estimate

Apple has declared that what used to be "Other Music Related Products and Services" ((Includes revenue from sales from the iTunes Store, App Store and iBookstore in addition to sales of iPod services and Apple-branded and third-party iPod accessories.)) plus "Software, Service and Other Sales" ((Includes revenue from sales of Apple-branded and third-party Mac software, and services.)) which was formerly known as "iTunes/Software/Services" ((Includes revenue from sales on the iTunes Store, the App Store, the Mac App Store, and the iBooks Store, and revenue from sales of AppleCare, licensing and other services)) is about to become "Services".

"We'll also have a category that we refer to as services and this will encompass everything we report under the heading of iTunes software and services today including content, apps, licensing and other services and beginning this month it will also include Apple Pay."

"Services" will therefore encompass a massive amount of revenue. The reported revenues for the fiscal 2014 were $18 billion. Including all billings, the turnover in sales is over $28 billion. For next year, assuming that Apple Pay, which is just getting started, is unlikely to contribute greatly to revenues, Services turnover will top over $35 billion. That figure would make Apple Services alone one of the top 90 companies in the Fortune 500.

Regardless, as a component of overall sales, the group formerly known as iTunes/Software/Services (shown in red above) was a modest 7% of total sales in the last quarter. Using all available information regarding downloads, payouts and reported financials, an estimate can be obtained on how this 7% is itself divisible into nine sub-segments:

• Pro Apps
• Music
• Video
• Apps
• Books
• OS X
• iWork
• iOS Apps
• Licensing and other income

These are shown above as either contributing to statement of operations (i.e. as reported, on right) or using billings (or the actual "cash register takings", on left). ((The primary distinction is in Apps billings where the 70% paid to developers is not shown as revenue.))

What would be ideal in understanding this Services segment would be to break the "Licensing and other income" into its component parts. Namely:

• Licensing revenues including Google's payments for traffic acquisition (TAC)
• AppleCare
• iTunes Match
• iTunes Radio
• iAd
• iCloud
• (and soon, Apple Pay)

In particular, it would be very interesting to know exactly how much revenue could be coming from iCloud. We have not heard from Apple on iCloud user numbers since mid-2013 and this was the data at the time:

Couple that to "Licensing and Other Income" as deduced from Services accounting yields the following picture:

It would appear that iCloud accounts are growing in proportion to "Licensing and Other Income". Note that at the point that iCloud accounts were zero, revenues from Licensing were about $225 million/quarter and growing slowly. The real growth kicked in when iCloud accounts started ramping up. Since revenues from iCloud has to be in the "other income" and since no then it is, I believe, reasonable to assume that the iCloud user base growth is a principal driver of growth ((Of course, AppleCare could also be a driver but AppleCare should follow overall device sales patterns and this is not clearly evident in the Licensing/Other curve))

Also, bursts in the Licensing and other income line occurred after several iCloud-specific marketing events:

Mobile Me migration started in October 2011 and on September 30, 2013 the complimentary iCloud storage plans expired and were automatically adjusted to the free 5 GB plan (with an offer to upgrade to a paid plan). Correspondingly, Q1 2012 and Q1 2014 showed the largest increases in Licensing and Other Income.

This is a multiplication of many assumptions, but there is some intuitive logic. The only place iCloud can be found seems to be growing in proportion to iCloud users and plan marketing.

So how much does iCloud contribute to Apple's sales? My guess would be about $1 billion per quarter. That would be spread over 500 million iCloud accounts and therefore an average revenue per account of $2/user/quarter or $8/user/yr.

The lowest non-free iCloud pricing is about $12/yr (5GB plan is free). This would imply that two thirds of iCloud users are paying users (and one third are opting for the 5G plan).

I realize that this attach rate to a paid service is astronomical. Anything over 10% is unheard of. I would say the error in my estimates could be 20% but that still leaves a huge gap to what seems reasonable.

[Put another way, if the attach rate were only 10% then iCloud revenues would have to be in the $600 million range and thus only about 10% of what Licensing and Other income seems to be. This would force the question of what could be generating the remaining $5.6 billion/yr.]

