China Mobile Is a Game Changer for Apple

Apple reported record 2Q15 earnings with revenue up 27% on strong iPhone sales. While the iPhone 6 and 6 Plus continue to sell well across the world, it is clear that China Mobile is driving Apple's recent financial resurgence. Relying on data from Apple's 2Q15 earnings report and 10-Q, I estimate Apple earned $2 billion of operating income from selling 10 million iPhones to China Mobile customers last quarter. 

Despite being told for years that China would become a very important country for Apple, there had been little to show for it in Apple's financial statements. China's second and third largest mobile carriers, China Unicom and China Telecom, respectively, were selling iPhone but with sales starting at such a low base, the growth wasn't a factor when compared to Apple's other operating segments. In December 2013, after years of negotiation and business talks, China Mobile and Apple announced an agreement for the world's largest mobile carrier to sell iPhone. It took a number of months for momentum to build, but all signs now point to China Mobile being a very significant partner for Apple. 

While it can be difficult to put China Mobile's size in perspective, we are able to get a good approximation of just how significant the largest carrier in the world is by looking at customer data. It is important to segment China Mobile's 815 million customers by 2G, 3G, and 4G subscribers in order to better understand the number of customers that are realistically in a position to buy an iPhone (denoted in blue in Exhibit 1). China Mobile's 378 million 3G and 4G customer base is 50% larger than the combined 254 million subscriber base for AT&T and Verizon. 

Exhibit 1: Total Customers for Largest Chinese and U.S. Mobile Carriers

Heading into this week's earnings, I was confident Apple would sell more iPhones than consensus was expecting because Tim Cook had previously disclosed that iPhone supply/demand was not in equilibrium until February. In addition, given how close China Mobile's iPhone launch was in January 2014 to the Chinese New Year that year, this year's Chinese New Year would see a much bigger boost from China Mobile selling iPhone. Cook reiterated this as a key driver to the strong quarter on the earnings call Monday evening. 

We are seeing the result of Apple pushing iPhone into previously untapped territories in China thanks to its China Mobile relationship. Apple is confident its products are making headway into China's middle class. Exhibit 2 highlights how the addition of China Mobile now brings the realistic target market for iPhone in China to 654 million customers. If one were to assume the top 10-15% of these customers buy an iPhone, similar to iPhone's share of the global overall smartphone market, Apple would sell 60 to 100 million iPhones in China. Taking into account the average iPhone lifecycle (2-3 years), Apple would eventually be in a position to sell 25 to 40 million iPhones in China each year to this loyal customer base.

Exhibit 2: Apple's Target Market for iPhone in China (3G/4G Customer Mix)

However, recent data from Kantar suggests that iPhone sales share is not 10-15% in China, but closer to 25% and climbing. Accordingly, such data would suggest Apple is selling upwards of 60 to 70 million iPhones in China each year, with China Mobile representing close to 60% of that total. It is possible China Mobile is selling 10 million iPhones a quarter, nearly 15% of Apple's global iPhone sales.  Exhibit 3 highlights how China Mobile likely accounted for 40% of Apple's iPhone unit growth this past quarter. Excluding the impact from China Mobile growth, iPhone unit sales would have been up 24% year-over-year, still stronger than the growth experienced in 2014, but a bit less than the reported 40% growth.  

Exhibit 3: Where is iPhone Growth Coming From?

Apple likely made close to $2 billion of operating income from China Mobile last quarter. As disclosed in Apple's latest 10-Q, Apple reported a 90% year-over-year increase (up $3 billion to $6.7 billion) in operating income in Greater China. I suspect China Mobile was the primary driver of that growth.

Even though iPhone sales growth remains robust in various countries including Korea, Singapore, Taiwan, Vietnam, Canada, Mexico, Germany, and Turkey, I suspect they pale in importance to the type of unit growth numbers coming from China Mobile in recent quarters. The iPhone's near-term sales trajectory will largely be determined by the iPhone upgrade cycle and Apple's success with selling the iPhone to China Mobile's 378 million 3G and 4G customers. China Mobile has become Apple's most important business partner.  

