Industry

Apple paid $10 billion to developers in calendar 2014. Additional statistics for the App store are:

• $500 million spent on iOS apps in first week of January 2015
• Billings for apps increased 50% in 2014
• Cumulative developer revenues were $25 billion (making 2014 revenues 40% of all app sales since store opened in 2008)
• 627,000 jobs created in the US
• 1.4 million iOS apps catalog is sold in 155 countries

Putting these data points together with others from previous releases results in a fairly clear picture of the iTunes/Software/Services ((soon to be renamed Services and encompass everything under the heading of iTunes software and services today including content, apps, licensing and other services and beginning Q4 2014 it will also include Apple Pay.))

The App ecosystem billings (what consumers actually pay) is shown in the red area above. 70% of those payments are transferred directly to developers and Apple reports the 30% remaining as part of its revenues. This view of the iTunes ecosystem shows the impact of Apps relative to the other media types. When we measure the payments to the content owners we can see that Apps also dominate: 

The red area above adds up to the approximately $25 billion total paid to developers. This view of the payments to ecosystem contributors shows how apps are now a bigger digital content business than music (( Music payments due to iTunes Radio streams are not shown as part of Music cost of sales. Streaming revenues are included in the services/licensing income and payments come out that cost structure.)) and TV programs and Movie rentals and purchases put together.

This is quite a story.

Put another way, in 2014 iOS app developers earned more than Hollywood did from box office in the US.

 

Although the totals for Domestic (US) Box Office are not the complete Hollywood revenues picture, Apple's App Store billings is not the complete App revenue picture either. The Apps economy includes Android and ads and service businesses and custom development.  Including all revenues, apps are still likely to be bigger than Hollywood.

But there's more to the story. It's also likely that the App industry is healthier. On an individual level, some App developers earn more than Hollywood stars ((so do YouTube stars, but that's another story.)) and I would guess that the median income of app developers is higher than the median income of actors. ((A large majority of actors earn less than $1,000 a year from acting jobs)) The app economy sustains more jobs (627,000 iOS jobs in the US vs. 374,000 in Hollywood) and is easier to enter and has wider reach. As the graph below shows It's also growing far more rapidly.

The curious thing is that even though the medium of apps is swamping other forms of entertainment in all measurable ways, comprehension of the phenomenon is lagging.

Information asymmetry is a wonderful thing.

My choices:

1. Cyanogen. This company should develop a credible path for AOSP (non-Google Android) especially in India. I expect a lot of traction as OEMs who embrace Android reject Google.

2. iPad. Not as a consumer product but for the Enterprise. The iPad grows up into a solid product for business while being replaced by phones in consumer “jobs to be done”.

A few more ideas are listed here: The 2015 "Sleeper Ideas" List: Trends, Stocks, And Private Companies To Watch - Forbes.

 

 

As corporate romances go, IBM and Apple's must rank among the most unexpected. As I wrote on the date they changed their Facebook status, the two companies were antagonists for the better part of twenty years and their rapprochement was met with a shrug mostly because yet more decades passed since.

Nostalgia aside, this new union is profoundly important. It indicates and evidences change on a vast scale. The companies' antagonism was due to being once aimed at the same business: computing. Since the early 1980s, "computing" came to be modularized into hundreds, perhaps thousands of business models. It is no longer as simple as selling beige boxes. IBM was forced out of building computers and into services and consulting while Apple moved to make devices and the software and services which make its hardware valuable.

The convergence of interests which was consummated into a deal this year stems from the migration of computing around what has come to be called "mobile". Apple intends to accelerate the adoption of its mobile platforms among the remaining non-adopters: enterprises–a group which, by now, qualifies as laggards. ((There was a time–when Apple was young–when enterprises were the innovators, early adopters. That role ended approximately in the year 2000)) Simultaneously IBM intends to connect data warehouses at those same enterprises to their employed users.

Both can achieve their goals better if they join forces: Apple offers assistance and expertise while obtaining access and lubrication for orifice entry. IBM offers modularized access to databases through its own APIs and obtains credible client experiences. The combination increases adoption of mobile (i.e. intuitive) solutions and an increase in productivity, benefiting the buyer.

The recent apps release showed just how transformative this relationship could be. We were witnesses to apps which appeared to be designed for users[!] They were not designed for committees that prepare checklists of requirements.

