Apple is now the biggest watchmaker in the world, overtaking Rolex during the last quarter. This achievement happened less than two and a half years after Apple entered the watch market. Rolex, on the other hand, was founded in 1905, 112 years ago at a time when watches were the avant-garde of technology. Given this revelation of sales, we can test the estimates I put forward on the Apple Watch sales, shown below:
We know that Rolex produces about 1 million watches a year and we also know that Rolex had sales of $4.7 billion in 2016. The average revenue per watch ((Includes services such as repairs)) was therefore about $4,700.
My estimate has been that Apple sold about 15 million Watches in the last 12 months at an average price of about $330. This puts the Apple Watch revenue run rate at $4.9 billion, indeed above Rolex.
They may be slightly high but the news makes me feel quite comfortable in my methodology. Note also that within the last quarter Apple said sales for the Watch increased by 50%. This is also reflected in my estimate of 3 million in Q2 vs. ~2 million for 2016 Q2.
Overall, about 33 million Apple Watch units have been sold since launch and they generated about $12 billion in sales. Coupled with a 95% customer satisfaction score, altogether, this has been a great success story. But only 2.5 years in, it's still act one.
To understand the long term trajectory, it's important to qualify this product as part of another, larger story. The Watch, even with LTE, is an accessory to the iPhone. It still cannot be activated without it. Even the coverage plan is an extension to an iPhone plan. The company is careful to address it as a companion product.
But how long will that last?
It used to be necessary to first attach an iPhone to a computer to activate it. That used to be cited as a reason for the iPhone not being a "proper computer", diverting attention from what it would inevitably become. Those who clung to that thin wire as a reason not to face the future were deceived. The iPhone and the iPad now stand alone of any PC or Mac. Will the Watch cut these familial links and stand alone some day?
I think this too is inevitable. The technology trajectories are easy enough to plot. Apple has invested enormously in the silicon that goes inside the Watch and has taken it to new levels of connectivity with LTE, 85% faster WiFi, and a 70% faster processor; all with 50% better power efficiency.
These enable independent voice entry, Siri everywhere, Find My Friends, Maps, music streaming. These breakthroughs are only possible with a new W2 processor which is more powerful than the first iPhone processors.
This comparison is apt: the Watch is effectively stealing usage from the iPhone. At first it took alerts, timekeeping, and basic messaging away. Now it's taking basic phone calls and music and maybe maps.
It's fitting therefore to remember how the iPhone was launched; as a tentpole troika: A wide-screen iPod, an Internet Communicator and a Phone. Today the new Watch is a small-screen iPod, an Internet Communicator and a Phone.
So not only is the Series 3 Watch more powerful than the original iPhone but it is also poetically capable of the same tentpole jobs. But it's not just a miniature iPhone. It has a new, completely orthogonal attack on non-consumption and market creation: fitness and health. This is a key point. The iPhone was born a phone but grew up to be something completely unprecedented, unforeseen by its creators and, frankly, undescribable in the language of 2007.
The Watch was born a timepiece but it is traversing through the early iPhone and pulling in a new direction all of its own. The fact that we are talking about "Resting Rate", "Arrhythmia" and "Atrial fibrillation" at a timekeeping launch event indicates that new behaviors will follow and so will the language we'll use to describe this child-like product once it grows up.
The answer, regardless of when you ask, is: The same as the current iPhone.
Of course, this is the answer to the question of what will the average new iPhone cost. The average selling price (which combines the revenues and the volumes of all units sold and is reported every quarter) has not varied very much since early 2008. To the degree that there is variance (between $600 and $700) it is due mostly to seasonality and reflects a mix of more expensive units during the launch quarters and a cheaper units during later periods when the product is older and due for an update.
The graph below shows the average selling price as a dashed line and the corresponding prices of individual product variants available for sale in the US during the same time frame. ((Prices outside the US vary depending on duties, taxes and currency hedging but generally are based on the US price))
The graph shows a high degree of consistency of pattern: Every year a new iPhone is launched which replaces the one launched the year before. The older product is still offered at a reduced price. Price brackets are very firm and set at fixed intervals about $100 apart.
