Apple Watch Sales and Earnings Projections
Apple will start selling Apple Watch in early 2015 and based off of my analyses, I estimate Apple will sell 20-30 million Apple Watches bringing in $11 billion to $17 billion of revenue and $0.70-$1.00 of EPS over the first 12 months on the market.
Apple Watch Addressable Market
Analysts are relying on various methods to arrive at Apple Watch's addressable market including surveys, prior Apple product launch sales trends, and current watch market data. I disagree with those methods since they contain significant issues or error-prone variables.
- Surveys. Customer intention patterns do not correspond well with actual behavior.
- Previous Apple Product Launches as a Proxy. My biggest issue with this method is that it ignores the passage of time and ecosystem changes.
- Current Watch Industry Data. As Apple has shown over the years it is pointless to use existing pre-Apple industry market data as a proxy for future Apple sales.
I extrapolate Apple's addressable market for Apple Watch from iOS adoption rates. I use the share of iOS devices that upgraded to the latest iOS release by the end of the first full day after release as a proxy for Apple's most loyal customer base. I classify these users as a fair approximation of Apple's initial addressable market for an Apple Watch. Using a 2.4-year iPhone replacement cycle, I estimate there are approximately 400 million iPhones in use today. Since there are older devices resold or passed down to children and relatives, I would label the 400M data point as a base case estimate.
I consider a user that upgrades to the latest iOS release within the first full day after release as someone who is more interested in their phone and consequentially Apple. Why? These users are actively seeking out, and then upgrading, their iOS software which demonstrates an interest in their device or a willingness to try the latest software product. The steep adoption rate drop-off from iOS7 to iOS8 suggest there wasn’t much of an impact from Apple automatically sending a download notification to devices on the first day of a major software release this year. Exhibit 1 displays adoption rate estimates for the previous three iOS version launches.
Exhibit 1: Apple iOS Adoption Rates
Using the average between Mixpanel and Fiksu, I arrive at 13%, however Mixpanel has historically tracked closer to Apple's reported adoption rates, therefore I increased the 13% average to 15% to reflect a greater weighting for Mixpanel. I then multiplied that percentage by the 400 million iPhones out in the wild to arrive at approximately 60M core iPhone users that serve as a prime target to sell Apple Watch (which requires an iPhone 5, 5c, 5s, 6, or 6 Plus). It is important to note, as Apple VP Greg Joswiak said recently at the Code/Mobile conference, the Apple Watch is geared for everyone and not just those interested in technology. However, due to the requirement of owning an iPhone, I think 60 million is a fair estimate of the number of people interested in buying an Apple Watch from Day 1. Another variable is since adoption rates reflect iOS devices, there may be an impact from the same user upgrading all of his or her iOS devices at the same time. Considering the steep adoption rate drop off from iOS 7 to iOS 8, this impact doesn't worry me too much as I consider my 15% estimate to be a base case as there were many users who could not upgrade to iOS 8 on the first day because of a lack of storage.
Apple Watch Sales Projections
With my 60M estimate for the addressable Apple Watch market, I assume everyone in this group buys an Apple Watch over the first 12-18 months. Taking into consideration Apple Watch prices, a certain amount of time may be needed before a purchase is made therefore I backloaded sales into the second year to arrive at 20-30M units sold in Year 1 and 30-40 million units sold in Year 2.
Exhibit 2: Apple Watch Sales Projections
Apple Watch Average Selling Price Estimate
I estimate the Apple Watch average selling price (ASP) to be $563, as shown in Exhibit 3. While the $349 price for Apple Watch Sport has been announced, I included estimated selling prices for the other two watch collections. My estimates do not include additional Apple Watch band revenue. I am estimating a $7,500 estimate for a supply constrained Apple Watch Edition. I wouldn't expect much of a difference in demand moving from $3,000 to $7,500, so in order to maintain its exclusivity, I expect Apple to set a high price. The obvious risk to my logic is if Apple prices the Edition collection closer to $1500 and includes a viable replacement program, driving much more in the way of sales, but even then the ASP would only change by approximately 15%. I expect China to be a big variable when estimating Apple Watch Edition sales, but for now I am including a limited production schedule at least in the first few quarters of release.
