From the initial product launch until the end of 2012, AT&T has activated 72 million iPhones. Verizon began selling iPhones four years after AT&T and managed to activate 26 million since. Sprint began nine months after Verizon and has activated 8.5 million.
In proportion of their subscriber bases, the activations are shown in the following graph.
I identified the reported iPhone activations with blue areas while the sum of green and blue areas represent total subs at the end a the given year.
I also took the liberty of forecasting 2013 data in order to try to estimate T-Mobile's contribution.
The method used was to look at the percent of total subs that each operator has been activating. Accounting for the limited sales period for Sprint in 2011, the sales patterns are consistent across the carriers. The longer the product is available, the higher the activation rate.
Therefore I estimated that in 2013 T-Mobile USA will sell about 10% of its subs base an iPhone. That would make its contribution to iPhone sales about 3.4 million.
It would also imply US sales among the top operators of 53 million iPhones in 2013.
That itself is 17% of 320 million subs.
So perhaps it's time for Apple to celebrate. This year, after six years, Apple will have completed entry into its first major phone market. The rest of the world will not be as quick.
As part of a continuing series on the iTunes economy I described how iTunes fits within Apple's overall revenue and cost structure. The operation is a modest contributor accounting for single-digits percent of revenue and operating margins.
One additional question is how does iTunes compare with other non-Apple retail businesses. The obvious comparable businesses are Google Play and Amazon's digital content businesses. Unfortunately we can't compare iTunes with Google Play because Google does not reveal any details about Play revenues (or units sold/downloaded or payments to developers or any other data.)
Also unfortunately, we can't compare iTunes with Amazon digital sales because Amazon does not provide that detail either.
What we do have is Amazon's overall revenues (and operating margin.) So that's what I have compared:
Since we have Amazon's overall retail revenues it seemed fitting to also add Apple's physical store retail data on top of iTunes for additional perspective.
Here are some observations:
Since 2008, Amazon's sales grew by a factor of 2.18. Apple's combined iTunes+Retail grew by 2.14x.
Apple's gross retail revenue was $11.1 billion in Q4, 52% of Amazon's overall revenues.
Apple's operating income from retail in 2012 was $6.8 billion, over ten times Amazon's $676 million.
Although Apple's overall retail operations are only about half of Amazon's they are far more profitable on an operating level. They are also growing at a similar pace. Amazon as an equity is priced at approximately twice sales. By that ratio, Apple's retail business would be worth $70 billion. Of course, that valuation presumes that, as with Amazon, operating profits are disposable.
However, as a part of the entire Apple revenue model, iTunes appears to be a small contributor. The following diagrams shows where revenues came from and where they were spent during the last quarter
A few notes:
Click on image to enlarge. The graph was produced using an iPad and it is rendered at iPad retina resolution.
The data covers only the Fourth Calendar Quarter of 2012.
For scale reference, "Dev Payments" equals $1 billion (as marked.)
When zoomed in, each pixel represents about $50 million (vertical dimension).
Revenues shown are "gross" and therefore greater than reported. See post on iTunes Revenue Recognition. �The same reason affects the total Cost of Sales (COS).
Sources of revenue are ranked according to size. Note that Music is higher than iPod or Peripherals and Apps are higher than Software.
Different Cost of Sales components are also ranked by value.
iTunes which is the sum of Music, App, Software, Video and books makes up about 7% of overall revenues but 10% of costs of sales and hence contribute about 4% (est.) of total operating margin.
A three year view of the same data is shown below:
The following is another excerpt from a report titled "iTunes Business Review" which will soon be available for purchase through the Asymco Store. If you are interested in the product please get in touch.
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iTunes store will be 10 years old next month. From its inception Apple has stated that it aims to run the store "at break-even". The business has grown so rapidly however that its profit-free nature has come under severe pressure.
