ecosystem

In March 2016 Ben Bajarin and I put on an event called SUBSCRIBE where we asked, among other things,

• How will the online services business models evolve?
• How will hardware affect software and services and vice versa?
• How will  users, usage, and capital connect?

Now is a good time to look back on that event.

For the keynote I prepared a model which predicted the mobile ecosystems for iOS, Android and Chinese Android over the next 5 years (to 2020). The methodology involved taking a measurement of the revenues of the top internet service companies, building up the categories these companies occupied, estimating how much of those revenues are through mobile distribution and then splitting the result among the three platforms of iOS and the two Androids.

Adding to that the "native" app and content revenues for each platform would yield the Ecosystem total value. Applying a growth rate would offer some visibility into the future.

The following images are screen captures of the Perspective presentation.

Of course there are several potential errors in this methodology. The categories were not all inclusive. I used Social, Media, Search, Maps, email, Messaging, e-commerce, Travel, Enterprise, Storage, Transportation, Travel and Other as the top level categories. There are many products and services who would end up in Other. Moreover, these categories were anchored by the top companies in each category and the share of the top names was not always clear. Finally, the growth rates for these categories were based on historic trends which could change either way.

The online services ecosystem (all platforms) was thus estimated to be $450 billion in 2015, growing to $820 billion by 2019 and $914 billion by 2020.

The mobile split would vary by segment but would be roughly 75% by 2020 (25% would not be mobile). The final assumption was based on the split among the existing mobile platforms. I put a multiple of roughly 50% for iOS and 35% for Google Android and the rest for China Android.

Multiplying all these assumptions gave me a figure of $275 billion for the iOS portion of the global online services market in 2019. (Incidentally, Android was estimated at $207 billion and China Android $110 billion.) Note that this does not mean this was an expectation of Apple's revenues or that this was the opportunity of Apple obtaining any percentage of this revenue. It was simply the value of what would transact through iOS, a platform which would act as a commerce enabler. This was to be the size of the iOS "ecosystem" or co-dependency between Apple and the companies delivering through its platform.

Ecosystems are a powerful idea. As I recall, this term applied to mobile was coined by a Palm executive in the late 1990s when he referred to the value of all the apps built for the Palm Pilot. The biological term refers to the system of multiple species living in close proximity. It implies an equilibrium as each species benefits from the others and the environment. There might be predators and prey but biodiversity is the successful construct.

The idea of an ecosystem for a platform was also the core strength of Microsoft's Windows which created the network effects around it and it has been the goal of every platform since. The nature of computing and networking implies that these systems grow faster and are more resilient than the more traditional value networks of other businesses or industries.

Now this ecosystem was something we wished to highlight in 2016 as a core strength for Apple. It was not considered as such at the time and I thought putting a figure of $275 billion in 4 years' time was a way to highlight the potential. Time since has proven us right.

This week Apple highlighted the result of another research team who attempted to measure the iOS ecosystem. Their conclusion was that billings and sales facilitated by the Apple App Store Ecosystem in 2019 was $519 billion. More than twice the amount I had so optimistically forecast four years earlier.

The authors also emphasize that this is a conservative estimate and should serve as a baseline.

I feel partly vindicated about that figure as my attempt at a figure was intended to highlight the scope of the ecosystem and it is better to have underestimated it than overestimated it. The authors' methodology was also similar in being bottom-up summation of components by categories of services but the information available today is enhanced by the new data Apple made available on subs and Services revenues and install base.

Note that in the graph below the salient data points of subscribers (red triangles) had not begun until 2017 causing the acceleration in Services revenue (yellow line). Note also the additional square points representing install base.

This figure of more than half a trillion dollars of value transacted through iOS should give some pause. It it a very powerful figure that can be combined with the other data from Apple:

• More than 1.5 billion active devices
• More than 1 billion iPhone users
• More than 500 million paid subscriptions
• More than $1/day iPhone hardware revenues for Apple

The half-trillion per year on services implies between $335 and $520 in spending per user (likely closer to $500) per year. This would be in addition to the approximately $365/yr in hardware spending per user (which Apple books as hardware revenue). In the case of the iPhone there is yet more: the cellular network service which may average $350 per year.

To simplify, the "average Apple user" spends $1/day for each device, $1/day for the network and $1.4/day on items bought through the device. Adding a margin of error, that's between $3.4 and $4 per day each user spends. Oh, and there are about a billion such users.

