Mac

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.

From How BlackBerry blew it: The inside story - The Globe and Mail

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.

 

Tim Cook famously said:

We can put all of our products on the table you’re sitting at. Those products together sell $40 billion per year. No other company can make that claim except perhaps an oil company.

For those of you laughing, that was three years ago. The revenues quadrupled since to a total of $170 for the last four quarters. But the more interesting thought is that the table has not gotten bigger. When Tim spoke the iPad had just been announced but was not yet for sale. So we can't be sure if he thought it should be on the table or not, but it does not take up that much space.

It would be fun to actually lay out all the Apple products on a table to see how big it would be. The trouble is that there are many things Apple sells which take up no space at all. Things like iTunes content or services and AppleCare.

So rather than trying to imagine a table full of Apple products (some of which are non-phyisical) I thought a more fitting analogy would be to allocate the revenues from these products to a table and thinking about how much space relative to each other the products would take.

To make conversion easier, I picked a rather large table; 10 feet long, big enough to fit a small conference room. What would this table covered in product revenue look like?

My estimate is that it would look like this:

I color coded the product lines as shown in the legend: Greens for iPhone, Browns for iPad, Blues for Mac, Yellow for iPod, Red/Purples for iTunes and Grey for Accessories.

At this categorization the table would allocate the following space to each category:

• iPhone (Greens): 60 inches or about half the table.
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  Product
  Inches
  iPhone 4
  4.7
  iPhone 4S
  11.4
  iPhone 5
  44.5
• iPad (Browns): 21 inches
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  iPad 2
  1.4
  iPad 4
  9.6
  iPad mini
  10.3
• Macs (Blues): 5 inches
  
  
  
  
  
  
  
  
  
  
  
  Desktops
  2.7
  Portable
  13.6
• iPod (yellows): 2.5 inches
  
  
  
  
  
  
  
  
  
  
  
  touch
  1.8
  iPod
  0.7
• iTunes (reds), software and services: 15.5 inches
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  music
  4.1
  video
  1.6
  Apps
  5.6
  Books
  0.8
  Pro SW
  1.4
  OS X
  0.5
  iWork
  0.5
  iOS Apps
  0.2
  Serv.
  0.9
• Accessories (Greys): 4 inches.
  
  
  
  
  
  
  
  
  
  
  
  Apple TV
  0.3
  Acc
  3.6

If this colorful table were used to support the actual products, where each product would have to fit within its color band, then the truth of one saying would become apparent: good things come in small packages.

My responses to questions from Juliette Garside of The Guardian newspaper:

Q: Will noise from Icahn distract the Cook from focussing on product?

A: Investors may think that they can influence management but they do so only when companies are in distress. It’s only then that shareholders can affect some change with their votes as they have a common purpose. The voice of investors carries little weight or distraction when a company is successful. At first glance it seems that Icahn thinks he can unlock value in Apple by getting management to accelerate share buybacks. That’s a modest goal and not one which needs to distract managers.

Q: What will do most for the share price – a buyback or a blockbuster new device?

A: Neither. What will do most for the share price is a change in the perception that Apple is not going to survive as a going concern. At this point of time, as at all other points of time in the past, no activity by Apple has been seen as sufficient for its survival. Apple has always been priced as a company that is in a perpetual state of free-fall. It’s a consequence of being dependent on breakthrough products for its survival. No matter how many breakthroughs it makes, the assumption is (and has always been) that there will never be another. When Apple was the Apple II company, its end was imminent because the Apple II had an easily foreseen demise. When Apple was a Mac company its end was imminent because the Mac was predictably going to decline. Repeat for iPod, iPhone and iPad. It’s a wonder that the company is worth anything at all.

The following interview took place by email on April 15th, 2013.

1. What are the truth and false about the 'Apple shock' currently? In what perspective should we see this?

First, I'd point out that during Steve Jobs' time the company suffered many such shocks. The stock fell many times far further than it just did for trivial and irrational reasons. Recently Warren Buffett himself pointed out that his own company had 50% drops in value four times in the past. Share prices are not always good indicators of potential and markets are not always efficient. I catalogued the dramatic share price declines in Apple during the last decade here.