We must applaud IBM for having the courage to resist the featuritis which plagues enterprise software design. This resistance requires saying No to those who specify and are thus authorized to purchase software and hardware. IBM has had to essentially say no to those who buy and yes to those who are paid to use. The quality of the experience is evident at first sight. The number of user actions, the number of screens to wade through have been ruthlessly culled. These are concepts and ideas which now permeate app design best practices. Yet they are practices which still elude the spec-driven enterprise software wastelands.

Simultaneously we must applaud Apple for accepting that there are throngs of unwashed masses laboring in cubicles which deserve to be served. They may be employed by laggards but they are people too. Apple management has made clear that they are being more inclusive and open minded. Extending that open hand to the downtrodden salaried masses must surely bring a tear to one's eye.

Being unexpected and yet explanatory of the state of technology today, the partnership between IBM and Apple is, in my opinion, the most significant technology news of 2014.

As a romance, it is at least as newsworthy as the divorce of Wintel was in 2012.

This year's Thanksgiving and Black Friday data from IBM shows a continuing pattern of growth for mobile devices. As the graph below shows, in the five years since 2010 mobile devices grew from 5% of the online shopping traffic to 50%.  Traditional computing (desktop and laptop) made up the difference.

The graph also shows that sales value via mobile devices crossed over 25% of online spending. The fact that mobile shopping is not equal to mobile spending is due to the convenience factor of mobile. It's more likely that users will spend idle time scanning for bargains or tracking down ideas from friends but wait until they are at home to make the final purchase decisions in front of a computer.

The transition to spending directly from a device is a slower process, but that process was also one that online had to undertake as buyers became comfortable with online commerce. When it comes to payment, buyers are understandably more cautious.

This does not change the prediction made last year that "the transition to post-PC consumption will also be practically completed by 2020". That leaves six years for mobile saturation and a total transition time of one decade.

At that point I expect 90% of browsing and perhaps 75% of spending to be happening on devices. Some of this will undoubtedly be enabled by biometric authentication as shown by Apple Pay. Trust and ease of use in this technology will undoubtedly accelerate the transition making mobile payments more comfortable and secure than on the legacy computer.

What is less predictable is how much those devices will also be used to transact payments for the physical retail stores. In some scenarios it's possible that by 2020 a majority of all shopping will be enabled by devices. ((There is also the matter of in-store discovery and advertising via NFC and bluetooth i.e. iBeacon)) That would subjugate the retail segment to the power politics of mobile platforms.

It is interesting therefore to note the mix between the platforms in the graphs above.

I tried to assess the opportunity of Apple Pay but found it to be mostly dependent on how quickly card payments will overtake cash. It seems that as payments move to a digital format they will move to a mobile device. The hurdle isn't going from a card to a phone but from cash to card.

Data published in The Growth and Diffusion of Credit Cards in Society  shows that between 1970 and 2001 households with at least one credit card in the US grew from 17% to 70%. More recent data shows 82% of US consumers have at least one credit card and 77% have a debit card.

The Total Addressable Market for Apple Pay then is dependent on how quickly this pattern repeats over the markets where iOS devices are in widespread use. Once cards are in use they are used with higher frequency and quickly overtake cash for the user.

The only assumption that needs to be made is that the device then replaces the plastic card. This seems a safe assumption as the benefits of the device as payment authenticator are high and the costs are negligible given a penetrated market.

The following graph shows an extrapolation of transaction volumes where Visa and MasterCard and Amex are showing moderating growth with UnionPay showing 20% constant growth through 2019. ((Supporting these assumptions is a forecast from Nilsen showing total number of cards in circulation by issuer and a forecast of total transactions

))

Two more assumptions are needed: the share of transaction value captured by Apple Pay and the Apple Pay fee. I used 15 basis points ($15/$10000) as the assumed Apple fee and a share schedule as follows:

• 2015: 0.5%
• 2016: 1%
• 2017: 1.5%
• 2018: 2%
• 2019: 3%

These assumptions result in a cumulative revenue of over $1 billion by 2018 and a yearly run rate of $1 billion in revenue by 2020.

Although this is not a huge amount relative to Apple's overall revenues ((No more than half of one percent of 2015 revenues)), it's important to note that these revenues are likely to go directly to earnings ((About 2% of 2015 earnings)) as there are negligible costs associated with the transactions that Apple needs to bear.

These assumptions make the statement that Apple Pay can become "A Billion Dollar Business" plausible by 2020. Perhaps sooner.

 

Samsung's smartphone ascent was breathtaking. From having essentially zero market share in the category in late 2010 to becoming the largest vendor took less than two years. In doing so it grew to become the largest phone vendor, smart or not--a goal which eluded them during the previous decade of effort. Samsung went on to capture not only the lion's share of unit volumes, they also took almost all the profits in the Android mobile phone market.

