Apple Watch

Apple Deserves More Credit for Wearables

The wearables era at Apple began years ago. However, Wall Street and Silicon Valley are only now slowly starting to pay attention to what Apple has been building. Apple is the undisputed leader in wearables, and they are pulling away from the competition. Given how Apple’s wearables strength continues to be underestimated, the company deserves more credit for what it has achieved and where it is headed.

The Data

A takeaway from Apple’s recent 3Q19 earnings was that we are witnessing the wearables era continue to unfold at Apple. Segmenting Apple’s quarterly revenue growth into product categories is one way of highlighting wearables momentum. Both an accurate financial model and close following of Apple clues over the past four years are required to accurately estimate Apple Watch and AirPods unit sales and average selling prices (ASPs). Therefore, this exercise has not been practiced by many.

The preceding totals represent the change in revenue from 3Q18 to 3Q19.

Apple Revenue Growth Drivers (3Q19)

  1. Services: $1.5 billion

  2. Wearables: $1.2 billion

  3. Home / Accessories: $0.6 billion

  4. Mac: $0.6 billion

  5. iPad: $0.4 billion

Note: These totals do not represent revenue totals but instead the change in revenue between 3Q18 and 3Q19.

The revelation from the preceding data is riveting. Wearables nearly exceeded Services in 3Q19 as Apple’s top revenue growth generator when looking at absolute dollars. Consensus was not expecting this to occur as Services was positioned as Apple’s growth engine. It is clear that consensus spent too much time on the Services highway and ended up missing the exit for wearables.

In taking a closer look at wearables revenue growth, it becomes evident that Apple is benefiting from both higher ASPs for Apple Watch and AirPods as well as continued strong unit sales growth. For AirPods, unit sales growth is nothing short of spectacular at 80%.

Speaking of unit sales, one out of five gadgets that Apple sells is now a wearables device. Exhibit 1 highlights the growing share that wearables represent when looking at overall Apple device unit sales.

Exhibit 1: Wearables Share of Apple Device Unit Sales

Exhibit 2 depicts wearables’ growing share of gadget sales relative to Apple’s other product categories. Apple is currently selling approximately 70M wearable devices per year. This includes 30 million Apple Watches and more than 30 million AirPods.

Exhibit 2: Apple Gadget Unit Sales

On a revenue basis, Apple’s wearables business is now at a $16 billion annual run rate growing at 55% to 60%. At the current pace, wearables will surpass both the iPad and Mac near the end of 2020 to become the third largest product category behind iPhone and Services when looking at revenue.

The Wearables Train

One way of thinking about Apple’s wearables business is that it’s a train gaining momentum. Competitors face declining odds of being able to stop the train.

The Apple wearables train is boosted by three items that no other company has the luxury of utilizing or leveraging:

  1. A massive installed base of iPhone users (925M globally).

  2. Core competencies and a company culture built on making technology more personal, intuitive, and easy to use.

  3. A thriving platform of multiple wearables products.

Apple is leveraging its ecosystem of users and devices to give its wearables business an ideal launching pad for success. While there are handful of companies with more than a billion users, no other company has an ecosystem of a billion users and nearly 1.5 billion devices (nearly 90% of which are running the latest software). The lack of a self-sustaining ecosystem is one of the primary factors driving Fitbit’s gradual fade into irrelevancy. This limitation manifests itself in new products like the Fitbit Versa smartwatch failing to catch the needed traction. 

Design, or the lack thereof, is proving to be another high barrier for many companies to get over in terms of wearables. Silicon Valley continues to focus too much on technology and not enough on design, or how we actually use technology. Google’s ineptitude when it comes to wearables is partially due to the company not having a clue as to how to get people to wear wearable devices. Management thought consumers would want to wear Pixel earbuds because the devices had real-time translation. In reality, consumers don’t want to be seen in public wearing wireless headphones that don’t reflect aspiration and coolness. A keen understanding of how to play in the luxury and fashion realms while simultaneously appealing to the mass market is tricky.

Flying Under the Radar

In assessing why Apple’s wearables business has received so little attention to date, one doesn’t have to look much further than the iPhone. Preoccupation with trying to find a singular product capable of replacing iPhone made it difficult for many to see how a platform of wearable devices is the answer for what can eventually serve as a viable iPhone alternative.

A cellular Apple Watch paired with AirPods is already able to handle a number of tasks currently given to the iPhone. Add a pair of smart glasses to the mix, and mobile devices like the iPhone and iPad stand to lose even more use cases.

It doesn’t help that new Apple products are also graded on a curve next to iPhone. If a new product is unable to move Apple’s financial meter out of the gate, the product is looked at as a flop, toy, or mere iPhone accessory. 

