Apple Watch is Coming to Best Buy - Above Avalon Premium Week in Review

Along with periodic Above Avalon posts, I send out a daily email about Apple to members (10-12 stories per week). The following story was sent to members on July 28th. 

Apple Watch is Coming to Best Buy

The Apple Watch continues to throw us curve balls. The latest is courtesy of a Best Buy press release:

"The Apple Watch, one of the year's most talked about and innovative products, is coming to Best Buy.

Starting Aug. 7, Best Buy will be the first national retailer, other than Apple Stores, where customers can buy the Apple Watch. It will begin to arrive in more than 100 Best Buy stores and will also be available on BestBuy.com. Another 200 of our stores will have the Apple Watch in time for holiday shopping."

The first thing to note is the relatively slow roll-out. Even though August 7th is next week, it sounds like it will take some time for Apple Watch to be in the first 100 stores. The U.S. holiday shopping season is still four months away, and there are 1,050 Best Buy stores in the U.S. For there to be only 300 stores to have the Watch by November suggests that there will likely be special Watch display areas set up in the Apple areas within Best Buy stores. Will Apple utilize Watch display tables similar to the ones in Apple retail stores or will Apple build special (smaller) tables just for Best Buy?

It's clear we should expect the Watch to be sold in a refined way, even at Best Buy. That is one reason why the Apple Watch display tables are so great, representing a new take on how luxury watches are displayed to the public. Traditionally, you think of a watch display case in a Bloomingdale's where dozens of watches are packed together in glass cases. In terms of other smartwatches, the display method is nothing short of a mess with some Android Wear devices attached to tables like a pen chained to the table at a bank. 

Best Buy detailed the Watch models that will be available in its stores: "[C]ustomers will be able to see, try and buy 16 Apple Watch models - including Sport and Watch models in both 38mm and 42mm sizes - and nearly 50 accessories, including watch bands, screen shields, stands, chargers and more." 

Does "try on" mean I would be able to wear the Watch or simply play with the device while it is stationed to the table? There are still questions left unanswered. 

The much bigger stories here are the expanding Watch retail distribution and the delicate balance Apple has to manage between selling luxury and premium mass-market items.

Apple Watch is currently sold in 266 Apple retail stores in the U.S., so this Best Buy deal effectively doubles the retail presence in the U.S., which should not be underestimated. It's important to remember that there are millions of people that don't live near an Apple store and have not had the opportunity to see or play with Apple Watch. I would expect other retailers to sell Apple Watch in time for the holidays as Apple management stressed that key shopping time frame on last week's earnings call.  

Over the past few weeks, because there has been so much attention given to whether the Apple Watch has been a flop or not, many have forgotten that Apple is now a premium mass-market luxury brand. By selling Watch models ranging from $349 to $17,000, Apple needs to rely on a particular kind of retail strategy in order to not alienate certain customers.

As I wrote a few months ago, the answer seems to be segmenting the Sport and Watch models from the Edition. Such segmentation makes it possible to sell the Sport and Watch in more mainstream retailers while not hurting the appeal of the Edition, or at least that would be the theory. 

Here's a snippet from a post I wrote back in March titled, "The New Apple: Embracing Personalized Technology with a Luxury Twist":

"Even though Apple has mastered the art of selling mass-market goods at premium prices, catering to a luxury clientele comes with new risks, including alienating core users who may be turned off by management's focus on the high-end at the detriment of the 'low-end'...There will likely be very few instances of $349 Apple Watch Sports being sold next to $17,000 Apple Watch Editions." 

We are in unchartered territory, not just because we are talking about a personal luxury tech gadget, but because Apple is actually pushing a different kind of luxury with all of the watch models having the same fundamental functionality, the only difference being aluminum, stainless steel, and gold watch cases.

While some may poke fun at Apple Watch being sold at Best Buy, in reality the decision makes perfect sense and will not hurt the luxury image that Apple is going after because of the Watch collection segmentation that is present.

Along with the preceding story, the full list of stories sent to Above Avalon members last week included: 

• Apple Talked with BMW About Electric Cars
• The Unknown Tablet Market
• Elon Musk is Experimenting (with electric car retail)
• I Saw My First Apple Watch in the Wild
• New Apple Watch Ads
• Apple Music Subscriber Numbers
• Apple Music's Problem
• Motorola's New Phones
• Why There's Nothing Quite Like iPhone 
• Thursday Q&A - Media Edition (Disney, Snapchat, and Vine)

Become a member to receive these stories and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.

