The App Store's Search Problem is Actually A Discovery Problem

Mobile apps are finally starting to fix web search. The side effect is trying to wade through 1.2 million apps in Apple's App Store. In solving one search problem, a new one has formed, only this time the answer isn’t to improve app search, but introduce better app discovery.

With the App Store honeymoon phase over and some of its coolness factor long gone, consumers' daily usage has settled on 12-24 apps with dozens more used sporadically. A few apps have done quite a good job at repackaging web content (WhatsApp, iMessage, email, Twitter, Facebook, Snapchat, Instagram) into an easily digestible format. As the number of apps available in the App Store exploded, the cries of a growing app search problem grew louder, but the main issue with this logic isn’t that users can’t find useful apps, it’s that users don’t know what they should even be searching for. If I hear about a specific app, I’m able to find it relatively quickly in the App Store. I rarely search for generic terms like “stock research” or “food” in the App Store primarily because there is no reason to search for apps like that, just as there is no reason to search the web like that.

The next phase in app discovery will be that same type of personalization we see now with how apps like Twitter are fixing web search, but this time combined with location data. Many apps are location-determinant as they have specific use cases in a certain environment: education, enterprise, sporting events, the list goes on. In iOS 7 Apple introduced the “Popular Near Me” feature, which shows apps that are popular near my current location. In my case, I am shown five local news apps. Am I interested in those apps? No, but at least it’s a start. In iOS 8, Apple introduced location-based app suggestions on the lock screen, but I rarely have seen real-world instances of this besides having a retail store app pop-up when I’m within a few hundreds yards.  In these two instances Apple is addressing the problem of finding apps, but not through better search, but rather better discovery.

A more useful method to foster app discovery is to combine continued location-based app suggestions with personalization. Knowing that I am interested in stocks and following certain people on Twitter, and seeing I’m in a bank, I can be given app suggestions that not only are related to finance, but have some connection to app developers I follow on Twitter or I have shown some liking in the past through other social platforms. My app suggestions are tailored just to me.  Apps are personal expressions of the world. Some of us will like certain apps while others won’t.  Bucket-type “apps near me” don’t work, just as location-based suggestions using nothing but my location doesn’t fully solve the app discovery problem either.  Once location and personalization are combined to give me relevant app suggestions, I will be able to look at the App Store's 1.2 million apps with a little bit less confusion and anxiety.  

P.S. Imagine if Ping was unveiled for the App Store instead of iTunes so that you can “follow” apps and developers while getting the much-requested app previews and free trials?  Would make personalization that much more interesting because I would bet if a consumer likes one developer, chances are good they may like other apps that developer "likes" or is friends with.

Finding Apple Strategy Clues in Apple Watch's Human Interface Guidelines

With over 40 tech blogs reporting on Apple's WatchKit release yesterday, there has been no shortage of designer and developer tidbits to digest including screen resolutions and fully native Apple Watch apps arriving in late 2015. I read the Apple Watch Human Interface Guidelines (HIG) with a different goal; to find clues as to how Apple will market Apple Watch.

During Apple's September Apple Watch keynote some observers thought Apple failed to demonstrate why someone should buy an Apple Watch. Instead of picking a few key selling points, Apple had VP of Technology Kevin Lynch go on stage and play with various apps and a confusing beehive-like layout of tiny icons. I disagreed as I thought Apple touched upon a few selling points that normal users might be interested in (maps, photos, communication) and the overall messaging was that the Apple Watch's full potential will be realized with third-party iOS apps. 

From my piece "Apple Keynote Notes":

"Apple didn't go into much detail about why someone should use an Apple Watch, instead demoing a few features that seemed cool or at least interesting. I think most of this is taken from the iPad playbook  - show users various things you can do with the device and then step back and see what sticks. At one point Apple even mentioned there is much more to say about the device, but there wasn't enough time."

