Tech Observations during the Holidays

I use holiday dinners, brunches, and gatherings to observe tech trends among family and friends. I’m convinced at times that anecdotal evidence is just as useful as a fancy “scientific” study. Since I am observing mostly the same people each year, sampling bias should be somewhat reduced. Here are some observations from the past two weeks:

1. Phones. Within my social circle, it comes down to an iPhone, Samsung Galaxy phone, or feature phone. It has been like this for at least a year, but I am not exaggerating when I say I saw no other kind of phone. The iPhone 6/6 Plus upgrade cycle looks to be very strong, with older iPhone models (iPhone 5c) making inroads in families with 3-4+ phones. Phone personalization via various phone cases is also rampant. 
2. Phone Sizes. A Samsung Galaxy Note (5.7-inch display) was the biggest phone I saw in the wild, although iPhone 6 Plus (5.5-inch display) was somewhat popular among teenagers. There is still a yearning for the iPhone 5s display (4-inch). 
3. Apps. A few years back, I would hear conversation about the latest downloaded app or how a particular app was very cool. Not anymore. 
4. Cameras. Last year, I still saw a few instances of people using dedicated regular cameras. This year: no dedicated cameras. Most have switched over to smartphones given much easier sharing capabilities.
5. Tablets. I didn't see as much enthusiasm for tablets in 2014. Tablets are primarily being used as video players (Netflix and YouTube).  
6. TV. Still popular with more than a handful of instances of upgraded TV sets.
7. Wearables. Crickets.
8. Smart Home Devices. Crickets.
9. Other. Frustration with cable and home internet service providers is continuing to grow.

 Summing up my 2014 holiday tech observations:

• The iPhone 6/6 Plus have ushered in the largest iPhone upgrade cycle Apple has ever experienced.
• Samsung is holding its own among its loyal users in the phone market, but newer users to the brand are opting for older and cheaper Samsung Galaxy models.
• Smartphones are basically turning into cameras with social messaging capabilities.
• App discovery (and sadly innovation) seems to be slowing with concentrated pockets of exception. 
• People like watching video on big screens (i.e. televisions).
• Tablets continue to lose their cool factor, and bigger phones are taking over many use cases once held by tablets. 
• The first wave of smartwatches flopped.

The iPhone Was Different

Apple is currently an iPhone company with ancillary iPad, Mac, and software businesses. Few would have expected the iPhone to not only represent 60% of Apple's overall revenue within a few years after launch, but also transform the mobile industry in the process. Steve Jobs' initial goal was for the iPhone to sell 10 million units (capture 1% of the phone market) in 2008. Six years later, Apple sold 169 million iPhones in 2014 (8% share of a much bigger phone market). With the Apple Watch launch a few months away, one question swirling around is how similar will the wearable device be compared to iPhone in terms of importance and popularity. While Apple may find success in positioning Apple Watch as a way to redefine certain aspects of mobile computing, the iPhone will always be known as the first mobile device that truly changed the world. A quick trip to the mall makes it very clear that the iPhone was different.

Over the weekend I ventured out to do some light shopping. Since it was still early in the morning, I decided to go past my usual turning point in the mall and walk the length of the complex. It was the first time I was seeing the other side of this particular mall in years. While there is always some level of attrition with mall retailers, I was quite surprised to see a series of storefronts that had bucked the trend. Instead of closing or reducing square footage, these stores had a larger footprint, merging a few storefronts, leading to a formidable presence in the mall's upper level. These stores started out as smaller kiosks near the food court, and now they were among the bigger stores in the mall. The growing footprint of these mobile carrier retail stores symbolize how the iPhone was different than other Apple products, riding the much bigger wave known as mobile.

Only 10 years ago, the mobile carriers were selling a few dozen "feature" phones, packed with the latest keyboard innovations. After a few minutes of figuring out how many night and weekend minutes would be acceptable, the new cellphone owner would run to find an area in the mall with good reception (that last part is still true today). With much higher foot traffic on any given day (U.S. smartphone penetration moved from 10% in 2009 to 70% in 2014), mobile carrier stores now serve as places to not only buy a more narrow range of gadgets, but also attend to monthly bills, and receive tech support (including cable and home internet for some). Since I buy my phones online, walking past the much-larger AT&T and Verizon stores in the mall reminded me how mobile computing has matured since the iPhone was introduced. While the iPhone is a great device enjoyed by millions, the mobile rocket it strapped itself to certainly helped drive cumulative sales of more than 550 million iPhones.  