Guardrails

For competitors, the bad news is that there is evidence that Apple is still applying some breaks to its wearables train. In some ways, Apple is holding things back. An iPhone is still required to set up an Apple Watch. A truly independent Apple Watch that doesn’t require an iPhone would grow the device’s addressable market by three times overnight. 

In addition, Apple currently only offers wearables devices for two pieces of real estate on the body: our wrists and ears. A compelling argument can be made that the most prized piece of wearables real estate, our eyes, remains untapped. 

Looking Ahead

We are witnessing wearables usher in a paradigm shift when it comes to how we use and interact with technology. Apple deserves more credit for not only choosing to ride the wearables wave, but also playing a crucial role in getting wearables off the ground.

Apple is well on its way to having Apple Watch and AirPods installed bases of 100M people each. The company is more than half way there with Apple Watch and is quickly approaching the same level with AirPods despite the product being sold for half the time.

Apple also finds itself in the midst of a major investment phase to expand its wearables platform. There is an opportunity to bring more utility, in addition to clearer vision, to the eyes in the form of smart glasses. Such a product would be a precursor to a pair of AR glasses.

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.

Apple's Product Strategy Is Changing

This year’s WWDC felt different. While every WWDC keynote is filled to the brim with new features, this year’s announcements included highly anticipated items like a new Mac Pro and differentiated iPad software features. In addition, there were some genuine surprises such as SwiftUI (a big deal with wide-ranging implications for Apple’s ecosystem). Despite there being no discernible change to the grand vision behind Apple’s product development, there does appear to be a noteworthy change to strategy.

The Past

Apple had been following a product strategy that can be thought of as a pull system. The company was most aggressive with the products capable of making technology more relevant and personal.

One way of conceptualizing this product strategy is to think of every major Apple product category being attached to a rope. The order in which these products were attached to the rope was determined by the degree to which technology was made more personal via new workflows and processes for getting work done. Accordingly, Apple Watch and iPhone were located on the end of the rope held by Apple management. Meanwhile, Mac desktops were located at the other end of the rope while iPads and Mac portables were somewhere in the middle.

As Apple management pulled on the rope, the Apple Watch and iPhone received much of the attention while the Mac increasingly resembled dead weight.

The preceding exhibit may make it seem like all of Apple’s product categories moved in sync with each other as Apple management pulled on the product “rope.” In reality, the quicker Apple pulled on the rope, the more chaotic the end of the rope moved. The following exhibit does a better job of demonstrating the chaos found at the end of the rope.

The Apple Watch and iPhone were Apple’s clear priorities while the iPad, Mac portables, and Mac desktops ended up facing a battle for management attention. The iPad seemed to have the clear advantage in that battle, at least when it came to capturing mindshare among Apple’s senior ranks. Recall Tim Cook’s comment about the iPad being the clearest expression of Apple’s vision of the future of personal computing.

Today

Over the past two years, we received clues that a major change was beginning to take hold in Apple’s product strategy. This change was on display during this year’s WWDC. Consider the following announcements:

  • The Apple Watch continues to gradually gain independence from iOS and the iPhone with its own App Store and the ability to create watchOS apps without an iPhone app.

  • iPadOS is a promise from Apple that iPad will be given unique software features versus iPhone. Features like multitasking and Apple Pencil support give iPad differentiation from its more popular sibling (iPhone).

  • The new Mac Pro is clear evidence of Apple industrial design, along with the engineering and product design teams, attempting to come up with a long-term solution for the most powerful computer in the product line.

  • SwiftUI is the kind of foundation Apple needs to properly leverage a thriving iOS developer ecosystem in order to benefit other product categories.

Apple no longer appears to be relying so much on a pull system when it comes to advancing its product line. Instead, a push system is being utilized, and every major product category is being pushed forward simultaneously. The change was designed to reduce the amount of chaos found at the end of the “rope” that Apple was pulling. Accordingly, the primary benefactors arising from this new strategy are the iPad and Mac. This explains why this year’s WWDC announcements felt more overwhelming than those of previous years. Apple was able to move its entire product category forward at the same time.

This revised strategy ends up supporting a core tenet of my Grand Unified Theory of Apple Products - a product category's design is tied to the role it is meant to play relative to other Apple products. (A deep dive into Apple’s product vision and the Grand Unified Theory of Apple Products is available here for Above Avalon members.) By pushing the products geared towards handling the most demanding workflows, Apple has a greater incentive to push the products capable of making technology more personal and relevant.

