Samsung's Issues Look Weirder by the Day

The WSJ is reporting ($) that Samsung is considering a significant management shake-up to address slumping Galaxy S5 sales and an overall deteriorating mobile device outlook. 

I have the following thoughts/questions:

• The WSJ, citing sources, reported that Samsung management mistakes and errors contributed to a significant Galaxy S5 inventory buildup "forcing Samsung to increase marketing expenditures to unload the devices". That line sounded odd to me given that Samsung had just come off of a record year for marketing costs, spending $14B in 2013, nearly 14x more than Apple on a dollar basis. Considering most of Samsung's 2013 phone sales involved some portion of this marketing/carrier promotion, were continued 2014 phone promotions actually a result of management incorrectly estimating demand or did Samsung simply carry-over some of these now dependent promotion practices from 2013 to maintain sales momentum?

• The article says 12M Galaxy S5 smartphones were "sold to consumers" in the first three months following launch. That figure seemed low to me, especially when I think back to prior WSJ articles, around the time the Galaxy S5 launched, discussing Samsung's bullish prospects and sales figures. After a few minutes of searching, I found($) the WSJ's "Samsung Says New Galaxy S5 Is Off to Strong Start" article in which Samsung Mobile Chief J.K. Shin was interviewed. He said sales of the Galaxy S5 were 11 million in the first month, outselling the Galaxy S4 by a million. Shin went on to say S5 sales were "much stronger than the Galaxy S4". How did the number of Galaxy S5 phones go from 11 million for the first month of sales to 12 million for the first three months? I assume it once again comes down to the "ship" vs. "sold" dynamic, where Samsung's sell-through sales were much weaker than units shipped to carriers,  but that doesn't give me much comfort as Shin even went out of his way and commented that S5 sales were much stronger than S4. I am left wondering if Shin was lying or if this is a case of Samsung losing touch with reality and not even having data as to how their phones were selling. 

• Galaxy S5 sales were down 50% in China versus Galaxy S4 during the first six months of sales, while the U.S. was the only major market where S5 sales were better than S4. Low-end Chinese smartphone competitors are impacting Samsung much more than third-tier phone vendors in the U.S., where Samsung faces slightly less competitive pressure on the low-end and subsidies mask some of the price differential. I suspect promotions are still playing quite an active role in the U.S. as well.  

All of this stands in stark contrast to Apple's iPhone strategy where product sell-through numbers don't diverge much from shipped figures, especially when Apple is experiencing a supply/demand imbalance, and if there is a difference, Apple will clearly indicate the change in the earnings conference call.  Apple's now notorious relationship with carriers, which include sometimes aggressive iPhone sales benchmarks and contracts, compare to Samsung's reliance on carriers for data about its products and markets. With Samsung overshooting Galaxy S5 demand by 40%, either management misread the market incorrectly or other opportunities and products served as a distraction. Given all of the turmoil, it's fair to start wondering if Samsung's response to the Apple Watch, if there will be one, is delayed or at least put on hold as a result of the company's mobile struggles.

Assessing Apple Watch's Primary Risk

Last week I published my Apple Watch sales projections. Some of the feedback I received dealt with how I can be confident that Apple Watch won't have build-quality issues or other performance problems. Taking into account Apple's product-focused structure and the way risk is mitigated, I think a more appropriate criticism would be to question Apple Watch's biggest risk: consumer acceptance.

Apple's Risk Mitigation

Much of Apple’s recent success can be explained by the company's organizational structure mitigating internal risk, such as lack of attention or motivation, and ineffective collaboration, leaving only external risk embodied by consumer demand. I went into this phenomenon in greater detail in my article, “Making Big Beats and Controlling Risk – How Apple Succeeds." Apple's structure allows decision makers (upper management) to come in contact with everything that is shipped to consumers and, more importantly, everyone who is in charge of the product (designers, marketers, engineers). Within the past four years, Apple's executive team has seen nearly 50% turnover, including a new CEO, and yet Apple is still functioning, showcasing how this process is built to last beyond its current operators.  

For many companies the concept of mitigating internal risk and leaving the consumer as the biggest unknown variable is underappreciated, since such an action positions a company to rely on marketing and storytelling to sell a well-designed product. The iPad is a prime example of this strategy as Apple's marketing team was tasked with addressing the last remaining risk factor: customer demand. Consumers needed to hold and play with the device in order to understand its magic and eventually find a need for it in their lives. If the device wasn't ready to ship due to hardware or software issues, Apple would have delayed the launch. On the other hand, Apple Maps is a good example of when the Apple Machine isn't well-oiled and risk is kept internally with nasty politics possibly getting in the way of Apple's product-focused strategy.

Apple Watch's Risk 

Apple Watch's biggest risk is consumer acceptance, not poor material design or bad software. Will consumers envision an Apple Watch fitting in their daily schedule? Over the past few weeks I've laid out several use cases that I think make a compelling argument for how the Apple Watch can function alongside an iPhone, all of which invoke the same theme: breaking the "problem" into more granular tasks, with the more complicated and power-hungry steps kept to iPhone, while Apple Watch tackles the finishing touches. Apple's primary job to address consumer demand risk is to focus on marketing, showcasing Apple Watch in various settings outside the tech world and installing Apple Watch demo units throughout the Apple retail distribution network, allowing consumers to wear and test the product. 

