Apple Questions for 2016

I'm not a fan of prediction posts at the start of each year. Instead, the much more valuable way to prepare for the new year is to embrace the unknown. By formulating and organizing a series of questions, it becomes that much easier to assess a company's strengths, weaknesses, priorities, and opportunities over the next twelve months. Here are my Apple questions for 2016:

Apple Watch

• Apple Watch 2. The Apple Watch has become a litmus test for Apple's ability to create compelling new product categories. What features will Apple look to improve when the Apple Watch is updated in a few months? There is low-hanging fruit in terms of features that can see improvement, including an Apple S2 chip and slightly better battery, although the device's small footprint should be taken into consideration when thinking of realistic near-term advancements. Will Apple push ahead with health and fitness and include additional health-related sensors in Apple Watch 2? In addition, how much change will Apple push in terms of the device's physical design attributes?

• New Watch Bands. Management has been very vocal in pushing the theme of buying additional watch bands to personalize Apple Watch. After only five months on the market, Apple unveiled a range of new Sport bands this past September, including a new leather band option. Will Apple come out with a range of new Watch band options for both the Sport and Watch collections alongside updated Apple Watch cases? It is important to remember that the Watch bands themselves will likely one day contain sensors and play a more vital role than just being a fashion item.

• Pricing. Will Apple maintain its current Apple Watch pricing? With the vast majority of Watch sales attributed to the Sport collection, the $349 and $399 entry-level models will be the key ones to watch going forward. It is not a given that Apple will keep selling the original Apple Watch alongside Apple Watch 2. There would be historical precedent for Apple to stop selling the original Apple Watch once the new Apple Watch is released, similar to what occurred with the iPhone and iPad. This has a major implication on Apple Watch pricing as Apple would not have a year-old model to sell at a lower price like we see with the iPhone and iPad in recent years. At the same time, Apple likely has fresh data on how Watch sales fare at lower prices considering Best Buy and Target had $100 off Watch promotions.

• Sales Disclosure. Will Apple begin to break out Apple Watch sales numbers in 2016? It is not a question of "if" but "when." From management's viewpoint, there are pros and cons to not revealing Watch sales but at a certain sales point, the material nature of the sales will be too much to keep hidden in the "Other Products" line item.

• Marketing. Where does Apple plan on taking Apple Watch marketing? We have already seen some changes in the way Apple describes the Watch with its TV ads, moving away from the "iPhone on your wrist" messaging and embracing a fun device that can do a number of small, convenient tasks.

• Apple Watch Edition. Leading up to the Apple Watch launch last year, the Apple Watch Edition collection received an oversized amount of attention. However, in recent months there has been little press attention given to the collection. Will Apple sell new Watch case materials, such as platinum or white gold, for the Edition collection? When considering that success for the Edition collection is not measured by unit sales, Apple is likely judging the collection by other factors including material design and allure. Will we get any evidence to suggest if management is pleased with how the world has embraced the Edition collection?

• New Luxury Partnerships. Will Apple launch another Apple Watch partnership? Apple's Hermès partnership may end up being one of the sleeper hits of Apple Watch's debut year, as Apple combined the worlds of traditional luxury with personal technology. Additional partnerships involving luxury brands holding notoriety around precious metals would be a logical next step.

iPhone

• The 4-inch iPhone. Is Apple planning on positioning a new 4-inch iPhone as a way to entice iPhone 5/5s/5c users to upgrade? There is no question that iPhone unit sales growth will slow in 2016 compared to 2015, a byproduct of strong iPhone 6 and 6 Plus sales in 2015 and what appears to be a slower iPhone upgrade cycle with the 6s and 6s Plus. A new 4-inch iPhone would be positioned as a catalyst to get current 4-inch screen iPhone users to make the jump.

• iPhone 7. Similar to every other annual iPhone release, Apple will strive to have three or four headline features with the iPhone 7. Will Apple remove extra bezel from the iPhone in order to make current screens feel a bit better in hand? In addition, an iPhone without a home button seems like an evolutionary next step, although it may be too big of a jump to take in the near-term with current iOS software. The biggest questions surrounding new iPhones relate to the Plus model. Will Apple begin to differentiate the iPhone Plus model beyond just screen size? Adding greater differentiation within the iPhone line would help in terms of ASP trends as well as better position the iPhone as a PC/Mac replacement.

• iPhone Upgrade Program. The highlight from Apple's "Hey Siri" keynote this past September was the iPhone Upgrade Program. Creating a process for users to easily buy a new iPhone every year directly from Apple has very significant ramifications in terms of the iPhone upgrade cycle. Currently the service is only available in Apple Retail stores in the U.S. Will Apple extend the iPhone Upgrade Program to additional countries, in addition to bringing the service online?

iPad

• New iPad Pro. The iPad Pro was the most noteworthy development for iPad in years. A 12.9-inch screen, combined with four stereo speakers, and productivity accessories, position the iPad Pro as the iPad's future. The iPad Pro pushes the larger iOS multi-touch tablet category forward by distinguishing itself from larger iPhones and smaller Macs. Will Apple push an iPad Pro update in 2016 or should we expect a longer update cycle?

• iPad Sales. Will we see early signs of iPad sales bottoming in 2016? The addition of the Pro model to the lineup will help offset some of the iPad mini sales declines, although the much bigger trend of larger iPhones cannibalizing iPad mini will continue.

• iPad Air 3. Apple did not update the iPad Air in 2015. Accordingly, does Apple plan on updating the Air in 2016?

• Apple Pencil. Will Apple ship a new Apple Pencil and extend Apple Pencil support to other iOS devices? The Apple Pencil is the most intriguing Apple accessory in 2015 with a clear directive of being used to mark, draw, or write, and not navigate. Such tasks may end up serving as a clue that Apple does not plan on expanding Apple Pencil support to other iOS devices in the near term.

iOS

• iOS 10. What will be the main features in iOS 10? The iOS home screen has been a crucial part of the iPhone user experience from the beginning. However, there are certain elements that are starting to feel a bit dated. I'm using the Spotlight search screen more frequently, and the addition of 3D Touch adds a new element to the conversation. Is Apple planning on rethinking the iOS home screen in iOS 10? Look at the iPad Pro's Springboard, and it becomes easier to conclude: yes, Apple may have something new planned for the home screen.

• App Store Debate. Up to now we really haven't seen much of a debate concerning the App Store (across all platforms). Developers have been increasingly vocal with their concerns surrounding app developer sustainability, while Apple has followed its playbook closely, listening much more than acting. With Phil Schiller now overseeing the managerial aspects of the App Store, one would expect Apple to increase its communication efforts with developers leading to an actual debate where we hear two sides of the argument.

Mac

• Trickle Down MacBooks. Apple's new $1,299 MacBook was the Mac highlight of 2015. The major theme to watch is Apple bringing features found in the new MacBook to other models in the Mac lineup.

• ARM-Based MacBook. Will Apple announce an ARM-based MacBook running an iOS derivative? There have been clues that such a move may be in the pipeline.

Project Titan (Apple's electric car)

• Construction/Real Estate. Apple acquired a significant amount of land in North San Jose through a series of closely guarded transactions in 2015. My theory is that this land is related to R&D facilities for Project Titan. Will we see Apple's plans for this North San Jose land begin to materialize in 2016? The level of progress seen in North San Jose may provide clues as to Project Titan's timeline.

• Employee Hires & Fires. One of the more tangible ways of monitoring Project Titan progress is to look at employee moves. Will Apple have any additional high-profile Project Titan hires in 2016? Contrary to consensus expectations, Apple may turn to the legacy auto industry for talent, similar to hiring Doug Betts from Chrysler. Even though Apple is focused on rethinking what it means to build and sell an automobile, such legacy auto hires have experience and background that will prove helpful for Apple.

• Regulatory Filings. The automobile space is unique compared to previous industries Apple has operated in given the much higher level of government regulation. Apple will need to adapt to these regulations, possibly providing a few early Project Titan clues for those closely monitoring Apple's every move.

Services

• Apple Music. All indications point to Apple Music currently appealing to a small base of iOS users (5-10M members) and to a lesser extent, Android users. Will Apple lobby the record labels to lower the $9.99 monthly membership price in order to attract a wider base and compete with Spotify?

• Apple Video. Bloomberg reported that Apple suspended its plans to launch a slimmed-down cable bundle. Will content companies have second thoughts and be willing to cooperate with Apple in order to launch some type of new package?

• Apple Pay. Despite improved financial institutional support, retailer support is still lacking, especially when it comes to reaching universal support. How will Apple increase customer awareness of Apple Pay, in addition to achieving much broader retail support?

Financials

• Share Buyback. Management spent the second half of 2015 buying as many AAPL shares as possible with the stock price declining in the face of slowing economic growth in China and concerns surrounding iPhone 6s and 6s Plus sales. Given Apple's current valuation of 10.8x forward earnings (6.9x forward earnings excluding cash and cash equivalents), how will management and the board respond when it comes time to update Apple's buyback authorization in April?

• Dividends. Apple's board is expected to increase the quarterly cash dividend in April. What payout ratio does the board feel comfortable targeting given Apple's cash needs for organic growth?

• Foreign Tax Reform. In what is turning into a reoccurring question, will we see any U.S. tax reform regarding taxation of overseas profit? Apple currently has $187 billion of cash and cash equivalents held overseas.

• EU Tax Investigation. The European Commission is expected to announce its decision regarding Apple/Ireland's tax dealings sometime in 2016. What financial impact, if any, will Apple face? If using the recently announced Apple settlement with Italian authorities regarding taxation as a barometer, the European Commission's investigation into Ireland's Apple tax treatment may result in some type of payment from Apple. Overall, there is skepticism that any judgment against Apple would result in long-term headwinds for the company or stock.

• R&D Expense. Apple's R&D expenditures increased dramatically during the summer of 2014 and remained elevated throughout 2015. Should we expect Apple's R&D to continue to outpace revenue growth in 2016?

Management

• Jony Ive. It has been approximately six months since Jony Ive officially relinquished day-to-day managerial control over Apple's industrial and software design teams. How will this change manifest itself in Apple product development in the long-run? There is little to no evidence to suggest much will change. However, additional time is the only way to confirm that the managerial change has been effective.

• Executive Turnover. With Apple Watch's debut now completely in the rearview mirror and the next big thing (Project Titan) likely at least two years away, will any senior Apple executives decide now is the time to retire/take a break? On the surface, no one executive comes to mind as being close to the exit door. Phil Schiller was recently given additional responsibilities while Cue, Federighi, Maestri, and Ahrendts are only now hitting their stride.

• Project Titan Leadership. Similar to Jeff Williams being put in charge of the Apple Watch team, when will Apple place a senior executive to oversee Project Titan? The logical choice is once again Jeff Williams, although this appointment may end up occurring in 2017 or later.

• Jeff Williams. Speaking of Apple's new COO, his stock is on the rise within Apple. Given Williams' increased visibility in 2015, should we expect Williams to play an even bigger role in Apple keynotes and the company's public image?

• Kevin Lynch. Will Kevin Lynch's stock continue to rise in Apple? The leader of Apple Watch software appears to be in a position of increasing power within Apple, and any continued move into wearables will only result in additional attention being given to Lynch.

Wildcards

• New Marketing Direction. Apple's hire of Tor Myhren as VP of Marketing Communications is intriguing on many levels. What should we expect from Myhren? With such a well-regarded and surprising senior hire, it is safe to expect something big in terms of Apple marketing campaigns from this development.

• Carl Icahn / Shareholder Activism. The longer a public company sits on a strong balance sheet while experiencing a declining valuation and languishing stock price, the more likely investors will become agitated. Even though Carl Icahn continues to pledge his support for Tim Cook and the rest of the management team, it would not be surprising to see individual Apple shareholders become a bit more vocal with "suggestions" for Apple on how to increase its valuation.

• M&A. In what areas does Apple feel the need to bolster its resources in 2016? Apple has been quite active on the M&A front in recent years and after considering Apple's product pipeline, continued M&A activity related to augmented reality and personal transport seems likely.

• A New Kind of Wearable Device. With a finished product from Project Titan still a few years out and the Apple machine busy cranking out iPhone, iPad, and Mac updates, the wearables category represents the best wildcard for a completely new Apple product. The leading candidates for new Apple wearables include a ring and wireless EarPods, both of which would be positioned as health-related iPhone accessories.

The Apple news, products, and events not reflected in any of these bullet points represent the unexpected. 

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Strategy Behind Retailers Discounting Apple Watch and iPad

One noticeable trend evolving over the past few weeks in the U.S. has been significant sales on Apple products at some of the country's largest brick and mortar retailers. Best Buy and Target have offered sales on Apple products in the past, but this year feels different. While some have looked at these promotions as signs of waning Apple product demand and a directive by Apple to push excess supply through the distribution channel, the reality is much different. Retailers are positioning Apple Watch and iPad as the top gifts of the year, betting discounts for those two products will drive foot traffic into stores and page views to online stores. The end goal for retailers offering Apple Watch and iPad discounts is to generate the needed buzz and revenue to better compete with one of the best performing retailers: Amazon.

Retailers Are Having a Difficult Year

Traditional brick and mortar retailers have now been embroiled in a tough fight against online retailers for years. The sheer competitiveness found throughout the retail segment is now turning traditional retailers against each other. The single-most important development for the retail landscape has been the smartphone and the exploding phenomenon of "showrooming." Consumers, armed with their smartphones, and in some cases tablets, head out to malls and shopping centers with the goal of trying on or testing products only to then use their smartphones to compare prices across various stores. This process often occurs right in the store and has become quite noticeable in data trends released by mobile app analytics companies. Showrooming is especially common for electronics and other big-ticket items available at a number of different retailers.

To make this year especially difficult for many U.S. retailers, weather patterns have led to unseasonably warm conditions through mid-December, especially in the U.S. Northeast. As a result, apparel sales, traditionally a key component of fourth quarter sales, have been hit hard. When looking at year-to-date sales trends, it quickly becomes clear that 2015 has been a difficult year for most traditional retailers. When comparing their revenue growth trends to those of Amazon, the mediocre results quickly stand out. 

U.S. Retailer Revenue Growth (year-to-date) 

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Note: Reflects only U.S./North American revenues where applicable.

New Retail Strategies and Tactics

Traditional retailers have begun to adapt to the new normal. Best Buy has embraced a number of new strategies to compete against Amazon and other e-commerce retailers. Phrases like "price matching" have become engrained in many consumers' minds. Instead of fighting against showrooming, price matching is all about brick and mortar retailers placing foot traffic and online page views above increased margins and profits. Instead of losing a sale to a different retailer online, retailers are willing to lose a bit of profit in order to keep that customer. 

The best retailers have gone even further and begun to turn their physical stores into something more than just a location for showrooming. Best Buy has doubled down on the concept of stores within stores, including 500 mini Apple stores. In addition, customer service, like the Geek Squad, has been positioned as a much bigger reason to venture to a Best Buy store. The long-term strategy behind such a plan would be to make up lost margin related to price matching with high margin service items such as extended warranties and repair jobs.

Niche retailers, like outdoor lifestyle retailers Cabela's and Pro Bass Shop, have been able to turn brick and mortar stores into a type of attraction or amusement where families can literally spend the day. Despite all of these various strategies, all retailers share the same goal: occupying customers' attention and dollars. This is where doorbuster sales and various other high-profile sales on Apple products enter the conversation as such sales are meant to grab buzz and interest. 

December Retail Observations

A few trends become apparent when looking at these recent Apple product sales at brick and mortar retailers. 

Apple Watch is positioned as tech gift of the year. Looking at the tech landscape and the best- selling new devices in recent months, 2015 has been the year of the wrist wearables. Accordingly, Fitbit and Apple are the two leaders of the very young market, taking a 82% adjusted market share. However, for retailers craving buzz, store traffic, and a revenue boost, Fitbit just does not compare with Apple Watch. Not only were Fitbit wearables available in 2014, but they cost approximately a third to a fourth the price of an Apple Watch. In addition, Fitbit does not offer much exclusivity as the devices are available in many retail locations. Meanwhile, this is the first holiday gifting season for Apple Watch, with the product remaining quite exclusive in terms of retailer availability (Best Buy, Target, Walmart, and mobile carriers). The end result is retailers positioning Apple Watch as tech gift of the year. 

Best Buy's Apple Watch sale includes $100 off all models, including both Sport and Watch collections. Meanwhile, Target's Apple Watch Sale includes $100 Target gift cards with the purchase of any Apple Watch.

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While Apple Watch remains polarizing within tech circles, the general population has shown to be much more receptive to the product, preferring its simplicity and ability to perform a few tasks, including receiving notifications. If going strictly by Apple Watch reviews on Best Buy's website, shown below, people think very highly of Apple's newest product category. 

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iPad is still one of the top tech sellers.  Even though the iPad has suffered from slowing sales momentum in recent years, the device is still a very good seller in absolute terms, especially during the holiday season. In addition, the distribution dynamic seen with the product ends up giving brick and mortar retailers an outsized share of sales compared to products like the iPhone sold at mobile carriers. The end result is the iPad makes one of the most popular gifts, especially for children and teens. It is in retailers best interest to have sales on iPads to appeal to customers and drive traffic into stores. 

Best Buy's iPad sale includes $100 or $125 off all models, except for iPad Pro. Meanwhile, Target's iPad sale includes $50 or $80 Target gift cards with the purchase of select iPad models.

No sales uniformity. Even though more than one retailer is having sizable discounts on Apple Watch and iPad, each retailer has slightly different promotions. Other retailers, like Walmart, don't have any Apple product sales. This tells me that these promotions are not necessarily directed by a third-party, but rather settled upon by each individual retailer.  

What about other tech products? Other than Apple Watch and iPad, there are very few tech products that will sell in the same ballpark in terms of quantity and revenue. The only exception would be Fitbit, which unveiled a very extensive marketing campaign for its range of wearables with the company expecting to sell upwards of eight millions device this current quarter. While Microsoft was able to generate some much needed buzz with the Surface line of tablets, sales are still quite a bit lower than iPad-like revenues. Meanwhile, Amazon Kindles lack the growth and excitment of previous years.   

The Strategy Behind Big Apple Sales

Best Buy and Target are discounting Apple Watches and iPads because they are confident those two products will be able to garner interest and buzz to generate increased foot traffic and page views. Only 2% of Target's sales originate from its website, with Best Buy seeing a bit larger percentage (10%). Accordingly, It is conceivable that these Apple product sales will drive traffic to stores. Given the competitive trends, being able to get a consumer to a store is becoming more difficult and expensive. Once in a store, Target can then do its job and sell additional product. It is a version of the milk and bread strategy where grocers place the milk and bread in the back corner of the store in order to get you to walk through all of the other aisles and items.  

Retailers have long relied on this strategy to boost revenues, but it has taken on greater importance in recent years as competition intensifies. Electronics retailing in the hundreds of dollars represent the keystone of this strategy, especially in the November and December timeframe as people are willing to spend hundreds of dollars buying gifts for loved ones in addition to splurging on gifts for themselves. 

Apple's Involvement with Sales

Similar to any consumer goods company, Apple has working relationships with its third-party retail partners. Unfortunately, when it comes to analysis, these relationships are cast in mystery as the details surrounding contracts are confidential. In addition, the information found in these contracts is often not known by many people and is rather bland, limiting the odds of leaks reaching the press since there is little interest in such details. Traditionally, companies compensate third-party retailers for selling their product by offering lower wholesale prices with a varying degree of built-in margin available to the retailer. This margin is dependent on a number of factors, including the amount of power each party holds in the relationship. Walmart, for example, is well known for its ruthlessness when it comes to its suppliers, demanding low prices in return for significant purchase orders. There are also stipulations where companies can dictate how low a retailer can sell a product for with various incentives in place to have retailers follow such clauses. 

When it comes to Apple's direct involvement with these Apple Watch and iPad sales at Best Buy and Target, the most likely scenario is that Apple is aware of and has signed off on such sales although much of the financial impact is carried by the third-party retailer. Why does Apple allow massive discounts on its products? Temporary discounts during peak shopping seasons of the year have little to no long-term negative consequences on branding. In fact, by embracing third-party sales while maintaining its own "no discount" policy at Apple Retail, Apple is further able to maintain its brand image. If Apple was providing significant kickbacks or compensation to these third-party retailers, such trends would appear in financial trends through the average selling price (ASP). This explains why Fitbit's ASP is well below the actual retail sales prices of its products. Fitbit provides retailers much better margins than compared to Apple. 

Financial Implications

From Apple's perspective, what may end up being the most valuable long-term financial takeaway from these Apple product sales is increased brand relevance for Apple Watch. Apple has sold seven million Apple Watches to date, and I currently estimate Apple will sell another five million Apple Watches during the current quarter. This would suggest that Target and Best Buy have the potential to move upwards of one million Apple Watches this quarter, or $400-$500 million of Apple Watch revenue. This is not a trivial amount for Target and Best Buy and would certainly help offset weakness in other areas such as winter apparel. A very successful holiday quarter will help cap off a successful launch calendar year for Apple Watch with unit sales nearing 11 million. The product category would be well positioned for Apple Watch 2 in the first half of 2016.