The total spending enabled by iOS thus is close to $1.4 trillion/yr.

That's a significant amount. It's bigger than many industries. There are only about 12 countries with higher GDP (Spain is about the same.)

How does Apple benefit from this?

Apple captures 30% of billings through its App Store. My estimate for these billings were $67.9 billion in 2019 which means App Store billings were 13% of the 2019 ecosystem. Apple's 30% cut of Billings amounts to 3.8% for the whole ecosystem. It's hardly an oppressive number.

If Apple only captures 3.8% what use is this to Apple?

The last decade has seen Apple emerge as the world's largest company in terms of market capitalization, and not doing so with a wild multiple of revenue or earnings, quite the opposite. It did this by creating the world's greatest customer base. Not in absolute scale. Android and Facebook have larger customer bases with multiple billions of users.

No, Apple's one billion users are simply the best billion users. They are the most likely to stick with Apple and they are the most likely to buy more from Apple and—this is crucial—they are the most likely to buy everything else. Those other companies whose sales come from Apple customers have been taking note. They know that Apple customers are desirable customers and choose to target Apple customers, as much as they can. Associating your company with Apple makes a lot of economic sense.

I will admit however that my argument that Apple created a customer base is contrived. The fact is that Apple creates products and services and those products are the root of its power to attract the right customers. By choosing to create the best products it coincidentally chooses to create the best customers. The power flows from product not from pricing or positioning. This is a lesson lost for many.

Developers and regulators might feel Apple's massive power is perhaps too much. In the last decade, the narration around Apple has shifted from Apple being perpetually "doomed" to it being too dominant. Although I'm sure there are some who will try to conflate the two declaring that dominance will inevitably result in doom, most critics of Apple went from laughing (at it) to crying (about its practices).

The argument that Apple should change its practices developed to price as it does, distribute as it does or design as it does because it was too successful or is "unfair" is getting the causality wrong. Dominance won't be altered by a few points of percentage change (on a tiny fraction of ecosystem transactions). Fairness won't be altered when there are thousands of business models and many remain to be invented. Case in point is pornography which is not permitted on the App Store but which exists in abundance thorough other access methods.

The argument is that Apple should be more generous. That it should decrease the "cut" it takes for distribution. Or that it should not enforce revenue split for the customers it exposes to others.

But this is problematic on many levels. The playing field for all developers needs to be level. The customer must be respected and access to that customer should be constrained or certainly metered. Abuses must be policed and that requires leverage.

These practices are inter-dependent and the effect multiplicative, not additive. Apple has a monopoly on iOS and on MacOS and WatchOS and iPadOS. It does this to control the experience, security and safety of the user. It's that control which created the customer in the first place. It should naturally control access to its hard-earned customers.

It does not monetize the distribution of content or apps unless the developer/creator directly charges for the product or service. Distribution is not cost free and to offer it for free is a subsidy which would create additional market and innovation disincentives. The loyalty of Apple users is evidenced by the 600 million paid subscriptions (end of year estimate) that are booked through the App Store. Developers benefit directly as a result.

One could argue that the abundance of services which don't distribute through the App Store is evidence that the system works as intended. Apple's App store front is its property and it reflects its core values.

Being on the shelf in the App Store means you operate on the terms of the shelf owner. If the rules are not agreeable then the half trillion dollars of ecosystem activity is testament to the availability of alternatives.

In its first 10 years, the iPhone will have sold at least 1.2 billion units, ((Includes forecast for first six months of 2017)) making it the most successful product of all time. The iPhone also enabled the iOS empire which includes the iPod touch, the iPad, the Apple Watch and Apple TV whose combined total unit sales will reach 1.75 billion units over 10 years. This total is likely to top 2 billion units by the end of 2018.

The revenues from iOS product sales will reach $980 billion by middle of this year. In addition to hardware Apple also books iOS services revenues (including content) which have totaled more than $100 billion to date.

This means that iOS will have generated over $1 trillion in revenues for Apple sometime this year.

In addition, developers building apps for iOS have been paid $60 billion. The rate of payments has now reached $20 billion/yr.

Not included in this payment total are "mobile-first" or "mobile mainly" businesses such as FaceBook, Twitter, Linkedin, Tencent, YouTube, Yahoo, NetEase, Pandora Radio, Google Search, Baidu, Google Maps, Gmail, Instagram, Amazon, eBay, JD.com, Alibaba, Priceline, Expedia, Salesforce and Other Enterprise Software, Ride Sharing Apps, AirBnB and many other services which monetize independently of the App Store.

