PC

Next week at AllThingsD's D11 conference in LA, Apple CEO Tim Cook will be interviewed by Kara Swisher and Walt Mossberg.

Here are some questions I'm hoping they will ask:

1. Why is the iPhone not sold as a portfolio product? Meaning, why, after six years, is there no iPhone product range being updated on a regular basis. Having a portfolio strategy is not only followed by every phone vendor but also by Apple for all its other product lines, including the iPad, which came after the iPhone. In other words, please explain why the iPhone is anomalous from a product portfolio point of view.
2. There are more than 800 operators world-wide so why are there only about 250 of them carrying your phone? Competitors large and small (from BlackBerry to Nokia to Samsung) have cited relationships with more than 500 operators so Apple is being uniquely selective. My question does not stem from a lack of patience: this total number of iPhone distributors has not increased markedly for over a year. Are you limiting distribution through conditions placed on operators (like the availability of sufficient quality data services) or are operators finding the distribution agreement too onerous (e.g. too high a minimum order quota)?
3. In 2012 Apple's capital spending has reached the extraordinary level of $10 billion/yr, higher than all but the most capital-intensive semiconductor manufacturers. This is unusual for Apple as it was less than $1 billion in the year before the iPhone launched. It's also unusual for Apple's competitors in phones, PCs or tablets. It's on a level matched only by semiconductor heavyweights. What is the purpose of this spending and what should we read into it leveling off at $10 billion for 2013?
4. Depending on one supplier is an operational faux pas, and yet Apple has found itself in that situation with Samsung for mobile microprocessors. It may be excusable in PCs with Intel having an architectural monopoly but it's not excusable for a chip that you designed yourself and purchase in massive quantities. Why did you give Samsung such a concession, especially knowing their potential as a competitor vis-à-vis alternative suppliers who had no such potential? Does the answer have something to do with the previous question?

According to Strategy Analytics 3 million Windows-based tablets shipped in Q1. That is not inconsequential. It would add 4% to the total Windows-based computers and reduce the decline in Windows PC growth to -8% (from -11%). You can see the effect of those units on share in the following graphs.

Note the "boundary layer" of pale blue Macs between the brown-hued Windows and the green-hued tablets.

Including tablets of all kinds, here is the market share growth in Windows PCs.

As the post-PC disruption evolves, Microsoft has made an effort to shift its business model. I discussed this some time ago and there remain quite a few questions about the sustainability of the strategy.

However, there might already be evidence that it's working. The clue is in the growth in Windows revenues at a time when PC shipments (at least traditional ones) are declining rapidly. Some of that might be due to deferrals and software assurance revenues which are insensitive to shipments. However some have to be due to the Surface.

Remember that Surface launched with an RT version priced starting at $499 (which did not sell well) but received a boost in Q1 with the Pro version priced at $899 to $999. If we assume a 80:20 mix of Pro to RT and an average price of $950 for the Pro and $550 for RT, 3 million units would generate at least $2.5 billion in gross revenues. Accounting for retail margins of 20%, Microsoft could still be recognizing $2 billion in revenues. That's a significant portion of $5.7 billion in Windows revenue.

We can back into this figure from another direction: Prior to Surface launch, the Windows revenue per PC shipped (combining Microsoft's revenues and Gartner's estimates) was about $50. After the Surface Pro shipped the revenue climbed to $73/PC.

Assuming the same pre-Surface revenue/PC and given the shipment figures for Q1 we would get about $3.7 billion for Windows. The difference to actual revenues is about $2 billion.

So the extrapolation of Windows royalties approach yields $2 billion in Surface sales and the Price x Units estimate also yields $ 2billion. It would suggest that Surface has had a significant impact already: More than a third of Windows revenues depend on it.

[UPDATE: I've been informed that not all the Windows tablet sales reported by Strategy Analytics are Surface products. As many as 1 million might not be. That would reduce the revenues as calculated to about $1.4 billion. In addition, not all Windows revenues are current with much of that deferred. Actual revenues were $4.6 billion. With both of these adjustments considered, the impact of Surface might be only 30%.)

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.