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Apple Watch: What Did Apple Just Roll out Here?

Reviewing an Apple Watch three days after launch in any traditional sense has as much long-term value as publishing an iPhone review on July 2, 2007 would have had. Instead, I am going to try a better approach. This post will be the start of what will become an ongoing series about my Apple Watch thoughts and observations with a focus on how the product will impact the world. 

• What is important?
• What isn't important?
• Financial implications.  
• Longer-term ideas and viewpoints.

I've already written a few words about Apple Watch, and I continue to think they provide a good foundation for beginning to analyze the device and wrist wearable product category.

1. Apple Watch's Secret Weapon
2. Apple Watch Isn't a Luxury Watch 
3. The Evolving Notification 
4. Apple Watch is Cool, Just like iPhone 

The Apple Watch Journey Begins

42mm Apple Watch Sport with Solar watch face.

I am convinced Apple Watch is not a watch. Positioned as my personal assistant who just began on-the-job training, the Watch has potential. While it isn't quite able to monitor and guide me through the world, the product has a coolness level that makes me want to wear it all day and begin incorporating it into my lifestyle. From Apple's point of view, I suspect that is a best case scenario for a new product category.

I ordered a 42mm Apple Watch Sport with the white sports band. I knew almost instantly when the Apple Watch was introduced, back in September 2014, that I wanted that particular model. I am a long-distance runner so I knew a Watch collection named "Sport" would be up my alley. In addition, I've owned and worn a regular watch for years, so I wanted something that did not remind me of a regular watch. 

UPS Delivery and Extensive Packaging

My Apple Watch experience started off with a memorable exchange this past Friday: 

• UPS delivery man [holding a "heavy" Apple Watch box at my door]: "What did Apple just roll out here?"
• Me: "Apple Watch. You have a lot of these boxes?"
• UPS delivery man: "Oh yeah. Couldn't figure out what it was."

I vividly recall the first time I first held iPhone and iPad. For iPhone, it was at an Apple store following a nightmarish visit to an AT&T store the day prior. For iPad, it was after picking up the device at the local shipping depot because I missed the delivery earlier in the day. I've always felt that the first time one sees and holds a product is quite telling as it can be used to judge not just the connection to a product, but also brand and company. There are companies besides Apple that have a similar ability to create such emotional connections, but it's rare for a company to mean so much to so many people. 

Extensive packaging for Apple Watch Sport.

As part of that introduction, the packaging that a product comes in plays a crucial role as the experience begins at delivery or purchase. I've always been intrigued by Apple packaging because of the time and effort put into something that will never look as perfect as when it is first opened. The Apple Watch Sport packaging is no different. Weighing in at a pound, the box had a noticeable and substantial weight to it. I would go so far as to say Apple Watch packaging was the most extensive, and thought-provoking, I have seen out of any Apple product in a very long time. No wonder the UPS delivery man mentioned how heavy the Watch box felt. Most of the weight is due to the white elongated case that Apple Watch comes in. I'm still not quite sure what to make of it; is it a carrying case or a cradle for my Watch while charging? The one I have is a less fancy version of the Watch collection case and a very distant cousin of the Edition case. However, even this case represented a faint connection or similarity that Apple relied on between Watch and traditional watches. Only watch wearers would be able to discern the familiarity. 

The Apple Watch came with a number of instructions, such as how to put the watch band on one's wrist, which I thought symbolized how people have tuned out modern-day watches to the point of not even knowing how to put one on.

The overall Apple Watch setup and pairing process with my iPhone will be fine for anyone comfortable using an iPhone. I did not encounter any issues. For those with a bit more hesitation, I think Apple holding special Apple Watch introduction sessions at Apple Retail locations is a smart move as it may be a bit overwhelming. 