I estimate that the cumulative revenues enabled by iOS across these businesses have exceeded $500 billion, with a rate of revenue soon to reach $300 billion/yr.

The revenue numbers can only hint at the change in behavior among users. An iPhone is unlocked 80 times a day. Assuming 600 million devices in use there are 48 billion sessions on iPhones every day. 17.5 trillion sessions every year. It is these instances of interaction and engagement which are desired by all businesses built on top of the ecosystem.

These instances of engagement must be multiplied by the quality of the customers which Apple captures. iOS users spend more and are more loyal than those on alternative platform thus qualifying the platform as "premium" and thus adding to its value in the eyes of developers, content producers and service providers.

As the install base of iOS increases and as users hire the devices to do more and spend more time with them the virtuous cycle of value creation will continue and accelerate.

There is a temptation to think that such a business is fragile and will be disrupted. Challengers appear daily and the number of iPhone "killers" is not measurable. One can cite the billion users of Nokia phones which defected. One can cite the loyalty of BlackBerry users that evaporated. One can even cite the juggernaut of Windows and how it became impotent. One can cite the vast number of Android devices offered at low prices.

But there are reasons to believe that the iOS empire is far stronger and resilient.

Unlike Nokia's phones, Apple's product is an ecosystem with network effects and dependencies on software and services. It's also a monolithic product with a singular interface and form factor.

Unlike BlackBerry, the iPhone does many jobs--too many to count. Indeed the iPhone evolves and changes its core value over time.

Although different in many ways from Windows there are strong similarities in terms of loyalty and persistence of users. iOS even developed a dominant position in enterprises. Microsoft's attempt to become a hardware company is a testament to the confluence of the two business models.

And whereas Android was originally seen as the "good enough" iPhone, potentially disrupting it, it turns out to be the ersatz iPhone. Chances are higher that users will switch from Android to iPhone and not the other way. Again, the reasons have more to do with the ecosystem and quality of users (which are hard to measure) than with the hardware (which is easy to measure.)

As we look toward the second decade of the iPhone, the expectation isn't one of another "big bang" but a process of continuous improvement. The market is nearing saturation so the goals must be to capture more switchers from Android. Apple has achieved this with the Mac: survival, persistence and eventual redemption.

More exciting is the apparent expansion of a network of ancillary "smart" accessories. The Apple Watch, the AirPods, Pencil and possible new wearables point toward a future where the iPhone is a hub to a mesh of personal devices. The seamless integration of such devices is what has always set Apple apart.

 

At WWDC 2016 Apple offered a set of new data points to illustrate its ecosystem's robustness.

First, the number of registered developers increased by 2 million in the last year to a total of 13 million. That is a growth rate of 18%. To compare this total consider that Oracle claimed in 2014 9 million Java developers and IDC claimed in 2014 there were 18.5 million software developers in the world, of which 11 million were professional software developers and 7.5 million were hobbyist developers. It's therefore possible that Apple's "market share" among developers is close to 70%.

Second, App installs have now reached 130 billion. The cumulative growth is shown in the graph below:

The rate of growth is also shown in the following graph:

Note that the rate of growth continues to increase and is now above 30 billion/yr. It turns out that apps continue to be a popular download item. The size of the audience continues to grow (see graph below) and it's therefore understandable that activity in the store continues to grow.

Third, the rate of payment to developers has also increased to over $20 billion/yr., with the total payments having reached $50 billion.

The graph above shows the derived payment rate (in green) relative to the download rate (blue). Although not completely parallel, the overall correlation is plain to see.

Fourth, there are more platforms than ever (four device and three services). As a result, Apps and services continue to outgrow traditional content revenues. Gross revenues for iTunes/Apps/Software/Services/Licensing is shown below:

Overall, economic activity transacted directly through Apple's platforms is approaching the run rate of $40 billion/yr. It continues to grow at about 20%, so it's foreseeable that it will reach at least $50 billion/yr.

It's hard to compare to other ecosystems as metrics vary but this rate alone places Services as one of the larges businesses in the world (service or otherwise).

