It feels like cracks are forming at Apple's edges. The company is straining to push out hardware updates. Supply issues are getting worse. Apple is reportedly moving away from selling beloved products like stand-alone displays and wireless routers. Meanwhile, Microsoft, Amazon, and Snap are gaining buzz with new niche hardware while Apple appears to be hanging back and resting on its laurels.
Something feels off with Apple, and the blame is increasingly pointed at Tim Cook. I suspect these feelings are a result of Cook betting now is the time to milk the iPhone. Apple is doubling down on the iPhone to build one of the world's most formidable tech ecosystems, and few are taking notice.
One key mistake Apple made with the Mac during the early 1990s was to focus too much on profits and not market share. This led Apple to lose its connection with the consumer. Declining sales ensued, leading Apple to make a series of questionable decisions. Apple found itself with a complicated web of Mac models, each with different feature sets meant to chase a particular market niche.
Apple has been following a very different strategy with iPhone. The best way to see this strategy is to look at the changing iPhone line. In 2011, Apple was selling two premium-priced iPhone models, one of which was the previous year's flagship phone. Sales were approximately 70M units per year. Five years later, Apple has expanded the iPhone line to include five models, two of which are last year's flagship versions. Despite still having a very focused product line, iPhone sales have tripled to more than 210M units per year.
Apple has been following a multi-year strategy of gradually lowering iPhone pricing in order to reach larger swaths of the smartphone user base. While such a strategy seems born out of a desire to boost sales and profits, management is motivated by something else. Apple has been working to make the iPhone accessible to more people. This is the exact opposite strategy that Apple used with the Mac in the early 1990s. New iPhone models, such as the iPhone SE, are not targeting market niches, but instead are meant to expand the iPhone's addressable market by hundreds of millions of users.
One benefit of keeping the iPhone line lean has been consistently strong profit margins. While the $399 iPhone SE has a lower selling price than its larger siblings, the device's profit margin is similar to that of other iPhone models. By remaining focused on the product, as seen by the limited number of iPhone models, management has been able to maintain industry-leading profit margins. This has played a big part in allowing Apple to continue lowering prices to reach new customers. We are moving to the point when Apple will be able to sell a $299 iPhone, appeal to an entirely new part of the smartphone market, and still be able to maintain profit margins.
Going After Users
As shown in Exhibit 2, Apple's strategy of focusing on the product has resulted in the iPhone installed base approaching 600M users at the end of September. This is a very different world than that of the Mac days of the early 1990s. When adding second-hand and used iPhones into the mix, there are more than 700M iPhones out in the wild. Much of this underlying iPhone strength has been masked by the preoccupation with slowing iPhone unit sales growth. The iPhone upgrade cycle has slowed, which is impacting the number of iPhones sold to existing iPhone users. However, sales to new users remain robust.
Exhibit 2: iPhone Installed Base
In FY2015, more than 100M new customers entered the iPhone installed base. In FY2016, the number was even higher, marking a new record. There have been a few drivers for the steady rate of new users buying an iPhone in recent years. The gradual expansion of carrier agreements around the world has helped. In addition, lower-priced iPhones such as the $399 iPhone SE have made the iPhone more accessible.
Building a Sandcastle
Milking the iPhone in order to build a formidable ecosystem has been one of Cook's defining moments as CEO. Unfortunately, consensus has not been grading Cook's performance as CEO along these terms.
Instead, many have graded Cook as a product visionary. The problem with that is Cook is not Apple's product visionary. (That title unofficially belongs to Jony Ive). Cook's appointment as CEO was not predicated on his ability to one day become a product visionary. Accordingly, Cook should not be judged as such. In addition, some have compared Cook to former Microsoft CEO Steve Ballmer. This is incorrect. Cook is not Apple's top salesperson. He does not possess Ballmer's keen sense of how to push product into every enterprise crevice. Instead, Cook has delegated that task to others, primarily through partnerships. Accordingly, Cook should not be judged as a salesperson.
Instead, Cook should be judged on his success in building out the Apple ecosystem. One way of visualizing this Apple ecosystem is to think of a sandcastle. The iPhone represents the highest tower in the castle while the iPad and Mac represent the much smaller outposts. Accessories like Apple Watch and Apple TV as well as services like iMessage and Apple Pay represent the high walls and moat meant to protect the castle against intruders.