Apple Car Development is Advancing - Above Avalon Premium Week in Review

Along with periodic Above Avalon posts, I send out a daily email about Apple to members (10-12 stories per week). The following story was sent to members on July 21st. 

Apple Car Development is Advancing 

The Apple Car development project appears to be on track. The WSJ is out with a new report indicating Apple continues to hire auto-related executives and researchers. The latest are Doug Betts, one of the highest auto executives confirmed to now work at Apple, and Paul Furgale, a researcher involved in autonomous vehicles, mapping, and robotics.

Since the Apple Car project remains unconfirmed, the primary evidence we have to judge the project's progression (or lack thereof) is hires and fires that are likely related to Apple's efforts with automobiles. 

Here is the WSJ:

"Mr. Betts could be the first major automotive executive to join Apple with experience leveled more at the manufacturing side of the business. 

For nearly two decades, he has worked in product quality and manufacturing at an auto company, first as a general manager at Toyota Motor Corp. and later as a vice president at Nissan Motor Co. and Chrysler Group LLC, now FCA US LLC.

In 2009, when Fiat SpA took over Chrysler, CEO Sergio Marchionne tapped Mr. Betts to lead the company's quality turnaround, giving him far-reaching authority over the company's brands and even the final say on key production launches.

Mr. Betts abruptly left Fiat Chrysler last year to pursue other interests. The move came less than a day after the car marker's brands ranked poorly in an influential reliability study."

The WSJ is being pretty kind here in describing Betts' departure. Most industry watchers think Betts was fired this past November due to Fiat, Jeep, Ram, and Dodge taking the bottom four slots on the influential Consumer Reports reliability survey, with the Chrysler brand not far behind.

Obviously, news of Betts being fired due to poor quality performance wouldn't seem to sit right with this latest news from the WSJ that Apple hired him. What is going on?

Industry watchers say Betts was likely used as a scapegoat as the quality problems facing Fiat due to acquiring Chrysler were simply insurmountable and indicative of much bigger company and culture issues, things that one person would not be able to solve on their own. The Daily Kanban, a site dedicated to covering news and analysis from the auto industry, with a focus on Toyota, summed up Chrysler's problems well:

"Chrysler's quality problems seem to be coming from nearly every possible corner. In just a few of the most recent issues to hit the media, FCA [Fiat Chrysler Automobiles] has shown it has problems with everything from a lack of development testing (vibration leading to cracks in Ram Ecodiesel exhaust coupling), to assembly problems (Hellcat fuel leaks). Supplier problems have also featured heavily in FCA's quality snafus, most recently in a recall of Chrysler 200 transmissions due to 'inconsistent assembly procedures at a supplier's plant,' even as [FCA CEO] Marchionne has targeted supplier profits. But perhaps most troubling is the evidence that FCA simply isn't able to catch quality problems before cars go out to customers...

[A] fired executive scapegoat and a snarky [YouTube] ad were deemed a solution to a long-term quality problem. Little wonder Chrysler still finds itself at the bottom of Consumer Reports recommendations."

When you take a step back, Betts' hire at Apple makes much more sense. Betts is a senior level auto executive with stints across a number of companies, including time as head of product quality and supply chain for the Tundra, Sequoia, and Sienna at Toyota in Indiana, where manufacturing techniques are still the envy of the auto industry. This may just be coincidence, but all three of those Toyota vehicles are either SUVs or trucks, and Apple's car project was rumored to include a larger, minivan-type vehicle. Even though he was not able to turn around FCA's fortunes, it is very well possible that Apple sees value in applying his skills and experience to their current project.

One other aspect of Betts that many may not catch is that he has previous experience as Head of Total Customer Satisfaction for Americas at Nissan, which in car lingo means controlling the experience a customer has with a car brand, including everything from how a car is built, to it being bought at a dealer. Betts was overlooking the Nissan experience. Now recall how Apple is all about selling experiences. It sure does seem to fit in my mind.