Second, I'd point out that the number of people watching and commenting on Apple has grown almost as fast as its sales and earnings. When Apple was small the people who studied Apple were few. (You could see this today for other, modest tech companies. There aren't 50 analysts writing reports every day and 2000 bloggers tweeting about Lenovo even though it's a successful and growing PC company.) Because of this growth, I would guess 80% of the observers have not observed Apple's prior painful episodes first hand. For them this is the first time a "dominant" Apple has slowed. The amplification of so many voices raising alarm makes it seem truer, but it isn't.

Third, the failures being cited are not significant. In terms of increased competition, before Samsung there was Nokia and Motorola and the mobile Operators and Microsoft and Dell and many others long forgotten. They were all about to "defeat" Apple. As a quick example when Apple was "the iPod company," iTunes was considered vulnerable and fragile due to DRM concerns or the Beatles not being on it. Microsoft was launching "Plays for Sure" and Zune and Creative was suing Apple over patents. These battles are long forgotten. Before those there were concerns about the viability of the Mac that go back decades. At the time those were actually very valid concerns. At the time Apple did not have half a billion users. It depended on one product. But what saved them was a process of development of new products not the products themselves. iPod faded, Mac faded. What mattered is that they created new things to replace them.

Finally, what is not commonly understood is that the mechanism for creating things at Apple is unchanged. Its functional organization is inherently unstable and chaotic, sometimes looking like it will derail. But that's the way it was designed to be. You just have to have faith that it's a system that works. Those who did in the past were well rewarded.

2. What possibilities out of 1~10, do you think, Apple will suffer the same downfall as Steve jobs has left the company in the past in current?

The threat is negligible. During the first departure of Jobs, the intention of management was to make the company into "a proper company." The plan was, essentially, to remove the chaotic model that Jobs had put in place and replace it with something more "rational" and "grown up." After he returned he set about not just returning the company to the way it was but to also codifying and identifying exactly what that was so that it did not happen again. You have to appreciate that the greatest thing Jobs ever created was not a product but Apple itself.

Note that Apple managers stay in their roles the whole time they are there, sometimes for decades. There is no "general purpose" manager and the whole company has been organized along these functional lines. The way to think about it is that during his first departure the new management tried to undo what Jobs had built which is why it became dysfunctional: the DNA did not match the body it was operating. His return re-aligned the culture and operations to what was originally developed. As long as new management does not try to undo that, they'll be all right.

3. Apple is now defined by some people, as 'the company who modifies well', not 'the company who innovates' well. What they made was ipad, ipod, iphone, apple tv and all the modifiers of the original products. Do you agree? If you do why?

Innovation is not invention. Innovation is the application of invention in ways that solve new needs. I'm always amazed at how misunderstood this term is even though the definition is easy to understand:

("Innovation differs from invention in that innovation refers to the use of a better and, as a result, novel idea or method, whereas invention refers more directly to the creation of the idea or method itself.")

Apple is an innovation machine. It does invent but that's not valuable in itself. Not all inventions are applied and not all innovations depend on internal inventions. Innovation is applied invention just like engineering is applied science. A better way to think about Apple is to think about Pixar. It's a blockbuster manufacturer. It makes blockbusters and nothing else. That means it does not make many of them and not always regularly and that the ideas may not be original, but the results are always very popular. Pixar is not like any other studio that makes some hits and some flops. Pixar is also a functional organization. It's not an accident that they were both built by the same person and that they are both successful after he left.

4. Google is forecasted to release lots of products this year, but Apple isn't really looking forward to so many innovations. Inside Apple, is the innovation team really making a new innovative product? what are their longterm plans to fight with Google, or Samsung and the rest of the competitors?

People outside of engineering organizations, especially large ones, don't appreciate the time scales involved. Products you see today were designed, planned and developed many years ago. We see plenty of evidence of this but we tend to ignore it. Consider that some prototypes end up on ebay showing they were built years before launch. It is the same with evidence presented in trials proving work on the product 4 to 5 years before it was launched. This is not the case just for Apple but all other technology companies.