Exhibit 3: Apple Watch Collection Breakdown and ASP Estimate
Apple Watch Sales and EPS Estimates
Exhibit 4 includes my estimates for a few Apple income statement line items. I estimate Apple Watch margins will come in less than iPhone, but higher than iPad with economics of scale adding a few hundred basis points of margin over time. Obviously this is an inexact science and watch accessories can help boost margin. Estimates reflect continued share buyback through 2016.
Exhibit 4: Apple Watch Revenue and EPS Estimates
Conclusions
I suspect Apple may have a hit on their hands with Apple Watch. Running with a 15% iPhone base penetration rate, I estimate Apple will be able to sell upwards of 60 million Apple Watches over the first 24 months on the market with more risk to the upside given Apple's strong iPhone guidance for this quarter. From an EPS perspective, Apple Watch can add between $0.70-$1.00 in the first 12 months after launch.
This report should be used to understand where I stand on Apple Watch especially when I discuss the product in my daily email, AAPL Orchard, or in other Above Avalon reports. Over the coming months, if new data becomes available, I will update my estimates accordingly. This report is not meant to be used as investment advice. Downside risks to my estimates include: Apple Watch supply issues and weaker-than-expected customer demand. Upside risks to my estimates include: Stronger-than-expected customer demand, especially in China. This report was produced by Neil Cybart on November 18, 2014.
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UnionPay Received an Apple Press Release
Event: Customers in China can now use UnionPay for App Store purchases.
1) Apple has issued 48 press releases YTD in 2014, all of which have a certain level of importance and noteworthiness, which stands at contrast to many other companies of Apple's size.
2) I judge an Apple press release's importance by its Apple executive quote. Apple SVP Eddy Cue in announcing UnionPay support: "The ability to buy apps and make purchases using UnionPay cards has been one of the most requested features from our customers in China" and "China is already [Apple's] second largest market for app downloads, and now we're providing users with an incredibly convenient way to purchase their favorite apps with just one-tap." I really wouldn't read much more into the announcement. Apple expects this deal will boost app purchases in China, simultaneously boosting the iOS ecosystem.
3) China is an interesting topic when analyzing Apple. Many assume that China represents untapped potential where Apple will win simply by opening retail stores and selling new product. In reality, Apple has been working extremely hard and has faced numerous challenges in China. Greater China (Hong Kong, Taiwan, and the mainland) currently represents approximately 15% of Apple's revenue. This UnionPay press release embodies one small victory that when combined with years of work will likely lead to China being Apple's largest market.
Samsung's White Flag
Samsung's battle with Apple in the high-end consumer tech space is likely over. This past February I wrote a piece titled, "Samsung's Crisis of Design 2.0" referencing Samsung's utter lack of direction and focus with half-baked smartwatch ideas and subpar smartphone industrial design. The first "crisis" occurred when Samsung was unsure how to compete with the iPhone's user experience back in 2010. Now in an effort to find growth Samsung is focused on the Internet of things despite software being the company's weak point. Engineers are being shuffled around, management tension is building, and the company is still trying to find something that will stick against the wall. Two months ago Tim Cook was on Charlie Rose and when the question about Apple's competitors came up, Tim Cook quickly responded "Google" and then mentioned how Google enables other hardware companies, like Samsung. The message was clear: Samsung was already placed in Apple's irrelevant bucket. I suspect Samsung will give the low-end smartwatch space another try once the Apple Watch is released, but with design and software being Samsung's weak points, my expectations are set pretty low.