On his LinkedIn [update: his profile has been deleted], Betts is likely using misdirection, simply saying he is working in Operations at Apple, similar to how former Mercedes R&D head, Johann Jungwirth, lists his job duty at Apple as Director of Mac Systems Engineering.

Betts would seem to be a senior-level hire for the Apple Car group, overseeing an entire team or division within the larger initiative led by Steve Zadesky. It is this type of structure that makes me much more bullish of a full-fledged product under development.

The WSJ has more on Apple apparently hiring Paul Furgale: 

"Earlier this year, Apple hired Paul Furgale a well-regarded autonomous vehicle researcher in Switzerland, and has begun recruiting other robotics and machine vision experts to work on a confidential project."

Just to give you a few examples of the type of research Furgale was previously involved in as late as last year, here is a sampling of the publications listing Furgale as a co-author: 

• Keyframe-based Visual-Inertial Odometry Using Nonlinear Optimization
• Lighting-Invariant Adaptive Route Following Using Iterative Closest Point Matching
• Infrastructure-Based Calibration of a Multi-Camera Rig
• Self-supervised Calibration for Robotic Systems

Here's more from the WSJ: 

"Mr. Furgale had been deputy director of the Autonomous Systems Lab at the Swiss Federal Institute of Technology, or ETH. Mr. Furgale previously had led a European Commission project called V-Charge that sought to develop self-parking vehicle technology...

Mr. Furgale has begun recruiting students and researchers to work with him. Apple has hired a graduate student studying at the University of Michigan and has quietly recruited others."  

Two points that I get from this news: 1) Compare Betts to Furgale. While one is a senior-level auto manager, the other is knee-deep in technology and research. Apple is hiring a mix of talent from both the legacy auto industry, as well as academia. 2) I look at the earlier reports back in February saying that Apple wasn't researching autonomous vehicles as a head fake, or misdirection. Evidence suggests they are. Of course, we need to take a few steps to get from Point A to Point B, including semi-autonomous features like better parking and highway travel, but like with any product, I suspect Apple is looking farther in the future, at a world where autonomous vehicles are much more likely to control the road.

Betts and Furgale are both interesting auto-related hires that further strengthen the theory that Apple's ambitions in the automobile industry have no bounds.

Along with the preceding story, the full list of stories sent to Above Avalon members last week included: 

• Apple Earnings Summary - Big Picture, Stock Price Reaction, iPhone: Relatively Quiet (Which is Good), Apple Watch: It's Very Early and Things Look Okay, iPad Sales Growth: Fact vs. Theory, Share Buyback: It's Slowing, Additional Earnings Call Notes
• The Day After Apple Earnings on Wall Street
• The Wild Ride on Wall Street 
• Judging Apple Watch Success/Failure
• Beme and the iPhone Ecosystem
• Apple Music - A Few Thoughts Three Weeks In
• Washington Looking at Foreign Cash Tax Reform 
• Thursday Q&A

Become a member to receive these stories, including my full AAPL 3Q15 earnings recap (will be sent to you via email), and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.

Flops, Winners, and Outliers

When is a product a flop? What does a winner look like in consumer technology? How can outliers complicate our thought process? The Apple Watch is getting us to ask all of these questions while failing to provide the instantaneous answers that we crave. Not only has Apple's recent success led market observers to put value in short-term thinking and cynicism, but we have lost all context for how to properly measure product success and failure. It is clear that instead of thinking of flops, winners, and outliers as meaning the same thing across products and companies, context and discernment are needed to properly assess reality. 

Flops

Apple has single-handedly morphed the definition of a flop. What once referred to products that were never able to make a lasting impression in consumers' minds (e.g. HP TouchPad, Blackberry Playbook) has now expanded to include product sales that are less than the best selling Apple products of all-time. Some of this aggressiveness to slap the flop label on new products so quickly comes from the proliferation of products not ready for prime time. It remains a mystery why the Amazon Fire Phone ever saw the light of day. Similarly, tech companies positioning their R&D efforts into the public sphere with products like Google Glass have gotten us trained to look for and expect instant flops: products that are never able to find a niche due to a plethora of reasons. Flops aren't just kept for hardware products as a number of Facebook apps, such as Poke and Camera, never were able to find an audience before being thrown aside. 