For this reason, what is happening in the market and what is happening inside the company are two completely different universes. The tendency is to assume a direct relationship between market momentum and current management decisions. These are connected but with many years in-between.

For example, globally accurate Maps require a minimum of five years of development. Decisions on what ended up being Apple Maps had to have been made by Jobs himself. Namely, he must have decided whether to buy or build Maps. Contrast with Nokia's decision in 2007 to buy maps for a cost of $8 billion; instead Apple licensed and then decided to build later. In 2007 Jobs decided that it was more important to work on the product itself, meaning the iPhone (while Nokia didn't prioritize product innovation.) The results are visible today: Apple is behind and needs to accelerate with Maps and Nokia with its great maps must find a way of staying in business.

Apple is not only working on the next product but probably 15 new products, of which 14 will be discarded. Again, I cite Pixar. Each movie is produced with multiple stories, multiple character decisions and different plots in parallel. Much ends up being thrown away. We don't see any of that.

Apple is extremely "myopic" in that it is very concerned with execution and there is no visible "strategy plan".  That's by design. The product comes first and then comes the market and then comes strategy. To create great products you need to tune out almost everything else. However, they do have a "strategy" and that has to do with which problems they should attack and which they shouldn't. Usually they are successful because what they can attack nobody else can. That is due to their integrated, functional approach.

5. Isn't Apple, relying too much on semiconductor manufacturers? Meaning, isn't Apple only try to be 'stable company' to supply their products on time? sometimes when companies have disruptive technologies, they have hard time supplying products.

You're touching on the question of the problems of integration. Yes, there are vulnerabilities but that's the way it has to be. To mitigate this Apple is increasing its integration of the value chains. For example developing its own chip design and owning a lot of capital equipment.

6. If you were Tim Cook, what would you do?

I'd buy Intel and turn them into Apple's microprocessor design and manufacturing group. They won't have much to do in a few years and they'll be cheap.

7. what are the reasons that Apple try to make a 'apple watch', 'apple bicycle'? How do you define these products, since, watchs and bicycles are a total different paradigm which is a totally different industries? Is Apple realizing that smartphone industry is hard for them to innovate?

Computers are becoming more personal, intimate. It's a natural evolution from large to mini to micro to portable to handheld. I don't see this slowing and Apple should re-define the user experience during every such shift. Here again integration is essential.

8. what are some of the stuff that we don't know about Tim Cook?

I can't help you there. Only thing I can say is that people who know him have told me he's not soft and gentle as a manager. He's tough.

9. How will Samsung and Apples patent fight come to conclusion?

Again, I can't add much to this. Litigation is often a decision made outside of market conditions so it can be arbitrary.

10. how does employees or executives inside apple think about their company?

It's hard to describe this without sounding soft, but the employees at Apple tend to love the brand. You can't measure that but I can think of one proxy: the number of applicants to retail jobs are in the hundreds for each opening.

[Update: Bono made an important observation regarding Jony Ive which was published after this interview: What the competitors don’t seem to understand is you cannot get people this smart to work this hard just for money. Jony is Obi-Wan. His team are Jedi whose nobility depends on the pursuit of greatness over profit, believing the latter will always follow the former, stubbornly passing up near-term good opportunities to pursue great ones in the distance]

The Windows PC market is contracting. The market data has been showing unit shipment declining for some time with the latest quarter having perhaps the steepest decline for two decades.

What remains undocumented however is how the market looks when considering economic value. A more complete picture would be to show revenues, average selling price (or revenue/unit), operating margins/unit and percent of profit capture.

The data is not beyond reach however. It involves combining the shipment estimates from e.g. Gartner with financial reports from the companies themselves. Some analysis is required to estimate margins but they are also not hard to obtain (e.g. from third parties.)

So here is a view of the market for the fourth quarter 2012:

The only inference I made was with respect to Apple's margins for the Mac. These are based on deriving a gross margin of 26% and adding an estimate of the SG&A and R&D "overhead" of 7.1% of sales, a figure which applies to the entire company. This yield an operating margin of 18.9%.

