Apple Isn't a Tech Company

Apple continues to be misunderstood. With the company's cash cows showing signs of maturity, Apple's interest in new industries is growing. Questions are swirling as to where Apple may be headed next. The answer is found by assessing how Apple views itself and the role it has to play in the world. Apple isn't a tech company, but rather it's a design company betting that consumers want something more than just technology in their lives. 

Defining Apple

Over the years, Apple has been given a number of labels: 

  • Computer company
  • Technology company
  • Product company
  • Consumer electronics provider
  • Mac company
  • iPod company
  • iPhone company
  • Luxury retailer
  • Consumer discretionary company
  • Consumer staples company

Some of these labels were more valid than others. In some cases, the label was meant to represent Apple's relationship with customers. Other labels went a bit further in an attempt to describe some aspect of Apple's culture or product philosophy.

Even Apple contributed to a few labels. In January 2007, Steve Jobs announced that Apple would drop the "Computer" from its name and become just "Apple Inc." to reflect the changing product line. The name change led some to believe that Apple now viewed itself as a consumer electronics company or even an iPhone company. However, a corporate name change doesn't tell us much about how best to define a company.

A more interesting clue about how Apple views itself came three years later, at the end of the iPad unveiling keynote, when Jobs talked about how Apple was able to make a device like the iPad. Here's Jobs: 

"The reason that Apple is able to create products like the iPad is because we've always tried to be at the intersection of technology and liberal arts. To be able to get the best of both. To make extremely advanced products from a technology point of view but also have them be intuitive, easy to use, fun to use, so that they really fit the users and users don't have to come to them, they come to the user. And it's the combination of these two things that I think let us make the kind of creative products like the iPad."

 
 

Clues

This location at the intersection of technology and liberal arts explained why competitors had such a difficult time competing against iPad (as they still do today). There was something more to the iPad than just technology. However, this still doesn't tell us how best to define Apple going forward. Instead, a closer examination of Apple's business provides more valuable clues. 

Power Structure. In the late 1990s, Steve Jobs shifted the power structure within Apple so that designers had control and influence over engineers. The logic in turning Apple into a design-led company was that design is the item that leads to great products. The iMac was the first product to be born out of this new power structure. 

Since becoming CEO in 2011, Tim Cook has made a number of leadership and managerial changes that amount to giving even more power to Apple designers. My theory is that these changes have reinforced a structure that splits Apple leadership into two groups:

  • Operations and corporate strategy
  • Product

An inner circle comprised of Tim Cook, Eddy Cue, Phil Schiller, and Jeff Williams oversees Apple's day-to-day operations and broader corporate strategy. This inner circle is supported by a number of SVPs and VPs. In addition, Cook increased the number of direct reports to the CEO while expanding the managerial reach of those making up the inner circle.

Meanwhile, the Apple Industrial Design group is positioned as the overseer of Apple's product direction. Christopher Stringer is a veteran Apple industrial designer who recently was reported to be leaving Apple. A few years ago, during Apple's Samsung trial, he explained that the job of an Apple industrial designer is "to imagine objects that don’t exist and to guide the process that brings them to life."

As seen in the following diagram, which was published in my "Grading Tim Cook" article, Apple leadership is split into two groups: operations/corporate strategy and product. This structure doesn't resemble that of a technology company. The Industrial Designers have continued to consolidate power during the Tim Cook era. 

Organizational Structure. It is logical to assume that the significant amount of change in power structure has resulted in cracks forming elsewhere within Apple. While some of this has manifested itself in certain groups losing influence or sway with management, the broader culture at Apple doesn't appear to have been jeopardized. The company's functional organizational structure has played a significant role in keeping corporate politics somewhat at bay. The focus, by design, remains on the product. 

In managing the Industrial Design group, Howarth isn't simply overseeing a team of 17 industrial designers. Instead, he is managing Apple's in-house design studio. Even after including the Human Interface team, Apple's core group of designers is remarkably small. This creates a contrast with tech companies employing hundreds of designers or utilizing various outside design consultants. Today, Apple handles all of its design internally.  

By rearranging the Apple leadership structure diagram shown above, we obtain a different look at Apple. The company is comprised of a nimble design studio supported by one of the largest technology arms in the world. It would be incorrect to classify Apple as just a design studio. The technology arm allows Apple to develop the technologies powering products created by the Industrial Design group. This dynamic is made possible by close collaboration between the designers and Apple's significant engineering resources. 

 
 

Storytelling. The next big clue as to how best to define Apple comes from observing how management has tried to tell the Apple story through the press. Consider some of the recent articles and interviews published in cooperation with Apple executives.

  • Jony Ive profile in The New Yorker (February 2015). The 16,000-word profile had Apple's full support and was one of the defining pieces written about the company this decade. Ian Parker used the Apple Watch as a prism to show how today's Apple is Jony's Apple. The messaging was clear: Apple's product strategy was now led by an industrial designer. Jony now had the role formerly held by Steve Jobs. 
  • Charlie Rose's exclusive look inside Apple (December 2015). Rose was given unprecedented excess inside Apple for a 60 Minutes report. The tour included the world's first genuine look inside Apple's Industrial Design studio. While a few photos of the studio were released in the past, Rose's access was unprecedented. In one scene, Rose and Jony talk about how few people get to be in the lab. Jony laughed and said "We don't like people in this room, period," in an obvious recognition of how unusual it was to have Rose and his entire entourage sitting in the studio. This raised the question of why Apple gave Rose such access in the first place. Apple felt that a look inside the design studio would help explain itself to the world.
  • Charlie Rose interview with Jony Ive (March 2016). The 72-minute interview aired in March 2016 and was aimed at figuring out what drives Apple. The interview went into detail as to how products are developed at Apple. It also addressed various topics pertaining to Jony and his design philosophies. 

In each of the preceding examples, Apple had one goal in mind: Shape its public image. Apple wanted to be known as more than just a technology company. Instead, Apple viewed itself as a company that puts the product above everything else. 

Products. Given that the product plays such a prominent role at Apple, the clue that best helps us define Apple is found in its products. Last month, Apple unveiled a number of new products through a series of press releases. (My complete review of Apple's new products is available for members here.) The new Apple products that contained the most intrigue were Apple Watch bands. There were a number of new Woven Nylon bands as well as Classic Buckle, Sport Band, and Hermès band options. The changes amounted to Apple unveiling its spring 2017 Watch band collection.

While Apple Watch bands remain a source of mockery within some Apple user circles, the product is incredibly important for Apple. Watch bands are the primary reason Apple has been able to sell close to 25M Apple Watches to date and become the wearables leader in the process. While there is value and convenience found with having a small screen positioned on the top of one's wrist, the only reason people are willing to wear that screen in the first place is because of Watch bands. It is not a coincidence that Apple Watch bands are the most frequently updated product at Apple.