The Watch Band

One trend that has taken place over the past few weeks is the Watch bands getting the most attention out of the entire Watch discussion. The interesting aspect of that is the band has very little to do with technology. I don't think that is by mistake. Of course, the bands are indeed a byproduct of manufacturing technology and innovation, but for the average consumer, the Watch bands are about fashion and personalization. 

Apple hit a home run with this initial sports band. It looks and feels great. Even putting the Watch on extra tight to see if there was any impact to my wrist's circulation, I was unable to have it leave any marks. I suspect the way the band connects to the Watch case, leaving a small amount of space between the case and skin on each side, is the primary reason I have a hard time having the band leave any marks. The slight protrusion at the bottom of the Watch where the heart rate monitor is allows me to enjoy the feeling of a nice tight band on my wrist without most of the negatives, such as perspiration, usually associated with such a thing. I can wave my arms and the watch will not move, which produces a certain kind of calm and relaxation. Even during a run, the Watch band performed well with no discernible markings while my previous running watch band would indeed leave marks because I had to wear it tightly in order to have it remain in place. I suspect the rubber band will change shape somewhat as time goes on, but with a small/medium band piece also included in the box, I am not concerned about the band becoming more loose as time goes on.

One interesting thing is that when I look at myself in a mirror with the Watch, the aluminum case melts away, and it looks like I have a white band with a black piece in the front of my wrist. It is hard to see that I have a watch case connected to a band.  They just look like one piece. I suspect this is the primary reason why the Apple Watch doesn't look quite like a smartwatch even though it is a rectangular piece of glass attached to a watch strap. I have definitely become more doubtful in recent days that circular smartwatch faces are anything but a calculated bet to grab sales from traditional watch owners that are familiar with a watch's circular look.

Watch Faces and Notifications 

I have long thought that the wrist is an interesting place for technology, breaking down some of the more complex tasks found in an iPhone to easier to digest bits of information. That doesn't mean that we take iPhone apps and shrink them down, keeping the same thought and design process, but applying it to a watch. Everything needs to be rethought. I've downloaded a few third-party Watch apps (or should I say extensions of iPhone apps?) and there really isn't much to write about. While some are adequate, I just couldn't find any that really got my imagination running. However, after only 12 hours of use, a few value-add uses for the Watch became apparent. 

One thing I am discovering is I really don't want to look at my watch screen too much. I could very well go a full evening at home with barely looking at Apple Watch. I don't look at that as a negative. While things can (and certainly will) change, I have no desire to sit on the couch and play with my watch while my iPhone is somewhere else in the house. Instead, I am finding myself wanting to feel notifications, or at the very least just turn my wrist periodically and look at the watch screen and see what I need to know quickly. The information can be as trivial as time or temperature. 

The Watch has two very valuable ways of displaying or giving information.

1. Watch faces
2. Notifications  

Turning my wrist and being able to see my selected Watch face automatically means that the ability to customize Watch faces to put specific information on that initial screen would be an incredible value proposition. It is no surprise that third-party app developers (as well as Apple) sense the untapped opportunity. The iPhone home screen displays nothing until the home button is pressed, and even then initially just time, data, and the slide to unlock button are displayed. In contrast, the Watch face provides much more valuable information without the need to do anything besides look at the Watch. I could also open an app on Watch and it will remain displayed on the watch screen (like a running app), however the hierarchy is still built around Watch faces.

Modular, Solar, and Utility Apple Watch faces.

In addition, the tapping and sounds from notifications, followed by a prominent position on the Watch as someone goes to check the notification by looking at their watch, represent additional valuable attention and location for information. While Glances are indeed easy to reach with just one swipe up from the Watch Face, the sheer number of them may limit their value a bit. I consider the Glances to be equivalent to apps on an iPhone home screen: easy to reach, but still one among a few. 

Apple Watch Use Cases 

Apple is aware of this type of attention hierarchy and will act accordingly by, I suspect, retaining much of the power around Watch faces for the foreseeable future because it impacts the user's experience to such a degree. But the implications of this hierarchy are indeed interesting for what the Watch can be used for. 