After n quarters of predictability, Apple surprised with sales performance that was 3.74% above the top of their guidance. This may not seem significant but since instituting a new range-bound guidance method in Q1 of last year the company reported revenue within about 1% of the top of the range.

This is in stark contrast to the wide variance in prior years. The following graph shows the "error" in guidance as the percent difference between reported sales and guidance ((Upper end of range in quarters where a range was given.)).

So prior to last quarter we were lulled into thinking that guidance was very nearly perfectly predicting the company. As I tweeted, it took the "sport" out of trying to do any forecasting. All an analyst had to do is tweak the main product growth figures to hit the sales target and then subtract the (generously provided) operating expenses and (also provided) tax rate to get the earnings. Only unknown to getting to an estimate of EPS was how many shares would still be outstanding. ((The company itself would not know shares outstanding as their buying was opportunistic during the quarter.))

Knowing Apple also means that average selling prices are also very rigidly set in stone so the degrees of freedom in analysis were becoming highly constrained.

But just when you think you spotted a pattern, it changes. The company surprised with performance outside the band. The following graph shows the estimate ranges it has given and the actual revenues delivered. ((Next quarter is also pencilled in.))

So what happened?

The answer seems to be better iPhone performance. The following table shows my expectations, which were tuned to return revenues exactly at the top of the guidance range.

On product shipments/sales I underestimated the iPhone and Mac and overestimated the iPad and iPod. I estimated iTunes accurately and underestimated accessories by 5%. I also generally got the blend of margins fairly close, being 1 point too low on gross margin.

The bottom line was that the Revenue and Earnings surprise could be accounted for through a significant outperformance on iPhone which offset a less significant underperformance on the iPad.

The iPhone grew sales by 14% which more than offset a drop of 13% in iPad sales and was enough to allow net sales to grow by 5%. Since the company guided nearly flat growth, that 5% was a big surprise.

Now one could ask whether 14% growth in the iPhone revenues is a meaningful change in the long-term evolution of the category. This is a difficult question. The way the iPhone is positioned makes it a great success in the premium segment of the market but it does not place it in competition with the perhaps 80% of the market which seems to be defined by a lower price point.

However let's not forget that pricing is correlative to the market but it may not be causal. Purchase decisions are complex and price is one aspect of that decision. But there are many others. Availability, channels, service, brand all play parts. The error of many analysts is to conclude that price and price alone is causal to behavior. That may be so with commodities, but let us not forget that these products and their uses are newly created and how value is perceived has been changing rapidly. Buyers follow a learning curve in terms of discovering the uses and value of products. These learning curves can be modeled and usually show several years (sometimes decades) for most populations between early and late adoption.

We don't know where the iPhone is on the learning curve for any particular region and that means we can still be surprised by how it grows.

During the latest shareholder meeting Tim Cook revealed that Apple TV sales were above $1 billion in the last fiscal year (ending September 2013). The company later clarified that this figure includes device and content sales.

This poses a problem. In previous statements the company cited device (unit) shipments rather than value. The statements made to date suggested that cumulative volume of 3rd (current) generation Apple TV totaled 6 million units as of January 1, 2013.

The following graph includes an estimate of quarterly Apple TV sales based on comments made to date.

As there were no additional comments during 2013, the "Billion Dollar" quote is all we have to go with for the year.  The problem with trying to separate content from hardware is complicated by several factors:

• How are we to attach content revenues to Apple TV? For example, what if I purchase a series of shows on iTunes or an iPhone and decide to watch them on my Apple TV. Do these purchases count as being "attached" to Apple TV? Do we attach the full transaction value or do we attach the portion that Apple keeps (as in agency accounting)?
• How does Apple account for channel placement on Apple TV? Do the channels prominently displayed on its user interface pay for this access (even though the user needs a cable subscription?) Is this the primary source of content revenue that is attributed to Apple TV?
• What about Netflix, YouTube, etc? What is the content licensing deal with these channels? Does the Netflix channel actually cause an Apple TV purchase or does the Apple TV purchase cause a Netflix subscription?
• Without content, one might think that the $1 billion revenue would yield total device shipments approximately 10 million units in fiscal 2013 (assuming $99 unit pricing). This is not quite right however as Apple's revenue per unit is unlikely to be $99 unless all units are sold through its own retail stores (including online). Sales through other retailers probably allow for some retailer margin so Apple's average selling price will be below $99.
• Another question is the fiscal year accounting. We have visibility into the fourth quarter of 2012 (about 2 million units est.) so we only need to fill in the first three calendar quarters of 2013 to understand the Billion Dollar volume.
• Finally, I already estimate separately the overall video market (in my iTunes Business Report) which, based on historic data and other inferences suggests a total video content gross (contributing to iTunes revenues) of $1.8 billion for the fiscal quarter. If a significant portion (50%) of this were allocated to Apple TV it would imply that the hardware business contracted sharply in 2013. Put another way, if I add what we know about C2012 units (6 million and an ASP of $89) to what I estimate video content revenues to have been in 2012 ($1.6 billion) I get a $2.1 billion business. This would be a "two billion dollar" business in 2012.

All this makes the Billion Dollar Hobby a puzzle. The way I can make it square with existing assumptions is by saying that "Apple TV content revenues" are mostly, if not entirely, distribution revenues from channel placement rather than iTunes purchases. ((This revenue will end up in licensing/other revenues in iTunes/Software/Services segment and separate from Apple TV (which is a part of Accessories).))  As a result, my best guess now is that there were about 7.6 million Apple TVs sold in fiscal 2013, with a bit over 8 million for calendar 2013.

If I'm right, the complete history of the shipments would be similar to this graph:

By Apple standards this is indeed a modest story. The total units sold would add up to more than 25 million units with healthy growth. But it would not be in the same magnitude as other iOS devices which have so far sold 800 million units.

More important than this picture however, or the Billion Dollar Business threshold, would be a better understanding of how Apple sees Apple TV as a business. We already knew that it was a low value hardware business. I even suggested that it's "Apple's equivalent of the Kindle": Hardware sold at low margins as a gateway for a high volume content business (iTunes). The problem with that model is that selling other people's content is never a good margin business. If it were to be sustained, Kindle may ultimately have to become an Amazon Prime salesman.

So that leaves the Apple TV as a product without a satisfactory business model. Unsatisfactory, at least, to Apple's standards; hence the hobby label. But what if the model is turning out to be a platform for discovery of content and therefore the equivalent of (dare I say it?) a portal! ((Exclamation point.)) The TV UI certainly limits search or traditional browsing interaction but it enables eye candy for a few choice placed offers. It is a low interaction model. Think of how the prevailing UI for TV for decades has been that of pressing one button repeatedly, also known as channel surfing.

If so , the business of Apple TV may be the auctioning of the real estate on the landing page. In some ways this is how iTunes is already behaving by "featuring" exclusive music content.

There are all sorts of implications, which I will leave as an exercise to the reader.

The increase in net sales of iTunes, Software and Services in the first quarter of 2014 compared to the first quarter of 2013 was due to growth in net sales from the iTunes Store, AppleCare and licensing. The iTunes Store generated a total of $2.4 billion in net sales during the first quarter of 2014 versus $2.1 billion during the first quarter of 2013. Growth in the iTunes Store, which includes the App Store, the Mac App Store and the iBooks Store, was driven by increases in revenue from App sales reflecting continued growth in the installed base of iOS devices and the expansion in the number of third-party iOS Apps available. Net sales of digital content, including music, movies, TV shows and books, from the iTunes Store was relatively flat in the first quarter of 2014 compared to the first quarter of 2013.

Apple Inc. Form 10-Q.

During the last quarter Apple changed the pricing for iWork and OS X to zero ((OS X server is still priced at $20 and iWork for previously unlicensed devices and computers is still priced above $0)).

I estimate the net effect to have been a reduction in revenues from those software titles of about $350 million for the quarter. Nevertheless, increases in services and app revenues means that the iTunes total reported revenues increased to a new record.

The total with estimated contributions by media and service components is shown below right.