The reasoning goes that as more media types have been added costs have increased but revenues have increased even faster. Consider the estimated gross revenue base as shown below:
What is known as iTunes today has quintupled in seven years. Although cost of content sales are likely to have been preserved as a ratio (about 30%) the vastness of transaction volume (estimated at 23 billion item transactions in 2012 alone) implies that there are some significant economies of scale.
This implies that the operating costs are spread more evenly and that therefore the possibility exists for some operating margin.
Put another way, at break-even the cost of operating iTunes stores would be about $3.75 billion. It's hard to imagine this level of operational expense for digital content.
For this reason, management has begun since 2010 to suggest that at least the App Store is run "a little over break-even". How little is a good question. A one percent operating margin (from gross revenues) would imply as much as $45 million margin. I estimate 2% is possible on Apps and 1% on Music.
That's $150 million in margin content. Heady stuff.
However, since folding its Software group into iTunes (the blue area in the graph above) the margin picture changes dramatically.
The Software group is one of the forgotten heroes of Apple.
Apple’s software division “Apple Software” is responsible for the following products:
iWork which includes Pages, Numbers and Keynote. These are available through the Mac App store at about $20 per product and the iOS App Store for $10.
iLife which includes iMovie, iTunes, iPhoto, GarageBand. The OS X versions are available free with new computers but they are also available as paid downloads for OS X through the Mac App Store at $15 each and for iOS devices through the App store at $4.99 per app.
OS products including downloads of iOS and OS X. These are mostly free but some OS X updates are not free (typically $19.99 for new version including the server version of OS X.)
Professional tools which include the following products: Final Cut Pro (Video editor $299.99), Logic Pro (Music editor $199.99), Aperture (Professional Photo workflow $79.99), Compressor (additional features for Final Cut Pro $49.99), Motion (video transition editing for Final Cut Pro $49.99)
Administration and development tools which include: Xcode integrated development environment which is free Apple Remote Desktop which is priced at $79.99.
All these products are now sold through either iTunes App Store or Mac App Store. They used to be sold as traditional boxed software for many years but Apple has transitioned them all to be download-only and folded them into the catalog of third party apps while lowering prices.
My estimate is that Apple’s own software generated $3.6 billion in Revenues in 2012. As you can imagine, this is a high margin business which grows at nearly 20%/yr. Although I estimate that the software business has been overtaken by the Apps and Music businesses in gross revenues, it keeps an operating margin similar to that of Microsoft or about 50%.
This means that iTunes inclusive of Apple's own Software generates as much as 15% operating margin on gross revenues. That's over $2 billion a year.
An excerpt from a report titled "iTunes Business Review" which I'm currently writing:
Revenue Recognition
Before proceeding it’s also important to understand one more detail: The company does not report all transactions through iTunes as revenue. To quote the 2012 Annual Report (10 K):
For third-party applications sold through the App Store and Mac App Store and certain digital content sold through the iTunes Store, the Company does not determine the selling price of the products and is not the primary obligor to the customer. Therefore, the Company accounts for such sales on a net basis by recognizing in net sales only the commission it retains from each sale. The portion of the gross amount billed to customers that is remitted by the Company to third-party app developers and certain digital content owners is not reflected in the Company’s Consolidated Statements of Operations.
What this means is that App revenues are only reported at the 30% level that is retained by Apple. The 70% paid to developers is excluded from Apple’s financial reports. The same is true for other products for which it considers to be acting as an agent. The difference seems to be mostly in cases where Apple does not define the end user pricing. This is mostly true for ebooks however that may not be true for all book titles.
This distinction between “gross” revenues and “reported” revenues is maintained in this report but both are presented for consideration. Gross revenues are needed for comparing the media businesses against each other and for competitive assessment but reported revenues are needed to test assumptions against ground truth.
This can be explained with an example:
If a song sells for 99c then Apple reports all 99c as Revenue and then pays the record company about 70c and uses 30c to operate the store and pay for transaction costs. In the case of music it means the Gross Revenue is 99c and the Reported Revenue is also 99c.