And in a market filled with competitors. Literally hundreds of vendors and thousands of products were available at every conceivable price point. Samsung did away with HTC, LG, and Motorola. HTC, the first Android vendor (and first to market with Windows Mobile), Motorola, Google's launch partner in the US and "Droid" brand partner (and future owner).  Google's own Nexus products. Samsung Galaxy ruled them all.

Galaxy swamped the Chinese market and the Indian market, the largest in the world. They were so powerful that they were singled out both by Microsoft and Apple for IP royalties.

All within two years or the average life-span of one smartphone.

But something went wrong in 2014. Growth in shipments suddenly stopped. This was not a problem with the overall market, which kept growing. The slowdown did not affect other vendors, especially the up-and-coming Lenovo and Xiaomi and the second and third tier vendors whose names are  known only in the local markets they serve.

The result of this slowdown is shown in the following graphs:

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Note how the wobble in units shipped was foretold by slowing revenues and an even more profound effect in profits. Peak revenues and profit occurred in Q3 2013 while volumes continued to grow until Q1 2014. Even in the last quarter, shipments are at near year-ago levels. Profits however have dropped to 2011 levels.

At the same time, Apple shipments continue to grow as do those of Lenovo, Huawei and Xiaomi. Xiaomi in fact is growing in a trajectory eerily parallel to that of Samsung from 2010. It just hit the same level of volume that Samsung had in Q2 2011. And Samsung had been making phones for decades while Xiaomi is barely two years old.

Having seen a boom/bust rise/fall pattern with other vendors (e.g. Nokia and Blackberry) it should behoove us to ask what are the causes of success and failure in this business. Samsung management suggests that they perceive speed of action, product mix/portfolio choices and hardware experimentation are the keys to their success.

However, competitors which are rising rapidly (at the expense of Samsung) are not acting in the same way. Xiaomi is patterned as a Chinese Apple, offering design, brand, attention to detail and software as differentiation. Lenovo is building on its computing roots and expanding with acquisition. Huawei and ZTE leverage networking business and operator relationships.

The crisper answer to causality may be that the market is bifurcating into an "upper" market where new jobs-to-be-done are being explored with integrated offerings (Apple and Xiaomi) and a "lower" market which is in the throes of low-end disruption. Both are competing with non-consumption though the upper market is service non-consumption and the lower market is feature non-consumption.

Samsung is stuck right in the middle ((Just like Nokia was.)) It defines itself on the basis of what exists. It competes only within a defined market and positions itself agains existing products. They claim to be "better" than the competition and make the point loudly with their advertising. However, being better is never a solid foundation. At some point you'll be either good enough or someone more agile will be faster than you.

At some point the fast follower exposes themselves to being faster followed. Better to find new lands to conquer.

In Q3 2014 Apple's revenues were 5.3% higher than the upper end of their guidance. This is the highest error in guidance since the new range-bound  reporting regime started two years ago.

The following graph shows the guidances given since 2005 and the actual revenues. The error (as a percent of upper guidance) is given in the second graph.

Note how since the newer, presumably more accurate method was introduced in 2012, the errors have decreased on average. As a result, for these two years, forecasting performance for Apple was no longer challenging. The only questions for the analyst were how to allocate the revenues among products and to guess how many shares would be retired.

Is this about to change? Could forecasting make a comeback as sport and leisure?

Assuming no error in Q4 yields the following shipment forecast:

That's about 95.5 million iOS devices in the quarter. That also means that the one billionth iOS device will have been sold sometime in the next few weeks. ((McDonalds took 23 years to serve its first billion hamburgers)) ((Over 650 million iPhones, 115 million iPods touch, 265 million iPads))

Samsung Electronics warned Tuesday that its third-quarter earnings would fall below market expectations. It did not cite a decrease in shipments but an increase in marketing expenses coupled with an unfavorable mix (i.e. more low-end units and fewer high-end units).

The headlines reporting the news emphasized the 60% forecast drop in operating income but the company also provided sales figures. Adjusting for exchange rates, the forecast revenues are shown in the following diagram:

 

Note that I also included Apple's revenue history and forecast. Samsung's revenues are shown on the right and Apple's on the left using the same scale (each horizontal gridline represents $10 billion/quarter.

The explicit cause for the drop is a decline in prices and "increased competition". ((Though one can't be sure when there was ever decreased competition in its markets.)) However a few more questions need to be answered regarding long-term success in the markets Samsung competes in.

