Trent Reznor Talks Apple Music & Above Avalon Premium Week in Review

Along with periodic Above Avalon posts, I send out a daily update containing stories (10-12 per week) to Above Avalon members via email. The following is a sample story sent to members on July 2nd. 

Trent Reznor Talks Apple Music

We are getting a much clearer picture of how Apple Music was created through the creative direction of Trent Reznor. 

As a very brief background on Reznor, he, along with Ian Rogers, joined Beats to help launch a music subscription service. The end result was very similar to what we see today with Apple Music. 

Reznor has been quite vocal in the past about the music industry and the volatile relationship between artists and music labels when it comes to money. He experienced the music industry from both the perspective of an independent artist and the view of an artist receiving support by a major label, which serves as good background for working on a music subscription service. 

Apple has made Reznor available for the Apple Music PR tour and Pitchfork published an interview with him yesterday. I enjoyed the interview for all of the imagery and candor found in his answers. 

Here's Reznor on the problem found with most music streaming services: 

"I feel like I'm walking into a big box store where all the merchandise is in a cardboard box. I mean, it's there, you can eat all you want. But it's searching for a box in a card catalog versus a place where you walk in and leave kind of blown away by the stuff you didn't realize you wanted when you went in there." 

You can start to see that Reznor thinks of music streaming differently than most people. Keep in mind that the product he is describing was what Beats was originally selling. The service never saw widespread adoption before getting bought by Apple. It's easy to see that the message Reznor is describing about how most music streaming sites are awful must have resonated with Apple. Could Apple have built its own music subscription service? Sure, but Beats' music streaming was built on ideals that matched Apple's philosophy. According to Reznor,

"What we tried to do with Apple Music is make the experience around the catalog feel like people that love music have touched it in the various ways it gets presented to you: playlists that noticeably feel better, radio stations that were programmed by people, recommendations that feel less like a computer and more like someone made you a mixtape and you like their taste."

Jimmy Iovine and Eddy Cue described Apple Music as a service a few weeks ago, which now seems much more business-like in retrospect. Meanwhile, I thought Reznor's Apple Music description was the most genuine I have seen published.

You start to understand why Apple is even bothering with music. It's all about selling an experience, something Apple excels at with its current products. That is what Apple means when they say music is in their DNA. There is more here then just Apple thinking they need to do music because they came out with iTunes and the iPod.

Here is Reznor describing what I would say is one of the more controversial parts of Apple Music, Connect: 

"[W]e just wanted to make a place where if you're an artist and you want to share something that's more promotional - you're not necessarily looking to get paid on it but you want people to hear it and have as wide a reach as possible - put it up here and it's not locked into anything. You can embed it wherever. It's not meant to just be over here behind this paywall...We wanted to create a place where the people making the art could feel like they could have a center, and ultimately, monetization, and the ability to be provided with some tools that didn't exist as elegantly as they do anywhere else." 

I think this is where Reznor's argument, while certainly still making a lot of sense, is being stretched just a bit. The Connect that is being described may be attractive to some artists, but with others there may not be much interest at all. I know in my situation, the 40 artists I am following haven't exactly been active on Connect, but others have said they are seeing plenty of activity. Will we see a split develop among the music community? Will we need to wait until there is a massive audience before we see artists begin to engage more on Connect? Time will tell. 

Reznor closes the interview with an interesting take on Apple and risk:

"I'm surrounded by enthusiasm and support and a company that's ready to take risks and allow, what I think, is risky good taste to be a fundamental part of what they're trying to do. It's pretty cool that the biggest company in the world feels that way. It feels good to me right now."

The closer you look at Apple Music, the more you realize Apple is taking a big risk here. While it is a music streaming service just like any other streaming service out there, it is based on ideals that are quite different from others. I think that is why it is so interesting of a product. 

