Apple's Cash Dilemma

With approximately $200 billion of cash on the balance sheet, Apple's financial strength has never been stronger. However, Apple has a growing dilemma on its hands concerning its cash and capital return program. Apple is unable to keep the pace of share buybacks and dividends in-line with its foreign cash generation.  As a result, excess cash that is not needed to run Apple's business continues to build on the balance sheet. While labeling a company with $200 billion of cash as having a cash dilemma seems like hyperbole, Apple's valuation metrics will likely be negatively impacted in the coming years if Apple is unable to return this excess cash to shareholders. 

Apple's Total Cash Continues to Increase

Apple currently has $194 billion of cash, cash equivalents, and marketable securities. Not only is this a record in terms of cash held by a single company, but it represents approximately 10% of all cash held on corporate balance sheets. Given Apple's business model, it does not need all of this cash to run its business. With an enterprise value of $583 billion, Apple would theoretically be able to repurchase 30% of itself using the cash on its balance sheet. In reality, things are much more complicated as most of this cash is not able to be used for share buyback because it is held offshore and would be liable for additional tax if returned to the U.S.

Exhibit 1: Apple's Total Cash, Cash Equivalents and Marketable Securities  

Most of Apple's Cash is Held Offshore

Apple's foreign cash continues to comprise a growing portion of Apple's overall cash. In the eight years since the iPhone was released, Apple's foreign cash has grown to $171 billion from $7 billion and now accounts for 89% of Apple's total cash, up from 44% in 2007. With approximately 70% of annual revenue coming from outside the U.S., Apple's foreign cash will continue to grow at a much faster pace than its U.S. cash. Apple has been content with keeping foreign cash offshore in order to avoid paying additional tax if it was brought back to the U.S. 

Exhibit 2: Apple's Total Cash, Cash Equivalents and Marketable Securities (Foreign vs. U.S.)

Apple has been using some of its foreign cash for organic growth initiatives, including component procurement, international retail and facility expansion, and clean energy initiatives. Even after all of these expenses, cash generation continues to exceed what management needs to run the business.  

This past quarter, Apple sold more iPhones in China than in the U.S. for the first time. Rather than this being an isolated event, China will only become a bigger piece of the iPhone sales pie given social-economic trends and an untapped market of more than 600 million phone users. The end result is Apple's foreign cash generation will continue to vastly outpace U.S. cash generation.

Apple's U.S. Cash is Being Depleted

With foreign cash being kept offshore, Apple is forced to use its U.S. cash to fund the capital return program. As a result, Apple has a more "modest" $22 billion of cash available in the U.S., which reflects the impact of more than $40 billion of debt issuance over the past three years. Without issuing debt, Apple would only be able to rely on U.S. free cash flow generation of approximately $20-$25 billion a year to fund buyback and dividends. It is important to remember that Apple needs a certain level of available cash in the U.S. to take care of routine business expenses, not to mention have cash on hand to take advantage of M&A opportunities. It is not prudent to allow this cash total to fall too low, and management has shown the willingness to slow share buybacks instead of depleting U.S. cash reserves.

Exhibit 3: Apple's Cash, Cash Equivalents and Marketable Securities (U.S.)

The Dilemma

Apple's cash dilemma is straight-forward: Apple is generating cash internationally at a much faster rate than it is able to spend on stock repurchases and cash dividends in the U.S. As China continues to make up a larger portion of Apple's product sales, boosting total free cash flow, management is facing some limits as to the amount of available funds used for stock buyback and dividends. The following exhibit shows how the amount of free cash flow (red line) is expected to outpace the amount of cash spent on buyback and dividends (blue line) in the coming years. China is increasingly causing the red line to slope upward as time goes on while the blue line is being pinned as the U.S. is becoming a smaller piece of the overall cash generation pie. In an ideal world, there would no gap between the red and blue lines as most of Apple's free cash flow would be spent on buyback and dividends. 

Exhibit 4: Apple's Cash Dilemma

Apple's Options

Management does not have many available options at its disposable for solving its cash dilemma. 