The latest data on PC shipments from Gartner showed a decline of  11.1% from the first quarter of 2012. As we don't yet have the final data on Apple's Mac shipments, I used my estimate of 4.38 million units (14% growth as per NPD estimate for the US) to obtain an estimate of Windows PC shipments.

That number is 74.8 million units. In the first quarter of 2012 the corresponding calculation yields 85.1 million units. That makes Windows PC rate of decline -12%.

The historic shipment data and growth rates are shown below:

 

Note that tablet data is not yet included in the shipments summary. Windows shipments are shown in shades of Brown and tablets in shades of Blue/Green.

The decline in PC shipments is persisting and even accelerating.

Coming only a week after the iPad's launch birthday, it's perhaps a fitting testament to its impact.

LG Electronics has acquired HP's WebOS for an undisclosed amount. When last it changed hands WebOS was part of Palm which was purchased for $1.2 billion in 2010.

Palm has thus been effectively divided into several smaller pieces distributed as follows:

HP will own:

• Support of existing Palm users
• Palm back-end assets including source code, infrastructure and talent
• webOS patents

LG will own:

• Stewardship of the Open WebOS and Enyo open-source projects where the source code resides
• Associated talent
• WebOS websites
• License for IP related to webOS

LG announced that it plans to offer an "intuitive user experience an Internet services across a range of consumer electronics devices." In an interview, the CTO of LG said that given the current situation with Android, LG does not plan on making smartphones running webOS but will use it in televisions and other devices such as cars, signage and appliances where there are no embedded OS's. "We'd like to secure a software platform across all devices."

Most commentary regarding the deal focused on the use of the platform for TVs but management seems to consider all devices, perhaps even phones, at some future date, to be webOS targets.

The TV however seems to be low hanging fruit today. The TV as an app platform will be the new ecosystem war and no platform today has a lock on the developers or users. The way this rivalry will shape up will not mirror other device classes for the same reason that current device classes are platform silos.

PCs, music players, tablets and phones all have different super-majority platform leaders. The association of a platform with a device class depends first on the distribution model, which favors a specific business model which favors a specific vendor which favors a specific platform. As each device is distributed differently, a different platform takes precedence.

Consider that the PC has historically been purchased by IT departments which led to a monoculture of Windows which led to a persistent leadership for Microsoft.

The music player created dominance around iTunes mostly because the distribution model for music labels was baked-in. With network effects, the iPod quickly gained and perpetually retained market share leadership.

The smartphone business initially favored Symbian and BlackBerry because they had the market access through operators. After the touch UI became dominant (and incumbents failed to respond in a timely manner), Apple and Google took leadership as soon as they accepted the operator distribution model. Android in particular is especially resonant with operators and has been developed with their requirements in mind.

The tablet business is more like the PC business but without enterprise requirements or patterns of purchase. This has meant that app/content ecosystems and retail distribution were the key gating factors. The story is still unfolding but so far Microsoft has not found a foothold while iOS and Android and Amazon have.

That leads to the question of how will smart TVs be sold and which business model (or go-to-market strategy) will succeed. Steve Jobs pointed out the difficulty in trying to deliver innovation into a value chain dominated by cable companies which can effectively block it. A TV which is an application execution device rather than a content terminal will require a re-definition of the category. That will require a re-positioining of this product. Few companies are able to do that. [See also my post Tele Vision from mid-2011].

Which brings us back to the question of webOS. As long as LG sells TVs as content terminals they might not obtain much value from webOS. If, on the other hand, LG were to use webOS to re-define their televisions to be something else entirely, namely software execution devices, sold differently and hired to do a different job than a TV, then webOS becomes not only necessary but potentially a source of great prosperity.

I last looked at the race to a billion in March 2011. Since then, I've been updating and adding data to the set giving a broader selection of platforms to compare.

Before we dive in, an explanation: the initial review excluded Windows (PC) and Facebook mainly because (a)  the ramp scale I'm using is about a decade in duration and (b) I was reluctant to compare platforms that require payment to join to those that don't. The (DOS/Windows) PC ramped over several decades (starting in 1981) and Facebook is a service that costs nothing to join. There was much gnashing of teeth and shaking of fists as a result.

