbian sales after over a decade since sales start and two years after it was declared that sales would end.

    The bad news remains that smart devices as defined by Nokia are still not profitable. If volumes grow it's possible that the cost structure (without further cuts) can be sustained and perhaps the business will get its footing.

    The level of 6 million units/quarter is about where HTC and RIM are today but only half of what ZTE and Huawei are probably shipping. As a hardware business it might work, barely. It certainly helps to have $250 million as platform support payments from Microsoft.

    As a platform it's still a very long haul for Windows Phone. Even if we assume a nominal $15 revenue/ Windows Phone license and ignore the kickback, at this level of sales the platform generates less income than what Microsoft gets from licensing IP to Android vendors.

  8. Horace Dediu Interview – Why Businesses are more Fragile than People

    Research · 7 comments

    The best and brightest are usually put to work on optimisation, and asked to improve the way things work. 'Can you make it better, faster, and stronger?' They will then go forward and solve the inefficiencies, and that’s where 99% of most energy is spent on. But, at some point you run out of room to improve things, and that’s when you have step aside and ask, can we make it different?

    via Horace Dediu: Asymco Interview – Why Businesses are more Fragile than People.

    Be sure to check out my "Favorites".

  9. Escaping PCs

    Research · 275 comments

    The Windows PC market is contracting. The market data has been showing unit shipment declining for some time with the latest quarter having perhaps the steepest decline for two decades.

    What remains undocumented however is how the market looks when considering economic value. A more complete picture would be to show revenues, average selling price (or revenue/unit), operating margins/unit and percent of profit capture.

    The data is not beyond reach however. It involves combining the shipment estimates from e.g. Gartner with financial reports from the companies themselves. Some analysis is required to estimate margins but they are also not hard to obtain (e.g. from third parties.)

    So here is a view of the market for the fourth quarter 2012:

    Screen Shot 2013-04-16 at 4-16-4.05.57 PM

    The only inference I made was with respect to Apple's margins for the Mac. These are based on deriving a gross margin of 26% and adding an estimate of the SG&A and R&D "overhead" of 7.1% of sales, a figure which applies to the entire company. This yield an operating margin of 18.9%.

    If this estimate is considered then the operating profits from PC operations imply that Apple generates more profit than all the top 5 PC vendors combined.

    Assuming further that "other" vendors have the same profitability ratio as the top 5 combined yields a figure of 45% "profit capture of PC market" for Apple. This is not as good as its performance in the phone market, where Apple has about 72%, but it's not bad.

    Screen Shot 2013-04-16 at 4-16-4.16.46 PM

    The real problem for the PC vendors is not that they have such low margins–they've had low margins for decades. It's that the volumes which "made up for" low margins are disappearing. Apple is not immune to a gradual erosion of Mac volumes, but they have positioned themselves for growth with devices and content commerce and services. They have essentially "escaped" PCs and indeed caused the need to escape in the first place.

    The problem is what could the others do? It seems all they can do is depend on Microsoft getting their strategy right.

    Sounds risky.