• Lobby for U.S. Tax Law Changes/Holiday. The preferred option would be returning cash currently held offshore back to the U.S. in an environment with a lower tax rate (15% or less), or during a special tax holiday similar to 2004. Obviously, Apple would want a rate in the single-digits, but Washington politics may make any change to tax policy a long shot. If the tax rate was lowered, Apple would be able to bring back $140-$150 billion of foreign cash and then buy back up to 20% of itself in relative short-order through a public tender offer. At a forward price/earnings ratio of 12x and a free cash flow yield of 6%, Apple management likely views AAPL's current valuation as attractive for such a tender offer. 
• Continue Issuing Debt to Fund Capital Return. Apple is currently using a combination of debt and U.S. free cash flow to fund share buyback and dividends. As Apple's foreign cash grows, Apple can continue to borrow additional debt. However, Apple's cash dilemma will not be solved as foreign cash generation will still likely outpace the rate of capital return even after considering a realistic amount of debt issuance each year. Eventually, Apple would be holding $400-$500 billion of cash, almost all of it offshore, and $150 billion of debt, all of which would have been spent on the capital return program. Apple would then need to manage its debt obligations, only straining its U.S. cash needs even more. Management may begin to cool to the idea of issuing significant amounts of debt if interest rates rise or if Apple's business slows, further making this option somewhat unsustainable in the long run. 
• Do Nothing. Management could also slow debt issuance and simply spend less on share buyback. This option would be taken with balance sheet preservation in mind. If Apple slowed all buyback activity, both U.S. and foreign cash would increase and Apple would likely reach $400 billion of total cash in relative short-order. The risk to this option is Wall Street's reaction to Apple sitting on too much excess capital, a scenario that had begun to play out in 2011-2012, and some can argue, is still playing out today. 

How is Holding too Much Cash a Dilemma?

Apple's market valuation is obtained in the marketplace at a price where AAPL buyers and sellers are willing to trade shares to each other. If there is greater demand for shares at a certain price, the price will rise until demand and supply are in equilibrium. Investors buying Apple shares are interested in owning a piece of the company's assets used to generate cash in the future. Since a company's value is obtained by discounting future cash flows and excess cash is not involved in future cash generation, the market is forced to include the cash in its Apple valuation. The end result is there is a high likelihood of either Apple's cash being valued incorrectly, or much more likely, Apple's underlying business being valued at a discount. This is the fundamental logic behind those that have been pushing Apple to use its excess cash to buy back more stock. 

Unless foreign cash is brought back to the U.S. in order to boost the magnitude of share buyback, Apple's excess cash will continue to grow, and the valuation metric that the market is giving Apple will continue to be suppressed. This is one likely reason why Apple is trading at a 12x forward P/E multiple. Apple CFO Luca Maestri has quite the dilemma on his hands.  

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Apple Is Playing Offense at WWDC

Apple is on the offensive. This is not a company content with standing by and letting Google, Facebook, Spotify and a handful of other third-parties take over critical elements of the user experience of approximately 500 million iPhone users. Instead of just swinging a sword and trying to compete with everyone indiscriminately, Apple is carefully positioning its resources and the overall iOS platform to stress value propositions at which Apple has historically excelled. These include personalization, emotion, and privacy. WWDC highlights how battles are being chosen meticulously as Apple's mission is clear: reducing its dependency on others. With the News app, Apple is trying to change users' habits in terms of how they get content. Apple Music is a test in how successful Apple will be once again in not just getting customers to pay for something that is free elsewhere, but rethinking the music industry. Siri and Spotlight are being positioned as Apple's method for rethinking search. Instead of sitting back and letting third-parties have all the fun, Apple wants more. 

The Chess Game Heading into WWDC

Apple had the wind at its back headed into this year's WWDC. The iPhone 6 and 6 Plus have resonated with consumers across the world, especially in China, leading to more than 40% unit growth year-to-date in 2015. One metric that Tim Cook has reiterated on recent earnings conference calls is the Android switcher rate, or the percent of iPhone sales that can be attributed to former Android users. Recent Kantar data and Above Avalon estimates would suggest that approximately 20-25% of iPhone sales in 2015 have come from customers new to iOS, which totals to nearly 25-30 million users entering the iOS ecosystem for the first time. 

The iOS platform has hit critical mass; it is large enough to sustain app innovation and developer interest. Nearly every major third-party consumer-facing technology company, including Google, Apple's primary competitor, have all but guaranteed support for the iOS platform, a noteworthy reversal from years of doubt and cynicism from those who warned Apple's smartphone 10% market share may eventually be outmatched by Android's massive reach. The problem with that logic turned out to be that Apple actually has 70%+ market share in the premium smartphone market which includes those who are very likely to use apps and services.