Therefore, in the interest of inclusion, I added both to the data set and let the chips fall where they may.

The data is shown below.

I kept the scale to about a decade so that individual lines can be resolved. As a result, you'll note that although Windows reached one billion first it did so slowly enough to be off the scale shown. Indeed, the "race to a billion" should be titled  "The race to one billion users in less than a decade".

In such a competition, the winner would be Facebook which, in October 2012, 35 quarters after launch, reached the finish line. The second looks to be Android (probably this year) and the third iOS (sometime next year.)

That may sound like the end of it, but what the graph also shows are the more subtle trends:

• Game consoles seem to saturate at below 100 million total. One can see the difference in ramps between recent mobile platforms and consoles in the second chart. There might be implications for which platforms will end up dominating the entertainment industry. There should also be some explanations of why consoles are so limited.
• iTunes accelerated with iOS and left the iPod behind. This is unsurprising but it shows that a content platform can be more flexible than one attached to any particular device or architecture. An important lesson perhaps for those in the content businesses.
• Early mobile platforms like Nokia's Symbian, RIM BlackBerry and Windows Mobile have faded indicating that there was no early-mover advantage in platforms. The same can be said for early PC platforms.
• Windows Phone began by tracking the Android/iOS ramps but seems not to be accelerating into its second year in a way that implies potential parity.
• Although Facebook did reach 1 billion rather quickly the slopes of Android and iOS indicate that they may overtake it in overall ecosystem size.

One billion is significant in several ways: First, because it is the "high-water mark" set by Windows and signifies what a global platform needs to become to be essentially "universal". Second, because it implies sustainability. A threshold perhaps from which network effects are sufficient to sustain (assuming some switching costs and an ability and willingness to adapt e.g. software, content or time investments from users.) Third, because it implies sufficient value to the ecosystem (assuming a monetization mechanism exists e.g. Windows software developers and IT managers.)

Looking beyond this milestone however, there is no reason why it should be thought of as a barrier. Mobile connections number over 5 billion and computing is likely to reach most of them. Therefore one billion may turn out to be only 20% penetration. In fact, I expect this series of posts will need to be updated in 2013 as "The race to two billion."

In 2011 Microsoft's CEO bemoaned that revenue in China was about 5% of what it obtained in the US. Yesterday Apple's CEO suggested that revenue from China will overtake the US in the near future.

The contrast is even more stark when one considers the time and effort each company has made in China. Microsoft has been investing and promoting itself in China for decades while Apple barely had any presence 3 years ago.

To put a finer point on this I show below Apple's sales by region:

Apple's China net sales in fiscal 2009 were only 769 million. In 2012 they were $22.8 billion. That is a figure greater than US sales three years earlier. Put another way, China sales grew in three years as much as they did in the US in 33.

The growth rates were astronomical: over 250% in 2010 and 350% in 2011. In 2012 the growth slowed to 83% but that is still almost twice the US or the global average. The growth rates are shown in the following chart:

I added an estimate for growth into the future moderating to 50% for China and 20% for the US. If that happens then China will become the largest market for Apple by 2016 as shown below.

The reason for this growth is, of course, the iOS product lines. Growth started when the iPhone was introduced and surged with the iPad and every time updates were released.

The contrast with Microsoft now comes back into focus. China and the US have a roughly equal number of PCs but the mobile users in China exceed the US by a factor of three to one. The pool of users is so great that Apple obtained its growth even with reaching only 30% mobile network distribution coverage.

Without a mobile portfolio Microsoft is severely hampered. Of course, Microsoft is trying and has made several attempts to place its Windows Phone in the hands of Chinese users. It's a tough sale however because Microsoft must work through partners. They need to get vendors to license the OS and the operators to range the devices and retailers to push it. Given the flood of "free" Android variants they are having trouble even starting down that long road.

But more fundamentally, Microsoft's software licensing business model is severely limited in China because what it offers is not what is valued. Both on the PC or on the mobile device, what China values is the tangible. Software can be made valuable only if it can affect the purchase decision of hardware and it can do so only if it's sold as part of an integrated product. With Surface, Microsoft shows that it understands this. What does this imply for a Microsoft phone?