With Watch bands, Apple is shipping a product that isn't powered by any software or technology. Instead, Watch bands are judged by tangibles and intangibles more likely to be found in the fashion world than in Silicon Valley. Watch bands end up serving as a big clue for the kind of company Apple is striving to be. It's certainly not to be just a tech company. 

The Mac provides another clue as to how best to define Apple. While we can point to a number of red flags appearing in the Mac business, the major trend taking place with the Mac is that the product is changing in an iOS world. What was once geared toward the liberal arts mindset is now finding itself more appealing to those in fields such as engineering. This transition coincides with the Mac becoming a bigger headache for management. The company knows how to make technology more personal, as with the iPad. However, when the same goal is attempted with the Mac, Apple receives pushback from a small but influential segment of the Mac user base. The struggles Apple is having with Mac end up showing that Apple isn't just a tech company. There is something else at play. 

Not Tech, but Design

All of the preceding clues for how best to define Apple contain a similarity: They revolve around some element of design.

  1. Apple is a company in which designers hold the most power and influence.
  2. Apple is structured to position the product above anything else.
  3. Apple management is eager to use design to tell its story.
  4. Apple's product line embodies the principle of technology not being enough.

At every turn, Apple is quick to discuss how something more than technology is needed. Even Apple's WWDC 2017 announcement reiterates this point, saying "Technology alone is not enough." That is a powerful statement to define what is arguably Apple's most tech-focused event of the year. 

 
 

Apple isn't a tech company, but rather it's a design company. 

By being defined as a design company, Apple is positioning the user experience  - how consumers interact with technology - as more important than focusing on the sheer power found with technology. This goal permeates throughout Apple. The company isn't just a design studio with a technology arm. Instead, every group at Apple is in one way or another focused on design. Apple is betting that design is the ingredient that will continue to put the product above anything else. 

Design vs. Technology

There is a way to differentiate a design company from a tech company: Observe how the company approaches technology. In every case, Apple views core technologies not as products themselves, but as ingredients for something else. Instead of wanting to chase after technology's raw capability, Apple is more interested in technology's functionality as it relates to the user experience. This brings up Jobs' reference to Apple being at the intersection of technology and liberal arts. By looking at the world through this lens, we receive a clearer roadmap as to where Apple is headed in terms of product strategy. 

Augmented Reality (AR). Apple has been investing significantly in AR for the past few years. Instead of acting like a tech company and positioning AR as a standalone product, Apple's primary focus is to incorporate the technology into products we already use (smartphones, tablets) and products we will begin to use in the future (entirely new wearable form factors). Apple views AR as a core technology that will transform products into a new breed of navigation tools. This will add a new dimension to the technology. The way we will interact with AR is often the part of the equation not discussed much by tech companies. Apple will attempt to figure it out. 

Autonomous Driving. Contrary to reports, Apple still wants to design its own car. Apple recently was granted a permit to begin testing autonomous driving technology on California public roads. Apple is researching autonomous driving technology because it will be a core ingredient powering a range of Apple products in the transportation space. Instead of partnering with legacy auto companies, Apple will look to do everything on its own. The motivation and ambition in such a move is born from Apple's adherence to design and the quest to control the entire user experience. 

Health Monitoring. There is a reason why Apple Watch bands are the most frequently updated product in Apple's line. The best way to get people to wear health monitoring technology is to have people want to wear health monitoring technology. Today, health monitoring primarily describes simple fitness and health tracking. Apple is actively researching different technologies, including those for possible blood sugar monitoring. If successful, the technology will play a vital role in Apple's wearables products. 

Voice. A tech company positions a voice assistant as the product. Cheap standalone speakers would be positioned as a way to get people to use the voice assistant as much as possible. Apple sees voice playing a different role in computing. Voice assistants can add value to products we already use and wear throughout the day. Instead of making the voice assistant the focus, Apple is interested in how we can use our voice to make technology more manageable. 

TV. Apple's decision to not ship a television set provides an example of not enough core technology resulting in a product receiving a "no" from the company. According to reports, Apple was not able to figure out a way to differentiate itself from the competition. This is another way of saying there was little found with a television set that could lead to an entirely new user experience. Television sets are stationary, large pieces of glasses positioned a few feet in front of us. While new technology in the form of a few front-facing cameras and sensors may add a few new twists to the equation, Apple didn't think the final offering would be compelling enough. Instead, Apple focused on the piece of the television experience we do interact with - the remote control and tvOS user interface. As it turned out, Apple ended up selling more than 255M "television sets" in 2016 anyway. They are called iPhones and iPads. 

Criticism

Much of the criticism directed at Apple can be traced back to how the company is defined. Because it is not a tech company, some have questioned Apple's ability to grasp future technology waves. These critics don't give Apple enough credit for the large technology arm connected to its design studio. Suggestions that Apple's services will remain inferior to those of its peers are becoming common occurrences. However, the progress Apple has made with Apple Maps suggests this is not the case. Apple's ability to excel at machine learning is routinely questioned. The criticism boils down to Apple focusing too much on functionality (how we use the technology) and not enough on capability (what the technology can do). 

At the same time, Apple receives pushback from being a design company. The significant backlash Apple is receiving from a portion of its pro Mac user base boils down to a broader dissatisfaction with the company betting too much on design. There are some Apple users who don't want the version of technology Apple is selling. In addition, there is no sign of this dissatisfaction going away.

In reality, Apple's largest risk isn't found in being a design company or not being a technology company. Instead, it's in becoming a tech company. If Apple finds itself moving away from being design-led, the product will be put into jeopardy. This is likely one reason why Cook continues to bet so heavily on design. 

The Apple Design Book

AirPods wasn't the surprise product of 2016. Rather, Apple's $199 design book came as a shock to the Apple community.

 
 

While many looked the book as Apple designers getting intoxicated by nostalgia, the book ends up being the clearest expression of what makes Apple a design company. Apple is focused on creating products that can change the world. The secret to accomplishing this goal is to place a bet that technology alone is not enough. 

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The Mac Is Turning into Apple's Achilles' Heel

Apple's decision to change course and develop a new Mac Pro has received near-universal praise from the company's pro community. While developing a new Mac Pro is the right decision for Apple to make given the current situation, it has become clear that the Mac is a major vulnerability in Apple's broader product strategy. The product that helped save Apple from bankruptcy 20 years ago is now turning into a barrier that is preventing Apple from focusing on what comes next. 

Apple's Mac Meeting

There were three takeaways from Apple's recent on-the-record meeting with five journalists in Cupertino to discuss the Mac.

  1. Apple is sorry about the lack of Mac updates targeting pro users.
  2. The current Mac Pro suffers from a fatal design decision (although the device will continue to be sold).
  3. Management debated the Mac Pro's future and decided to change strategy and begin work on an entirely new Mac Pro. The company will also work on an Apple-branded pro display to go along with a new Mac Pro. 