On top of that, Google and Facebook have business models that depend on obtaining data at scale, and Apple's highly engaged users are a prime target. It would be difficult, if not impossible, for Google and Facebook to ignore 500 million iPhone users. 

Given the current environment, one would assume Apple is feeling pretty good. Executives could push out an iOS refinement update, watch iPhone sales roll in, and coast along until WWDC 2016. In reality, Apple is more nervous now than ever before. 

This nervousness is not born from weakness, but rather strength. Apple is nervous about the unknown, the low probability event, the Black Swan that we can't even imagine. It is with this nervousness that Apple positioned certain new OS X and iOS 9 features as preemptive moves on the hypothetical chess board. 

Apple wants to be in a position where it can counter the scenario of Google, Facebook, or another powerful third-party taking over such a large amount of the user experience that Apple's relationship with the user is harmed. People are spending an increasing amount of time on social networks while music streaming is taking over. Even though both of these activities are not directly hurting Apple's financials, it's clear management wants to be better positioned to respond to each trend. 

While there are very few, if any, credible competitors that can truly ship software, services, and hardware at scale, it would be theoretically possible for a company to take user engagement on iOS and try to leverage it into a new direction using their own differentiated hardware. If Apple can position itself more strategically as a counter to third-party offerings, reducing its dependency on others, Apple could be in a better position to maintain the user experience and battle third-party apps and services in the future.

Fighting for Your Attention 

Although Apple may be seeing success in terms of smartphone sales, a fierce battle has been occurring for our attention once we turn on our gadgets.  Press and hold the iPhone home button and the battleground emerges: our home screen.  Software and services companies are each angling for our attention. Tech pundits often say Facebook's greatest threat is Google. Instead, Facebook's greatest threat is our short attention span. Services that largely do similar things are increasingly fighting for mind share in the areas of messaging, email, photo storage, and entertainment. When considering that a service can benefit from a network effect, the battle is only intensified as the apps and services with the most users achieve the best quality, thereby making it that much easier to attract new users. 

Whereas hardware manufacturers measure success by the 10s of millions of users, for software, success is now measured in 100s of millions. As more people spend more time on smartphones, the battle for our attention is only intensifying. It is for this reason that iOS is such an attractive proposition for companies craving reach and scale amongst premium users. 

In the early days of the iPhone, it was common to see a smartphone with lots of apps, each possessing a specific duty or job role. I created separate folders for social apps and news. Today, I still open my social app folder every day, but now my news folder has become irrelevant as I get most of my news from Twitter. This type of fierce competition for my attention is still playing out in area of social platforms and media brands, but it's clear that given the finite amount of attention, there will be winners and losers.  

With a suite of over 20 apps, Apple has relied on its vertical integration of shipping hardware, apps and services. In 2012, Apple jumped into maps. In 2014 Apple launched its health, fitness, and payments initiatives. And at this week's WWDC, Apple launched new News and Music apps, with rumors of a video service arriving sometime later this year or 2016. All of these services share one purpose: controlling our time and experience. They are meant to represent tasks or things that we do each day and to which Apple can add differentiation. One should not expect Apple to try to be the answer to everything, such as entering social media or other services that are inherently less fundamental to Apple's product line-up.

News

Apple's News app isn't so much a competitive jab at Facebook, but instead a hook for grabbing people's attention. Apple's description of the new app is quite clear: "News conveniently collects all the stories you want to read, from top news sources, based on topics you're most interested in - so you no longer need to move from app to app to stay informed." With News, Apple is trying to keep our attention just a little bit longer. Take a look at Facebook's Instant Articles and Snapchat's Discover to see what the war over attention is leading to. Technology companies are trying to shift commoditized news into a differentiated service meant to keep you within their properties.

This type of attention-holding strategy isn't new. In brick-and-mortar retail, Walmart includes various stores within its stores, such as vision centers, fast food restaurants, and medical clinics in an effort to get you inside a Walmart.  Similarly, Facebook wants people to spend more time within its apps by offering additional services, like news.

I don't view Apple as necessarily trying to rethink news or put other companies out of business. Instead, it is looked at as a tool to enrich the iOS platform while maintaining a closer relationship with the user. 