Set in this somewhat confusing environment is Apple, a company that has relied on a strategy of placing very few hardware bets in order to focus attention and resources on a handful of products. In some ways, this rare and unique strategy, which other companies look down upon as being too risky for their own taste, would seem to necessitate a different kind of analysis when it comes to flops. Consensus opinion has landed on the stance that if Apple gave the green light to a new product, that must mean Apple expects it sell in numbers like an iPhone and iPad; anything short of this threshold should earn the flop label. 

The primary problem with that thinking, and flops in general, are that they require context, both in terms of setting and timing. There is simply too much diversion in company resources and strategy to use the same flop brush across products, not to mention companies. Even though Apple releases very few products, not everything that comes out Apple HQ is positioned to reach tens of millions of users. Going further, certain models or SKUs may be geared toward a very specific niche that doesn't add up to more than 100,000 customers (think: Mac Pro). This introduces confusion and complexity into what is a flop. 

Winners

There is still much disagreement over how to quantify winners in consumer technology. Is market share leader the title one should strive for? In the phone industry, the feature phone master, Symbian, was cast aside in a few short years. Blackberry's early smartphone power was decimated within roughly the same time span. While some may point to profit market share as the more suitable choice for determining success, Apple's monopoly on profits in markets that it plays in doesn't sit well with some people. How about year-over-year growth being used as a litmus test for success? There was a time when Microsoft being able to grow its smartphone market share from one to two percent was classified as a resounding success. 

Similar to how flops require context for proper judgement, a product's success is also relative. For a smaller company like GoPro or Fitbit, if the latest camera or fitness wearable registered one million unit sales in a quarter, Wall Street may reward the company with accolades and rating upgrades. For Apple, the same sales rate for a more mature product would be a disappointment, and surely earn a flop badge. There is nothing inherently wrong with this differing rating system and one could argue that is exactly how it should work. The problem with that line of thinking is that success for a company like Apple begins to take on mythical proportions. Everything to come out of the design labs would inevitably be compared to iPhone, a product that Apple is on track to sell 250 million units per year. 

How should a winner be defined? Ultimately, the easiest and most universal definition may involve measuring a product's trajectory and looking for signs of momentum. 

Outliers

If it wasn't already difficult to figure out how to define a flop or winner, outliers may lead us to continue to struggle trying to find answers to these questions. The iPad is a great example of an outlier, a product that had impeccable market timing and an environment ripe for early sales success. The end result is 280 million units being sold in five years. Today, the product is facing questions as to its long-term trajectories with much of its functionality now being met with other products. When the iPad was launched, the running joke was that it was just a big iPod touch. In retrospect, it was that label that likely indicated why it sold so well, so quickly. It was a product that shared most of the allure of iPhone, only with no contract and a much larger and attractive screen. Once the iPhone screen got larger (and the Mac got thinner and lighter), the iPad was squeezed. The much longer life cycle for the product hasn't helped sales either as consumers hold on to their iPads for much longer than their iPhones.

In our attempt to quantify Apple Watch success, comparisons to the iPad may lead to faulty conclusions, both from a positive and negative angle. It may be too optimistic to assume that a new Apple product can see the same adoption rate as iPad. Just as the iPad is now facing a sales plateau, such a barrier may represent an incorrect conclusion as to how well a new product could do over time.

Another outlier question that undoubtedly needs to be asked involves the iPhone. Is Apple's juggernaut truly a one-of-a-kind product? With such a short upgrade cycle, aided by Apple's relationship with mobile carriers across the world, will it be extremely difficult for another product to meet similar annual sales rates? 

What to do?

Taking into account the complications and difficulty in defining flops and winners, set within a sea that contains a few outliers, how should one go about measuring a product's performance? 

1) Establish Context. What kind of product is being measured? A $99 fitness wearable that requires no other device to do its job or a $3,500 Mac Pro designed for movie makers? Does the product require a monthly contract or other recurring cost? Will a decaying battery over time require the product to be replaced in a few years, or is the product designed to last many years?

2) Establish Parameters. How should success be defined? Obviously there are major differences when discussing hardware and software initiatives. On one hand, quarterly unit sales may suffice while on the other hand, reaching scale in the form hundreds of millions of users may be the only way to reach success. Even within the same product category, different parameters may exist. For a phone, should we measure success in terms of sales share, profit share, or mind share? 