The Apple Watch will excel at:

• Recording aspects of my behavior/movement and then providing feedback. Track miles run, sending me taps after each mile, or monitoring health vitals and then creating recommendations.
• Real-world notifications. Notify via tap or sound that a shower or thunderstorm will be at my current location in ten minutes. 
• Identification. Use Apple Watch to enter my office and home, unlock a car, as well as contain information that is inaccessible when Watch is removed from the wrist.

While there are other devices, including the iPhone, that can do most of these tasks, it is the ability to have it on the wrist in a more ergonomic fashion, void of additional distraction, that makes things interesting. In addition, the aspects of maintaining identity once the Watch is attached to my body is, in a weird way, incredibly refreshing and reassuring. 

A few hours after my Apple Watch arrived via UPS, I took it out on a seven-mile run. I don't take my iPhone on runs or any physical exercise that involves motion, so I was going to just use the Watch as a timer, knowing it didn't have its own GPS.  Around eight minutes into my run, I received a slight tap on the wrist, I lifted my wrist up, and it said I had ran one mile. Having run this same route for years, I knew it was spot-on. Throughout my run I was getting accurate mile readings. How is this possible when the watch doesn't have GPS? Apple had previously asked me a few questions during the Fitness app set-up including my height, weight, and age. In addition, since I have been running for years, I have a pretty consistent stride. I suspect that consistency is what gave the Watch the ability to measure my stride to produce mileage and be so accurate without any iPhone calibration. 

The ability for the watch to give me information (mile readings) without needing to look at it (taps) was incredibly valuable to me and my needs as a runner, especially with not having to carry a bulky iPhone. I actually found myself every so often lifting my wrist up to see other metrics such as my mileage pace. The Watch is essentially taking elements that I used to rely on a few devices for and combining them into a device where fitness and health is just one feature. This is why there is something more behind Apple Watch. 

Early Signs of Behavioral Pattern Change

While it is early to reach any conclusions about long-term behavioral change, I have noticed that I have an urge to see why my Watch is tapping me or making a noise. I had very few vibration and sound alerts for my iPhone, so it may just be a realization that allowing some kind of notification through the filters could prove to be valuable. In addition, I have this weird urge to keep the watch on regardless of what I am doing once I put it on each morning. If I am washing my hands or am wrist deep in food preparation, I don't think twice about keeping my Watch on. It's not so much an annoyance to take it off that is the primary culprit, but I am starting to sense a little bit of connectivity as I am wanting to not miss something. Having it be so comfortable helps in this regard. 

Apple Watch Is Definitely Not a Watch

There is no question in my mind that the Apple Watch is not a watch. The way I use the device is nothing like the way I would use a watch. While Apple is undoubtedly taking certain elements of the watch world to sell Apple Watch, much of that is merely due to providing some level of comfort and recognition to avoid consumer backlash and risk aversion. It is much easier to position the Watch as a better watch than an ancillary iPhone screen. The Watch is something different. 

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Apple 2Q15 Earnings Preview: Another Strong Quarter Driven by iPhone in China

Apple will likely report a 2Q15 beat to consensus EPS of $2.14 this coming Monday on strong revenue growth (up 24% from last year) and margin trends (41.0% vs. 39.3% last year). The iPhone will be the primary focus as investors look for any indication of continued above average sales trends compared to previous iPhone cycles. While recent iPhone sales share in the U.S. and Europe appear slightly ahead of previous years, strong sales in China will be the primary driver behind 35% growth in iPhone unit sales. In addition to earnings, Apple is expected to announce an updated capital return program. The Mac and iPad are becoming less of a factor for earnings as those two product categories now represent a smaller percentage of Apple's overall business. It will be difficult to get Apple Watch sales expectations from guidance, but management may give commentary on how the Watch launch is proceeding. Similar to last quarter, the impact from a strong dollar will be reflected in management's revenue and margin guidance for 3Q15.  

iPhone: The Big Story for the Foreseeable Future

Representing close to 70% of Apple's quarterly revenue and 80% of gross profit, the iPhone will likely remain the primary focus for Apple investors until new Apple products gain enough momentum to account for a bigger piece of the financial pie. While there is nothing inherently wrong with this situation, it does serve as a reminder that the iPad and Mac are becoming less of a factor on earnings day. The following exhibits highlight the changing revenue and gross profit mix over the past two years as the iPhone's share has grown, while iPad and Mac share have declined.  

