iPhone

The Mac grew at 28% while the overall PC market contracted at 3%. The Mac has outperformed the PC market overall for 20 consecutive quarters.

Prices increased sequentially and year-to-year.

I've mentioned the increasing shift of Mac mix to portables as a possible reason for the growth of the business. The Mac was one of the first to move to a portable form factor and has been pushing portability over performance for many years.

The following chart shows the relationship between growth and portable mix:

The trouble is that mix is not enough to explain the increasing gap with the rest of the PC industry. Windows PCs have also embraced portability and have even run down the path of over-serving portability with the netbook.

Clearly something else must also be at work. This was even noted by Apple's COO Tim Cook in the last conference call in response to question on the effect of iPhone growth on the Mac:

[iPhone] clearly seems to be creating a halo effect for the Mac. And I think that's one reason we see the growth that we are seeing on the Mac. It's amazing when you see the 28% year-over-year versus the worldwide market in PCs contracting by 3 points. It's an astonishing delta.

The delta has been there for a while but it's widening and it's persistent.

I've never been comfortable with the halo effect. Not because it's not happening but because we don't have a way to measure it. I've never seen reliable data that establishes a causal link. Lots of anecdote but little proof.

The other problem with halo is that it implies illusion and hence impermanence. The halo effect is a cognitive bias which can mislead. An example would be judging a good-looking person as more intelligent.

This effect is often exploited in marketing. It's quite common in the automotive industry where halo vehicles (e.g. Ford GT 40 or Dodge Viper) are created which promote sales for the entire brand even though they may lose money. These efforts often fail or have temporary benefits at best.

When it's deliberate and an attempt to prop up something unworthy it seems deceptive, dangerous and temporary (buyers may be disappointed when they buy a Ford or Dodge and realize that they are not supercars and a reverse halo effect can emerge.)

A halo effect should be used to boost a product that is under-rated not badly rated. This is when the effect creates benefit over a long period of time like the five years over which the Mac has over-performed.

Apple's last quarter's sales growth was an impressive 83%. It was not as high as the 92% earnings rise because there was a higher mix of iPhones this quarter than in the past. The iPhone is the most profitable product in Apple's portfolio so it impacts the gross margin significantly.

The iPhone is, in fact, a huge part of Apple's business. In units it reached 5% global share and 14% US share. I'll go over the overall industry data as soon as all the major reports are in, but already it has been estimated that Apple is the largest phone vendor by profit and sales.

In the following chart, you can see just how important the iPhone has become. Together with the iPad and iPod touch, iOS-powered devices make up about 65% of sales. That's almost three times the value of OS X based products which make up 23% of sales. That also leaves just 12% of sales not directly affected by these two juggernaut platforms (though music and peripherals are clearly indirectly affected by Apple's own platform products.)

The following chart shows the same information as shares of total net sales.

I've read that some of the uncertainty around Apple's future prospects is driven by the perceived vulnerability of these new blockbuster iOS products. At first glance this growth looks quite unprecedented and hence risky. 65% of sales from iOS did not exist four years ago. If you look at the sector it's hard to find any company that has doubled its sales in a few years from completely new product lines. Especially a mature company over 40 years in the business.

Well, there is one.

If you look again at the second chart above, you'll note that the proportion of sales held by iOS devices has mostly replaced the sales share that used to be held by iPod, itself a product that did not exist four years prior to the time of these charts.

Apple consistently doubled its sales on the basis of the iPod. It's now consistently doubling on the basis of iOS.

Exceptional claims require exceptional evidence. But that's exactly what the investment thesis for Apple should be: Exceptional growth is no exception.

Steve Jobs himself said it well once: "I wasn't alive then, but from everything I've heard, Babe Ruth only had one home run. He just kept hitting it over and over again."

Even this exceptionalism is not unique. It happens not just at Apple, but at another of Jobs' creations: Pixar.

Perhaps this magic formula for exceptionalism is itself a fluke but what if it's not. What if blockbusters are really something that can be built with repeatable consistency. What would that be worth?

As chronicled here, this quarter I went through three sets of estimates. This is a departure from my standard practice of sticking with one forecast made three months in advance. I felt last quarter was filled with materially important developments which deserved updating.