(My complete review of Apple's emergency Mac meeting is available for members here.)

It is easy to look at this highly unusual meeting as being just about the Mac Pro and Apple trying to prevent influential content creators from jumping to a competing platform. However, read between the lines, and it becomes clear that Apple has a much bigger problem on its hands than simply an outdated Mac Pro.

The Mac has become a major headache for Apple, and management is on the verge on going down the Mac rabbit hole, funneling an increasing amount of resources and attention into a product category that doesn't represent the future of personal computing. The risk is that Apple will be stuck with a $25B legacy business and corresponding user base that will threaten the company's increasingly ambitious product strategy.

Tale of Two Apples

Apple is like a novel where two characters are battling each other in the post-PC era. When it comes to mobile, Apple's success is unmatched. The company is connecting with the mass market like never before. The iPhone is bringing more than 100M new people into the Apple ecosystem each year. Apple Watch momentum is building with a user base surpassing 20M people. Early AirPods sales trends look even more promising. More importantly, Apple executives have been on the same page with each other when it comes to strategy. 

This cohesion in strategy extends to how Apple continues to place big bets in an effort to control its own destiny in mobile. Recent news of Apple developing its own GPU solution is the latest step in the company's quest to ship a single system-on-the-chip (SOC) powering a range of mobile and wearable devices. This will give Apple a competitive advantage measured in decades. The company is also placing big bets on mobile services such as mapping and payments, items that will serve to create a competitive advantage in the changing tech landscape. 

In stark contrast, Apple's Mac strategy looks like a slow-motion train wreck. While Apple has made some progress with bringing elements of mobile such as Touch ID, multi-touch displays, and ARM processors, to the Mac, years of sporadic updates have overshadowed the positives. Apple's relationship with its pro Mac user community has deteriorated and can now be described as toxic. To make matters worse, there appears to be a growing rift among Apple executives concerning Mac strategy. 

As for why Apple's problematic Mac strategy hasn't caused too many issues for the company up the now, the business has become niche. As seen in Exhibit 1, Apple is selling more than 250M iOS devices per year.  In comparison, they are selling fewer than 20M Macs. The Mac accounts for just 11% of Apple's overall revenue. More importantly, the Mac is no longer the primary way new users enter the Apple ecosystem. In addition, one can also argue that pro Mac users haven't had much in the way of alternative platforms up until recently, although this is still being debated. 

Exhibit 1: The Post-PC Era at Apple

The Achilles' Heel

Apple's Achilles' heel is becoming visible. As Apple gets better at making technology more personal for the mass market, the company is losing touch with its legacy pro users. The situation came to a head last week with Apple announcing that it began work on a new Mac Pro. While one can chalk up a new Mac Pro as a one-off cost for keeping iOS app developers engaged in the platform, Apple's vulnerability extends much deeper than one Mac model.

There appears to be a growing rift among Apple executives when it comes to Mac strategy. Apple Industrial Design and Apple management have spent the better part of the past 10 years focused on devices designed to move hundreds of millions of people beyond the Mac. However, this strategy did not address 30M Apple users dependent on pro Mac hardware and software. While this segment only accounts for 4% of Apple's user base, it is responsible for creating content consumed by the other 96% of Apple users. These content creators have played a major role in Apple's mobile success. 

Apple's Achilles' heel is found with the niche devices at the tail end of the business. As seen in Exhibit 2, when compared to smaller screen unit sales, devices targeting pro users barely register. Apple has come to the realization that these niche devices, instead of being cast off or ignored, need ongoing attention and resources. 

Exhibit 2: Apple Device Sales Mix (Screen Size)

Path to Today

It is fair to ask how Apple got into this predicament.  

The Mac isn't like the iPod, a device cleanly and quickly cannibalized by a newer Apple product. iOS and multi-touch are not able to handle all of the tasks given to Mac. This is one reason why Apple has been extremely vocal about continuing to invest in the Mac despite running forward with iPhone and iPad. The debate was never about whether or not Apple will continue to sell Macs, but rather about how best to bring the Mac into the future. 

One path forward was for Apple to consolidate resources and place a bet that higher-end MacBook Pros and iMacs would be able to handle the needs of most Mac Pro users. Apple ended up being partly right. A majority of pro Mac users have transitioned their workflows to MacBooks and iMacs without incident. 

Apple ran into an issue when it came to addressing the niche of the niche. Millions of pro users could not make the jump from Mac Pros or other high-end PCs to a MacBook Pro or iMac. Apple needed to support these users for no other reason than they create the content consumed by the rest of the user base. 

Issues

Apple's decision to work on a new Mac Pro raises a number of red flags. 

Resource strain. Even though Apple has $246B of cash and cash equivalents, the company is resource-constrained when it comes to time and attention. Apple's functional organizational structure produces a constant battle among products and teams to grab that finite amount of management's attention. For management to dedicate attention to new pro Mac hardware, the company may need to take its foot off the accelerator with other products. This may seem like a major flaw, and judging from the amount of criticism directed towards Apple's organizational structure, such an opinion is widely held. However, Apple's structure is put in place in order for the product to be put ahead of everything else. It is not a disadvantage or weakness, but rather one of Apple's secrets to success. There is value found in having Apple's Industrial Design team, along with Tim Cook and his inner circle, move from product to product throughout the year in order to place a select few big bets.

Broader cultural differences. Some may argue that Apple is capable enough to develop mobile and wearable devices while selling pro Macs at the same time. This ignores the much more complicated aspect of Apple satisfying vastly different user needs with pro Macs. Apple would not only be developing a new Mac Pro or standalone display, but also sustaining a small but influential base of pro users dependent on macOS. Similar to how the iPhone user base is changing, Apple's overall user base has become quite heterogeneous in terms of technology wants and needs. It may be nearly impossible for Apple to satisfy all of its users. 

Product strategy hole. According to consensus, the biggest challenge Apple is facing is finding a business as profitable and influential as the iPhone. This extends to Apple not being able to expand its developer and app success to newer product platforms. It has become clear that Apple's inability to move beyond the Mac poses a much bigger long-term risk. 

There may be a hole developing in The Grand Unified Theory of Apple Products (shown below). The idea behind the theory is that Mac portables and desktops are positioned as the most powerful machines in Apple's product line. These machines will then serve to push the rest of Apple's product line forward. However, there isn't much evidence of this actually taking place. Instead, iPhones and iPads are being used to decide where to bring MacBooks and iMacs. There is also the awkward situation of iPad Pro beginning to give Mac a run for its money in terms of performance. 