Above Avalon members also received the following stories this past week:

Android Switcher Rates Bode Well for iPhone Sales

Q&A Thursday (collection of submitted questions by members)

Apple is Growing Faster than Xiaomi

Apple Music Observations 

Apple Music's Problem

Reflections on iPhone's 8th Anniversary

Greece's Impact on Apple

Attaching a Price to Apple's Free Music Trial

The Big Bet Behind Beats 1

New iPhones Entering Production

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Beats 1 is the New iPod and Apple's Latest Bet

The iPod was hip and cool. A device that was introduced to the world as being able to hold one thousand songs in your pocket went on to be Apple's trojan horse and take over not only the music industry, but also the entire music culture. The iPod won because it was different and cool, working seamlessly with iTunes in bringing emotion and passion back to music. Fourteen years later, Apple finds itself in a new music predicament. Holding on to the paid music download model a few years too long, Apple is once again trying to recapture music mindshare with Apple Music. Instead of competing on technological terms, Apple is positioning Beats 1 as the new iPod, a tool meant to add emotion and coolness to a sea of commodity music streaming services.  

The iPod Was Cool 

On October 23, 2001, Apple unveiled a device that went on to position the Mac as the temporary hub of our digital lives and ultimately play a role in shaping modern culture. Wearing a pair of white headphones didn't just mean that you had an iPod in your pocket, but also meant that you were a rebel, someone who thought differently. 

Something interesting happened with the iPod. It went from a sign of being different to an outright symbol of being cool. During a time when Macs were destined for art classrooms, and mobile phones left much to be desired in terms of design and functionality, iPods were taking over college campuses and schools like nothing seen before. Music was once again something fun, something that could be listened to mostly anywhere. A fact that now seems like a given was a new experience just 10 years ago. 

Beats 1 Is the New iPod   

With Apple Music, Apple is once again looking to leave its mark on music culture, which is arguably much more important and valuable than the $15 billion of annual digital and physical music sales. We are no longer in the iTunes era. The iPod we have come to know is now just a footnote in Apple's financial statements. Instead, Beats 1 is being positioned as the new iPod.

Consider how during what was arguably the most important day in Apple's music history, nearly the entire discussion was centered around Beats 1. The 30 million songs now available for streaming are nice, but we are already used to that with other streaming sites. Lots of curated music playlists are helpful, but something seems to be missing. Apple's intention on launch day was clear. The buzz surrounded Beats 1. What was Zane Lowe saying? Who was he playing? What are other people thinking? 

At first glance, Beats 1 would seem to be a highly unlikely candidate for being the new iPod. How is a radio station with a preprogrammed schedule pushing content to listeners considered hip and cool in 2015?

However, Beats 1 is trying to do much more than be a radio station. Instead of just pushing songs to our iPhones, Beats 1 aims to make us live and breathe music. The modern era of music streaming with millions of songs at our disposal has led us to think of music simply by genre. How else would one sort through millions of songs? As we rely more on the algorithm to control our music listening experience, we are left with a product that is lacking emotion and passion. We remain tied to what we think we know and enjoy. Music discovery is never allowed to materialize. Beats 1 is trying to get us to appreciate and discover music again.

Trent Reznor, one of the masterminds behind Apple Music, explained Apple's motivation to Pitchfork :

"Personally, one of the things that interests me in this space as a fan is that consumption of music is radically different from when I was a kid. You had to make a choice of what you wanted to invest in. There were some good things about that. I listened to some records that I didn’t necessarily like at first, but I listened to them because it was all I had. It shaped the way I think about things. And now that access is ubiquitous and everybody has access, to me, that puts the burden on the service to make music enticing—different portals and entryways and rabbit holes. And what if that experience could be one that turns more people on to great music? I think that’s exciting."

Zane Lowe

Similar to how Apple relied on celebrities to market the iPod, the company is once again adding a new modern twist to the equation with Beats 1, placing Zane Lowe as the face of Apple Music. While he may not be a household name, his ability to discover talent and appreciate the art of music has not been lost. Apple is investing in other personalities along with Lowe, each with a slightly different take and style. But at the end of the day, Beats 1 is Zane Lowe. Notice during the Apple Music launch how Apple executives, many of whom have been quite active on Twitter recently, were quiet. There was not one tweet or message about Apple Music. Instead, it was all Zane Lowe. 