So how did I do?

I wanted to see if the additional information helped or hindered predictability so I put my three predictions side-by-side and measured the errors. I also added the "legal leak" from April 15th (published April 19th) to see whether it was an accurate predictor. The table below shows the error rates with the lowest error highlighted.

It's clear that my error rate decreased as new information was used. It's also clear that the "legal leak" was very accurate. What follows is a discussion of each line item.

The iPhone forecast was very accurate both early and late in the quarter. At 1.36% error it was even lower than what was leaked by Apple. I used the information about China and Verizon to boost sell-in and increased the growth rate to 110%. That proved to be the right call. I did not pay any attention to talk of component shortages as I did not consider them to affect Apple whose market share of devices is so low. I would score my "late" estimate as an "A".

Even though I disclaimed it, my iPad forecast was very inaccurate. In contrast, the leak was very accurate. Although mitigated by the higher sell-through (5.1 million) shipments were constrained by the change in product. Details like the date of shipment, the date of announcement and the ramps made this a particularly difficult transition to predict. At 36% error, I score it as an "F".

The iPod error was about 10%. That's mediocre. The product dropped in sales by 17% (vs. 10% expected). Again, the mitigating factors, like higher mix of iPod touch and thus increased prices helped to keep the financial performance decent. I score this as a B-.

The Mac prediction was accurate. The error was less than 5%. I will discuss the Mac business in a separate posting but it suffices to say that the growth was excellent but predictable. I score my prediction as an "A-".

Revenues were reasonably predictable however pricing seems to have been affected by exchange rate volatility. The iPhone turned out to have a huge average selling price ($660) which made up for the lower revenues from iPad. The error of 3.25% is acceptable. I score it as an "A".

The Earnings number was very accurate. The error for the late estimate was less than one half of one percent. This bottom line number is a function of all the other numbers so it's the most encompassing. You have to account for factors like interest income, changes in the number of outstanding shares and tax rates. None of these are predictable. However, I was lucky. With an error below 1%, I rate this as an "A+".

My overall performance as a grade point average would be 3.43 or B.

Thanks to Nilay Patel at This is My Next for posting the complaint filed on April 15th against Samsung by Apple which revealed some potentially material data about its performance in the last quarter (which won't be public until the 20th).

On page 4:

"As of March 2011, more than 108 million iPhones had been sold worldwide"
"By March 2011, Apple had sold over 60 million (iPod touch) units."

On page 5:

"By March 2011, Apple sold over 19 million iPads".

These numbers are material because we know units sold prior to CQ1 and can derive the minimum units sold for these three product lines during Q1.

Namely:

• Total iPhones sold before Q1: 89,971,000 implying a minimum of 18.1 million sold during the quarter (my estimate is 18.4)
• Total iPod touch sold before Q1 (estimated): 55.5 million implying a minimum of 4.5 million iPod touch sold during the quarter (my estimate 5 million)
• Total iPads sold before Q1: 14,789,000 implying a minimum of 4.2 million iPads sold during the quarter (my estimate is 7.3 million).

The only outlier in terms of delta to my estimates is the iPad units which has always been the wildcard.

Apple published lower bound figures but it's a matter of speculation as to how far below actuals they are. Nevertheless, I would treat the iPad numbers with extreme caution.

Estimates for Apple’s second quarter earnings ending March | asymco.

Since making the original estimates In January,

• Revenue: $24.5 billion
• EPS: 5.89
• iPhone unit sales: 18.4m
• iPod unit sales: 10m
• Mac unit sales: 3.6m
• iPad unit sales: 7.3m
• Gross margin percentage: 38.8%

I revised them at the end of March to the following:

• Revenue: $25 billion
• EPS: 6.21
• iPhone unit sales: 17.5m
• iPod unit sales: 10m
• Mac unit sales: 3.6m
• iPad unit sales: 7.3m
• Gross margin percentage: 39.6%

In the past I was comfortable keeping untouched estimates made three months in advance. This quarter however there have been several developments during the quarter which were unforeseen and cause me to revisit my estimates.