A few minor changes in pattern over the years can be observed:
The original iPhone price changed due to a shift in subsidy model shortly after launch.
An increase of $50 mid-2011 when the iPhone became available unlocked.
Every three years a new, higher, price bracket is introduced, with a doubling of maximum memory capacity.
The iPhone SE was introduced at a slightly lower price.
The last year saw a slight increase in the highest price.
The overall pattern looks like a staircase with a widening price range where the lowest price remains constant and the upper price rises every three years by $100.
The "floor" of the range is a consistent $400 while the "ceiling" has expanded from $700 to about $950.
This year's ceiling is due for the fourth leg up and if the pattern persists, we should expect it to reach $1100.
This iPhone staircase has been built over 10 years and I don't see it changing over the next three. I therefore drew the blank box over what I thought would be the price range from now until late 2020.
This is what I call the staircase model of Apple pricing. The staircase model must be understood in combination with the flat iPhone average price as the product matures.
As the product matures the user base grows (to nearly 1 billion today). Later buyers will opt for the lower price points, but the availability of higher, more aspirational models (sustained by the brand) means that a minority will gravitate upward, mainly because they can. This ensures that although the median and mode of the price trend downward, the average price stays the same.
The flatness of iPhone pricing is also to be understood in combination with the flatness of Mac, iPod and iPad average pricing (shown below)
The technique of preservation of average price seems to be in effect across Apple. In other words, the evidence suggests that Apple prefers to keep average pricing for all products constant. Individual variants are priced so that, as the category matures, the changing mix leads to consistency in price ownership.
Thus the iPhone can be seen as controlling the $650 point, the Mac $1200, the iPod $200 and the iPad $450. This pricing signals the product's value and the value of the brand.
The signaling is not just to buyers but also to competitors. Ownership of price forces competitors to occupy adjacent brackets. This process begins at launch: the new Apple product is introduced in what is perceived as a premium stratum ((See for example the pricing of the new HomePod)) thus the reaction from competitors is to "undercut" it. But, as Apple climbs the price staircase, preserving the floor, it keeps competitors bunched up at the bottom. Competing in the same brackets with Apple is futile as other brands can't sustain the perceived premium position.
The result is a remarkable consistency of average pricing which, coupled with a remarkable consistency of competitive positioning, coupled with a remarkable consistency of customer satisfaction and loyalty, leads to a remarkable predictability of cash flows and ability to invest in new product creation..
Apple is thus quite easily understood as a remarkably consistent consumer products business. The only surprise that remains is how long it takes for that understanding to propagate.
From the way Apple reports its revenues you might think that the company has several operating segments. There are the iPhone, the Mac, the iPad for which units and revenues are reported. Then there are Services and Other Products for which we have revenues only.
Services is a collection of all non-hardware revenues and is (finally) being recognized as a non-trivial business. With reported revenues of $26.6 billion in the last twelve months, it's big enough to be a Fortune 100 company and set to double in four years. ((Although a non-zero business, the valuation of Services continues to confound observers who cannot separate it from the hardware businesses it attaches to--which themselves are considered near commodity value--thus paradoxically valuing the overlying asset of Services near or precisely at zero. Incidentally, Facebook is Fortune 98 at $27.3 billion and it is also one of the top 5 largest business by market capitalization.))
That leaves "Other Products" which now becomes the revenue segment that is "most likely to be ignored." This segment had revenues of only about $11.5 billion in the last 12 months which would place it at only a Fortune 245 ranking, equivalent to a Toys "R" Us or Biogen. How should we value Other Products?
Other includes many hardware products including iPod, Apple TV, Beats, Apple Watch, AirPods and, soon, HomePod. Each is a significant product, with Watch probably the largest single contributor. But since we don't have specific unit numbers, we are left guessing at the contribution of each.