However, if an app sells for 99c then Apple reports only about 30c as Revenue. It does not consider the portion paid to developers as revenues for itself. It spends a portion of the 30c to pay for transactions, hosting, and the time testing and accepting the apps. In the case of apps and books it means the Gross Revenue is 99c and the Reported Revenue is 30c.
So if Apple sells one song and one app then the Consolidated Gross Revenue is 2 x 99c or $1.98 but the Consolidated Reported Revenue is only $1.29 (99c + 30c).
The difference in accounting is sometimes called "agency" vs. "wholesale" and it applies in some retail businesses. Another term sometimes used for used goods is selling items "on consignment".
The reasoning for why some media are treated one way or another is cited in the Annual report as "the Company does not determine the selling price of the products and is not the primary obligor to the customer". In the case of Apps, the price is set by the developer and the developer is obligated to deliver on the promise. Apple acts as transaction processor and they don't consider that they ever owned (and hence never sold) the app. Note that this accounting is probably discretionary. They decided to do it this way and it's not clear that it was necessary to do it this way by any regulation.
This distinction between two treatments of revenue makes it difficult to understand the complete story behind iTunes.
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If you're interested in the full report, contact me directly.
UPDATE:
Apple’s rationale can be partly justified from a reading of a Financial Accounting Standards Board statement titled “Reporting Revenue Gross as a Principal versus Net as an Agent” (Emerging Issues Task Force Abstract EITF 99-19 http://www.fasb.org/pdf/abs99-19.pdf) a portion of which is quoted below.
“Indicators of Net Revenue Reporting
15. The supplier (not the company) is the primary obligor in the arrangement— Whether a supplier or a company is responsible for providing the product or service desired by a customer is a strong indicator of the company's role in the transaction. If a supplier (and not the company) is responsible for fulfillment, including the acceptability of the product(s) or service(s) ordered or purchased by a customer, that fact may indicate that the company does not have risks and rewards as principal in the transaction and that it should record revenue net based on the amount retained (that is, the amount billed to the customer less the amount paid to a supplier). Representations (written or otherwise) made by a company during marketing and the terms of the sales contract generally will provide evidence as to a customer's understanding of whether the company or the supplier is responsible for fulfilling the ordered product or service.
This interview took place on the eve of the launch of the Galaxy S4. Anouch Seydtaghia is Deputy Head of the Economic & Finance Section chez Le Temps Geneva, Switzerland.
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Q: How can you explain that Samsung organizes such a huge event in NY for the S4?
A: The S4 is a very important product as it's probably the second most profitable mobile phone in the world. Samsung is trying to position it as a premium product and is using every means available to do so.
What are your thoughts about the huge marketing budget of Samsung?
Samsung's marketing budget has been a constant percent of their sales (approximately). As sales have risen, the budget has risen. This is not considered a normal situation if sales grow very rapidly but Samsung seems to consider x% of sales to be appropriate spending level. Note that Apple's marketing has fallen as a percent of sales while its sales have grown dramatically.
If we read the media, we see a lot of speculation about the features of the future S4. Can we now compare that to the expectations before a new iPhone?
There are speculations about all phones, from Nokia to HTC and BlackBerry. I don't see the speculation to be different between all the major companies.
Can Apple regain the lead in the smartphone market? If yes, how?
Apple had leadership in the phone market for two quarters (see graphic below.)
It's a myth to think that Apple was dominant for any extended period of time. The top spot is very difficult to obtain unless a company has a large portfolio of products which are sold in all markets. Apple has less than half the operator distribution of Samsung and keeps only one new product in the market each year.
Apple also has a very high price due to the distribution model it uses for the iPhone. The primary buyers are operators who made large volume purchase commitments a few years ago. The iPhone strategy can be summarized as "skimming" where they pick the most profitable customers rather than "penetration" where there is a focus on market share. It's therefore very surprising that Apple was able to ship as many phones as it did.
