There are signs that something interesting continues to unfold within Apple when it comes to wearables. While the tech industry's response to wearables remains lukewarm, with Facebook, Microsoft and Google showing greater interest elsewhere, Apple has been thinking very differently about where consumer trends are headed. With the Apple Watch launch in the rearview mirror, Apple's bet on wearables will grow, not shrink. Silicon Valley is underestimating wearables while Apple has spent the past four years planting the seeds for doing the seemingly impossible: moving beyond the iPhone and positioning itself as the driver of the next technological era.
The iPhone Company
Apple is currently the iPhone company. With the product representing 65% of Apple's annual revenue and an even larger share of its operating income, the iPhone is crucial to Apple's current financial success. Exhibit 1 highlights the iPhone's growing share of Apple's revenue and operating income since launch.
Exhibit 1: iPhone's Share of Apple Revenue and Operating Income
One consequence of Apple's growing dependency on the iPhone has been increased Wall Street jitteriness at any sign of slowing or softening iPhone demand. With Apple's near-term cash flows and earnings heavily impacted by iPhone sales, investors have turned decidedly more pessimistic about the the company's long-term prospects given slowing iPhone growth trends as shown in Exhibit 2.
Exhibit 2: iPhone Unit Sales Growth (Trailing Twelve Months)
While Wall Street may have turned negative on the iPhone business, when looking at the smartphone landscape, it is easy to see that the iPhone is actually continuing to gain power. China Mobile has proven to be a game changer for Apple, leading to a record number of new users entering the iPhone ecosystem. All the while, Apple continues to hold a monopoly-like grip on smartphone industry profits. Apple finds itself with an extremely lucrative business that has never been stronger, albeit with slowing growth prospects.
What's next for the iPhone company? If going by business textbooks, Apple should cut iPhone pricing in an effort to expand market share and chase growth, especially in emerging markets. However, there are clues that Apple not only has little interest in that strategy, but has already been thinking of new products in an effort to move beyond the iPhone. Management is aware that iPhone growth will not continue indefinitely and that at a certain point Apple's resources will be better spent coming up with new products that can do an even better job at making technology more personal.
Laying the Groundwork
Management has spent years planting the seeds for an era in which Apple will no longer be known as just the iPhone company. While that statement may seem comical today considering how dominant of a force the iPhone is in Apple's business, Apple is no stranger to the process of coming up with new products despite selling much more lucrative and popular devices. We got our first glimpse of those first small steps of moving beyond the iPhone back at the Flint Center in September 2014. The hype surrounding the event was quite high, primarily built-up by Apple, with the anticipation coming second only to the iPhone keynote seven years earlier.
When compared to the iPhone keynote, the Apple Watch unveiling seemed a bit lacking. This uneven comparsion between the iPhone and Apple Watch launches have come to symbolize the Apple Watch's first year on the market. When compared to the iPhone, the Apple Watch looks very inconsequential. The fact is that when comparing anything to the iPhone, it is nearly impossible to match the iPhone's popularity. This is not a sign that the iPhone will forever remain the most important device in our lives, but that a new device will appear lacking for many tasks, but attractive for a few dedicated uses.
Apple has been laying the groundwork for its vision of a world where our growing dependency on smartphones actually creates possibilities for new devices to enter the equation, similar to how smartphones didn't replace laptops and desktops but began to handle certain tasks once given to larger and more powerful PCs. The only way for Apple to plant the seeds for a post-iPhone era is to ship a product that seems woefully inadequate for replacing the iPhone today, but remarkably intriguing in how it can make technology more personal. The goal for this new product is not to "replace" the iPhone, but instead to be able to handle a growing number of tasks once given to the iPhone.
Apple's strategy to look beyond the iPhone depends on a few steps that may seem extremely counterintuitive but are essential for driving consumers to embrace new forms of personal technology.
1) Increase our dependency on iPhones. The best way to move beyond the iPhone is to give the iPhone an even greater role in our lives. This process has been occurring for years, but Apple needs to push even harder in positioning the iPhone as the most valuable computer in our lives.
2) Begin addressing friction points created by greater iPhone dependency. By giving the iPhone a larger role in our lives, there is a much greater likelihood that friction points will develop around small, seemingly inconsequential tasks like checking the time, reading messages, paying for items in a store, using maps to find a destination, and communicating with friends and families. It's not that iPhones can't do any of these tasks, but because the iPhone is positioned as our primary computer, there is room for a simpler device to handle these tasks in a much more efficient and easy way.
3) Embrace luxury and fashion themes. The iPhone is the most personal computing device for hundreds of millions of users. Therefore, one way of coming up with even more personal devices tasked with handling simpler tasks is to remove any remaining barriers between the user and technology. As soon as we talk about devices worn on the body, new themes around luxury and fashion have to be considered. This is where the technology industry is finding much difficulty as very often these themes are intangible and more of an art than a science.