The Watch itself has been a point of scrutiny as it could be initially teased out of the mix through an observation of the before-and-after launch vs. trend-line as shown below:
This separation of Watch became harder to discern after the launch of AirPods. Though they are still very hard to obtain, they might be "moving the needle" by now with a contribution that would muddy the Other category further. Same with updated Beats headphones.
This separation will be harder still with the launch of HomePod later this year. This product is priced at a point similar to the Watch and the quantities sold will be very hard to estimate without Apple's revealing of actuals.
Fundamentally however, all the "Other products" will have a common relationship to the iOS and MacOS hardware: attachment to and integration with a "parent" platform. Apple TV might be stand-alone but I strongly doubt there are many sold into offices or households which don't have iOS usage.
This means that "Other Products" are very similar to "Services" in that there is a dependency on a primary platform and, as it has been argued, they are therefore fragile. If the core platform declines then the Services and Other Products decline as well.
Given this dependency it makes little sense to carve these categories out as separate businesses. They cannot stand alone. They are very much the "children" of the parent platforms.
This is why it's assumed that Services, (a Fortune 100 company) and Other Products (a Fortune 250 company) can be discounted to zero. By focusing attention on the iPhone one can capture all the essential value of Apple. This is in contrast to the "sum-of-parts" valuation that could be applied to a set of independent business units in other companies.
And yet I started this discussion with the point that you might be tempted to look at Apple on the basis of these reported revenue segments. The choice of what Apple reports is arbitrary. It could report no segment revenues at all and publish just one revenue number. This is roughly what Google Amazon and Facebook do. Or it could report segments in some other way. For instance, app store revenues and AirPods could be reported as part of "The iPhone Division". Or maybe it could bundle all iOS devices and services and accessories into another segment called "The iOS Group". Or it could create a "Devices group" and a "Personal Computing" group. Microsoft famously shuffles its revenues into creative segments based on various organizational structures or choice of what it wants to project as its focus.
There is no limit to the ways Apple could slice revenues into segments. The reason Apple does it the way they do is mostly due to historical reasons. The company used to report the iPod separately as a segment but it no longer does. It also used to report Software separately, because, presumably, it charged for it but now it no longer does. It also separated laptops or portables from desktops.
The current reporting system is tempting us to draw certain "business unit" conclusions. These boundaries are illusions because Apple does not have business units. It has only one Profit and Loss statement (P/L) and is organized functionally. There is no "head of iPhone" or "head of Mac" responsible for each siloed revenue and cost structure. Instead, the entire business should be seen as a whole because it is managed as a whole.
This is easily evident in how the products are designed and marketed and how they are engineered. The iPhone may spawn AirPods and AirPods may have no value outside the iPhone but the iPhone is valuable precisely because it has AirPods and Apps and Music and iCloud. And Apple TV, and HomePod and whatever comes next. The reason the iPhone can be sold at three times the price of competitor products is because of the Services and Other Products and iPad and Mac symbiosis. This integration drives the satisfaction, loyalty, price and brand value. There there are the Apple Stores and the launch events and the countless details that make up the ownership experience.
The fact is that you can't slice and dice Apple.
There is one Apple and it must be analyzed as a unitary entity. That analysis is therefore difficult. It is easy to pick up the numbers given and study them in isolation. The iPhone, the iPad, the Mac. We all do that.. However we miss a great deal in doing that.
The lesson is that data we obtain leads us to see something but it also blinds us by taking attention away from what we cannot see. All data lies by omission. That which is left unmeasured may be where all the truth lies.
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.
Apple's new watches are priced in a pattern unlike any of the previous pricing models for Apple products.
Previous pricing models for iPhone, iPad, Mac and iPod were typically structured around storage differences. The higher the storage, the higher the price. The Mac had a slight variation where processor and graphics offered some additional configuration options. To illustrate, the graph below shows typical price bands for the iPhone (2011 and 2012)
In contrast, the watches are differentiated by size, materials and bands. There are also a total of 38 watch configurations available at launch (SKUs) and another 38 bands that can be purchased separately.
The bands come in four price points and the watches in 15. Of these 15 watch prices, four are dramatically different. The pricing of the watches is shown in the two graphs below (with and without the Edition).