Zane Lowe. Photo: The New York Times

Beats Brand Lives On

Even the name of Beats 1 is quite telling. Apple's $3 billion acquisition of Beats last year included branding and people. The Beats brand carries a young, cool and hip connotation while iTunes brings up thoughts of slowness, bloatware, and oldness. I have a difficult time seeing "iTunes 1" having the same kind of impact as Beats 1. 

Beats 1 Gives Apple a Fighting Chance

The iPod was a risk. In reality, nearly everything that has turned out successful for Apple was at one time considered to be a big risk. That is not to suggest that everything Apple touches turns into gold, but rather that risk is needed to really change the status quo. Beats 1 is Apple's latest bet. It may not work. People may be turned off by the variety of music and simply not value Zane Lowe's or the other DJ's personality or musical acumen. Radio was mostly declared dead and reimagined as Pandora. Will the world be willing to think again about what radio can be? Trent Reznor summed it up well:

"I’m surrounded by enthusiasm and support and a company that’s ready to take risks and allow, what I think, is risky good taste to be a fundamental part of what they’re trying to do. It’s pretty cool that the biggest company in the world feels that way."

Apple is not starting Beats 1 to appeal to the masses but rather to add something new to the music discussion. After being on the market for years and experiencing refined product and pricing strategy, the iPod changed the game. Beats 1 represents Apple's most likely path toward taking back the music industry. Using a radio station in 2015 to take back music culture - now that is thinking differently.

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The Great Apple Music Pivot

Apple Music is the right product at the wrong price. Music subscriptions based on human curation and discovery are the future, but putting more than 30 million songs behind a paywall won't help facilitate widespread adoption. Apple Music's family plan option will give the service life, but more is needed. The free music subscription model will eventually be too difficult for Apple to ignore. By pivoting to include free music, Apple Music will then be in a much better position to put the business of music on a path to sustainability. The music industry needs its "App Store" moment, and the combination of free music, Apple's premium user base, and Apple Music's Connect would be the closest thing yet to that vision becoming a reality.  

Apple Music Ambitions

While the press has run with the Apple Music versus Spotify storyline, in reality, Apple's music ambitions are much more grandiose. Apple is once again trying to build music sustainability by selling an all-encompassing music service. There is precedent for such lofty goals as the iTunes ecosystem presented the music industry with a much needed reprieve from the rise of piracy and genuine questions of music's sustainability. Apple relied on a service that capitalized on ease of use to stoke demand for paid music downloads. Ten years later, while things may have not changed much as labels are still making short-term decisions guided by money, and there are renewed questions around music sustainability, we now live in a world where free music subscriptions are gaining momentum and acceptance.

One reason Apple is fully embracing paid music streaming and avoiding a free music steaming tier is to change the perception surrounding music's inherent value. By having consumers look at music as something worth paying for - a good with inherent value - it will be easier to get people to pay for music through other mediums in the future. A culture based on free may not bode too well when trying to sell new music initiatives and services. Take a look at the App Store for evidence of this trend. 

As Spotify has shown, when both a free and paid streaming option are available, a vast majority of users stick with free. With Apple Music, by not offering a free music subscription option, Apple is trying to increase the paid tier's value as that would be the only way to enjoy the full service being sold. There is no question that Apple Music will gain users, and I would go so far to say that it would be shocking if Apple is unable to become the largest paid music streaming service. It helps that Apple's user base is comprised of premium smartphone users that have shown the tendency to spend more on apps and other content.  However, I doubt it will be enough to move paid music streaming far beyond the segment of the population that has been paying for music all along.

