iPhone Evolution

The iPhone's most remarkable quality is the degree to which its role in our lives has changed. In 2007, the iPhone was a computer that fit in our pocket. The product evolved into the most valuable communications tool in our life thanks to advances in camera technology. We are now on the verge of the iPhone becoming a new kind of personal navigator as Apple embraces augmented reality. The iPhone's role in our life doesn't remain static, but rather it evolves. This fact has major implications when it comes to thinking about iPhone sales and pricing, screen size preference, upgrade trends, and even how other gadgets will fit into our lives. 

The iPhone 7 Plus

One takeaway from Apple's 2Q17 earnings was that the iPhone 7 Plus is selling surprisingly well. Management assumed the larger iPhone form factor would gain popularity, but iPhone 7 Plus demand has exceeded Apple's internal expectations. Not only has the iPhone 7 Plus sold well in the U.S. and Europe, but the model is seeing double-digit sales growth in China.

Relying on app usage trends provided by Fiksu, iPhone 7 Plus demand looks to be up at least 20% year-over-year compared to the iPhone 6s Plus. Given that overall iPhone sales are trending flat year-over-year, sales of the other iPhone models are not as robust as that of iPhone 7 Plus. In fact, management commented on how subdued interest in older iPhone models drove much of the sales weakness in China last quarter.

This raises an obvious question: Why has the iPhone 7 Plus seen such strong demand? The model looks very similar to an iPhone 6 Plus and iPhone 6s Plus. In addition, consumers have had the option to buy an iPhone with a 5.5-inch screen for three years. 

The most logical explanation is that the iPhone's role in our lives continues to change, and iPhone 7 Plus features have become more appealing than those of smaller iPhones. Bigger screens are gaining popularity because photos and videos are becoming a more crucial part of our daily communication. While large screen smartphones have been popular in Asia for years, momentum is only now building in Western markets. In addition, the dual-camera system in the iPhone 7 Plus has led to Apple's significant marketing campaign around Portrait Mode. The iPhone 7 Plus camera is actually one of the more marketable iPhone features in years, which speaks volumes about iPhone being the key communication device in our lives. 

Evolution

Up to now, iPhone evolution has meant the process of Apple gradually improving features and components each year. Rather than calling a new iPhone a revolutionary update, we look at year-to-year hardware and software changes as evolutionary. However, this doesn't do a great job of describing what is really taking place with the iPhone. The iPhone's role in our lives is the item actually evolving. The iPhone is not a static product providing a similar experience year in and year out, much like a laptop or desktop. Instead, the iPhone's definition changes over time thanks to software and hardware advancements.

2007. Next month marks the tenth anniversary of the iPhone's launch. In what is now widely referred to as the greatest product unveiling of all time, the iPhone introduction provides an easy way to see the iPhone's initial definition out of the gate. The iPhone was positioned as a widescreen iPod with touch controls, a revolutionary mobile phone, and a breakthrough internet communicator wrapped into one product. Judging by the audience's reaction and applause, the most anticipated feature was the revolutionary mobile phone, not the internet communicator. Said another way, the iPhone was initially viewed as a different kind of phone. 

Steve Jobs introduces the iPhone in January 2007.

2008. The App Store introduction in July 2008 set the iPhone on its current trajectory. It became clear that the iPhone wasn't just a phone, but rather a computer that fit in one's pocket. The potential found with iOS was not fully appreciated at launch. A smartphone was initially looked at as a device supplementing our PC usage while away from the desk or home. This is one reason why Blackberry was so popular among business users. For the first time, they had access to their email while away from the office.

2012. Facebook's acquisition of Instagram in 2012 was a turning point not for Facebook, but rather for the smartphone camera. Around this time, the iPhone's role in our lives was also changing. The device was no longer just about having email or webpage browsing in our pocket. The camera began to gain value. We started using cameras for more than just capturing memories. Social networks based entirely on pictures started to take off. Other companies, including Snapchat, soon followed in terms of fostering new forms of communication based on new visual mediums. If the camera renaissance began in 2012, then the video renaissance started a few years later. Everyone is now battling for live streaming prominence. The latest trend with video filters begins to reveal where things are headed: augmented reality.  

