Strategy Behind Retailers Discounting Apple Watch and iPad

One noticeable trend evolving over the past few weeks in the U.S. has been significant sales on Apple products at some of the country's largest brick and mortar retailers. Best Buy and Target have offered sales on Apple products in the past, but this year feels different. While some have looked at these promotions as signs of waning Apple product demand and a directive by Apple to push excess supply through the distribution channel, the reality is much different. Retailers are positioning Apple Watch and iPad as the top gifts of the year, betting discounts for those two products will drive foot traffic into stores and page views to online stores. The end goal for retailers offering Apple Watch and iPad discounts is to generate the needed buzz and revenue to better compete with one of the best performing retailers: Amazon.

Retailers Are Having a Difficult Year

Traditional brick and mortar retailers have now been embroiled in a tough fight against online retailers for years. The sheer competitiveness found throughout the retail segment is now turning traditional retailers against each other. The single-most important development for the retail landscape has been the smartphone and the exploding phenomenon of "showrooming." Consumers, armed with their smartphones, and in some cases tablets, head out to malls and shopping centers with the goal of trying on or testing products only to then use their smartphones to compare prices across various stores. This process often occurs right in the store and has become quite noticeable in data trends released by mobile app analytics companies. Showrooming is especially common for electronics and other big-ticket items available at a number of different retailers.

To make this year especially difficult for many U.S. retailers, weather patterns have led to unseasonably warm conditions through mid-December, especially in the U.S. Northeast. As a result, apparel sales, traditionally a key component of fourth quarter sales, have been hit hard. When looking at year-to-date sales trends, it quickly becomes clear that 2015 has been a difficult year for most traditional retailers. When comparing their revenue growth trends to those of Amazon, the mediocre results quickly stand out. 

U.S. Retailer Revenue Growth (year-to-date) 

Note: Reflects only U.S./North American revenues where applicable.

New Retail Strategies and Tactics

Traditional retailers have begun to adapt to the new normal. Best Buy has embraced a number of new strategies to compete against Amazon and other e-commerce retailers. Phrases like "price matching" have become engrained in many consumers' minds. Instead of fighting against showrooming, price matching is all about brick and mortar retailers placing foot traffic and online page views above increased margins and profits. Instead of losing a sale to a different retailer online, retailers are willing to lose a bit of profit in order to keep that customer. 

The best retailers have gone even further and begun to turn their physical stores into something more than just a location for showrooming. Best Buy has doubled down on the concept of stores within stores, including 500 mini Apple stores. In addition, customer service, like the Geek Squad, has been positioned as a much bigger reason to venture to a Best Buy store. The long-term strategy behind such a plan would be to make up lost margin related to price matching with high margin service items such as extended warranties and repair jobs.

Niche retailers, like outdoor lifestyle retailers Cabela's and Pro Bass Shop, have been able to turn brick and mortar stores into a type of attraction or amusement where families can literally spend the day. Despite all of these various strategies, all retailers share the same goal: occupying customers' attention and dollars. This is where doorbuster sales and various other high-profile sales on Apple products enter the conversation as such sales are meant to grab buzz and interest. 

December Retail Observations

A few trends become apparent when looking at these recent Apple product sales at brick and mortar retailers. 

Apple Watch is positioned as tech gift of the year. Looking at the tech landscape and the best- selling new devices in recent months, 2015 has been the year of the wrist wearables. Accordingly, Fitbit and Apple are the two leaders of the very young market, taking a 82% adjusted market share. However, for retailers craving buzz, store traffic, and a revenue boost, Fitbit just does not compare with Apple Watch. Not only were Fitbit wearables available in 2014, but they cost approximately a third to a fourth the price of an Apple Watch. In addition, Fitbit does not offer much exclusivity as the devices are available in many retail locations. Meanwhile, this is the first holiday gifting season for Apple Watch, with the product remaining quite exclusive in terms of retailer availability (Best Buy, Target, Walmart, and mobile carriers). The end result is retailers positioning Apple Watch as tech gift of the year. 