The Record Labels

In today's disjointed environment where digital music industry revenue is still coming from many directions, record labels continue to spend big money on marketing and promoting their portfolio of music artists in an effort to gain mind share and exposure. The IFPI estimates that over the past five years, labels have spent $20 billion on artists and repertoire (A&R) and marketing. In this environment, free music streaming is an attractive proposition for record labels because their portfolio of artists is able to reach a much wider audience. Simply put, record labels have taken free music streaming hostage. This is one reason why the major labels put their music on YouTube, Spotify's free music tier, and even went so far as to agree to Apple's initial "no pay" stance on Apple Music's three-month free trial. Ultimately, it is this desire for exposure on the part of labels that represents Apple Music's biggest headache as charging for music is made that much more difficult when music is free elsewhere. 

Free Music Streaming

Over the past few years, free music streaming has received a bad rap. Free music subscriptions have the potential to be attractive for both music artists and fans because artists gain valuable exposure while fans have access to a vast amount of music. However, there continues to be one major problem with free music subscriptions: ad-supported free music streaming simply does not provide enough revenue for musicians. There are very few alternative monetization techniques available for the average musician unable to tour or grab sponsorships. Meanwhile, paid music subscriptions, which Apple is betting on, remains niche with no evidence of mass market appeal given the presence of free music options elsewhere. It would seem that the music industry is in quite a predicament. 

In 2014, subscription streams income accounted for 23% of the music industry's $6.85 billion of digital music revenue. However, in an alarming sign of what is to come without significant industry change, ad-supported free music stream income, despite having 2.5x the number of users, accounted for only a third of the revenue from paid music subscriptions. The math just doesn't add up for free music streaming in its current form, despite its growing popularity. That doesn't mean that free music subscriptions should go away, but rather that more needs to be done to build other ways of valuing music. 

Meanwhile, YouTube remains the most popular option to access free music, with more than 1 billion users. According to the IFPI, approximately 27% of internet users listen to music on YouTube without watching the video. Despite having upwards of 10x the number of users compared to music subscription services, YouTube and other video platforms accounted for only $650 million of digital music revenue last year, less than half of the revenue attributed to subscription services. 

One positive sign is we are still in the very early stages of the music subscription era. The vast majority of people have not used music streaming. According to the IFPI, there were only 141 million active users for music subscription services at the end of 2014, of which 41 million were paying global subscribers. For perspective, there are approximately 475 million iPhone users out in the wild. Recent user surveys from Ipsos placed paid streaming usage at 16% while free streaming stood at 35% across 13 selected markets. This suggests that there is still time to come up with new and exciting ways of  building monetization into free music streaming.

Apple Music Pricing

Apple faces an uphill battle with Apple Music pricing largely as result of the music labels. Initially, it was reported that Apple wanted to price Apple Music at $5 per month to match the amount of money people spent on music in iTunes. The labels said no. Instead, with single memberships at $10 per month, Apple Music is priced in-line with other streaming services, offering full membership for $120 per year.

At first glance, Apple Music would appear to be dead on arrival given that price. However, there are a few other variables at play that will result in Apple Music having some life. While Apple was not able to get labels to agree to lower the price for single memberships, Eddy Cue was able to get the labels to come down in price to $15 per month for the family membership. Given that up to six people can be on the same iCloud account, Apple Music's family pricing will likely be much more popular than single memberships. 

In addition, it is important to remember that Spotify has 20 million subscribers paying $10 per month for its music streaming service. Since music streaming is still in the early innings, I suspect Apple will make inroads into this market, and it would be surprising if Apple cannot get more than 20 million people to sign up. The problem is that the upside to this number is limited by not having a free music streaming option. 

Apple is aware that entering the music subscription era without a free music tier is like entering a fist fight with both hands tied behind one's back. Accordingly, Apple has made certain aspects of Apple Music accessible to everyone. In terms of marketing, Apple's messaging continues to shift the focus away from music streaming (which is mostly a commodity these days) and instead towards playing up the idea of Apple Music as one service containing various ways of listening to music, curation and discovery led by music tastemakers, and interaction with your favorite artists. Said another way, Apple is trying to build music culture instead of being just a paid music steaming service. 