Large M&A Is Not in Apple’s DNA: Case Study of Why Apple Won’t Buy Tesla
Apple’s Beats acquisition raised questions pertaining to Apple’s attitude towards acquisitions. The $3 billion price tag was approximately five times higher than that of its previous largest acquisition, NeXT in 1997, after adjusting for inflation. Was Beats the start of a new era in which Apple would follow other large tech companies and use some of its $150 billion cash pile to fund larger acquisitions? While Apple may alter its outward appearance in reaction to the environment, large M&A is not part of Apple’s DNA. With Apple’s product success built on collaboration and design and reinforced by Apple’s organizational structure, there is no room for large M&A. Using this theory to address a real case study, Apple will not buy Tesla because of the low probability of long-term value creation.
Acquiring Beats
Beats did not represent a change in Apple’s acquisition strategy. The $3 billion price, while large on paper, is a bit misleading because Apple acquired a significant amount of intangible assets, including brand and human capital, which I discussed in my piece titled “What the Beats is Going on? Thoughts on Apple Acquiring Beats” published soon after the rumor broke. With only 700 employees, Beats was not a large company. Approximately 200 employees were not given long-term Apple employment according to Bloomberg, leaving roughly a 500-person team, or a team the size of a small Apple division. If additional personnel are shifted to other departments over time, Apple is left with a 300-person team that can easily fit into Apple’s way of doing business. Beats ends up looking very similar to many other Apple acquisitions. I look at the Beats deal as Apple reacting to the changing music industry with no underlining change to its philosophy of avoiding large acquisitions, just as someone can change his or her physical appearance, despite having the same personality and DNA.
Apple’s Keys to Success
Apple SVP of Design Jony Ive isn’t one to shy away from describing how Apple has been so successful, and that trend continued last week with a talk he gave at Design Museum in London. To Jony, success is born from complete collaboration and focus, which at Apple means something more unique than at other companies.
Apple’s 18-person core industrial design team remains very loyal and tight-knit with no deflections over the years. The group’s small size and the benefits that arise from that make Jony hesitant to grow the group much more. It is that family-like bond that contributes to Apple’s success as products are created over a multi-year period with conversations in the earliest stages often determining where the next steps will lead. Jony told the audience at Design Museum, “[p]articularly at the beginning of ideas, we have to have incredible discipline to listen really hard. To realise we can end up somewhere very different if we make these decisions…[product design] always starts off as a conversation and a thought.”
Collaboration
Collaboration manifests itself elsewhere in Apple’s structure as major initiatives take resources from different departments. An analogy I like to use associates an upcoming Apple product with a Macy’s Thanksgiving Day Parade balloon float. The rope handlers (those who help guide the balloon) represent resources from different Apple departments. If a few aren’t on the same page, the float may veer of course or become unsteady. Once the float has navigated the parade route safely, the rope handlers (employees) can move on to the next balloon (product). Bloomberg had reported that the Apple Watch had “hundreds of engineers, designers, and marketing people” working together over the span of two years. How can big M&A fit into this required collaboration to create additional value?
Design
Even if a company can find the secret to bottle collaboration, success is still not guaranteed as the keystone; intuitive design, is missing from the arch of success. Design and collaboration go hand-in-hand, not just for consumer tech hardware companies, but for any company selling a product. Jony explained this trend when he said, “I think it’s much harder for good design to come out of an organization and to come from that as a driving force. [Apple’s] goal is to desperately try to make the best products we can.” Adding in new teams, resources, and ideas to a very tightly controlled equation raises the risk of failure without adding much in the way of upside. With Apple being a product-focused company, this delicate combination of intuitive design and collaboration makes it that much more difficult to add large M&A into the mix.
Apple’s Existing M&A Strategy
Apple has been quite active on the acquirer front, with approximately 35 acquisitions since the beginning of 2013, most of which were never made public. A few commonalities amongst these companies: small, focused, bolt-on type transactions. Apple looks at acquisitions as a way to fill talent and resource holes that could only be addressed in a timely manner by acquisition. Tim Cook has often said while Apple has a significant amount of cash, Apple does not have unlimited resources in terms of human capital and will have holes that become apparent either in the areas of software deficiencies or hardware design.