Accordingly, Cook should be judged on his ability to build the sandcastle over the years. Since he became CEO in 2011:
- The iPhone installed base has grown by 500M users.
- The iPad installed base has grown by 175M users.
- The Mac installed base has grown by 50M users.
- Apple introduced Apple Watch, the company's first wearable product. Approximately 18M Apple Watches, a device positioned as an iPhone accessory, have been sold to date.
- Apple is earning more than $6B per year of revenue through app sales via the App Store.
- Apple successfully made the difficult jump from a paid music download model to streaming and is approaching 20M paying Apple Music subscribers.
- Apple continues to push forward with Apple TV. The company is approaching 10M units sold since the device was updated in 2015.
- Apple continues to develop key services including Apple Pay, Messages, and Maps.
(The math behind these figures and estimates are available for Above Avalon members. You can become a member here.)
It quickly becomes clear that Cook has built a spectacular sandcastle. Apple has never had a stronger ecosystem. There are now more than one billion Apple devices in use and 800 million people own at least one Apple product. More remarkably, the average Apple user owns more than one Apple product. This is even more astounding when considering the competitive landscape.
Apple is making a very bold statement that it is still time to double down on the iPhone. It would be an understatement to say that Apple stands out from its largest peers with that thinking. Look at some of the leading tech companies' primary advertising campaigns:
- Apple: a smartphone (iPhone).
- Amazon: a voice assistant (Echo).
- Google: a voice assistant (Google Home).
- Microsoft: a touch-based laptop/tablet (Surface).
The companies lacking a smartphone offering are increasingly trying to get consumers to move on to the "next big thing." Amazon is pushing the idea of using a voice assistant and series of speakers to replace your smartphone. Google is doing the same with Google Home. (Pixel is actually a Google services play.) Microsoft is focused on trying to carve some kind of niche for itself by focusing on touch-based PCs. We can even add Snap to the mix and position Spectacles as early motivation for wanting to impact smartphone usage.
Meanwhile, Apple is placing a big bet that we are still firmly in the smartphone era. In Apple's view, many of these competing products are distractions trying to get us to move prematurely beyond the smartphone. This stance has contributed to the view that Apple is missing a step and resting on its laurels. While Microsoft pushes Surface Book and Surface Studio and Snap unveils sunglasses with a camera, Apple is still betting on a smartphone, a product unveiled in 2007.
Cracks at the Edges
This pursuit of milking the iPhone has contributed to cracks forming at Apple's edges. The friction is found when looking at Apple's efforts to build a wider ecosystem that extends beyond the iPhone. There is evidence that Apple management wants to follow a product strategy described in my "Apple Experience Era" article. Consumers can pick and choose a range of Apple products that best fit their lifestyles. This is why Apple is very vocal about continuing to invest in the Mac. In addition, Cook has reiterated his view that the iPad is the clearest expression of Apple's vision of the future of personal computing.
However, Apple's handling of the Mac line has been increasingly questionable. The same can be said of the iPad line. It will have taken Apple at least two years to unveil a line of "Pro" iPad models spanning from 7.9-inch screens to the 12.9-inch model.
While some have been quick to throw Apple's functional organizational structure under the bus for causing these cracks, the organizational structure is not to blame. The issue doesn't relate to a lack of focus either. Apple still isn't selling that many products. Instead, these cracks are a result of today's changing tech environment.
When looking at some of the key accomplishments during the Tim Cook era, the installed base growth figures for Apple's top products stand out. For every 100 users by which the iPhone installed base increases, the iPad installed base will grow by 35 users, and the Mac will increase by 10 users.
A vast majority of these new iPhone users will never own a Mac. As iPhones have become larger, odds have increased that these iPhone users may never own an iPad either. The iPhone has gained so much power in recent years that the iPad and Mac's long-term sales trajectory have faded. I suspect this reality explains why iPad updates are less frequent these days. The same can be said of the Mac. More frequent updates for iPad or Mac likely wouldn't increase sales.
Many have been quick to label the new MacBook Pro as flawed and not truly a "Pro" computer. In reality, Apple is focused more on redefining Pro's definition in addition to expanding the MacBook Pro's mass market appeal. This is why Apple is focused on bringing aspects of the iPhone to the Mac (multi-touch screen positioned above the keyboard, Touch ID).