If this estimate is considered then the operating profits from PC operations imply that Apple generates more profit than all the top 5 PC vendors combined.

Assuming further that "other" vendors have the same profitability ratio as the top 5 combined yields a figure of 45% "profit capture of PC market" for Apple. This is not as good as its performance in the phone market, where Apple has about 72%, but it's not bad.

The real problem for the PC vendors is not that they have such low margins–they've had low margins for decades. It's that the volumes which "made up for" low margins are disappearing. Apple is not immune to a gradual erosion of Mac volumes, but they have positioned themselves for growth with devices and content commerce and services. They have essentially "escaped" PCs and indeed caused the need to escape in the first place.

The problem is what could the others do? It seems all they can do is depend on Microsoft getting their strategy right.

Sounds risky.

As Apple introduced a new set of revenue categories, the performance of its "minor" businesses has become clearer. The changes include re-statement of what used to be called "Software" revenues as part of iTunes. Apple Software includes sales of OS X, iWork and its pro tools. These products are now sold through the Mac App and since that is a part of iTunes its inclusion makes sense.

However, we have to understand that iTunes now is a blend of many business models. Some, like music, use a wholesale revenue recognition method and have very low to zero margins, others, like eBooks and Apps, are sold using an "agency" revenue model with potentially higher margins and some, like Software, are recognized at full value with very high margins.

When re-stated this way, iTunes becomes much more than a "break-even" business. My own estimate for its gross margin as currently reported is between 15% and 17% but it could be even higher. This allows the following picture to emerge:

These graphs show contributions to Revenue and Gross Margins of the various reported product categories. Note that restatements for Accessories and iTunes only extend back to Q4 2010 and the older "Software" is still shown for earlier periods.

Note also that Accessories are now including some of the revenue that used to be reported as part of iPad and iPhone revenues. This was discussed in more detail here.

There are several observations we can make:

1. iTunes now becomes a steadily and rapidly growing business. Growth over the previous two years averages well over 30% and is consistent across seasons.
2. The absolute revenue number is substantial: $13.5 billion for 2012 (up from $10.2 billion in 2011).
3. Assuming a gross margin of 15% to 17% yields contribution of $2 billion in margin in 2012 and $1.6 the year before.
4. iTunes is now Apple's fourth largest business, having overtaken the iPod in revenues two years ago
5. iTunes growth relative to the Mac means that it could become the third largest business during this year.

When seen this way, as a percent of total, iTunes begins to look increasingly as a viable "leg stool" upon which Apple rests. Note that in the following charts the percent of total for iTunes holds steady while Mac and iPod decline.

Adding the Accessories business (which includes Apple TV and is showing in Orange above) these "other" businesses are already bigger than the Mac. Of course, content, software, accessories and services depend on a healthy device business, but the size of these ancillaries are beginning to be substantial and Apple's ecosystem may begin to be valued more than just as an incentive to buy the devices.

Indeed, if seen in isolation, iTunes+Accessories combined is a bigger business in terms of revenues than any of the other phone vendors except Samsung:

 

The iPhone is a severely constrained product. We're used to thinking that it's production constrained—and it is, but it's also distribution constrained. It has a business model that is almost completely dependent on operator subsidy. Few end users pay the $650 average price that Apple obtains and that price point has held for a remarkably long time. This price point is largely invisible to the user.

In this regard it's very different from all the other products Apple sells. Historically, the company has preferred having its customers to also be its users and maintained a direct relationship with them, strengthening that relationship through its own retail channel for the last decade. Pricing is used by Apple as a signal to clearly illustrate value to the user and pricing is part of the communication about the product that Apple makes very explicit. This has been true for the iPod and Mac and is still true of the iPad. But this is not so for the iPhone. The entire marketing strategy for the iPhone (and hence the entire product concept itself) is "off message".

Why is this?