The risk in the strategy is that many users still have to go to Facebook, regardless of reading news. Going back to the Walmart analogy, it would be the equivalent of having to go to Walmart regardless of which medical clinic you visited. Chances are good you will end at the clinic inside Walmart rather than going across town to the stand-alone clinic. At the end of the day, the easiest path usually wins. It is for this reason that I think caution needs to be held before assuming News will be a runaway hit. Instead, I look at it as Apple moving a piece on the chess board, trying to gain a better competitive position in the future. 

Apple Music 

Apple's ambitions in music are underestimated. As Eddy Cue and Jimmy Iovine have made it very clear, Apple Music is not about music streaming, but rather a new music ecosystem meant to offer listeners across the world (100+ countries at launch) a place to not only access music, but become part of something bigger, interacting with musicians and receiving recommendations. Eddy Cue and Jimmy Iovine don't say it, but Apple Music is inherently built to keep your attention rather than just engage you in the physical act of listening to music. Technically speaking, Apple is now getting into content creation with its 24/7 radio station, Beats 1, as Zane Lowe will have a music show that contains interviews and other content. 

Connect, which will serve as a venue for musicians to connect with their fans, while distinct enough from the Ping disaster, contains just enough social media to make people begin wondering if there may be a bit more that meets the eye, where Connect can become a musician's first stop for sharing content. It is important to point out that despite Apple introducing new features that undoubtedly chase people's attention, the company is not being hostile to third-parties. Connect allows sharing through Facebook and Twitter. 

Apple Music is competing with the free streaming services of the world, including YouTube. While Apple may have indeed gotten people to pay for music once around (iTunes), it will be challenging for Apple to completely rethink the music industry without a free, ad-supported streaming option. Nevertheless, Apple is going to give it a try, positioning service and a new culture-defining internet radio option, as reasons customers will be willing to give Apple Music their attention and pay for something that can be gotten for free in the next app over.

Siri and Spotlight

We saw hints of Apple's ambitions in search last year, but this year's WWDC all but confirmed that Apple is quickly looking to distance itself from Google search.  

Apple's intentions on reducing its dependence on third-parties is not just limited to apps and software. All of Apple's new announcements related to an improved Siri and Spotlight, not to mention a new search API, are meant to have us move past Google dependence. In the process, Apple is able to build on its relationship with the user and not necessarily collect troves of data. Apple feels very confident that it doesn't need all of your data to produce "magic" as Phil Schiller described it. In reality, what Apple is suggesting is that it can produce an enjoyable environment that doesn't let technology overwhelm the user, yet still position the iPhone as a personal assistant. Apple calls it "intelligence," which is appropriately quite different from the connotations surrounding Google's "machine-learning" initiatives. 

Pushing Forward with iPad and Apple Watch Software

Apple’s mission hasn’t changed from its founding in the 1970s. As Jony Ive put it at the Condé Nast International Luxury Conference this past April, Apple has always been about making technology more personal. The primary way Apple will be able to continue going down that path is if they control our time and attention by selling gadgets filled with apps and services that we increasingly use to navigate the world. 

Nowhere is this strategy more apparent than Apple’s current product line-up, pieces of glass ranging from the Apple Watch to the iMac. At every stage in between, each product possesses a different function or role. This is the primary reason why Tim Cook hasn’t sounded the alarm about the iPad despite the product losing all of its sales momentum. For Apple, the iPad still has a role in the world. It’s just that a greater number of people are able to get their jobs done using iPhones and Macs. At WWDC, Apple all but assured us that a larger 12.9-inch iPad Plus will be released in the future with Split View, Slide Over, and picture-in-picture video. An iPad Plus isn't meant to turn around the iPad line, but instead serve a particular set of needs that can be answered with a multi-touch Force Touch-enabled large display. Some of Apple's products are simply more popular than others, based on screen size and mobility. Success isn't determined by the number of unit sales, but instead how effective a product is in addressing a particular set of problems. 