1. The Verizon iPhone launch. Observations of the event focused on line lengths and buying activity. However, Apple reports shipments not sell-through. I believe the deal structure was such that Apple obtained a very large order as condition to the relationship. The January and March update analysis did not consider this order size. We have also more data on sales from HTC and RIM and there is no letup in the market's growth. As a result I am revising the growth for the iPhone back up to 110% y/y and 18.4 million units.
2. Crucially, I'm increasing iPhone ASP to $625 on the basis of this new demand and the likely delay of iPhone 5 launch.
3. The iPad 2 launch. This product is still too young to see production and sales patterns. However, demand for the second version seems higher than for the first. Distribution is broader too. The unknown is production. I am keeping the unit number at 7.3 million which is the same as the level of CQ4.
4. China is booming. The Chinese New Year occurred in the quarter and since last year that has meant a sequential increase in device sales for Apple. But it's a double edged-sword. Almost all production activity is shut down during the holiday period. Apple depends on China exclusively for manufacturing so they will certainly be affected. So whereas it's likely that we'll see increased demand from China this year due to even better distribution, macroeconomics and brand value I'm unsure if supply rose to match. Overall, I'm not changing unit growth due to his increased demand but I'm cautioning that there could be downside bias in my estimates.
5. The tsunami disaster in Japan will affect some demand in Japan and some of the supply chain will be disrupted. However, the effect will be felt more by weaker competitors. It's possible that the event will amplify the shortages that Apple's pre-purchase agreements already created. The consequences are bad news for Apple's competitors but I rate it as neutral for Apple.

Given these new facts coming to light, I would update my estimates as follows:

• Revenue: $25.5 billion
• EPS: 6.43
• iPhone unit sales: 18.4m
• iPod unit sales: 10m
• Mac unit sales: 3.6m
• iPad unit sales: 7.3m
• Gross margin percentage: 39.9%

Resulting EPS growth would thus be 93%.

For the record, I value my January estimates since they are based on long-term pattern recognition rather than transient events and thus are more useful in forming a market theory.

However, these transient events cannot be ignored and analysis needs to be informed by both theory and events. I will be watching to see which set of predictions (early, mid or late) will be more accurate.

Until the iPhone's arrival in 2007, upgrading the software on a mobile phone was a rare experience for users. So rare that effectively it was not done. Few people were bothered though since they did not see the product they used as a software product.

This was even true for Windows Mobile and Symbian which were licensed platforms. Microsoft tried several times to offer upgrade paths, but more often than not the device vendors did not push out updates or the process required to perform an upgrade made it the reserve of either those who were paid to do it or those who enjoyed the challenge.

In the era of the modern smartphone, upgrades are more common. Certainly with the iPhone the process is easy enough that opting out of an upgrade is more challenging than opting in. But it's still not as common with other platforms. Even with all the resources and experience behind them, Microsoft is still stumbling with Windows Phone upgrading.

UPDATE 1-Microsoft explains phone software update delay | Reuters

But is it really a matter of blundering or is there evidence of nominal partners working at cross-purposes?

Upgrading a mobile device is technically challenging. There are many things that can go wrong. Integration helps, but it is also possible for a modular solution to be implemented. There are harder things to coordinate.

However, things go wrong and as the linked article above shows, fingers get pointed. Device vendors who have no stake in a platform can easily interpretan upgraded OS as one fewer hardware upgrade. Platform vendor's lament that device guys want to proliferate unique versions and act with passive aggression. Device vendors see the software upgrade cycle as increased support and engineering costs with no upside. Consumers don't know whom to blame and often turn to the operators since that's who they pay every month.

The problem of upgrade failure is a symptom of a deeper dysfunction inherent in immature modular business architectures. It's not just that the brightest at Microsoft or Nokia or Google can't make an upgrade stick. It's that the upgrade is not universally beneficial to the value chain. To remedy this, licensors have to resort to contractual obligations to ensure upgrades, but enforcement is non-trivial and can lead to aggravated relationships.

Unless all licensees of a platform find compelling value in shouldering the burden of upgrades, they will continue to be really hard. This leads to increasing fragmentation and a corrosion of platform value for licensed platforms vis-à-vis their integrated alternatives.