Apple laid out three overarching design themes for Apple Watch in the HIG released yesterday: personal, holistic, and lightweight. Each not only helps describe Apple Watch, from its size to functionality, but also sheds some light on how Apple will market the device in relation to the iPhone. 

Personal - Apple goes out of its way to remind developers that the Apple Watch is something that is worn and therefore requires a level of personalization that has yet to be seen in the tech space.  The device's personal communication aspect (Digital Touch and the Taptic Engine) stands out as something that an iPhone just isn't able to accomplish. 

Holistic - A few days after purchasing my iPad, I knew the device was going to be a hit as the hardware seemingly melted away whenever I touched the screen. 

From my piece "iOS App Innovation and iPad 2 Design Lead to Magic":

"Remove the intermediary and let users interact directly with innovation." 

Apple is following a similar path with Apple Watch by stressing that the software must make the hardware disappear during usage. Such a requirement is made even more important due to the device being worn all day. 

Lightweight - The Apple Watch is meant to display small snippets of information and data. Instead of thinking of the device as a mini-iPhone, Apple wants developers to rethink how an Apple Watch user can consume data in a completely new way. Apple stressed key words that contained descriptive imagery, such as "briefly", "frequently", and "small display". 

I think these three Apple Watch design tenets go a long way in describing how Apple could market an Apple Watch. Apple will walk a thin line because if too much focus is put on the need to connect Apple Watch to an iPhone, consumers may look at the Apple Watch as an overpriced iPhone accessory, but overhype Apple Watch's capabilities and users may think they don't need the latest and greatest iPhone. 

How can Apple sell Apple Watch? Position the device as a way of improving one's iPhone. A device that can take iPhone's drawbacks and repackage the problem into new solutions. A few real-world examples of this strategy:

1. Communication. One of iPhone's communication problems is that the device needs to be both within the user's line-of-sight and reach to initiate or continue communication with someone. With Apple Watch, the user will be able to communicate only by touch (Taptic Engine) while the iPhone is tucked away in a pocket or purse, or lying on the passenger car seat. Granted, that type of communication is rudimentary when compared to iPhone's capabilities, but in certain contexts it is both efficient and effective. Users now have two distinct forms of communication: iPhone and Apple Watch.
2. Maps. The iPhone can be used to get turn-by-turn navigation to reach a parking lot or destination, but once the user is near that location on foot, the iPhone's utility diminishes as the need to actively look for real-world visual clues, as well as weaving in-and-out of pedestrian foot traffic, makes it difficult to have an iPhone in hand. An Apple Watch can be used via quick glances to determine if the destination is one block ahead or on the other side of the street while the iPhone is kept in a back pocket or backpack. Users now have two devices to use directions to reach a destination: iPhone for the sheer grunt work, Apple Watch for the nuance details at the end of the trip. 
3. Apple Pay. While Apple Pay and iPhone seem to work flawlessly, having to take your iPhone out of pocket and then hold it up to a POS terminal is not the most efficient process. Instead if users can rely on iPhone to manage payment information as well as retailer loyalty programs, but use Apple Watch to complete the retail transaction at POS. The iPhone remains safely in pocket or purse throughout the transaction, simplifying the process. 

In each case, both the Apple Watch and iPhone are required to accomplish a task, but the process of working through the "problem" is broken down into more granular tasks, with the more complicated and power-hungry steps kept on iPhone, while Apple Watch tackles the small finishing touches. Over time, it's not hard to see Apple Watch gaining more capabilities, but in the near-term the Apple Watch and iPhone can work together to improve one's efficiency. Apple's job in marketing Apple Watch will be to demonstrate how the iPhone's sheer power and capabilities produces some annoyances and then explain how Apple Watch can help solve those inconveniences.

Apple Watch Sales and Earnings Projections

Apple will start selling Apple Watch in early 2015 and based off of my analyses, I estimate Apple will sell 20-30 million Apple Watches bringing in $11 billion to $17 billion of revenue and $0.70-$1.00 of EPS over the first 12 months on the market. 