This mix of product makes average pricing estimation more challenging, but the more pertinent question is what does this new pricing model signify? Is it something that Apple can "pull off"? Can Apple actually price not on functionality (or options thereon) but on materials?
It used to be said that Apple's profit engine was fueled by the ability to price memory at a significant mark-up on its cost. The iPod earned the vast bulk of music player profits by offering additional memory increments at significant price increments. Even today, a 64GB iPod Touch is priced $100 higher than a 16GB version. Sounds reasonable, but a quick check shows that 64GB of Flash memory probably costs about $5. This exploitation of pricing/cost differences at the margin allows for great profitability and is rooted in the ways the buyers contemplate value.
Therefore the difference between memory-based pricing and materials-based pricing is only in the choice of how to attach value in the mind of the buyer. In one case it's having the option on storage, in the other it's having the option, perhaps, of more durability, quality or glamour.
The tricky part is understanding just how much the market will bear. What is the right differential for pricing of steel vs. aluminum? Or what makes gold worth so much more?
The cost of these materials (and the processes needed to manufacture them) is not very important. As with memories, the differences are not that significant. It could even be that the Aluminum process is more expensive than the steel process--it depends also on volume.
What matters most is how to gauge the perception of value.
This is where one can take cues from the existing market. Gold is costlier than steel but the pricing difference is greater still. Multiplying $1000 (cost) by 10 (to get a price) yields far more profit than multiplying $1 by 20. This perception of gold as being worth it is far beyond its utility--a perception which has taken centuries to build. What Apple is doing with Watch pricing is simply leveraging existing perceptions of value for materials and using them to capture profits for an otherwise purely functional product.
But that process of using perception to gain pricing advantage for function is how Prestige branding has always worked. The notion that materials, craftsmanship and attention to detail can be priced at huge multiples of cost is possible only with the right brand. That brand, itself built over decades, even generations, gives assurance of quality, perhaps exclusivity and comforts the purchaser in the moment of decision. It also provides assurance after the purchase and preserves the feeling of value well into the future. So-called Luxury brands are those which can impart these qualities on their products and extract the pricing advantage.
Sounds great, so why doesn't everybody do it? The answer is that it takes time and perseverance, with typically low volumes. This is not something technology brands have been able to do. Mainly because the products are perishable but also because they have not been around for long. With technology, the value is high at purchase on a functional basis but diminishes rapidly afterwards. It's as if, in order to preserve notional brand value, a product needs to be a functional commodity, undifferentiated on what it does but differentiated on the way it does it.
This is the unique value of Apple's brand: among technological brands it can stretch to cover the perception of value for design, materials, craftsmanship and prestige. At the same time it offers new experiences and introduces new products for new jobs to be done.
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.]
When the iPhone launched, Steve Jobs introduced it as being three products in one:
A wide-screen iPod
A phone
A breakthrough internet communicator
When the Apple Watch launched, Tim Cook introduced it as being three things:
A precise timepiece
A new, intimate way to communicate
A comprehensive health and fitness device.
As in the Revolutionary User Interface story, the symmetry in approach to the launch is telling, but what I want to note is that the three things which the iPhone was defined as being are no longer things that it is most used for.
Yes, the iPhone is still a wide-screen iPod which gets plenty of use but I don't think anyone thinks that is a defining feature. It's also a phone, but the Phone is just an app which, for me at least, is not frequently used. I communicate with my iPhone but the go-to app is iMessage or FaceTime or Skype or maybe Email or Twitter. Phone is something I use so rarely that the interface sometimes baffles me. And yes, it's an Internet appliance. Browsing is something I do quite a bit but many of the browsing jobs-to-be-done are done better by apps. News, shopping Facebook and maps are "things which were once done in a browser."
So I wonder whether the tentpole product-defining anchors used to introduce the Apple Watch will be faintly amusing a few years from now.