The World-Wide Developer Conference is an event for developers. It is not a trade show and it is not a consumer show or an enterprise show for salespeople. Except for the keynote, all events are subject to Non-disclosure Agreements so it's not even an event whose proceedings can be discussed openly.

It's also expensive. Registration is at least $1,500. Attendants are there to learn and ask detailed questions about development. It's not for deal making. People not familiar with development would not be well served by the event. Registrations are therefore somewhat limited to about 5000.

After the iPhone SDK was launched, the WWDC took on a new dimension. It became a mobile development event. As a result, 2008 was the first year when WWDC sold out. Attendance tripled over the Mac-only event the previous year.

Every year since, not only has WWDC sold out but it has sold out quicker every time. The following chart shows the days it took to sell out WWDC. I also added Google I/O data for comparison.

In the era of the iPhone, the limited resource of attendant seats has always been exhausted at accelerated rates: from 60 days in 2008 to 0.5 days in 2011. A similar pattern emerged for the Android event.

What should be noted is that these events are focused on post-PC development[1][2]. Clearly the increased interest among developers is for the mobile side of the business.

Developers certainly seem to sense the way the wind is blowing. They are, as humans, prone to over-confidence but they are also often accused of being hard to please. The most common lament among new platform builders is "How do we attract developers?"  The platforms showcased here had no trouble attracting developers in the tens of thousands three years after being launched.

The Post-PC era is evident in all kinds of data. This set (developer attendance to mobile development) is particularly stark. It's a proxy for investment and IT interest. There is a non-linear nature to this growth and history shows that non-linearity leads to unpredictable or unforeseeable change.

---

Notes:

1. WWDC still has Mac OS X tracks but that track was there pre-2008 and did not sell out the event.
2. Microsoft hosts several developer events (PDC, MIX, and Tech·Ed) some of which also sell out, but they have a far wider focus.

Apple's second fiscal quarter has just ended. Time for analysts to put forward their predictions for the quarter's report (due in about 3 weeks.) If history is a guide, the estimates will range quite widely and accuracy will be determined mostly by the ability of an analyst to predict iOS device sales (and iPhone most of all).

How hard can it be?

It depends on what you choose to prioritize as the proxy for sales. In competitive markets there is usually a constraint on demand and rivalry among suppliers. If that's your assumption you might want to use samples from the sales channel as a proxy. That means sampling distribution channels and sales through to end users at retail. You might even watch competitors and index them to each other using historic market shares.

In markets where demand outstrips supply, the best method would be to determine the constraints to production and measure those.

In Apple's case we know from company statements that Apple faces more demand than it can supply. That makes things easier for the amateur because she can just figure out production. In other words, the logical way to forecast Apple's iPhone sales is to guess how many they can make.

That is not trivial since production data is not public. However, we have historic sales data. We also can make assumptions about how much inventory is carried (some data is actually available here as well.)

Combining these public data sets we can build up a model of production ramps and look for patterns of growth.

So here are the patterns of sales for the four versions of iPhone sold to date with some production ramps overlaid. The monthly sales are approximations based on actual quarterly sales divided over the months according to the number of days available.

The assumptions are:

1. Inventory during any one month has to be greater than zero.
2. Inventory must be minimized. Ideally it should not exceed 2 million units and preferably should be around 1 million units at any given time.
3. There is a limited amount of overlap between production of various generations. I.e. once a new version is launched, the older product should end production. Continuing sales of older model should be made available from inventory.

The following chart shows the ramps for the various versions of iPhone that satisfy these assumptions and are shown relative to the same time frame (each line shows the number of units produced per month for each generation of iPhone):

I need to stress that this is just my estimate. It's an approximation and not reality. What it does is give reasonably accurate predictions for units sold.

What I've always assumed is that each new version of the iPhone sells twice as many units as the last. This is roughly translated into: each ramp is roughly double the previous ramp (at least on average). The data bears this out. Apple has been very considerate in keeping products on similar cycle times so that we can see this pattern emerge.