Apple M&A Case Study: Tesla
BI Deputy Editor Jay Yarow published an article last week titled, “Apple Should Buy Tesla,” containing four reasons why Apple should acquire Tesla:
Apple can afford to spend $60 billion on Tesla so it should spend the cash.
Apple knows how to manufacture complex objects like phones and tablets, so a car shouldn’t be that much different.
Elon Musk could focus on other ventures besides cars.
Apple executives Eddy Cue, Phil Schiller, and Jony like cars.
While I assume some of these reasons are a bit tongue-in-cheek, and Yarow primarily is looking at Tesla’s popular Model S vehicle and the inability to meet demand due to manufacturing “troubles” as reasons for Apple to acquire the company, does Tesla pass the litmus test for representing a key Apple acquisition target? Three reasons lead me to conclude no; a Tesla acquisition would make little sense for Apple.
1) Tesla doesn’t bring enough value to the table. I struggle to see the value Tesla would provide Apple especially when compared to the value Tesla is creating on its own concerning energy generation, storage, and distribution.
Does Tesla have design talent? Yes. Does Apple need a significant infusion of design talent? No.
Does Tesla have a great product? Yes, the Model S. Does Apple need to have that product to offset a weaker product portfolio or missing hole in its ecosystem? No.
Does Tesla provide any strategic benefits to current Apple products? No (excluding possibly some aspects of battery R&D).
Does Tesla have headwinds or negatives that may continue after an acquisition? Yes. Regulatory roadblocks concerning vehicle sales as well as consumer limitations with electric cars.
2) Tesla is too large and complex. With approximately 10,000 employees, a 5.5 million square foot assembly facility in Fremont, California, and now a $5 billion advanced battery factory being built in Nevada, Tesla would not be easy company to fold into Apple. Add in the financial complexity from building cars and owning such significant level of assets, and the financial impact on Apple quickly becomes just as ugly. Apple has traditionally outsourced manufacturing and assembly, and with Tesla that would be drastically altered as Tesla is known for its ability to turn raw materials into a finished product all in the same plant – one reason contributing to the vehicle’s high price.
3) Apple doesn’t need Elon Musk. Steve Jobs’ greatest product was Apple: a company built to allow complete collaboration and focus. At this point in Apple’s history, the company doesn’t need an Elon Musk figure, whose aspirational dreams concerning transportation and civilization may cause friction within Apple. That type of overarching reach and generalization could lead to significant issues for Apple and its product-led, design-focused goal where end products may end up having just as big impacts on society as some of Musk’s reaches, but without the fanfare during the development stage.
In a situation where Tesla did have value to bring to the table, such as incorporating CarPlay into its vehicles or battery technology, a partnership with Apple would make more sense, similar to Apple’s recent IBM enterprise partnership for getting more iOS devices into the corporate world. In addition, even though Apple already has R&D dedicated to transport and vehicles, primarily on the side of energy production and efficiency, it’s not clear what the automotive industry will look like in 5-10 years and if there is a need for Apple to enter the space. It may be more likely that Apple gets involved in automobiles at a point where the industry has shifted to a position where a new entrant with a different way of looking at the world and automobiles can enter the space to create a great product.
Apple’s M&A Going Forward
I wouldn’t expect any slowdown in Apple’s acquisition pace as the company continues to push the envelope with various products such as more powerful mobile devices, innovative industrial design, and new services for content (music, video, apps, and communication). By remaining “focused” on a few products, Apple does leave itself exposed to holes where outside talent may be needed, but with $150 billion of cash and a company DNA that doesn’t include large M&A, Apple has significant resources to accomplish the goal of making great products.
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Week in Review; Most Popular Daily Email Links
I look back at the most popular links found in the AAPL Orchard daily email this past week. To receive this daily email containing Apple-related links and analysis, please subscribe here.