Instead of transcending the mobile carriers, new Apple products in the near-term will likely be positioned to supplement the iPhone, improving on the device's initial breakthroughs in mobile. The iPhone was truly different; it only took a short walk in the mall, and a quick glance at the mobile carrier stores, to serve as a reminder. 

Apple SVP Operations Jeff Williams on BBC's Anti-Apple Documentary

One of my stories in today's AAPL Orchard email was the BBC going undercover into Pegatron, one of Apple's iPhone assemblers. This morning after publication, Apple's head of operations, Jeff Williams, wrote a memo to Apple's UK team addressing BBC's "Apple's Broken Promises" documentary. BBC sent three reporters undercover to work in a Pegatron iPhone factory. I was able to watch the documentary last night. I would recommend watching the video as I thought the first 30 minutes were relatively fair from a journalistic standpoint, including observations and recordings from inside Pegatron. I thought the documentary started to lose credibility in the second half when the discussion turned to the very bottom of Apple's supply chain, focused on tin mining. I wasn't alone as Apple's Williams dedicated a good portion of his memo to that part of the documentary.

Apple SVP Operations Jeff Williams:  

“Panorama showed some of the shocking conditions around tin mining in Indonesia. Apple has publicly stated that tin from Indonesia ends up in our products, and some of that tin likely comes from illegal mines. Here are the facts:

Tens of thousands of artisanal miners are selling tin through many middlemen to the smelters who supply to component suppliers who sell to the world. The government is not addressing the issue, and there is widespread corruption in the undeveloped supply chain. Our team visited the same parts of Indonesia visited by the BBC, and of course we are appalled by what’s going on there.

Apple has two choices: We could make sure all of our suppliers buy tin from smelters outside of Indonesia, which would probably be the easiest thing for us to do and would certainly shield us from criticism. But it would be the lazy and cowardly path, because it would do nothing to improve the situation for Indonesian workers or the environment since Apple consumes a tiny fraction of the tin mined there. We chose the second path, which is to stay engaged and try to drive a collective solution.

We spearheaded the creation of an Indonesian Tin Working Group with other technology companies. Apple is pushing to find and implement a system that holds smelters accountable so we can influence artisanal mining in Indonesia. It could be an approach such as “bagging and tagging” legally mined material, which has been successful over time in the Democratic Republic of the Congo. We are looking to drive similar results in Indonesia, which is the right thing to do.”

I thought the entire memo, but in particular that particular section, was well-written. It was tough watching children work in tin mines, but I knew that the BBC positioning these awful situations as being somehow approved by Apple was unfair and not trying to actually help these people. Williams did a good job at clearly explaining what Apple has been doing to address the situation, instead of simply telling its suppliers not to buy tin from those mines. The weird part about the BBC documentary was that the undercover reporters did notice a few protocols not being met inside Pegatron, which I assumed have already been addressed, but BBC went further and started to frame Apple as simply not caring about what was going on in its supply chain, or insinuating the more disingenuous claim that Apple approved of shortcuts or cheats meant to meet certain safety benchmarks or ratios. I thought the BBC reporter had an interesting story idea and took some risk to get the unique footage, but I suspect the conclusions were stretched too far in order to find a juicy story.  

Apple Will Save $3 Billion in 2015 by Selling the 16GB iPhone 6/6 Plus

Apple's decision to keep the entry-level storage tier at 16GB for the iPhone 6 and 6 Plus, despite doubling the other capacities to 64GB and 128GB, continues to raise eyebrows. Daring Fireball's John Gruber called it "the single-most disappointing aspect of the new phones." By not doubling the entry-level storage tier to 32GB, I estimate Apple will save $3 billion of profit in 2015. I suspect Apple's bigger concern was the long-term balance between customer's storages needs and maintaining the iPhone's aspirational brand.

Apple's near-term motive behind keeping the 16GB capacity option is pretty clear: get people to buy the 64GB option. From Apple's point of view, consumers would benefit as Apple didn't raise the price of the middle-tier or upper-tier iPhone storage options, despite doubling storage to 64GB and 128GB, respectively. I suspect the issue is a bit more complicated and involves setting precedence for future iPhone revisions, as shown in Exhibit 1. The problem with having three storage tiers in an environment where the lowest storage capacity will soon be able to outstrip customer needs is that Apple risks permanently moving users from higher-priced to lower-priced models, where the cumulative change starts impacting iPhone average selling prices (ASPs) by hundreds of dollars, representing a significant portion of the company's net income. 