There are other ecosystems "on top" of iOS which transact outside the Apple systems (and hence are not reported in the total above). These include Facebook, Google, Uber, Amazon and other economies which use iOS devices to enable engagement. These add up to hundreds of billions of dollars in transactional value. My estimate is that all mobile services are at least $250 billion/yr today and will reach $800 billion/yr in 2020. Apple is and will continue to be the home or enabler to the majority of this revenue.

But the more profound point to be made is that this ecosystem relies mainly on direct payments by the beneficiaries of the service or content. Apple contents itself with the $35 billion it can transact through its own storefronts because it feels that the business models are compatible with its brand.

When it comes to all the ways of "monetizing" platforms, this may be a very conservative strategy but it's one that also avoids the potential pitfalls of social scandal.

In Apple's first 40 years it shipped 1,591,092,250 computers ((including Apple II, Mac, iPhone, iPad and iPod touch; excluding Apple Watch, Apple TV and other iPods. Includes Q1 shipments estimated at 63,597,000 Macs, iPhones and iPads)).

This shipment total is higher than any other computer company in its first 40 years. Actually there are no other PC makers that are 40 years old. One computer maker (IBM) is older but they only sold PCs for 24 years and what they still sell they don't sell in high numbers.

That does not make it the top seller in a given year. Looking at only the Mac, Apple's traditional form factor personal computer, Apple has only returned to the top 5 last year. Only if including the iPad it was the top computer vendor in 2011 and including iPhone, it was first in 2009.

After having a 40 year run and after selling more computers than all American and Japanese computer companies put together, how should we think about the next 40 years?

First, clearly Apple shifted from being a "computer company". It has already changed its name to exclude the word "Computer" but that has been interpreted as saying that it sells devices (which happen to also be computers.) The word "computer" is already archaic. We stopped using computers to compute in the 40s. We used them to make decisions, keep track of things, speed things up and then to communicate and then to entertain.

Devices, it seems, are what customers mainly use to do, well, everything. Computing has grown to encompass most activities we engage in. So is Apple then a device maker?

More broadly, irrespective of the name, is Apple at 40 still defined as a hardware company? Certainly Wall Street ((i.e. average people)) still think so. The conversations one hears clearly consider Apple's future to be tied to the sales volume of specific products. At one time it may have been the Mac, another, the iPod and now the iPhone. This thinking is again a legacy of where the company was but mainly it's a reflection of how revenues are reported.

We see a line item in the income statement that says "iPhone" and it has a big number next to it so we, of course, fixate on that big shiny number. But if we were to unpack that number and see why it's so big we would discover that buyers are buying something other than what financial statements report.

Buyers are buying experiences, I hear you say. Yes, but more than that. Much more. They are buying safety, comfort, convenience, simplicity, productivity. They are buying modules to combine with other modules that help to do something. Something better. They are buying hope, satisfaction, escape or vanity. In other words they don't know what they want but know when they have it. They trust products unseen which have a reputation of delivering that which they think they might like, without knowing what that is. By employing the product, and a whole lot more—effort, time, mental energy and repetitive actions—they learn to exploit a product to achieve satisfaction.

Products are enablers, as are experiences and software and ecosystems and services. They are modules used in a melee of activity to make the user feel they are making progress. And if that module is better than no module then it will command a price and if it's better than another module or modules then it will command a premium. And if most people agree then it will be popular with many. And only if all these are true will it create a big number on a report.

And so we must search for other names to call a company that delivers an enabler that may lead to progress. Crude categorization like the reporting of finances leads to self-deception and a loss of opportunity to understand. Firms are often victims of this self-deception because they start believing that customers buy the things they sell. They start to believe that what is on their financial reports is a reflection of the value they create. It's a simple mistake to make, but a mistake which leads to catastrophe. If its data is mis-categorized, by chasing numbers the company runs away from opportunity, leaving it to competitors otherwise unencumbered with knowledge of numbers.

Assuming Apple avoids mis-categorizing what it does, will it be a "solutions" or "services" or "brand" company? Is it, as I used to say, a "blockbuster manufacturing line"?

Yes, and still that's not all it could be. Nor is it enough to understand what will come.

My simple proposal is to think of Apple (and actually any company) as a customer creator. It creates and maintains customers. The more it creates, the more it prospers. The more customers it preserves the more it's likely to persevere. This measure of performance for a company is not easy to obtain. It's not a line item in any financial report.

The closest figure we have is that today Apple has one billion active devices in use. We're not told of the total users or total customers because Apple cannot count people or wallets as accurately as it can count active devices. But as imperfect as it is, this number gives us a way to get close to counting customers.