Apple's Long-Term Music Plan

Apple will pivot Apple Music to embrace free music streaming. However, any early success seen with family plans will not be lost. Evidence of a vibrant ecosystem and user base would be very appealing to music labels, which would agree to have their artists and catalogues included in a free music streaming tier on Apple Music. 

Music Culture/Discovery.  Apple is investing heavily in human discovery and curation by allowing tastemakers like Zane Lowe to represent the face of Apple Music. Beats 1 is positioned as a 24/7 radio station guided by one mission: play great music. The point of such a product is to build excitement, push music discovery, and introduce passion back into music. Having a host of DJs ranging from Drake to Elton John is meant to add personality to what has increasingly been algorithm-driven playlists and radio stations. There are many questions as to how one channel broadcasted across the world is going to work, especially considering all of the different tastes represented by the guest DJs. Nevertheless, much of this focus on music culture will remain a central theme of Apple Music regardless of price and whether Apple has a free music streaming tier.  

Connect. In what may the most interesting and intriguing aspect of Apple Music, Connect has the potential to be the very early stage of a fundamentally new kind of service that the music industry has never seen. Connect is a way for artists to connect with fans by sharing content such as pictures, short clips, and exclusive material. While the service has very subtle similarities to Apple's ill-fated Ping product, management has learned its lesson that the world doesn't need another social network. 

Connect may be so significant, it can represent the music industry's "App Store" moment. Connect can become the primary medium through which artists can monetize their art beyond music. Typically, the argument has been that artists can monetize free music through merchandising and touring. While for some that may work, the much more sustainable method would simply be to create a medium by which fans can support artists directly through either subscriptions or different access tiers. In the process, the definition of a musician changes. We soon can all become musicians with a route to monetization, even if we aren't professionals. Music is the art of expressing our emotion and views on the world. To think that the only people capable of making money from music are those that go on tour and sell t-shirts is missing the much bigger point. 

In a world where all music is free, Connect can be the way that artists sell subscriptions for complete access to the process behind their art. Videos, blogs, and other exclusive content can arguably be much more valuable than the actual music itself. In such a world, discoverability and the ability to reach hundreds of millions of users is critical because to find sustainability, an artist would only need to reach a very small group of loyal fans. Instead of 20% of the population paying $120/year for all the music they want, which primarily would go to the big labels and megastars, in this new world, 100% of the population can listen to all the music they want while supporting artists that they feel a connection to.

The theme behind all of this is decentralizing power from a few labels to everyone: 

• Music will be free. As a result, music artists can reach hundreds of millions, if not billions of users.
• Artists have access to information on their fans, making it easy to set up monetization efforts.
• Artists can rely on software to monetize their brand (image and personality) primarily through subscriptions and advertisements, but also through merchandising and sponsorships.
• New talent can transition from discovery to monetization quickly without many barriers.
• The definition of “music artist” becomes boarder to emphasize a wider range of content creators.

The problem with the current music industry structure is that it is difficult, if not impossible, to accomplish many of the preceding bullet points, especially without the support of a label. However, change is in the air. A music artist no longer needs to be sponsored by a Fortune 500 company, sell out the local sports arena, or have 10 million followers on social media to find sustainability. Instead, finding one's true fans and focusing attention on those individuals can lead to sustainability. In such an environment, the most difficult bullet point remains discoverability, which is conveniently one of the underlining themes found within Apple Music. 

Measuring Success

Success with Apple Music will change over time. At first, success will be judged by share of the paid music streaming market. The discussion will focus on Apple owning the "premium" music market, or those who are in a position to pay for music. Next, the discussion will focus on ecosystem strength, where the total number of users is paraded around, including those that just listen to Beats 1 and other radio channels. This is where the prospect of free music will be too hard to ignore. Meanwhile, Apple will work on expanding Apple Music's reach into other forms of music content, not to mention mind share. Apple would then introduce a new version of Connect where fans have the opportunity to buy the full experience from individual artists. All the while, the record labels will fight and drag their feet against these changes because they essentially are anti-label, giving most of the power to artists and fans. As Apple begins its new music journey, Apple Music has a future, but a few changes are needed to give the service widespread appeal and the ability to truly add sustainability back to the business of music. 