Once you build these models, forecasts are not that hard to make:

• The current generation will probably sell around 60 to 65 million units.
• The product will still sell for at least one more quarter (CQ2, FQ3)
• We know how many have been sold so far, so we can be pretty sure what will happen in the quarter just ended and the one just starting.
• Looking at the pattern between generations, we can guess what the iPhone 5 curve will look like and build up the units forecast by month and quarter.

You can sanity-check the forecast by looking at overall market shares for Apple and overall market growth. If share moves too far up or down it might makes sense to revisit the data.

As iPad shipment volumes increase and as the iPod touch becomes the de-facto iPod, it's time to look at the overall split between iOS devices.

I will focus the discussion between iPhone and iOS "others" because I believe the two categories differ greatly in terms of their positioning and market strategy due to the different channels.

The company does not provide iPod touch units shipment data but it can be estimated that, based on overall iOS numbers released in September, iPod touch represents approximately 50% of iPod units sold.

If we put all we know together about volumes, we have the following chart:

Note that iPod touch has, occasionally outsold the iPhone. The pattern of approximately equal volumes for the two types of products is likely to continue depending greatly on the growth rates.

Next, I turn the spotlight on revenues.

 

Over $10 billion flowed in from Operators, and a bit under $8 billion from other channels.

Note that I labeled the iPod touch and iPad as non-operator channel (Consumer electronics) distribution. Although this is not entirely true (and conversely iPhones are often sold through Apple stores) this gives a rough indication of split.

The iPhone business is staying ahead of the other iOS businesses but the gap is narrowing.

As previously noted, the iPhone is a unique product in Apple's portfolio. It depends on a distribution channel that no other product was designed around. This has advantages and disadvantages. The advantage is a high margin due to service revenue sharing but the disadvantage of network incompatibilities, politics and a range of telecom-related regulations.

What I believe is that the non-operator channel will grow as a proportion of iOS revenues. This is both as iPad grows to disrupt personal computing and as the iPad emerges as a communications tool.

As time passes, I believe Apple is motivated to also move revenues to its traditional channels. Whether, or to what extent, cellular phones will move in that direction remains to be estimated.

The last time I took a snapshot of the iPad death watch it was March 9th, 2010. Almost a year ago. The now-classic quotes are reproduced here.  Last May I wrote:

Apple keeps a tight lid on new products so that competitors don’t get a head-start on copying, but in the case of the iPad, advance knowledge would not have had any impact. Competitors look at the iPad and see nothing.  They’ll only react once the market explodes and they start to feel belated pain.

I thought that would be that. As the success of the product would become self-evident, predictions of imminent demise would trail off. The pain of share loss would prompt a wave of challenger copycats. Imitation would be the the best form of flattery.

But no.

Critics were not silenced. One year, 15 million units, and $9.2 billion later I went back to the source of the quotes and found the following (published quotes dated after March 9th 2010). (Cited from aaplinvestors.net with some editing for brevity and relevance):

“Problematically, the Android competition is just as expensive as the iPad lineup, so Apple obviously feels free to continue gouging consumers on iPad pricing.” Paul Thurrott, Windows IT Pro, 3 March 2011

“Apple’s iPad 2 might be ‘magical’ but it still should’ve been better ... It needs more G’s. It’s still just a toy” Zach Epstein, Boy Genius 2 March 2011

“11 reasons NOT to buy an iPad 2 ... Reason 5: Competition David Gewirtz, ZDNet, 23 February 2011

“Given what I’ve seen of Honeycomb and Motorola’s excellent tablet, Cupertino will have some serious catching up to do with their iPad 2.” J.P. Mangalindan, Fortune, 4 February 2011

“We very carefully chose our tablet processor, the Nvidia Tegra 2, and to really compete it will take [Apple] some time. You know, [Nvidia] is well known for graphics.” Jonney Shih, Asustek Computer, 3 February 2011

“If you were to ask me in two years time, will Apple have less than 50 percent of the global tablet market, I think that’s a certainty. Neil Mawston, Strategy Analytics, 31 January 2011

“We have an extreme focus on the innovation of LePad and LePhone because these products will dominate the future market. Though Apple is winning a significant share in the Chinese market, it has not gained a clearly leading position yet. Our advantage is we know this market better.” Liu Chuanzhi, Lenovo, 27 January 2011