Before we get into causes, let's try to measure the distribution channel for the iPhone. Apple occasionally reports the total number of carriers it has relationships with. The last update was in the summer when Peter Oppenheimer, Apple CFO discussed the quarter ending June:

We added several small regional carriers during the quarter and now have iPhone distribution through over 250 carriers in over 100 countries.…

We added China Telecom as the second [Chinese] carrier in March…

We also don’t expect to add any significant new country or carrier additions in the September quarter…

In addition, Apple publishes the list of operators it sells through on its web site. The last time I counted I got 227 listed operators.

If we contrast this with the total number of global operators (excluding MVNOs) there might be a way to measure distribution penetration. I compiled a list of all such operators based on information available in Wikipedia. You can browse the list here (Google Docs [1]).

This global list includes 802 operators. The list is not current, being mostly based on 2009 data but it's pretty close. I've read that a more recent (non-public) estimate is 816.

By this measure we can say that Apple has distribution through about 30% of the total operators. Consider also that RIM reports that it sells BlackBerry through 565 wireless carriers in over 175 countries. By this metric alone BlackBerry has twice the addressable market of the iPhone.

But we can do better than counting operators. We should account for the fact that some operators have more subscribers than others.

Using the same database, I measured the subscriber count of iPhone distributing carriers vs. overall subscriber count. The ratio was about 50%.

iPhone "addresses" about 2.8 billion connections whereas there are about 5.7 billion available connections. Note that this is not users but subscriptions—essentially SIM cards.

The ratios vary by region:

• Middle-east/Africa has 29%
• Asia/Pacific is at 39%
• Europe 73%
• The Americas 83%

 

We can take it a step further and identify which countries hold the highest opportunity for iPhone distribution. The top 5 are:

1. India: 658 million
2. China: 622 million
3. Pakistan: 116 million
4. Russia: 102 million
5. Nigeria: 89 million

But the opportunity is not only in emerging markets. Japan is a 69 million subs opportunity and even the US has 80 million subs without direct (i.e. subsidized) access to the iPhone.

So we can now return to the question of why the iPhone is sold the way it is.

First I should point out that the addressable market of Samsung or Android in general is larger than that of the iPhone. Samsung has relationships with far more operators, at least on the scale of RIM or Nokia, perhaps even more. It might be safe to assume that Android is completely unconstrained in distribution and therefore its addressable market is the entire subscriber space (meaning that Android has twice the addressable market of the iPhone.) For Apple to compete on the basis of volume or market share it would make sense to broaden this network. So what's holding it back?

I think the answer is the other constraint mentioned: production. The company is still iterating the product on a yearly basis and needs to ramp production to reach all its carrier partners in a timely fashion. The carriers use the iPhone as differentiation and a way to uplift their core business. Therefore they want the latest version as quickly as possible. To satisfy this, Apple needs to manufacture the latest variant very quickly. But that's not easy. Peak production is one thing but getting there quickly is another. This is the problem which Apple's vast capital expenditures is trying to solve.

So far the production capacity has been increasing at nearly 100% per annum. This is an astonishing achievement but it's still not enough. The product is supply constrained during much of the launch quarter. Therefore, to summarize, the entire business model for the iPhone revolves around this question:

Can enough units be shipped in a sufficiently short time frame to allow a limited (but large) subset of operators to create competitive advantage which sustains a generous up-front subsidy.

At this time the answer seems to be that the model can work for about 30% of operators serving 50% of subscribers. The crucial question for the business is how much higher can these numbers get?

Note that this is not a debate about market share or consumer preference but about delivering a particular value proposition to network operators, (which sustains a premium price point.) The iPhone is built around this business model and to alter it would alter the very essence of what the product is. The addressable market is one piece of the product but it interconnects with the price, margin, design, production and breadth of offering. You cannot change one without changing the others. It's a product whose distribution model is part and parcel of its design.

I believe that the particular way this product translates into a business is very rigid, which is why it has not changed much during the life of the product. This is in contrast to Apple's other products which exhibit more market flexibility. Inter-dependency is not a new concept for Apple products (e.g. iPod/iTunes, Mac/MacOS) but the iPhone shows a level of inter-dependency with distribution and production the likes of which has never been seen.