Of course, the reason iPhone outgrew its tentpoles is because of the app economy. 1.3 million apps does that to a product. When it becomes a platform a product invites collaboration on the problem of innovation. Collaborative innovation explodes the opportunity to discover new needs and uses. How, when and why people use the product changes beyond anyone's imagination.
But this does not mean that the tentpoles used at launch are in any way in error. They are necessary to explain the value of a new category. The audience can't be told "wait and see all the cool stuff you'll be able to do with it". They need to be told why it's useful today. They speak in the language the audience can understand today. Steve Jobs could not talk in the language of apps and services in 2007. The unforeseen became the inevitable.
Tentpoles therefore don't define the product but do provide the starting blocks from which the initial buyers make a cognition leap. And once they're off, the others will know where to go.
In the graph below the grey circles represent the US penetration (percentage of households which own) MP3 players.
Superimposed on this sparse sample graph is a line showing the sales of iPod touch. This second graph has a different scale, shown with a gridline at 10,000, representing millions of units shipped by Apple. To smooth out seasonality I show the trailing four quarter average with a thick line.
The correlation is fairly evident. As iPod sales grew, penetration grew and "peak MP3" was recorded in September 2010 while peak sales occurred at the end of that year.
It's not a stretch to say that iPod touch sales are causal to MP3 penetration, especially since the iPod has remained the market share leader in the segment for a long time (at least 70% share) and that the iPod touch is consistently half or more of the iPod.
The absence of data for penetration beyond 2012 is therefore not a problem. We can assume that MP3 devices have a finite lifespan and, if not replaced, the penetration will decline.
I modeled both the increase and decline with a diffusion curve as follows:
As longevity goes, this is quite generous but it's safe to say that fewer than 10% of US households will have a dedicated MP3 player by the end of the decade.
MP3 players turn out to be a "ballistic technology". Their failure is two fold: first, they did not reach saturation, gaining popularity with only half of US households; second, they were substituted and thus went out of use. Note that I kept the graph's upper bound at 90%, suggesting the limitation of the device popularity.
There are many technologies which are in this state: camcorders, pagers, VCRs, game consoles.
On the other hand there are some technologies which prove to be both ubiquitous and resilient. I call these "perpetual technologies". Substitution may occur but it may take decades. Examples are stoves, autos, microwave ovens, refrigerators, radios, vacuum cleaners, TV, telephones (fixed wire and cellular).
Yet another category exists where the technology does not quite reach ubiquity but is common enough that it's refused by only about 20% of the population. I call these "Inertial technologies". They also have relatively long periods of slower growth and similar lengths of decline, sometimes substituted by services rather than equivalent objects. The Examples are washing machines, the Internet, personal computers.
Some technologies never reach mainstream use (below 10% penetration). I call these "dud technologies". These failures are very common and can be discerned easily. Examples include the Segway, Google Glass, SPOT watches, PDAs.
So to summarize:
Dud technologies: Never reach 10% penetration, are money losers, do not create an industry.
Ballistic technologies: Reach between 30% and 70% penetration but are substituted quickly. They are profitable but only for the duration of their ascent. Generally do not create industries, ecosystems or network effects.
Inertial technologies: Have steady growth but never reach ubiquity. They are bound by frictions which impede their broad adoption but also impede their substitution. They do create industries and network effects but suffer from corrosion and monopoly.
Perpetual technologies: They reach ubiquity, usually quickly and remain there indefinitely. Substituted only by improvements which supersede performance (e.g. Color TV vs. B&W TV). Usually solve a universal problem everybody has. Create disruptive growth and have world-changing effects.
Knowing in advance which category a technology will reach can be very valuable. Not only can investment be directed, but career decisions, education choices and fundamental research can be better allocated.
The question is therefore how to tell early enough where an emergent technology fits in this categorization.
I'll be discussing a methodology for doing this, the processes for creation and covering at least twenty case studies at the Postmodern Computing Summit in June in San Francisco.