Apple Watch Addressable Market

Analysts are relying on various methods to arrive at Apple Watch's addressable market including surveys, prior Apple product launch sales trends, and current watch market data. I disagree with those methods since they contain significant issues or error-prone variables.

1. Surveys. Customer intention patterns do not correspond well with actual behavior. 
2. Previous Apple Product Launches as a Proxy. My biggest issue with this method is that it ignores the passage of time and ecosystem changes.
3. Current Watch Industry Data. As Apple has shown over the years it is pointless to use existing pre-Apple industry market data as a proxy for future Apple sales.

I extrapolate Apple's addressable market for Apple Watch from iOS adoption rates. I use the share of iOS devices that upgraded to the latest iOS release by the end of the first full day after release as a proxy for Apple's most loyal customer base. I classify these users as a fair approximation of Apple's initial addressable market for an Apple Watch. Using a 2.4-year iPhone replacement cycle, I estimate there are approximately 400 million iPhones in use today. Since there are older devices resold or passed down to children and relatives, I would label the 400M data point as a base case estimate.

I consider a user that upgrades to the latest iOS release within the first full day after release as someone who is more interested in their phone and consequentially Apple. Why? These users are actively seeking out, and then upgrading, their iOS software which demonstrates an interest in their device or a willingness to try the latest software product. The steep adoption rate drop-off from iOS7 to iOS8 suggest there wasn’t much of an impact from Apple automatically sending a download notification to devices on the first day of a major software release this year. Exhibit 1 displays adoption rate estimates for the previous three iOS version launches. 

Exhibit 1: Apple iOS Adoption Rates 

Using the average between Mixpanel and Fiksu, I arrive at 13%, however Mixpanel has historically tracked closer to Apple's reported adoption rates, therefore I increased the 13% average to 15% to reflect a greater weighting for Mixpanel. I then multiplied that percentage by the 400 million iPhones out in the wild to arrive at approximately 60M core iPhone users that serve as a prime target to sell Apple Watch (which requires an iPhone 5, 5c, 5s, 6, or 6 Plus). It is important to note, as Apple VP Greg Joswiak said recently at the Code/Mobile conference, the Apple Watch is geared for everyone and not just those interested in technology. However, due to the requirement of owning an iPhone, I think 60 million is a fair estimate of the number of people interested in buying an Apple Watch from Day 1. Another variable is since adoption rates reflect iOS devices, there may be an impact from the same user upgrading all of his or her iOS devices at the same time. Considering the steep adoption rate drop off from iOS 7 to iOS 8, this impact doesn't worry me too much as I consider my 15% estimate to be a base case as there were many users who could not upgrade to iOS 8 on the first day because of a lack of storage. 

Apple Watch Sales Projections 

With my 60M estimate for the addressable Apple Watch market, I assume everyone in this group buys an Apple Watch over the first 12-18 months. Taking into consideration Apple Watch prices, a certain amount of time may be needed before a purchase is made therefore I backloaded sales into the second year to arrive at 20-30M units sold in Year 1 and 30-40 million units sold in Year 2. 

Exhibit 2: Apple Watch Sales Projections

Apple Watch Average Selling Price Estimate 

I estimate the Apple Watch average selling price (ASP) to be $563, as shown in Exhibit 3. While the $349 price for Apple Watch Sport has been announced, I included estimated selling prices for the other two watch collections. My estimates do not include additional Apple Watch band revenue. I am estimating a $7,500 estimate for a supply constrained Apple Watch Edition. I wouldn't expect much of a difference in demand moving from $3,000 to  $7,500, so in order to maintain its exclusivity, I expect Apple to set a high price.  The obvious risk to my logic is if Apple prices the Edition collection closer to $1500 and includes a viable replacement program, driving much more in the way of sales, but even then the ASP would only change by approximately 15%.  I expect China to be a big variable when estimating Apple Watch Edition sales, but for now I am including a limited production schedule at least in the first few quarters of release.