AR Navigator

There are signs that the iPhone's role in our lives is about to change once again. We are on the verge of the augmented reality (AR) era. Apple has been investing heavily in AR for years with a number of notable acquisitions including Metaio, Emotient, Polar Rose, Faceshift, PrimeSense, Flyby Media, and Perceptio. AR is going to turn the iPhone into a smart pair of eyes. These eyes will transform the iPhone's functionality. Much of what has been written and said about AR positions the technology as merely an interlacing of objects with a real-world layer. Snapchat filters come to mind. However, the much more interesting and valuable attribute found with AR is having a device extract data from our surroundings and then offer additional value and context to the user. The dual-camera system found in the iPhone 7 Plus is able to extract more data than any other iPhone camera. 

Near-Term Implications

Higher Pricing. As the iPhone's role in our live continues to evolve, the device has been able to capture an increasing amount of value. When phones were just phones, we were willing to spend a certain amount on the device and corresponding service (voice minutes and text messages). Once the iPhone kicked off the era of smartphones turning into computers, we valued "phones" differently. We were willing to pay much higher prices because the devices provided additional value. Once an iPhone becomes an AR device, we are going to place even more value on the device. This will manifest itself in higher iPhone pricing. There is a reason why there has been an increasing number of reports and rumors about future iPhone pricing exceeding $1,000: It makes plenty of sense. 

Higher Costs. Simply put, it is costing Apple more to build iPhones. Apple is passing these higher component costs on to consumers. Apple increased iPhone pricing by $100 in 2014 for the 5.5-inch screen found with the iPhone 6 Plus. Pricing was raised by another $20 last year to account for the dual-camera system found in the iPhone 7 Plus. An iPhone model exceeding $1,000 is inevitable due to the simple fact that screen and camera technology costs are increasing. This may seem to be a recipe for disaster when it comes to iPhone demand. However, iPhone 7 Plus shows there has been a certain level of inelasticity found with iPhone demand. It all comes back to iPhone evolution and the iPhone's role in our lives changing to support higher pricing. 

Screen Size Preference. The 4-inch iPhone SE served Apple well over the past year. According to my estimates, Apple sold 30M iPhone SE units to date. However, the iPhone's evolution will likely impact screen size preference going forward. The desire for one-handed iPhone use is being surpassed by the desire to consume photos and videos on larger screens. It is becoming difficult to see 4-inch iPhone screens remaining in Apple's product line. Instead, the product will likely be cannibalized by iPhones with larger screen to bezel ratios. Apple will be able to fit larger screens in a similar form factor, thereby solving the dilemma experienced by those wanting not only one-handed iPhone use, but also larger screens.

Long-Term Implications

iPad Demand. As larger iPhone screens become the norm, small iPad screen demand will continue to decline. As discussed in my "Peak iPad Mini" article published in November 2015, there is no room for the iPad mini in Apple's evolving product line. Going forward, the iPhone will continue to represent the iPad's biggest headache. Larger iPhone screens handle many of the core items that were initially positioned as key iPad selling points. This will force Apple to position the iPad as a high-end device focused on larger screens and tasks such as writing, drawing, and sketching.

Wearables Demand. The iPhone may be great at capturing the world around us, but it comes up short in terms of capturing a crucial part of our lives: biometrics data. Health monitoring will represent a key use case for wearables (not just for Apple Watch). It may seem counterintuitive, but the more crucial of a device the iPhone becomes in our life, the more room there may be for a new breed of device. 

Upgrade Trends. While the iPhone upgrade cycle will continue to elongate, a ceiling may begin to appear preventing the iPhone upgrade cycle from approaching that of a PC or Mac. The iPhone's evolving role in our lives makes the product much more dynamic than a laptop or tablet. The amount of change seen over the course of four to five iPhone versions will likely keep the average upgrade cycle from extending beyond five years. The wild card is the degree to which consumers embrace annual upgrade plans that take much of the decision-making out of the process and make iPhones that much more accessible to the mass market. 

It's All About the Camera

Critics have been wrong about iPhone over the past 10 years because they failed to predict iPhone evolution. When the iPhone was just a computer in our pocket, the device was said to eventually lose to lower-priced computers. Instead, the iPhone became the most valued communication tool in our lives. Some now think the iPhone will lose to the most powerful communication services currently running on the iOS platform. However, the iPhone won't just remain a communication tool. Instead, the iPhone is quickly becoming a personal navigator capable of capturing much more data around us. 