So we know that at least Apple has created a large number of customers. Knowing total devices sold and number in use means that we can be sure that 63% of all the computers Apple sold are still in use. This means that most customers are recent customers. That is not necessarily good news. New customers are not well understood. We don't know how these new customers might behave in the future.

Will they come back for more of whatever Apple makes? If we look at the history of competitors or technology products in general, chances are they won't. The industries Apple has been a part of are filled with one hit wonders. Companies which had parabolic trajectories and built no loyalties. Statistically speaking, success in Apple's markets is always followed by failure.

But what if we did not seek correlation but looked for causation? What if we ignore statistics about companies other than Apple and focus on statistics about Apple's actual customers? Rather than assume all companies are the same, what if we assume that some can be exceptional?  What if we we look for the anomalies, not the clusters?

We might want to ask about the causes of success or failure for a single company. We might want to sample its specific customers.  We might want to observe how Apple's own customers behaved in the past.  We might want to use theories of brand value or theories of network effects or theories of software ecosystems.

These measures, rather than those of "comparable companies" might lead to different conclusions: That customers are loyal, that they will value the brand and that they are invested in a network. In other words, that they will buy from Apple again.

If we then factor in the size and persistence of Apple's audience (customer base) we might conclude that there are factors which will allow it to grow rather than shrink. My analysis based on public data shows that the customer base has been increasing steadily.

Considering this audience and the revenues generated, we can categorize the revenue by active device as follows.

Each bar represents that product's revenue per day in a given quarter (from Q4 2012 to Q4 2015). Each year is therefore represented by a different color. Dark green for 2012, light green for 2013, burgundy red for 2014 and dark red for 2015. For example, each iPhone in use was generating exactly $1/day in revenues (including services and accessories) during the first quarter 2013.

This allocates all of Apple's revenues to these products and by proxy to customers.

In summary, the "average revenue per Apple device per day" is currently $0.68. If we assume one unique user per device then Apple collects 68 cents from each customer each day. ((In reality the figure may be closer to $1, as there are likely to be more 1.2 to 1.5 devices per person.))

Combining the history of customer creation and customer preservation with the value obtained from each customer implies that the next 40 years will be about creating another large tranche of customers whose willingness to spend on whatever Apple creates will be relatively unchanged.

We don't know the limit. One billion was hard to imagine even one year ago. We might see two billion devices in short order. Perhaps not. Perhaps as we have a multitude of devices about us all day the number will become less meaningful. But if the number of middle class customers grows and as Apple keeps its products within their reach, there is no reason to think that there will be a reversal of the last 40 years in terms of customer acquisition.

This analysis contradicts the current perception of the company as reflected by its stock price. That price assumes the audience will wither ((With a P/E ratio of 11, without a change in revenue per user, the only justification would be the audience shrinking by more than 90% over the next 20 years.)) That is not insanity. It is what we could expect if Apple were unexceptional.

We could surrender to correlation and ignore causation but statistics show that such an approach rarely works.

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Incidentally, this and a lot more will be discussed at the next Subscribe conference.

In my quoting of the "Cook Doctrine" I cited the primary criteria for Apple to enter a new market:

We believe that we need to own and control the primary technologies behind the products we make, and participate only in markets where we can make a significant contribution.

These criteria, often repeated, were certainly in force when Apple chose to enter the watch market. Apple has sought and achieved a significant market share and did so while owning and controlling the primary technologies behind the product.

I now turn to the significant contribution criterion to study the possibility of Apple's entry into the car industry. ((Control of the primary technologies behind the product is a topic for another post.))

The significance test shifts the speculation from whether Apple would build a car, to how many cars is could build. Making a few cars is easy (see first commandment of The Entrant's Guide to the Automotive Industry). Making lots of cars is hard and hence significance in the automotive market (as in watches and phones) means achieving some degree of adoption, a higher degree of usage and a very high degree of profitability.

So what does being significant in the car business mean? Does it mean becoming the next Tesla? The next BYD or the next VW? How quickly?