Most Popular Links of the Week:
1) Apple SVP of Design Jony Ive's talk at Design Museum in London. The talk focused on the issues with the way designers are educated and the lack of focus on making physical products. I thought Jony's comment on “careless” products from other companies and designers was pretty interesting: "If you expect me to buy something where all I can sense is carelessness, actually I think that is personally offensive...It's offensive culturally, because it shows a disregard for our fellow human." Jony spoke for an hour and covered a range of topics. Dezeen took splendid notes. If you are interested in Apple or design, I recommend finding 10 minutes today and taking a read. - Dezeen
2) Apple Has a New Product: $300 Wireless Beats Headphones. They actually look pretty nice. It makes it even more amazing how Apple was able to turn generic white EarPods that came free with iPods and iPhones (and cost a few bucks to make) into such a powerful marketing tool up until a few years ago. - MacRumors
In a follow-up post, it seems like initial reviews are positive. - MacRumors
Related: My four main takeaways from Beats' new $300 headphones. - Above Avalon
3) Apple's $3 Billion Bet on Reinventing the Music Industry. I had been mulling Apple and music for a number of weeks and over the past few days the increasing number of music-related news items actually makes my piece quite timely. There’s a lot to think about in the post, and I add more perspective and color on the subject in the upcoming Above Avalon podcast which will be published in the coming days. I think all music will eventually be free, but the music industry first needs its own “App Store” moment where a software platform can reset how the music industry makes money and Beats can be that platform. Similar to software post-App Store launch, music creation, distribution, and monetization can be revolutionized by a new platform where there are minimal barriers between fans and content creators. - Above Avalon
Reminders:
Podcast. The first episode of the Above Avalon podcast was published earlier this week containing introductions and comments about Apple Pay. Each week I will focus on one Apple-related topic. Listen and subscribe (for iTunes and Overcast) here. A new episode will be published in the coming days.
Four Interesting Things About Apple's New $300 Beats Headphones
Event: Beats announces new $299 Solo2 Wireless on-ear headphones.
1) These headphones are the same price as an iPad mini 2. Higher-end Beats headphones go for $399; the price of iPad mini 3. The iPad mini will likely go down as having the lowest margins out of any mainstream Apple product in recent years (closer to 25-30% vs. iPhone's 55-60%). I would venture a guess that these Beats headphones probably have margins closer to iPhone (if not exceeding) and that is before taking into account any savings from Apple buying the company.
2) Beats is using color as a price differentiator. Red, black, white, and blue costs $299, while Stone Grey, Hunter Green, Imperial Violet, Blush Rose, and Sapphire Blue costs $199. Reminds me a little bit of iPhone 5c. Interestingly, the red is only available at Verizon (I assume some prior business partnership?) Edit: Looks like the five additional colors is actually for the wired Solo2. Color still being used as differentiator but for different models.
3) I estimate Apple will sell around 2-3M Beats headphones in 2015. A high estimate would be around 4M. With an average selling price of around $285, Apple may bring in $600-800M of annual revenue, or 10% of Apple's old "accessory" revenue which is not a big line item when compared to overall revenue. These headphones will not move any financial needle for Apple. Instead these devices are all about brand positioning and mindshare (getting people to see them and talking about them).
4) Looking at $299 headphones makes it that much more amazing to think how Apple was able to turn generic white EarPods that came free with iPods and iPhones into such a powerful marketing tool up to a few years ago.
Bonus: I expect to see more interesting things come from the wireless on-ear/in-ear headphone space.
Yale Researcher Inadvertently Helps Market the Apple Watch
Craig Palsson looked at the way the iPhone 3G was launched exclusive to AT&T, tying the subsequent 3G roll-out in the U.S. to nearby hospital data. He found that injuries to children under five increased 10% from 2005 to 2012 while there was no discernible increase for older children. The full report can be found here. Palsson theorizes that parents are more distracted since they can do more work around the house on their iPhone resulting in lower parental supervision.