On a recent podcast I noted that Google was perceived as invulnerable. In contrast, Apple is seen as temporarily enjoying a stay of execution. ((The list of Apple Achilles' Heels is so long and creatively composed that it would take ages to compile, but here are just a few: the Mac (vs. Windows), Digital Rights Management (which kept the iPod alive), dozens of lawsuits (including from The Beatles), the Mac (when it ran Windows), PlaysForSure, Music Labels retaliation, the Zune, Android and clones, the Kindle and Amazon in general, more Mac, iTunes, iPod and iPhone and iPad killers than can be counted; Steve Jobs is ill, Jony Ive will quit, Tony Fadell quit, Rubinstein quit, Forstall was fired, etc. Feel free to add more through comments. See also Apple Death Knell Counter.)) This is not necessarily a bad thing for Apple. The more gushing the loathing or scorn, the more likely it's a reaction to love and attraction. A brand dies not from hate but from apathy.
But nor is it necessarily a good thing for Google be be seen as invulnerable. There might be no "Google death knell counter". There might not be a "Google is doomed" trope. If an executive from Google quits or is fired there is no investor panic. If a product is withdrawn there is no mourning. There are no journalists pursuing Pulitzer prizes by describing some seamy underside of Google. But there are no overt displays of affection either. Google is seen, on balance, as benevolent and hopeful. The discussion on business robustness is simply missing.
I suspect the absence of scrutiny comes from Google being seen as an analogy of the Internet itself. We don't question the survival of the Internet so we don't question the survival of Google -- its backbone, its index, and its pervasive ads which, somehow, keep the lights on. We believe Google is infrastructure. We don't dwell on whether electric grids are vulnerable, or supplies of fuel, or the weather(!)
Too complex, too pervasive. These are systems, not things. And people are not designed to contemplate systems. We leave that to experts, or better yet, computers.
The reason Apple is contemplated at all is that it's not seen as a system. Even the suggestion that Apple is a system is implicitly treated as an impossibility. Because it's not a system it's fragile. It's a person, or an idea, or a product or a singular "key" to something. It is, ultimately, mortal. The only debate is when it will die and points are earned for calling it sooner rather than later.
But what if Apple were a system? And what if Google were a person (or three?)
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.
Publicly, Mr. Lazaridis and Mr. Balsillie belittled the iPhone and its shortcomings, including its short battery life, weaker security and initial lack of e-mail. […]
Internally, he had a very different message. “If that thing catches on, we’re competing with a Mac, not a Nokia,” he recalled telling his staff.
The whole article is worth reading, detailing as it does the decision process inside BlackBerry during the painful disruption of its core business.
What struck me most however was how similar their decisions were to those of Nokia at about the same time. Consider:
The engineering priorities placed on optimization around constrained hardware. Although engineers knew how to build the right products, the business priorities caused them to be deployed in the wrong direction.
The delays these misdirected efforts caused. Mobile phones have narrow windows of opportunity but long lead times. A strategic mistake is very costly and most probably impossible to remedy. In the case of BlackBerry, buying QNX came too late while for Nokia the deprecation of Symbian was catastrophically managed.
The feedback loop from network operators which shut down any initiatives for improved user experiences. Your best customers provide all the wrong information when the market is being disrupted. Ignoring them is impossible while complying is a strategic mistake.
The demand from network operators to develop "killers" to competing platform-based products ((Ironically, Nokia was asked to do a BlackBerry killer)) and the subsequent "jumping at the opportunity".
Listening to large buyers at the expense of users. While BlackBerry was guided to omit consumer features from its enterprise buyers, Nokia never secured enterprise buyers of any significance ((though they tried very hard to get them)). Nevertheless it created the "E series" business-friendly phones which suppressed features like cameras and music.
The celebrity sponsorships and wasted promotional efforts in the face of structural failures. This is manifested today by HTC as well.
The parallelism of this synchronized failure can be seen in the following graph showing smartphone volumes.
The striking thing is how the two companies peaked are almost precisely the same time and how that moment (end of 2010) was not related to the entry timing of their nominal disruptor.