Fortunately, we have something to compare an Apple entry to. Apple has made a "significant" market entry in phones and others have made entries in cars. If we contrast the rate of growth of Tesla, EVs, and Hybrids ((Of which Toyota has 70% to 80% share)) to the rate of growth of iPhones in their respective US markets, we obtain a test of significance:

The graph shows the percent of sales for the alternative car technologies (and Tesla) vs. the percent of US phone users using iPhones (comScore). Here are the conclusions:

• Hybrid cars were introduced in 2000 in the US. They managed to gain 2.5% within 8 years but have not increased to a consistently higher level since.
• Electric vehicle sales re-sarted in earnest in 2008 and have gained 0.4% share in eight years. They are still growing, partly helped by significant federal and state subsidies.
• Between sales start in 2008 and 2015 Tesla achieved 0.15% share.
• The iPhone ushered in a new paradigm within the phone market ((Incidentally the number of phones in use and cars in use in the US is comparable.)) in mid 2007. In the time since, Apple achieved the equivalent of about 35% share of unit sales. ((Significantly more in terms of sales value and over 90% of profitability.))
• Between 2002 and 2015 the share of smartphones as a percent of all phones reached over 80%.

To summarize, the range for entrant technology share capture spans between 0.4% (EVs between 2008 and 2015), 2.4% (Hybrids between 2000 and 2015) and 80% (Smartphones between 2002 and 2015).

Within a similar time frame, the range for entrant company share capture spanned between 0.15% (Tesla as percent of US car market) and 35% (Apple iPhone percent of US phone market). ((Toyota's capture of 2% of the market with hybrids may or may not be considered entrant--I chose to consider Toyota an incumbent which took share from others with the Prius))

The differences thus span two orders of magnitude (>100x). Put another way, if Tesla's car entry was equivalent to Apple's iPhone entry they would have delivered about 5.5 million cars rather than the 50.5k they delivered in 2015.

This wide gap in the impact of entry in the two markets has much to do with how modular are the systems being engaged by the entrants. An electric automotive system requires new infrastructure, new user behavior, and, in the case of Tesla, new distribution network and new post-sales support network. Offsetting this partially is a government subsidy.

In contrast, the smartphone communications and computing system leveraged existing infrastructure ((And vice-versa)), consistent behavior, at least initially, and the same distribution and support network. In addition, smartphones benefited from significant hardware and software and services ecosystems which encouraged third parties to add value to the system.

The difference in collaborative development and conforming user experiences (i.e. modularity) between the two innovations allowed the speed of change to be two orders of magnitude faster. The result is what I would consider significance for the iPhone vs. insignificance for electric vehicles to date.

Which leads us back to the question of why Apple would enter this market. If the absence of modularity prevents rapid change, that implies Apple cannot achieve any significant impact from entry.

We could ask the question differently: If they do enter, they could achieve significance only if they change the degree of modularity in the system. Think of it as allowing infrastructure leverage, consistent user behavior, wide distribution, wide support network, ecosystems, and component architecture; allowing rapid scale production and lower costs, etc.

Therefore the only way that Apple could justify entry would be if they "rationalized" the system into a sufficiently modular alternative. Only if we assume that change is possible could we then target share above the 0.1% insignificant change that has been demonstrated. They might even perhaps aim at 1% impact within a few years of entry. 1% was the iPhone target within the first full year of sales.

If system-wide change could be brought about and made uniquely (through some form of sustainable asymmetry) then the foreseeable share possibility quickly reaches the 10% range.

The last time that happened was when Toyota changed the way cars are designed and built. ((VW before Toyota and GM before VW. Incidentally Toyota, GM and VW are now nearly tied as the top three automakers globally.))

I was always bemused by the notion that the Internet was able to exist solely because most users did not know they could install an ad blocker. Like removing Flash, using an Ad blocker was a rebellious act but one which paid off only for early adopters. But like all good ideas, it seemed obvious that this idea would spread.

What we never know is how quickly diffusion happens. I've observed "no-brainer" technologies or ideas lie unadopted for decades, languishing in perpetual indifference and suddenly, with no apparent cause, flip into ubiquity and inevitability at a vicious rate of adoption.

Watching this phenomenon for most of my life, I developed a theory of causation. This theory is that for adoption to accelerate there has to be a combination of conformability to the adopter's manifest needs (the pull) combined with a concerted collaboration of producers to promote the solution (the push). Absent either pull or push, adoption of even the brightest and most self-evident ideas drags on.

Ad blocking offers a real-time example of this phenomenon. On desktop or even laptop computers ads were tolerable and the steps required to naviagate in order to implement effective ((By effective I mean a combination of whitelists and customizations)) blocking were non-trivial. In addition, no platform vendors were keen to promote products which hindered revenues for their most important ecosystem partners.