“The iPad may still be the lone leader, but with 100+ competitors on the way, it won’t likely keep its majority market share unless the pending next generation iPad really addresses all the complaints about the current version, like a missing camera and a lack of a USB port, and the company has to add those features without a major price increase - a tall order, to be sure.” James Brumley, Investopedia, 13 January 2011

“Hands-on PlayBook demonstrations at CES showed its differentiation in multitasking and performance, which may be difficult for Apple/Android to rival.” Mike Abramsky, Royal Bank of Canada Analyst, 11 January 2011

“Apple Inc.’s popular iPad is getting its strongest competition thus far as consumer-electronics manufacturers unveil tablet computers with bigger screens, front-facing cameras for video chatting and more.” Rachel Metz, AP Technology Writer, 3 January 2011

Apple may be simply trying to get in ahead of Research in Motion’s aggressively priced PlayBook or combat the early success of Samsung’s Galaxy Tab.” Rick Aristotle Munarriz, The Street, 29 December 2010

4. Competitors are coming. Brett Arends, Wall Street Journal, 22 December 2010

Reason 6: WiFi is still unreliable David Gewirtz, ZDNet, 16 December 2010

“I can’t imagine anyone under the age of 30 wanting an iPad. A PS3, Wii, GameBoy, or even a useful laptop maybe, but an iPad? Furthermore, I do not recall ever seeing anyone under 30 actually using an iPad.” John C. Dvorak, PC Mag, 13 December 2010

“We hope our tablet PCs can reach a global market share of 10-20% initially, and become the market leader in two to three years.” Gianfranco Lanci, CEO and President, Acer, 26 November 2010

“It’s a nice-to-have product, for those of us who don’t have a budget, but is it a must-have product? I don’t think so.” Ashok Kumar, Analyst, Rodman & Renshaw LLC, 12 November 2010

“Steve Jobs never says anything without thinking through it carefully. But I think in this case he may be a little afraid of this category. And he’s finding whatever he can to attack because he sees [seven-inch tablets] as a challenge to the dominance of the iPad.” Adam Hanin, VP Marketing, Viewsonic, 1 November 2010

“There could literally be millions of first-generation iPads gathering dust in people’s home offices already. This product is the tech industry’s biggest MacGuffin yet.” Paul Thurrott, Windows IT Pro, 23 October 2010

“I cannot see a need for the thing.”John Dvorak, MarketWatch, 22 October 2010

”For those of us who live outside of Apple’s distortion field, we know that 7″ tablets will actually be a big portion of the market and we know that Adobe Flash support actually matters to customers who want a real web experience.” Jim Balsillie, Research In Motion, 20 October 2010

“iPhone and iPad have been amazing products that have opened new markets. But I do not think they will own either market in a few years. Android will.” Fred Wilson, AVC.com, 18 October 2010

“The constant search for an ‘iPad killer’ and the sheer multitude of tablet computers launching in the next 18 months should make Apple aware that its competition is fierce and will only become tougher.” Barbara E. Hernandez, PCWorld, 5 October 2010

“HP’s New Tablet Could Be an iPad Spoiler HP’s decision to bundle a tablet computer with its new $399 printer could make trouble for competitors.” Cliff Edwards and Aaron Ricadela, Bloomberg Businessweek, 23 September 2010

“Our tablet will be better than the iPad.” Chang Ma, VP Marketing, LG, 20 August 2010

“Not only is Apple typically lost in the enterprise, but it focuses very little of its time there. And with a new, potentially more compelling tablet coming — the Cisco Cius — the iPad’s success in the corporate world could be short-lived. Here’s why:... 10 The power of Windows” Don Reisinger, Channel Insider, 5 August 2010

“I don’t think there is one size that fits all…I’ve been to too many meetings with journalists who spent the first 10 minutes of the meeting setting up iPad to look like a laptop.” Steve Ballmer, Microsoft, 29 July 2010

“ [...] It still isn’t the device that I’d take to a meeting because it has no input.” Bill Gates, Microsoft, 2 June 2010