Note that revenues do not reflect total billings. As Apple reports only the 30% of App transaction values, the full iTunes/Software/Services transaction values are shown in the above graph on the left.

The "gross" revenues are now nearly $7 billion per quarter. On a yearly basis the iTunes/Software/Services group had gross revenues of $23.5 billion with growth of 34% y/y.

Other estimates for full year 2013 growth are:

• Third party content +46.6%.
• Music downloads -14%
• Video +19%
• Apps +105%
• Books -9%
• Services +37%
• Pro apps +29%
• OS X -8%
• iWork and iLife -8%

Although iTunes/Software/Services are not usually included in a "sum-of-the-parts" total contributing to Apple's overall enterprise value, the scale of volume and value of transactions is becoming harder to ignore.

To illustrate this, I plotted the history of gross iTunes revenues vs. Google's search business ((Excludes Motorola and "Other" segments as reported by Google))

On a yearly basis iTunes/Software/Services is nearly half of Google's core business and growing slightly faster.

The iTunes "empire" of content and services would be ranked as number 130 in the Fortune 500 ranking of companies (slightly below Alcoa and above Eli Lilly).

As Philip Elmer-DeWitt is still interested in my estimates I provided the following:

Revenues ($B) 57.8
EPS ($) 14 (908m shares)
iPhone (units) 56.4 million
iPod (units) 7.6 million
Mac (units) 4.14 million
iPad (units) 26.5 million
iTunes/Software/Services ($) 4.2B
Accessories ($) 2.2B
GM% (percentage) 37.1%

I arrived at these estimates without looking at anyone else's (except for Apple's own published guidance). Soon after sending them I noticed that Daniel Tello published his own.

In the same format as above, I quote them for comparison. Please visit his post for additional detail.

Revenues ($B) 59.0
EPS ($) 14.92 (895m shares)
iPhone (units) 56 million
iPod (units) 9 million
Mac (units) 4.65 million
iPad (units) 25.5 million
iTunes/Software/Services ($) 4.3B
Accessories ($) 1.8B
GM% (percentage) 37.8%

The graph below shows the history of revenue guidance vs. revenue reported. The last quarter shows my estimate for net sales.

Note that the company achieved at or slightly above its upper guidance ever since they started offering a range for guidance (i.e. since Q1 2013). My estimate for sales is therefore very near the top of guidance. The figures for units earnings and margins all result from this assumption.

In 2013 there were 18.8 times more Windows PCs sold than Macs. This is a reduction in the Windows advantage from about 19.8x in 2012. This decline is mostly due to the more rapid decline in Windows PC shipments relative to the more modest decline in Mac unit shipments. Gartner estimates that about 309 million Windows PCs were shipped, ((This figure is not published publicly but can be derived from subtracting Mac shipments from the total PC shipments which are published)) down from 337 million in 2012 (which was down from 344 million in 2011, the year PCs peaked.) I estimate about 16.4 million Macs were shipped in 2013 down from 17 million in 2012.

The history of PC shipments relative to Mac shipments is shown in the following graph:

I chose to graph the Mac data as an area with additional areas for iOS devices layered on top.

When comparing these platforms, the contribution of the Apple mobile platform becomes striking.

Nevertheless, it's still important to understand the role of the Mac. In years gone, the advantage of Windows was measured in multiples of Mac sales. That peak occurred in 2004 when there were 56 times more PCs sold than Macs. At that moment, when the Windows advantage peaked, the Mac sold 3.2 million units  into a market where 182 million PCs shipped. This means the Mac had 1.7% market share.

And yet, remarkably, even with 1.7% share, the Mac did not disappear. The figure of 3.2 million units was not great and below the peak to date ((which was 4.5 million in 1996)) but it was enough to sustain Apple while it developed its next products. At the time the iPod was starting to grow rapidly and development on iPhone/iPad was already underway. The point being that there were new products. 3.2 million was a sufficient volume to preserve the company until such time when they would be ready.

Today the situation is quite different. The total number of platform products Apple sold in 2013 was about 260 million ((This includes my estimates for Q4. We'll have the exact figure in a few days.)) The total number of users Apple has is above 550 million. ((Possibly 600 million.))