 
 

Meanwhile, there isn't much evidence of MacBook or iMac features serving as inspiration for Apple's smaller screens. This is a sign of value destruction occurring with larger screens found at Apple's tail end of the business. We are giving more of our time to the smaller screens in our lives. Where does this leave Macs within Apple's broader product strategy? It increasingly looks like an odd fit as the Mac becomes a legacy platform.

Additional Concerns

The need to have a highly unusual private, on-the-record briefing with five journalists to explain a complete reversal in Mac strategy signals a management team on defense. Apple is afraid of influential Mac content creators jumping ship. This is the exact opposite of the aggressiveness Apple has shown with mobile and wearables. The more one looks into the topic, the more worrying things appear.

In an attempt to explain Apple's new Mac strategy, Apple SVP Phil Schiller wiped the dust off the old quadrant product grid. At the same time, Schiller has been increasingly vocal about the Mac being around for the next quarter of a century. Here's Schiller in late 2016:

"The new MacBook Pro is a product that celebrates that it is a notebook, this shape that has been with us for the last 25 years is probably going to be with us for another 25 years because there’s something eternal about the basic notebook form factor. You have a surface that you type down on with your hands, with a screen facing you vertically. That basic orientation, that L shape makes perfect sense and won’t go away." 

Schiller is likely guided by the desire to calm pro Mac users' fears. Arguing that the Mac will be around for 25 years means that these users won't need to worry about transitioning away from the Mac during their careers. However, this stance places Apple in an awkward situation. Nowhere is this seen more clearly than in Apple's recent iPad Pro ad campaign. On one hand, Apple is saying it thinks the laptop form factor will be around for 25 years. However, Apple then launches a marketing campaign positioning the iPad Pro as a better computer than MacBook. 

The Way Forward

My suspicion is that instead of trying to get around its Achilles' heel, Apple will try to be more cognizant of it. It is likely that a majority of Apple's senior executives, including Apple's Industrial Design group, still view the iPad and iOS as the more promising platform than Mac and macOS for the next 25 years of computing. Apple is pushing iPad like never before. New pro Mac hardware will not change this dynamic. However, it has become clear that Apple realizes its previous Mac strategy fell short as there was no viable path forward for tens of millions of pro Mac users.

Apple disclosed a few facts about its pro Mac users as measured by pro software usage. The data contains clues as to where Apple's product strategy may be headed. According to Apple, 70% of the Mac user base does not use pro software and would not classify as pro users. This is another way of saying that the iPad Pro could do quite well serving the needs of 70M Mac users. Meanwhile, the other 30% of the Mac user base wants and needs the power and flexibility that Apple has historically had trouble selling. 

Apple will likely position the Mac as a computing platform for legacy pro users while iOS will be targeted to everyone else. This will entail a few steps: 

1) Triple down on iPad. The writing is on the wall. Apple will not be able to address its Achilles' heel until iPad can be used for developing apps. This will involve Apple ramping investment and resources into iPad software, hardware, and accessories. While consensus assumes Apple should look to the Mac for iPad software inspiration, the more appropriate course of action is to look at the iPhone for inspiration. There is a reason that the iPhone is outselling the Mac by 10x. People enjoy iOS as a computing platform. After all, the iPad is just a bigger iPhone.

2) Continue to be aggressive with Mac design. Apple Industrial Design will continue to be aggressive in bringing the Mac experience forward. There have been some controversial Mac design decisions taken recently, including decisions about the Touch Bar and the insistence that multi-touch does not make sense on vertical Mac displays. Some may argue that Apple needs to look at a new Mac Pro as a hardware engineering problem and have the Industrial Design team take a back seat. This may be a recipe for disaster. It just goes to show how tricky of a proposition pro Mac hardware is for this management team. 

3) Running fast with new endeavors. The Mac does not represent Apple's future. Instead, the changing tech landscape will require Apple to play in new industries. The company needs to be extra aware of the long-term damage done by the Mac becoming a resource strain and jeopardizing other initiatives.  

Figuring Out What Comes Next

Apple still needs the Mac. Tens of millions of users aren't able to pack away their large displays and embrace iPhones and iPads. However, the Mac debate has never been about whether or not Apple will stop selling Macs. Instead, the question has been, how will management be able to retain the value of the laptop and desktop form factors in today's mobile world?

The most important thing for Apple to do when it comes to the Mac is to think about what comes next. Apple's broader mission is to use devices capable of making technology more personal to inspire a new generation of content creators. It is clear that iPhone and iPad are already inspiring tomorrow's content creators. Apple Watch and AirPods are not far behind in terms of being able to inspire.

When taking into consideration new technologies such as augmented reality, it is fair to wonder just how important large screens will even be in our lives in the future. Small screens are going to transition from being just tablets, smartphones, and smartwatches to being augmented reality navigators. In such a world, large screens will look like relics. The path forward for Mac looks bumpy.

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Apple Is Pushing iPad Like Never Before

Apple is pulling out all the stops when it comes to selling iPad. We are seeing the company take its most aggressive stance yet in getting existing iPad owners to upgrade. For the first time, Apple is also making a concerted effort to reach prospective iPad owners by targeting PC users. On the surface, these efforts seem like a last ditch effort to save iPad, which faces continued sales declines. However, Apple is guided by a different motive. There are signs of Apple pushing iPad like never before in order to solve its growing Mac dilemma.

Initial Look at iPad Sales

A quick look at overall iPad sales reveals an ominous trend. Sales have declined for 12 consecutive quarters. After topping out 74M units in 1Q14, the annualized iPad sales rate has declined by 42% to 43M units.

Exhibit 1: iPad Unit Sales (TTM)

When iPad is compared to iPhone and Mac, its sales weakness becomes even more pronounced. The sales gap between iPad and Mac continues to shrink. This has drawn into question Apple's vision for iPad and whether or not the device is the best representation of the future of personal computing. There are even people beginning to question some aspects of the post-PC era as steady Mac sales suggest consumers aren't moving away from laptops and desktops. 

Exhibit 2: iPhone, iPad, Mac Unit Sales (TTM)

For the past four years, we have seen various theories put forth to explain the significant drop in iPad sales. Longer upgrade cycles, larger iPhones, inferior software, lack of professional apps, and even poor Apple storytelling have been given as factors driving iPad sales weakness. 

iPad Strategy Changes

As sales have declined, Apple has implemented a number of significant changes in its iPad strategy. Many of these changes have occurred within the past year and a half. The latest changes were unveiled last week when Apple announced the new 9.7-inch iPad. (My complete review of Apple's new product announcements is available for members here.)

iPad Pro. The most obvious change relates to the iPad Pro line. The defining features of the iPad Pro are the Apple Pencil and Smart Keyboard support, which were introduced in 2015. One of the biggest criticisms facing the iPad over the past few years is that it is a consumption device used primarily for watching video. The iPad Pro seeks to change that narrative. The overall strategy with the iPad Pro is to release higher-priced SKUs offering additional functionality and capability.