I don't view the iPhone, or any smartphone for that matter, as the most efficient device for consuming information. If I'm not actively interacting with the device, swiping left and right or tapping various buttons, then the device isn't providing much data and information. I am also forced to jump through hoops just to get the same small bits of information throughout the day such as a stock ticker, email, or location marker.
Enter: Apple Watch.
Apple Watch will excel at displaying cursory information on a display that is always in line-of-sight. How would you know when to briefly look down at your wrist? Taptic Engine (produces haptic feedback). We can take it even further and the Taptic Engine may remove the need to actually look at the device. Your significant other can let you know they are on their way home by three quick taps. By streamlining the way we consume data using new sensory signals, the Apple Watch will not only usher in the era of personalized technology but also a new form of personal communication.
Less time focused on our gadgets and more time viewing the world around us.
Apple's Mac Resilience in a Mobile World
A curious thing happened to Apple last quarter: Seven years after launching the iPhone and four years after launching the iPad, Apple reported the best sales quarter ever for Mac. The belief that Apple would never sell as many Macs as it did during the first quarter of 2012 (known as “Peak Mac”) was busted. Tim Cook and Apple are as bullish as ever on Mac. I don’t think it’s a stretch to theorize that Mac’s resilience is born from the phones and tablets that many assumed would make the Mac irrelevant. As mobile devices continue to invade our culture, the Mac may find an attractive computing niche thanks to its special use cases and design.
Mac vs. Mobile Devices
Tim Cook spoke highly about the Mac a couple of weeks ago at WSJD, summing it up with “people love big screens”. It is that stark contrast to mobile devices that benefits the Mac as consumers have an easier time differentiating the uses cases between a Mac and mobile device. After the iPad was launched, consensus quickly settled on the iPad cannibalizing the Mac. Running with Apple’s stereotypical “cannibalization is good as long as one of our products is to blame” and a cursory glance at Apple’s 2013 quarterly results, which showed declining Mac sales, was enough for many to cast the Mac aside.
I even thought the “iPad will cannibalize the Mac” argument made sense as I owned an older 2008 Macbook, which was giving me a lot of trouble, and my new iPad 2 was occupying all of my attention. But as smartphone penetration grew, and more importantly, mobile device capability expanded, the Mac started to stand for something that a phone or tablet would never be able to bring to the table: a nice big screen. Compared to a 4.7-inch iPhone or an iPad, an 11-inch and 13-inch Macbook Air are more enjoyable to do various tasks and work, such as researching a topic or writing a report. A 27-inch iMac? Even better.
Fast forward a few years and I knew I needed a new computer so I bought a new iMac instead of an iPad Air because I had to do more writing and wanted a bigger screen for watching video. My Mac just cannibalized an iPad sale. I must not be alone as Mac unit sales have begun to stabilize and grew 21% year-over-year last quarter, aided by recent price cuts to MacBook Pro. Looking ahead, recent product updates should help continue year-over-year growth trends through 2015, highlighted by the grey bars in the following chart.
Mac is the Steady Ship to Mobile's Ebb and Flow
The Mac may also be benefitting from the continued ebb and flow of mobile devices. Consumers are still trying to decide what size of glass to carry in their pockets and soon on wrists. For some the trend is larger, embracing the 5.5-inch smartphone, for others the 4.7 and 4.0-inch form factor is best. Similarly with tablets, the iPad mini seemed to be the darling of the iPad line in 2013, but now looks increasingly likely to be discontinued with the iPad Air 2 as the best-selling iPad. All the while, the Mac’s large gorgeous screens have remained largely unchanged as its discovery phase occurred last decade. Consumers know what it's like using a Mac/PC. It's that comfort that can drive consistent upgrades through the years while our mobile devices continue to morph in order to find that perfect combination.