It’s not that every product category in Apple’s line is now on equal footing in terms of importance and focus. Some products will receive updates every few years while others require more attention due to needing annual updates. In addition, Apple’s revised product strategy likely won’t change the sales ratios between product categories (iPhone outselling iPad by four times while iPad outsells Mac by more than two to one). Instead, the change from a pull to push system manifests itself with each product category being given a defined and unique role to handle within the Apple ecosystem.

  • Wearables are tasked with handling entirely new workflows in addition to a growing number of workflows that had been given to iPhones and iPads.

  • The iPhone is the most powerful camera and video player in our lives.

  • iPads and Macs are content creation tools.

Implications

There are a number of product-related implications arising from Apple’s revised strategy:

Mac Desktops. Despite being in the post-PC era, desktops are experiencing some kind of renaissance. Some of this isn’t entirely surprising given how the desktop has always been viewed as an antidote to some of the ideals found with mobile. However, what is new is the realization of the desktop’s role in the AR era. Mac desktops are niche in terms of the number of users relative to other Apple product categories, albeit a very powerful and crucial niche.

Mac Portables. It is time to take Apple management at its word when it says the Mac is important to Apple’s future. Mac portables will likely retain a place in Apple’s product line for the foreseeable future. A few years ago, low-end Mac portables seemed to be on a dead-end path thanks to iPads. There is no longer any evidence that such thinking is widely held in Apple’s senior ranks. An ARM-based Mac portable seems inevitable at this point.

iPad. Just a few years ago, some in the tech pundit world thought the iPad lacked a future. Such thinking was due to slowing iPad sales combined with larger iPhones being able to handle many of the use cases originally given to iPad. While the iPad has always been viewed as the future of computing within Apple, we are starting to see that vision materialize. iPad sales are now routinely surprising to the upside as Apple adds a “pro” layer to the iPad category in terms of powerful hardware and software.

iPhone. The iPhone as a product category continues to mature, as seen with a longer upgrade cycle. Going forward, the iPhone will primarily be known as the most powerful camera in our lives and a video consumption device. Many of the less intensive use cases and workflows currently given to the iPhone will naturally flow to wearables over time.

Wearables. Apple is the wearables leader. Fitbit would arguably be the closest from the perspective of unit sales but even then, the company is quickly losing momentum. Lessons that Apple learned with iPhone and iPad are now giving the company a wearables advantage that is likely at least five years. An independent Apple Watch not requiring an iPhone to set up is inevitable. The move would increase Apple Watch’s addressable market by three times overnight. In addition, Apple is well on its way to establishing a wearables platform as it competes for prime real estate on our wrists, in our ears, and in front of our eyes.

Will It Work?

Is Apple making the right product strategy decision moving from a pull to push system? It’s too early to tell. At first, the revised strategy may seem like a no brainer as each product category ends up benefitting from more attention. However, it’s not a given that such a dynamic is in Apple’s best long-term interests.

The source of my hesitation in Apple’s new product strategy is that the company’s long-term success is dependent on one item: making technology more personal. Anything that takes away from that goal ends up being a hurdle. Is Apple supporting legacy workflows to the detriment of Apple’s long-standing mission of making technology more personal and relevant?

One reason Apple decided to change product strategies in the first place was to avoid an all-out uprising among the 1% of the user base creating content consumed by the other 99%. The mistake Apple made over the past few years was pulling the product “rope” too fast and in the process, leaving many of its pro users, defined by the workflows needed to be supported, behind.

For a company that is resource constrained when it comes to time and attention, there is no guarantee that Apple’s functional organizational structure and design-led culture can realistically scale to push an endless number of product categories at the same time. This was the key benefit found with Apple’s pull system. The focus was to advance the products capable of making technology more personal and relevant while trying to bring as much of the broader product portfolio along for the ride. The move to a push system is inherently more complex. Apple finds itself doing a whole lot more that it did just a few years ago.

Some will push back at the claim that Apple is resource constrained considering the company has $113 billion of net cash on the balance sheet. However, such a view doesn’t take into account how Apple functions. Apple could have thrown together some components in a big box and shipped a new Mac Pro shortly after realizing that the previous Mac Pro design was a dead end. Instead, Apple’s industrial designers, working in close collaboration with various teams, took a little over two and a half years to come up with what is marketed as a long-term solution for handling the most demanding content creation workflows. Similar questions now plague Apple pertaining to its approach to “pro” Mac portables.