Exhibit 1: Apple's Shifting Revenue Mix (2Q13 vs. 2Q15)

Exhibit 2: Apple's Shifting Gross Profit Mix (2Q13 vs. 2Q15)

I estimate Apple sold 60 million iPhones last quarter, which would represent 37% growth from last year. On last quarter's earnings call, management noted that global iPhone supply/demand remained out of balance for most of January. Accordingly, I am assuming Apple sold as many units as it was able to produce for one-third of the quarter (24 million units in January). Once supply/demand was in equilibrium in February, I am running with a 20-25% reduction in shipments (19 million units in February and 17 million in March). Apple will need to ship millions of iPhones just to get channel inventory into an acceptable range, but management noted this will be done over time. As shown in Exhibit 3, I would consider iPhone sales between 57 million and 63 million to be relatively in-line with my estimate and not causing much change to my forward iPhone estimates. 

Exhibit 3: iPhone Unit Sales Expectation Meter (2Q15)

Capital Return Program Revision Expectations

The board is expected to announce an increase to the quarterly cash dividend and additional authorization for the share buyback program. Last month, I went into detail on prospects for both the quarterly cash dividend increase and share repurchase program. I expect the quarterly cash dividend to be increased approximately 8% to $0.50/share to $0.51/share. The share buyback authorization will likely be increased $35 to $45 billion, bringing total authorization to $125 to $135 billion. It will be important to watch for any change in commentary and tone regarding the capital return program, especially as Apple is currently near the maximum buyback pace that it can sustain given its U.S. free cash flow and debt issuances. Consensus already expects a pretty significant change to the buyback ($30-$40 billion increase), so it may take an increase of more than $40 billion to move the stock specifically related to the buyback news.

Guidance

I currently have $47 billion of revenue estimated for 3Q15. A revenue guidance range of $43-$46 billion would suggest that my estimates are on track. Apple's guidance will include Apple Watch revenue, although the data will be lumped in with the "Other Products" category. I still think it will be possible to arrive at some conclusions as to how many watches Apple sold since the Watch will make up a good portion of "Other Products". While it remains very difficult to judge Watch supply over the next two months (3Q15), I would expect the Watch to contribute around $2 billion of revenue from April 24th to the end of the quarter in June. 

iPad and Mac: No Significant Changes

As discussed by management, there won't be much change to continued weak iPad sales momentum. The entire tablet category is facing increased competition from larger smartphones. The iPhone 6 and 6 Plus, in addition to a strong MacBook line-up, continues to pressure iPad sales. I expect iPad unit sales to decline 22% to 12.8 million, which would track close to the decline seen last quarter (18%). iPad channel inventory was already at sufficient levels coming into 2Q15. The iPad is still in the process of finding its normal sales run-rate, but that level may still be quite a bit lower than current sales levels. For perspective, the iPad is outselling the Mac by nearly three-to-one. 

Exhibit 4: iPad Unit Sales Expectation Meter (2Q15)

Mac sales will likely continue to follow the 10-20% growth experienced over the past five quarters as the current product mix resonates with consumers that want a more powerful machine compared to the iPad Air or iPhone 6/6 Plus. 

Exhibit 5: Mac Unit Sales Expectation Meter (2Q15) 

Other Thoughts

Given the current point in the iPhone cycle, it's fair to assume the average selling price will decline a bit (to around $650 from $687), but some of this decline should be offset by an increase in profit margins. Apple's guidance will reflect the impact from the stronger dollar, but with trends stabilizing in recent weeks, management may be able to get a better handle on foreign currency trends.