Additional Simplicity. The iPad Air era is officially over at Apple. By positioning the new 9.7-inch iPad as the iPad Air 2 successor, the overall iPad line is much simpler. In fact, the iPad line contains the most simplicity in years. The "iPad Air" nomenclature had lost much of its meaning last year following the 9.7-inch iPad Pro unveiling as each device shared similar dimensions and identical weight. 

As seen below, Apple reduced the iPad line by 20% (five models down to four) and simplified the branding. 

 
 

By removing the iPad Air from the line, Apple made the iPad buying equation that much easier for consumers. This simplicity is a sign of Apple doubling down on the 9.7-inch iPad as the flagship iPad size. (The actual screen size may change slightly going forward depending on the screen to bezel ratio.) The choice is either between an iPad Pro or an iPad. Meanwhile, the iPad mini will become niche, available for consumers wanting an iPad with a smaller footprint.

Aggressive Pricing. Apple slashed the entry-level price for the 9.7-inch iPad to $329 from $399. Special $299 pricing for education institutions is also available. This is an aggressive pricing strategy considering that Apple was selling the 9.7-inch iPad Air 2 for $499 as recently as 12 months ago. The iPad mini had represented the entry-level iPad model when it came to pricing. Since the company is now positioning the smaller iPad as a niche device, the new distinction comes with a higher price.

Clearer Storytelling. Apple recently launched its largest iPad ad campaign to date. In what is called "Real Problems... answered," Apple showcases real tweets depicting computing problems and then demonstrates how the iPad Pro offers solutions. The ad campaign is a big deal for Apple and a sign of management directly reaching out to PC users as potential iPad purchasers. The company has been quite aggressive with its airing of the ads in recent weeks. 

 
 

One of the more interesting observations about the ads is how they end up making long-time MacBook users nervous. Apple is positioning iPad Pro as a better computer than laptops, and by extension, MacBooks.

Closer Look at iPad Sales

In order to properly assess all of the recent changes to iPad strategy, a closer look at sales is needed. While overall iPad sales have been in decline for years, reports of iPad's death have been greatly exaggerated. There is much more going on behind the scenes.

iPad sales have faced one major headwind in recent years. This item explains a significant portion of the sales decline. It's not inferior software, weak storytelling, or even a longer upgrade cycle. Instead, the iPad's problem has been the iPad mini.

People aren't buying as many iPad mini devices these days. Excluding 7.9-inch iPad mini sales from overall iPad sales results in a completely different sales picture. As seen in Exhibit 3, iPad mini unit sales have declined 70% after peaking in 4Q13 and 1Q14. The product's value proposition has been permanently reduced due to larger iPhones. Apple has clearly experienced Peak iPad Mini. It's not that the iPad mini form factor is going away, but rather that it will play a smaller role going forward. 

iPad mini sales weakness has masked stronger sales trends for larger iPads. In what will come as a surprise to many, the iPad Air 2 has been the best-selling iPad to date. In addition, more than half of people buying an iPad Air 2 were new to iPad. These are very promising signs for the iPad business. Not only are large screen (9.7-inch and 12.9-inch) iPad sales relatively unchanged over the past four years, but they actually have increased year-over-year this past holiday quarter. The iPad Pro line played a major role in this sales rebound. 

Exhibit 3: iPad Unit Sales by Screen Size (TTM)

Given iPad mini sales weakness, management is placing a big bet on larger iPad screens. By lowering the entry-level cost of the 9.7-inch model to $329, Apple is looking to make the most appealing iPad size more accessible. At the same time, the company is offsetting margin and ASP pressure by moving up market with more capable iPad Pro SKUs and accessories. The Apple Pencil accessory is one of the most underrated Apple products in years. 

Solving the Mac Dilemma

Since large screen iPads having shown much more resiliency over the past few years, Apple's recent iPad changes seem peculiar. Why double down on the iPad now?

Apple is pushing the iPad like never before in order to solve its Mac dilemma.

Ultimately, management has two options for the Mac:

  1. Double down. From a product perspective, there is a clear path forward for the laptop and desktop form factors at Apple. The company could continue bringing elements of mobile to the Mac. Apple can control more of the core technologies powering the Mac, and this would include bringing a version of iOS to the laptop and desktop form factors. The effort would take years to accomplish and utilize a significant amount of resources. 
  2. Move beyond the Mac. This option would begin with more sporadic updates to the Mac line and then eventually lead to Apple placing less and less attention on the category as other products gain priority and resources. While Apple would still sell Macs, it would become clear that the company's focus is on newer products designed to handle the tasks currently given to the Mac.

Management faces a difficult choice between the two options as the Mac is still selling very well. The product category is bringing in nearly $23B of revenue per year, $4B more than iPad thanks to a much higher ASP. Some companies are powered by Macs (although Apple executives seem to rely quite a bit on their iPads these days). Tens of millions of users rely on Macs to get work done every day. A portion of these users are adamant that a move away from Mac is nearly impossible given their current workflows.

My suspicion is that Apple is pushing larger screen iPads because management is determined to move beyond the Mac. Apple thinks now is the time to raise awareness that the iPad is a legitimate PC alternative for hundreds of millions of consumers. 

A move away from the Mac goes against much of the public commentary from Apple management. Tim Cook, Phil Schiller, and others have been quick to mention Apple's long-term commitment to the Mac with Phil Schiller even saying the laptop form factor will be around for another 25 years. However, management's recent actions speak louder:

  • Tim Cook calling the iPad the clearest expression of Apple's vision of the future of personal computing.
  • The new iPad Pro ad campaign elevating the iPad at the expense of Mac.
  • Aggressive iPad pricing highlighting Apple's desire to position the device for mass market consumption, while Mac pricing is more reflective of a niche product.

The iPad Strategy

As seen in Exhibit 4, the sales gap between large screen iPads and Mac peaked five years ago. The gap has since closed, with large screen iPad sales bouncing around 30M units annually and Mac sales seeing a slight improvement to 19M units. If Mac were to outsell iPad, this would certainly make Apple's goal in moving beyond the Mac that much more difficult. It would demonstrate how Apple has a serious problem on its hand as the iPad is not able to entice users away from Mac. Management is interested in avoiding that outcome.

Apple wants to push iPad sales now like never before in order to widen the sales gap between iPad and Mac. Large screen iPads have experienced some momentum in recent months. Management is building off that strength to unveil a broader campaign to boost iPad sales. If Apple is successful in increasing large screen iPad sales to a 40M unit sales annual pace (a 30% increase from current levels), iPad would be outselling Mac by 2x. This would certainly help change the iPad versus Mac narrative in the marketplace, giving Apple that much more motivation to dedicate attention and resources to other products. 