My theory as to why the iPhone has evolved while larger screens like tablets, PCs, and TVs have seen much less change is that the iPhone contains the most valuable camera in our lives. As the iPhone's role in our lives has changed, camera usage has increased. We are giving much more value to the most mobile camera in our lives. The fact that we have our iPhones on us throughout the day breeds this evolutionary process. It also helps having an industry the size of the smartphone industry work on advancing certain core technologies found with the camera (hardware and software). The camera's importance to iPhone evolution raises an intriguing idea. The iPhone's future may be found by forecasting how we will use and value cameras in our lives.

Receive my analysis and perspective on Apple throughout the week via exclusive daily emails (2-3 stories a day, 10-12 stories a week). To sign up, visit the membership page.

Apple Wearables Sales Outpacing iPhone out of the Gate

Apple's wearables platform is gaining momentum. According to Apple's most recent earnings and management commentary, the company sold more than five million wearable devices last quarter. When combined, Apple Watch, AirPods, and W1 chip-enabled Beats headphones are now outselling Mac in terms of unit sales. More impressively, Apple wearables are tracking ahead of iPhone in terms of unit sales out of the gate. As competitors continue to approach wearables with caution, Apple is doubling down. 

Apple's Wearables Platform

Apple's wearables platform consists of three product categories:

• Apple Watch. Launched in April 2015, Apple Watch is Apple's first wearables device. After reconfiguring the Apple Watch line this past September, Apple now sells five Watch models ranging from a $269 Apple Watch Series 1 to a $1,499 Apple Watch Hermès. To date, Apple has sold 25M Apple Watches (my estimate). 
• AirPods. AirPods are much more than just a pair of wireless headphones. The inclusion of Apple's new W1 chip, along with a series of sensors and voice accelerometers, position AirPods as Apple's second major wearables product. Despite launching with very limited supply in December 2016, Apple has managed to ship at least three million AirPods (my estimate) in a little more than three months on the market. This amounts to $475 million of revenue in just the first 14 weeks on the market. 
• Beats headphones. The inclusion of Apple's new W1 chip means three Beats headphone models (BeatsX, Solo3, and Powerbeats3) should be classified as Apple wearables. The expectation is that these headphones will gain additional features in subsequent versions. 

Apple launched a wearables platform with Apple Watch two years ago in April 2015. Apple has since expanded the platform to include devices for the ears (AirPods and Beats headphones). As Apple unveils new wearable devices and form factors, those products will expand the company's wearables platform.

Sales Trends

There has been an intense debate involving wearables and how to define sales success. The best way to begin addressing the issue is to go over the sales numbers. As seen in Exhibit 1, Apple Watch and iPhone have been trending similarly when we look at sales out of the gate. When looking at the first two years each product was available in the market, we see that both Apple Watch and iPhone are outpacing early iPod sales by a wide margin.

Exhibit 1: Early Sales Trends (Two Years Following Launch)

Rearranging the data from Exhibit 1 into cumulative unit sales removes the seasonal impact. It becomes easier to see how Apple Watch and iPhone are running neck-and-neck for second best-selling Apple product category across the first eight quarters following launch. The fact that Apple has sold nearly the same number of Apple Watches as iPhones during the first two years on the market will surprise many people. The narrative surrounding Apple Watch does not match that of a product very close to being the second best-selling product out of the gate in Apple's history.

This past quarter marked the eighth quarter that Apple has been selling a wearable device. When AirPods and Beats headphones unit sales are added to Apple Watch sales, the true extent of Apple's wearables platform becomes apparent. Apple's total wearables sales are outpacing iPhone sales out of the gate. As seen in Exhibit 2, AirPods and Beats headphones sales boosted Apple wearables sales in the seventh and eight quarters following Apple's wearables platform launch.

Exhibit 2: Early Sales Trends (Two Years Following Launch)

On a cumulative unit sales basis, Apple wearables sales are exceeding iPhone sales by two million units after the first eight quarters on the market. Wearables are Apple's second best-selling product category out of the gate.

Key Considerations

Whenever sales comparisons are made between Apple wearables and iPhone and iPad, there are a number of key differences between the product categories that need to be discussed.

iPhone. In 2007, Apple launched the iPhone with very limited distribution. For the first four months, iPhone was only available at AT&T in the U.S. By time the iPhone 3GS launched in 2009, the iPhone was available in 80 countries. The iPhone's limited distribution masked the product's underlying adoption trends. During those first two years on the market, consumers began to see value in a hand-held computer. This makes it impossible to know how well the first iPhone would have sold if it was given a much wider launch. It took a few years for the mass market to become interested in iPhone. 

iPad. The iPad launch was timed perfectly and enabled the iPad to ride the iPhones' coattails. The iPhone app bonanza certainly contributed to iPad sales in addition to the fascination found with much larger multi-touch screens running iOS. While the iPad saw a limited rollout at launch, distribution was much wider than it was with the iPhone launch a few years earlier. 