 

Early data shows that the PC market has not experienced a "pop" from Windows 8. Market watchers have been anticipating this pop since every previous version of Windows has led to a surge in shipments. PC vendors have also been hoping for this to lift their volumes. Volumes have been stagnant for a while, as the following chart shows:

If we combine the traditional PC and tablet markets—what I refer to as "large and medium screen PCs"— there has been growth. However the growth is all due to the tablets. When seen in a share split (blue tablets vs. brown Windows PC's) the shift toward tablet computing is clear.

The question is whether Microsoft will be successful in shifting to this new computing model? Microsoft's problem is not that it has difficulty offering an operating system for tablets. The problem is that the economics of both systems and application software on tablets is destructive to its margins.

A PC has for several decades been "taxed"[1] with a Windows and Office license. The exact figure is imprecise because of subscription accounting used by Microsoft, but we can take Microsoft revenues for Windows and Office and divide by PC shipments to get an average.

This view shows how Windows revenues per PC have held steady for the last three years and Office have moved up slightly. In the latest quarter Windows "captured" $52 per PC shipment and Office "captured" $67.

The problem for Microsoft is that pricing systems software at $50 and a suite of apps at $67 for a tablet that costs $200 to the end-user is prohibitive.

Firstly because an OEM could not justify paying $50 to Microsoft while competing with another vendor whose (Android) software license costs nothing. It implies an increase in his bill of materials without the ability to charge more for the product and hence a reduction or elimination of margin.

Secondly because consumers (or IT buyers) would have a hard time justifying $67 for an Office license for every tablet when most apps are either free or under $10. (Apple charges $9.99 each for iOS versions of Pages, Numbers and Keynote which can be installed on several devices.)

The economics of tablets imply a "commoditization" of system and application software. So what's Microsoft to do?

The answer is Surface where the software margin is captured in hardware. This explains the pricing of Surface. The price isn't significantly below what Apple charges because Microsoft wants to capture a comparable (30%+) margin. On a $500 product that amounts to $150. After subtracting hardware operating and distribution costs we can get pretty close to the $120 it currently obtains from a PC.

This also explains the lack of appetite for "partnerships". OEMs which would normally compete on hardware would have to deal with zero margins (or less) after license fees and would be encouraged to cut corners and shave costs, compromising the experience and causing the platform to suffer.

Microsoft does not like the phrase "post-PC" because it implies the end of its hegemony. They like to think of the PC becoming a new form factor in which they have the same role they've always had. However, looking beyond the form factor we see that mobility itself is disruptive in the implied modularity of the PC.

Device economics offer the explanation for an otherwise perplexing Surface strategy. The question remains how many Surface units could Microsoft possibly sell to maintain its revenues.

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1. A "tax" is implied only when purchases are mandatory.

The iPad launched in April (i.e. Q2) 2010. Since then the PC industry (excluding Macs) has seen a decline in growth. The following graph illustrates global shipments as reported by Gartner:

Note that the growth rate has been negative for 4 out of the eight quarters since. The latest data shows a decline in shipments of over 9% bringing yearly growth to negative territory for the first time since the recession of 11 years ago.

There's not much I can say that hasn't been said every quarter since 2010. The industry analysis as provided by Gartner suggests a different cause for the decline, becoming more creative each quarter. This time it's "challenging economic environment" and "lack of appeal and innovation", "delays due to tax incentives", "lack of new models", "conservatism", "clearing out inventory" and "softness".

The primary challenge to these ascribed causes has to be that all these factors also affect the tablet industry and yet it's growing at phenomenal rates. The rate of new product introductions is not faster for the iPad than for PC vendors. The public and private sector buying conditions are the same. The "conservatism" on the part of institutional buyers should affect the newcomer more than the established.

The notion that an outside challenger with a new platform, an unproven set of features and missing "security" should grow in the face of difficult macro conditions that are slowing the established platform makes no sense.