For iPad, the iPad mini experiences strong sales each fourth quarter followed by a steady and dramatic drop-off in sales in subsequent quarters. I estimate Apple selling 17 million iPads during the current quarter which means Target and Best Buy could sell up to three or four million iPads, or another $1.3 to $1.7 billion dollars. Combining Apple Watch and iPad sales, these Best Buy and Target sales are likely worth at least $1.5 billion of revenue. When considering the additional product sales resulting from customers visiting stores in search of these Apple products, Best Buy and Target will likely bring in more than $2 billion of revenue this quarter related to Apple promotions. In the competitive retail landscape, discounting Apple products ends up being a worthwhile bet. 

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The Grand Unified Theory of Apple Products

There is much debate and intrigue regarding how Apple's expanding product line fits together. The addition of an entirely new product category with Apple Watch and new models such as iPad Pro have led some to wonder if Apple is losing focus or is unsure as to where the technology puck is headed. However, in a somewhat unpublicized interview for the new iMacs this past October, Phil Schiller, Apple SVP of Marketing, described a new theory for Apple's product line, which I am calling "The Grand Unified Theory of Apple Products."  This theory provides a glimpse into how Apple looks at the world and more importantly, some clues as to where Apple product categories are likely headed over the next few years. 

Product Line Expansion

One theme that has come to represent the Tim Cook era is product line expansion. Over the past four years, Apple has doubled its product lineup from 12 distinct models to more than 24, including a new product category. On a SKU basis, the growth is even more noticeable when taking into account additional finish options and various iPhone models geared toward specific mobile carriers. The ability to not just ship hundreds of millions of iOS devices each year, but to do so while offering so many SKUs, says a lot about Apple's supply chain prowess.

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Much of this product expansion has come in the form of additional models reaching lower price ranges. Apple followed a similar method with the iPod in the early and mid-2000s. The difference now is we are seeing this occur with multiple product categories at the same time. Apple's expanded product line has contributed to total revenues more than doubling to $234 billion in FY2015 from $108 billion in FY2011.

Explaining Apple's Product Line

One question that has been raised by Apple's continued product expansion is how do all of these products fit together to produce one cohesive platform and encourage a broader ecosystem? The lines between product categories have become somewhat blurry. Upon closer examination, Apple's methodology of explaining its product line has matured over the years from talking about the iPad and a product's unique role to including the Apple Watch on a single product spectrum where personal choice is required to decide which products to buy. 

Unique Roles. When Apple announced the iPad in 2010, there was much attention and resources dedicated to explaining why a multi-touch tablet with a 9.7-inch screen should exist in a world with 3.5-inch screen iPhones and 13-inch MacBooks. The implied message was that the iPad would fit in most consumers' lives as it was a device that could do a list of things better than both an iPhone and a Mac. The iPad was given a very specific role to play. The now infamous slide Steve Jobs used to introduce the iPad (included below) is considered one of Apple's best marketing slides. It includes iPhone on one side, Mac on the other, and space in the middle with a list of various activities that can be done better by a new type of device.

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The intriguing aspect of the slide was that it was geared toward consumers more so than analysts and technology pundits. Apple made it very clear as to why someone should buy an iPad. Judging from the early sales success, Apple's clear messaging worked. However, the broader implication from this marketing was that each Apple product had a particular role to play in our lives. Since Apple sold a handful of products, it wasn't much of a stretch for a consumer to buy every product category as each had its own unique role. Fast forward five years, and the product dynamic has changed to such a degree that the iPad seems like a redundant device to many people. The space between an iPhone and Mac continues to shrink, and iPad sales are declining. Apple's previous strategy of selling the idea that there was room in our lives for every Apple product category was beginning to come undone. Apple needed a new way of explaining its product line. 

A Spectrum. At the Apple Watch introduction keynote, Apple changed its tune when explaining its product line. Instead of positioning product categories in such a way that each product played a specific role in our lives, Apple began moving down the path of consumers picking and choosing the devices that made the most sense for them. The now classic, "product profile" slide made its debut (pictured below).  All of Apple's primary products fit on one spectrum. 

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The message behind the slide was simple: each distinct product category possesses a different ratio of personal technology and power. The smaller the device, the more personal the technology. Meanwhile, the large iMac is positioned as the ultimate computing machine. The best choice as to what to buy or use is dependent on the individual. All of a sudden, Apple had a way to explain iPad's declining sales momentum (cannibalization by other Apple products), while also planting the seed that not every one will want an Apple Watch in the near-term. Instead, it's all about personal preference. It seemed that Apple under Tim Cook was moving towards a company tasked with selling a range of computing devices to allow the average consumer to choose what makes the most sense for him or her. 

While this message may seem to answer most lingering questions regarding Apple's product strategy, it still contains a number of drawbacks and questions. From a customer viewpoint, there is still confusion as to how all of these products come together. Look no further than the tricky iPad versus Mac debate. In addition, the descriptions used for each device concerning powerful technology on our wrist, in our pocket, or in hand are still somewhat vague and open to interpretation. From an analyst viewpoint, Apple's desire to look at its products on a spectrum has resulted in a rather wide range of opinions, including many pessimistic views on Apple's broader product strategy.

The Grand Unified Theory of Apple Products

This past October, Phil Schiller, in a rare interview with Steven Levy, talked about the new iMac. He took the opportunity to discuss a new way of thinking about the Apple product line, and I found it to be most revealing from a strategic perspective. Instead of describing how each product has a new unique role in our lives or simply placing Apple's entire product category on the same spectrum with an Apple Watch on one end and an iMac on the other, Schiller gave each product a job: make consumers feel like they don't need a larger, more powerful, Apple device in their lives. 

Schiller's theory is best viewed by taking his comments to Steven Levy and breaking them out by product category.

• Apple Watch: "The job of the watch is to do more and more things on your wrist so that you don't need to pick up your phone as often."

• iPhone: "The job of the phone is to do more and more things such that maybe you don't need your iPad, and it should be always trying and striving to do that."

• iPad: "The job of the iPad should be to be so powerful and capable that you never need a notebook. Like, Why do I need a notebook? I can add a keyboard! I can do all these things!"

• MacBook: "The job of the notebook is to make it so you never need a desktop, right? It's been doing this for a decade. So that leaves the poor desktop at the end of the line, What's its job?..."

• iMac: "It's job is to challenge what we think a computer can do and do things that no computer has ever done before, be more and more powerful and capable so that we need a desktop because of its capabilities. Because if all it's doing is competing with the notebook and being thinner and lighter, then it doesn't need to be."

The first thing to notice about Schiller's new product theory is that it is actually a series of goals that also serve a dual purpose: help describe the product. What is the Apple Watch? It is a device that is supposed to handle a growing number of tasks once given to your iPhone. What is the iPhone? It is a device that is supposed to handle a growing number of tasks once given to your iPad. The argument can be made that all of this is just theory and that reality is not exactly keeping up with this vision, but that is exactly why it is called "The Grand Unified Theory of Apple Products." Upon closer examination, there is quite a bit of evidence to suggest that this theory actually does a good job of describing Apple's product line. In fact, Schiller's message provides the clearest clue yet as to how Apple management views its product lineup, even more so than the previous product theories put forth with the iPad and Apple Watch introductions. 

There are three major takeaways from Schiller's new product theory:  

1) The Apple Watch is a classic Apple bet. The very fundamental underpinning to Schiller's new product theory is that Apple Watch holds the most potential for making technology more personal. When looking at Apple's strategy over the years, the one overarching theme that transcends everything is the desire to make technology more personal, removing the barriers and allowing consumers to develop new and engaging relationships with technology. I continue to think the Apple Watch is being underestimated as elevated expectations for the product were reset over the past few months. The mistake many people continue to make when thinking of Apple Watch is looking at it as an inadequate iPhone replacement. Instead, Schiller's comments about Apple Watch denote a subtle distinction - the Apple Watch's role is to handle a growing number of tasks formerly given to the iPhone. For now, those tasks may be just simple notifications and things like checking time, but similar to how Apple handles product development, the Watch will soon handle more in the way of finance, health, identity, and communication. In many ways, the Apple Watch is setting up a classic Apple bet that a simpler device will eventually be able to handle many of the tasks currently given to larger and more powerful devices.

2) Greater iPhone differentiation is coming. While the recent debate has been stuck on whether the iPad can replace PCs, the real discussion that we should be having is how iPhones are replacing PCs. The iPhone is nothing more a smaller iPad. Of course, that subtle distinction ends up being the difference between a product selling 50 million units a year and 250 million units a year. The iPhone's form factor gives it the secret to success: mobility. Similar to how computing needs vary with the Mac and iPad, this same variability will come to the device being positioned to replace them. The writing is on the wall: expect the iPhone line to see greater diversification with a Plus model standing out from other models. So far, that diversification has primarily taken the form of screen size, but over time I would expect new ways for the Plus model to stand out from its iPhone siblings. 

3) Don't expect an iPad/Mac hybrid. Apple will not follow Microsoft down the iPad/Mac hybrid path. While it is easy to focus on the iPhone and Apple Watch as the future, it is crucial to note the role the Mac plays in Schiller's product theory. The Mac is the device that pushes everything forward. It may sound extreme, but Apple looks at a future Apple Watch as one day being just as useful as a current iMac. However, that goal is only possible if the iMac continues to receive the attention and resources to see what is possible at the upper limits of personal computing. A iPad/Mac hybrid would run against this trend as such a device is an explicit acknowledgement that the Mac is flawed as a product category. Instead, there is still much that can be done to push the Mac forward. 

A Roadmap, Not Destination

Schiller's grand product theory serves as a roadmap for where Apple wants to bring its current product line over the next few years, but it is important to not think of it as a destination. In a few years, the work from Apple's Project Titan will represent a new direction for Apple. While an electric car may not seem to fit in with a portfolio of watches, smartphones, tablets, laptops, and desktops, it is important to not get caught up by form factors but instead to look at what all of these products have in common: creating a experience. The simple fact that a device is used on a desk, held in hand, worn on the wrist, or sat in, doesn't change Apple's fundamental goal: make technology more personal.

For us to even be in a position to say that a 5-inch piece of glass held in our hand can replace a MacBook or iMac should help show that personal technology is about taking complicated tasks and breaking them down into more granular tasks, which are then able to be accomplished by smaller and simpler devices. This process will continue until we find ourselves in a position to begin looking up from our Apple Watches and iPhone screens but still feel connected to the world. The connected room era will have officially begun and Apple thinks those connected rooms will have four wheels. 

Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.

Listen to this week's Above Avalon podcast episode (Episode 44: The Grand Unified Theory of Apple Products) for more information on this topic: Above Avalon, Overcast, iTunes.

Peak iPad Mini

The iPad mini's best days are behind it. Using app analytics data from Fiksu and Mixpanel, along with my own iOS device sales estimates and projections, I was able to derive iPad mini sales since launch. Over the past two years, iPad mini sales trends have deteriorated much faster than most people think. When taking into account the move to larger iPhones and iPads, the iPad mini's value proposition has likely been weakened to such a degree that the decline in sales is permanent. We have experienced "Peak iPad mini." More importantly, by analyzing the iPad mini's sales trends, we have better insight as to where the iPhone and iPad product lines are headed and the iOS platform's overall direction when it comes to form factors. 

iPad Mini Has Fallen Out of Favor

Conventional wisdom would suggest that the iPad mini has been the better performing iPad line due to its low price and feature set. In reality, the iPad mini has seen much weaker sales trends compared to its larger 9.7-inch screen sibling. As shown in Exhibit 1, when looking at iPad mini sales on a trailing twelve month (TTM) basis, the device's multi-year sales decline becomes quite obvious. Apple would need to sell close to double the number of iPad minis sold over the last 12 months to set a new sales record, a feat that is looking very unlikely. 

Exhibit 1: iPad Mini Unit Sales (TTM)

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While everyone is aware of the iPad's sales troubles, one surprising observation is that most of the iPad's sales decline can be attributed to the iPad mini line. As seen in Exhibit 2, the 7.9-inch screen form factor has seen a dramatic 50% drop in sales on a TTM basis over the past two years while the 9.7-inch iPad line has seen much more resilient sales. This trend seems counterintuitive but provides a very strong clue as to how consumers are thinking about the iPad. When taking into account this granular iPad sales data, Apple management likely had a much easier time deciding to launch the larger iPad Pro. The trend towards larger iPads has already been years in the making.  

Exhibit 2: iPad Unit Sales by Screen Size (TTM)

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What Happened?

There has been a polarizing debate as to what happened to iPad sales. Some have blamed slowing sales on longer life cycles while others have pointed to iPhone cannibalization or a combination of the two. The latest theory is that iPad software issues and a flawed App Store are to blame. When considering that the smaller iPad mini is becoming less popular than the larger models, many of those reasons fall by the wayside.

In reality, the iPad was a victim of its own success. The combination of a very popular iPad 2 (decent weight, okay screen, and good battery) and the launch of a smaller iPad mini (with a low price) led to a boom in sales that resulted in iPad sales growth peaking only three months after the iPad mini went on sale.

In retrospect, the iPad mini served as a great precursor to the phenomenon known as larger screen iPhones. There was likely significant demand for an iOS device larger than the current iPhone at the time (iPhone 5's 4-inch screen) but a bit less bulky than the 9.7-inch screen iPad. Soon, all of these reasons began to be wiped away with new, larger iPhones and thinner iPads. While the iPad mini's low price meant the device was the more popular iPad for gifting around the holidays, which is likely still true today, the need for an iPad mini was increasingly being met by the iPhone and larger iPads. 

iPad Mini's Declining Value Proposition

A slowdown in iPad mini sales is not enough to lead to the conclusion that the product line will see a permanent reduction in sales. The Mac serves as great example of this as the product seemed to have seen peak sales, only to come roaring back in subsequent quarters. Instead, the Peak iPad mini theory is predicated on the idea that the device's position in the market has fundamentally changed, leading to a weaker value proposition and corresponding cut in sales. One example of this type of value destruction is found with iPod and how the smartphone led to less demand for dedicated music players. Peak iPod occurred in 2008, a year after the iPhone was released. 

The very significant move towards larger screen iPhones has altered the iPad mini's ultimate sales trajectory. As shown in Exhibit 3, when the iPad mini was first introduced in 2012, the world was predominately using 3.5-inch screen iPhones. Meanwhile, the Android phablet movement was only just beginning to take off.  Over the course of the next two years, iPhone sales trended towards bigger screens. Today, a vast majority of iPhones sold include a 4.7-inch or 5.5-inch screen. These larger devices are increasingly serving as better consumption devices, taking away a key value proposition previously held by the iPad mini. 

Exhibit 3: iPhone Sales Breakdown by Screen Size

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Meanwhile, on the other end of the spectrum, the iPad Air's resilient sales (as shown in Exhibit 2) suggest that an increasing number of consumers are looking to use an iPad as a laptop and desktop replacement. Accordingly, the iPad mini's smaller screen is not preferred as the reduction in screen real estate leads to a less useful product for media consumption, web surfing, and other basic computing tasks. 

Some have said that the iPad is being squeezed between the iPhone and Mac. In reality, the iPad mini is being squeezed between larger iPhones and the iPad Air and iPad Pro. 

iPad Mini's Price Advantage is Overrated

The iPad mini was launched in 2012 as a defense against Android OEM competitors potentially underpricing the iPad and risking a repeat of the Windows vs. Mac battle. In reality, the iPad mini is still too expensive to compete with pure media consumption devices running Android, but there is no evidence such devices pose a threat to iOS. Many now point to price as the iPad mini's secret weapon that should not be underestimated. In reality, this strength is likely overrated. At $399, a new iPad mini is only $100 less than a new iPad Air and the same price as a year-old iPad Air. This pricing dynamic likely explains why the iPad mini sales have declined more than sales of the more expensive iPad Air models. 

Meanwhile, the year old iPad mini is still $70 more than the entry-level iPod touch, which is the lowest cost entry point for the iOS ecosystem. While some may look at the iPad mini as holding a better future than the iPod touch, that isn't exactly saying much considering the iPod touch's lackluster sales. 

iOS Sales Spectrum

The iPad mini's declining sales provides clues as to iOS form factor trends. Instead of looking at the iPhone and iPad as separate product categories, I like to think of them as existing on the same iOS spectrum but occupying different screen size segments. The fact that iPhone and iPad rely on the same mobile operating system makes this view reasonable. In Exhibit 4, iOS sales according to screen size are depicted for 2013 and 2015. 

Exhibit 4: iOS Sales Spectrum (2013 vs. 2015)

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In the span of two years, screen size preferences have shifted to larger screens (reflected by the blue line in Exhibit 4 shifting to the right in 2015). Notice the iOS screen sizes that saw the largest sales declines between 2013 and 2015: 3.5-inch iPhone, 4-inch iPhone, and 7.9-inch iPad. A better way to see this trend is to picture the lines in Exhibit 4 as waves, depicted in Exhibit 5. Note two differences: The new sales peaks (in blue) are now found with 4.7-inch iPhones and 9.7-inch iPads while the amplitude of the wave at 4.7-inch iPhones is increasing. Over time, it is conceivable that the wave in blue continues to shift to the right with a higher iPhone crest. 

Exhibit 5:  iOS Sales Spectrum (2013 and 2015)

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A few takeaways:

1) Consumers are increasingly allowing iPhones to play a greater role in their lives. Consequentially, purchasing habits are trending to larger screen iPhones. Apple will likely look to the 5.5-inch iPhone form factor as positioned well for potential sales growth, not to mention increased revenue and profit share. There is room for Apple to slim the device's bezels, making the device easier to hold in one hand while maintaining the 5.5-inch screen. 

2) The iPad Pro is positioned well to see an increasing share of iPad sales as consumers position the device as a laptop and desktop replacement. While this replacement transition is not possible for everyone at this time, the definition of work is changing and for many consumers typing is becoming one of the last barriers to switching completely to iPad. 

3) The 7.9-inch iPad from factor is caught in the middle.  It is too big to be put in a pocket or held in one hand but too small to replace a laptop or desktop. 

iPad Mini Is a Fading Star

Apple is still selling too many iPad minis for the product to be mothballed. However, the more likely path will be a slow yet steady slide into irrelevancy. The product will see more sporadic refreshes, which has already happened with the iPad line, while the value proposition continues to become less compelling. Holiday quarters will represent iPad mini's best sales times, and it will possibly even outsell the iPad Air during certain months, but the elephant in the room will keep a lid on iPad mini's upside. Ultimately, the iPhone is the single biggest threat to both the iPad mini and the broader iPad category as Apple pushes forward in differentiating the iPhone Plus line. Such a device holds the best chance of being the most popular and useful iOS form factor. From Apple's perspective, having the iPad mini be cannibalized by an iOS device with a higher profit margin may actually turn out to be a long-term positive from a financial and strategic perspective.   

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Making the Case Against an Apple Television Set

The Apple TV and iPhone were both formally introduced to the world on January 9th, 2007. One went on to sell over 700 million units and is now responsible for an active installed base of approximately 500 million users. The other was classified as a hobby and went on to sell "only" 20 million units. In 2014, Apple reportedly shelved the idea of selling its own television set. Given renewed focus around the launch of a new Apple TV platform, have the odds of Apple having second thoughts about selling its own branded television set gone up? No. Upon closer examination, there are very few reasons to justify an Apple-branded television set. In fact, a very strong case revolving around the television's ultimate value in a mobile world can be made demonstrating why an Apple television will not receive the green light to market.

The Long Journey to Today

The technology industry has struggled for the past decade in trying to define TV's future. Countless attempts to make TVs "smart" never caught on. The problem wasn't that companies weren't thinking outside the box, but rather that they were overthinking it. The future wasn't going to be found by turning our television into a desktop computer with an accompanying keyboard. Instead, TV's future became visible only after recognizing that a television is inherently a consumption device in need of content and an easy user interface. 

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The new Apple TV is a product that has literally been years in the making, dating back to Apple's sneak preview of the "iTV" project in late 2006. Over the years, as the iPhone and iPad gained momentum and priority within Apple, Apple TV and the entire television category was negated to a long-term opportunity. While early Apple TVs were okay for consuming iTunes content, the value proposition to the average consumer just wasn't too appealing. We knew television was going to change and had a general framework as to what was needed to make that change happen, but we weren't sure when that change would unfold. All the while, speculation grew that Apple would unveil its own branded television set with a built-in Apple TV box.

Enter Netflix, Hulu and HBO Now. With a growing number of new content companies gaining strength and giving the consumer revamped content bundles that went up and beyond what we were used to with traditional broadcast and cable programming, the future started to come into focus. Meanwhile, instead of pushing forward with its own television, Apple reportedly canned the project to instead focus on taking lessons learned from iPhone and iPad in terms of how voice and touch could create a user interface that works with large screens positioned a few feet in front of us.  

The New Apple TV

There are two key elements to the new Apple TV that make the product stand out from previous reiterations: a new voice-based interface and an App Store.

New Voice-Based Interface. I had one "wow" moment while interacting with the new Apple TV for the first time: using Siri to navigate my television. Relying on Siri to search for movies or TV shows, and in the process being able to avoid the tedious task of using text to search, demonstrates that voice is an attractive way to navigate a large screen positioned a few feet away. I found voice so compelling that not being able to use Siri to search for videos within YouTube quickly led me to avoid using the YouTube app on Apple TV altogether. I simply had no desire to search by manually typing each letter one at a time using finger swiping on the Siri remote. While at first it sounded like a gimmick, using Siri to check the weather, stock prices, or sports scores was quite compelling even though I could have gotten the same information on my iPhone or Apple Watch. The ability to simply press a button and talk casually was riveting. I found the error rate with Siri on the new Apple TV to be low with the only hiccups resulting from asking questions that will likely be supported in future versions.