Best Buy's Apple Watch sale includes $100 off all models, including both Sport and Watch collections. Meanwhile, Target's Apple Watch Sale includes $100 Target gift cards with the purchase of any Apple Watch.

While Apple Watch remains polarizing within tech circles, the general population has shown to be much more receptive to the product, preferring its simplicity and ability to perform a few tasks, including receiving notifications. If going strictly by Apple Watch reviews on Best Buy's website, shown below, people think very highly of Apple's newest product category. 

iPad is still one of the top tech sellers.  Even though the iPad has suffered from slowing sales momentum in recent years, the device is still a very good seller in absolute terms, especially during the holiday season. In addition, the distribution dynamic seen with the product ends up giving brick and mortar retailers an outsized share of sales compared to products like the iPhone sold at mobile carriers. The end result is the iPad makes one of the most popular gifts, especially for children and teens. It is in retailers best interest to have sales on iPads to appeal to customers and drive traffic into stores. 

Best Buy's iPad sale includes $100 or $125 off all models, except for iPad Pro. Meanwhile, Target's iPad sale includes $50 or $80 Target gift cards with the purchase of select iPad models.

No sales uniformity. Even though more than one retailer is having sizable discounts on Apple Watch and iPad, each retailer has slightly different promotions. Other retailers, like Walmart, don't have any Apple product sales. This tells me that these promotions are not necessarily directed by a third-party, but rather settled upon by each individual retailer.  

What about other tech products? Other than Apple Watch and iPad, there are very few tech products that will sell in the same ballpark in terms of quantity and revenue. The only exception would be Fitbit, which unveiled a very extensive marketing campaign for its range of wearables with the company expecting to sell upwards of eight millions device this current quarter. While Microsoft was able to generate some much needed buzz with the Surface line of tablets, sales are still quite a bit lower than iPad-like revenues. Meanwhile, Amazon Kindles lack the growth and excitment of previous years.   

The Strategy Behind Big Apple Sales

Best Buy and Target are discounting Apple Watches and iPads because they are confident those two products will be able to garner interest and buzz to generate increased foot traffic and page views. Only 2% of Target's sales originate from its website, with Best Buy seeing a bit larger percentage (10%). Accordingly, It is conceivable that these Apple product sales will drive traffic to stores. Given the competitive trends, being able to get a consumer to a store is becoming more difficult and expensive. Once in a store, Target can then do its job and sell additional product. It is a version of the milk and bread strategy where grocers place the milk and bread in the back corner of the store in order to get you to walk through all of the other aisles and items.  

Retailers have long relied on this strategy to boost revenues, but it has taken on greater importance in recent years as competition intensifies. Electronics retailing in the hundreds of dollars represent the keystone of this strategy, especially in the November and December timeframe as people are willing to spend hundreds of dollars buying gifts for loved ones in addition to splurging on gifts for themselves. 

Apple's Involvement with Sales

Similar to any consumer goods company, Apple has working relationships with its third-party retail partners. Unfortunately, when it comes to analysis, these relationships are cast in mystery as the details surrounding contracts are confidential. In addition, the information found in these contracts is often not known by many people and is rather bland, limiting the odds of leaks reaching the press since there is little interest in such details. Traditionally, companies compensate third-party retailers for selling their product by offering lower wholesale prices with a varying degree of built-in margin available to the retailer. This margin is dependent on a number of factors, including the amount of power each party holds in the relationship. Walmart, for example, is well known for its ruthlessness when it comes to its suppliers, demanding low prices in return for significant purchase orders. There are also stipulations where companies can dictate how low a retailer can sell a product for with various incentives in place to have retailers follow such clauses. 