Is there a difference between what Samsung and Apple invest in R&D?
Of course, but we don't have details. Samsung Electronics has to develop semiconductor processes and build large fabrication plants. Apple has a vast software engineering operation. Apple has iTunes and web services while Samsung has appliances and TVs. The two R&D efforts are vastly different.
What could be the new features in the next smartphone?
The most important innovation in smartphones will be a product that is not a smartphone. The category will be eliminated through a disruptive approach just like all other technologies that have come before it. My expectation is that when it comes it won't be recognized as important or relevant.
As a follow-up:
- Thank you very much! So do you mean that for Apple, marketing is just 1% of sales?
It's difficult to compare the two exactly.
We don't have specific data on Apple's marketing. We have either Advertising or SG&A (which includes marketing.) Samsung reports “Marketing Expenses” every quarter but these figures appear to be the sum of Ad spending, Sales Promotions, Public Relations and a portion of “other” expenses as a part of SG&A.
What seems to be happening is that Samsung increases its spending in proportion to sales while Apple grows marketing a bit more slowly.
Basically, Samsung is treating SG&A as a "variable" expense which is tied to sales whereas Apple is managing it as organic growth.
The difference might be that Marketing at Apple is mostly an internal effort and thus depending on headcount while Samsung might be spending mostly externally. If costs are internal then it would be hard to pare them down if sales slow whereas if they are external then they can easily be made variable.
I've received comments suggesting that Samsung's approach is unorthodox and that the quality of marketing cannot be maintained if it grows as quickly as Samsung has grown it. This is a matter of speculation however.
In June of 2011 Apple announced that 130 million ebooks were sold through iTunes. In October of 2012 it announced that 400 million sold.
That means 270 million ebooks were sold in 16 months. Or about 17 million units per month, on average. It also suggests 2012 ebook sales of about 200 million units.[1] The following graph shows the download rate of books relative to apps and songs:
The download rate looks paltry but we need to remember that Apps have a very low average selling price (about 23 cents including in-app purchases) and that Songs are probably priced around $1.1 on average. In contrast each ebook could be generating about $10 per download.
However that may be a bit high. We don't know the mix of lower priced and higher priced books. Many best sellers are $13 or $14 but there might be some free books in the mix as well.
If I choose a more conservative $9 average selling price and assuming a 70% share for the publisher then Apple's iBooks generated about $1.3 billion in payments and grossed about $1.8 billion.
In the past few posts I measured the iTunes App ecosystem and the Music economy. With the iBook market now measured we can derive the size of the only remaining media type: video.
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Notes:
I've seen one estimate that world-wide ebook unit sales reached 860 million implying Apple's share was about 24%.
The International Federation of the Phonographic Industry (IFPI) reported that global digital revenues were $5.6 billion in 2012. This represented about 9% growth from 2011 and accounted for 34% of total industry revenues[1].
Apple regularly reports iTunes as a separate revenue item and occasionally it also reports payments data for developers and app download rates. By interpolating the data published and combining it with some assumptions it's possible to estimate the mix of revenues (and costs) associated with iTunes.
My yearly estimates are summarized below.
Note that I also included historic digital music industry revenues (as a line). I also included the following summary items:
iTunes reported revenues were $13.5 billion (including Apple's own software sales)
iTunes gross revenues were about $15.6 billion (including payments to developers)
The iOS and OSX "App Economy" was about $7.5 billion while the iTunes "Media Economy" was about $8.1 billion (both figures include transaction costs.)
The iTunes Music economy was $4.3 billion of which $3.4b was paid to music labels.[2]
In terms of percent of total value the components are:
Looking at growth, these estimates imply that App revenues are growing at about 50% while iTunes Music is at 10% and Video+other at 90%.
Looking at profitability, there is potential for operating margin in Apple Software and App Agency Fees and perhaps some of the Media Transaction Fees (exploded wedges above). Historically, Apple suggested that their App and Media stores ran at break-even but that may no longer be the case. Operating margins from Software may be significant.