App Store. This past May at a conference in Germany, Netflix CEO Reed Hastings declared the future of TV would revolve around apps. A few months later, Apple threw its support beyond the app model as well. After using the new Apple TV for a few minutes, it's clear Netflix and Apple are correct in getting behind the app model. Apple TV's primary purpose is to consume content. Without third party apps like Netflix, HBO, or Hulu (and active subscriptions), Apple TV's value proposition would decline dramatically. 

An app's value is rather straightforward when it comes to consuming content on a television. Instead of one company pushing the same content to all viewers, an app makes it possible to have a very tailored and personal viewing experience, even within the same household. An app also makes it possible to search a wide variety of content depending on our current interests and mood. 

When Apple introduced Apple TV this past September in San Francisco, much of the press focused on the device's App Store and how gaming will be revolutionized. An App Store for Apple TV was craved by core Apple users ever since 2008 when Apple launched the iOS App Store. While apps are likely the future of television, I remain a bit more contained in my enthusiasm for many of the apps currently being paraded around. While there may be a loyal group of users that will be attracted to gaming on Apple TV, I am skeptical gaming will be able to move beyond its niche focus. Instead, apps that are focused on helping the user consume content in a more personal way have an incredible amount of potential. 

Saying No to an Apple-Branded Television

This past May, the WSJ reported that Apple had shelved its television plans in early 2014. While the exact details may forever be kept to a select few, Apple simply was not able to make the case for why an Apple-branded television deserved the green light. The WSJ article gave hope to long-time Apple television proponents by saying that the television project was never officially killed. Apple will have a hard time justifying selling its own television due to two reasons: TVs are impersonal devices meant purely for consumption, and the television's future in a mobile world is up in the air. 

An Impersonal Consumption Device. While some may look at the new Apple TV as a device capable of turning our television into an iPhone, in reality the device's features reinforce the fact that television is inherently used for consumption. Such a scenario makes it extremely difficult for Apple to position a television screen as being able to produce the kind of premium experience users have come to know from Apple. Everything from the new voice user interface to the App Store is built to make it easy to find and consume content while sitting a few feet away from a large piece of glass. While Apple has previously sold devices like the iPod for consumption, the iPod contained a certain level of personal connection to the user - through how it was meant to be carried, touched, and even worn. We see that these personal ingredients are needed to produce premium experiences with Apple Watch, iPhone, iPad, and the Mac. The end result is that consumers are willing to value and appreciate such premium experiences. A television's inherently impersonal and immobile nature gives Apple less opportunities to make an Apple-branded television stand out from alternatives. If Apple positioned a television to be used for more than just consumption by adding cameras or sensors, the problem would be that we don't live in a vacuum and will likely have even more capable devices in the form of smartphones and tablets nearby that could handle such tasks. 

Television's Questionable Future. Apple TV may very well represent television's future, but in an increasingly mobile world, the television screen will likely play a declining role, regardless of 4K or future technological trends. As a prime example of how a large television screen will likely remain a consumption screen with consumers, after using the new Apple TV with my television for a few minutes, I found myself increasingly looking down and interacting with my iPhone. I don't think this was by mistake. While I may be entertained for a few minutes by a few apps on Apple TV, its purpose is to display long-form content that I am not interested in viewing on my mobile devices. Over time, this dynamic may change as we rely even more on our iPhones and iPads to watch content. For a company that is willing to make very few big bets every few years, putting resources into a product like a television set with a future that is inherently opposite to themes found with mobile seems counterproductive for Apple. Meanwhile, content born out of mobile like short video clips found on Vine, Instagram, and YouTube feel off when viewed on a large TV screen. Instead, being able to consume such videos on our smartphones makes much more sense. Meanwhile, new products like the iPad Pro are designed with content consumption in mind with a superior speaker system and large screen. The end result is more people will consume video content on an iPad Pro as time goes on while momentum remains on the side of mobile.

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Looking Beyond Dollars and Cents

Notice the lack of "revenue," "profit," or "margin" in the preceding paragraphs for why it doesn't make sense for Apple to sell its own branded television. This wasn't by accident, but rather those financial metrics are simply byproducts of Apple being able to sell a premium experience. Apple doesn't sell a product simply because it meets certain financial criteria. Instead, management evaluates if it can improve a product to the point where it possesses certain characteristics that lead to a premium experience. Metrics such as TV life cycles, low margins, or the fact that Apple would likely only be able to sell one unit to a household simply don't play a role in the fundamental case against an Apple television set. 

Apple TV's Role

Instead of simply controlling the large piece of glass in our living room, Apple TV's more valuable role is to further position Apple as a content distributor. When looking specifically at video content, Apple's interest in creating a slimmed down bundle of broadcast and cable programming can help the company provide a full assortment of video content to its users. This range of video content would then be able to be viewed on the hundreds of millions of personal Apple devices being sold each year including iPhones, iPads, and Macs. In a way, the Apple TV is Apple's trojan horse to gain power in the quest to become an improved content distributor. This characteristic is much more interesting from an experience-building perspective than compared to the idea of selling a large piece of Apple glass. Apple was right to shelve plans to build its own Apple television. 

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Decoding Apple's North San Jose Land Mystery

Apple has big plans for north San Jose. In the past few months, Apple has spent more than $300 million quietly purchasing or leasing land close to San Jose International Airport and only 11 miles away from Apple Campus 2. When adding up the possible square footage of office space that can be built on this land, Apple would be able to erect another "Apple Campus 2." At initial glance, there are three likely scenarios that can explain Apple's motivation buying land in north San Jose. However, after looking closer at Apple's employee and office space growth as well as the company's product development strategy and pipeline, the most likely scenario is that Apple is building an R&D center for Project Titan, specifically a prototyping and testing facility for a range of automobile products.  

The Property Transactions

After a few months of rumors within Silicon Valley commercial real estate circles, Apple's play for north San Jose began to take shape this past July when reports came out that the company signed a lease for a 290,000 square foot office building close to San Jose International Airport. Over the following four months, Apple has reportedly had three additional transactions resulting in the company owning or leasing nearly 90 acres.

July, 9, 2015. Apple reportedly leases a 290,000 square foot building from Ellis Partners at 2325 Orchard Parkway. The building is able to support 1,450 employees with 12 adjacent acres approved for 665,000 square feet of additional office space. The proximity of this building and open land to San Jose international airport (bottom left corner) can be seen below.

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Apple's initial land transaction in north San Jose.

August 3, 2015. Apple purchases 43-acres of open land for $138 million from Lowe Enterprises at 2347 North First St. The 2.8M square feet that is approved for the land could support up to 14,000 employees. As shown below, the 43-acre plot of land is touching land Apple had been leasing from Ellis Partners.

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Apple's second land transaction in north San Jose.

September 25, 2015. Apple buys a building previously leased from Ellis Partners, along with 12 adjacent acres of open land, for $166 million. Apple now owns enough land to support approximately 3.8 million square feet of potential office space. 

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Apple's third land transaction in north San Jose.

October 22, 2015. Apple leases a 202,000 square foot building at 2509 Orchard Parkway from Steelwave. The land is adjacent, as shown below, to previously purchased land from Ellis Partners and Lowe Enterprises. Apple now owns enough land to support approximately 4.3 million square feet of potential office space. 

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Apple's fourth land transaction in north San Jose.

Three Possible Explanations for Apple's Land Purchases

When contemplating Apple's plans with these land transactions, three scenarios seem to rise to the top: stockpiling land for eventual use in the future, building additional office buildings for a growing employee base, and building a research and development facility for Project Titan and Apple's growing automobile ambitions. 

Stockpiling Land for the Future. This theory is mostly based around the fact that land in Silicon Valley is a hot commodity. With little to no leased office space remaining in Cupertino and Sunnyvale (one estimate pegged Apple as representing 40% of Cupertino's office jobs), this theory positions that Apple management is looking to buy land in order to have room for future growth. While Apple may not have immediate plans for the land, the optionality provided by owning land in an up-and-coming geographic area somewhat close to Cupertino would give management enough reason to begin "stockpiling" land.

Upon closer examination, there are a number of holes in this stockpiling land theory that lead me to believe Apple is not just simply buying land to hold on to it for some undetermined future use down the road. The first is that Apple has never shown the desire to buy land indiscriminately without having a specific purpose or function for the land. Apple's focus mantra does not fit with a strategy of just buying large swaths of land with no clear agenda in mind. When looking at prior Apple land transactions, everything has had a purpose or reason. Apple purchased the land that is now home to Apple Campus 2 from HP years before construction began. Management has since gone on record to say the land had been purchased with a new headquarters in mind. Across the U.S. and the world, Apple's land transactions (both purchased and leased) have been conducted with specific growth plans in mind and include various locations in California, Austin, Texas, data centers in various states, Ireland, and recent sustainable forest transactions in North Carolina and Maine, as well as renewable energy initiatives in China.

One can also question the viability of a strategy where a company is spending close to $300 million dollars on land (much of it open land) simply out of fear of not having enough space to grow in the future. It just doesn't add up. Similar to how the Apple Campus 2 land became available due to rough times at HP, it is unreasonable to assume additional land wouldn't eventually become available around the Valley during an economic downturn or simple evolution of technology. It doesn't seem likely that Apple is stockpiling land in north San Jose just in case it may need it in the future. Recent reports seem to validate this stance as Apple is already working toward a development agreement with city officials. Apple has something specific in mind for this land.

Additional Office Buildings for Employees. The next plausible theory is that Apple needs additional office space for a growing employee base. This essentially represents the safe answer as to what Apple may be doing in north San Jose, and it is the one often paraded around in the press. Apple discloses its total employee count in 10-K filings each year. However, additional work is needed to break down this number into Retail Segment employees, temporary or part-time workers, and full-time non-Retail employees. Upon closer examination, I estimate Apple has approximately 60,000 full-time non-Retail employees across the world. As seen in the exhibit below, this employee count has grown significantly in the past five years and, assuming 10-15% growth each year over the next few years, it will not be long before Apple crosses 100,000 non-Retail full-time employees. It would then seem logical that Apple is looking to buy land to house all of these additional employees. 

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However, a few things about this theory don't quite sit right with me. The first is that Apple is building a brand new headquarters (Apple Campus 2) with the stated goal of having most of its employees located in one large building in order to foster collaboration. Apple management has been very vocal with this reasoning, even taking journalists to tour the construction site to highlight the building's unique layout. Apple is taking pride in what they are building at Apple Campus 2. 

In order to gain perspective on how much land Apple now has in north San Jose, Apple Campus 2 will have 3.4 million square feet of office space compared to the 4.3 million square feet of potential office space in north San Jose.  I'm doubtful Apple is looking to build a sprawling campus that is larger than Apple Campus 2. The much bigger reason that I'm skeptical is that building an even bigger campus away from headquarters just doesn't fit with Apple's long-standing narrative as to how it views its functional organizational structure. 

Additional doubts that Apple is planning on building another large Apple Campus in north San Jose are raised when looking at some of the details around Apple's employee base. Apple Campus 2 will be able to house 14,200 employees. While large, the building is not large enough to house the roughly 20,000 Apple employees that work in the Cupertino/Sunnyvale area. Accordingly, Apple will continue to use its current headquarters at 1 Infinite Loop (home to 3,000 employees) and surrounding buildings. Run the math and once Apple Campus 2 is finished, Apple would actually be able to consolidate buildings. Why would management spend hundreds of millions of dollars to buy enough land in north San Jose to be able to build another Apple campus for nearly 20,000 employees when Apple Campus 2 has been the multi-year focus and cornerstone of the company's infrastructure development? I suspect the reason is that Apple isn't actually planning on building 4.3 million square feet of office buildings for 20,000 employees in north San Jose. Instead, Apple has a different type of structure in mind for the land. 

Research Facility for Project Titan. What if instead of building another large office building in north San Jose, Apple is looking to build a research facility?  What if this facility is actually a giant R&D complex in order to work on automobiles prototypes and conduct regulatory and safety testing? All of the evidence seems to point to such a thing. 

While we have no confirmation from Apple that they plan on building an electric car, there are enough clues to have a very high level of certainty that Apple is actively working on a self-driving electric car. Everything from a litany of recent automobile-related hires to Apple's interest in self-driving car testing facilities, a recent ramp in R&D spending, and overall automobile industry trends, not to mention accurate reporting from WSJ and at a handful of other publications, point to Apple planning something big with personal transport. 

Recent rumors peg Apple's Project Titan as being housed in leased office space in Sunnyvale, California, closer to Apple HQ. Apple has reportedly leased additional space in Sunnyvale to accommodate Project Titan employee growth. While this location might be a suitable place for employees to work, it is unlikely there is enough room to conduct a full range of electric car testing, including researching manufacturing techniques. 

Even though I suspect Apple is looking to build a Project Titan facility in north San Jose, I have doubts that this location will become the official Apple Car factory. As seen in the map below, there are currently two plots of land (shaded in red) that Apple has still not purchased or leased in north San Jose that are adjacent to Apple's recent land acquisitions. One is open space and the other has three buildings located on it. Even If Apple were to buy these two pieces of land, Apple's total ownership would measure approximately 140 acres. While this plot of land is indeed massive, it's quite small for it to be the location where an "Apple Car" would be manufactured at any level of scale. The lack of nearby rail also raises doubts that this location will become the primary location for manufacturing cars as rail is a cost effective way to transport finished product, not to mention receive raw material. Instead, this site's acreage would be more suitable for R&D purposes, a fact that even Apple has gone on record to discuss when questioned over these recent land purchases. 

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Apple's previously acquired/leased land (green) and property currently not owned by Apple (red).

It is difficult to discuss electric automobile testing and assembly in Silicon Valley without mentioning Tesla's Fremont Factory (shown below), the former Toyota car factory located only 20 minutes away from north San Jose. Coming in at 340 acres (nearly four times the size of Apple's current north San Jose land holdings), the Fremont factory is overwhelming. Most of Tesla's assembly occurs on only roughly 120 acres of the site. However, it is important to remember that Tesla is only producing 50,000 vehicles a year, a far cry from the millions produced by the automobile industry's giants. One takeaway from the Fremont Factory is that building electric cars involves much more than just one big building. Instead, the ancillary buildings needed for handling incoming raw materials, producing components, assembly, and parking lots for finished product and transport infrastructure (like railroads), all point to these factories resembling cities rather than just factories. Looking at Apple's north San Jose land holdings, it's tough to see a similar operation like the Fremont Factory being built unless Apple plans on buying out dozens of additional buildings and hundreds of acres of land, something that doesn't seem too realistic or logical when looking at a map of the surrounding area. 

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The Tesla Factory in Fremont, California

Additional evidence suggesting Apple would need much more space to actually manufacture an Apple Car in north San Jose can be found with BMW. The company's i-series electric cars, along with other models, are produced in a factory that measures 23 million square feet. As a reminder, Apple's acquired land holdings in north San Jose amount to 4 million square feet of possible space. 

The clearest answer for what Apple has in mind for north San Jose likely rests with Apple's product philosophy and strategy. Apple will likely rely on the same manufacturing process undertaken with most of its products, including the iPhone. Instead of actually building its own car in its own factories, Apple would look to contract manufacturers to build components and conduct the actual assembly. The important point about this strategy is that Apple would still need to conduct vehicle prototyping and research in order to figure out what should or shouldn't be included in an Apple Car. Testing facilities for Apple Car would likely require a hundred acres by itself. The scale required for car development cannot be stressed.

Elon Musk is right when he said two months ago in an interview with a German newspaper that Apple can't just go to Foxconn and say, "build me a car." Look at how the iPhone became a reality. Apple didn't just go to Foxconn saying, "build us a phone." Instead, Apple needed to figure out how to put together an iPhone and come up with new machinery and processes along the way. Only after that R&D phase had been conducted, did Apple executives head to China and work with Foxconn on learning and replicating the process. As Tony Fadell recalled about iPhone development, building the first iPhone was the easy part. The much harder part was being able to produce millions of iPhones. While early stage iPhone prototyping was done at Apple HQ, in addition to testing (recall Apple's iPhone antenna labs), the actual assembly occurred in China.

When looking at north San Jose, Apple could turn its recently purchased land into an Apple Car R&D campus complete with a giant testing facility and several smaller office buildings supporting more clerical aspects of testing and more nuanced design R&D efforts. 

Future Clues in North San Jose

Apple is reportedly fast-tracking its north San Jose development plans, having submitted preliminary plans with San Jose officials. If Apple were looking to build an Apple Car R&D facility, I would expect pretty quick progress towards construction to be made in the coming months. The speed at which Apple acquired the land may be a sign of Apple's urgency. The WSJ had previously said Apple is targeting a 2019 "ship" date for an electric car. While the exact definition of a ship date is up for a debate, it's clear that Apple won't likely sit on this land for too long without much action if an Apple Car R&D facility is the ultimate goal.  

I would expect Apple to remain as tight-lipped and secretive as possible in regards to these land purchases and subsequent construction activities. While we will undoubtedly be able to track the project's physical development (via drone), Apple could end up building one large, relatively generic structure with most details hidden from the public. Management would also be able to conveniently use CarPlay or other generic R&D initiatives as reasons for the facility.

Main Takeaway: Apple Is Making Progress With Project Titan

When news first broke that Apple was thinking about designing its own electric car, many company observers were doubters. The thought of a company that had spent years building computers that can fit in a pocket all of a sudden building an automobile was just too much for many to believe. Apple would need to acquire such a significant amount of talent, in addition to constructing new R&D labs, all the while figuring out who would even build the product. However, over the past nine months, we are seeing Apple make progress toward addressing these exact concerns and doubts. Apple has been hiring the people needed for a car, and these land purchases in north San Jose would be the first tangible sign of Apple building the infrastructure for electric car testing and research. If we zoom out and look at the big picture, Apple is moving incredibly fast with its electric car plans. Apple has likely been able to work on much of the internal components of an Apple Car, including the passenger compartment. More granular work involving the battery, electric drive train, and autonomous driving software is also likely to be conducted in relatively traditional office space/commercial real estate. We are likely approaching the next stage requiring much more space and infrastructure. While 2019 seems like still a long time out, it is in fact a very aggressive timeline to develop an electric car considering that iPhone and Apple Watch were developed in 2-3 years.

Apple's $304 million of land purchases in north San Jose hint at something much larger than simple office buildings, yet not quite large enough for a sprawling electric car manufacturing facility. Instead, a R&D complex for prototyping and testing various personal transport initiatives is the leading candidate. 

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Apple Is Buying Back Shares Like There's No Tomorrow

Tim Cook and Luca Maestri are literally buying back Apple shares as fast as they can. When comparing the pace of Apple buyback over the past six months to that of the program's previous three years, it is clear that management made the decision to be opportunistic to take advantage of Apple's languishing stock price. Apple management is showing an increasing level of confidence in its future. 

While everyone quickly focused on iPhone unit sales growth guidance and clues about Apple Watch sales when Apple reported 4Q15 earnings last week, one data point that jumped out at me was the amount Apple spent on share buyback. Management bought more shares in the open market last quarter than any previous quarter. In fact, when looking at the past six months, including the most recent ASR (accelerated share repurchase program), Apple bought back $24 billion of its shares, which is a record for any six-month stretch. All of this is made even more remarkable when considering that Apple's stock price is more than 60% higher than when Apple began buying back its shares in late 2012. This shows management remains quite optimistic about Apple's future and value found in Apple shares at current price levels. 

A closer examination of Apple's buyback activity is required to notice underlining trends. When looking at the pace of buyback on a very simple annual basis (Exhibit 1), nothing stands out from the ordinary. Apple has consistently repurchased shares since launching its repurchase program in late 2012, and it would appear that the pace of buyback slowed somewhat dramatically in 2015 due to a rising stock price and dwindling U.S. cash levels.

Exhibit 1: Apple Share Buyback (Annual - Fiscal Year)

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However, if looking at the pace of Apple's share buyback on a quarterly basis, as shown in Exhibit 2, we arrive at a different conclusion as to how Apple has conducted its share repurchases. Apple's elevated pace of buyback over the past few months becomes apparent. As Apple's stock price declined this past summer due to a number of reasons including fears around slowing economic growth in China, Apple management increased its share repurchase activity. The $14 billion spent on share repurchases last quarter ranks as the fourth largest quarterly amount spent on buyback. 

Exhibit 2: Apple Share Buyback (Quarterly - Fiscal Year)

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However, looking at share repurchases on a quarterly basis still doesn't do the best job of explaining management's view on share buyback. The true extent of Apple's aggressive buyback activity only becomes apparent when looking at the pace of buyback on a trailing six-month basis, shown in Exhibit 3. This timeframe is able to capture management's changed attitude toward buyback this past summer. Over the past six months, Apple has spent more on buyback than any previous six month period. 

Exhibit 3: Apple Share Buyback (Trailing Six Months - Fiscal Year)

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When we look at Apple's stock buyback activity in FY2015, specifically the past six months, management's motivation becomes clear. As displayed down below in Exhibit 4, the yellow highlighted months (February, August, and September) represent the three busiest months in terms of management buying back shares in the open market. In FY2015, Apple spent $30B on share buyback in the open market, repurchasing 255M shares for an average selling price at $117.68. Looking back at the news flow from recent months, the pace of share buyback increased around the time Tim Cook emailed CNBC's Jim Cramer to say that business in China was holding up well. More interestingly, Apple maintained the pace of buyback through September up to the iPhone 6s and 6s Plus launch. These actions don't seem to come from a management team that is too worried about Apple's long-term trajectory.  

Exhibit 4: Apple Share Buyback (Monthly Open Market Purchases in FY2015)

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When thinking about the pace of future stock buyback, Apple's U.S. cash levels need to be addressed. The amount of cash held offshore cannot be used for share buyback (or quarterly cash dividends). I previously chronicled the dilemma this presents. Due to strong iPhone sales in China, Apple is earning more cash internationally than it can spend in the U.S. on share buyback and dividends. One near-term solution has been for management to issue debt in order to fund the capital return program. While this plan is not a long-term solution, it is likely the best near-term plan while management lobbies for U.S. corporate tax reform addressing repatriation tax on offshore earnings. In 4Q15, Apple issued $10 billion of debt to fund share repurchases in August and September (shown in Exhibit 5). This is the most likely reason why Apple didn't begin another ASR over the summer.

Exhibit 5: Apple Debt Issuance (Quarterly - Fiscal Year)

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When looking at the pace of debt issuance, it is clear that Apple is only able to buy back its stock as fast as it can raise debt. Over the past nine months, Apple has issued $29 billion of debt while buying back $31 billion of shares. When taking quarterly cash dividends and Apple's routine cash needs into consideration, Apple is literally buying back shares as fast as it can. 

While ASRs represent the quickest way to buy back shares, one requirement is to have the cash up front when the ASR is initialized, something that was likely not possible over the summer. Instead of beginning another "modest" ASR of a few billion dollars, Apple management likely wanted to be much more opportunistic with buyback. The second-best alternative was to issue debt across a number of weeks and then repurchase shares in open market transactions, buying a greater number of shares as the stock price continued to drop in August and September. In terms of open market purchases, highlighted in Exhibit 6, 4Q15 was the busiest month since Apple began its buyback program, exceeding the second most active quarter by 75%. 

Exhibit 6: Apple Share Buyback (Quarterly Open Market Purchases - Fiscal Year)

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When looking at the pace of debt issued and the resulting pace of buyback, I have doubts Apple management could have done much more to buy shares at a faster pace over the summer given the circumstances and share price. While Apple could have returned the $187 billion of foreign cash back to the U.S., paying the required tax on such funds would not be the most shareholder-friendly option. Stock buyback does not operate in a vacuum with management needing to weigh the costs of returning cash to the U.S. against raising debt. 

It is important to remember that share repurchases, both open market and ASRs, are unable to keep Apple's stock price from declining in the future. There are a number of high-profile examples within the financial sector were management teams were buying back stock in 2007 and 2008 only to then need to raise capital in the subsequent recession as their companies encountered a more difficult operating environment. Instead, the main takeaway from Apple's buyback program is that management increased the pace of buyback as Apple's stock price declined nearly 30% from all-time highs. The striking aspect of Apple's buyback is how management is actually buying more shares as Apple's stock price increases. In 2015, Apple repurchased shares at a $118 average stock price, 25% higher than the average price paid in 2014. When looking back at 2013, Apple was buying shares at price levels that were 65% lower than the current stock price.

Tim Cook and Luca Maestri are likely becoming more confident in Apple's future when looking at iPhone's position in the smartphone industry. The ability to entice Android smartphone owners while serving as an aspirational brand causing consumers to strive to move up to iPhone's price layers represents a long-term positive. In addition, while this may be just a coincidence, Apple management increased the pace of buyback in February 2015, around the time reports came out depicting Project Titan and Apple's growing ambitions with electric cars. Then, over the summer, the increased pace of buyback once again seemed to correspond to new reports indicating new Project Titan hires and a WSJ report in September saying the project received the green light with a 2019 target. Management is now left with $36 billion of remaining share repurchase authorization with the board planning to update the capital return program in 2016. We are seeing a management team that is betting big on a future that the stock market is still unable to see.

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Apple's 4Q15 Earnings Preview

Apple's upcoming earnings report is set within a tumultuous market. We find ourselves in a changing environment with fears surrounding China's economy subsiding and optimism around the U.S. economy and the technology sector on the rise. Last week, large cap tech saw a resurgence as Microsoft, Amazon, and Google all reported strong 4Q earnings compared to expectations. Apple shares have traded up since bottoming at the end of August even though Wall Street continues to question iPhone sales strength. Apple's 4Q15 will provide the clearest read yet on how the global economy did this past summer as the iPhone has become the unofficial economic bellwether for China and global consumer demand.  

The following table includes my estimates for Apple's 4Q15. Where applicable, I have compared my estimates to management's guidance. 

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iPhone

Investors remain nervous about iPhone sales. Upon closer examination, this nervousness has been around for close to a year, dating back to when the iPhone 6 and 6 Plus launched in September 2014. Since Apple's 4Q15 earnings reflect iPhones sales from July to September, results will primarily reflect how the iPhone 6 and 6 Plus did in China over the summer. In many ways, Apple's 4Q15 is a transitory quarter as attention will quickly move to FY2016 and iPhone 6s and 6s Plus demand. 

Exhibit 1: iPhone Unit Sales Expectation Meter (4Q15)

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I remain above consensus with my 50.5M iPhone unit sales estimate. Much of my optimistic stance rests on the belief that Apple saw continued robust iPhone sales in Greater China over the summer. I am also assuming Apple experienced an average level of iPhone sales seasonality in the weeks leading up the the new iPhone launch. I consider iPhone unit sales in the range of 46M to 51M as close to my expectations. If Apple reports iPhone unit sales of closer to 40 million units, I will need to readjust my FY2016 iPhone sales view as it is likely Apple saw decelerating iPhone unit sales growth in China at a much faster pace that I expected. 

iPad and Mac

Similar to the past few quarters, the iPad and Mac will not make or break Apple's earnings report. When taking a step back from the quarterly fluctuations, Apple is still trying to find the iPad's normalized sales run rate where the pace of iPad upgraders and new customers will lead to stable growth trends. We are not there yet. The Mac continues to perform well in an environment where the laptop and desktop form factors are struggling in the face of smartphones. 

Exhibit 2: iPad and Mac Unit Sales Expectation Meters (4Q15)

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Apple Watch

As we saw with Apple's 3Q15 earnings report, due to Apple not disclosing Apple Watch sales estimates, we end up with an "inside baseball" back-and-forth debate among financial analysts trying to back into Apple Watch sales estimates. Consensus seems to have settled on Apple selling 2.5 million to 3.5 million Apple Watches last quarter (I estimated Apple sold 2.6 million). At last week's WSJDLive conference, Tim Cook all but assured us that Apple will have shipped more than 2.5 million Apple Watches in 4Q15. My official Apple Watch unit sales estimate is 3 million, bringing the five month total for Apple Watch unit sales to 5.6 million. 

Guidance

Management's guidance will provide a clue as to how iPhone 6 and 6s Plus are selling. Unfortunately, Apple Watch revenue may make it more difficult to convert revenue guidance into an iPhone unit sales estimate. The debate surrounding iPhone is whether Apple can continue to grow the product category in FY2016. If revenue guidance comes in less than $75 billion, many investors will use that as evidence that Apple will struggle growing iPhone unit sales in 2016. 

Exhibit 3: Revenue and Margin Guidance Expectation Meters (for 1Q16)

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Summary

Expectations surrounding Apple are much more varied heading into Tuesday's earnings report. With iPhone sales expectations more subdued this time around compared to previous quarters, it may take less for Apple to please Wall Street. I will be looking for any signs as to how management looks at the pace in bringing new customers to iPhone. While a slowdown in new user acquisition from FY2015 should be expected, the market will likely look favorably upon evidence that suggests the iPhone 6s and 6s Plus are still effective in expanding the iPhone user base at levels similar to iPhone 6 and 6 Plus. Several analysts have already given up on the iPhone 6s and 6s Plus narrative and are now focusing on iPhone 7 in late 2016. 

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Leasing Solves Apple's Cheap iPhone Dilemma

Apple is on track to sell more than 250 million iPhones over the next 12 months. When looking at overall sales share, the iPhone remains a small player, representing only 15% of overall phone shipments. However, on a profit share basis, the iPhone has rewritten the rules guiding the smartphone market, commanding upwards of 90% of the industry's profit. Even though Apple's mission has never been to sell the most of a product, there may be a way that Apple can grow iPhone's sales share rather significantly while retaining control of the smartphone industry's profits. An iPhone leasing model solves Apple's dilemma of how to address a larger portion of the smartphone market without diluting its aspirational brand and iPhone experience.  Leasing will usher in the next major phase of the smartphone industry by solving Apple's cheap iPhone dilemma.

The Changing Smartphone Market

In the early days, the prevailing way consumers bought an iPhone was with carrier subsidies. Instead of paying the $649 up-front price for the base iPhone model, AT&T would "subsidize" $450 of the cost, which would later be indirectly recouped by charging higher monthly service fees. However, as time went on and additional carriers began selling iPhone, the subsidy model represented a declining percentage of overall iPhone sales. A growing share of iPhone buyers were now paying full price for iPhone but in return getting lower monthly service fees from their carrier. Over the past eight years, in an environment where the iPhone's full cost is either born by the consumer up front or the carrier through a subsidy and subsequent two or three year contract, the iPhone was able to grab a commanding share of the premium portion of the smartphone market (>$400) with much less success in the middle market ($200-$400).

Spurred on by competition and unsustainable growth in iPhone subsidy costs, U.S. mobile carriers began to move away from the smartphone subsidy model and are currently embracing a leasing paradigm. Consumers are now able to pay either nothing up front or a small initial payment and then pay back the rest of the iPhone across a number of months, usually 24. Since carriers are no longer on the hook to "subsidize" part of the iPhone's cost, monthly service costs have been reduced although data has continued to become more expensive over the years. 

In an effort to retain the best customers, and as a sign of the iPhone's market power, carriers have included options for iPhone users to lease a new iPhone each year by simply turning in their old iPhone. The end result is a growing number of iPhone owners that lease their iPhone, paying the same price each month, but upgrading to the newest iPhone each year. 

Apple has recently gotten involved in the mix by launching the iPhone Upgrade Program in conjunction with the iPhone 6s and 6s Plus launch. While currently only available at Apple Stores in the U.S., the program is designed for those who want a new iPhone each year with the added peace of mind provided by AppleCare+. Customers apply for a loan financed by Citizens to cover the cost of the iPhone, AppleCare+, and sales tax. After the initial payment is made, the loan holder then has to pay back the price of the iPhone and AppleCare+ in 23 equal installments. However, after the 12th payment, the loan holder can hand in his or her current iPhone at an Apple Store and then upgrade to the newest iPhone by signing up for another 24-month loan. The cycle then repeats itself until the next year. Similar to what is happening at the carriers, the iPhone Upgrade Program is creating a growing number of iPhone owners that lease iPhones which shortens the iPhone upgrade cycle, boosting iPhone sales.

While we are still early in the iPhone leasing movement, early survey results suggest there is interest in leasing programs, including Apple's iPhone Upgrade Program. Since so few iPhone sales occur in U.S. Apple Stores, any near-term impact directly related to the iPhone Upgrade Program will likely be moot. Citizens expects less than one million customers to use the iPhone Upgrade Program over the first 12 months. Longer-term trends, and more importantly, the learning experience Apple is receiving by leasing iPhones, bode well for the program. It would be surprising if Apple does not expand the program to new countries over time. 

The Cheap iPhone Is a Myth

The call for Apple to release a cheap iPhone reached a fever pitch a few years ago when Apple first entered China with China Unicom and China Telecom relationships. Even though Apple has steadily grown market share and unit sales, a certain group of analysts and pundits continue to think the only way Apple would be able to do well in China and emerging markets would be to release a "cheap" iPhone. The problem with this thesis is that there were very few strategies Apple could realistically use to sell a genuinely low cost iPhone without undermining its business.

A base model iPhone 6s retails for $649 and has an gross margin of approximately 45%. In theory, Apple could sell such a device for $350 and break even, but with a business model dependent on making money from hardware, this isn't a viable long-term solution. Another possible way to sell a cheap iPhone would be for Apple to take a base model and strip out features and components. However, upon closer examination, this is much easier said than done. The iPhone's popularity is a result of the experience obtained from using it. Accordingly, it would be very difficult to maintain that experience by selling a stripped down iPhone with lower quality cameras, screens, and processors. Even then, a stripped down iPhone would still likely sell in the $300-$400 price range, which does not address the low-end of the market.

Another option to market a cheap iPhone would be for Apple to segment screen size according to price tiers. A 4-inch iPhone "mini" could sell for a lower price than bigger-screen options. However, recent iPhone sales trends would suggest a 4-inch screen iPhone would likely become a niche device as consumer preferences are overwhelmingly moving towards larger form factors like the iPhone 6 and 6s, with a growing number of users opting for the larger screens found with the iPhone 6 Plus and 6s Plus. 

Apple would have much difficulty selling a low-cost iPhone at a price that would make it competitive in completely new market segments. The most likely scenario that many have not considered is that a cheap iPhone probably wouldn't be as popular as consensus assumes. In fact, I would go so far as to say a low-cost iPhone would likely disappoint on the sales front. The iPhone's success comes from the branding and aspirational feeling attached to the device. By selling a low-cost version of this experience, consumers would likely not value the device in the same way. 

We saw a real-world example of this buyer aversion in 2013 when Apple unveiled the iPhone 5c. Instead of keeping the previous year's flagship phone, the iPhone 5, around and lowering the price by $100, Apple reconfigured the device by giving it a plastic shell. While the iPhone 5c did sell (I estimate approximately 40 million units were sold during its lifetime from 2013 to 2015), it was not enough to change the game. Instead, the device quickly gained the nickname "the cheap iPhone" as the device's colorful plastic shell easily signaled to people it was the cheaper iPhone version compared to that year's more expensive flagship, the iPhone 5s. It was never able to shake its cheap nomenclature. Many consumers buy iPhone for the intangibles that come with such a purchase such as being able to show it (and its high price tag) off to others. The iPhone 5c experiment is a preview of how an actual cheap iPhone would fare in the marketplace: not as well as many assume. 

The much bigger question to ask with a cheap iPhone is what is even considered "cheap"? Even though the iPhone 5c was mocked, the device still sold for a not cheap $549. A stripped down iPhone selling for $300 to $400 wouldn't classify as a cheap iPhone either, especially with other smartphone manufacturers selling product in the $150 to $200 range. The cheap iPhone may be a myth, but Apple is able to recreate many of its benefits, as well as come up with new benefits, by embracing the leasing model. 

Leasing is the Answer

A world in which iPhones are leased solves Apple's cheap iPhone dilemma. With leasing, multiple owners are able to value the same product differently. For some, there is value in being able to use the latest and greatest gadget while for others, the value is in low cost and being able to hold on to a device for a long time.

An iPhone leasing paradigm depends on a few variables including a functioning grey, or resale, market and healthy residual values. A grey market where buyers and sellers are able to transact in a low-cost, convenient, and safe manner is required for a leasing model to effectively move iPhone units from initial buyers to the next group of buyers. Since iPhones retain a good portion of their value as time goes on due to the device's build quality, popularity, and lack of lower cost models, the iPhone has high residual values. Accordingly, iPhones are able to be leased in a cost effective manner. If the iPhone did not hold on to its value well, leasing would prove to be a very expensive option as customers would end up paying most of the iPhone's retail price during the first year of ownership. As a result, the incentive to trade in an iPhone and upgrade would not be high. However, with a high residual value, an iPhone leasing model involves paying only 50% of the iPhone's retail price during the first year. In such a scenario, many would be willing to trade an iPhone in after a year for a new model since most owners currently hold on to their iPhones for two years. 

Leasing creates supply of one-year-old gently used iPhones that can be resold to new customers for less than the cost of a one-year iPhone sold by Apple. If we continue with this example for another year, leasing would create a supply of two-year old iPhones that can be resold to new customers for much less than the cost of a two-year iPhone sold by Apple. With leasing, iPhones make their way down to segments of the market that are not addressed by Apple. Even in an environment without leasing, there is a thriving grey market due to resales. Leasing would only legitimize and expand the grey market. The following chart compares new iPhone pricing at Apple to used iPhone pricing at Gazelle and eBay. Notice how used iPhone pricing currently stabilizes around $200.

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Notes: Pricing is for entry-level storage. Gazelle and eBay prices are for unlocked models.

While Apple would not make money on these iPhone resales, Apple would benefit by selling new iPhones to its installed base each year. Apple would therefore be able to address a larger portion of the smartphone market while not jeopardizing its profit share. The cheap iPhone dilemma would be solved. 

The key reason someone would purchase a used iPhone that was previously leased instead of a cheaper iPhone with stripped down parts is that used iPhones retain Apple's aspirational brand characteristics. Instead of using a cheap iPhone that either looks or behaves differently than other more expensive iPhones models, used iPhones would appear and act the same as brand new iPhones. The iPhone user experience remains intact much more in a leasing paradigm. We see this play out in the automobile industry where premium brands such as Mercedes-Benz, BMW, and Audi each have vibrant leasing ecosystems where consumers can lease two to three-year-old automobiles for a much lower price rather than buy scaled-down, low-priced models that question premium car brand attributes.

Follow the iPhone

To better understand how leasing can help Apple address the low-end of the smartphone market, we can follow the path of an iPhone from original purchase to final destination a few years down the road, taking a look at the various owners and pricing along the way. 

• Step 1: A customer buys a new iPhone 6s 16GB for $649 at an Apple Store using the iPhone Upgrade Program. A two-year loan was originated to finance the cost of the iPhone and AppleCare+.  
• Step 2: At the end of the first year, the original owner returns the iPhone 6s to Apple. The original loan is then paid off. The one-year old iPhone 6s is then transferred to a third-party specializing in recycling or reselling used smartphones. The original owner leases a new iPhone from Apple with a new two-year loan. 
• Step 3: The gently used one-year-old iPhone enters the grey market and is resold to a different customer for $450. A comparative one-year-old model would sell at Apple for $550. 
• Step 4: A year later, the now two-year-old iPhone can still fetch $200 in the grey market. The second owner then decides to sell the device to someone on eBay for $200. A comparative two -year old model would sell at Apple for $450. 

In this timeline, a $649 iPhone was able to be "bought" by three customers over the span of three years for a collective $1,299. The difference in prices helps facilitate the grey market transactions. A larger and more robust leasing paradigm would make this process much more efficient and legitimate, similar to how leasing used cars pretty much involves the same process and players as leasing a new car. Over time, used iPhones would be able to be purchased or leased at many of the same locations where new iPhones could be purchased. 

One consequence of additional iPhone supply entering the grey market as a result of additional iPhone leasing is that resale prices may fall in order to match demand. However, there appears to be significant room for prices to fall without impacting the leasing paradigm, as displayed in the following chart. The black dashed line represents the point where iPhone resale values could fall to in order to still work with Apple's iPhone Upgrade Program.

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Notes: Pricing is for entry-level storage. Gazelle and eBay prices are for unlocked models.

Financial Impact

Apple currently has an iPhone installed base of approximately 500 million users. When taking into consideration hand-me-downs and the resale market, the total number of iPhone users exceeds 500 million. If we were to assume leasing will be the only method by which iPhones will be purchased in the future, than theoretically, Apple would sell 500 million iPhones a year (every iPhone user would simply lease a new iPhone every year). A 500 million iPhone annual sales rate would be 98% higher than the current 253 million sales that I expect Apple to sell over the next 12 months. 

In reality, we are still in the very early innings of the iPhone leasing model, and not everyone will want to lease their iPhone. However, running with conservative estimates of 20-25% adoption rates for iPhone leasing over time, it does not take much to begin seeing a tangible benefit to Apple's iPhone sales. At 20% adoption, Apple would sell an additional 50 million iPhones a year. Said another way, if 100 million iPhone users leased their iPhones each year, Apple would see a 50 million unit boost to unit sales each year. The other benefit from leasing would be that used iPhones would help expand the iPhone user base benefitting the iOS ecosystem which may come in handy as Apple continues to push on content deals (Apple Music, Apple Video in 2016) and services such as Apple Pay. 

With iPhone leasing at 20% adoption, it is conceivable for iPhone's smartphone sales share to increase by 4-5% to 20% without even needing an entry-level low-cost iPhone to boost sales.  

iPhone Leasing Momentum

Ultimately, the only reason leasing iPhones makes sense in the first place is that the iPhone is becoming the primary computing device for hundreds of millions of people. There is a significant need and desire to use the newest iPhone each year. This would be a new type of hardware paradigm compared to previous computer technology eras where consumers bought and then held on to gadgets for years. Another reason an iPhone leasing model works is that consumers have noticed Apple's iPhone development cycle and the company's ability to ship new iPhone features each year. Mediocre annual iPhone upgrades would likely make leasing a much harder sell as consumers would decide just to hold on to their new iPhone for a few years, a much cheaper alternative than leasing. Ultimately, leasing changes the smartphone game by expanding Apple's addressable market and solving the company's cheap iPhone dilemma. 

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Apple Uses Good Design to Marginalize Industries

What makes a great product? 

How can one product change an entire industry?

One of Apple's most significant accomplishments has been a dedication to design that borders on the line of obsessiveness. As people decipher the driving factors behind what makes a product like the iPod, iPhone, and iPad so successful, it is crucial to recognize how a product's design has the potential not just to alter industries, but go so far as to marginalize them. The iPhone relegated the mobile phone to a single app. Apple Watch is being positioned to turn the modern Watch industry on its head. Apple's ambitions with the automobile will be nothing short of a transformational shift in how we think and use automobiles. When a company places only a few big design bets every few years, the resulting bets need to be huge, and Apple positions good design as the guiding light with all of its bets. 

What is Good Design?

Apple has thrust the topic of design into today's society. There is more cultural awareness of design than ever before. While this may sound like a good thing, the definition of design has seemingly expanded along with its growing popularity. The end result is growing confusion as to what design even means. Apple has always positioned design as a guiding principle even though consumer demand for such design is still a recent phenomenon. The world needed to see what the lack of design in the PC market looked like before craving Apple products born from the rebirth of the design-led process in the late 1990s.

With good design, a product is able to tell the world something about the person who created it. Good design is born during the product development stage when a fragile idea is allowed to advance and mature without compromises. So much of the corporate world is built in such a way as to stifle good design. The end result is that we are left with industries that play a crucial role in our lives but are susceptible to being altered by products that are created with additional care and intuition. The difficult part is looking at these legacy industries in a way that allows one to discover how they can be improved. While a handful of companies may realize the pieces to the puzzle for unlocking good design, there are even fewer companies that actually possess those pieces. An Apple led by Jony Ive is currently one of those companies, and Apple's $200 billion of cash is one tangible piece of evidence that Apple has possessed these pieces for years. 

Software Represents Additional Design Tools

Software allows good design to posses a different dimension. Similar to how a new paint color added to one's palette can result in a completely different picture, software allows a designer to add something to a product and to accomplish what would otherwise be impossible. It's not that software should be looked at as completing good design, but it provides a set of additional tools to interpret the world. Software makes it possible for us to interact with products in new ways that once seemed unimaginable. 

Turning Phones into Computers

When Apple executives began to seriously consider entering the cellphone industry, the motive was clear: come up with a phone that people want to use. Even though the iPhone is only eight years old, the world was a much different place in the mid-2000s. The cellphone industry was being built on a paradigm where phones were used to dial a long list of numbers in order to speak to someone. Innovation came in the form of a better keyboard; each button moved from having three letters to having its own letter. The world accepted these products with open arms because we were able to send and receive email when away from our computer. 

A cellphone's keyboard was quickly turning into a limiting factor, a feature that was holding back the device's potential. Few saw this taking place, especially the phone industry leaders. Even more remarkable was the untapped potential for the phone form factor: a device that could be small and light enough to be carried around with us all day. 

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The iPhone ended up representing a simple question: Is there something better than a physical phone keyboard? The iPhone's design represented the answer. By removing the keyboard, a smartphone's potential was unleashed. Of course, those industry leaders clearly invested in the old paradigm not only did not understand the appeal of not having a keyboard, but also lacked an understanding of the potential now created by removing the keyboard as a limiting factor.  

The iPhone's design doesn't just stop with the lack of a physical keyboard. Everything from hardware design elements like physical volume button placement to software features like pinch-to-zoom told us something about who created the device. The iPhone stressed intuitiveness above all else, and this goal ended up positioning the iPhone a good five years ahead of the competition. The iPhone was one product that was able to upend not just the mobile phone market, but the entire computer industry. 

The iPad's Magic

The iPhone was a byproduct of research and development originally geared for a larger tablet device. With lessons learned from iPhone development, Apple returned to what ended up being unveiled to the world only three years after the iPhone: the iPad. 

The iPad has since had a storied history, despite tallying only five years. It came out of the gate as the fastest selling consumer gadget in history, (Apple sold 19 million iPads in the first year on the market) but the device is now experiencing waning sales momentum as the entire tablet market has shown structural issues. 

When the iPad was first introduced to the world, many called it a big iPod touch in an effort to discredit Apple's design foray into the tablet market. In reality, the iPad's greatness resided in it being "just" a big iPod touch. The device's intuitiveness was nothing short of earthshaking. The iPad's recent sales struggle isn't so much an indication that multi-touch computing has hit a saturation point or is being replaced by another computing paradigm. Instead, consumers are still experimenting with multi-touch screen form factors. For many people, a larger iPhone is a more optimal form factor than an iPad. Accordingly, we are left with a situation where smaller iPads are seeing weakening sales momentum while Apple moves faster at the high-end of the market. This is likely just the start of where the iPad is headed. Ultimately, the iPad was a computer designed to have the hardware melt away during use, leaving the software as the primary user interface. Apple's quest to make the most personal computers came to fruition. 

Apple Watch's Mission

Good design was used to question a cellphone's keyboard, unleashing the device's functionality. Similarly, the Apple Watch is given a mission to redefine utility on the wrist. As both Jony Ive and Marc Newson have mentioned publicly, Apple Watch wasn't born out of disgust with the modern wristwatch. There was something else at play, and the Watch's design gives us clues about this driving motivation and why Apple Watch represents a pivotal turning point in the watch industry.

Apple Watch design represents a simple question: can a device worn on the wrist include additional utility? Giving Apple Watch a rectangular watch face, something that was steadfast from early in the Watch development process, emphasizes the device's purpose to display text in the most space-efficient manner possible. The Apple Watch's design does not imply that the device is trying to be a mini iPhone, but instead a device that is meant to take certain tasks once destined for the iPhone (checking the time, receiving notifications, tracking health and fitness) and display information in a location with proper line of sight to the wearer. Haptic feedback serves to replace line of sight for some users as well as create another form of notification. 

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Design is also found in the Apple Watch bands, demonstrating that the Watch is a fashion accessory worn on one's body and on display to the world. In a way, watch bands can be thought of as a form of software. It is perhaps fitting that with the Hermès partnership, Apple introduced leather watch bands in addition to software specifically designed for the Hermès collection. 

The end result, and one that we find ourselves in the early innings of, is a watch industry coping with the prospects of adding additional utility on the wrist. The Apple Watch draws into question how timelessness and craftsmanship should enter the buying equation (both are now largely marginalized in their current form). While some still think certain segments of the luxury watch market will be able to ignore the smartwatch movement, the aggressive moves Apple is making in the fields of traditional luxury, including the Hermès partnership, should serve as an indicator that few watch makers will be able to avoid the future brought on by software on the wrist. 

Marginalizing the Auto Industry By Looking Inside

With the automobile, Apple will once again look to position good design to marginalize a legacy auto industry that is more than 100 years old and has played a defining role in how we live our lives. The modern day automobile is not intuitive. Drivers need to learn to operate an automobile. Passengers have to conform to a car's existing seating arrangement with only marginal modification. Software has the potential to change all of these limitations. 

While Tesla has become a pioneer in electric vehicles and BMW continues to slowly build momentum in the space, both companies have not actually altered the automobile's fundamental purpose. Nowhere is this seen more than inside the Tesla Model X and BMW i3. While the dashboards have seen a change, in Tesla's case most of the dials and knobs having simply been converted into software and placed on a large tablet. There is much room for improvement. 

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The way we think about automobiles today will be different than how we look at the automobile in the future. Good design is powerful enough to alter our prevailing attitudes and views of a product. Simply put, we are being held back by our prevailing attitudes of what an automobile is. With Apple Car, Apple would reposition the car as a connected room on wheels. The car interior is being held back by both legacy automobile design and the lack of software. Take into account how software holds the potential to add magic to a user's iPhone or iPad, and the same can apply to the experience in a car. We are still stuck in the era of trying to improve the smartphone keyboard when it's time to drop the keyboard altogether. This would mark a significant departure for an auto industry that has rode the combustible engine to the end of the road. 

Good Design Is All About Taking Risks

The one recurring theme found with all of Apple's products unveiled over the past 15 years is they were all high-risk. The iPod, iPhone, and iPad were all bets that the consumer would place value in doing something in a different way. The Apple Watch is a bet that people want additional utility on the wrist. Project Titan will be positioned as nothing short of a bet-the-company play in the automobile industry. Failure would be measured not only in billions of dollars, but more importantly, in time. 

Good design contains risk, the same risk that legacy companies did not want to take to move their industries forward. 

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Apple Watch Is Being Severely Underestimated

The Apple Watch continues to show incredible promise although much of it is being masked behind an iPhone lens. Unrealistic expectations positioning Apple Watch as the next iPhone in terms of sales and popularity have now resulted in many people ignoring positive Apple Watch developments. When analyzing geographic and retail distribution expansion, product and market strategy, and the competitive landscape, it is clear that the Apple Watch is not just being severely underestimated but has quickly become one of the best-selling wearable devices.

Apple Watch Expectations Pendulum

With Apple Watch representing Apple's newest product category since the iPad in 2010 and the first genuine new product developed during the Tim Cook and Jony Ive era at Apple, the product launch received quite a bit of attention. Apple helped build the excitement as the Apple Watch debut in September 2014 was billed as one of the bigger Apple product keynotes in recent history, even beating the iPad's unveiling in 2010. Expectations were set high. In reality, these expectations were too high. The Apple Watch was being thought of as the next iPhone, a device that would quickly surpass the device we already carried with us all day, every day. Many compared the Apple Watch keynote to the iPhone keynote, looking for the device's three key features. For iPhone, it was a telephone, communication device, and iPod. Apple obliged with most of these requests, as they followed a similar playbook with Apple Watch, labeling the device as a communications and health & fitness device as well as a timepiece. Once again, expectations were likely mispositioned. 

If Apple Watch expectations were a pendulum, right before the Apple Watch was launched, the weight on the end of the string was pulled all the way back to "the next iPhone" as expectations were quite high. However, in the weeks following launch, the overall feel towards the product took on a completely different tone. There was increased attention given to posts discussing how the Apple Watch was just a toy and not ready for prime time. One post went as far as being just a GIF of Apple Watch being thrown on top of a bunch of leftover and old chargers in a desk drawer. The word "flop" was being passed around with increased frequency. Sticking with the pendulum theme, Apple Watch expectations had quickly moved to the completely opposite end of its trajectory, now classified as a flop. Five months have since passed Apple Watch's launch and after looking at sales, usage patterns, and customer satisfaction surveys, it would appear that the Apple Watch is neither the next new iPhone (at least not in the near-term) or a flop. Instead, it is a fun and cool product with much promise and intrigue. The pendulum will eventually come to rest between both extremes. 

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Massive Launch for First Generation Product

The Apple Watch launch was unlike recent new Apple product launches. There were no lines outside Apple Stores, carrier stores weren't selling Apple Watch models, and there was much mystery as to how to sell such a personal device with so many different options. Some even wondered if Apple would be able to find a way to sell Apple Watch in the same setting that it used to sell desktops, laptops, tablets, and smartphones. With the launch now in the rearview mirror, we have a much clearer picture of the issues Apple faced leading up to the first Apple Watch sale. While all new Apple products suffer from supply issues at launch, Apple Watch supply was much more limited than most realized. Some blamed Angela Ahrendts for a "botched" Apple Watch retail launch while others even looked at Jeff Williams as holding some responsibility for confusion surrounding Apple Watch availability. The WSJ went on to report that faulty taptic engines in some Apple Watches led to Apple not being able to sell a certain percentage of assembled units, leaving the company with not enough stock to have the device available for in-store purchase. What had been billed as the largest Apple product launch in years seemed to miss the mark.

However, when Apple reported earnings at the end of July, a different picture began to appear. Even though Apple Watch revenue and unit sales were not disclosed, one is able to back into a fair estimate of such metrics using an accurate financial earnings model. Apple likely shipped 2.6 million Apple Watches from launch to the end of June. Taking into account that many of these shipments were ordered at or close to launch, we are then able to paint a picture as to what kind of launch the Apple Watch really had.

Apple likely sold around two million Apple Watches at or close to launch. On an absolute basis, this would classify as the biggest product launch in Apple's history despite there being no long lines. In the preceding weeks after launch, Apple Watch supply then improved rather dramatically. Apple just had completed its quietest record-breaking product launch in its history. When comparing the first quarter of Apple Watch unit sales to previous flagship products, the Apple Watch and iPad are closely ranked. The iPad had a few extra weeks of sales in its first quarter on the market, which distorts the numbers a bit. Regardless of timing, Apple sold more Apple Watches than either iPhones and iPods during the first three months on the market. 

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Geographic and Retail Point of Sale Expansion

With Apple Watch supply improving dramatically beginning in June, Apple has been expanding Apple Watch distribution at an unprecedented rate. From both a geographic and retail point of sale perspective, the Apple Watch is now available at many more locations across the world. While this doesn't necessarily suggest that Apple Watch demand has dramatically improved since launch, it does tell us that many more potential consumers are in a position to be introduced to Apple Watch. From Apple's perspective, the hardest part of selling Apple Watch is getting it in front of customers to try out and purchase. The more options and alternatives at the consumer's fingertips, the better.  The Watch can now be bought not only at Apple Stores, but also at select third-party electronics stores in a few countries, including Best Buy in the U.S. A few mobile carriers have begun to sell the device, and we are now seeing the first big box retailers sell Apple Watch. It would appear the goal is to build out the Watch's retail availability in order to have a successful holiday shopping season beginning in November. The following two exhibits highlight the expanded geographic expansion for Apple Watch as well as the additional retail locations in the U.S.

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Product Strategy & Marketing

There have been some subtle changes in the way Apple has been marketing and selling Apple Watch. One way of quantifying some of this difference is to look at changes seen with Apple's Watch mini site. While Apple is still relying on a few major use cases for why someone may want to buy an Apple Watch, there is much more attention given on some of the intangibles attached to the device. Watch bands and different watch cases are now emphasized as a way to demonstrate not only how the device is making technology more personal, but also how there is the ability to personalize the watch's appearance in many more ways than there was even at launch. 

Apple's Apple Watch page - April 24, 2015 (Watch launch):

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Apple's Apple Watch page - October 5, 2015

There is much more focus on some of the Apple Watch intangibles and different looks. 

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It is telling that after only a few months on the market, Apple released a plethora of new Apple Watch Sport Band options, along with Gold and Rose Gold Sport Watch case colors. Having used Apple Watch since launch, I am confident in describing the band as both the Apple Watch's most important aspect and most intriguing element going forward. 

Apple Watch bands hold the potential of easily turning one Apple Watch into a number of different watches. While the technology and components found in one Apple Watch case may not change, buying a new watch band could lead to the feeling of owning a completely new watch. This is an intriguing aspect to the device considering how the watch bands do not contain any technology. Surveys indicate around 30-40% of Apple Watch buyers will likely buy more than one band, demonstrating some of the financial and marketing appeal of highlighting various bands available for sale. 

When thinking about the future direction for some of the Apple Watch's design and features, it is likely that we will see much more change with watch bands compared to watch cases. Considering that some Apple Watch owners will have multiple watch bands, with some costing hundreds of dollars, it is not likely that Apple will frequently change the Watch case in such a way as to no longer work with previous watch bands. This may suggest that we will see more innovation found with the Apple Watch bands themselves, including options that contain sensors and technological components within the bands themselves. In the long run, it is not crazy to envision certain types of bands being sold where the entire band is one, long flexible display able to show certain notifications or alerts to the user. 

Competitors

Despite much attention being put on the current watch industry as being the source of a true Apple Watch competitor, early indication would position Fitbit as Apple's most significant rival in the wearable market. Not only does Fitbit have a much better retail distribution than most watchmakers, including even Apple Watch (for now), but the combination of low prices and customer awareness gives Fitbit some advantages over Apple in the beginning. While Apple Watch and Fitbit wearables are not exactly direct competitors when looking at prices and feature sets, there is evidence that many consumers consider them to be rivals. I would go even further to say that many look at Apple Watch and Fitbit as the two primary pioneers in the wearable space, even though there were others before them. The following chart highlights Fitbit's annual unit sales, including 11 million units shipped in 2014. The company already shipped eight million devices in the first six months of 2015. The upcoming U.S. holiday quarter will be crucial for Fitbit. 

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There continues to be many questions as to the long-lasting effect wearables will have on health and fitness. Early indication would show that there is an element of interest in health and fitness wearables beginning to wear off after a certain time leading to customers discarding or no longer wearing the device. It is likely that fitness will remain a niche use case while there continues to be potential for health to be positioned as a long-term use case for a wearable device. There is evidence that future Apple Watch models will improve on the device's health applications. 

Apple Watch Sales Estimates

Expanded Apple Watch distribution bodes well for improving Apple Watch sales momentum as more consumers are exposed to the device, not to mention that Apple is building the Apple Watch retail channel. While it may not be reasonable to expect continuously improving Apple Watch sales on a month-to-month basis, the upcoming holiday season (beginning in November for many countries and including February for China) will be crucial when expecting improving Apple Watch sales numbers. The following are my Apple Watch unit sales estimates for the next four quarters. 

• 3Q15: 3M units (reported)
• 4Q15: 3M units (increased retail distribution)
• 1Q16: 5M units (holiday quarter)
• 2Q16: 3M units (Chinese New Year)
• 3Q16: 3M units

During the first 12 months on the market, I expect Apple Watch sales to approach 15 million units. When comparing this sales number to the total iPhone installed base, Apple Watch adoption would be approximately three percent. Fifteen million Apple Watch sales in the first 12 months on market would beat iPod and iPhone in terms of initial sales. The following exhibit highlights my trajectory for Apple Watch unit sales in the coming years. 

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Apple Watch sales trends also demonstrate some of the device's drawbacks. Apple Watch has to be paired with an iPhone. This requirement limits the target market for Watch to current iPhone owners. Even though there are more than 500 million iPhone users in the world, that is a smaller number than the number of people in a position to buy the iPad when it hit the market in 2010. In a rather remarkable sign of iPad's initial sales success, Apple sold 19 million iPads in the first 12 months on the market, which would be 4-5 million more than my Watch sales expectations for the same time period. 

Additional Questions

A "cheap" Apple Watch. One question that may take time to answer is how the Apple Watch demand curve looks when plotted against price. Much of Apple Watch's appeal may originate around the fact that it is a premium mass-market luxury object with a starting price of $349. Would a lower-priced collection priced around $200 be a panacea for the product category or would we see something similar to the iPhone 5c phenomenon where the device was never able to shake its "cheap" nomenclature when sold alongside more expensive alternatives? 

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Retail Strategy. It is clear that Apple has been experimenting with the strategy used to sell Apple Watch. After a few months of sales, early trends would suggest that the way people buy Apple Watch Sport at Target will likely be quite a bit different than buying Apple Watch Hermès or Apple Watch Edition. When Best Buy began selling Apple Watch, the company reported much stronger than expected sales. The interesting part is that Best Buy was selling just a few models from the Apple Watch collection with only a few stores even having them on display. Most of these sales were Apple Watch Sport models and done on Best Buy's website. This would suggest that consumers look at the Apple Watch Sport as more like an iPod, iPhone, or iPad, a device that may not necessarily need the personal attention of trying it on. 

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Meanwhile, someone buying Apple Watch Hermès will likely want a more personal touch during the buying process. Apple's answer to this seems to be to segment Apple Watch collections to certain retail locations. Apple Watch Hermès is available at 70 locations worldwide while Apple Watch Sport is now sold in thousands of retail locations. When it comes to Apple Stores and selling Apple Watch, we will likely continue to see change in the coming years as Apple figures out what works best for selling various models of the same product, each with different intangibles that enter the buying process. 

Don't Underestimate Apple Watch

The Apple Watch contains too much promise and potential to question it's long-term viability as a product category. It is becoming clear that the device was dealt a bad hand when it comes to early expectations, being compared too much to its very successful siblings - the iPhone and iPad. However, when looking at all of the various data points, estimates, and trends, it becomes clear that the Apple Watch is doing much better than it seems. We are living in an iPhone world with Apple expected to sell more than 250 million iPhones over the next 12 months. The iPhone 6s and 6s Plus position the iPhone that much closer to becoming someone's sole computer. In such a world, the Apple Watch likely has a role in handling some of the more simple tasks that were once given to iPhones, in addition to being given an expanding list of use cases that revolve around identity, monitoring, and personality. In a world moving towards more personal technology, Apple Watch has a place. It's time to stop underestimating Apple Watch.

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Apple Is Building Its Largest Startup Ever

What was once discussed within certain technology circles is now in mainstream news. Apple is building a startup focused on designing an electric car. When compared to previous product initiatives, Apple is embarking on its most ambitious project in its history. In recent years, there has been much debate surrounding the factors that have contributed to Apple becoming the most valuable company in the world. There is growing evidence that Apple is confident it still has the keys to success. The startup team Apple is putting together and the corporate values that support such a team will determine Apple's ultimate success in the automobile industry. 

Project Titan

Apple wants to design a car and has formed its own startup to assemble a team of automotive and robotic experts. Apple's ambition with the automobile has been in the making for years, but only in recent months has Apple's outside hiring led many to conclude that development may be far more advanced than first thought. Unsurprisingly, most were skeptical of Apple designing its own car, especially if the untapped potential in the automative space was not clear. There continues to be many questions as to how Apple could position itself to come up with a new kind of experience on the road by designing the entire automobile. 

This past February, the WSJ gave the most detail about Apple's Project Titan project, reporting that Apple's automobile initiative had managerial hierarchy and structure. On September 21st, the WSJ revealed additional information about Project Titan, including news that it had progressed to the point of being given the green light with managers now having permission to expand the team to 1,800 people. Recent reports have pointed to Project Titan's headquarters being located in Apple-leased office space in nearby Sunnyvale, a short distance from Apple HQ in Cupertino.  

In recent months, there has been a running tally of employees believed to be working on Project Titan. Given that the team already includes hundreds of employees, the following list represents a small percentage of the total group. Nevertheless, a few trends become apparent.

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WSJ, 9to5Mac, Reuters

1. Project Titan is being led by long-time Apple managers dating back to the iPod development in the early 2000s.
2. Apple already had numerous employees with automobile-related experience, including a few from the Industrial Design group. 
3. Apple has poached employees from a range of automobile manufacturers including Tesla, Ford, Volkswagen, Fiat Chrysler, and Mercedes-Benz. 
4. There is evidence that Apple is specifically interested in the areas of battery technology (A123 Systems hires) and autonomous driving (numerous hires). 
5. Outside hiring continues to ramp indicating an increasing level of advancement, importance, and priority.  

As reported by the WSJ, Steve Zadesky appears to be playing a major role in Apple Car development. In addition, Jony Ive and Marc Newson will likely play a pivotal role in coming up not only with Apple Car's design, but also the materials and manufacturing processes involved in such a product. 

A Startup Mentality

Apple's ultimate success with Project Titan will depend not on whether Apple can build autonomous features into an automobile or come up with a breakthrough user interface. Rather, those features are byproducts of the much bigger product that Apple is trying to build: the best team of automotive experts in the world. Even though Apple prides itself on a culture that puts the product first, the biggest risk factor to Apple Car is corporate politics and too many layers of management and decision-making. Success will come from allowing ideas to grow from the design labs to showroom without having interference. In addition, having a team comprised of members with various backgrounds and experiences could prove to be detrimental in making technology more personal. The following table highlights Apple's increased ambition with Apple Car compared to iPhone and Apple Watch development.

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Using the Same Apple Playbook for Apple Car

Early Apple Car development shares aspects of previous Apple product development cycles. In the mid-2000s, hundreds of engineers working on the iPhone were separated from the rest of Apple. Adam Lashinsky detailed the thought process behind this move in his book "Inside Apple":

"By selectively keeping some employees from concerning themselves with colleagues elsewhere in a giant company, Apple creates the illusion that these employees in fact don't work for a giant company. They work for a giant start-up...The original iPhone team, for example, didn't interact with the people working on the iPod, then the dominant and fast-growing product at Apple. The iPhone organization was allowed to raid the iPod group and other areas of the company for engineering talent. That's because the iPhone was a corporate priority, driven from the top."

Evidence suggests Apple Car is Apple's growing priority. Project Titan leadership has reportedly been poaching employees from other divisions, and one should expect this trend to intensity in the coming years. This is not to suggest that the iPhone, iPad, and Mac will be put on the back-burner. Instead, Apple is only now finding its stride with those products. As seen with the iPhone 6s / 6s Plus, Apple did not settle for a "S" cycle update but is instead much more focused on shipping new iPhone features each year that help support the shift to a leasing paradigm where many iPhone buyers upgrade to the latest iPhone model every year. Take a look at iPod trends back when the iPhone was being developed; Apple actually saw increasing iPod sales on new and innovative models all the way up to 2008. It is important to not underestimate the breadth of talent Apple has dedicated to its current product lineup, even after taking into consideration losses to Project Titan.

The other element that Apple has used masterfully to build suspense for its products over the years is secrecy. This extends even to the actual team working on the product under development. It is very likely only a small number of Project Titan members have seen automobile prototypes. This would be similar to the way Apple allowed very few people to know  the full story about the iPhone during development, as chronicled in Fred Vogelstein's "Dogfight: How Apple and Google Went to War and Started a Revolution": 

"Engineers designing the iPhone's electronics weren't allowed to see the software it would run. When they needed software to test the electronics, they were given proxy code, not the real thing. If you were working on the software, you used a simulator to test hardware performance." 

The end goal is simple: limit the number of people that have access to the most valuable information. 

Adapting the Apple Playbook to the Environment

There are signs that Apple isn't just trying to repeat the path to success taken with past products, but rather is adapting to the current environment. In a sign that Apple is moving beyond its traditional comfort zone with automobiles, the company has needed to look outside to hire many Project Titan team members. The intriguing theme found with Project Titan recruitment is that Apple has hired talent from various industries and fields including the current automotive industry, software and technology industries, and even R&D labs in academia. All of this is in contrast to how the iPhone was developed. The Apple vs. Samsung patent trial revealed certain aspects as to how the iPhone team came into existence. Scott Forstall, head of iOS software at the time, described some of the parameters including looking within to hire all software people:

"Steve [Jobs] didn't want to hire anyone from outside of Apple to work on the software, but he said I could hire anyone in the company I wanted. So I'd bring recruits into my office. Sit them down and tell them, 'You are a superstar at Apple. Whatever you are doing now, you'll do fine. But I have another project that I want you to consider. I can't tell you what it is. All I can say is that you will have to give up untold nights and weekends and that you will work harder than you have ever worked in your life."

Talent Wars

Personal transport will be the next big battleground for technology companies. We are already seeing the early stages of this battle when it comes to retaining talent, not to mention intense recruitment battles. One benefit, and some say reason, for all of the reports on Project Titan is that Apple is able to inform the world, unofficially, that they are assembling a team tasked with producing an electric car. In a way it can be thought of as a casting call sent out not just to other technology companies, but to entire industries including automobile manufacturers and supply chain management experts. One can also include the mapping and augmented reality fields as being connected to the automobile space, from which Apple has been actively acquiring talent over the past year.

Apple, Google, Tesla, and Uber have shown a willingness to get involved in the transportation space, and it is not unreasonable to expect others to join in the coming years. At the same time, current automakers are quickly building up their own R&D labs in Silicon Valley with the focus being on the software side of the equation, including autonomous driving. The winners in this war will be those that are able to attract the best and brightest. One way of accomplishing this goal is to create an environment conducive to achieving results. This is one benefit from Project Titan where new employees are likely brought on with the premise that the team acts like any other startup but has the backing of a $650 billion market cap company with $200 billion of cash and cash equivalents on the balance sheet. 

Tim Cook's and Jony's Role

Project Titan represents Apple's second new product category in the Tim Cook era. There are similarities in how the Apple Car and Apple Watch were developed which provide clues as to the type of leader Tim Cook is and how he thinks about Apple's values. With Apple Watch, Apple was willing to alter some of its outward appearance and take on slightly different goals involving wearables and luxury themes. This same philosophy will apply to Project Titan where Apple will need to change some of its practices, such as working with regulatory agencies more, in order to be able to ship a working product.

Tim Cook's role and value as CEO continues to come into focus: find the most talented people in a certain field, and get them to come to Apple by building the right kind of environment conducive to making the impossible seem in reach. Meanwhile, Jony is tasked with making sure the product always comes first, ranging from new iPhones and iPads to new Apple Stores and Apple Campus 2. 

Cook and Jony are overseeing Apple's largest creation yet: an electric car startup called Project Titan.

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The Pixar iPhone

It is time to start questioning the iPhone "S" cycle, the often referred to development cycle theory in which a significant iPhone update is followed by a more minor, evolutionary update the following year. Instead, the best way to understand how Apple thinks about iPhone development is to look at Pixar. The film company has multiple films under development at any given time in order to ship at least one new film a year. Similarly, Apple is developing a number of iPhone features at any given time with the goal of shipping a more advanced iPhone at least once a year. As more people upgrade their iPhones annually using monthly leases, shipping iPhone features just to match a two-year iPhone "S" cycle begins to look like a dated theory.

The iPhone "S" Cycle Theory

"Which iPhone cycle are you on?"

This question has come to symbolize the iPhone development cycle. Partly due to Apple's own iPhone nomenclature, consensus has settled on the theory that Apple keeps its significant iPhone updates for whole numbered years (iPhone 3G, 4, 5, 6, and so on). Consequently, the odd years, or so-called "S" years, are characterized by more modest, evolutionary software and hardware upgrades (iPhone 3GS, 4s, 5s, 6s and so on). Exhibit 1 depicts the iPhone "S" cycle theory in which greater advancements in iPhone development are said to occur every other year. 

Exhibit 1: The iPhone "S" Cycle Development Theory

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The major implication from the iPhone "S" cycle is that Apple is guided by a two-year development cycle where the focus is on getting iPhone users to upgrade their iPhone not every year, but rather every two years. Much of this theory is based on the early days of mobile carriers subsidizing iPhones. By having carriers "subsidize" the iPhone's cost, customers agreed to be locked into a multi-year contract. With early iPhone upgrades being nearly nonexistent, it was often in the customer's best interest to upgrade their iPhone soon after their standard two-year contract expired. 

As Apple expanded the iPhone into new geographies and carriers, this subsidized model began representing a smaller portion of iPhones sold. Today, the subsidy model is breaking apart as the up-front costs associated with such plans have weighed on carriers. In its place, carriers are embracing monthly lease plans which amount to nothing more than interest-free financing.

Annual iPhone Upgrades

The iPhone Upgrade Program was one of the more strategically important announcements announced at Apple's "Hey Siri" keynote. Apple's goal is rather straightforward: make it easier for consumers to upgrade to a new iPhone every year. Apple isn't reinventing the wheel with the iPhone Upgrade Program as AT&T, T-Mobile, and Sprint have similar iPhone leasing and upgrade options. The major implication from the move towards iPhone leasing is that millions of iPhone customers will be moving from a two-year iPhone upgrade cycle to an annual iPhone upgrade cycle. With these plans, not only are there no carrier penalties associated with upgrading to the latest iPhone each year, but in some ways such behavior is even promoted by the carrier. The incentive is no longer to wait to buy a new iPhone. In some ways, this trend is a byproduct of an iPhone development cycle that has been able to entice users to want the latest and greatest iPhone. If the iPhone truly followed an "on and off year" cycle, few would feel the need to want a new iPhone every year. 

A Different Kind of iPhone Cycle

There are additional signs that the iPhone "S" development cycle may have ended years ago, if it ever existed. When looking at the last four iPhone updates, it's clear that Apple is using a different upgrade cycle. The following features were the tentpole features of that particular iPhone release:

• iPhone 5: Larger iPhone screen
• iPhone 5s: Touch ID / Gold color
• iPhone 6 / 6 Plus: Larger iPhone screens / Apple Pay 
• iPhone 6s / 6s Plus: 3D Touch / Live Photos / Rose Gold color

Not only has there been at least one noteworthy new iPhone feature each year, but it could be argued that the updates seen in the "S" years (iPhone 5s and iPhone 6s / 6s Plus) are more strategically important than the cosmetic changes seen in the "non-S" (iPhone 5 and iPhone 6 / 6 Plus) years. Touch ID has become a crucial element of the iPhone ecosystem, and 3D Touch will likely follow the same path. Meanwhile, the iPhone's screen growing size, especially to 4.7 and 5.5 inches, has been a game changer across the world. The takeaway is that the "S" cycle concept where there are more important iPhone upgrades every other year is starting to look incomplete and not representative of how Apple thinks about iPhone development. Something else is at play driving iPhone development.

Exhibit 2 shows a more likely representation of iPhone development. Instead of shipping the most advanced features every other year, Apple strives to ship at least one major, new iPhone feature every year. The goal is simple and straightforward: ship a more advanced iPhone that beats the previous year's model. Market analysts often debate Apple's biggest competitor to iPhone each year. In reality, the iPhone's biggest competitor is the previous year's iPhone. 

Exhibit 2: A Revised iPhone Development Theory

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Tim Cook recently talked with BuzzFeed's John Paczkowski about a number of topics, including the "S" iPhone cycle. His comments support the view that the tick-tock nature of an "S" cycle is no longer relevant. Speaking about Apple's latest iPhones, Paczkowski wrote, "Apple released the iPhone on a tick-tock cycle; with the 'tock' device typically being a modest refinement of the 'tick' device that debuted the year prior with a new form factor and other big upgrades. This is traditionally a 'tock' year, but [Tim] Cook bristles at this notion. '[The iPhone 6s / 6s Plus update] is clearly not an off-year issue,' he argues. 'This is a substantial change.'"  

Cook went on to say, "[a]s soon as products are ready we're going to release them...There's no holding back. We're not going to look at something and say 'let's keep that one for next time.' We'd rather ship everything we've got, and put pressure on ourselves to do something even greater next time." Cook's comments describe a different iPhone development model than what is implied with the iPhone "S" cycle. 

The Pixar Model of Product Development

One company that stands out for its superior product development is Pixar. Instead of putting all of its resources into working on one film a year, the film studio has multiple films under development at any given time since it takes longer than a year to bring a movie from concept to a finished product. The end result is a steady product release schedule that has moved from a new film every few years to soon two films a year. Exhibit 3 highlights the development timeline for each Pixar movie. The company went from developing one movie at a time in the early 1990s (Toy Story) to having at least seven films at some stage of development in 2015 (Inside Out, The Good Dinosaur, Finding Dory, Toy Story 4, Coco, Cars 3, and The Incredibles 2).

Exhibit 3: Pixar Film Development Timeline (click to enlarge)

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For Apple, the iPhone is likely following a product development strategy and timeline similar to that of Pixar. At any one time, Apple has a number of iPhone features under development since it takes more than one year for many features to go from concept to finished product. Even though the iPhone 6s and 6s Plus were just announced, Apple has already been working on features for next year's iPhones and even the iPhones for the year after. The goal is to have a new iPhone with at least one major new feature at least every year. 

We got a closer look at this development schedule with 3D Touch. Phil Schiller commented to Bloomberg that 3D Touch was in development for years. "Engineering-wise, the hardware to build a display that does what [3D Touch] does is unbelievably hard...And we're going to waste a whole year of engineering - really, two- at a tremendous amount of cost and investment in manufacturing if it doesn't do something that [people] are going to use. If it's just a demo feature and a month later nobody is really using it, this is a huge waste of engineering talent." The same could be said of Apple Pay, the new cameras, iOS features, not to mention the different iPhone colors."

Expanding iPhone Development Capabilities

Similar to how Pixar has grown its development capabilities over the years from being able to do one film every few years to soon two films a year, I expect the iPhone development cycle to accelerate in the coming years. In some ways, Apple has already been showing this level of expansion. We went from one new iPhone model a year to now having two new models a year (iPhone 6s and 6s Plus). It is not unfathomable to see Apple expand this to three new models a year and embrace a product line with different screen sizes corresponding to different models (iPhone Plus, iPhone, iPhone mini).

The era of a tick-tock development cycle for iPhone is over. 

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iPhone Launch Weekends are Getting Silly - Above Avalon Premium Week in Review

Along with periodic Above Avalon posts available to everyone, I send out an exclusive daily email about Apple to members (10-12 stories per week). You can subscribe here. The following story was sent to members on September 15th. 

iPhone Launch Weekends are Getting Silly

On Monday morning, Twitter went a bit crazy right around 8:30 a.m. ET as some began wondering if Apple would issue a press release disclosing how many iPhone pre-orders it saw this past weekend. Apple had done exactly that last year, reporting four million iPhone 6 and 6 Plus pre-orders. 

We didn't get a press release this year, but instead an Apple statement disseminated through the press. It's rather short, so I've included the entire statement below:

"Customer response to iPhone 6s and iPhone 6s Plus has been extremely positive and pre-orders this weekend were very strong around the world. We are on pace to beat last year's 10 million unit first-weekend record when the new iPhones go on sale September 25. As many customers noticed, the online demand for iPhone 6s Plus has been exceptionally strong and exceeded our own forecasts for the pre-order period. We are working to catch up as quickly as we can, and we will have iPhone 6s Plus as well as iPhone 6s units available at Apple retail stores when they open next Friday."

There was a little bit for everyone in that statement, but the biggest takeaway I got from that is that this entire fascination with opening weekend sales feels old, a relic from a begone era. Essentially, its a leftover from the smartphone wars where opening weekend sales were a sign that your phones were popular.   

As expected, Wall Street analysts quickly began trying to read in between the lines, figuring out a way of using Apple's 103-word statement to judge their 2016 iPhone sales estimate. This represents the fundamental problem Wall Street has with Apple. The focus is on the wrong thing. I even saw some analysts comparing this year's Saturday morning iPhone pre-order release to last year's Friday morning release and then making some guesses as to what it all means about year-over-year growth. It's getting silly. 

This trend of Apple releasing iPhone opening weekend sales number goes back to the original iPhone and that is one reason why so many observers are so flummoxed with yesterday's statement from Apple. We were accustomed to very detailed iPhone and iPad opening weekend sales announcements and now we are getting less and less in the way of disclosure. In reality, the usefulness of these releases has steadily declined, but most people haven't noticed. 

When you consider that we are effectively using 4-5 million iPhone pre-orders to try to discern how Apple will do over the next 12 months selling up to 270 million iPhones, the silliness becomes apparent.

My philosophy on Apple announcing sales numbers has been very straight-forward. If Apple thought it had something to gain from releasing sales numbers, then they should release them.

• Early iPod sales numbers? Tell the world that Apple actually has a product people want.  
• Early iPhone sales numbers? Tell the world that people actually want a smartphone with no physical keyboard.
• Early iPad sales numbers? Tell the world that people really do want "just a big iPod touch."

By releasing sales numbers, Apple had something to prove to the world. That motivation is disappearing with iPhone. Opening weekend sales now represents just 4% of annual iPhone sales. Instead, analysts want Apple to release numbers in order to parse out if iPhone sales are growing or not. It's that simple. Of course, Apple ends up releasing iPhone sales numbers in financial filings anyways, but the short-term focus takes precedence.  

In reality, Apple's language around opening weekend sales has become more vague over the years, especially last year:  

• iPhone 1st gen (2007) = 1M in 74 days (U.S. only - AT&T)
• 3G (2008) = 1M in 3 days (21 countries)
• 3GS (2009) = Over 1M in 3 days (9 countries)
• 4 (2010) = 1.7M in 3 days (600,000 pre-orders on first day) (5 countries)
• 4s (2011) = Over 4M in 3 days (1 million pre-orders on first day) (7 countries)
• 5 (2012) = Over 5M in 3 days (2 million pre-orders on first day) (9 countries)
• 5c / 5s (2013) = 9M in 3 days (11 countries including China in launch window for the first time)
• 6/ 6 Plus (2014) = Over 10M in 3 days (4 million pre-orders on first day) (10 countries not including China)
• 6s / 6s Plus (2015) = Better sales than last year (12 countries including China)

The reason I say that the language is a bit unclear is that last year's "over 10M in 3 days" could very well have been closer to 11M iPhone units, but instead Apple felt "over 10M" would be good enough when compared to the 9M iPhones reported in 2013. Expectations weren't too high since China wasn't in the original launch country list last year. The market would understand if Apple didn't report too much of a sales increase from 2013. This point only goes to show how irrelevant iPhone opening weekend sales have become. 

Over the past few years, iPhone opening weekend sales have been more a sign of how Apple has been able to ramp iPhone supply instead of demand. Without going into too much accounting detail, the only iPhone sales Apple includes in opening weekend numbers are those units that have been shipped to an end user. If you pre-order an iPhone, but need to wait a few weeks to receive it, you are not included in opening weekend sales. The pre-order numbers were therefore a bit clearer picture of demand since a pre-order is not the same thing as a sale. Of course, Apple started releasing pre-order numbers once opening weekend sales numbers started to look less attractive on a year-over-year basis.  

I would not be surprised if Apple eventually moves away from announcing opening weekend product sales altogether. Apple has shown no interest in disclosing Apple Watch sales, and Apple stopped releasing opening weekend iPad sales right around when unit sales started to decline (another sign that disclosing opening weekend sales is one big game). Critics will say Apple stopped releasing sales because of weaker sales growth. While iPhone sales growth may very well slow, I rather look at it as Apple is now a much bigger company in a different landscape. The Android/iOS activation wars are over. There are other ways to convince the world that iPhones are popular and worth buying besides releasing opening weekend sales. In addition, opening weekend numbers aren't even a good measure of iPhone growth. If we compare the change in opening weekend sales to the corresponding iPhone growth over the following FY year: 

• 2010: 70% growth in iPhone opening weekend sales (81% iPhone unit growth in following year)
• 2011: 135% (73%)
• 2012: 25% (20%)
• 2013: 80% (13%)
• 2014: 11% (38%)

I look at that discrepancy as reason for why opening weekend sales is not the most useful parameter to judge iPhone sales. 

Over the years there have been ulterior motives to disclose opening weekend sales. Times change. It's making less sense these days to disclose arbitrary sales numbers spanning a few days. 

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

• Apple Watch Hermès Collection is Intriguing
• 3D Touch is a Game Changer
• Thinking About the Big Picture for Apple
• Thoughts on the iPhone Upgrade Program (seven sections: The Details, History, Dollars and Cents, Short-Term Impacts, Long-Term Impacts, Overall Observations, Is It a Good Deal?)
• Making Sense Out of Apple's Mapsense Acquisition
• Kardashian/Jenner Sisters Take on the App Store
• Thursday Q&A: Why Would the iPhone Upgrade Program Lead to a Larger Grey Market for iPhones?

Become a member today to receive these stories (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.

The New Apple Era

We love our smartphones. Not only have they become our most used computer, but more importantly, smartphones provide an unimaginable amount of power at our fingertips. However, the smartphone form factor leaves opportunities for other devices to provide this same kind of incredible power only in even more personal ways. Apple is laying the groundwork for new platforms based on wearables, the connected home, and eventually the car that will combine to form one large encompassing ecosystem that ushers in a new level of personal technology. We are entering a new Apple era. 

The Old Era

Apple's product line used to be thought of as a stool with each leg representing a different product. While a few legs were clearly more popular and financially lucrative than others, Apple was a technology company that sold a handful of hardware devices with iTunes (and increasingly iCloud) serving as the glue that held everything together.  

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Consensus was set on the iPhone, iPad, and Mac forming an ecosystem that will play a crucial role in our lives. In reality, these three product categories are much more similar than people have been thinking. New platforms are needed to help make technology more approachable and personal.

The New Era

The iPhone, iPad, and Mac are converging into one central "brain" while new platforms will be formed focused on key aspects of our lives including transportation, home, and body (wearables). In this new era, the iPhone is positioned as the center point of our digital lives with iCloud and Apple services representing the glue connecting everything together. 

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Earlier this year at WWDC, Apple unveiled watchOS, its first wearables platform. Last week, Apple added a new platform to the mix with tvOS. The two platforms serve as examples for how Apple will eventually embrace bigger themes like wearables and the connected home (and eventually the car). All the while, iOS is maturing and becoming a platform for a range of mobile devices with various screen sizes. 

The Opportunity

iPhone. The iPhone, iPad, and Mac product categories will continue to merge. In the future, the three product lines will run the same operating system with the degree of mobility, as measured by screen size, positioned as the primary differentiator. The iPhone will always have the most power due to its mobility, while the iPad brings multi-touch (and eventually 3D Touch) to a bigger screen. All the while, the Mac includes the best keyboards for those jobs that require a significant amount of typing. The differences between the three product categories will continue to shrink. 

Apple's new 3D Touch feature not only brings an additional user interface to iPhone, but should be thought of as the missing piece for allowing iPhone screens to become even larger without increasing the iPhone's form factor. 3D Touch begins to reduce the need for the home button, which has turned into a type of reset button used to switch between apps. By removing the iPhone home button and filling the additional space with screen real estate, the iPhone will only gain more power and capabilities when compared to devices like the iPad mini and Air. Less mobile devices, like the larger screen iPad Pro, will continue to become more like the Mac, with the primary difference between the two product categories continuing to be the keyboard. Bringing 3D Touch to the iPad Pro and supporting a tactile onscreen keyboard may be the next step to further blur the lines between iPad and Mac. At the same time, the Mac continues to move towards the iPad with a new revolutionary design that places mobility as a key value proposition. The end result is a world where iPhone can accomplish most basic computing tasks with iPad/Mac running the same operating system serving the high-end. 

Wearables. In just a little over two months, Apple went from selling its first genuine wearable device to unveiling an SDK for native Apple Watch apps. While many have tried to think of Apple Watch as a mini iPhone on the wrist, in reality, the Apple Watch represents a different type of power requiring a complete rethink of what kind of jobs can be done on the wrist. Last week, Apple rolled out a significant update to Apple Watch in the form of a new Hermès collection and new Apple Watch sport bands. This update exemplifies how success in wearables is determined by much more than just the idea of putting technology on a wrist. There are different types of emotions and guiding principles that enter the equation when thinking about devices that are meant to be worn on the body.

Apple's new Hermès partnership is a game changer in that Apple is not just embracing the concept of luxury, but is set on showing the world a completely new type of personal technology. The entire luxury industry needs to take note of what Apple is trying to accomplish as software continues to move quickly into other elements of the luxury wearable market. Apple isn't taking the same page from its iPhone playbook and applying it to wearables. Instead, the strategy is being adapted to fit the environment. It is incredibly intelligent and bodes well for new platforms such as TV (home) and eventually the car. As for wearables, the much bigger concept of body and mind are brought to the forefront as health tracking will likely be positioned as a key value proposition in the wearables category. In addition, identity and geolocation themes will likely become popular. Each case is made possible by the fact that a wearable device does a better job of being carried and representing the user than a smartphone does.   

Home. Apple TV is the start of a much broader move by Apple into the connected home category. The primary takeaway from the all-new Apple TV is that Apple is including a new user input in the form of voice. Siri not only took front and center stage when it came to Apple's September keynote invites, but the personal assistant is quickly being able to handle an increasing number of tasks beginning with content curation and discovery, and then eventually handling automation tasks. Apple TV may be focused today on delivering content to a big screen but will likely move to become a device able to turn spacial and facial recognition into a new realm of personal computing. Apple began controlling the living room years ago with the iPhone, but Apple TV will begin to better address the ideas of the connected room in a more direct way than the iPhone will ever be able to. Similar to wearables, Apple is relying on a new class of hardware (and user interfaces) to make technology approachable and personal. 

Car. Apple wants to design its own self-driving car. This is a company that has no interest in just creating a platform so that less capable car manufacturers can ruin the user experience. We are quickly moving to a world where technology will take over the transportation industry, and Apple has no choice but be part of the mix. The Apple Car's key value proposition won't revolve around performance, but rather good design and an intuitive user interface (not having to drive at all is an entirely new level of intuitiveness). A self-driving electric vehicle is nothing more than a mobile room on wheels, which only emphasizes the concept of personal technology as we all won't want to ride in the same kind of room. Accordingly, the themes of connected home and self-driving cars become intertwined.

Apps Provide a Personal Touch

Apple wants to position apps as the guiding principle of its strategy to move from a company that sells a collection of computing devices to delivering a complete user experience that spans most tasks that make up our daily lives. The app ecosystem transformed the iPhone into an all-powerful device by allowing each device to become something unique to its user. Apple is looking to do the same with Apple Watch (watchOS) and now Apple TV (tvOS). The hardware remains a critical requirement for ultimate success, but apps complete the picture. 

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Looking back at Apple's WWDC keynote, the significance of the "The App Effect" video that was shown takes on a whole new meaning after seeing Apple unveil watchOS and tvOS. While the video was focused on iPhone apps, it is reasonable to one day replace "iPhone" with "Apple Watch," "Home," and even "Car." Apple looks at apps as the path to accomplishing its long term goals. 

The App Store has grown from 500 apps to well over a million in just 7 years. The software world is now a level playing field for developers and the experiences they are creating have enriched, empowered and truly changed all of our lives.

Apple's new platforms will be embraced by app developers because the categories that Apple is playing in are simply too large and lucrative to ignore. App developer characteristics may change as larger developers begin to control more of the app environment, likely continuing to push down the price of paid downloads with business models based instead on subscriptions and services. At the same time, Apple is in a prime position to embrace and help push its own suite of apps. The IBM partnership may be positioned today for iPad in the workplace, but such a partnership could one day embrace a range of new apps across product categories. Along similar lines, the Cisco partnership is already expected to begin embracing new product categories other than iPhone, iPad, and Mac.

The Long-Term Plan

The iPhone was launched in 2007 and in just eight years has gone on to not just change the world, but provide a framework as to how apps and software can begin to take over other key aspects of our lives. As we look much further into the future, it is likely incorrect to assume that an iPhone will always be required in order to get the most out of the connected world. 

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In the future, the iPhone may melt away, and a range of devices will be able to provide an unimaginable level of personal technology. Apple Watch will likely be able to stand on its own in due time. As the definition of work changes, more and more will be designated for the wrist, further strengthening the appeal of wearables. Transportation and the connected home will be looked at as providing the same kind of personal experience. 

Targeting our Time

Apple's long-term goal is to bring personal technology into new parts of our lives. Looking ahead, the iPhone will not be able to bring this kind of technology to every part of our lives. Instead, Apple will rely on new platforms and devices suited to address our particular needs. The best way to predict where Apple is looking to expand is to look at the time. The aspects of our life that take up most of our time are the most likely opportunities as to where Apple will see if it has something to contribute. 

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Making technology personal entails moving beyond just simply combining hardware and software. Instead, the way the hardware (and software) looks, feels, and moves will become crucial factors, all of which are things Apple has been perfecting for years. The groundwork is being laid for an era in which the iPhone is just one piece of the personal technology puzzle.   

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Above Avalon members have access to my full notes and observations from Apple's September keynote.

Bill Graham Civic Auditorium Intrigue & Above Avalon Premium Weekly Recap

Along with periodic Above Avalon posts, I send out an exclusive daily email about Apple to members (10-12 stories per week). You can subscribe here. The following story was sent to members on August 31st. 

Bill Graham Civic Auditorium Intrigue

Apple keynotes are products in themselves. While it is easy to spot the immense level of training and practice that goes into delivering the keynote, the entire event plays a role in how Apple wants to explain itself to the world. 

In today's media landscape, an Apple keynote has taken on a different role, maturing from the single most important way to drum up interest in a product, to one step in a series of events, interviews, and presentations aimed to keep Apple at the top of the ever-changing news cycle. Along those lines, an Apple keynote, all the way down to the venue choice, can be an incredibly useful and valuable piece for figuring out Apple marketing and strategy. 

Over the past four years, Apple has relied on three primary locations for its keynotes: Town Hall at Apple HQ, Yerba Buena Center for the Arts in San Francisco, and of course Moscone West for WWDC. The one exception was last year's iPhone 6/6 Plus and Apple Watch event held at the Flint Center. That particular venue was noteworthy not just for its larger auditorium seating capacity, but also for the clear excitement and anticipation surrounding the event as Apple entered its first new product category since the iPad in 2010.

Past Apple keynotes: 

• 2012 - February 22 - Yerba Buena Center for the Arts
• 2012 - WWDC - Moscone West
• 2012- September 12 - Yerba Buena Center for the Arts
• 2013 - WWDC - Moscone West
• 2013 - September 10 - Town Hall at Apple HQ
• 2013 - October 22 - Yerba Buena Center for the Arts
• 2014 - WWDC - Moscone West
• 2014 - September 9 - Flint Center for the Performing Arts at De Anza College
• 2014 - October 16 - Town Hall at Apple HQ
• 2015 - March 9 - Yerba Buena Center for the Arts
• 2015 - WWDC - Moscone West

Seating capacities for these locations ranged from the smaller Town Hall (301) and Yerba Buena Center (757) to Flint Center (2,405). WWDC has 5,000 total attendees although not everyone is able to have a seat in the main Moscone West keynote room. 

Speculation over Apple's upcoming event started to take off last week when Hoodline, a San Francisco neighborhood news site, published a story about there being quite a bit of activity taking place at the Bill Graham Civic Auditorium despite nothing being publicly planned for the venue until mid-September.

Regulars began to notice security guards and police officers stationed around the building. In addition, there had been quite a bit of construction activity, including the installation of large power generators and AC units outside blocking a few lanes of traffic. One Hoodline reader commented that he saw forklifts bringing in what appeared to be temporary flooring. Apparently, whatever was being done inside had been going on for weeks.

Last Wednesday, Hoodline ran a story that said Apple was indeed the company up to something at the Bill Graham Civic Auditorium and that there were a number of street closures around the building planned for the week of September 8th to 10th. As a fun fact, the Apple II was introduced at the same location in 1977 at the West Coast Computer Faire. Back then it was called the San Francisco Civc Auditorium. My interest was piqued by the Bill Graham Civic Auditorium being the choice for Apple's next keynote. 

After Apple sent out event invites this past Thursday, I took a closer look at the venue choice since it still stood out to me. The first thing that caught my attention was that the building is quite large with a 7,000-person capacity, which is nearly 10x larger than the Yerba Buena Center. The other aspect of the location that seemed a bit strange is its layout and floor plan. It is actually an arena with a high ceiling. Along with music concerts, the venue is used for trade shows and sporting events. There is a large flat seating area (similar to Moscone) surrounded by a significant amount of balcony seating in a U-shape. It is quite different from prior Apple keynote venues. 

Using such a large venue for an Apple product unveiling obviously brings up the question if Apple is planning on having a large guest list including press and guests from a wide range of industries. Last year, Apple invited quite a few additional people to the Apple Watch unveiling at the Flint Center. Not only were there people from the fashion and fitness industries on hand, including more celebrities than normal, but there were also a significant number of Apple employees in attendance. Most of the Flint Center's 2,500 seats were filled. What could Apple possibly do with an area with nearly 4,500 additional seats?

After posting that question on Twitter, I didn't find much evidence to suggest that Apple had invited that many more people than was the case with previous events. However, I did start to get a few clues as to what Apple may have had in mind by choosing the Bill Graham Civic Auditorium. One Above Avalon member pointed me to a tweet musing that Apple may look to transform the inside of the building into a space that would be completely unrecognizable. Last year, Dot Party, an event series created by Markus Persson, creator of Minecraft, held a concert at the Bill Graham Civic Auditorium. After quite a bit of construction, the space was turned into a pretty interesting concert/music hall. 

A few people have speculated Apple may in fact be building an entire structure within the arena (which explains all of the extra air cooling machinery). Think of something like an enclosed stage/audience seating area positioned next to another completely enclosed room housing the demo area. One large open space would be turned into a series of still-large rooms. 

Putting all of the pieces together, it is likely that Apple chose the Bill Graham Civic Auditorium due to the ability to customize the space much more than what would be possible at locations like the Yerba Buena Center. In addition, the space is able to handle a more decent-sized crowd than Town Hall at Apple HQ. However, it does not seem likely that Apple is planning on having a record guest list numbering close to 7,000 people. 

Judging by the Apple event invitation byline of "Hey Siri, give us a hint." one can deduce that Siri will play a pivotal role in the event. In addition, with rumors that Apple will unveil a new Apple TV, the prospects of a Siri-controlled Apple TV may require unique stage and demo areas. Don't forget how Apple constructed an entire temporary structure next to the Flint Center last year just to house a special demo area. The same level of construction seems to be occurring at the Bill Graham Civic Auditorium, only inside. 

Eventually, Apple will host many of its product events at the 1000-seat underground auditorium being built at Apple Campus 2. However, I would not be shocked if Apple still goes elsewhere for a keynote from time to time (like WWDC and other locations). The ability to suit a particular site for a specific product can be incredibly rewarding.   

A few weeks worth of construction at a new venue means that the location for this upcoming Apple keynote will add to the mystery and intrigue leading up to September 9th. 

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

Apple Watch's Biggest Competitor

The Android Smartwatch Army

Apple's Original Programming Temptation

Apple Event "Leaks"

Global Smartphone Trends for July

The Apple/Cisco Partnership

Apple Takes Washington

Thursday Q&A: How is the premium email going? Spoiler: It's going great.

Become a member today to receive these stories (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.

Apple's Cheaper Stock Buyback

It is becoming cheaper for Apple to buy back its shares. Since Apple reported 3Q15 earnings, AAPL shares have been down by as much as 30%. Looking ahead, AAPL volatility will continue as the market continues to worry about slowing revenue growth in China. With $50 billion of share repurchase authorization remaining, Apple is in prime position to take advantage of stock market volatility and buy back its stock at a 15% discount to all-time highs resulting in up to $4 billion of "savings" over the next six months.

Apple Valuation

Stock valuation is a complicated subject. While finance textbooks explain how to take a series of numbers and assumptions and arrive at a stock's intrinsic value, the truth is market participants determine a stock's true worth. A stock price is merely the point at which a buyer and seller agree to exchange shares. Emotion and psychology play just as important of a role in determining a stock price as sales, earnings, and growth potential. 

Apple is currently trading at a 11x forward earnings multiple (20% EPS growth), a 40% discount to the overall market's 18x forward earnings multiple. If excluding $35 of cash per share, Apple is trading at a 7x forward earnings multiple, a 60% discount to the overall market. If Apple traded with a 18x forward earnings multiple ex-cash, shares would trade at $225, a 100% premium to the current market price. 

Growth Concerns

Many look at the valuation discrepancy as evidence that Apple is being penalized by Wall Street due to the lack of confidence in its ability to grow. However, nearly every sell-side Apple analyst is relying on higher earnings multiples, despite slowing operating income growth, to arrive at target prices that are well above the current market price. This doesn't strike me as overly pessimistic.

Instead, Apple continues to suffer from a lack of confidence and conviction on the part of current and prospective shareholders. Since growth concerns are a bit generic, more specific issues plaguing Apple continue to include doubt that strong Apple customer loyalty will continue and a business model that makes it difficult to forecast earnings. 

Apple Customer Loyalty Doubt. It is no secret that Apple is the iPhone company. With the product representing 60% of revenue and 80% of operating income, the iPhone deserves the attention it is receiving on Wall Street. However, there continues to be a general lack of understanding over the dynamics underlying iPhones sales, including the impact that Apple customer loyalty has on sales. 

Approximately 75%-80% of iPhones sold each year are to previous iPhone owners. Many on Wall Street look at the fact that Apple is relying on its existing user base to drive sales as a negative. Not only do repeat customers make up a significant amount of iPhone sales, but this actually describes Apple's business model. A company that sells not just products, but experiences, relies on repeat customers to offset any negative implications from the decision to not chase market share. This is one reason why Apple management has a tendency to focus on customer satisfaction rates whenever possible. High satisfaction is suspected to eventually turn into loyalty and repeat customers.  

When thinking about iPhone sales growth in 2016, having approximately 75-80% of unit sales come from the 525 million iPhone user base is an indication that the Apple machine is functioning properly. The iPhone upgrade cycle is dependent on evolutionary features that do not over serve the customer base but instead entice upgrades. A high percentage of repeat iPhone customers is actually a strength for Apple, not a weakness. Apple would then need to focus on bringing in approximately 40 million new users to the iOS ecosystem annually in order to report ongoing iPhone growth. When considering the large market opportunity in China and ongoing troubles with Samsung, this 40 million new user target is achievable.

One of the concerns Wall Street has with Apple's customer loyalty is questions about how long the trend can continue. The ongoing debate over smartphone "subsidies" going away (they aren't), not to mention cheaper smartphone alternatives from China, are continuously positioned as factors that may cause iPhone owners to look elsewhere for their next smartphone. 

A few Apple analysts have attempted to tackle this customer loyalty issue indirectly by coming at it from an ecosystem angle. By attaching a certain amount of revenue (and profit) to each iOS user over time, one can start to look at the iOS user base as a large annuity that will kick off profits each year. While the idea doesn't exactly rely on the most politically-correct analogy, the general idea is a fair one to make. The problem is that it does little to drive increased confidence that Apple's high customer loyalty will continue in the future. 

Difficult Business Model to Forecast Trends. Apple has a business model that makes it very difficult to forecast financial trends 3-5 years out. While some of this is born from the company's thoughts on secrecy and surprise, the reasoning actually goes much deeper. Apple's business model is built on the belief that things will not remain steady over the long-run. Management is constantly looking to break itself, only enjoying key sales milestones for a short while before looking to do something else. In recent years that may have meant cannibalizing existing products, while in the future, it may be moving from its comfort zone into new industries. Compare this to something like Google's search business which had never been thought of to be in trouble by many on Wall Street until only recently or Facebook's recent announcement that 1 billion people went to Facebook in a single day. These businesses, while inherently more complex and confusing than Apple, are thought of as more sustainable over the long-run, while Apple's business comes across as more susceptible to market forces. 

This lack of business model visibility boils all the way down to granular features found in Apple products. When Apple introduces a new user interface for iPhones next week, it will be difficult for many to envision such a feature becoming a crucial feature across the iPhone line one day, opening the door to significant design changes. Apple is well aware of the 3-5 year plan with features and products, often introducing certain features just to serve as a stepping stone to future revisions. Extend this exercise to nearly every Apple action, and the end result is Wall Street placing heavy reliance on short-term actions with little to no value attached to the long-term. It is tough to value something that will happen in the future when it is not obvious it will occur. 

Even though this model of constantly looking to change the equation plays a key role in Apple's goal of remaining relevant over the long-term (what if Apple never moved past the iPod?), from Wall Street's perspective, such never-ending change is difficult to measure and value. Moving from counting iPod profits to iPhone margins, and soon financials behind monthly automobile leases, is not easy and results in low conviction. The end result is lower valuation multiples to compensate for this unknown. I suspect this has been one of the primary reasons over the years for Apple's valuation discount to the market. 

Google and Amazon continue to stand out to investors as both companies share some similarities with Apple in terms of unknown futures. The difference is that while Apple is reporting strong profits on very disciplined expense management, Google and Amazon are considered founder-led companies that keep profits artificially low due to excess expenses and investment. As a result, Google and Amazon are rewarded with higher valuation multiples on what appear to be more mediocre profit and growth trends compared to Apple. Some may disagree with this treatment, but the thing to keep in mind is Wall Street will continue to think a certain way until it no longer wants to. It is impossible to predict when that moment will arrive.  

Apple's Share Buyback Program

I continue to view Apple buying back its shares as the most appropriate use of excess cash that is not needed for organic growth and M&A. 

As of June 27, 2015, Apple had $50 billion of share buyback authorization remaining out of a total of $140 billion of authorization. Theoretically, Apple could repurchase 8% of itself without any additional authorization from the board of directors.  However, when looking at cash available for buyback, it becomes clear that Apple is not in a position to buy back that many shares at this time.

Apple is only able to use U.S. cash on hand to repurchase shares and as of June 27, 2015, Apple had $22 billion of domestic cash ($181 billion is held offshore).  When forecasting earnings through the second half of CY2015 and taking into consideration debt issuance and U.S. free cash flow generation, Apple will have approximately $50 billion of domestic cash available by year-end. After adjusting for routine cash needs, including cash dividends, as well as the need for a cash buffer, Apple will likely be in a position to spend $20-$25 billion on buyback over the next six months (July to December 2015).