Namely:

• The absence of a software platform fully within its control
• The absence of control over an ecosystem of content and apps
• The absence of services
• The lack of integration of software, services and hardware
• The absence of differentiation vis-a-vis other vendors
• The indefensibility of its low end offerings from low end disruptors
• The pattern of commoditization in all its markets

Samsung is a very big company but many very big companies came to become small companies. They all followed similar roads.

If software can be injected into an industry's product it will bend to the will of the software writers.

This theory expands on Marc Andreessen's observation that "software is eating the world". The evidence is that software, coupled with microprocessors, sensors, batteries and networking becomes applicable to an increasingly larger set of problems to be solved ((Or, put another way, is eligible to be hired to perform an increasingly large set of jobs)). Software has "eaten" large portions of entertainment (e.g. Pixar, iTunes, video games), telecommunications (iPhone, Android, Messaging), various professions including journalism, management and law, and is entering transportation, energy and health care and poised over banking, finance and government.

As entry happens, asymmetries are enabled and disruption follows. This is the bending to the will of the writers--who tend not to be incumbents. The incumbents can't embrace the changes in business models enabled by software without destroying their core businesses and thus, invariably, they disappear.

The pattern is easily observed but the speed and timing of it is difficult to predict and hence investment success is not certain. ((Which, ironically, means that the jobs of venture capitalists are still safe. At least until the theory develops to the point where it can predict with more accuracy winners and losers.)) There are many entrants who try and few succeed and there are many incumbents who will survive longer than a prophet can stay hungry.

Nevertheless, this process of software-induced turnover in wealth--and, incidentally, vast, additional wealth creation--is inevitable.

But can we predict anything other than timing? For example, can we predict the next industry to succumb to this force?

There is hope because the last big disruption was predictable. When looking at what caused telecom to become a domino, the pattern of development of hardware pointed the way. It was clear in the late 1990s that computers would become small enough to fit in one hand. The first instances were PDAs (mid-1990s) and once they proved valuable in solving many jobs it was easy to plot their evolution into phones.

So if we follow the "packaging" constraint, it's clear that computers are becoming small enough to be worn. Many prototypes exist and even small companies can build them.

All that is needed is a new user interface and a new platform will be born. Once a platform is born, the creativity of millions can be unleashed to expand the problem set that can be solved. The process then repeats.

So it's obvious that as a computer becomes wearable it will affect the industry that currently is hired to also be worn: apparel.

Apparel is the word describing every garment, shoe and accessory product sold and amounts to about $1.2 trillion/yr. ((The US is about $331 billion or 28%.)) ((The Telecom industry is slightly larger at about $1.3 trillion)) This amount of money is not spent only to protect the wearer from the elements--any more than the money spent on telecommunications is spent to convey vital information. Most of the value in apparel, perhaps 80%, is spent on solving psychological needs.

And therein lies the opportunity. As the value is beyond functional, substitution of psychological jobs by new products is a matter of engineering better solutions. Consider the behavior of US teens: anecdotally, their spending on apparel is fading as the solution to feeling good about themselves increasingly relies on a device and service. Already, in this context, apparel retail is in crisis while buying shifts to devices.

While looking at the spending, it's also easy to see how much there is to divert from a non-functional to a functional/service bundle:

In many markets individuals spend more on apparel than on personal technology. And as personal technology increasingly competes for the same jobs to be done, that spending will transfer to the entrants.

To know who's already planning for this you can follow the trade news on the hiring of talent.

My thanks to Eric Jackson for his thought-out questions on Apple. As published in Forbes, here is his Interview With Horace Dediu: What To Expect When Apples Expecting.

A few excerpts:

Q: Do you expect to see a sapphire cover on the new iPhone(s)? Is that material significant?

I expect Sapphire will become a signature feature across many products. I don’t know if they will have capacity to deploy on iPhone this year but on a watch it’s essential. Here’s a clue: if the screen has any curvature, especially around edges, it needs to be sapphire as glass can’t take strain in that shape. The scope of the plant they are building with GT implies that they will have massive volume potential with at least one major iPhone model using the material. It’s a significant material because it allows design freedom in new directions, especially curved (concave) touch surfaces that retain a jewel-like feel. This has Jony Ive all over it.

Q: Is it fair to conclude now based on the 5C and 5S that Apple will never launch a “cheap iPhone”?

Oscar Wilde said a cynic is someone who knows the price of everything and the value of nothing. When I see the word “cheap” I never know if it refers to price or value. And even when we talk about price, an iPhone is cheaper than buying all the things it replaces so it’s always been a low end disruptor in my mind. (I saw a tweet with an image of a Radio Shack ad from the 1980s and every single item available on that page is now a part of the iPhone. It would have cost thousands to buy all those things back then–and dollars were worth a lot more.) Furthermore, I think Apple holds a black belt in pricing. They seem to define their position in the market by anchoring certain prices and “owning” them. Given all that I would say that Apple is not going to move their price points much. They will expand the portfolio and offer some iPhones at $300 but they will be older models. The average selling price (ASP) I expect to remain constant on a year-long average.

Q: In the past, Apple critics were quick to dismiss the new iPad and 5C iPhone as failures upon their introduction.  You never judge. You just report the facts and data.  That said, is there anything about past new Apple products launches that we should look at as a predictor of how a new iWatch might be received by customers?

When the iPad was imminent the great debate was over whether it would run iOS or OS X. Many imagined a touch-based Mac rather than the “big screen iPod touch”. It was a tough call and one which Microsoft could not and still does not make. Therefore, the interesting question for me with respect to iWatch is: What OS it will run? I will be shocked to the core if it does not run iOS. It is my opinion that making iOS work on it is the entire reason Apple is sweating this segment. They are in it because they are trying to make a platform product with a novel user experience and all the power of an ecosystem run on a wrist. It’s as big a problem as getting a phone-sized device to run a touch UI was in 2007. That is the crucial contribution that Apple is making to this next generation of computing. Now you might ask what users are asking for in this segment. The answer is nothing. Nobody is asking for this. As nobody asked for the iPhone (or the Mac or the iPad). It’s a new computer form factor and how it will be used will be determined by the apps written for it. But it will work and be magical out of the box in version 1. This is in contrast to the single purpose or accessory model of wearables we see to date.

Q: As a student of disruption, where is Apple most vulnerable to being disrupted?

Apple is a new market disruptor but much of what is put forward as a threat to it is low-end disruption. I think Apple knows enough about how that happens that it can manage its way around it. The strategy they employ is one of attrition. If you wait long enough a low-end threat tends to wear itself out as it starves of profit and is constantly gnawed-at by alternatives. (You see, if the disruptor cannot manage a profit then they cannot climb up the trajectory to get on top of the incumbent. Being profitable is a key requirement for successful disruption in the long term.) The attrition strategy works as long as you have the fortitude to hold out and the deep pockets to keep improving your product as alternatives flame out. It is my belief that Jobs made sure that thinking is inculcated in the company. So if not low-end is the company vulnerable to new-market disruptors? This is more subtle and the threat here is what Google/FaceBook/Amazon and the other ecosystems are all about. It’s creating new usage models and shifting where consumers place brand value. I think this is more what keeps Apple’s management awake at night. They are not standing still however. iTunes and Software and Services (now with Beats on board) is the way they are staying on top of that threat.

Lots more here.

Amazon's recent disputes with publishers (Hachette and Disney) shows a degree of market power that is closer to monopsony than to monopoly but this power is nevertheless real. It may not not be something that requires intervention, regulation or even scrutiny but market power is evident in both how companies operate and in how they are valued.

If you look at the following graph, it's easy to spot those with "monopoly" power. The graph shows a short history of revenues/operating income and P/E ratios. Modest or no growth in earnings coupled with extraordinary high P/E ratios indicate that the market understands the business is not threatened by competition.

In contrast, "beleaguered" companies include those with great sales growth but no perceived long term prospects. This perception is evidenced by a low P/E ratio. It indicates how long the company can maintain its present level of profitability. I've highlighted Apple's continuing, and indeed perpetual, beleaguered state. Excluding its existing capital base, Apple rarely gets votes for a life span longer than 10 years. One can see the same status in many Asian companies. Samsung is even more beleaguered than Apple by this measure.

The underlying implication is axiomatic as far as investments are concerned.: Being under threat all the time is undesirable.

But is this true?

One of the issues with monopoly/monopsony is that it leads to business practices and strategic priorities that are tainted by hubris. In contrast, the stress of competition leads to "paranoia" and to a sense of urgency which is blessed by innovative insight.

This is a corollary of Grove's "only the paranoid survive" or Jobs' rant on why Microsoft was unable to come up with breakthroughs. Grove and Jobs looked at dominance of a market (as either buyer or seller) and saw a curse. Their understanding of the human condition went beyond what the arithmetic of markets would suggest. Running a business and managing people who are asked to create things leads to this insight. Peering at spreadsheets doesn't.

The observation to be made is that those who invest in companies haven't caught on.