4) Nurture new use cases. Despite the iPhone's growing popularity, there are certain things that the smartphone form factor will never be optimized to handle, including health monitoring and biometric identification.
5) Give software room to breathe. Apple needs to develop a platform for third party developers that embraces new ideas and methods. Much like how the app revolution changed the smartphone's trajectory, having developers embrace new types of devices will give the category that much more potential. It's still too early to say if wearables will have a similar "app" moment. A convincing argument can be made that the very fundamental nature of an app will change for wearables given a vastly different user input method (no software keyboard) and smaller form factor (much less screen real estate).
Apple has already spent a great deal of resources on the the first three steps on this list. Steps four and five are very much a work in progress.
Early Signs of Success
Judging by 2015 trends, Apple's strategy of looking beyond the iPhone is seeing some early success. Contrary to much of what has been reported in the tech press, consumers spent the year embracing wrist wearables. The two market leaders of the industry, Fitbit and Apple, likely sold approximately 35 million wearable devices for the wrist in 2015. On a revenue basis, the two companies brought in close to $7 billion for devices worn on the wrist. For Apple, we will get a better look at Apple Watch sales with earnings next week, but there is no question that Apple sold at least nine million Apple Watches in the first eight months on the market, with the possibility of up to 12 million.
While these numbers pale in comparsion to smartphone sales, that type of comparsion misses what is happening at a ground level. Tens of millions of consumers are finding a place in their lives for technology on the wrist, an area of the body that was once controlled by watchmakers and other fashion players. The fact that a growing number of consumers were choosing not to wear anything on their wrist likely told Apple there was potential for change. A more appropriate measure is to compare Apple Watch sales to early iPhone sales after launch. By that measure, the Apple Watch is the second best selling Apple product out of the gate.
Exhibit 3: Early Apple Product Sales
Some have looked at Apple Watch's widespread availability, especially when compared to the limited launches of iPad and iPhone, as evidence that Apple Watch adoption is not as strong as absolute sales may suggest. While that argument is valid, it fails to recognize the Watch's primary objective, which is to handle a few tasks currently given to the iPhone. Such a dynamic produces a situation in which Watch adoption may be artificially low in the beginning.
If additional evidence is needed to demonstrate early success with wrist wearables, the luxury watch industry, and in particular those companies with products in the same price range as Apple Watch, look to be in downright panic mode with nearly every data point coming from the industry since summer of 2015 showing deteriorating market conditions.
The buzz surrounding smartphones has declined. While there is still plenty of innovation left for the small computers in our pockets both in terms of hardware and software (the iPhone home button is turning into a limiting factor), evidence is growing that Apple has been thinking about "what comes next" for years. One would think that many of Apple's competitors are just as focused on embracing this next era and the idea of wearables beginning to handle a growing number of tasks given to our smartphones, but reality is very different.
While no one is outright ignoring or betting against wearables, very few are showing the focus or interest in wrist and other "non-eye" wearables like Apple. Google has Android Wear and is showing continued fascination with smart glasses, as demonstrated by Tony Fadell's increased involvement, but for a company that is all about conducting R&D in public view, the lack of progress is noteworthy. The same can be said for Facebook and Microsoft, companies that have shown much greater interest in augmented and virtual reality glasses. When considering how so few companies are even capable of doing much in the wearables space given either a shortcoming when looking at hardware, software, or both, not to mention luxury and fashion expertise, the lack of excitment surrounding wearables is understandable.
One of the most remarkable things about Apple looking beyond the iPhone is that on paper it makes little sense. The iPhone is the single most successful consumer tech product in history, bringing in more than $150 billion of revenue a year. Why should Apple come up with something that will eventually replace the iPhone? Exhibit 4 highlights how the iPhone went from being just a footnote next to iPod sales in 2007 (chart on the left) to making ten million Apple Watches look like a footnote just eight years later (chart on the right).
Exhibit 4: Apple Footnotes (iPhone in 2007 vs. Apple Watch in 2015)
However, Apple thinks differently. Apple knows that one day the world will move beyond the iPhone. That day won't be tomorrow, next month, or even next year. It may not even be for another five years. Apple could very well make another trillion dollars of revenue from the iPhone. But it is inevitable that the iPhone will eventually lose relevency. Apple knows the best way of navigating such a future is to be the one that makes the iPhone irrelevant.
Exhibit 5: Apple's Long-Term Game Plan
While the world is still preoccupied with wondering what comes after smartphones, notice how much progress Apple has made in moving beyond the iPhone (Exhibit 5). The Apple Watch is on the market, and signs point to Apple coming up with additional devices for different parts of the body. Meanwhile, Apple is busy building its largest startup ever. The iPhone company is planning for a day when it is no longer the iPhone company.
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