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Taylor Swift is Backing Herself Into a Corner - Above Avalon Premium Week in Review

Along with periodic Above Avalon posts accessible to everyone, I write 10-12 stories a week about Apple sent exclusively to Above Avalon members via a daily email. The following story was sent to members on June 22nd. For more information and to sign-up, visit the membership page.

Taylor Swift is Backing Herself Into a Corner

Taylor Swift was able to capture much of the Sunday news cycle with a well-circulated Tumblr post with a passive aggressive "To Apple, Love Taylor" title. The seven paragraphs that made up the post can be summed up in three sentences:

"I'm sure you are aware that Apple Music will be offering a free 3 month trial to anyone who signs up for the service. I'm not sure you know that Apple Music will not be paying writers, producers, or artists for those three months. I find it to be shocking, disappointing, and completely unlike this historically progressive and generous company."

Eddy Cue responded within 17 hours saying via Twitter that Apple had changed its mind and will pay artists during the free trial period. Apparently, Apple will pay rights holders on per-stream basis, the details of which were not disclosed [Apple will pay 0.2 cents for each song streamed]. It would seem the rate will be less than the regular rate once the trial period ends. Regardless, the change in Apple's stance occurred very quickly. Does this mean everything is okay? Not quite.

Before I go any further, I think it's important to note that Taylor Swift knows exactly what she is doing. Beginning with her WSJ op-ed last year and her recent spat with Spotify where she removed her entire music catalog from the music streaming service, Swift has fully embraced the message that music needs to be valued appropriately. Not only does such positioning likely hold true to her beliefs, but it serves her well from a business sense.

Taylor Swift is arguably the biggest music act going today. She is one of the few that can sell out venues each night for months across the world. She has spent years developing her fan base and connects with them extremely well. Simply put, she can afford to take these kind of hard stances and use her music as a bargaining chip.  

You will quickly discover that you can't go far talking about music without discussing record labels and the complicated structure where everything is done in such a way as to position the dollar as the ultimate goal. In many ways, Taylor Swift transcends all of this talk because of the power she holds. This means that any discussion involving Taylor Swift is often much more ideological than practical as we can ignore the record label. 

At the end of the day, this Taylor Swift vs. Apple battle wasn't even about Apple. It's about valuing music. Swift previously battled Spotify. Yesterday, she called out Apple. Tomorrow, she will call out someone else. Apple is simply a symbol of what Swift is fighting for: raising awareness that the music industry is selling an art form that should be valued accordingly. 

Swift's primary argument against Apple's 3 month tier was that such a feature does not value music appropriately. If you are a music artist and you release a new album from July to September, you would have received $0 from Apple Music and the 10s of millions of people trying the service out. While simplistic in thought, basically the entire music industry would have received $0 from Apple for those three months. When you say it like that, it is hard not to agree with Swift's argument, and I suspect that is why Apple changed its tune, deciding to pay artists during the trial period. Swift wasn't the only one to raise this issue in recent days, so it is possible that Apple was at least thinking about this topic for a few days and Swift was the final straw. 

Even though Swift won this latest battle (Apple probably will face no long-term negative implications from this though), I still think Swift's long-term positioning in terms of valuing music is problematic. Swift is combining short-term goals with long-term ambitions. She is upset with any service or feature that doesn't value music correctly. She raises very valid (and convincing) arguments. However, when looking at the long-term, Swift is likely backing herself into a corner.

One theme that has developed in the music industry over the past decades, especially the last 10-15 years, is that technology is a formidable force. The music industry has not been able to figure out how to find sustainability with music streaming. There is pain in the streets. Taylor Swift, and a handful of other actors, are using what essentially boils down to aggressive negotiation tactics to force change (i.e. getting people to pay for music). In the near-term, Swift's exposure and power will increase. Her fans will like her even more. And she may very well win many battles (as she did vs. Apple).