From Apple’s perspective, positioning the iPhone as a computer in our pocket is central to controlling our time because of how we are able to bring the iPhone mostly everywhere we go. Taking things further, in a quest to control even more of our time, what better way than to sell a computer that is literally on us?  The Apple Watch is Apple's first personalized piece of technology that can be worn. The outlook for native apps able to tap into much of the advanced components found in the Watch only validates Tim Cook's claim that the wrist is indeed a very interesting place. The day is still early with wearables, but Apple isn't waiting to push the envelope on what can be done on the wrist.    

WWDC 2016 and Beyond 

When considering Apple’s future, take a look at your daily calendar and at the activities that take up significant portions of your day. Anything from sleeping, watching TV, and commuting to and from work likely represent areas of interest for Apple. Of course, management is quite selective and as Tim Cook mentioned last year, executives actually spend most of their day debating what not to do. Apple is built on a model of placing very few big bets that can change the world, not lots of little bets very likely to fail but not likely to have much long-lasting impact. Apple's offensive strategy was on display at this year's WWDC including additional Siri capability, new and updated apps meant to hold user's attention, and a new Music platform positioned to regain music mindshare. Such tactical maneuvering is indicative that Apple is not pausing despite its improved market positioning when compared to Android. Apple is playing offense. 

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Apple's Metaio Acquisition Could Be a Game Changer (Above Avalon Premium Sample)

Along with weekly Above Avalon posts accessible to everyone, I write 2-3 stories about Apple each day covering a range of topics delivered exclusively via email ($10/month or $100/year). The following story was included in the email sent on June 1, 2015. To sign up, visit the membership page.   

While most think Apple is asleep at the wheel, busy spending all of its cash on share buybacks, evidence continues to add up that Apple is planning for the future. News broke late last week that Apple bought Metaio. Even though Apple confirmed the deal by providing the typical PR response about buying small companies from time to time, signs point to this Metaio acquisition being a bit different. There is evidence to suggest this is a big deal in terms of implications on future products and services. 

Metaio is a leader in augmented reality (AR) and co-founders Thomas Alt and Peter Meier are considered some of the industry's pioneers. Even though Metaio is called a "start-up," the company has been around for over a decade and actually had its founding as a research initiative from VW back in 2000. In one keynote, Alt introduced Metaio with "we've been around forever." Metaio even organized the biggest AR conference each year. Simply put, I have a hard time seeing Metaio selling to Apple without something significant coming from this. That theory is also supported by Apple's track record with M&A where they typically buy companies and technology with a clear goal in mind, often to plug a hole in product strategy.

Last year, Thomas Alt gave a talk that touched on a few reasons why I suspect he may have went on to sell to Apple. 1) monetization remains hard in the field 2) it is becoming increasingly more difficult with the resources Metaio had to track unknown, or outdoor environments, and not just a closed, indoor environment. Said another way, Metaio may have run its course as an independent company and needed a bigger partner to reach its future goals, including the much bigger mission of getting the AR industry off the ground.

The impressive thing about Metaio is the entire vertical chain of products that they offer from Metaio SDK/Creator/Cloud and Junaio (an AR browser across platforms). The company has 140,000+ developers (many of which aren't happy with this sudden news of an acquisition), 1000+ B2B customers including eight automakers, 130 employees, and a patent and IP portfolio. 

What can AR be used for? Metaio had previously marketed itself to industrial clients for the following use cases: digital manuals, training education, monitoring, accessories and spare parts (think cars), customer service, inspection, and remote maintenance. 

AR has a very basic premise: interact with the world. The problem I have had with many AR use cases (and increasingly much of the hardware developed for AR) is that it is very obtrusive and distorts reality to such a degree that I think side effects are created. If there is a way to position AR as a way of actually improving reality and not just adding more noise, I can see Apple moving forward with such initiatives. 

It is very easy to see that Metaio has been heavily involved in the auto market and the concept of the augmented city. There are many interesting possibilities around this use case, building off of AR's primary value of helping to navigate the world. Add this acquisition to Apple's Primesense acquisition (which one of Metaio's co-founders had previously classified as interesting), and I think the concepts of both indoor (and outdoor) mapping where depth and mobility are present start to head in the direction Apple may be headed.  

Metaio's developer tools and prior discussion around AR's biggest road block being the lack of relevant content would suggest that Apple may look to bring developers into the fold which would not only give AR a big shot in the arm, but support Metaio's vision of getting AR off the ground. 