When it comes to Apple's direct involvement with these Apple Watch and iPad sales at Best Buy and Target, the most likely scenario is that Apple is aware of and has signed off on such sales although much of the financial impact is carried by the third-party retailer. Why does Apple allow massive discounts on its products? Temporary discounts during peak shopping seasons of the year have little to no long-term negative consequences on branding. In fact, by embracing third-party sales while maintaining its own "no discount" policy at Apple Retail, Apple is further able to maintain its brand image. If Apple was providing significant kickbacks or compensation to these third-party retailers, such trends would appear in financial trends through the average selling price (ASP). This explains why Fitbit's ASP is well below the actual retail sales prices of its products. Fitbit provides retailers much better margins than compared to Apple. 

Financial Implications

From Apple's perspective, what may end up being the most valuable long-term financial takeaway from these Apple product sales is increased brand relevance for Apple Watch. Apple has sold seven million Apple Watches to date, and I currently estimate Apple will sell another five million Apple Watches during the current quarter. This would suggest that Target and Best Buy have the potential to move upwards of one million Apple Watches this quarter, or $400-$500 million of Apple Watch revenue. This is not a trivial amount for Target and Best Buy and would certainly help offset weakness in other areas such as winter apparel. A very successful holiday quarter will help cap off a successful launch calendar year for Apple Watch with unit sales nearing 11 million. The product category would be well positioned for Apple Watch 2 in the first half of 2016.

For iPad, the iPad mini experiences strong sales each fourth quarter followed by a steady and dramatic drop-off in sales in subsequent quarters. I estimate Apple selling 17 million iPads during the current quarter which means Target and Best Buy could sell up to three or four million iPads, or another $1.3 to $1.7 billion dollars. Combining Apple Watch and iPad sales, these Best Buy and Target sales are likely worth at least $1.5 billion of revenue. When considering the additional product sales resulting from customers visiting stores in search of these Apple products, Best Buy and Target will likely bring in more than $2 billion of revenue this quarter related to Apple promotions. In the competitive retail landscape, discounting Apple products ends up being a worthwhile bet. 

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The Grand Unified Theory of Apple Products

There is much debate and intrigue regarding how Apple's expanding product line fits together. The addition of an entirely new product category with Apple Watch and new models such as iPad Pro have led some to wonder if Apple is losing focus or is unsure as to where the technology puck is headed. However, in a somewhat unpublicized interview for the new iMacs this past October, Phil Schiller, Apple SVP of Marketing, described a new theory for Apple's product line, which I am calling "The Grand Unified Theory of Apple Products."  This theory provides a glimpse into how Apple looks at the world and more importantly, some clues as to where Apple product categories are likely headed over the next few years. 

Product Line Expansion

One theme that has come to represent the Tim Cook era is product line expansion. Over the past four years, Apple has doubled its product lineup from 12 distinct models to more than 24, including a new product category. On a SKU basis, the growth is even more noticeable when taking into account additional finish options and various iPhone models geared toward specific mobile carriers. The ability to not just ship hundreds of millions of iOS devices each year, but to do so while offering so many SKUs, says a lot about Apple's supply chain prowess.

Much of this product expansion has come in the form of additional models reaching lower price ranges. Apple followed a similar method with the iPod in the early and mid-2000s. The difference now is we are seeing this occur with multiple product categories at the same time. Apple's expanded product line has contributed to total revenues more than doubling to $234 billion in FY2015 from $108 billion in FY2011.

Explaining Apple's Product Line

One question that has been raised by Apple's continued product expansion is how do all of these products fit together to produce one cohesive platform and encourage a broader ecosystem? The lines between product categories have become somewhat blurry. Upon closer examination, Apple's methodology of explaining its product line has matured over the years from talking about the iPad and a product's unique role to including the Apple Watch on a single product spectrum where personal choice is required to decide which products to buy. 

Unique Roles. When Apple announced the iPad in 2010, there was much attention and resources dedicated to explaining why a multi-touch tablet with a 9.7-inch screen should exist in a world with 3.5-inch screen iPhones and 13-inch MacBooks. The implied message was that the iPad would fit in most consumers' lives as it was a device that could do a list of things better than both an iPhone and a Mac. The iPad was given a very specific role to play. The now infamous slide Steve Jobs used to introduce the iPad (included below) is considered one of Apple's best marketing slides. It includes iPhone on one side, Mac on the other, and space in the middle with a list of various activities that can be done better by a new type of device.