Recall that both companies cite the iPhone as the factor which caused a shift in the basis of competition. But the iPhone launched in mid 2007 (at the beginning of the graph's date range.) BlackBerry had 16 quarters of growth after the iPhone and Nokia nearly the same. The stock prices of the companies also prospered for a period long after the iPhone entered the scene validating a do-nothing approach. So this is the crux of the incumbent's dilemma: how do you rally a response when you don't feel any pain? It's worse actually: how do you embark on a painful course of action while feeling comfortable and safe?
The reason the companies did not suffer immediately from the iPhone was because it (and its Android equivalents) took time to reach the core customer bases. Remember that the iPhone was not "good enough" to be an enterprise product at launch and Android was not the first to serve the low end of the market, where Nokia was dominant.
Vision is worth exactly nothing without timing.
But enough about ancient history. The crucial question is what does it teach us. It's tempting to suggest that this disruption is happening again with the iPhone today.
There is one big problem with this. The iPhone was not a low-end disruption. It was exactly the opposite. The BlackBerry and the Nokia products were striving for the low end. They observed the discipline of constrained resources. They were expanding into emerging markets. They watched every fraction of a penny on the bill of materials. The low end was manna for the whole industry. Even Microsoft with Windows Mobile was better positioned for the low end than Apple.
Instead, what Apple did was unthinkable. It entered with a high end product. It even promoted its high price ($500, subsidized!) This is why it was laughed at.
Theirs was "the Mac in a phone" idea. The reason it worked was that it was not a phone. The reason it worked is because it was the hardest disruption to spot:
A new market disruption ((The reason Clayton Christensen and his disruption consulting black belts could not spot it is mostly because new market disruption requires deep industry domain knowledge))
Disruption is not a process that merely rewards breaking convention. Any fool can rebel against the status quo. To change it requires a process that rewards asymmetric competition. Finding a way to be seen as irrelevant and yet conquering at the same time. Being disruptive is, above all, being imperceptibly valuable.
For iPhone the core asymmetry was that it was a computing product and not a telecommunications product. Every decision thereafter flowed from the calculus of computing and not the compliance with telco convention. The ecosystem, the rapid rate of improvement, the rich user experience, the tie into other product lines.
It was this asymmetry which confused every observer. Predicting how a high end product can conquer the low end is fiendishly counterintuitive.
In contrast, spotting low end disruption is a parlor game. There is little challenge in observing a cheaper alternative competing as a commodity. For evidence look at how markets react. Whereas they could not understand the value of the iPhone (or iPod or iPad) they reacted instantly to the whiff of a commoditization play. Angst surrounding cheaper alternatives pervades. ((The contrarian should note that commoditization plays are hard bets to win since everybody can spot them.))
The problem with the low end disruption thesis is that low end is also much easier to respond to, especially now that everyone read the book. The incumbent simply needs to have a flexible cost structure and a vast margin to dip into. Most failures to respond to a low end disruption come from companies stuck in a high cost structure not from a failure to see a low end alternative. ((Christensen case studies almost always cite how the low end disruption was perceived easily but the response was felt to be marginally worse than not responding or fleeing upmarket.))
Apple's costs are mostly variable and their fixed (R&D and SG&A) are growing far slower than sales. There are huge margins and more cash being spun out than anyone can figure out what to do with it.
The distressed response to the low end tends to be a retreat into the higher margins and an abandonment of existing customers.
I don't see Apple doing either. Rather, it is gradually adjusting its portfolio toward lower end alternatives. Note that demand for the lower end product is far less than for the high end. Instinct would suggest that they should have stuck with the 5S alone. But it moved down anyway. It also did so with the iPod, iPad and Mac mini.
The idea that Apple is vulnerable to the low end is a relic of an idea. It goes back to the Mac of the 1990s, at a time when the world-wide computing market was orders of magnitude smaller than today and where purchasing and development decisions centralized in the hands of a few large companies ((essentially B2B as Ben Thompson points out)). And even when looking at that competition, the Mac somehow managed to survive.
That's not likely to be the case for those who found themselves in competition with the Mac in its pocketable re-incaration.