One theme that is apparent these past few months: there are a growing number of signs that Apple is building and planning for future (unannounced) initiatives. This acquisition firmly places Apple in the augmented reality game, and I suspect the end goal is much bigger than just gaming and other gimmicky demos. 

In addition to the preceding post, Above Avalon members received the following articles this past week (100 percent related to Apple). To read these stories and to receive future stories via email, sign-up at the membership page. 

• Tim Cook's Stance on Privacy Isn't Actually About Your Data
• The Chess Game Heading into WWDC
• Odds of Apple Replacing Google as Default Search in Safari Going Up
• Apple Music is Sounding More Interesting
• A Closer Look at Apple's Services Business Segment
• New iPhone Ads
• iPhone Sales Share - April Update
• Jay Blahnik Touting Apple's Health Strategy
• Next Phase of Apple Watch Retail
• Google I/O
• IBM Loves MacBooks

The Apple vs. Google Battle Has Changed

The biggest takeaway from Google I/O 2015 was how different Apple and Google are approaching mobile, each guided by their own mission statement and strategy. After years of fierce competition for smartphone market share, the battle between the two companies has changed. Google's ambitions include connecting the next billion users and obtaining scale across its suite of services which requires supporting an iPhone user base quickly moving towards 500 million users. Apple's ambitions are aimed at making technology more personal and lessening its dependency on Google, its primary competitor. The next battle in mobile has begun and it may be just as fierce as the initial rounds. The battle is moving beyond the smartphone and is now based on which platform is more successful in occupying a user's time with the best experience. 

Since the iPhone launch in 2007, the Apple vs. Google battle has not remained constant, instead going through distinct stages, beginning with an arms-race for market share, followed by an Android OEM consolidation phase led by Samsung, and now the large screen iPhone renaissance ushering in the current phase where the battle is moving beyond the smartphone. 

Battling over Daily Activations (2009-2011)

The early days of the smartphone war were all about market share. The daily beat of the tech press was focused on which mobile operating system was doing better in terms of sales. Google, and Andy Rubin especially, prided themselves on periodically announcing Android daily activations. One of the rare times Steve Jobs was on an Apple earnings conference call with analysts occurred in 4Q10 to put some cold water on Android activations news. The mission was clear: promote iOS as a platform worth developing apps for. Here was Jobs:

"Last week, Eric Schmidt reiterated that they are activating 200,000 Android devices per day. And have around 90,000 apps in their App Store. For comparison, Apple has activated around 275,000 iOS devices per day on average for the past 30 days with a peak of almost 300,000 iOS devices per day on a few of those days. And Apple has 300,000 apps on its App Store.

Unfortunately, there is no solid data on how many Android phones are shipped each quarter. We hope that manufacturers will soon start reporting the number of Android handsets they ship each quarter. But today that just isn't the case."

The battle was not only fought in the marketplace and press, but also in the court room as Apple began setting up its patent litigation offense against various hardware companies using Android to compete with Apple. Apple's goal with litigation wasn't about the money, but rather pride and to slow competitors down in the marketplace. Market share was everything in the early days of the smartphone race. 

Samsung's Reign (2012-2013)

The 2012-2013 time frame was interesting for Apple as Samsung was able to make very strong inroads within the Android ecosystem, capitalizing on the lack of a large-screen iPhone in the high-end of the market and lack of proper competition in the low-end. While there was never much in the way of widespread defections of iOS users fleeing to Samsung, the ability for one hardware manufacturer with such immense distribution network to grab so much power within the Android ecosystem was alarming to Apple. The battle was aired on TV in the form of a very successful line of Samsung commercials mocking Apple customers, not to mention continued battles in the courtroom.

As evidence of how seriously Apple took the Samsung threat, in 2012, Phil Schiller tried to preempt Samsung's big Galaxy S4 keynote in NYC by talking with the WSJ the day prior in order to discredit Android and provide some counter balance to the overwhelmingly positive press coverage given to Samsung. Schiller went on to say:

"Android is often given as a free replacement for a feature phone and the experience isn't as good as an iPhone...When you take an Android device out of the box, you have to sign up to nine accounts with different vendors to get the experience iOS comes with."

It is important to note how Apple positioned Samsung as merely the preferred hardware competitor at the moment. Google, not Samsung, was the ultimate long-term threat as Apple saw that Samsung was gaining market share purely on the back of Android. Without Android, Samsung phones would not be viable competition for the iPhone.