My concerns regarding Apple’s revised product strategy would be alleviated if Apple came up with a plan to push legacy platforms forward by doubling down on future initiatives involving making technology more personal. This is why SwiftUI is intriguing. Apple is positioning SwiftUI as a way to improve a developer's productivity by requiring less code, resulting in better code. What if that is only scratching the surface as to Apple’s ultimate objective? What if the Mac is being repositioned as an AR creation platform while iOS is gradually positioned as a platform for developing wearables apps? Using a billion iPhones to develop apps consumed on billions of wearable devices is the type of goal that would require years of work, foundation building, and periodic changes to product strategy.

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.

Apple Keynote Notes

My notes from Apple’s keynote:

  • Development. The tech landscape saw this wearable device coming from a mile away. Over the past year, competitors have come out with their own watches, and in many cases, have already shown a few reiterations. I suspect Apple Watch development started in earnest back in 2011 with most features at least thought out by 2013 and everything largely set by early 2014. The growing phenomenon of people using the iPod nano as a watch in 2010 most likely got the ball rolling. Yes, that means Steve Jobs was around for at least the early watch discussions, although Tim Cook told ABC News that Apple Watch development began around late 2011/early 2012. 
  • AskTog. In early 2013, former Apple employee Bruce Tognazzini wrote what I term “the iWatch manifesto”, a highly detailed, yet supposedly hypothetical, wish list of what an Apple smartwatch could or should do. As I expected, most of his commentary turned out to be true and was announced today.  I suspect some of his points that were not released today will be included in future versions. One has to imagine competitors were aware of the article and knew most of the features announced today were coming.  
  • Hardware & Software. From a hardware perspective, the Apple Watch doesn’t strike me as overly magical (like the iPhone did). However, the software is differentiated from peers. 
  • Battery. People are worried about battery life. Apple didn’t say, but implied an Apple Watch battery will last roughly a day. I think a 12-14 battery life is probably the most likely answer and I don’t see much issue with such a span for a first release. I don’t wear a watch in bed now, so I think it would be common practice to charge your Apple Watch every night.  What does this mean for sleep tracking or those with extra long daily schedules? Maybe buying two watches is their answer. 
  • Use Case. Apple didn’t go into much detail about why someone should use an Apple Watch, instead demoing a few features that seemed cool or at least interesting. I think most of this is taken from the iPad playbook - show users various things you can do with the device and then step back and see what sticks.  At one point Apple even mentioned there is much more to say about the device, but there wasn’t enough time.  
  • Goal. Apple is going after the watch, not the smart watch. 
  • Competition.  I suspect Samsung (and many others) will come out with various watches that look very similar to Apple Watch in a few months (some larger or smaller than Apple Watch). 
  • Pricing. Apple said Apple Watch would start at $349.  I imagine some of the higher-end models will likely go for over $1000.  I would not be shocked if over time, you see Apple watches retail for thousands of dollars (a special Marc Newson $5000 edition anyone?). Of course, Apple will also work to lower the entry-level price to a more manageable $99 etc. 
  • Future. I see a world where the watch will eventually replace the phone.  We aren’t there yet, but I think it’s coming and most major tech players will have a wearable tech platform up and running by 2015-2016. 
  • Retail.  Apple will need to figure out a way to showcase dozens of Apple Watch variations in Apple stores, requiring a new way of thinking of wearable retail. Angela Ahrendts has her hands full. 
  • iPhone.  New models largely as expected. The iPhone 6 Plus (5.5-inch screen) seems a tad large, especially when compared to the iPhone 6 (4.7-inch screen). The gold version does not look as good with these larger phones. I suspect the 4.7-inch iPhone 6 silver will be a top seller.  These news phones will likely maintain Apple’s iPhone unit sales growth in 2015, especially from strong sales in Asia. 
  • Apple Pay. Apple introduced a mobile payments platform and while I am interested, I am a tad skeptical at how this is going to trend in real world implications. If I still need to carry credit cards because there are various retailers who don’t support Apple Pay, how effective is such a service? Certainly Apple Pay represents the strongest movement yet for the mobile payments arena, but for now I am taking a wait-and-see approach. 
  • U2. I still don’t quite understand the point of Apple subsidizing a U2 album.  I get that Apple wanted a musical act to close out the event, but U2? 
  • Summary. Apple did what it had to do to give Apple Watch a solid chance of succeeding. The hype for today’s event seemed higher than the initial iPad event and I think it’s clear Apple wanted people to know Apple Watch is a big deal and should garner the corresponding attention. For now, I think Apple early adopters will buy Apple Watch (5-8 million units), with a decent uptake in some market niches (another 5-10 million units). While some are expecting 60 million units sold in the first year, I am taking a more measured 2-3 year horizon before we see those kind of sales numbers. Ultimately, I think Apple has a winner with Apple Watch.