3) Look for Momentum. Rather that merely thinking about a product's long-term potential, it is important to find momentum or signs of life. App developer involvement, early success within a specific demographic, or increased word of mouth may all signal that a product has life and potential to grow over time. 

4) Measure Results. It is important to find ways of quantifying parameters and momentum. It is not a coincidence that many technology companies have adopted policies that revolve around providing little to no product sales disclosure. While some of this could be related to competitive reasons, the much more likely reason is to hinder Step #3 from above, making it difficult to know if a product is failing in the marketplace. While Amazon is known for its lack of disclosure, the company has not been shy when disclosing the number of Prime memberships. Along similar lines, Samsung was quick to reveal smartphone sales as the company was consolidating power within the Android OEM space, but when facing struggles at both the low-end and high-end of the smartphone market, the company has now adopted a policy of not disclosing smartphone sales. Even Apple is known to partake in the "tell the world good numbers" party while keeping mediocre results private. 

These four steps indicate that measuring flops, winners, and outliers is not easy and likely involves much effort and time: attributes that are seemingly in decreasing supply. The iPhone and iPad may have spoiled us when it comes to thinking about what failure and success mean in consumer technology. In order to get a better grasp of what is happening close to the ground, more effort will be required to bypass the rhetoric and rely on logic and processes to guide the thought process. It won't be easy, but we need to start somewhere. 

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AAPL 3Q15 Earnings Preview

Apple is positioned to report another quarterly earnings beat when reporting 3Q results on July 21st. Apple continues to benefit from attractive year-over-year sales comparisons in China. Overall revenue growth is tracking close to 35 percent, with earnings growth exceeding 50 percent. With the iPhone now representing close to 70 percent of Apple's operating income, the product category has become the single-most important factor driving earnings, and that trend will continue in the near-term. With lingering Apple Watch demand questions, many will use earnings as the first opportunity to back into Watch unit sales. Apple guidance should be informative, reflecting not only a new iPhone launch, but also an early read on July sales and any impact from ongoing economic turmoil in China. 

Earnings Preview Reading

Over the past three months, the major stories impacting Apple financials have centered around three topics: the iPhone's growing power, Apple's cash, and China Mobile. The following stories serve as good background reading in the lead-up to Apple earnings.

1. The iPhone is Taking Over Apple - Apple will be the iPhone company for the foreseeable future. The iPhone's gravitational pull is simply too strong for any new product or service to reach escape velocity and become the next big thing for Apple in the near-term.
2. Apple's Cash Dilemma - Apple is unable to keep the pace of share buybacks and dividends in line with its foreign cash generation.
3. China Mobile is a Game Changer for Apple - China Mobile has become Apple's most important business partner.

iPhone: No Change in Momentum

Strong iPhone sales trends in China, Europe, and emerging markets will continue to offset lackluster smartphone growth in the U.S. Last quarter, I estimated China Mobile accounted for nearly 40% of Apple's year-over-year iPhone growth, which was certainly boosted by the Chinese New Year in February. China Mobile's importance cannot be stressed enough as the largest mobile carrier in the world will soon account for 20% of all iPhone shipments. Given lower smartphone adoption rate in China compared to U.S. and Europe, I would expect China to continue representing a majority of iPhone growth for the next few quarters. 

Exhibit 1: iPhone Unit Sales Expectation Meter (3Q15)

Mac and iPad: No Longer Earnings Factors, but Still Interesting

Due to the iPhone's elevated share of earnings, the Mac and iPad are no longer relevant from an earnings day perspective. There are still interesting trends at play within each category. The Mac is continuing to take share in a category that is pretty much being decimated with overall PC shipments forecasted to be down 5-10% year-over-year this past quarter. The iPad continues to struggle as the product finds a normalized run rate where the combination of first-time buyers and upgraders results in roughly flat growth. We are not there yet.

Exhibit 2: iPad and Mac Unit Sales Expectation Meters (3Q15)

Apple Watch

Even though Apple is not expected to disclose Apple Watch sales, keen observers with an Apple earnings model will be able to back into a relatively good approximation of Apple Watch sales. I am expecting Apple to have sold 4.25 million Apple Watches from April to June. While there has been much debate as to how the Apple Watch has been selling, more time will be needed to gauge normalized demand; there was evidence of pent-up demand at launch as would be the case with any new Apple product category. 