The New Battle

Apple now finds itself with an iPhone user base approaching 500 million users, and strong market positions in key geographic territories including the U.S. (40% sales share), U.K (40% share), and China (25% share). Any concerns related to iOS being crowded out by Android OEMs in a repeat of the Windows era have likely been put to bed. Apple's iOS platform now has critical mass, or the ability to entice developers and third-parties, including Google, Facebook, and Twitter, to support iOS users.

One of the clearest themes from Google I/O 2015 was that Google needs iOS and its 475 million highly-engaged iPhone users for Google's business model to succeed. Looking ahead a few years and assuming continued 10-20% iPhone unit sales growth, it will be nearly impossible for a third-party with a business model dependent on achieving scale to ignore what has the potential to be a 600-700 million user ecosystem (if not larger).

While one can make an argument that Google made a strategic misstep by limiting Google Maps on iOS a few years ago, which ended up pushing Apple into developing its own maps initiative, hindsight is 20/20. Google may have thought it was worth taking the bet at that time as iOS was a very different, and weaker, platform in 2012 than today. 

The Apple vs. Google battle has now moved beyond the smartphone. Walk into a carrier store and given the choice between an iPhone or Android-powered smartphone (the two most likely options), Google's services will be found on each. In addition, the prices between an iPhone and high-end Android-powered phone will be roughly the same. While Google may be excelling at machine learning-based cloud initiatives, it is not being positioned as a factor for buying an Android phone instead of an iPhone. Given the limited distribution behind Nexus devices, it is difficult to have much confidence in that line of Android hardware representing a viable alternative for most consumers. 

Instead, the smartphone buying decision is likely related more to the other pieces of glass either being worn (smartwatches), in one's purse or backpack (tablets), or at home and on the work desk (desktops/laptops). Extend the exercise further to incorporate third-party devices in the home and driveway, and the entire iOS or Android ecosystem is becoming the much bigger deciding factor for what will be your next smartphone. 

Apple's Strategy

Apple wants to be at the intersection of technology and liberal arts. Producing personalized technology experiences will require Apple to maintain control over the variables that come together to create experiences for the user. A key component will be owning critical technologies and services that may otherwise rely or require scale in future initiatives.  A prime example would be avoiding the debacle over maps where functionality was limited by a third-party. In the future, mapping will likely be a required core competency for personal transport ambitions. If iOS represents a minority share of the automobile market, such a market position may pose a competitive risk in terms of relying on third-partners for map data. 

The same thinking applies to Apple controlling the experience for providing content like movies and music to consumers. Notice how Apple doesn't need to own or produce the content in order to accomplish its goal. Instead, being the broker between the content owner and the consumer provides Apple room to add something new to the experience. Apple could then extend this experience to Android to further entice people to make the switch to iOS (as is planned with Apple Music).

Another way Apple can maintain its consumer experience is to embrace the emotion and feeling found with luxury. As seen with the Apple Watch, relying on materials and looks as the primary differentiation between a $400 and $17,000 device produces certain emotions that would be hard to match on Android or a competing platform where the virtues of luxury don't exist. 

Google's Strategy

Google's ambition for its cloud-based services is increasingly competing more with Facebook than Apple as Google's business model is based on solving technological problems by accessing the world's data. Google wants all smartphone users to use its products, regardless if on Android or iOS.  Similarly, Facebook is after the same data. Just like how Facebook unbundled its core app into a suite of apps, Google seems to be following a similar path, transforming into a suite of services and apps. Google wants to be at the intersection of technology and computer science. Judging by its engineering talent, I don't think anyone doubts Google will continue to push the envelope with such initiatives.

Going Forward

Google I/O made it clear that Google needs Apple and iOS. To ignore such a vibrant base of highly-engaged users, especially when other companies like Facebook enjoy a prominent place in the platform, would be highly destructive to Google's ambitions.  On the other hand, Apple also needs Google as its services remain very popular among iOS users. However, judging from Apple's prior actions and mission statement to personalize technology, I would expect Apple will continue to try to minimize its dependence on Google as such a situation represents a long-term threat to Apple's mission.