The intriguing aspect of the slide was that it was geared toward consumers more so than analysts and technology pundits. Apple made it very clear as to why someone should buy an iPad. Judging from the early sales success, Apple's clear messaging worked. However, the broader implication from this marketing was that each Apple product had a particular role to play in our lives. Since Apple sold a handful of products, it wasn't much of a stretch for a consumer to buy every product category as each had its own unique role. Fast forward five years, and the product dynamic has changed to such a degree that the iPad seems like a redundant device to many people. The space between an iPhone and Mac continues to shrink, and iPad sales are declining. Apple's previous strategy of selling the idea that there was room in our lives for every Apple product category was beginning to come undone. Apple needed a new way of explaining its product line. 

A Spectrum. At the Apple Watch introduction keynote, Apple changed its tune when explaining its product line. Instead of positioning product categories in such a way that each product played a specific role in our lives, Apple began moving down the path of consumers picking and choosing the devices that made the most sense for them. The now classic, "product profile" slide made its debut (pictured below).  All of Apple's primary products fit on one spectrum. 

The message behind the slide was simple: each distinct product category possesses a different ratio of personal technology and power. The smaller the device, the more personal the technology. Meanwhile, the large iMac is positioned as the ultimate computing machine. The best choice as to what to buy or use is dependent on the individual. All of a sudden, Apple had a way to explain iPad's declining sales momentum (cannibalization by other Apple products), while also planting the seed that not every one will want an Apple Watch in the near-term. Instead, it's all about personal preference. It seemed that Apple under Tim Cook was moving towards a company tasked with selling a range of computing devices to allow the average consumer to choose what makes the most sense for him or her. 

While this message may seem to answer most lingering questions regarding Apple's product strategy, it still contains a number of drawbacks and questions. From a customer viewpoint, there is still confusion as to how all of these products come together. Look no further than the tricky iPad versus Mac debate. In addition, the descriptions used for each device concerning powerful technology on our wrist, in our pocket, or in hand are still somewhat vague and open to interpretation. From an analyst viewpoint, Apple's desire to look at its products on a spectrum has resulted in a rather wide range of opinions, including many pessimistic views on Apple's broader product strategy.

The Grand Unified Theory of Apple Products

This past October, Phil Schiller, in a rare interview with Steven Levy, talked about the new iMac. He took the opportunity to discuss a new way of thinking about the Apple product line, and I found it to be most revealing from a strategic perspective. Instead of describing how each product has a new unique role in our lives or simply placing Apple's entire product category on the same spectrum with an Apple Watch on one end and an iMac on the other, Schiller gave each product a job: make consumers feel like they don't need a larger, more powerful, Apple device in their lives. 

Schiller's theory is best viewed by taking his comments to Steven Levy and breaking them out by product category.

• Apple Watch: "The job of the watch is to do more and more things on your wrist so that you don't need to pick up your phone as often." 
• iPhone: "The job of the phone is to do more and more things such that maybe you don't need your iPad, and it should be always trying and striving to do that."
• iPad: "The job of the iPad should be to be so powerful and capable that you never need a notebook. Like, Why do I need a notebook? I can add a keyboard! I can do all these things!"
• MacBook: "The job of the notebook is to make it so you never need a desktop, right? It's been doing this for a decade. So that leaves the poor desktop at the end of the line, What's its job?..."
• iMac: "It's job is to challenge what we think a computer can do and do things that no computer has ever done before, be more and more powerful and capable so that we need a desktop because of its capabilities. Because if all it's doing is competing with the notebook and being thinner and lighter, then it doesn't need to be."