Note the effect in the graph above. Even if we only consider the Mac, the Windows advantage has decreased considerably, and the platform was certainly not extinguished. The new form factor Mac Pro and the continuing improvements in the thinnest of laptops shows how Mac has not just survived but prospered as the underdog which easily captures the bulk of profits.

But the bigger story is how Apple's mobile platform has nearly reached the sales volume of Windows. In 2013 there were only 1.18 more Windows PCs than Apple devices sold. Odds are that in 2014 they will be at parity. ((The prediction I made in 2012 was that "it’s safe to expect a “parity” of iOS+OS X vs. Windows within one or two years". The data so far does not change this expectation.))

But will it last?

It's important to understand just how the quantities involved here have a quality of their own. The quantities themselves speak of a change. It's not convincing to suggest that what comes around goes around and a reversal of fortune can be reversed yet again when there are several zeros added to the end of the figures involved.

We have to understand that the Windows advantage itself came from the way computing was purchased in the period of its ascent. In the 1980s and 1990s computing platform decisions were made first by companies then by developers and later by individuals who took their cues from what standards were already established. As these decisions created network effects, the cycle repeated and the majority platform strengthened.

But it was the large companies who made the core decisions. In the 1980s if the Fortune 500 companies all standardized on Windows then their suppliers and customers would also standardize on it. Add governments and other institutions and 80% of the market is probably decided. There was concentration in decision making. In other words, in the 80s a platform could win by convincing 500 individuals who had the authority (as CIOs) to impose through fiat a standard on the centers of gravity of purchasing power.

Today, with mobile products there are billions of decision makers. 500 decisions mean nothing. In fact, Apple with at least 500 million loyal and wealthy users is considered to be in a precarious situation. That's partly due to the way other platforms like BlackBerry and Symbian found themselves in crisis with tens of millions of users. ((and hundreds, perhaps thousands, of corporate buyers deciding to support its platform exclusively. What IT does matters for little.))

The decision making process for buying computers, which began with large companies IT departments making decisions with multi-year horizons, has changed to billions of individuals making decisions with no horizons. Companies have become the laggards and individuals the early adopters of technology.

The fundamental shift is therefore in the quantity of decision makers and the quality of those decisions. Those who buy are also those who use and their decisions will be perhaps whimsical, maybe impulsive and not calculated, but fundamentally, in the aggregate, wise.

Ultimately, it was the removal of the intermediary between buyer and beneficiary which dissolved Microsoft's power over the purchase decision. It's not just unlikely that this situation will be reversed, it's impossible. Computing decision making has moved to the furthest edge where use has been for decades. The computer has become personal not just in the sense of how it's used but in the sense of how it's owned.

Exactly one year ago, on January 7th, 2013, Apple announced that the App Store reached 40 billion downloads ((Unique downloads excluding re-downloads and updated)). Here are additional data points from that release:

• 20 billion downloads in 2012
• 2 billion downloads in December 2012
• 500 million active iTunes accounts
• 775,000 apps
• sold in 155 countries
• 300,000 native iPad apps
• over $7 billion in developer payments

This year, on January 7th, 2014, Apple announced a new set of data points:

• $10 billion spent on the App Store in 2013
• $1 billion in December 2013
• 3 billion app downloads in December 2013
• 1,000,000 apps
• sold in 155 countries
• 500,000 native iPad apps
• $15 billion in developer payments

The obvious:

1. 225,000 apps were added in 2013
2. 200,000 native iPad apps added in 2013
3. App download rate for December increased by 50%
4. No new countries were added in 2013
5. $8 billion was paid to developers in 2013 (more than in all previous years put together)

The less obvious:

1.  No update on iTunes accounts this time but there was a mid-year update (June 10th) which put iTunes accounts at 575 million. iTunes accounts have grown linearly since mid 2011 so it's quite probable that the current total is above 650 million. 