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Notes:
These revenues were from recorded music and don't include live performance
My estimate for the iTunes Music payments to publishers is equivalent to about 60% of total industry revenues.
In 2012 Apple opened 41 stores. The total is the second highest yearly opening rate since the stores first began operating. The highest total was in 2008 when 47 stores opened.
Although it is a healthy total, the surprising story about retail is that stores are not being opened as quickly as Apple's sales and reach are growing. The following graph shows the yearly opening rate.
The line in the graph above shows the change net sales since 2006 (right scale).
The store opening rate has been around 40/yr. during the last five years, up from 30/yr. during first seven but a 33% growth rate it's still a frustratingly slow rate of growth. Consider that during 2007 when Apple opened 34 stores, Apple's net sales were growing at the rate of $7 billion/yr and that in 2012 when it opened 41 stores sales grew about $37 billion or more than 5 times faster.
Although performance for the stores has improved (i.e. the sales per store went up), sales outside of their own retail channel are now a far higher portion of total. 2007 retail revenues were $4.7 billion or 17% while 2012 were $19.1 billion or 12%. You can see the mix by region in the following graph:
Note that these are quarterly figures. Now consider the split of stores currently open in each region:
We can then conclude that for sales outside of the retail channel, the split of sales and stores is as follows:
Americas: 37% of sales 69% of stores (63% in US, 6% in Canada)
Europe: 23% of sales 22% of stores
Japan: 8% of sales, 2% of stores
China: 13% of sales, 3% of stores
Rest of Asia: 7% of sales, 4.5% of stores (all in Australia)
This explains the current mix of store openings, shown below:
In 2012 only about 15% of store openings were in the US. It would seem reasonable therefore to expect that the priority for most, if not all, future openings should be outside the US to address the current sales/retail presence imbalance and to accommodate the bulk of future growth.
On February 6th, 2013 Apple reported that a total of 25 billion songs had been downloaded from its iTunes music store. The previous definitive value was in October 2011 though there was mention of "more than 20 billion" in November. App download totals have recently been much more frequently updated as the following chart shows:
[I estimated 21 billion for the November total.]
The latest two data points point to a surge in iTunes song download rates. Prior to last fall the download rate seemed to be hovering around 10 million songs per day.
The new data implies that the rate may be now perhaps 20 million per day however I would be cautious about this estimate given the latest point being such an outlier. One reason for the surge might be the opening of new stores in previously unserved countries. Another could be the usual post-holiday surge driven by gift cards.
Given this data, it would be interesting to calculate the share of overall music downloads that iTunes has been able to secure.
Based on the samples offered by Apple, and the data from International Federation of the Phonographic Industry (IFPI) we can estimate that in 2011 iTunes captured 90% of digital music revenues and 31% of the total music industry. (I estimate iTunes was responsible for about 4.3 billion downloads and I applied a price per download of $1.1).
Looking to 2012, applying a growth rate of 8% to digital sales (same as that of 2011) and an 8% decline in the physical business (vs. 8.7% decline for 2011) we get 98% iTunes share for digital and 37% share for all music. (I estimate that iTunes was responsible for about 5 billion downloads and I applied a price per download of $1.1).
Therefore it seems reasonable to estimate that Apple will reach 97% share for iTunes music in 2013. That assumes a 10% growth in the music download business and translates into 5.5 billion downloads or about 15 million songs per day. That's well within the trajectory seen above.
These data result in the following market overview:
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:
iTunes now becomes a steadily and rapidly growing business. Growth over the previous two years averages well over 30% and is consistent across seasons.
The absolute revenue number is substantial: $13.5 billion for 2012 (up from $10.2 billion in 2011).
Assuming a gross margin of 15% to 17% yields contribution of $2 billion in margin in 2012 and $1.6 the year before.
iTunes is now Apple's fourth largest business, having overtaken the iPod in revenues two years ago
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:
