Above Avalon Podcast Episode 147: A Faster Bumper Car

In episode 147, we take a look at the changing competitive landscape facing the giants (Amazon, Apple, Facebook, Google, and Microsoft). Comparing the situation to bumper cars, we discuss why Google and Facebook have the slower cars that are no longer able to hide within the traffic. Additional topics include deep dives into three competitive battles in particular: Apple vs. Google, Apple vs. Facebook, and Amazon vs. Facebook vs. Google.

To listen to episode 147, go here

The complete Above Avalon podcast episode archive is available here

Tech's Tectonic Plates Are Starting to Shift

For the past decade, the giants (Amazon, Apple, Facebook, Google, and Microsoft) have been able to grow while staying out of each other’s lanes. This dynamic has been nothing short of remarkable. However, things are starting to change.

We are seeing the early signs of a new competitive landscape take hold in the tech space. Facebook and Google find themselves increasingly getting squeezed. Meanwhile, Amazon, Apple, and Microsoft are gaining competitive strength. Each is building stronger customer bonds while also expanding its respective ecosystem.

Bumper Cars

One of the best and easiest ways to visualize this changing competitive landscape is to think of the giants as bumper cars. In the beginning, the bumper cars were on a track with a guardrail in the middle preventing head-on collisions. All of the cars moved safely around the loop in the same direction. Despite a few bumps here and there, each company (car) was able to largely do what it wanted without running into too many competitive hiccups.

This dynamic has changed. The guardrail found in the middle of the track has been removed. Head-on collisions are becoming more common as there is no longer a right or wrong direction. Where did the guardrail go? Apple and Amazon tore it apart in their quests to strengthen their respective ecosystems. Apple now finds itself in a league of its own with wearables. In addition, Apple is reaching far beyond its core competency in terms of building out a content distribution arm based on curation. Similarly, Amazon’s Whole Foods, Ring, and Eero acquisitions are byproducts of a company following a singular goal of removing as many friction points as possible when it comes to online commerce. Amazon wants to know more about its customers in order to then be in a better position to sell products.

Sticking with the bumper car analogy, the companies with the slower cars fueled by ad revenue (Google and Facebook) are no longer able to hide within the traffic. Instead, they are increasingly vulnerable, getting hit from multiple directions by faster, more nimble cars fueled by non-ad revenue (Amazon, Apple, and Microsoft). In addition, those faster cars have become much more strategic in deciding when and how to go after the slower cars.

Competition

A number of interesting battles have been unfolding in the tech landscape:

  1. Google is being attacked by Amazon, Apple, and Facebook across a number of segments and industries ranging from AI and digital voice assistants to digital mapping and hardware.

  2. Facebook is being attacked by Apple in the areas of content delivery and private communication.

  3. Apple continues to face modest skirmishes with Amazon, Microsoft, Facebook, and Google when it comes to hardware.

  4. Amazon and Microsoft have their own unique battle forming when it comes to providing tools for businesses.

While these battles have been around for some time, Amazon and Apple are beginning to land some serious punches. For example, Apple shocked everyone when it came to finding success in the area of written content distribution with Apple News. At the same time, iMessage and FaceTime continue to gain momentum and now represent legitimate competition for traditional social networks. Amazon is increasingly becoming a thorn in Google’s side in terms of user data collection via subsidized services.

Three battles in particular stand out to me:

  • Apple vs. Google

  • Apple vs. Facebook

  • Amazon vs. Facebook vs. Google

Apple vs. Google

Google is a services company focused on offering free, data-capturing tools to as many people as possible. The necessity found with such a mission is having access to as many users as possible. This is where Google finds itself in growing trouble. Apple is gaining power as a gatekeeper between Google and the most valuable customers that Google needs for its services: Apple users.

Apple is a design company tasked with coming up with tools capable of changing people’s lives. These tools include a portfolio of hardware, software, and services. Apple is showing increased interest in stepping into Google’s turf and launching its own services where it feels it has something different to bring to the table. Such unique attributes can range from having a much-needed layer of design (i.e. a focus on the user experience) that Google struggles to add to its services, to data privacy and security.

Five years ago, the discussion was about Apple facing the risk of Google turning off its services to Apple users. Today, the reverse is true. Apple is now in the position of power. Google would find itself in deep trouble if its arrangement regarding default search on iPhones and iPads was put into jeopardy.

What changed?

Apple has been leveraging its hardware and software expertise to create a stronger ecosystem of products. This has given Apple the ability to strengthen its customer relationships while still attracting new customers. Said another way, the Apple ecosystem is gaining strength, and that strength is now beginning to extend to the adoption of Apple services.

Set within this changing dynamic, this year’s Google I/O keynote left me completely underwhelmed. Aside from a few flashy yet unmemorable demos, Google found itself relying on what it knows best: data collection and elevating technology over the user experience - neither of which is a winning strategy on its own.

The numbers speak for themselves. According to Apple, the iPhone installed base grew by almost 75M people in 2018. According to my estimates, approximately 40M of those users switched from Android. Google continues to lose its grip on the premium segment of the mobile market.

Apple vs. Facebook

The Apple versus Facebook battle has been the most surprising given how few people saw Apple having any overlap with Facebook. While some were busy suggesting that Apple needed to buy its way into social networking with a flashy acquisition, Apple was quietly putting together the foundation of a different kind of social network. iMessage and FaceTime comprise Apple’s identity network. As Facebook evolved to offer a curated version of the web via News Feed, Apple bet on the relationships that actually matter to people: family and close friends.

Given Facebook’s recently announced pivot to a privacy-focused social platform built around messaging, there is no question that Apple had the right strategy while Facebook went down the wrong path. Messenger and WhatsApp will now be increasingly positioned against iMessage and FaceTime.

With Apple News, Apple was able to crack content distribution in a way that Facebook failed at miserably. The secret ended up being human curation instead of machine learning. Apple continues to work on expanding Apple News to other countries with Canada being the most recent addition. Apple News may just be one of the best new services Apple launched from scratch in recent years.

Facebook vs. Google vs. Amazon

In the battle for commerce, Google, Facebook, and Amazon are increasingly becoming competitors and the battle for ad revenue is only the tip of the iceberg. At a fundamental level, Amazon is trying to systemically remove Google and Facebook from a customer’s memory when it comes to buying products online.

Given Facebook’s renewed push to position Instagram and Facebook as commerce platforms, it’s safe to say things are going to get dicey in the race for users’ attention. In fact, all three companies are targeting the home with hardware devices (speakers, screens, and other smart home devices) given how the home has become an e-commerce engine. In addition, our home is the delivery point for all of those goods. 

We are moving to the point where a consumer will have the opportunity to go all-in on an “Amazon home” in which Echo speakers, microphones, locks, a security system, a Wi-Fi router, and various third-party smart appliances with Alexa built in are all connected to Amazon.

What About Data?

One potential area of pushback to my comments would come from tech proponents who argue that Google is building an insurmountable advantage against peers given its data-capturing services. Such a view could best be described as the “data is everything” school of thought.

For example, voice first and autonomous driving advocates would likely take issue with the claim that Google is losing power in mobile. The fundamental issue that advocates of specialized tech verticals suffer from is not thinking enough about the user experience.

More people are switching from Android to iOS rather than the other way around. That sure doesn’t support the view that consumers are clamoring to use Google services given the company’s data superiority. Meanwhile, other clues such as Pixel smartphone sales being lackluster and smart speakers being used primarily for music consumption and not much more speak to the broader disconnect that has developed between “data is everything” proponents and how people actually use technology.

Changing Landscape

Up to now, many people would position Amazon, Apple, Facebook, Google, and Microsoft as equals when it comes to ecosystem strength and fundamentals. I don't think that is correct. Instead, two tiers have formed. Amazon, Apple, and Microsoft are in the top tier while Google and Facebook make up the bottom tier. Google is gradually losing its power in mobile as Apple and Amazon consolidate power within their own realms. Similarly, Facebook’s business model is coming under fire on all sides. Is it a coincidence that the two companies that originate the vast majority of their revenue from ads appear to be in the toughest positions going forward?

The much more interesting developments will be found not with the rivalry between Amazon, Apple, and Microsoft, but with the competition between the two tiers. As Amazon, Apple, and Microsoft continue to strengthen their ecosystems, a byproduct will be each company wanting to control more of the key attributes powering those ecosystems. This will leave Google and Facebook increasingly on the outside, looking in.

Apple’s licensing relationship with Google will likely be put in a brighter spotlight going forward. According to my estimate, Apple is receiving approximately $9B per year of licensing revenue from Google to be the default search provider on iPhones, iPads, and for Siri. This is a few billion dollars less than the amount of revenue Apple is taking in from the App Store each year.

Apple is increasingly being called a hypocrite in some circles for talking extensively about having a culture based on privacy while at the same time taking billions of dollars from Google to literally get in front of Apple users’ eyes. In my view, the issue isn’t so cut and dry. There is a critical angle to this topic that is often not discussed. Apple users do have the option to choose their own default for search. Apple’s licensing arrangement with Google is also likely tied to the number of users who actually use Google for search.

It’s fair to begin wondering about the long-term viability of Apple’s licensing relationship with Google. It is in Apple’s best interest to continue moving users off of Google services rather than to cancel or end the arrangement. The amount of money Google is paying Apple to be the default search provider will likely still increase. Google has little or no choice but to continue paying more to access what would be a declining portion of the Apple installed base.