Exhibit 4: Mac, Large Screen iPad Unit Sales (TTM)

Apple is making its iPad sales pitch to two groups: existing iPad users and long-time PC users. According to my estimates, there are 100M users still using older iPads (iPad 1, iPad 2, iPad 3, iPad 4, iPad mini). A significant portion of these users are using devices that don't even support the latest iOS release. Management thinks simpler storytelling and an aggressively low $329 price will entice these users to upgrade to the new 9.7-inch iPad.

The fact that 100M people are still using older iPads demonstrates that the product provides value. Apple is also confident that users will see the significant improvement between the latest iPads and models from five to seven years ago. As for PC users, Apple thinks the iPad Pro line is capable of handling the vast majority of tasks currently given to laptops. Apple looks at the iPad Pro line, which includes Apple Pencil and Smart Keyboard, as a better solution for consumers than even the Mac. This is quite telling as to management's long-term motivation. 

While the iPhone has likely reduced the iPad's long-term sales trajectory, the iPad category is being underestimated. Apple thinks that now is the time to become much more aggressive in selling iPad. Fortunately, we will be able to judge Apple's progress by monitoring quarterly iPad sales. With a dramatic price cut, simpler sales pitch, reduced headwind from iPad mini sales, and a differentiated product line, Apple is confident the iPad will return to growth. A growing iPad business will then make it that much easier for Apple to move beyond the Mac and focus on creating a new breed of personal gadgets that make technology more personal. 

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The Curious State of Apple Product Pricing

As Apple pushes deeper into luxury brand territory, the company is making its products more accessible through lower pricing. At $159, Apple is underpricing AirPods. The same can be said for Apple Watch, priced at $269. In just ten years, we have moved from the "Apple Tax" days, when Apple was accused of pricing products artificially high, to Apple products being priced below the competition. Apple is using its balance sheet and scale to grab new users, and in the process, redefine luxury. 

Underpricing AirPods

After using AirPods for the past three months, one takeaway relates to pricing. It is clear that Apple is underpricing AirPods. While this statement may sound outlandish considering that a pair of EarPods is included in every iPhone box, AirPods are not just any pair of headphones. The combination of accelerometers, optical sensors, Apple's new W1 chip, and a well-designed charging case, position AirPods as Apple's second wearables product. AirPods are computers for your ears. This distinction does a better job at framing the device's surprisingly low $159 price. 

 
 

Contrary to the conclusions found in most headphone buying guides, AirPods should not be compared to lower-priced, wired headphones. These buying guides not only lean on sound quality to unfairly shortchange truly wireless headphones, but also misidentify why consumers want to buy wireless headphones in the first place. AirPods' primary value proposition isn't found with sound quality but rather with not having any wires. Accordingly, the product should be compared to other truly wireless headphones. 

It is very difficult to find a pair of wireless headphones priced lower than AirPods. In the run-up to Apple unveiling AirPods this past September, the wireless headphone market consisted of the following players: 

  • Kanoa: $300
  • Bragi Dash: $299
  • Erato Apollo 7: $289
  • Skybuds: $279
  • Earin: $249
  • Motorola VerveOnes+: $249
  • Samsung Gear IconX: $199
  • Bragi Headphone: $149 

Given the preceding list, a strong case could have been made for Apple to price its new wireless headphones at $249, or even $299. The fact that Samsung priced its Gear IconX at $199 seemed to suggest a sub-$200 retail price for AirPods was unlikely. Instead, Apple sent shockwaves pulsing through the market by pricing AirPods at only $159. The action instantly removed all available oxygen from the wireless headphone space. The idea of Apple coming out with a new product that would underprice nearly every other competitor was unimaginable ten years ago. 

Many wireless headphone companies have been forced to cut pricing in an attempt to better compete with AirPods. Even after price cuts, competitors are still unable to come close to AirPods pricing. While some of these competing headphones include additional capabilities and functionality, much of this benefit is overshadowed by the lack of Apple's W1 chip. When it comes to contributing to the premium experience found with AirPods, the W1 chip is near the top of the list.

Underpricing Apple Watch

A similar pricing dynamic is found with Apple Watch. After cutting the entry-level price $50 to $299 in March 2016, Apple unveiled a new Apple Watch pricing strategy last September. Apple upgraded the first generation Apple Watch device with a new dual-core processor, the same processor found in the higher-priced Apple Watch Series 2 models. In addition, Apple gave the Watch a new name, Apple Watch Series 1, and a $30 price cut to $269.

 
 

At $269, Apple Watch Series 1 is one of lowest-priced smartwatches worth buying in the marketplace. Attractive pricing was one key factor driving record Apple Watch sales this past holiday quarter. In fact, even the Apple Watch Series 2, at $349, is one of the lowest-priced smartwatches in its class:

  • Fossil Fenix 5: $599
  • Garmin Forerunner 630: $399
  • Michael Kors Access: $350
  • Samsung Gear S3: $349
  • Fossil Q Founder: $275

Apple's aggressive pricing strategy has also gone a long way in shrinking the price gap between Apple Watch and dedicated health and fitness trackers. There is now only a $70 difference between an Apple Watch Series 1 and Fitbit Blaze. 

Three Pricing Theories

There are three theories to explain Apple's AirPods and Apple Watch pricing strategy. 

A) iPhone as Hub. Instead of making a profit on Apple Watch and AirPods, Apple is underpricing the devices in an effort to boost iPhone sales. The logic is that since Apple Watch and AirPods are being positioned as iPhone accessories, Apple views the devices as tools to keep consumers attached to their iPhones. Apple compensates for the lack of Apple Watch and AirPods profit by selling high-margin iPhones and Services. 

B) Manufacturing Scale. This is the most straightforward theory. Apple has simply gotten better at making products at a lower cost. With a sizable production ramp (millions of units), Apple management can use scale and its existing supply chain to quickly bring down component and manufacturing costs for a new breed of personal tech gadgets. 

C) Consumer Segmentation. Management is using product pricing to grow Apple's user base. On one end, management cuts entry-level pricing in an effort to make products more accessible. However, management then pushes at the other end of the pricing spectrum with premium SKUs targeting a different part of the user base. The higher-priced SKUs help boost Apple's overall margin profile. 

History

On the surface, each of the three preceding theories seem to contain some logic. The iPhone is not only Apple's best-selling product, but also the most effective tool for growing the user base. At the same time, Apple has seen much progress in keeping component costs contained across its product line.

However, upon further examination, there is a serious flaw found with Theory A (besides the fact that Apple is moving beyond the iPhone as Hub product strategy). AirPods and Apple Watch pricing doesn't reflect a new strategy designed to juice iPhone sales. Instead, Apple has actually been traveling down this pricing path for years. Apple's decision to unveil the initial iPad at $499 in 2010, and then come out with a $329 iPad mini just two years later, marked a sea change in the way Apple approached product pricing. 