Apple Watch. Despite Apple Watch seeing a much wider rollout at launch, the product has faced a different kind of constraint. Apple Watch requires an iPhone. This has the effect of more than doubling the entry-level price of Apple Watch for non-iPhone owners. Even though the Apple Watch was available in nine countries, including China, at launch, the product's target market was closer to 500M people. 

AirPods. AirPods launched this past December in more than 100 countries. Exhibit 2 adds AirPods sales to Apple Watch and Beats headphones sales beginning in the sixth quarter following Apple's platform launch. This ends up adding quite a bit of conservatism to Apple wearables sales as AirPods will likely be on an annual sales pace measured in the tens of millions per year by time they have been available in market for eight quarters. As long as supply improves, AirPods will likely give the iPad a run for its money in terms of it being the best-selling Apple product out of the gate over the first two years. (The methodology and math behind my AirPods sales estimates are available for members here.)

Context

One takeaway from all of these launch and distribution differences is that each product has faced its own set of unique situations and challenges. However, there is value found in comparing sales of wearables to those of early iPhone and iPad because such comparisons provide context for wearables sales.

Many people have been grading Apple wearables on a curve, looking at the devices through an iPhone lens. Since unit sales pale in comparison to current iPhone unit sales (220M a year), wearables are being cast off as either disappointing or irrelevant. This ignores what is growing momentum for Apple's wearables platform.

To have Apple wearables sales outpace iPhone sales out of the gate when looking at the first two years of availability demonstrates that wearables are a thing. Apple has built and sold more wearables than iPhones after the first two years in the market. That fact goes a long way in helping to define just how significant Apple wearables sales have been. It is irrelevant if Apple could have shipped additional iPhones by launching with wider distribution back in the late 2000s. An argument can be made that Apple would have sold many more wearables this past quarter if it wasn't for severely constrained AirPods supply.  

Redefining Wearables

Too much attention is being placed on Apple Watch as holder of the wearables torch. Instead, the focus needs to be placed on both Apple Watch and AirPods, with W1 chip-equipped Beats headphones representing Apple's third wearables product category. Instead of looking at these wearable devices as standalone products with few similarities or overlap, we should view them as coming together to create a platform, as shown below. AirPods usage increases the value found with Apple Watch ownership. The reverse applies as well. Apple Watch usage increases the value found in AirPods ownership. This interdependency is only going to intensify and likely boost overall Apple wearables sales.

Looking Ahead

According to my estimates, Apple is on track to sell more than 30M wearable devices in 2017. This is an astounding figure considering that it would represent approximately 15% of the number of iPhones Apple is expected to sell in 2017. As seen in Exhibit 3, there is a strong probability that Apple wearables sales will continue to outpace iPhone sales when looking at the first three years of availability following launch.

Exhibit 3: Early Sales Trends (Three Years Following Launch)

Note: AboveAvalon.com projections used for wearables sales quarters 9 to 12.

Looking out a bit further to the first five years of availability following launch, things become even more interesting. The iPhone began to outsell the iPad three years following launch, and the sales gap has increased ever since. Similarly, Apple's wearables platform is positioned to outsell iPad in roughly the same amount of time following launch. It is not out of question that Apple wearables will continue outpacing iPhone as we move to four years of availability following launch. While this is no small task as Apple would likely need to double the number of wearables it is currently selling, AirPods would play a key role. 

Exhibit 4: Early Sales Trends (Five Years Following Launch)

Note: AboveAvalon.com projections used for wearables sales quarters 9 to 12.

Momentum Building

This past holiday season, Apple passed Fitbit to grab the title of largest wearables company. This past quarter, for the first time, more Apple Watches than Fitbit devices were sold. The number of people wearing an Apple wearable device has likely surpassed 20M. Apple is laying the foundation for a wearables platform that will eventually grow to annual unit sales in the hundreds of millions of devices. 

Receive my analysis and perspective on Apple throughout the week via exclusive daily emails (2-3 stories a day, 10-12 stories a week). To sign up, visit the membership page.