“Which means I end up on the iPad — and tablets more generally — where I started. Tablets will not create a new category, but will supplant (or merge with) one or more of the current substitutes: smartphones or netbooks.Here I am less optimistic about the iPhone and webOS than I am about Android. ” Joel West, professor of Innovation & Entrepreneurship, College of Business at San José State University, 30 May 2010

“The iPad is useless. Beautiful, but useless. The iPad is too heavy. It’s awkward to hold and view in public. It’s fragile. It requires expensive accessories to protect it and extract more functionality. ”Josh Belzman, MSNBC.com, 20 May 2010

“Mum, the iPad is not ‘amazing.’ It’s just marketed very well, both by Apple and its culpable partners in mainstream media. ” Paul Thurrott (in response to comment by Mum), Paul Thurrott’s Super Site for Windows, 26 April 2010

“In short, I don’t get the ‘magical and revolutionary’ vibe that Apple chief executive Steve Jobs touted at the iPad’s January unveiling.” Rob Pegoraro, Washington Post, 9 April 2010

“The first troubling sign is the fact that you can still get an iPad today. They didn’t sell out. The pure slate form factor has failed all these years because, other than for vertical applications, people want and/or need a keyboard for regular use. The fact of the matter is that a touch screen or bluetooth keyboard just doesn’t compensate.” Jonathan Yarmis, Ovum, part of Datamonitor Group, 6 April 2010

“I don’t get it. It costs $500 for the basic model, when you could get a laptop with a lot more functionality for about the same price. The iPad hype machine has been in full effect this week, and I still think it’s just that—hype. ” Alex Cook, Frontier Outlook, 3 April 2010

“As far as what this means to Apple, one thing to keep in mind: Even if the iPad sells more than the iPhone did in its first year, it’s still only around 5% of the company’s revenue. So it’s a very small slice. From there, it probably doesn’t grow as large as the smartphone market. So, if you’re buying under rumors, keep perspective in mind. The iPad’s a great product, but it’s probably not a game-changer.” Eric Bleeker, Analyst, Fool.com, 31 March 2010

“The iPad will remain an expensive, niche device compared to all-purpose netbooks.I think that one of the iPad’s most important uses will be for reading ebooks and publications. Even so, though, when it comes to the marketplace, netbooks will sales still far outstrip those of the iPad.” Preston Gralla, PC World, 30 March 2010

“Don’t Believe the iPad Hype. Apple has sold out pre-orders of the forthcoming device, but it could all be a marketing tactic. By not manufacturing enough iPads for the initial launch date, is this a case of Apple shooting itself in the foot?” Mike Schuster, Minyanville.com, 29 March 2010

“‘iPad Killer’ May be Palm’s Last Hope”Tom Bradley, PC World, 20 March 2010

“Even if your company has relented and now supports the iPhone, as growing numbers of businesses do (70% of the Fortune 100 are at least testing it, says Apple) you’ll want to say “No” to the iPad and other tablets. Here’s why: 8. Speaking of money, there is no money in the company budget to pay for iPads. 9. Not supporting iPad will be the enterprise norm. Robert McGarvey, CIO Update, 16 March 2010

“This morning, the fool’s parade gets started. Apple is taking online “pre-orders” for its iPad tablet, which is supposed to begin shipping on April 3. Buying a new kind of product sight unseen is foolish. Especially given how mysterious Apple has been on what the iPad can do and what restrictions on capabilities and media access it will place on users and content providers.” Galen Gruman, InfoWorld, 12 March 2010

“The recent launch of Apple, the iPad tablet, has won the award for the second edition of Fiasco Awards delivered this Thursday in Barcelona. From the more than 7,000 people who voted via the website www.fiascoawards.com, 4,325 have considered it the fiasco of the year. Fiasco Awards, 2010, 11 March 2010

“I think I’ve mentioned this once or twice before, but it bears repeating until it sinks in: the Apple iPad is not unique, nor necessarily the best of breed in the media tablet sector it is spearheading. And it ain’t gonna help Apple shareholders any.’” Anders Bylund (TMF Zahrim), 11 March 2010

From this critical review, it looks like 2011 will indeed be the year of the iPad 2.

On the eve of iPad 2.0, it's time to think again about this curious new computer. My intuition tells me that this product category will behave very differently from the iPhone and will not be subject to the same sales ramp.