Word-of-mouth marketing is another variable that is left largely out of Apple's control. With an addressable market numbering in the 10s of millions of iOS users, these early Apple Watch adopters will play a role in determining what kind of adoption rate the Apple Watch experiences in its first few years on the market. If internal risk factors are mitigated during the product development cycle, a well-engineered device is created with consumer demand left as the biggest risk.

Estimating Subscribers for a Revamped Beats Music Streaming Service

With three publications reporting Apple is looking to bundle Beats Music into iOS in 2015, it's prudent to start thinking about the size of an Apple music streaming service.

U.S. Market Opportunity

A Beats Music streaming service bundled into a future iOS update has the potential of being the largest paid subscription music service in the U.S. assuming Apple adopts a free ad-supported tier as well as a $5/month or $60/year paid tier. I reach this hypothesis by taking iTunes Radio adoption and growing it to account for a much better streaming Beats service (using the current product as a base).  Exhibit 1 includes my estimates for U.S. paid and total subscribers as well as my rationale behind the estimates marked in red.

Exhibit 1: Beats Music Streaming Sub Potential - U.S. 

Global Market (Including U.S.) Opportunity 

One of the big unknowns is if Beats Music will eventually have the same global footprint as Spotify. Assuming Beats Music is bundled in iOS and is available in many countries, I suspect Apple's music streaming service could be bigger than Spotify. I reach this hypothesis by using Spotify's global to U.S. paid subscriber ratio and assuming Beats carries a more U.S.-centric focus, detailed in Exhibit 2. 

Exhibit 2: Beats Music Streaming Sub Potential - Global. 

Running further with revenue assumptions would quickly reveal that a Beats Music streaming service bundled into a future iOS update would not have a significant impact on Apple's income statement. Nevertheless the potential of Apple holding off competitors and remaining on top of the music relevancy chart has the potential of being much more valuable.

Interesting iPhone/Sapphire Tidbit from the WSJ

Event: Information about Apple's sapphire usage was tucked within the WSJ's fascinating look into the troubled Apple and GT Advanced Technologies sapphire deal. - Link ($)

From the WSJ: 

"Apple consumes one-fourth of the world’s supply of sapphire to cover the iPhone’s camera lens and fingerprint reader. Early last year, the company began looking for a much larger supply, to cover the iPhone’s screen."

Apple's intention with sapphire and the iPhone is becoming clearer: With sapphire already being used for the iPhone camera lens and fingerprint reader, and now the iPad fingerprint reader, Apple needed a significant amount of sapphire supply to come onto the market if it wanted to use the material for iPhone screens. Sapphire's biggest benefit is being scratch resistance, as seen in this video, while negatives include weight and cost (which Apple looked to alleviate by having GT innovate in terms of production). Due to the combination of managerial mishaps at GT and changing Apple requests, the sapphire being produced did not meet Apple's strict standards. 

From all indications Apple is still interested in using sapphire for iPhone screens (would have served as a nice upgrade feature for the more expensive 6 Plus), but for now any near-term plans seem to be on hold. There is no reason to assume Apple is facing a sapphire supply issue for Apple Watch (the Apple Watch and Apple Watch Edition collections use sapphire crystal) considering GT was geared towards sapphire for iPhone screens. I estimate Apple will sell approximately 30 million Apple Watch and Apple Watch Edition collection units over the first two years on the market (out of a total 60 million Apple Watch units). The sapphire supply needed for 30 million Apple Watch screens over the next two years pales in comparsion to the approximate 400 million iPhones that will be sold during the same time period. 

iPhone 6 vs. iPhone 6 Plus Sales Update

With the new iPhones on the market for a little over two months, I'm able to make some initial comments as to how the iPhone 6 is selling in comparsion to the iPhone 6 Plus. 

What the data says: The iPhone 6 was initially outselling the iPhone 6 Plus by approximately 6 to 1 at launch, but over the last nine weeks as iPhone 6 Plus supply has ramped up and the new iPhones launched in China, the iPhone 6 is now outselling the Plus by approximately 3 to 1 according to Mixpanel and Fiksu. Tech analyst Ben Bajarin reported Baidu/Umeng data suggests a similar breakdown between iPhone models in China. 

What the data doesn't say: We still don't know how iPhone demand/supply imbalance is impacting consumer purchasing decisions. Are consumers choosing the model that is in stock in-stores or with a shorter wait time online? In the Apple U.S. online store, the 16GB iPhone 6 Plus ships in 7-10 business days while the 16GB iPhone 6 ships in 5-7 business days. 

Looking ahead: I wouldn't be surprised if the iPhone 6 to iPhone 6 Plus ratio trends towards 2.5 to 1 suggesting approximately 70% of consumers are choosing iPhone 6 and 30% are choosing iPhone 6 Plus. Why? The iPhone 6 Plus may represent a good compromise for consumers deciding between a phone and tablet. I can envision a scenario where some consumers not interested in the latest tech gadget actually prefer the iPhone 6 Plus because it is easier to read text and watch video on compared to the iPhone 6. Offsetting this trend, the Plus' higher price tag may make the iPhone 6 a more popular choice for parents buying phones for their children or budget-conscious customers that don't want an iPhone 5s or 5c.  

Apple Impact: The iPhone 6 Plus has a higher margin than the iPhone 6 which should help Apple's financials. I still view iPad cannibalization at the hands of iPhone 6 Plus as a long-term positive for Apple given the higher iPhone margin and the customer remaining in the iOS ecosystem.