Guidance

Management's guidance will be useful for a few reasons. Since we are quickly approaching the new iPhone launch, guidance will help determine what Apple has seen so far in the month of July in terms of iPhone demand. While there shouldn't be much spillover just yet from the volatile Chinese stock market, any caution built into China sales due to economic concerns may become apparent in guidance. In addition, next quarter will present a more informative view on Apple Watch sales as we move away from launch.  

Exhibit 3: Revenue and Margin Guidance Expectation Meters (for 4Q15)

Wall Street Concerns

The biggest headwind facing Apple continues to be fears of slowing iPhone growth in 2016. As has been the case for the past few conference calls, analysts will look for any new commentary on Android switcher rates and iPhone penetration in China and other developing markets. If 2015 was the year of China Mobile and large screen iPhones, company observers are becoming skeptical that the new iPhones will be able to sustain the same type of growth rates next year.  

For additional commentary and perspective on Apple's upcoming earnings, become a member to receive my premium emails from this week (Tuesday, Wednesday and Thursday). To receive these emails and future daily emails containing Apple analysis (10-12 stories per week), sign-up here.

The iPhone is Taking Over Apple

One theme has become clear in 2015: the iPhone's gravitational pull is simply too strong for any new Apple product or service to reach escape velocity and become the next big thing for Apple in the near-term. From a financial and business perspective, the iPhone is the only product that matters. The iPhone is amassing so much power at Apple, it is difficult to imagine any product being able to dramatically surpass the iPhone in terms of importance over the next five years. Apple will be the iPhone company for the foreseeable future, and that classification introduces opportunities and risks that Apple will need to navigate over the coming years.  

Perspective

This past month, the iPhone celebrated its 8th anniversary. It is easy to forget how significant of a factor the iPhone has been to Apple's business since launching in 2007. Taking a look at cumulative data over that time span helps to put the iPhone's one-of-a-kind product status into perspective. 

• 726 million iPhones sold
• $443 billion of revenue (50% of total) 
• $200 billion of gross profit (60% of total)
• $120 billion of net income (60% of total) 

As a sign of continued iPhone momentum, Apple is now selling up to 250 million iPhones a year, or close to a third of total iPhones sold to date. 

iPhone's Importance to Apple's Financials 

Everyone knows the iPhone is a crucial part of Apple's business, but few realize the extent to which the iPhone is literally taking over Apple's financials. In the first half of FY2015, the iPhone accounted for 69% of Apple's total revenue, up from 57% of revenue during the same time period last year. In terms of gross profit, the trend is even more pronounced, with iPhone accounting for 81% of Apple's gross profit over the past two quarters, up from 68%. Much of this change is related to strong iPhone sales in China following the iPhone 6 and 6 Plus launch in addition to China Mobile beginning to sell the iPhone last year. It has gotten to the point that Apple's quarterly earnings reports should be renamed "iPhone sales updates" because no other part of Apple's business is able to impact the financial statements quite like iPhone.

Exhibits 1 and 2 highlight the iPhone's overall contribution to Apple's revenue and gross profit.

Exhibit 1: iPhone Revenue as Percent of Total Apple Revenue (Fiscal Year)

Exhibit 2: iPhone Gross Profit as Percent of Total Apple Gross Profit  (Fiscal Year)

The iPhone's strong margins and short upgrade cycle contribute to the device's significant share of Apple's revenue and earnings as iPhone users are likely to upgrade their high-margin phones every two or three years.  

One example of how important the iPhone is to Apple's earnings is a hypothetical scenario in which Apple missed iPhone unit sales quarterly expectations by 10%. Such a scenario wouldn't necessarily be too much of a stretch considering Samsung misjudged demand for the Samsung Galaxy S5 by 40% last year. If Apple missed iPhone sales expectations by 10%, or five million units, EPS would have fallen by 10%. If we then assumed iPad or Mac sales missed expectations by 10%, the resulting EPS impact would be a rounding error. 