Apple faces a major risk in relying so much on the iPhone to build its ecosystem. While this may be heresy in Silicon Valley, ecosystems are not everything. There has never been an ecosystem strong enough to stand the test of time. The App Store is not invincible. At a certain point, Apple will need to be willing to put its iPhone ecosystem at risk.
There are many signs that Apple management is keenly aware of this since Apple has had to risk its ecosystem multiple times over the past two decades. During the late 1990s and early 2000s, Apple spent years rebuilding the Mac ecosystem. Recall Apple's "Mac as the hub of your digital life" product strategy. The iPod was merely a Mac accessory at launch. However, Apple's decision to eventually bring iTunes to Windows changed the game. The move threatened the very same Mac ecosystem Apple had spent years building. Users would no longer need a Mac to use an iPod. Apple was willing to risk its current ecosystem in order to catch the next technology wave.
However, instead of doom, the iPod became a household name and played a role in helping the iPhone get off the ground. Meanwhile, the Mac was no longer going to be the center of Apple, and more importantly, our lives.
This raises an interesting question. Is it possible that Apple management is okay with the cracks that are forming at the edges? While the new MacBook Pro may infuriate loyal Mac users, a strong case can be made that management truly thinks such a product is the right one to ship in today's environment. To see why, notice how Apple is milking the iPhone: having the product appeal to a wider user base. Instead of chasing profits, Apple is following the same strategy with the new MacBook Pro. Apple has no interest in repeating mistakes from the early 1990s and selling product to the smallest of niches.
Apple is confident we are still in the era where it makes sense to milk the iPhone. Consumers are giving even more tasks to their smartphones. This may continue for another two years, or maybe even five years. While Apple may be building a sandcastle around the iPhone today, the company will need to find the next big wave that may topple that very same sandcastle. The company is looking at two industries to pivot into:
- Wearables. We are talking devices for the wrist (Apple Watch), ear (AirPods), body (clothing), and possibly even eyes. Apple's growing investment in health is a big clue as to Apple's intentions in this area.
- Transportation. Apple would develop an array of personal transportation options in various geographies. With ridesharing and autonomous driving, someone will be in a position to rethink the car within the next 10 years. Apple has many of the ingredients in place to be that company.
Neither industry is niche. Health is something that will appeal to pretty much every human. Wearables have the potential to have adoption curves similar to smartphones. Similarly, nearly every human has some need for moving form Point A to Point B. More importantly, transportation is the gateway to the grand prize: housing. When contemplating a smart home, there is nowhere better to start than developing smart rooms on wheels.
In both cases, the ecosystem that Apple has spent the past nine years building with the iPhone will provide the company a head start. It is much easier selling Apple Watches into an ecosystem of 800 million users familiar with Apple products. However, Apple will need to eventually take a leap without knowing exactly where it will land.
One question facing Apple today is whether opportunities are being passed over because of its iPhone dependency. A convincing argument can be made that Apple's early missteps with Apple Watch were due to the company looking at the device too much through an iPhone lens. What if Apple approached the Apple Watch as something other than an iPhone accessory?
A Fundamental Theory
This brings us to one of my fundamental theories regarding Apple. For Apple to remain relevant in the future, the company will need to attack itself. Management will need to risk its own ecosystem.
When it comes to catching the next big wave, an Apple Watch with cellular connectivity may end up representing the single biggest game-changing device Apple has shipped since the original iPhone. It would be that big of a deal. The reason such a product contains so much risk for Apple is that it threatens the iPhone. Why buy a brand new iPhone every year when your Apple Watch (with AirPods) are handling tasks that you used to give your iPhone? In addition, a cellular Apple Watch will more than double the device's addressable market to include all Android users.
There is a possibility that Android users may embrace Apple Watch without buying an iPhone, iPad, or other Apple product. Apple would seemingly be giving away the keys to its iPhone sandcastle. However, instead of causing panic within Apple HQ, this would be done by design. Apple would be willing to risk its ecosystem in order to build a new ecosystem around wearables.
Apple shouldn't get rid of its functional organizational structure. In addition, there is no evidence of Apple needing a management reshuffle. While there is clearly room for improvement in many parts of Apple's business, management's actions are very rational. Apple is taking lessons learned from the 1990s and using them to not repeat the same mistakes with the iPhone. Milk the iPhone today, and then figure out what comes next.
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