Apple management can make a dollar worth of share buyback go much further when Apple's stock price is depressed. With shares down 15% from all-time highs, Apple could theoretically buy back 15% additional Apple shares with the same amount of cash resulting in a "savings" of close to $4 billion over the next six months. 

There are three likely strategies Apple can take in regards to its buyback: 

1) Scheduled Share Repurchases. Apple could follow a very strict schedule as to when excess cash is spent on buyback. It would be equivalent to an investor buying an index fund the same day each month to gain market exposure, regardless of whether the market was up or down. As each quarter comes and goes, Apple will spend the same amount on buyback, resulting in additional shares being bought if the share price decreases. There is evidence of Apple following this type of repurchase schedule with $5 billion spend on share buyback in 4Q13, 1Q14, 3Q14, and 1Q15. 

2) Opportunistic Share Repurchases. Instead of simply following a schedule, Tim Cook and Luca Maestri could take stock valuation and timing into greater consideration, resulting in an ebb and flow to the pace of buyback. Apple has shown the tendency of being opportunistic, such as in February 2014, when Tim Cook announced Apple had repurchased close $14 billion of shares over the span of two weeks (shares were trading around $70 at the time). 

Beginning in 3Q15, Apple initiated a new accelerated share repurchase arrangement (ASR). The mechanics of such a program may at first seem a bit opaque, but they are actually relatively straightforward. The investment bank(s) handling the ASR borrow AAPL shares in order to deliver a large number of shares to Apple up-front. The banks then proceed to buy back shares over the span of weeks and months to cover their borrow. With AAPL shares having been weak since 3Q15 earnings, Apple will actually be able to take full advantage of its lower stock price by receiving cash back from the investment bank(s) in charge of the ASR. 

3) Hybrid Strategy. Apple can combine the two strategies, and have both a scheduled buyback plan in place in addition to buying more shares during times of market weakness. Judging from historical trends, Apple management is following this strategy, suggesting there may be increased motivation to increase the pace of buyback during times of market weakness. 

In reality, few companies take aggressive, bold moves with buyback programs during periods of market turmoil. Instead, capital management strategies tend to become more conservative as companies prepare for adverse capital market conditions. There had been a noticeable decline in the pace of Apple buyback recently, but it's difficult to know if it was due to a rising stock price, depleted U.S. cash reserves, or a combination of the two factors. Year-to-date, Apple spent $17 billion on buyback, 26% less than the $23 billion spent during the same time period in 2014. It will be important to see if this pace changes in the face of market volatility and lower share prices.  

Volatility Will Continue

There is no evidence to suggest that AAPL volatility will decline anytime soon. The market will focus on slowing EPS growth in 2016 while in reality, there will be much deeper issues at play. Customer loyalty and Apple's eventual embrace of new product categories will likely continue to be ignored by Wall Street. One of the primary ways for a $640 billion market cap company to grow in terms of valuation multiples is for current shareholders to become more comfortable owning a greater share of the company. As long as there are still basic misunderstandings about how Apple thinks about the future, valuation multiples will remain range bound, and management will rely on the share buyback program to take advantage of any perceived market dislocation. 

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Members have access to the Above Avalon stock buyback primer which can be used to become familiar with Apple's share buyback.

Apple's Plan to Destroy the Large Cable Bundle

The cable bundle is misunderstood. While analysts and pundits focus on when the cable bundle will finally succumb to Netflix, HBO, and Hulu, the reality is the future of television will be built on the video bundle's back. Due to attractive economics, video bundles are one of the best values in the media space and will remain the dominant way we receive premium video content. We are quickly approaching the point where Apple can capitalize on market dislocation to destroy the modern-day big cable bundle with a leaner bundle that is built to thrive in a mobile world. 

Video Bundle Economics

The cable bundle has been one of the best consumer deals in the modern era. By subsidizing content's true cost, the bundle makes it possible for consumers to receive a vast amount of video content for an artificially low monthly price. The bundle works marvelously well as long as everyone pays into the system, and this has been the case for the last 20 years. Nielsen estimated there were 116 million homes with televisions in the U.S., of which approximately 100 million had some form of pay TV for the 2014-2015 TV season. ESPN is one of the most widely distributed cable networks, reaching 95 million homes. ESPN has a farther reach than Facebook, a testament to how much power the cable bundle holds.  

While the video bundle will remain relevant for many years, the content associated with the bundle will change. New companies have relied on the old bundle parameter, namely, selling a wide range of content to as many people as possible to carve out a piece of the subscription video streaming market. Companies like Netflix, HBO, and Hulu sell video bundles. Instead of charging viewers by individual shows and series, these companies charge for access to a wide selection of content appealing to a range of consumers.

Most cable networks are in existence today because of the large cable bundle. Without the bundle, these networks would not be able to fund their current slate of programming. The mistake many people make when analyzing the bundle is to ignore the value of access. Having a window to nearly 100 million households is in many ways more lucrative than the pennies or nickels that the average channel receives from each household each month. This is a cable distributor's key selling point, and we often see fighting between content owners and distributors over access.

The Trickiness in Going Direct to Consumer

When contemplating the future of television, many have thought the strongest cable networks can one day bypass the large cable bundle and sell their programming direct to consumer. For simplicity's sake, I position ESPN and AMC as the poster children of this theory. In the current system, ESPN receives approximately $6 per month from every household subscribing to cable. AMC receives quite a bit less, approximately $0.50, although it is still well above the average $0.15 received. If ESPN and AMC were to leave the bundle and embrace the direct to consumer model, they would need not only to make up lost subscriber fee revenue, but also contemplate losing access to 100 million households. AMC relies on that access to sell new series, like "Fear the Walking Dead," to viewers. "Fear the Walking Dead" just became the highest-rated series premiere in cable TV history thanks to AMC's reach.  ESPN also benefits from grouping sports programming into one channel, appealing to a much wider fan base, including those who may only watch a game or two each month. 

There is no question that the best networks will have loyal fans ready to pay top dollar for a direct to consumer option. However, that won't be enough since these networks are simply not built to support such a model. It will be very difficult for ESPN and AMC to stop subscribers from signing up for their content only to watch their favorite series or sports season and then cancel their membership afterwards. With the cable bundle, such month-to-month volatility does not exist. 

I am very skeptical that a cable network will be able to go 100 percent direct to consumer. The economics are just not in their favor. Instead, a hybrid approach may work although in many instances, the best case scenario would be to just get to a point that matches the current large cable bundle. There is much incentive on the part of cable networks to make the bundle work. 

Time for Action

The mobile revolution has weakened the large cable bundle's fundamental underpinning. Mobile hasn't changed just the way we communicate, but also the way we create and consume content. Having new types of video content in our pocket has led us to no longer sit in a particular room at a particular time to watch a particular show. As smartphones continue to grow in screen size, all other pieces of smart glass in our lives, including our television sets, will lose value and importance.

The old definition of TV doesn't do justice to the much wider array of available content that we now have at our fingertips. As smartphone adoption grew, the idea that anyone could be a content creator became reality. While YouTube may still lead in terms of mindshare when thinking of user-generated content, we also have plenty of interesting content found on video-sharing networks like Vine, Snapchat, and Periscope, not to mention premium content from the likes of Netflix, HBO Now, Hulu, and Amazon.

One example of an entirely new form of content that people are increasingly turning to is vlogs, which is short for video blogs. The following Google Trends chart highlights vlogging's expanding popularity. The vlogging industry, notorious with young people chronicling their daily activities, is still in its infancy. Vlogging combines elements of reality TV with scripted television as many vloggers record real-life situations although the heavy use of editing and some pre-planning suggest there are also elements of a regular sitcom.

Exhibit 1: Google Trends for Vlogging

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All of this new and entertaining content made available due to mobile and new video bundles suggest that the large cable bundle is a house of cards held together by cable distributors. We have evidence that the large cable bundle is fraying a bit at the edges although collapse is not imminent. Disney CEO Bob Iger started a panic on Wall Street a few weeks ago when he disclosed on Disney's earnings conference call that ESPN had continued to see modest subscriber losses. Anyone following ESPN's recent cost cutting initiatives, including a move away from expensive on-air talent, would have seen this news coming. Assuming Iger's comments about ESPN subscriber loss trends remain unchanged for the rest of the year, ESPN will likely report a 2-3 million decline in subscribers in 2015, which may actually represent a slight improvement in the rate of decline compared to last year. 

Exhibit 2: Change in ESPN Subscribers

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Although ESPN is experiencing recent weakness, there is no evidence to suggest an exodus from the bundle is taking place.

I suspect cable subscriber trends are being impacted by cable distributors. As anyone trying to cancel his or her cable can attest to, it is not the easiest process, and very often consumers receive discounts or other promotions from their cable company to keep the bundle instead of completely canceling cable. The problem for many cable content owners is that if things remain status quo, we will enter a vicious cycle where weaker cable viewer ratings will result in less ad revenue, leading to inferior programming, which will only drive weaker ratings over time. Instead of there being a quick implosion, the cable bundle would deteriorate over time. The cable industry needs that one factor that will not only cause the house of cards to fall, but also address fundamental issues plaguing the large cable bundle.

Apple's Plan

The modern-day cable bundle is now vulnerable. Apple's strategy to destroy the large cable bundle would entail taking the best parts of the current bundle and creating an improved bundle. Essentially, Apple would be using a slimmer cable bundle to kill the large cable bundle. This may not seem too innovative. However, it is one way of addressing the biggest issue people have with their large cable bundle: finding and watching content at a time of their choosing. 

As has been previously reported by the WSJ and Re/code, Apple's slimmed down cable bundle would include 20-30 channels and be delivered over the internet to iOS devices. These channels could be considered as home to the best content found within the current large cable bundle. Similar to the modern cable paradigm, the combination of monthly subscriber fees and advertising revenue would represent the primary funding sources for networks included in the bundle. Add in live programming like sports, which come with a hefty price tag, and local news, which depend heavily on advertising revenue, and a new kind of bundle begins to take shape. 

Why would networks work with Apple? Having a customer base of nearly 90 million iPhone users and rising in the U.S. is very appealing to content owners. In an era where content bundles obtain their economics by having the widest access, 90 million users represent great opportunity. Similar to how Apple Music will be available on Android, it would be in Apple's best interest to make this new video streaming bundle available to Android as well. 

With a rethought cable bundle, Apple would be appealing to the 95 million households that still subscribe to cable, not those who stopped paying for cable. To destroy the large cable bundle, Apple will need to have current cable subscribers be willing to go through the hoops of canceling their current cable with their distributor. The house of cards would then collapse. 

Sling TV

On paper, Sling TV, an over-the-top video service owned by Dish Network, sounds similar to the bundle Apple would be looking to put together: a collection of 22 channels, including ESPN, for $20 per month. The problem is Sling TV is designed for those who aren't subscribed to cable, the exact opposite target market for an Apple streaming video service. Sling TV has limitations that cable payers would simply not be able to put up with such as only being accessible on a single device at a time and not including broadcast networks or stations. There are also valid questions over the quality of Sling TV's streaming with many reports of inferior viewing experience during popular shows. 

Video Bundles on a Smartphone are the New TV

Mobile will determine not just television's future, but also video's future. Any company or producer that thinks otherwise will likely be left behind to fight over legacy remnants of a bygone era. Instead of some truly revolutionary video streaming service that leaves all prior ideas about cable and TV in the dust, we are headed towards a future that has distinct similarities to the past, namely a handful of companies subsidizing a vast amount of content by offering video bundles to tens of millions of people. The large cable bundle's demise will occur when the 95 million U.S. households that still pay for cable each month are presented with an attractive alternative that takes the best parts of the bundle, adds better discovery and curation, and finally embraces mobile. 

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Apple Scouting a Self-Driving Car Testing Area - 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 August 17th. 

Apple Scouting a Self-Driving Car Testing Area

In an article with quite the intriguing title of "Documents confirm Apple is building self-driving car," the Guardian became the latest publication to add their take to the ever-growing Apple Car debate.  

Here's the Guardian:

"Apple is building a self-driving car in Silicon Valley, and is scouting for secure locations in the San Francisco Bay area to test it, the Guardian has learned. Documents show the oft-rumored Apple car project appears to be further along than many suspected.  

In May, engineers from Apple's secretive Special Project group met with officials from GoMentum Station, a 2,100-acre former naval base near San Francisco that is being turned into a high-security testing ground for autonomous vehicles."  

The Guardian published certain parts of correspondence between Apple and GoMentum Station, obtained under a public records act request. The language would seem to show that Apple was interested in doing something at the testing location.

Frank Fearon, an Apple engineer wrote: "We are hoping to see a presentation on the...testing grounds with a layout, photos, and description of how the various areas of the grounds could be used." Additional correspondence from Apple included: "We would...like to get an understanding of timing and availability for the space, and how we would need to coordinate around other parties who would be using [it]." Meanwhile, Jack Hall, a program manager at GoMentum Station responded saying a tour of the facility needed to be postponed along with saying: "We would still like to meet in order to keep everything moving and to meet your testing schedule." In reference to Apple showing interest in the site, Hall told the AP, "We don't know. [Apple hasn't] said what they want to test. It could be an iPhone." 

In a rather comical confirmation that Apple did in fact reach out to GoMentum, an executive director at the Contra Costa Transportation Authority, owner of GoMentum Station, told the Guardian: "we had to sign a non-disclosure agreement with Apple...We can't tell you anything other than they've come in and they're interested." So much for that non-disclosure agreement.

The first thing that stood out to me about this report is that it was indeed a great find by the Guardian. It would seem that the GoMentum Station project was thrown back in the public spotlight a few weeks ago when the town of Concord and the Contra Costa Transportation Authority reached an agreement for how the space will be governed. GoMentum Station won't just be a testing site for self-driving cars, but also vehicles with self-driving technology and "smart" traffic signals and other technologies. Up to five automakers and 15 other companies may use the base with Honda and Mercedes-Benz having already agreed to test autonomous vehicles there.

Before then, the only confirmation that this site was going to be used to test self-driving cars seemed to come from a press release from this past October saying Mercedes signed up as a test partner. Considering that Apple communicated with GoMentum Station officials from this location only a few months ago, it's likely that the Guardian may have been the first outlet to find this scoop, or certainly unveil the details of correspondence between Apple and GoMentum.

The other aspect of the article relates to the seemingly definite title and byline in which the Guardian said: "Correspondence obtained by the Guardian shows Project Titan is further along than many suspected and company is scouting for test locations." There was nothing found in the correspondence published in the article that showed Apple was looking to test an actual Apple-branded self-driving car. Instead, we have information indicating Apple showed interest in using the testing area.

Instead of Apple looking to test a complete self-driving car in the near-term, it is much more likely that Apple is interested in using GoMentum Station to further advance its self-driving technologies. Think more along the lines of the cameras, sensors, and software that would make up the navigational brain of the car rather than a full car with carbon fiber and battery. Being able to test a self-driving rig in a real-world scenario with weathered roads, railroad track crossings, and tunnels would be an essential stage for Apple to take before getting to the point of testing the "Apple Car." 

With nearly all evidence pointing to Apple giving the Apple Car project the green light approximately a year ago, I'm skeptical that Apple has a fully functional prototype ready to hit the road. The timing for something like that so soon after a team had been assembled (and is still being put together judging by recent hires) just doesn't sound right.

Apple is unable to test its self-driving technology on public roads in California without going through the permitting process which would serve as confirmation that Apple was indeed testing self-driving car technology. While Apple wouldn't need to disclose much information as part of the permitting process in California, aside from any information related to accidents, the mere confirmation that the company was looking to test self-driving car technology wouldn't exactly fit with Apple's model of placing an incredible amount of value in secrecy and surprise. If public roads are out of the question, that would mean that the only other option is GoMentum Station, another privately owned plot of land, or an Apple-owned location. There are plans to have other fake towns built around the U.S. to test self-driving cars, like Mcity, which is a 32-acre fake town in Michigan that opened last month. Ford, GM, Delphi and Toyota have all shown interest in using Mcity for testing. Considering GoMentum Station's proximity to Apple's resources and staff, this particular location in Concord would seem to be too good to be true.

Recall the WSJ article from this past February which explicitly made the claim that Apple's Titan project did not include a self-driving car. I think that was a head-fake, purposely passed down the grapevine to throw off competitors. There is increasing evidence that self-driving capabilities may in fact be positioned as an eventual selling point for an Apple-branded car. Self-driving technology, or even just the beginning stages of it, would go a long way in positioning such things as safety and convenience as attractive value propositions to consumers.

If you're Apple, a 2,100-acre former naval base lined with barbed wire would certainly seem to be a testing site worth checking out. 

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

• The iPhone's Future (six sections - Too Much Focus on the Near-Term, the iPhone's Changing Role in Our Lives, Form Factor Optimization, Addressing Price Layers, Changing Resource Allocation, About that Watch...)
• Samsung's Unpacked Event
• Comcast's Latest Investment in BuzzFeed and Vox is Significant
• Abysmal Cable Network Viewership Trends
• More Evidence Apple Music is Doing Just OK
• Sprint is Betting the Company on iPhone
• Free Cash Flow 101 (a key AAPL valuation metric)
• A Closer Look at iPad Financials
• A Closer Look at Mac Financials
• Thursday Q&A (Why U.S. mobile carriers seem to love the iPhone all of a sudden?)

Become a member to receive these stories (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.

U.S. Watch Sales Collapsed in June - 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 August 11th. 

This story flew under the radar late last week. Watch sales in the U.S. seem to be collapsing. Here's Bloomberg:

"U.S. watch sales fell the most in seven years in June, one of the first signs Apple Inc.'s watch is eroding demand for traditional timepieces. Retailers sold $375 million of watches during the month, 11 percent less than in June 2014, according to data from NPD Group. The 14 percent decline in unit sales was the largest since 2008, according to Fred Levin, head of the market researcher's luxury division."

A 14% year-over-year drop in unit sales is a pretty significant drop. According to NPD, timepieces priced from $50 to $999 saw declines in June, with the $100 to $149.99 range seeing the biggest drop, registering a 24% decline in unit sales. Just a few notes about NPD's data: they rely on consumer surveys along with point-of-sale data collected at individual retailers. NPD doesn't include sales from boutiques owned by watch brands, supermarket chains like Walmart, and online retailers. Think of it as if you are willing to share your sales data with NPD, you will then get much more comprehensive data from NPD in return.

Let's get the obvious out of the way first: we don't know if the Apple Watch is the reason for this watch implosion. Consider that Fitbit's earnings implied that the company sold at least 1 to 2 million devices in June, most of which were in the U.S. I think it is much safer to say that something is going on in the "wrist wearable" market because this watch sales decline is just too significant. 

Apple could very well have been the top watch manufacturer in the U.S. during the month of June when looking at revenue. While NPD pegged U.S. watch revenue in June at $375 million, it is likely Apple sold around 1.5M Apple Watches in the U.S. during the same period bringing in somewhere around $700 million of Watch revenue. This estimate comes from the fact that Apple sold between 2 and 3 million Watches last quarter at an average selling price (ASP) of around $475. My theory is that the U.S. represented an outsized portion of Watch sales because of the number of U.S. Apple retail stores, which were important locations for showcasing the Watch to consumers. In addition, Watch sales were backloaded in June due to supply/demand imbalance.

There is evidence to suggest that much of the collapse in U.S. Watch sales was segmented to the low-end of the market. Swiss watch export trends did not show a similar level of collapse in June with U.S watch revenue actually up 5% in June. 

When you add Apple Watch U.S. sales to those of other wearables like Fitbit, you likely had 2-3 million "smart wrist devices" being sold in June, which would come very close to outpacing the number of watches sold in the U.S. 

It is an understatement to say we are still the early days of wearables (I have only seen one Apple Watch in the wild, although I am seeing more Fitbits these days), but I would look at NPD's watch sales data as one of very first pieces of evidence that there could indeed be deterioration in the traditional watch market caused by smart devices in the form of watches and fitness trackers with Apple and Fitbit being the market leaders. 

Since owning Apple Watch, I'm more confident in saying the device may be a bit much to get used to at first if you are a luxury watch owner. It's not due to any particular inferior aspect of Apple Watch, but instead just the fundamental difference between wearing a computer on your wrist that tells time and so much more and a luxury watch that is worn for other reasons besides just giving you the time.

I do think it is more likely that Apple Watch will initially impact the low-end watch industry, which I will call "casual watch owners," those who may buy a $99-$299 watch just to have something on the wrist. This may explain why, according to NPD, the $100 to $150 space saw the biggest drop even though the Apple Watch retails for a good 3-4x the cost. In addition, watch loyalty at the low end is likely to be weak, and these consumers would be continuously on the lookout for new things to wear. Said another way, buyers in the $100 to $150 Watch range are more likely to experiment.

Given June's awful U.S. watch sales data, it is important to monitor if this is the start of a trend throughout the summer. If there are continued sales declines, then we are in a much stronger position to make more solid declarations about smart wrist wearables. 

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

• China's Yuan Devaluation and Apple (2,500-word story broken into various subtopics: What Happened?, Brief Background, Apple's China Growth Story is Cracking, Continued Yuan Devaluation Headwinds, Where Does This Leave Apple?, Final Takeaways)
• The Smartphone Subsidy Myth
• Thoughts on Alphabet
• Finding iPad's Future
• Apple Music Family Membership Strength
• Jimmy Iovine on Curation
• Cable's Problem
• Fossil is Seeing Issues in the Watch Market
• Thursday Q&A (AAPL valuation metrics)

Become a member to receive these stories (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.