1. Given mid-year updates to earnings/revenue and the October 22nd update that 60 billion total apps were downloaded and the May 15th update that 50 billion total apps were downloaded it's possible to estimate with confidence that there are now 68 billion total apps downloaded and that were about 27 billion app downloads in 2013. This is an increase of 35% in the yearly download rate. As noted above, the December growth alone was 50%.
2. Given mid-year updates on developer payments, and download rates we can estimate revenues per app have increased. As in-app purchasing has taken off it's no longer meaningful to assign a "purchase value" to each download. The rate of payments to developers is increasing faster than the download rate. Currently $26 million is paid out every day while about 100 million apps are downloaded daily. Note that the trend lines below are arbitrary: 

1. As other reports have noted, there was a decrease in music downloads in 2013. This is also evident when backing into a download total for music given the earnings data and the above evidence of app growth. My estimates below may be overly generous for music unit downloads as they also assume lower pricing. Overall gross music revenues through the iTunes music store ((Excluding new iTunes radio and revenues from services such as Match)) are flat for the year and may even have begun declining precipitously. App revenues are more than compensating for this. 

1. The iTunes content economy is grossing about $17.5 billion/yr. Apple's own software and services (reported as part of the iTunes segment) add another $6.2 billion/yr. The combined total of $23.7 billion/yr. is slightly lower than what Apple net sales were during its fiscal 2007 year or what Amazon sold in 2009.
2. A complete report on the iTunes economy and pro-forma iTunes income statement is available for purchase at store.asymco.com.

So much for the data. What is really happening?

First, it's tempting to look at music and suggest that music downloads are suffering from streaming, just as it was tempting to suggest that CD buying was suffering from piracy (and later, downloads.) But this is falling into the trap of defining a product's use by the metrics used to measure transactions. These metrics are but a proxy for what consumers are actually doing with their time.

Consumers have a fixed time budget, a more rigid constraint than their spending budget. Competition for a slice of a consumer's time budget is far tougher than competition for a slice of a consumer's wallet. So what's amazing is that apps have successfully grabbed a share of this time budget. I believe that the reason they succeeded is that they initially fit into niche time slices that were previously unoccupied. ((Interestingly, this was how music, especially digital music as enabled by the iPod, gained traction))

Downtime or "boredom" was filled with app interaction. This includes some social media consumption. These are not immersive experiences. They are "casual",  inconsequential and trivial. At first anyway. And that's the rub. As apps enter a consumer's world they initially take on non-consumption, which is easy to beat. But as the experiences become increasingly compelling they "move upmarket" and compete more aggressively with existing media consumption patterns.

For instance, one might allow casual gaming to take root in non-consuming contexts such as commuting, waiting, and escaping time niches. But if the experience becomes addictive, the gaming takes over time previously spent watching TV or using console games. The same can be observed for app-based experiences of social media, shopping and chatting.

This is the insidious march of a disruptor. It gains a foothold in a context where it has no competition and then relentlessly gets better, eventually displacing the far better suited alternatives. This is what I believe is happening with apps. They are asymmetric in their competition with established media and as a result they are easily ignored and brushed off as irrelevant competition. That is until the incumbent media sees a sudden drop in consumption. Even then, the culprit blamed is not the upstart but some structural issue.

Music would appear less vulnerable to this app-based substitution because it's an eyes-free experience and can be easily consumed concurrent with another activity. There is however, a subtle de-emphasis and hence devaluation of the experience as it fades into the background. The "job it's hired to do" changes.

Second, and relatedly, the other meta-observation is that apps are media. They are produced, marketed and priced in ways analogous to other media types. This has implications for the artist/producer/creator. For them movement into apps is natural and effortless. It's how developers moved into them without thinking twice. Trouble is that this transition is not at all simple for those who distribute media.

I tweeted that the media industry deplored the shift of "digital pennies for analog dollars" ((Original quote was made by Jeff Zucker, president of NBC Universal, in 2008 in reference to the future of TV)) as the packaging of their product changed. The angst and trauma suffered by the media industry when dealing with what could be seen as a trivial change in the encoding of content are the stuff of lore and legend. Moving to apps could be even more troubling. Mainly because there is already a distribution channel in place. And it's owned by a set of companies whose motives and business models are completely different.