The first thing to notice about Schiller's new product theory is that it is actually a series of goals that also serve a dual purpose: help describe the product. What is the Apple Watch? It is a device that is supposed to handle a growing number of tasks once given to your iPhone. What is the iPhone? It is a device that is supposed to handle a growing number of tasks once given to your iPad. The argument can be made that all of this is just theory and that reality is not exactly keeping up with this vision, but that is exactly why it is called "The Grand Unified Theory of Apple Products." Upon closer examination, there is quite a bit of evidence to suggest that this theory actually does a good job of describing Apple's product line. In fact, Schiller's message provides the clearest clue yet as to how Apple management views its product lineup, even more so than the previous product theories put forth with the iPad and Apple Watch introductions. 

There are three major takeaways from Schiller's new product theory:  

1) The Apple Watch is a classic Apple bet. The very fundamental underpinning to Schiller's new product theory is that Apple Watch holds the most potential for making technology more personal. When looking at Apple's strategy over the years, the one overarching theme that transcends everything is the desire to make technology more personal, removing the barriers and allowing consumers to develop new and engaging relationships with technology. I continue to think the Apple Watch is being underestimated as elevated expectations for the product were reset over the past few months. The mistake many people continue to make when thinking of Apple Watch is looking at it as an inadequate iPhone replacement. Instead, Schiller's comments about Apple Watch denote a subtle distinction - the Apple Watch's role is to handle a growing number of tasks formerly given to the iPhone. For now, those tasks may be just simple notifications and things like checking time, but similar to how Apple handles product development, the Watch will soon handle more in the way of finance, health, identity, and communication. In many ways, the Apple Watch is setting up a classic Apple bet that a simpler device will eventually be able to handle many of the tasks currently given to larger and more powerful devices.

2) Greater iPhone differentiation is coming. While the recent debate has been stuck on whether the iPad can replace PCs, the real discussion that we should be having is how iPhones are replacing PCs. The iPhone is nothing more a smaller iPad. Of course, that subtle distinction ends up being the difference between a product selling 50 million units a year and 250 million units a year. The iPhone's form factor gives it the secret to success: mobility. Similar to how computing needs vary with the Mac and iPad, this same variability will come to the device being positioned to replace them. The writing is on the wall: expect the iPhone line to see greater diversification with a Plus model standing out from other models. So far, that diversification has primarily taken the form of screen size, but over time I would expect new ways for the Plus model to stand out from its iPhone siblings. 

3) Don't expect an iPad/Mac hybrid. Apple will not follow Microsoft down the iPad/Mac hybrid path. While it is easy to focus on the iPhone and Apple Watch as the future, it is crucial to note the role the Mac plays in Schiller's product theory. The Mac is the device that pushes everything forward. It may sound extreme, but Apple looks at a future Apple Watch as one day being just as useful as a current iMac. However, that goal is only possible if the iMac continues to receive the attention and resources to see what is possible at the upper limits of personal computing. A iPad/Mac hybrid would run against this trend as such a device is an explicit acknowledgement that the Mac is flawed as a product category. Instead, there is still much that can be done to push the Mac forward. 

A Roadmap, Not Destination

Schiller's grand product theory serves as a roadmap for where Apple wants to bring its current product line over the next few years, but it is important to not think of it as a destination. In a few years, the work from Apple's Project Titan will represent a new direction for Apple. While an electric car may not seem to fit in with a portfolio of watches, smartphones, tablets, laptops, and desktops, it is important to not get caught up by form factors but instead to look at what all of these products have in common: creating a experience. The simple fact that a device is used on a desk, held in hand, worn on the wrist, or sat in, doesn't change Apple's fundamental goal: make technology more personal.

For us to even be in a position to say that a 5-inch piece of glass held in our hand can replace a MacBook or iMac should help show that personal technology is about taking complicated tasks and breaking them down into more granular tasks, which are then able to be accomplished by smaller and simpler devices. This process will continue until we find ourselves in a position to begin looking up from our Apple Watches and iPhone screens but still feel connected to the world. The connected room era will have officially begun and Apple thinks those connected rooms will have four wheels. 

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Listen to this week's Above Avalon podcast episode (Episode 44: The Grand Unified Theory of Apple Products) for more information on this topic: Above Avalon, Overcast, iTunes.