In addition to publishing periodic essays and podcast episodes, which are accessible to everyone, I publish exclusive daily updates all about Apple. These emails contain my perspective and analysis on Apple business, product, and financial strategy, in addition to industry developments. The updates have become widely read and influential in the world of Apple.

During the second quarter of 2021 (April to June), 47 Above Avalon daily updates were published, chronicling the major industry and Apple-specific news stories. Major themes included Apple hosting a virtual WWDC, major developments in the paid video streaming space, bluetooth trackers being put front and center as Apple unveiled AirTags at a spring product event, and tech antitrust legislation / regulation developments.

The Above Avalon 2Q21 Recap begins by going over these major themes and the corresponding daily updates that went over the themes. The focus then shifts to the Above Avalon daily update of the quarter - a daily update that stood out for its Apple analysis.

Major Themes

WWDC 2021

Last month, Apple held its largest event of the year - WWDC. Similar to last year, WWDC 2021 was an impressive one. When considering the breadth of new features announced, no company is in a position to match Apple. By leveraging its ecosystem of products and services to sell premium experiences to a billion people, Apple continues to pull away from the competition.

Video Streaming Industry News

Last year was a big year for paid video streaming as Netflix began to face genuine competition with other paid video bundles. Based on the busy news flow so far in 2021, there continues to be much interest and intrigue found with paid video streaming. The two big industry events that occurred in 2Q21 were AT&T announcing its intention to spin off WarnerMedia with Discovery and Amazon offering $8.5B for MGM. The former is all about AT&T trying to get back to the basics while the latter is about Amazon reducing churn and keeping Prime users as video viewers.

AirTag / Find My Network / Location Layers

After more than a year of rumor head fakes, Apple finally unveiled its answer for bluetooth trackers at a virtual product event in April. AirTag and the broader idea of finding / locating devices in the physical world is a precursor to Apple building location layers, which will be crucial for the company’s move into AR.

Antitrust Legislation / Regulation

Last month, focus was placed on Washington as six anti-tech bills moved from the antitrust subcommittee to the broader judiciary committee. Apple not only held behind closed door discussions with some lawmakers, but also unveiled its public response to the bills by publishing a white paper on iOS side loading and funding more analysis into the App Store ecosystem. As the bills progressed, it became easier to see where opposition to the bills will materialize.

There were 30 additional updates which covered various Apple topics, tech industry developments, and ideas that were of interest to me. The following updates in particular stood out:

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Daily Update of the Quarter

In June, Apple unveiled Beats Studio Buds for $150. The move led me to investigate Apple’s broader headphones strategy. For non-members, the following update provides a great feel for the length, detail, and analysis that is found in every daily update.

The following was sent out to members on June 17th.

June 17th, 2021: Dissecting Apple’s Headphones Line, Apple’s Headphones Strategy, Sizing Up Apple’s Headphones Business

Hello everyone. Given how Beats Studio Buds continue to be on my mind, today’s update is going to be a bit different as we take a deeper dive into Apple’s headphones strategy. We will examine Apple's headphones line, discuss the strategy found with both AirPods and Beats headphones, and conclude with a look at Apple headphones financials.

Dissecting Apple’s Headphones Line

Apple sells three AirPods-branded products:

AirPods (includes H1 chip) for $159. Notes: The model with wireless charging case is $199.
AirPods Pro (H1 chip) for $249. Notes: Has a shorter stem than AirPods and includes active noise cancellation, transparency mode, spatial audio (with head tracking), and multiple size tips.
AirPods Max (includes two H1 chips) for $549. Notes: Comes in five colors and includes active noise cancellation, transparency mode, and spatial audio (with head tracking)

Looking at just those three headphones, AirPods Pro is likely the most popular and best-selling. Apple is now able to use AirPods Max as a price anchor, which makes the $249 for AirPods Pro look even more reasonable than before. The jump from AirPods to AirPods Pro is substantial not only because there is a visible difference between the two, which should not be underestimated as driving purchasing behavior, but also due to a notable expansion in features.

In addition to AirPods, Apple sells a number of Beats-branded headphones (all of which are available in multiple colors).

Beats Flex (includes W1 chip) for $50
Beats EP for $130. Notes: A wired pair of headphones.
Beats Studio Buds for $150. Notes: Truly wireless headphones that include active noise cancellation, transparency mode, spatial audio.
Powerbeats (H1 chip) for $150
Powerbeats Pro (H1 chip) for $170 promotional rate / $250 regular . Notes: Truly wireless headphones.
Beats Solo3 Wireless (W1 chip) for $200
Solo Pro (H1 chip)for $300. Notes: Includes active noise cancellation, transparency mode.
Beats Studio3 Wireless (W1 chip) for $350. Notes: Includes active noise cancellation.

Apple’s H1 chip is the successor to the W1 chip offering better power management, more talk time, faster connection times when switching between Apple devices, and Hey Siri integration.

The first thing that jumps out to me when comparing AirPods to Beats is how much broader the Beats portfolio is compared to the AirPods line (eight Beats models versus just three AirPods models). The other item that is noteworthy is the degree to which Beats headphones include either a W1 or H1 chip. After years of updates, just two Beats headphones, one of which was just announced, lack Apple silicon. This explains why pretty much all of Apple’s Beats revenue has been included within my “Apple wearables” unit sales and revenue estimates.

The fact that pretty much every Beats headphones model contains Apple silicon also shows why Beats Studio Buds present a challenge for me in terms of whether or not to change my “must include Apple silicon” requirement for a product to be included next to AirPods and Apple Watch as an Apple wearable.