My hypothesis is that the new products are solving new jobs for the users and those new solutions are trumping any "softness" in demand. In other words, an upgrade to an over-serving product will be deferred at the slightest excuse while an installation of an under-serving product that attacks an unsolved problem will be rationalized no matter the circumstances.

One product will be met with "Why should we buy it?" and the other by "Why shouldn't we buy it?"

These are the decisions made by millions every day and yet it seems that some analysts don't see any pattern forming. Such is the dilemma of disruption.

A recorded interview Peter Wells at Swipe Conference. We discuss the rise and fall of the PC, and some of the parallels that can be drawn from the rise of mobile platforms today. Which mobile platforms are destined to succeed, and who will fade away? And why can't some analysts count the iPad as a PC replacement? Horace also discusses the amazing iPad app he used today in his presentation.

via MacTalk - MacTalk Podcast Special | Horace Dediu.

This interview was conducted with Bruno Ferrari Editor of Exame magazine in Brazil.

First, do you have forecasts for tablet market share including Microsoft for next years? (Apple, Android, Amazon etc)?

I have some guesses but I don't think it's something that is defensible. Too many things can change. Fundamentally I believe Microsoft sees the tablet as a PC and intends to migrate a substantial portion of would-be PC customers to tablet forms. If they are successful then they preserve the existing PC user base and allow it to grow a bit.

In contrast Apple sees the iPad as a new type of device that is used for things not directly related to PC style computing. In that sense the iPad competes with PC non-consumption. It means people may own both a PC and an iPad and some will own only an iPad. The iPad will expand the market while taking share from the PC. Windows tablets will try to hold the Windows share steady.

 How do you analyze Microsoft’s strategy with Microsoft Surface? Don’t you think they’re admitting themselves that Apple was right since the beginning?

We don't know the strategy yet. Without pricing and an idea of how the other OEMs will respond, I have more questions than answers. The fact that they are doing their own PC hardware does indicate that they see the industry architecture changing and that a large number of vendors offering hardware "choice" is not really the basis of competition in PCs. In other words, buyers are not willing to pay a premium for Windows because the hardware it's available on is offered in a wide range of options.

Do you think MS growth at tablet market will surpass the lost at PC (desktop and notebook) market in the next years?

This is a crucial question. It's possible that Windows 8 on tablets will create new markets, like the iPad has done and it could take the leading role in expanding computing in a post-PC era. However, to do this, Windows 8 and its successors need to be optimized to solve the new jobs people may have for mobile devices. They have to do this even though they need to sustain the old use cases and business models. To succeed Microsoft needs to "fork" the business model and create new ways of profiting from hardware and software. The rumors that Windows 8 RT devices will be sold at a loss is perhaps a hint that this is the plan.

Did you see the rumor of a 199 dollars Surface? If it’s true, do you think is a good strategy?

It all depends on what will be the alternate source of revenue. I assume there will be some sort of subscription service, taking a page from the telecom industry. Perhaps a mixture of Windows Live services (media, documents in the cloud and software updates). We have to see whether subscription computing makes sense for consumers.

How do you see the problem that MS is creating with its OEM by turning itself on a tablet maker?

There is a problem, of course. However here again the question is whether they are moving to an "ecosystem subscription" model and whether they want to offer revenue share to OEMs. If they offer something then Microsoft plays the role of the operator and device makers are paid some up-front subsidy in exchange for keeping their systems locked into the network.

 One more questions: did you already estimate the shipments of Samsung Galaxy Tab since its launch?

Sorry, I don't have the Galaxy Tab estimate. However, here is what I found:

A week after its release, Samsung announced that they had sold 600,000 units. On the 4 December, it was reported that the 1 million mark was reached, two months after launch. However, an executive at Lenovo claimed that Samsung had only sold 20,000 out of the 1 million Galaxy Tabs that were shipped. In January 2011 Samsung announced they had shipped 2 million units to stores. In August 2012, actual sales figures were released in the patent infringement court case against Apple showing that a total of 725,000 Galaxy Tabs were sold through Q2 of 2012.

Source: Wikipedia.

Note that the figure of 725k is US only.