Similar to last quarter, all eyes will be on iPhone on Monday. For every one million iPhones sold, Apple EPS is impacted by $0.04/share. The difference between 55M and 60M iPhone unit sales explains most of the Street's EPS estimate variation. It looks increasingly likely that China will once again prove to be the quarter's primary revenue driver.

This report was produced by Neil Cybart on April 22, 2015 and is not meant to be used as investment advice.

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Betting Big on the Camera

The camera's primary role has changed from capturing memories to becoming a full-fledged communication tool. Apple's recent $20 million acquisition of LinX serves as a reminder that the camera is positioned to be not only one of the most important smartphone components, but also a tool that will play a major role in how technology impacts society. Instead of betting on mobile platforms, a bet on the camera will likely pay more consistent dividends.

The Camera's Expanding Job Title

The camera's original use case was straightforward: capture memories. Moments in time ranging from a birthday party, graduation, or wedding were chronicled in order to tell a story in the future. Discretion was taken as to what subject or event should be captured as both film and the process of getting film developed were expensive. A week-long trip abroad would likely result in a splurge of maybe eight or nine rolls of film and a total of 200-300 pictures, of which a handful ended up being worth including in a photo album.

Everything changed in 2010 when Instagram was able to successfully position the photograph as a communication medium in the mobile era. Up to that point, phone cameras had been underwhelming with many people needing to carry both a phone and camera. In 2010, the world had just been introduced to the iPhone 4 and Android smartphones were starting to take off. In other words, it was the right time for something like Instagram to start pushing the camera beyond just memory capture.

Instagram's popularity was based on taking photographs with mediocre image quality and turning them into something cool by often making them look even older and grainier by applying fun filters. Users were then able to share their creations with others. In a world dominated by text-based Facebook and Twitter, Instagram represented a refreshing alternative. 

Instead of using our smartphone camera just to capture momentous occasions in life, we began to use them to capture everything from the breakfasts we ate, to the magazines and books that we read. The camera was turning into another pair of eyes, and an internet connection allowed others to see the world through those eyes. 

The camera's changing role wasn't confined to just software companies. With an initial mission to take photographs while surfing, GoPro was started as a way of have point-and-shoot cameras handle extreme environments. GoPro eventually experienced the same advancements in camera technology and social trends benefitting Instagram, where the camera was turning into a way of sharing unique vantage points and not just memory capture. The camera's expanded job title turned GoPro from a niche camera company into a $6 billion hardware and content company with even bigger plans of becoming a media powerhouse. 

Apple and the iPhone Camera

We now find ourselves in a world where cameras are becoming ever more capable in a smaller footprint. Apple's LinX acquisition is all about multi-aperture cameras, suggesting the desire to fit more power in a smaller form factor using sensors and software to capture multiple images simultaneously. The result is better quality, and more importantly, depth and three-dimensional capabilities.

We have reached the point where the camera found in one's smartphone is likely to be the best camera they have ever owned. As Apple continues to push the boundaries on iPhone innovation, the camera will be positioned as one of the likely components that will not only drive iPhone upgrades, but expand the iPhone's use case. While the camera has been used by third-party developers to accomplish various tasks such as scanning barcodes in stores or using augmented reality to display travel directions or public transit, Apple's primary near-term goal will be to improve the camera's ability to take photos and video in various settings to foster an even greater reliance on non-text communication. 

Cameras in the Future

Three primary use cases demonstrate how the camera will continue to change the world.

Memory Organization. While we will still use cameras to capture important moments in our lives, much of the focus will be on the software required to navigate the thousands of pictures found on our smartphones, likely taking up precious phone storage if we haven't signed up for a photo cloud service. New capabilities to catalog photographs as they are taken and then search through old digital photographs will serve as features deserving of a keynote slide or two. I suspect Apple and other software companies would be able to contribute much in this area in the coming years, assuming they give the topic enough attention and resources. One issue is that memory capture is simply unable to grab the hearts and minds like it once did. This area will not entice the high valuations from venture capitalists as memory capture has more of a connection to yesterday than the future. While we will still have start-ups trying to fill the niche, the camera's bright future isn't built around simply capturing memories.  