One thing that is worth clarifying from yesterday’s update: Despite not including the H1 chip, Beats Studio Buds include Hey Siri integration. This is one of the main reasons for referring to Beats Studio Buds, along with every W1/H1 pair of Beats headphones, as an Apple wearable.

Apple’s Headphones Strategy

Controlling sound is one way of delivering impactful and memorable user experiences. This is a strategy that Apple has been developing for decades .The iPod changed the way we consumed music on the go, offering a much better experience than existing mobile listening options at the time. Then, the iPhone redefined what it meant to bring sound on the go to the mass market. Now, AirPods have been born out of the belief that there isn't a place for wires in a wearables world.

With each product category, the guiding principles are to deliver superior experiences. Along those lines, consider the following features that Apple has rolled out for AirPods over the past four years since launch:

Active noise cancellation
Transparency mode
Spatial audio (with head tracking)
Conversation boost (announced at WWDC 2021)

These features, some may also call them technologies, end up being experiences for sound on the go. This is a key reason why all Apple headphones with either a W1 or H1chip can be thought of as a platform. We are seeing Apple continue to announce new features for its audio platform.

Going forward, health tracking and monitoring capabilities are certainly worth investigating with wireless headphones in mind. In addition, third-party developer support for AirPods seems inevitable as we move into the AR and mixed reality era.

Beats headphones are also part of Apple’s sound-on-the-go strategy. However, Beats serves a different target market than AirPods, which ends up positioning Beats as a compliment to AirPods.

While there is likely some overlap between Beats and AirPods addressable markets, Apple is using the Beats brand to tap into markets that may want a bit more customization than what is found with AirPods. Even if Beats eats into AirPods sales, Apple is not going to be worried or upset as they would much rather be the one eating into AirPods sales than having competitors grab traction.

Turning to Apple’s headphones pricing strategy, if we take the granular information about Apple’s different headphone models from above and look at the line just in terms of prices, we arrive at the following:

$50
$150
$150
$159
$170
$200
$249
$300
$350
$549

The following graph makes it easier to analyze Apple’s headphone pricing spectrum:

Note: The $159 AirPods is included under $150 while the $170 Powerbeats Pro is marked under $175.

Two big observations from the preceding exhibit:

The sweet spot for Apple wireless headphones is in the $150 to $200 range. If you are competing against Apple (AirPods or Beats), it will be tough to price your product above this range. As for AirPods and Beats forming some kind of price umbrella for competitors to undercut Apple, AirPods are routinely available for less than $150 at third-party retailers. Best Buy currently has AirPods at $130 and AirPods Pro for $200. Weaker headphone brands have offerings in the $25 to $50 range but these products are not serious contenders to AirPods. One reason many people buy AirPods is to be seen wearing AirPods. It’s also not easy for companies selling $25 to $50 pairs of wireless headphones to make much money while also trying to match the overall user experience found with $130 to $160 AirPods.
The $549 AirPods Max sure do seem like an outlier going by price. Much of that dynamic likely reflects Apple running with unit sales assumptions for the number of people interested in over-ear headphones and pricing AirPods Max accordingly with the goal of maximizing overall gross margin dollars.

Sizing Up Apple’s Headphones Business

Here are my estimates for Apple headphones revenue (includes both AirPods and Beats headphones)

2017: $2.1B
2018: $3.8B
2019: $7.3B
2020: $12.0B
2021E: $14.5B

Note: The FY2021 total does not include Beats Studio Buds.

On a year-over-year basis, Apple headphones revenue is growing by 15% to 20%. This growth rate is lower than the ~30% seen last year. AirPods sales have slowed a bit due to a combination of factors including the pandemic impacting commuting and replacement sales, lack of updates, and a slowdown in upgrading.

In order to put the $14.5B of revenue in context, the total represents just 4% of Apple’s overall revenue in FY2021E. Compared to iPad or Mac, Apple headphones revenue is trending at about 40% of the revenue seen with those product categories. As for the Apple Watch versus AirPods revenue race, it looks like Apple Watch revenue still exceeds headphones revenue by about $1B per year.

Of the $14.5B headphones revenue total for FY2021E, $2.4B or 16% is from Beats headphones with a W1 or H1 chip. That may come as a surprise to some people who haven’t paid much attention to Beats. However, the Beats brand has been strong for many years, especially in certain verticals like sports. Customer awareness of the brand is up there, which is one reason why Beats headphones include the Beats logo. Since Apple has an even stronger brand relative to Beats, Apple device industrial design is increasingly becoming a type of logo (24-inch iMac, iPhone notch, Apple Watch, AirPods).

One quick note regarding how my Apple headphones revenue estimates are derived. For the past few quarters, Apple has compared the size of its wearables business to that of Fortune 500 firms. In the past, Apple even provided some clues regarding the year-over-year change in wearables revenue. These clues are very helpful in estimating Apple Watch revenue and unit sales and then backing into estimates for both AirPods and Beats. This is one reason why estimating Apple wearables financials is like putting together a giant puzzle.

Turning to unit sales, here are my estimates for the number of headphones Apple sold:

2017: 12M
2018: 24M
2019: 42M
2020: 60M
2021E: 70M

Note: The FY2021 total does not include Beats Studio Buds.

My ASP (average selling price) assumptions for AirPods has increased from about $150 out of the gate to more than $200 today. My Beats ASP assumption is a little over $200.

Seventy million headphones sold per year represents about 15% of the devices that Apple ships annually.

My estimate is that Apple headphones sales to new users is less than the ~75% seen with Apple Watch. This reflects a decent amount of AirPods owners either upgrading to AirPods Pro or simply getting a second (or third) pair. The heavier reliance on sales to upgraders exposes AirPods to more revenue and unit sales volatility than is seen with Apple Watch.