This topic will be further discussed at Asymconf in January as the fourth quarter data will then be available and there will be an opportunity to debate it live with an august audience.

---

Notes:

1. The database is neither current nor complete. If you would like to help maintain the data based on local (public) information, please get in touch and I can grant access to edit it.

In the parlance of developers Apple keeps "throwing exceptions." This quarter the iPad surprised with a significant decline in sales growth. I placed a table showing the sales growth for this quarter as well as the previous 22 quarters at the bottom of this post.

Here is a quick review of each line:

1. The iPhone returned to a more customary growth rate (which I rate as Very Good--above 50%). The quarter was bound to be quirky due to it being both a transition quarter and a launch quarter. The launch of the iPhone 5 came quite late but not too late to make a contribution. It was also widely rumored and anticipated so there was slowing of the previous generation product. I expect growth to accelerate further in the last quarter of the year.
2. The Mac turned in a commendable 6% revenue growth (1% unit growth) on the back of the new 15" Retina screen MacBook. The average sales price increased sequentially and the mix of portables to desktops reached a new high of above 80%. More about the Mac will be written in a future post.
3. The iPod continued its decline. The 26% sales decline was in-line with other non-launch quarters. The company tipped its hand and let us know that iPod touch now makes up 60% of iPod volumes. At 3.2 million iPod touch units, it's a significant iOS contributor but still a declining number.
4. The iPad was painfully underperforming. With only 9% revenue growth, it was a complete reversal of the torrid growth of the last two years. Management blamed both anticipation of a new product and a reduction of inventory ahead of refresh of the larger screen retina. The only silver lining was that the average price decline was moderate (down about $3/unit). Overall, I'm very disappointed with the pause in the product but the new mini could change the character of the product dramatically in a way similar to how the iPod mini turbo-charged the iPod line.
5. iTunes had a very good quarter. It's the perennial growth engine with the most consistent performance throughout the time period shown. It was the second fastest growing line item firmly in the "High" growth bracket.
6. Peripherals, including Apple TV had a moderate quarter. Management revealed that about 5 million Apple TV units shipped in the fiscal year. That adds up to a half-billion dollar revenue business. Peripherals had $2.8 billion over the same time frame so Apple TV was about 18% on a yearly basis. This does not include content revenues.
7. Software had a modest growth of 22% but has come to be the high end of the range. Since changing the way it prices OS X updates, the era of Apple software windfalls is over. Still, at nearly $1 billion per quarter it's nice pocket change, especially as it's nearly all margin.
8. The overall top line (net sales) was a bit improved sequentially (+4 points of percent) but still in the "transition quarter" range of moderate growth. The company may be shifting its launch cycles and as a result we're seeing a break in pattern. As pricing for iPhone and iPad did not change very much the slowing of top line growth is entirely due to a unit shipment reduction. Again, the primary cause is transitions in multiple lines simultaneously.
9. The bottom line (earnings) followed the same pattern as top line (slight sequential increase in growth). There was a slight attenuation of margins (gross margins are down to 40%).

Overall, the quarter was not up to the recent level of performance for Apple. Growth was overall "moderate".

It looks like the next iPhone will be called the iPhone 5. What's in a name? As it turns out, quite a lot.

Every hardware product that Apple has released has had a brand and a sub-brand. Macs for example use the Mac brand and a sub-brand as follows:

• iMac
• Mac Pro
• Mac mini
• MacBook

Thus each sub-brand imparts certain meaning to the buyer. i, Pro, mini, book are all evocative. MacBook even has its own sub-brands:

• MacBook Pro
• MacBook Air

These Mac sub-sub-brands of Pro and Air are specifically designed to also distinguish and convey meaning.

iPods as well use the iPod brand followed by a sub-brand.

• iPod Classic
• iPod touch
• iPod mini
• iPod shuffle
• iPod nano

Note how the mini  sub-brand was retired from the iPod line to be used exclusively in the Mac product line. That may not be specifically necessary or desirable but it is an interesting coincidence. (The Pro sub-brand is shared between different Mac lines)

However, when we look at the iPhone and the iPad, the nomenclature has been distinctly different. Both products have been using generational naming conventions. This implies no sub-branding as the iPhone and iPad are the only identifiers of brand and hence the only meaning being imparted to the buyer. You either get an iPhone or and old iPhone.