Communication. The camera's new functionality as a communication tool is impacting billions of lives, drawing a great deal of attention from investors and users. It is all too obvious by Snapchat's success and the modern-day mobile video boom including Periscope, Meerkat, Facebook, YouTube, Twitter, and various messaging platforms, that the world has moved beyond text to tell stories. Photographs and video are occupying a larger role in our daily lives which by its very nature reduces the desire to hold on to so many reminders of relative mundane aspects of our day, summing up Snapchat's appeal.  

Interpretation. While there is still plenty of innovation left with how we use cameras to communicate with others, the camera's most exciting role will be utilizing software to help us interact with and navigate the world. The camera will become an input device for software to interpret clues in various settings at home, the office, or school. The camera essentially becomes a pair of intelligent eyes that goes beyond simple image capture.

The camera's changing role has brought up important discussions concerning how technology impacts humanity. With some companies selling the idea to film one's entire day by wearing cameras on the face or body, questions around privacy and morality will need to be addressed. At what point does obtrusive technology do more harm than good? 

The camera discussion has usually been about Kodak, and other camera companies from yesterday, missing the mobile bandwagon. We have now moved to a point where such a story is no longer relevant. The software that turned cameras into critical pieces of communication would have never have been created by traditional camera makers. The camera's potential was unleashed by mobile as smartphones were primarily cameras with a mobile connection. The camera's ability to not only capture the world around us, but begin interpreting that world, suggests the camera's impact on society is still being underestimated. There's still time to place a big bet that the camera will play a much bigger role in our lives in the future. 

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Apple's Watch Strategy Embraces the 80-20 Rule

We are starting to get early reads on how Apple Watch pre-order mix is trending and there are a number of surprises. It is obvious why Apple will not disclose Apple Watch revenue data. By knowing which Watch collections are selling and at what price, it would be easier for competitors to reach conclusions on customer preferences. Using early pre-orders reports and a few long-standing theories, the Apple Watch will likely be loosely guided by the premise behind the 80-20 rule, where approximately 80% of Apple Watch profits will come from 20% of Apple Watch customers. In essence, the Apple Watch and Edition collections will likely account for a small portion of sales, yet play a much bigger role in terms of Apple Watch profit. The implications are significant when contemplating how management will treat the Apple Watch line in subsequent years.

Sport is the Most Popular Collection by a Wide Margin

The two most popular Watch models have been space gray aluminum with black sport band and silver aluminum with white sport band. Using U.S. pre-order data from Slice, and extrapolating across the world, these two models could represent close to 70% of Apple Watch pre-orders. There will be millions of wrists with a black or white sports band in the coming months. The sheer popularity of these two models suggest there may be something more at play, possibly related to customers not wanting to spend more than $400 and these particular options representing the most popular color choices. 

Majority of People Are Not Valuing Stainless Steel and Sapphire Screen for $200

Most consumers are not valuing the stainless steel case and sapphire crystal screen at an additional $200. The easiest way to see this is compare the black and white sport band models in the Sport and Watch collections, with the only difference being the watch face (sapphire vs. Ion-X glass) and watch case (stainless steel vs. aluminum). When given the choice between a $399 Apple Watch Sport - black band and $599 Apple Watch - black band, pre-order data would suggest customers are overwhelmingly choosing the Sport by a magnitude of 5-10x. 

This isn't to suggest that sapphire and stainless steel aren't worth the extra $200, but rather consumers are not reaching that conclusion. Apple Watch try-on appointments may give consumers the best opportunity to make a more informed decision between the two collections, resulting in a slight shift in sales trends. 