Similar to how the Nexus experience provides the closest thing to pure Android, I suspect Apple wants to continue down the path of being in a position to ship an iPhone and suite of apps and services that make it possible to live within the Apple ecosystem without much interference from Google. While most consumers will end up settling somewhere in the middle, using both Apple and Google products and services, it is this quest to control the entire user experience that ultimately validates the competition between Apple and Google as genuine. 

The probability of a world where Android excels as a direct result of iOS faltering is becoming more remote as time goes on. Instead, Google is becoming more reliant on a healthy iOS platform, which improves the chances of iOS continuing to grow and gain additional power. Meanwhile, the Android platform continues to become splintered and less effective at Google's mission of positioning services in such a way as to reach scale. 

The primary question is now focused on how successful Apple will be in loosening its dependency on Google services. There are signs that we may see a more aggressive stance from Apple towards replacing many Google services with homegrown alternatives. This motivation will likely come to represent the driving factor for the continued battle between the two companies. While we may see skirmishes from time to time over individual features and services, the much bigger battle is clear: Apple and Google are built on a fundamentally different view of the world and each will now fight to occupy a user's time with the best experience. The battle has moved beyond the smartphone.

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Apple Watch is Making Luxury Watchmakers Uncomfortable - Above Avalon Premium Weekly Recap

The following post is the sample story used to demonstrate the type of stories sent daily to Above Avalon Premium Members. The following story was sent on May 25th, 2015.

Apple Watch is Making Luxury Watchmakers Uncomfortable

The luxury watch industry still can't understand why someone would buy an Apple Watch.

Here's Alexander Schmiedt, managing director for watches at Montblanc, speaking with Bloomberg: "Our products should have very long life cycles. In modern technologies the life cycle is exactly the opposite. It may be the hottest thing today, and in one year it's already outdated, and in two years you're made fun of for still using it."

Montblanc will be selling a $390 "e-Strap," a stainless steel display designed to be attached to the watch band and worn on the underside of the wrist. Functionality is pretty limited compared to something like Apple Watch.

And here's Johann Rupert, owner of Montblanc: "I love Apple, but just when I've gone and set everything up for an iPhone 5, the iPhone 6 is coming out and the cords change. That is not to say the Apple Watch is not a great product. I predict it will do very well, but I don't think that customers are going to be ecstatic to throw away watches in one to two years when the technology is obsolete."

I thought those two quotes summed up the luxury watch industry's reaction to Apple Watch pretty well. Jean-Claude Biver of TAG Heuer has said something similar, unsure how to compete with something that isn't timeless. It's not that technology is foreign to luxury watchmakers, but I suspect software and the fast-pace of change found in technology are creating headaches. An iPhone 5 doesn't become obsolete in two years on its own, but rather a legitimately better device in the market helps to make it obsolete. The same dynamic is not found in the watch market. 

Such uneasiness towards Apple Watch originates from the changing value proposition found in the luxury watch industry. With Apple Watch, consumers can begin valuing utility on the wrist. A luxury watch's timelessness was something that you were required to value if you wanted high-end jewelry for the wrist.

I suspect we are entering an era where people are still going to want the jewelry aspect found in their old watch, including the craftsmanship, but no longer place the same kind of value on a device's timelessness. For an industry built on timelessness, you can start to see how the Apple Watch spells trouble.  

The other common reaction that I'm seeing related to Apple Watch is that the product increases awareness for other timepieces and wearables, almost like the Apple Watch is a gateway drug for "real" watches. I'm not so sure about that. After using Apple Watch, I don't have a greater appreciation for wearables or traditional luxury watches. If anything, the feeling is less. I just don't look at the Apple Watch as a watch.  

If I craved something that looked more refined or polished, I could just upgrade from the Sport to Watch collection or change watch bands, and that type of reasoning is why I think Apple will actually keep the innovation and updates pretty vibrant for the higher-end Watch models. The Watch and Edition collections will likely account for 80% of Apple Watch profits despite only accounting for 20% of sales.

Consensus already assumes the low-end luxury Watch market (watches selling in the $200-$1000) is in trouble, but very few people will go on record and discuss how the overall watch market, including watches sold at higher prices, is in trouble because of devices that add utility to the wrist. The problem may not necessarily be that their current customers will run out and buy an Apple Watch, but that young professionals end up valuing utility over the traits the luxury watch market have traditionally marketed.

If new money stops flowing to the luxury watch market, the environment will become very difficult.

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