Ad blocking as an activity had neither the pull nor the push.

However—and there's always a however—as browsing moved to mobile devices and as ad networks hijacked the relationships between publisher and consumer, ads became detrimental to the experiences platform vendors depended on to remain competitive. Apple first (and no doubt others soon) chose to enable mobile browsers to load third party content blocking software. This is a hesitant first step. No major promotional effort and only the most obscure setting was enabled (defaulting to off).

Nevertheless, it's important to see this action as a "push". The bit that flipped was not of the consumer but of the producer. Movement to a new consuming paradigm and the incessant corrosion of the online experience threatened to taint a platform and something had to give.

Thus the "push" signal was sent and the consumer now has to pick up with a "pull" action. We still have to watch how quickly the pull happens and how network effects of users showing one-another the results will accelerate adoption and whether the push intensifies as the solutions improve.

But from this first enablement, the ecosystem, network effects, distribution and value chain leverage could cause gates to open and ad blocking reach majority followed by universal adoption. Measuring the ease of switching, the independence of the solution from other frictions and basing the estimate on historic rates, I could imagine internet ads will become largely invisible in less than five years.

Alternatives will emerge; the written word will find its business model, yet again. But the current model, contemptuous of the reader and disrespecting of the art will not long last.

Apple is categorized as a vendor of consumer electronics. More specifically, a member of the "Electronic Equipment" industry in the "Consumer Goods" sector. If indeed this is what it's thought to be selling, there is a problem because it isn't  what its customers are buying.

Apple's customers buy a mix of hardware, software and services under a brand that assures a certain quality of experience. This bundling and integration of otherwise disparate things is why the brand is such a success.

This anomaly between what Apple is thought to sell and what buyers actually buy can leave the casual observer confused. As a result the company's categorization as vendor of hardware deeply discounts its shares. It is, in other words a less valuable business. This is because a seller of consumer electronics does not benefit from "system valuation" since there is minimal loyalty to the product after the sale.

The consumer electronics vendor has no network to leverage, no ecosystem adding value after the sale, no platform and works through multiple levels of distribution to reach the customer. In contrast, a system vendor can expect benefits from network effects, ecosystems, and a coveted relationship with the end user.

The result is that the valuation of a consumer electronics vendor is based on the momentum of individual products. Apple has always been valued this way. Each hit product is considered to be a stroke of luck/genius and the chances of recurring are discounted to about zero. Regardless of the fact that it has a track record of "home runs", Apple's hit rate is not considered sustainable. ((The P/E ratio is the primary indicator in this analysis)). Certainly Apple is not valued as being able to generate reliably recurring revenues.

But what if we were to value Apple on the basis of what people are buying rather than what it's thought to be selling?

The model is simple enough: determine the number of users, estimate the lifespan of the products, and figure out the services attached to the products; then, given the price, obtain a price per product per day. You then can get a recurring revenue figure.

I did just that and the results are in the following table:

The first column is the product, the second is the Average Selling Price (ASP), the third is the expected lifespan of the product, and the fourth column is a calculation of the end user’s “spending per year” on the product.

The fifth column is an estimate of the revenues from Apple's Services and "Other" groups from post-sale revenues attached to the product. This Services revenue includes AppleCare, iCloud, Music, App Store, other stores, Beats, accessories, iAd, and Made for i (MFI) licensing. It also includes Google traffic acquisition revenues and other licensing.

The sixth column is an estimate of the consumer "spend per day" on Apple's product lines taking into consideration Services.

The seventh column is an estimate of the number of active devices in the hands of users. Note that these are expected to change over time.

The eighth column is a calculation of Services/Other income on a per-product allocation. This is a test of the Services+Other estimate and is meant to sum to nearly what Apple currently reports as Services+Other revenues.

The ninth column is a test of overall revenues on a per-product allocation. This should add up to total revenues (estimated for next year.) ((Naturally, the active devices estimate is the most sensitive but it should be tweaked to create a reasonable forecast for next year.))

The bottom line is the following graph which shows the revenue per device per day inclusive of Services and Other income (The sixth column).

This is, in my opinion, a reasonable way to approach valuation of Apple as a business. It's also a way to inspect its strategy.