However, look at what happened with Swift's battle with Spotify. The music streaming service's momentum in terms of user growth (the most important metric for Spotify) has shown no signs of slowing down after Swift pulled her music collection. In fact, one can argue Spotify gained exposure following Swift's very public battle with its free streaming tier. Here is where I think Swift will find some trouble. She will not be able to control technology. Even though she is the most popular music artist in the world today, that is not enough to shift what will be inevitable in terms of music and technology. She is trying to get everyone to play nicely, but no one person holds enough power to keep everyone in line. A stronger Spotify, including a more popular free streaming option, would seem to go against what Swift is advocating. 

Look at how Kid Rock turned out in his opposition to paid downloads on iTunes. Technology, and the world, passed him over. The same will happen with Swift if she doesn't change her tune (which I think she will) over time, concerning how music should ultimately be valued. 

Swift wants people to value music appropriately. Apple does too. Swift thinks the best way of doing that is to pay for music. I'm not sure Apple feels the same way long-term. Technology likely has other plans in mind (and I suspect Apple does too) in terms of how one can monetize music to ensure sustainability. Free music streaming isn't going away, regardless of how much Taylor Swift hates it.

In addition to the preceding story, Above Avalon members also received the following stories this past week:

• Apple Stock Buyback Primer (seven chapters)
• Apple's Cash Dilemma (Why Not Just Pay the Tax?) 
• One Drawback of Holding $194 Billion of Cash
• The Symbolism Behind the Gold iPhone
• Google's Early Approach to Take On Apple Watch
• Calculating Apple Watch Band Profit
• Just Doing What's Right (Tim Cook and Eddy Cue edition)
• Improving iOS 9 Adoption is High Priority at Apple

To read these stories (accessible via email) and receive future stories containing Apple analysis, sign-up at the membership page. A weekly option is also available containing all of the week's articles in one email delivered at the end of the week. Above Avalon is supported 100 percent by its members. Thank for your continued support. 

Wall Street Starting to Doubt Apple Watch - Above Avalon Premium Week in Review

Along with periodic Above Avalon posts accessible to everyone, I write 10-12 articles a week about Apple sent exclusively to Above Avalon members via a daily email. The following article was sent to members on June 17th. Please visit the membership page for more information and to sign-up.

Wall Street Starting to Doubt Apple Watch 

One by one, sell-side analysts are starting to turn cold on Apple Watch, a product released seven weeks ago. Yesterday, Pacific Crest analyst Andy Hargreaves published a note saying his confidence in Apple Watch is declining as interest appears to be higher in the iPod than Apple Watch, judging by Google Trends, and something needs to be done or else Apple will struggle meeting Watch expectations. Here's Hargreaves:

"Initial Apple Watch demand has been very strong and our most recent checks suggest Apple remains well positioned to produce enough units to meet or exceed our FQ3 unit estimate of 5.5 million and our F2015 unit estimate of 11 million. However, reviews of the device have been mixed, the fashion angle appears to be leaning a bit too much toward "calculator watch," and general consumer interest as measured by search volume is below the iPod (with an "o")...All of this suggests a dramatic increase in functionality is likely needed to grow unit sales and meet current expectations for F2016 unit volumes. Given Apple's developer community, this is clearly possible. However, our confidence is declining, which suggests risk to our F2016 unit estimate of 24 million is increasing."

I will comment on his Watch sales estimates shortly, but it's important to note what he is arguing: once early adopters buy the Watch, evidence in the form of Google Trends would suggest sales will slow. The focus isn't so much on Apple Watch sales for the current quarter or even next (those will probably be fine), but the follow-through as we move away from launch. Basically, the question being raised is will normal people buy the Watch?