It is getting to the point that the iPad or Mac are nothing more than asterisks on Apple's quarterly earnings reports which is saying a lot given their influence and sales numbers. Even the pace of Apple's capital return program is starting to be controlled by the iPhone given the product's significant contribution to U.S. cash flow and consequentially available funds to spend on buyback and dividends. Over the course of eight years, the iPhone has earned more than $100 billion of cash for Apple, which has gone a long way in buying back shares and paying dividends. 

iPhone's Importance to Apple's Business

From management's point of view, the iPhone's significant power presents both business opportunities and risks. The iPhone's success has given Apple a formidable presence in mobile in terms of market power and positioning. Across the world, the iPhone 6 and 6 Plus have helped Apple grow market share, with a total iPhone user base close to 500 million. This environment remains quite appealing to developers and third-party companies willing to invest in the iOS ecosystem. 

Besides funding the capital return program, the cash flow produced from iPhone sales has also been used to help develop new products and initiatives. While iPod sales helped fund iPhone development, iPhone sales will help fund Apple Car development.

Nevertheless, very strong iPhone growth trends do present some risks. From Apple's point of view, it is in their best interest to keep the iPhone user base vibrant and engaged. Such efforts go a long way in preventing fragmentation or stagnation.  Accordingly, a situation may arise in which Apple finds itself with such a large iPhone user base that a growing number of users do not upgrade to the latest OS version, weakening the iPhone ecosystem.

In iOS 9, Apple included a series of features to address and turn around slowing iOS adoption rates likely due to users not having enough iPhone storage. As one example, users will receive a pop-up when trying to install iOS 9 on a device with insufficient space and offer to temporarily delete apps in order to make room for the update. The deleted apps would be reinstalled once iOS 9 has been installed. In addition, app thinning, app slicing, on-demand resources, and bitcode are all designed to maintain the vibrant nature of the iPhone user base, especially those who may be using older models.

Another risk created with strong iPhone sales is the difficult part of needing to push the iPhone forward in terms of hardware or software design while facing a growing amount of pushback from users opposed to change. The theory here is that the larger the user base, the more heterogeneous the composition including variation in taste and desires. The end result may be that changes alienate a group of iPhone users. One example of this is Apple changing the iPhone dock connector. A software example is how iOS 7 brought a new look to everyone's iPhone. The fear of embracing change due to potential user pushback or revolt has led to disaster at other technology companies since the lack of change gave competitors room to offer a better product. Evidence would suggest Apple has no intention of following a similar path. Take a look at the newest Macbook for evidence of Apple not being afraid to push design forward even if it meant alienating some users. 

One of the biggest risks that Apple faces from a strong iPhone is that the product's importance leads management to ignore other opportunities that may seem too small to matter and are unlikely to reach the iPhone's stature in terms of revenue and profit. In reality, it is those kinds of risks that need to be taken in order to be in a position to eventually ship a product that will one day surpass the iPhone in terms of importance.  Once again, Apple seems to be aware of this risk as the Apple Watch certainly contains attributes that may one day lead to people being able to accomplish a good portion of their computing needs with just a device worn on their wrist. 

Strengthening iPhone's Value Proposition

The next five years for Apple will likely focus on new products and services positioned to increase the iPhone's value proposition instead of become the next big thing that will eventually surpass the iPhone. On some level, that may sound like Apple is operating in a lower gear than it did in the 2005-2010 period, and in some ways that is true for the simple fact that it is incredibly difficult to ship a product that is more important than the iPhone within a few years of its birth. This dynamic raises some interesting questions including whether this is one reason for Jony Ive's promotion to Chief Design Officer, which frees him from day-to-day managerial duties and instead allows him to look at more strategic tasks in terms of Apple design. These tasks include adapting the company's retail infrastructure to embrace luxury wearables.

It is impossible to say Apple will never ship a product as important and profitable as the iPhone because "never" is quite a long time. Most consumers spend $600-$700 on an iPhone every two or three years which means there is plenty of opportunity to have people spend more money on new Apple products and services. However, over the next five years, the iPhone will remain the most important product that Apple sells, and it would seem that Apple wouldn't have it any other way.

One of Steve Jobs' quotes that has been displayed at Apple HQ sums up Apple's long-term plan with the iPhone really well: "If you do something and it turns out pretty good, then you should go do something else wonderful, not dwell on it for too long. Just figure out what's next."

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