Exhibit 3: Apple Watch Collection Breakdown and ASP Estimate

Apple Watch Sales and EPS Estimates 

Exhibit 4 includes my estimates for a few Apple income statement line items. I estimate Apple Watch margins will come in less than iPhone, but higher than iPad with economics of scale adding a few hundred basis points of margin over time. Obviously this is an inexact science and watch accessories can help boost margin. Estimates reflect continued share buyback through 2016.

Exhibit 4: Apple Watch Revenue and EPS Estimates

Conclusions

I suspect Apple may have a hit on their hands with Apple Watch. Running with a 15% iPhone base penetration rate, I estimate Apple will be able to sell upwards of 60 million Apple Watches over the first 24 months on the market with more risk to the upside given Apple's strong iPhone guidance for this quarter.  From an EPS perspective, Apple Watch can add between $0.70-$1.00 in the first 12 months after launch. 

 

This report should be used to understand where I stand on Apple Watch especially when I discuss the product in my daily email, AAPL Orchard, or in other Above Avalon reports. Over the coming months, if new data becomes available, I will update my estimates accordingly. This report is not meant to be used as investment advice. Downside risks to my estimates include: Apple Watch supply issues and weaker-than-expected customer demand. Upside risks to my estimates include: Stronger-than-expected customer demand, especially in China.  This report was produced by Neil Cybart on November 18, 2014. 

I publish a daily email called AAPL Orchard containing interesting Apple-related links and analyses. Click here to subscribe. 

UnionPay Received an Apple Press Release

Event: Customers in China can now use UnionPay for App Store purchases.  

1) Apple has issued 48 press releases YTD in 2014, all of which have a certain level of importance and noteworthiness, which stands at contrast to many other companies of Apple's size. 

2) I judge an Apple press release's importance by its Apple executive quote. Apple SVP Eddy Cue in announcing UnionPay support: "The ability to buy apps and make purchases using UnionPay cards has been one of the most requested features from our customers in China" and "China is already [Apple's] second largest market for app downloads, and now we're providing users with an incredibly convenient way to purchase their favorite apps with just one-tap." I really wouldn't read much more into the announcement. Apple expects this deal will boost app purchases in China, simultaneously boosting the iOS ecosystem. 

3) China is an interesting topic when analyzing Apple. Many assume that China represents untapped potential where Apple will win simply by opening retail stores and selling new product. In reality, Apple has been working extremely hard and has faced numerous challenges in China.  Greater China (Hong Kong, Taiwan, and the mainland) currently represents approximately 15% of Apple's revenue. This UnionPay press release embodies one small victory that when combined with years of work will likely lead to China being Apple's largest market. 

Samsung's White Flag

Event: With its smartphone business prospects looking darker by the day, Samsung is now turning to the Internet of things for growth.  

Samsung's battle with Apple in the high-end consumer tech space is likely over.  This past February I wrote a piece titled, "Samsung's Crisis of Design 2.0" referencing Samsung's utter lack of direction and focus with half-baked smartwatch ideas and subpar smartphone industrial design. The first "crisis" occurred when Samsung was unsure how to compete with the iPhone's user experience back in 2010. Now in an effort to find growth Samsung is focused on the Internet of things despite software being the company's weak point. Engineers are being shuffled around,  management tension is building, and the company is still trying to find something that will stick against the wall.  Two months ago Tim Cook was on Charlie Rose and when the question about Apple's competitors came up, Tim Cook quickly responded "Google" and then mentioned how Google enables other hardware companies, like Samsung.  The message was clear: Samsung was already placed in Apple's irrelevant bucket.  I suspect Samsung will give the low-end smartwatch space another try once the Apple Watch is released, but with design and software being Samsung's weak points, my expectations are set pretty low.