Hargreaves is not the first analyst to raise Watch concerns. On Apple's last earnings quarter, Toni Sacconaghi of Sanford Bernstein took issue with Tim Cook's attitude and tone when discussing Apple Watch. Here's Sacconaghi:

"I just wanted to revisit the watch. Tim, I think you've said, when you were talking about your new products, you said we're 'very happy with the reception' and in response to a previous answer, you said, 'relative to demand, it's hard to gauge with no product in the stores.' I would say relative to other product launches, where your commentary around demand was characterized by superlative after superlative, that assessment feels very modest." 

Tim responded, "I'm thrilled with it, Tony, so I don't want you to read anything I'm saying any way other than that. So I'm not sure how to say that any clearer than that." Sacconaghi recently visited with Tim Cook and Luca Maestri and once again he made note of their demeanor, saying their tone was "confident, though not ebullient."

All of this doubt should be expected as Apple chose not to disclose Apple Watch sales. That decision was likely not taken too lightly at Apple HQ. If management announced opening weekend sales, a can of worms would be opened where people would expect such disclosure at every turn and any slight deviation would be marked as a negative. Take a look at iPad to see what being aware that unit sales are declining year-over-year can do to a product's perception.

However, by not releasing sales numbers, doubt and worry are allowed to build as there is no concrete evidence to refute an analyst's analysis. Instead, some are left resorting to analyzing management's tone when talking about the Watch.

I suspect one of the driving reasons that led management to keep Apple Watch sales under wraps is that given the current environment, Apple doesn't need to release Watch sales numbers. With the iPhone selling so well and representing a large portion of operating income, I can see Apple looking at that and saying that there wouldn't be much benefit from releasing Watch sales numbers. When you are selling 50 million iPhones a quarter, announcing four million Apple Watch sales may be lost on many market observers. In addition, the less Watch disclosure, the harder it would be for competitors to respond.

The very little amount of data that we do have on Watch sales (primarily from Slice Intelligence, but also Apple revenue guidance for the current quarter) would suggest that Apple Watch sales look solid (4M so far), although the adoption rate may be a bit weaker than that of the initial iPad in 2010. Said another way, the Watch may indeed take a bit longer to catch on with people compared to how the world seemed to accept the iPad over night. Did Apple expect this and feel it was prudent to not release sales early on? It's possible. In a way, Apple would be somewhat hedging its bet just a bit.

Let's not forget, Apple has been big about disclosing sales numbers if they are strong. That's why I think this decision may be related to iPhone strength. Apple would have decided they weren't going to break out Watch sales numbers months ago. I suspect this is not a decision based on opening weekend sales strength or weakness. 

Ultimately, Wall Street is all about expectations. Back in November 2014, my very first Watch sales estimate was for 20-30 million units to be sold in the first 12 months on the market. In March 2015, I fine-tuned my estimate to 28 million units in the first 12 months on the market. These numbers are important because they help frame how I look at the Watch and what would be "disappointing" results or "strong" numbers. Every analyst is different, and that is important to take into account when they issue research notes discussing the Watch. Looking back at Hargreaves' note, his 12-month Watch sales estimate looks to be pretty similar to mine across the board, so he's not overly optimistic or pessimistic.

If analysts' main concern is around Apple Watch sales in 2016, I have a feeling we may need to get used to this Apple Watch doubt. We are in the very early innings of this game, and there is no evidence yet to suggest the Watch has struck out.

In addition to the preceding article, Above Avalon members also received the following articles this past week:

• The Genius Move Behind the Phil Schiller Interview 
• How to Discover Apple Watch Sales 
• Apple is Playing Offense, not Defense 
• New Productivity Features Hint at iPad's Future
• Fitbit Prices IPO Above Expectations 
• Cablevision CEO Sees Cable Bundle Dying 
• Apple's New Search APIs 
• Apple Retail Store Renovations  
• Apple Hiring News Editors
• Apple Correctly Killed Plans for Beats Wifi Speakers 

To read these articles (accessible via email) and receive future articles containing Apple analysis, subscribe at the membership page. A weekly option is also available containing all of the week's articles in one email delivered at the end of the week. Above Avalon is supported 100 percent by its members. Thank for your continued support.