In the mid-1990s, Apple made a series of strategic mistakes related to the Mac. Instead of trying to grow market share, management chased profit. Apple introduced a variety of high-priced Macs targeting existing Mac users. Apple was having difficulty targeting new users in the face of the strengthening Windows empire. Apple was doubling down on niche instead of chasing mass market. 

Apple took a completely different strategy with iPad. With iPad, Apple cared much more about grabbing market share. This attitude was born from motivation to not repeat Apple's dark days from the 1990s. Up until last year, there was thought to be one major caveat to Apple's market share ambition. Apple was interested in initially grabbing share in the premium segment of the market and then gradually working its way down market. There is evidence to suggest this attitude is now changing a bit as Apple is selling wearables.

Apple's Pricing Strategy

AirPods and Apple Watch pricing demonstrate how Apple is looking to own not only the premium segment of the wearables market, but rather the entire market. As Apple runs deeper into luxury, the company is reducing entry-level pricing. This is a curious development as one assumes the opposite would have occurred - Apple would keep prices high to maintain a certain level of exclusivity or scarcity. Instead, Apple is redefining the concept of luxury in order to sell mass-market products. 

Consider Apple's approach to Apple Watch pricing. With $269 and $369 Apple Watch options, Apple is very competitive with nearly every smartwatch. However, at the other end of the product line with Apple Watch Hermès and Edition starting at $1,149 and $1,249 respectively, Apple is selling different materials, and a different kind of experience, at much higher prices. Apple is segmenting the product line to appeal to a wider variety of users. 

With Apple's entry-level Apple Watch pricing, management isn't necessarily targeting a premium segment of the smartwatch market, but rather its going after the entire market. AirPods represents an even more extreme case study of this mass-market appeal. 

Apple is able to sell product at low prices by utilizing its strong balance sheet and powerful supply chain to secure very attractive component orders. In addition, the company's efforts to own its own silicon and other core technologies are starting to pay dividends from both a performance and pricing perspective. Apple's growing vertical integration is allowing the company to run with lower pricing yet still maintain historically high margins. The growing legal battle between Apple and Qualcomm isn't just about Apple being unhappy with Qualcomm's business model. Rather, it's about Apple wanting to eventually get into the baseband processor business. (A full primer related to the lawsuit is available for members here.) This will come in handy when selling a cellular Apple Watch down the road as Apple can create its own system on a chip (SOC) containing its own AX processors, GPU, and an LTE modem chip. 

Lower-priced Apple products result in increased sales, which leads to Apple's ability to place even larger component orders. Apple will soon be on pace to sell 20M Apple Watches per year. For AirPods, annual unit sales will likely be even higher. These sales numbers provide Apple flexibility to reduce the pricing of older models even further. Meanwhile, competitors are unable to get a foot in the door. We saw a version of this dynamic unfold in the tablet market during the early 2010s. The same thing is now taking place in the smartwatch market, and it could even expand to the wireless headphone industry. 

Things to Monitor

Given Apple's revised pricing strategy, there are a few developments worth monitoring: 

  1. Apple Watch. A $199 Apple Watch is inevitable at this point. On the other end of the pricing spectrum, new partnerships with luxury brands similar to Hermès seem likely. 
  2. AirPods. It is not unreasonable for Apple to eventually have an entire AirPods platform comprised of lower-priced models with certain features and components as well as higher-end options targeting a more premium segment of the market. Interestingly, Apple started towards the low end and may work its way up market as additional functionality is added. 
  3. iPhone. Stronger than expected demand for the higher-priced iPhone 7 Plus tells us that higher-priced iPhones are coming. Higher prices will be justified as iPhones morph from being computers that fit in one’s pocket into personal augmented reality navigators utilizing the most capable cameras to ever fit in a pocket. Meanwhile, Apple continues to reduce entry-level iPhone pricing. The most recent example is Apple bringing back the iPhone 6 in a few select markets and pricing it a bit lower than iPhone SE. 
  4. iPad. Given the iPad's position within Apple's broader product line, the product category is following the iPhone in terms of higher-priced models. On the other end, there may not be much room left for Apple to lower iPad's entry-level pricing to significantly less than $269. 

Redefining Luxury

Apple's pricing strategy is ultimately about bringing new users into the Apple ecosystem. While the iPhone remains the most effective tool for accomplishing this, Apple wearables will increasingly represent another new user tool at management's disposal. It may be difficult to believe, but AirPods likely represent the first Apple product for more than a few people. Additional value will flow to companies selling multiple wearables products to the same user. As it currently stands, the average Apple user owns more than one Apple product. This trend will only intensify as time goes on when considering Apple Watch and AirPods. 

The trickiest aspect of Apple's pricing strategy is running with lower prices while at the same time, becoming more of a luxury brand. In essence, Apple is redefining luxury. While other luxury brands have utilized lower-priced items to serve as brand entry points, Apple is taking the practice to an entirely new level by pricing products below the competition. Apple is making luxury much more accessible with the idea that low-priced gadgets can create an experience just as luxurious as that of premium gadgets. It's going to be difficult for other consumer tech companies to play in this game. 

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The New Leader in Wearables

There has been a sea change within the wearables industry. In a remarkable turn of events, Apple looks to have grabbed the wearables unit sales crown from Fitbit this past holiday season. It's time to begin thinking about wearables not just as standalone devices for the wrist, but rather platforms containing a number of products designed for different parts of the body. In this environment, Apple has become the new wearables leader.

Change Is in the Air

Over the past few years, the wearables industry had come to revolve around two product categories targeting the wrist: 

  • Health & fitness trackers
  • Smartwatches

Fitbit and Apple have been the top two companies selling wearables in volume. While Fitbit's assortment of health & fitness trackers outsold Apple Watch in terms of unit sales, the higher-priced Apple Watch gave Apple the revenue edge. After initially positioning Apple Watch as a mini iPhone on the wrist, Apple changed strategies last year in an effort to close the unit sales gap between Fitbit and Apple Watch. Management shifted Apple Watch marketing more towards health & fitness while lowering the entry-level price and expanding the product line to include more fitness-oriented Watches. 

The ingredients for an interesting holiday quarter for the wearables industry seemed to be in place. The debate centered on whether or not Apple would be able to entice people to embrace smartwatches instead of dedicated health & fitness trackers. However, Fitbit had an early November surprise announcement. The company disclosed a sudden deterioration in customer demand in 3Q16, and the negative trends had continued into October. The slowdown caught Fitbit off guard. Management was forced to issue very weak financial guidance for the upcoming holiday shopping season. More worrying, management didn't seem to know what was driving the sudden decline in demand. While Apple Watch was a prime suspect, Fitbit has never publicly viewed Apple as a competitive threat.