The app economy shows that there are big opportunities in "digital pennies" and that the figures are beginning to match even the "analog dollars". In fact, I suspect eventually digital pennies will dwarf analog dollars. The trouble is that these pennies will not be earned at the same control points. Bits are already big bucks. They're just not the bits we are used to.

 

In yesterday's post forecasting smartphone penetration I neglected to mention the exact subset of the US population being sampled. The analysis is based on comScore's sampling which covers only those devices which are the "primary phone" for users  over 13 years old and not provided by an employer.

In other words, the population being sampled is not meant to identify how many phones will be in use but rather what is the primary phone for those non-children who choose their own phones.

So the measurement that can be obtained from the S curve analysis is a subset of all phone users and will not identify exactly how many phones will be in use. Given that, this is what that subset looks like:

I drew a line showing the census data (and projection) for the US population and estimated what percent of that population might be older than 13 years ((I estimate 19% of the population is 0 to 13 years of age.))

Of the remaining population, I expect smartphones will be used by nearly all by end of 2020.

That means about 270 million users. It also means that about 125 million more than are using smartphones today. Note also that a significant number of those under 13 will also use smartphones and that the metric is "primary phone" and insofar as there are more than one phone for some users they are a multiplicative factor. Finally this measure does not account for company assigned devices.

So although this measures how many users will use smartphones, the total number of such phones in use is likely to be significantly higher.

Finally, when considering the market's potential size it's important to have an accurate estimate of how frequently these phones are replaced. So, for instance, if we guess that 300 million smartphones will be in use and that they get replaced every 2 years then it follows that the US market for smartphones would be about 150 million units per year in 2020.

The latest comScore data places penetration at about 61%, up over 10 percentage points from the same time last year. The 50% last year is itself up nearly 14 percentage points from the same time in 2011. This progress in the diffusion of smartphones is shown the following graph:

I set the time frame for the graph to start in 2005 because there was still a market at the time. We can estimate the number of users from data supplied by RIM. They had about 2 million subs in 2005, the majority of whom were in the US.

Given these data points we can draw a new penetration graph extrapolating to the complete date range.

 

I added a few events that mark some of the product launched during this period.

The penetration curve shown happens to be defined as the "Logistic Function" whose equation is well known:

 p1  is the number of periods (in months) that it took for the market to reach 50% penetration and p2 is an index of which can be adjusted for this market.

Note that I also identified successive groups of consumers adopting smartphones as defined by Rogers in his Diffusion of Innovations.  This is easily done since the formula for penetration gives us the answer (as the integral):

• The Innovators (first 2.5% of the market) were recruited by February 2007, one month after the iPhone was announced. They were almost all BlackBerry users
• The Early Adopters (the 13.5% which followed the innovators) were all using smartphones by the beginning of 2010. They were served mainly by iPhone 3GS and BlackBerries
• The Early Majority were on board by October 2012, just in time for iPhone 4, Droid, Galaxy.
• We are now in the Late majority which will run out by November 2015. The iPhone 5S came out about one third of the way through this period.

The next few years are shown in the following extrapolation. 

 

The laggards will adopt smartphones from late 2015 until late 2020.

As this is the diffusion curve for the US, most other large regions are going to be shifted to the right and the global total can probably be estimated.

What remains to be done is to estimate the way the platform colors will fill in over this time frame for the US and to do the same analysis on a global level.

Bill, I think the smartphone market has always been competitive. [Only] the names have been changed.

Tim Cook responding to Bill Shope's question on the competitive landscape, April, 2013.

Indeed, over the years, the companies considered Apple's primary competitor have been many.

In years gone by in the phone market there were RIM and Nokia and Palm and HTC. In the iPod era there was Creative and Sony and innumerable others long forgotten (not to mention the tyranny of DRM).

Even today we struggle to decide whether Apple competes with Google first or Samsung. Or perhaps with the iPad it's with Amazon or  Microsoft. Or maybe iTunes is threatened by Netflix or Spotify. The Mac surely competes with HP and Dell and Toshiba. What about iCloud? Clearly it's Dropbox or Google Drive. iWork? Both Office and Google Docs.