Instead of looking for a company to implode as a result of tech’s competitive tectonic plates starting to shift, the equivalent of an earthquake or volcano are found with companies like Facebook and Google pivoting to privacy. While pivots, like earthquakes and volcanoes, are natural and essential, value is found in assessing how such pivots will change the overall landscape. We may never return to an environment in which the five giants were able to thrive next to each other peacefully.

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Apple 2Q19 Earnings Expectation Meters

Based on Apple’s revised financial disclosure, the Above Avalon expectation meters have received a makeover for 2Q19 earnings. Unit sales meters have been retired and replaced with revenue meters. In addition, an entirely new expectation meter is being included to reflect Apple’s changing business as non-iPhone revenue now plays a larger part in Apple’s growth story.

Estimates

The following table contains my Apple 2Q19 estimates.

The methodology and perspective behind the preceding estimates are found in my 3,400-word Apple 2Q19 earnings preview available here exclusively for Above Avalon members. (To become a member and access my full earnings preview, visit the membership page.)

I am publishing three expectation meters for Apple's 2Q19:

  1. iPhone revenue

  2. Non-iPhone revenue

  3. 3Q19 revenue guidance

iPhone Revenue

My expectation is for Apple to report continued weak iPhone revenue growth in 2Q19 as the company spent much of the quarter working through an iPhone channel inventory build that took place in 1Q19. This channel inventory headwind was partially offset by Apple’s move to cut iPhone pricing outside the U.S. and more attractive offers for iPhone upgrades in the U.S.

While Apple is no longer disclosing iPhone unit sales, the company will continue reporting iPhone revenue. Accordingly, in order to estimate revenue, one will have to derive estimates for iPhone unit sales and average selling price (ASP).

Apple provided some clues regarding iPhone sales mix in order to reach more reliable estimates for ASP. In addition, the company’s not-so-secret strategy of cutting iPhone pricing outside the U.S. will impact ASP. Refined modeling work when it comes to iPhone channel inventory changes will lead to more accurate estimates for iPhone unit sales. Given the moving parts, there will likely be a wider-than-usual discrepancy when it comes to iPhone revenue estimates as analysts with less robust Apple earnings models struggle to adapt to changes in disclosure.

iPhone revenue that exceeds $33B would be considered strong as it bodes well for Apple to report improved iPhone sell-through (i.e. customer) demand in the second half of 2019. However, iPhone revenue of less than $30B would point to continued problematic iPhone sell-through demand.

Non-iPhone Revenue

For the first time, non-iPhone revenue is receiving its own Above Avalon expectation meter. Apple’s non-iPhone revenue includes the following line items:

  • Services

  • Mac

  • Wearables / Home / Accessories

  • iPad

One of the major themes from Apple’s 1Q19 earnings is that despite weak iPhone sales, the company’s non-iPhone side of the business performed well with 19% revenue growth, driven by robust wearables and Services growth. In addition, the Mac and iPad product categories demonstrated stabilization. Much attention will be given to monitoring whether or not this trend continued in 2Q19.

My expectation is for Apple to report $27B of non-iPhone revenue. A revenue number north of $29B would be considered strong while a number less than $26B would be on the weak side.

Guidance

Consensus is calling for Apple to report $52B of revenue in 3Q19. My estimate is for Apple to announce 3Q19 revenue guidance in the range of $52B to $55B. There are two possible explanations for the difference: Wearables revenue expectations and different estimates for iPhone sell-through demand.

Additional information on my perspective and thoughts heading into Apple’s 2Q19 earnings are available in my full earnings preview, which contains three parts:

  1. Setting the Stage

  2. iPhone, Services, Mac, Wearables / Home / Accessories, and iPad Estimates

  3. 3Q19 Guidance, Updated Apple Earnings Model, Final Thoughts

To access my earnings preview and receive my Apple earnings review in your email inbox later this week, sign up at the membership page

Above Avalon Podcast Episode 146: Tackling Apple's Excess Cash

In what has become an annual trend, Apple uses FY2Q earnings to also update its share buyback authorization and quarterly cash dividend. In episode 146, we preview the changes Apple will likely announce to its capital return program. The discussion begins by going over how Apple has adjusted its buyback pace following U.S. tax reform and why the company will eventually have to cut back on buyback. We then go over my expectations for what Apple’s board will approve in terms of increases to the buyback authorization and quarterly cash dividend. Additional topics include the debate surrounding Apple capital return and why the company has so few viable options for spending excess cash.

To listen to episode 146, go here

The complete Above Avalon podcast episode archive is available here