As a valuation we can easily obtain the net present value. The model gives us sales and by estimating a net margin (which is remarkably steady around 22%) we can get the free cash flow.Iterate into perpetuity with a discount rate, and you can get the net present value of the company. With a modest growth rate leading to a billion active devices in use and a normalized revenue per device of $0.92 you can easily see cash flows equivalent to $1 trillion in present value.

But much more interesting than this value is the notion that Apple is in business to deliver a product/service mix to loyal customers and to preserve their loyalty through constant improvement and innovation. You can see strategic intent in increasing the attach rate of services per device. You can see a strategic intent in building loyalty and the right customer base which is likely to be loyal. You can see strategic intent in the iteration of the product in a way that extends loyalty and expands the solid base but also increases the $/day rate. This analysis correctly informs almost all decisions the company makes.

What we just saw in the launch of a new Apple TV and a new iPad is consistent with this strategy. Apple TV will have a higher service attach rate with apps while keeping pricing well below consoles thus expanding the user base. The iPad is increasing in price and getting more accessories. The developers are encouraged to build richer and more valuable apps that are uniquely enabled by the new device.

The fact that Apple has just launched a subscription service for the iPhone  makes what was clearly their strategy all along plain to see however it has been a strategy in effect for decades.

It isn't a difficult idea to embrace. It always surprises me that it's not more commonly held. The reason may be that Apple is mis-categorized.

Or perhaps the entire categorization of industries and sectors is obsolete in what is a new post-industrial age. Some have figured this out already. Others will take longer.

 

Will there come a time when Samsung will earn more profits from the iPhone franchise than from its own Galaxy product line?

The problem for Samsung is that although it still sells the most phones ((over 80 million but we don't have a precise figure)), and the most smartphones, the price and margins for these products are collapsing. The pattern is shown in the graphs below:

Phone operating margins peaked in Q1 2014 at 20% but are half that level today. These margins have dropped to levels Samsung had in 2009, before the Galaxy launched and before they had any substantial revenues from smartphones.

In contrast, the semiconductor group is growing both revenues and margins. Margins and operating profits are both 50% higher than those of devices.

We also know that Apple is Samsung Semiconductor's single biggest customer. We can't be sure how much of the total revenue/profit comes from Apple but if the pattern continues then Apple could be the greatest contributor to Samsung's profitability in the near future.

How could this be? Wasn't Samsung supposed to "disrupt" Apple?

The reality is that Samsung's own smartphones are being disrupted by good-enough Android devices, typically made by Chinese brands. This low-end disruption is also affecting LG, another phone maker and Apple supplier.

Unlike Samsung and LG, Apple is less susceptible to low-end disruption. What Apple offers is a brand promise, an ecosystem, associated products and services and what amounts to a new market. It's this parallel value network that competes with Android/Google, rather than with Samsung.

Samsung is a supplier in the Apple network and a licensee in the Google network. As a result, it has a near monopoly position with a platform controller (Apple) and a commodity position with a platform licensor.

Neither position is one of control, but the current market stage benefits Samsung within the Apple ecosystem more than  in Google's ecosystem. It's a situation analogous to one where Intel made both x86 chips and PCs that ran Windows. Long term it's likely that the sole-source chip business does a lot better than the multi-source systems business.

That should be a warning to others who hoped to survive as Android OEMs. They don't have semiconductors to sell to Apple.

 

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.

In 2011 I wrote:

My hypothesis is that The Primary Cause for the shift of profits from Incumbents to Entrants has been the disruptive impact of a new input method.

It was a description of what I considered to be the "disruptive technology" which caused incumbents which had a "front-row seat" to the future of their industry to be completely displaced and marginalized by an entrant ((later more than one)) with no discernible right to do what they did.

I illustrated what underpinned the sea change in the phone business via the slide that Steve Jobs used in the iPhone launch event:

 

I added the years when each input method was introduced and the  platform/ecosystems created as a result. These new ecosystems were the primary cause for dramatic industry-sized shifts in profits.

Not coincidentally, during the 2014 Apple Watch launch, the presentation began ((Begins one hour into the 2 hour downloadable video)) with a re-telling of the "mouse, click wheel and Multi-Touch" story.

Seven years later, the difference is that there is a new object added to the story. It answers the question that has been on my mind since that first post on revolutionary user interfaces was written: what will come next.

Now that we have an answer, the next step is to understand the new platform, its ecosystem; which industry will be affected and which incumbents will be displaced and to what degree will value be created beyond that which will be displaced.

Piece of cake.

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.