Doing a competitive analysis for Apple is then mostly a struggle of whom to compare it to. So forgive me that I only track the few challengers shown below.

Note also that these companies all may compete with Apple to some degree but they may not compete with each other. Competition, it seems, is not transitive.

There isn't much that I can observe in the data that hasn't already been observed. Google shows steady but not spectacular growth in revenues with decreasing margins. Microsoft shows even more modest growth in revenues with flat earnings. Apple growth is moderating from near vertical while earnings pause. Samsung has great growth but there is a similar set of doubts about its sustainability and finally, Amazon continues to grow the top line by 20% and  has nothing to show for it.

Operating margins have mostly fallen with the exception of Samsung whose increasing reliance on smartphones has led to a modest increase, though not nearly to the level of the others. (Amazon, lacking in profits, cannot be compared.)

 

In summary there is little change to report.

Except that it's been reported that in the last quarter Samsung managed to "dethrone" Apple from the phone operating profit crown. This is a matter of estimates and for that we need to understand clearly the assumptions.

I estimate that this is not the case. That indeed Apple remains most profitable phone maker by a wide margin.

To estimate operating margins you need to estimate gross margin and the allocation of operating expenses (SG&A and R&D) to a particular "division" or product line. The problem is that Apple does not operate as a divisional organization so its marketing and R&D budgets (i.e. people) are not assigned permanently. You have to move them around based on whatever is being worked on at any given time.

What's more, we need to account for the huge SG&A costs associated with iTunes and Retail. They both consume vast resources which cannot be allocated directly to any product. There are 41,000 people working in retail.  Also, some of the expenses for iTunes are overhead and cannot be considered cost of sales. That's also SG&A. Then there's corp research and design (Mansfield and Ive), which are not allocated to any particular product. When you slice out these costs, there is very little to apply to iPhone, etc.

So if (and it's a big, sanctimonious if) you want to cast iPhone out as a separate business unit, it would be wildly profitable. There is a huge gross margin of 46% (this assumes a cost per unit of $316) and only another 5% of sales spent on engineering and marketing leaves a 41% operating margin or $7.4 billion. (Why only 5%? Because there's only 10.8% to allocate and after taking out iTunes, Retail you're really only left with 4.49% for SG&A and 3.3% for R&D or 7.79% so 5% is about two thirds of the operating budget).

If you take all of Samsung's IM division which is PCs, Tablets and phones their operating profit was only $5.6 billion.

You can see the difference in the grey areas of operating profit in the first graph above.

Bear in mind that this is still an artificial comparison. The split of profit between product groups is not only an estimate by the analyst, it would be an estimate for Apple itself since it has only one P/L.

It's been five years since we had an update on TV show downloads and six years since we've had an update on movie downloads from Apple. In Q3 2008 Apple announced 200 million TV show downloads and in Q2 2007 2 million movies. That's a long period with no information making a tough extrapolation to the present.

Nevertheless, I tried. My estimates for these two quantities were 963 million TV Shows and 108.2 million movies to date.

So I was quite surprised to see that figures for both TV show downloads and Movie downloads were published today. The figures were 1 billion and 380 million respectively.

My TV show forecast has proven to be very accurate but I severely underestimated movie download rates. Apple states that the movie download rate is 350k/day. My estimate  was only about 126k/day.

After adjusting for the new data, the picture of downloads that emerges looks like this:

The overall iTunes gross revenues by sub-component becomes:

As a result, my new estimate for the rate of spending on iTunes video is about $1.75 billion/yr. This is much more substantial than prior estimates mainly because movies are much more valuable. A tripling of the download rate shows up as a significant rise in the profile of video vis-à-vis the other media types.

Apps and software are firmly defined and music was somewhat clear. The upward adjustment in Video means that I have to reduce either Music or services. I presently am reducing service revenues but might adjust music as well.

The overall picture of iTunes is becoming clearer every day. We have more information about number of users (575 million), what they spend on media and software and services ($20 billion/yr.) and, increasingly what they spend on each media type (about $9/yr on Software, $2/yr on books, $16/yr on apps $12/yr on music and $4/yr on video.)