That changed with the iPad however. The third generation iPad became just iPad. This was deliberate (why would they want to confuse buyers?) I think there is some logic to this.

Note the parallel to the convention of the original iPod. When the iPod launched it was just the iPod. Subsequent versions were identified by a generation, but not a specific sub-brand. After the third generation iPod (still called iPod), the mini version was launched, creating the sub-brand convention that remains in use to this day. The iPod therefore was born generational but switched to sub-branding in adolescence.

The possibility exists, therefore, that there will be a sub-brand for the iPad. Perhaps "mini" is being reserved for a new iPad, to distinguish it from the regular iPad (no sub-brand) that is likely to remain in production. The logic is to make room for sub-brands when the core brand begins to cover a wider array of form factors, themselves proxies for separate use cases or jobs to be done.

So what about the iPhone?

The iPhone has remained, stubbornly, after five years, stuck with a generational naming convention vis-à-vis the sub-brand convention used in every other mature product line from Apple. (Note that software from Apple adheres strictly to a generational naming convention because there is no "room" for a sub-brand under a software brand. There can be no "iWork Pro" or "Final Cut EZ". [Update: there once was Final Cut Express])

Prior to today I entertained the possibility that the new iPhone will follow the iPad in dropping generational naming in favor of sub-branding thus implying that the brand would develop into a portfolio of sub-brands (like the iPad seems about to.)

Alas, that possibility now seems moot. The launch announcement seems to clearly point to "5" being the name of the new iPhone. The brand remains iPhone and there will be no sub-branding.

This can only mean that Apple intends to preserve a single product strategy for the brand. There will be no "special" iPhone for different (e.g. low-end) markets. There will be no different form factor to accommodate different use cases. There will be no new jobs to be done for the iPhone.

What a bummer.

However, there may be something more curious happening. Note all the service brands being launched on the iOS platform. There's Siri, (as yet unnamed) Maps, GameCenter and PassBook. These are not Apps. These are services designed to be unique to iOS, perhaps even unique to the iPhone. The difference with the iPhone brand may not be that it spans a multitude of sub-brands in hardware but that it covers a multitude of new service brands. As brands imply meaning, the iPhone brand may imply that it's a platform in and of itself.

Now that's an interesting development.

 

The Mac grew at the extremely low rate of 1.8% over last year's second quarter. Although it grew faster than the Windows PC market, the gap has narrowed quite a bit. The following graph shows the growth of the two members of the computing Ancien Régime.

We have to wait a few more quarters before we can decide whether the Mac will enter a new phase of diminished expectations. Although it's not immune from the impact of the iPad, the effect can take a long time to be evident and in either case, growth can come from conversion of Windows users which vastly outnumber loyal Mac users who might upgrade.

If we see the computing market as the superset of keyboard+mouse input and touch-based input then new computing consumption becomes easier to spot:

Seen this way, rather than there being a crisis in personal computing, we have a renaissance. And as in the actual Renaissance, it's a volatile and unsettling period.

Nowhere more so than in the changing of bases of power. Consider the following data:

A change in perspective leads one to conclude that Apple is the new leader in selling personal computers. Maybe this charting is putting too fine a point on it, but the data is beginning to make evident that which has been perceived subjectively by only a few.

Here is the second Perspective "padcast" where I discuss:

1. Top and bottom line growth
2. iPhone, iPad, iPod and Mac revenue growth
3. iPad vs. Mac
4. iOS product mix
5. Other product line growth
6. Gross Margins by product
7. Pricing and revenue per unit by product
8. Cash and cash growth
9. Guidance and whether results were a surprise to management

The discussion is an audio presentation with animated, interactive motion charts which can be manipulated by the user.

It's available as an in-app purchase for $0.99 on the iTunes app store via the Perspective iPad app.