The iPad has been on the market for less than a year but it's still a puzzle for many. It's a product that's often seen as an iPhone product line extension. From a hardware point of view, it certainly seems to be. It has an almost identical internal architecture and uses almost the same software. An engineer would look at it and reasonably say it's the same thing.

However, from the way it's used and the way it's sold, it has very little in common with its smaller cousin. There are plenty of experts who can detail how the products are used differently, but I would highlight the portability of the iPhone makes it suitable for a completely different set of tasks than the less portable but more immersive iPad.

But what I want to dwell on here is how differently the products are sold.

I'll build the case from evidence that Apple provides. The most important observation is that the iPad is an unlocked product. Although you can hire an operator to provide you with data services for it, the product is designed not to rely on that. As a result the product is effectively "divorced" from the operator channel. This means it does not typically benefit (or suffer) from subsidy.

This may seem an interesting side-note to the iPad story, but I think this is a central pillar of the market strategy. The iPhone was designed around a high-ARPU data plan. I've even suggested that the iPhone is nothing more than a data plan wrapped in glass and polished metal. Because it was designed to enable migration of cellular voice users to data plans, it's priced to skim profits from the migration. At some future point in time when a skimming strategy is no longer optimal, the iPhone might be re-positioned for penetration, but that time is not now.

As part of a skimming strategy, the iPhone has a limited distribution channel. It's only sold through special agreement with selected operators. Again, timing is crucial. That channel is expanding, but for nearly four years the product has not been positioned for sale through any channel other than Apple retail and Operator retail.

On the other hand, the iPad is marketed for penetration. It had a low price and an unlimited distribution strategy. It could be sold through any consumer electronics product point of sale. And then some. It could conceivably be sold through as many if not more points of sale as the iPod (i.e. tens of thousands.)

It can be sold in any country, can be distributed through middlemen and can be priced arbitrarily [1]. It can be bought in bulk by companies or schools or hospitals. It can be re-sold in a secondary market. It is essentially a perfectly liquid commodity.

Now we can step back and ask why and what are the implications for competitors.

The reason the iPad was positioned asymmetrically to the iPhone is, I believe, because it could be. I believe that the iPhone is sold the way it is (through operators) because that's the only way it could be sold effectively. Cellular products have always come with lots of fine print, footnotes and asterisks rooted in the regulatory environment that underlies the industry.

The iPad is a product built and sold along the lines of the Mac and the iPod--unrestricted by orifices and aligned with the unregulated environment that computers have always enjoyed. Essentially, for the iPhone, Apple chose to go along with the telecom industry's rules but as soon as it had a product that did not need to comply to those rules, it ran back to its comfort zone: control.

If we take this to be the cause, the implications for competitors become clearer. Apple is more in its element selling the iPad than it is in selling the iPhone. Other tablet contenders however are in an opposite strategic stance. Almost all the credible tablet alternatives rely on the telecom channel for distribution. The rush to build iPad alternatives is as predictable as the derision that was poured on the product when it was launched.

But the alternative products are positioned in different ways. They are positioned as big phones.

Which brings me to my final point: selling big phones is hard.

These products are not compliant with what users expect from an operator: a service plan. As a result they are also not competitively priced with the iPad. Apple engineered a price for the iPad that makes comparisons extremely favorable. Buyers know the thing they are buying is not a phone so they look at the price carefully.

But the most crucial weakness of alternative vendors is the fact that operators don't know how to sell tablets. Tablets are small computers. They are bought in the same way that buyers buy laptops: in-store testing. Notice that except for the iPhone operators only provide phone mockups in their stores. This is because they want buyers to discuss their purchase with a sales rep. This is not the way laptop hunters shop. Another tell-tale sign of a disconnect between operators and tablets is that operator shops are physically tiny. PCs (and tablets) need large tables for users to look, touch, heft and fondle. Just on square feet alone, operators and tablets are not a good match.

If you need any more evidence, consider the plight of operator-subsidized netbooks.

 

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Notes:

1. I realize that this is not currently true and the distribution is limited but that's only a matter of supply constraints. There is no theoretical positioning limitation.