Despite lowering sales expectations, Fitbit still ended up missing its holiday sales forecast. The company hit a brick wall in terms of sales growth. Demand for Fitbit products completely evaporated at the end of the year with the company seeing a 21% decline in unit sales in 4Q16. Just one year earlier, Fitbit had reported 55% unit sales growth. 

While Fitbit saw weakening consumer demand, other wearables players reported much more positive results. Apple reported record Apple Watch sales in 4Q16. Fossil and Garmin also saw promising smartwatch trends. (My Fossil and Garmin 4Q16 earnings analysis is available here and here, respectively.) Garmin even described a scenario of robust smartwatch demand during the holidays. While consumers turned away from Fitbit health & fitness trackers during the second half of 2016, smartwatches have been gaining momentum. 

By the Numbers

The shift in consumer preferences regarding fitness & health trackers and smartwatches is visible when comparing Fitbit and Apple Watch unit sales. As seen in Exhibit 1, Apple nearly closed the unit sales gap between Apple Watch and Fitbit last quarter. During 4Q16, Fitbit sold 6.5M devices at an average selling price of $85. Meanwhile, Apple sold 5.6M Apple Watches at an average selling price of $372. 

Exhibit 1: Fitbit vs. Apple Watch Unit Sales

Exhibit 1 would seem to suggest that despite significant sales trouble, Fitbit was still able to keep its title as the best-selling wearables company in the world. Upon closer examination, there is more to the story. Apple was not able to meet Apple Watch demand during the holiday quarter as Apple Watch Series 2 faced severe supply shortages. Meanwhile, Fitbit was stuck with elevated inventory levels throughout the holiday season. Accordingly, on a sell-through basis, Apple Watch and Fitbit demand was likely neck and neck. This is an astounding turn of events from the previous holiday quarter when Fitbit outsold Apple Watch by 1.7x.

A New Product

On a sell-through basis, Fitbit may have been able to just squeak by Apple Watch to retain the title of best-selling wearables company over the holidays. However, there is still a missing piece to the discussion. The definition of wearables has changed. This past holiday season saw the introduction of AirPods, Apple's second wearables product

After a two-month delay, Apple began selling AirPods in mid-December. When taking into account AirPods launch sales during the last two weeks of December, I estimate Apple sold more wearables devices than Fitbit during the holiday quarter.

Apple's 4Q16 Wearables Sales:

  • Apple Watch: 5.6M units (my estimate - details are available here)
  • AirPods: 1.0M units (my estimate - details are available here)
  • Total: 6.6M units

Note: This total does not include Beats headphones containing Apple's W1 chip. 

When taking into account AirPods sales, the sales data from Exhibit 1 looks a bit different. As seen in Exhibit 2, Apple sold more wearables than Fitbit for the first time last quarter. Considering how both Apple Watch and AirPods were supply constrained (AirPods are still severely supply constrained), it is responsible to assume Apple could have easily sold eight or nine million wearables devices last quarter. This would be 60% more than the number of Macs sold and 65% of iPad unit sales. 

Exhibit 2: Fitbit vs. Apple Watch and AirPods Unit Sales

Platform Play

On Apple's 1Q17 earnings call, Apple introduced a new way of describing Apple Watch and AirPods. Here's Tim Cook: 

"With AirPods off to a fantastic start, a strong full first year for Apple Watch, and Beats headphones offering a great wireless experience using the Apple-designed W1 chip, we now have a rich lineup of wearable products. Their design, elegance, and ease of use make us very excited about the huge growth potential for wearables going forward."

The wearables industry is rapidly turning into a platform play. The winners will be those companies offering a range of wearable devices. Apple Watch, AirPods, and W1 chip-equipped Beats headphones represent Apple's wearables platform. As seen in the following diagram, the wearables market is best viewed as a collection of distinct battles for real estate: wrists, ears, eyes, and body (i.e. clothing). At this point, the wrist and ears are the two areas ready for mass-market products. Additional battles for the eyes and body remain R&D projects at this point given design and technological barriers. 

 
 

Apple is currently the only company playing in at least two wearables geographies at scale (wrist and ears). Many are underestimating the benefits associated with this type of control over a wearables platform. Similar to how strong loyalty and high satisfaction have resulted in low churn within the iPhone installed base, satisfied Apple Watch owners are that much more likely to buy AirPods and vice versa. As consumers embrace a full suite of wearables products, it doesn't hurt Apple to have an existing user base of more than 800 million people. 

Changing Competition

The significant change found at the top of the wearables market with Apple overtaking Fitbit in terms of unit sales signals a broader shift within the industry. Consumers are gravitating toward greater utility on the wrist. Dedicated health & fitness trackers are displaying many of the same characteristics shown by cheap MP3 players at the beginning of the iPod era. Consumers are beginning to bypass cheap alternatives with limited functionality and reliability and instead value additional functionality. 

Fitbit's growing struggles provide a new perspective on how competition is unfolding in the wearables market. Instead of the battle existing between wearables companies, the true competition is found between wearables and non-wearables. Apple's primary wearables competitor isn't Fitbit, Garmin, Fossil, or Samsung. Instead, Apple is competing for the same wrist real estate as legacy watch and jewelry companies. Even bare wrists represent prime competition for Apple Watch. Going forward, this battle for real estate is only going to intensify and expand to the ears. 

A closer look at Fitbit's strategy would reveal the company misidentified its competition. Instead of looking at bare wrists and non-wearables as the competition, which would have led Fitbit to push much further and faster up market in terms of capability and functionality, Fitbit assumed its only competition was multi-purpose smartwatches retailing for four or five times the price of Fitbit. Management assumed the dedicated health & fitness tracker and smartwatch segments were distinct enough to coexist and appeal to different target markets. In reality, the pricing gap between the two categories had been rapidly shrinking, and the two product categories were increasingly chasing after the same group of people, which only made matters worse for Fitbit. The company got caught with an inadequate product line that didn't resonate with consumers. This would explain Fitbit's recent decision to reduce its product line in 2017 and instead go up market with its own smartwatch.

As for Apple, the company is showing all of the signs of placing a very big bet on wearables. Not only is management completely on board with wearables, but the company's Industrial Design group has been moving towards wearables for years. As seen in Exhibit 3, the wearables segment represents a key growth opportunity for Apple. In 2016, there were approximately 50M wearable devices shipped (not including cheap step and sleep trackers). This compares to the nearly 175M tablets and 1.5 billion smartphones shipped. It is only a matter of time before wearables outsell tablets. 

Exhibit 3: Wearables, Tablets, and Smartphones Unit Sales (2016)

The body represents a new battleground in tech. A vibrant wearables platform consisting of Apple Watch, AirPods, and Beats headphones has positioned Apple as the new leader in the wearables market. While Apple still faces various risks and challenges in the wearables space when it comes to adoption, the amount of progress seen in just the past two years bodes well for wearables playing a pivotal role in our lives.

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