Exhibit 1: iPhone Storage Scenarios 

With Option A, if Apple kept a 16GB storage tier for an additional year (as they are doing now) and got people to upgrade to 64GB (represented by the red arrow), in subsequent years, consumers will likely develop a dependency on that storage level and remain in that middle tier, even after Apple increases the lower tier to 32GB in the future. With Option B, by upgrading all three storage capacities at the same time in Year 2, some consumers will downgrade to the lower storage capacity (represented by the red arrows) as their storage needs would be met with a less expensive model. With both Options A and B, the most popular iPhone model by Year 3 would be the same: 64GB, only with Option A, consumers are paying an additional $100.  

Calculating the financial impact from keeping the 16GB model includes a few steps and calculations, highlighted in Exhibits 2 and 3. I have combined the financial impact from the iPhone 6 and 6 Plus in order to not miss the main point of this exercise; finding the difference in iPhone margin, both with and without the 16GB storage capacity tier.

Exhibit 2: Estimated iPhone 6/6 Plus Sales Mix and Margin Data Given Two Case Scenarios

By doubling the middle tier storage capacity to 64GB, while maintaining the price, and keeping the 16GB storage capacity at the bottom tier, I estimate that approximately 30% of previous 16GB iPhone owners will upgrade to 64GB to take advantage of the better deal, resulting in the 64GB being the best selling storage option (48% of sales mix), just slightly outpacing the 16GB version (43%). With the iPhone 5s/5c, I estimate the 16GB tier accounted for 60% of sales. If Apple upgraded the 16GB option to 32GB without changing the price, then it would have continued to be the most popular tier, even enticing some who had previously paid extra for 32GB to downgrade and buy the lower tier.

I estimate Apple's cost to upgrade the 16GB tier to 32GB to be approximately $15/device, leading to a little less than a 100 basis point weighted average decline in iPhone margin (to 48% from 49%).   

Exhibit 3: Estimated iPhone 6/6 Plus Sales, ASP, Revenue, and Net Income Data in 2015 Given Storage Scenarios from Exhibit 2

All else equal, I estimate that doubling the iPhone's lowest storage capacity tier from 16GB to 32GB would lower Apple's profit by $3 billion. While the storage differences would likely not have an impact on overall iPhone sales, ASP would decline as users opt for the less-expensive model. iPhone revenue would decline by an estimated $5 billion, leading to an after-tax decline of $3 billion in net income.

While some may say this discussion of purposely limiting storage capacities to help maintain profitability is anti-consumer and a money grab, observers need to look at this process as a bit more than just greed. Apple is able to manage iPhone's brand and image by maintaining the device's high price.  A case can be made that Apple is looking to get users dependent on higher storage capacities (at some point in the near future, 64GB will likely seem inadequate), by carefully guiding customers into a particular iPhone model each year. I suspect Apple kept the 16GB iPhone 6/6 Plus around in order to make future storage jumps, across all three tiers, a bit more manageable.  

Want to read more posts like this? Above Avalon is supported by members that receive my premium daily email containing additional Apple analysis (10-12 stories a week). For more information and to sign-up, visit the membership page.

Putting Apple's 20 Million Facebook Video Ad Views into Perspective

Last night I was surfing my Facebook News Feed, and up came Apple's recently released holiday commercial, "The Song." Facebook had it on muted autoplay. A screenshot is included:

The commercial has received 20.7 million total views. Last night around 9:00PM ET the video had around 18M views and was averaging nearly 1.3M views an hour. It would appear that it was showing up on News Feeds up until 11PM ET judging by the frequency and timing of new comments. Along with 20M+ views, the video has 210,000 likes and 8,800 comments, most of them positive (see Exhibit 1), so the engagement was definitely there despite the video being on autoplay. 

Exhibit 1: Comments Posted to Apple's Facebook Ad

At 20 million views, I was curious how that compared to Apple's typical advertisement venue; television (the video has 2.4 million views on YouTube where it doesn't seem like it has been part of a YouTube advertisement campaign). While an apples-to-apples comparsion would be tough, I looked at viewership data for Tuesday night's network TV lineup. 

Exhibit 2: U.S. Network Television Viewer Data - Top Shows - December 16, 2014

The obvious caveat is that viewer data for the networks includes both live and same day (DVR usage up until 3AM the following morning), while I can only estimate when the Apple ad first appeared on my News Feed. I'm sure there are additional subtleties that matter to marketers, such as 18-49 share, but the takeaway is clear: Facebook video ads matter. With a daily reach roughly on the same scale as prime time network television, not to mention all of the viewer interaction and targeted campaign possibilities, I expect to see future Apple video ads in my Facebook News Feed.