One theory is that many consumers pre-ordered the Sport for the first version and plan on upgrading to a better watch in 2016 or 2017. This may be true, but the impact may be overshadowed by new Apple Watch buyers deciding to go with the Sport. In essence, the sales mix will likely remain the same, regardless of first-generation owners upgrading their watches over time.

Demand for Expensive Watch Bands is Niche

Even though much attention has been given to the higher-quality watch bands, it would appear that the majority of people are opting for the sports bands. At least judging by pre-order data from Slice, there is tepid demand for higher-end watch bands made of metal and leather.  The Milanese Loop would appear to be the best selling watch band out of the non-Sport options, which may give Apple confidence that consumers will value band innovation that moves away from traditional watch bands. The leather band options will likely remain quite niche. My Apple Watch observations would back these claims as I actually thought the sport bands were more comfortable and bold than some of the leather bands.

Financial Impact from Watch Bands

The conventional wisdom is that Watch bands will play a crucial role in Watch financials. I think it will be a bit more complicated.

1. One can make a strong case that customers will update their Apple Watches every 2-3 years. In this scenario, the Apple Watch will experience an update cycle that mirrors the iPhone more than iPad. Since each purchase will come with a new band, consumers may not see the need to spend money buying another watch band. Watch average selling price (ASP) and revenue will be driven more by case upgrades ($399+), not additional bands.   
2. With most people opting for the Sport over Watch, I have difficulty envisioning the majority of customers buying expensive additional watch bands. Instead, there may be demand for cheap, but fun, third-party bands ($29-$49). While such bands may have attractive margins, from a dollar perspective, Watch cases will still account for a majority of the Watch category's profit.
3. I suspect 10-20% of Apple Watch owners may be willing to buy an additional high-quality watch band. This is the part of the market where watch bands may become an attractive revenue and margin proposition. Apple will likely want to compete in this lucrative segment of the market, which may include traditional luxury brands. 

The 80/20 Rule

The Apple Watch is being sold as the most personal device with 25 distinct styles, yet four options (all with black or white sports bands) comprised a clear majority of pre-orders in the U.S. on the first day according to Slice. On the surface, that would suggest the other models aren't important and Apple should just concentrate on the sports bands. However, in reality, the exact opposite is true. When looking at profits, I suspect the 20% of customers opting for the Watch and Edition collections will likely represent 70-80% of Apple Watch profits. A few equations will help demonstrate what is happening:

• Revenue: One $17,000 Apple Watch Edition = 42 $400 Apple Watch Sport
• Profit:  One $17,000 Apple Watch Edition = 75 $400 Apple Watch Sports 

Karl Lagerfeld's custom Apple Watch with gold link bracelet. Source: Instagram

The implications from this are far-reaching. Apple will likely dedicate significant attention and resources to updating higher-end Apple Watch models and bands. Rumors had indicated a platinum option priced higher than the current gold Edition models. Karl Lagerfeld's custom Apple Watch with gold link bracelet will likely be available one day for more than $50,000. Marc Newson's schooling and experience with jewelry design will likely play a major role in this effort. In essence, Apple would be catering to the 20% of the iOS customer base that values exclusive personalization, which will boost revenues and margin.

Longer-Term Watch Implications

As long as the Watch is considered an iPhone accessory, I'm not convinced the majority of people are willing to spend more than $500 for one, which will position the Sport collection as the most popular option by a good margin. Meanwhile, the Watch and Edition collections will continue to represent approximately 20-25% of sales, but account for a clear majority of profits, and this ratio may even become more pronounced as Apple introduces additional high-quality bands with higher margins.

Apple is now a premium mass market luxury brand. The Apple Watch Sport is positioned for mass market consumption, reflected by the lowest entry-level price of any new Apple product category. Meanwhile, the Watch, and especially the Edition, are produced with luxury in mind, catering to the 20% of Apple consumers that have been craving personalization. Apple's Watch strategy will cater to both types of consumers, balancing well-crafted, yet practical mass-market items where price matters, and extravagant opulence where price doesn't factor into the purchasing decision. Welcome to the wearable market. 

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