Design and Innovation
Instead of winding down Mac R&D, Apple continues to give the lineup the required attention and resources needed for continued evolutionary and revolutionary updates. Apple’s 2014 Mac lineup speaks volumes with a new Mac Pro , Mac mini, and retina iMac, along with solid updates to the rest of the Mac lineup. Has the Mac line ever been stronger?
Source: Apple
Compared to other research budgets in Cupertino, the Mac simply doesn’t compare, but that’s not the point and instead a better comparison would be Mac’s R&D spend today to that from a few years ago. I would wager there hasn’t been much of a reduction. In some ways, Mac’s design is the number one reason that people choose a Mac over PC. While a larger screen and dedicated keyboard may be what gets a customer interested in Mac, the design often is what leads to the purchase button being pressed. Competitors realize this and miraculously their designs have begun to mirror that of Mac.
Mac’s Growing Niche and the Future
The Mac has found its niche. Apple will likely sell 200M+ iPhones, 60M+ iPads, and 20M Macs over the next four quarters. Twenty million units is not bad for a product that was supposed to be made irrelevant by mobile. Going forward, there are a few larger themes that will help when thinking about Mac.
- Apple will continue to work on lowering Mac prices, especially at the low-end of the lineup.
- The Mac’s differentiated software from iOS will be a selling point.
- Apple will continue to innovate with Mac where it matters (productivity and design).
I suspect there will be a few wildcards thrown into the mix, possibly as early as next year. An iPad Pro, which I discussed in more detail a few weeks ago in my "Thoughts on iPad" post, may be unveiled (think iPad Air but with a 12.9-inch display and possibly new software features and accessories). Such a device would represent Apple’s response to softening iPad sales in the face of larger smartphones and Mac's resiliency. Looking further out I wouldn’t be surprised if Apple tracks how a larger iPad sells in comparison to the Mac line and then uses that information to decide if it is time to rethink both the Mac and iPad lines and if there is some kind of new device that would take the best features of iPad and Mac while not adding new friction points. In addition, Chromebooks in education deserve to be mentioned but at this point I still see Chromebooks more as a threat to Windows machines than the Mac. Many school districts like Chromebooks because of their low costs, placing them in a different target market than the Mac.
As Steve Jobs said, “If you do something and it turns out pretty good, then you should go do something else wonderful, not dwell on it for too long. Just figure out what's next." For Apple, the Mac has been great and I’m sure they are busy on making it even better.
U.S. and China Reach Trade Deal Reducing Tariffs on Tech Products
In an effort to boost cooperation and the global economy, it will be hard to find enough negatives in this announcement to outweigh the positives. The WSJ has a very detailed breakdown of possible implications. In terms of Apple, I wouldn't expect a $100 price reduction across the Mac lineup next year due to this agreement, although there may very well be a $100 price reduction across the Mac lineup due to other reasons (economies of scale, improved engineering). The WSJ mentions the tariff reduction agreement may actually help prevent software piracy, impacting the iTunes store. This whole story got me thinking about Apple's experiment with the Mac Pro being manufactured in the U.S. I wonder how that has been trending. Surely Apple has been learning a lot from the endeavor.
Two days ago someone asked me out of the blue, "Why doesn't Apple assemble iPhones in the U.S.?" I listed my laundry list of reasons. At the end, this person said, "Oh please, that's nothing. It's Apple." I didn't have a response. As global trade (and automation) become more efficient, my laundry list of reasons for why Apple doesn't assemble more things in the U.S. will shrink.
Apple’s $3 Billion Bet on Reinventing the Music Industry
Apple’s $3 billion Beats acquisition was puzzling to many tech industry observers, not because Beats sold expensive headphones, but due to the music business having largely been ignored for the past few years. Why did Apple invest $3 billion in music when it seemed like not much else could be added to the equation to change the inevitable shift to music streaming? Surely, Tim Cook had lost his mind. Six months later, Apple’s vision for Beats is becoming clearer and Apple is aiming quite high. Apple wants to reinvent the music industry (again) and place it on a more sustainable track.
Today's Music Landscape
The music industry is far from perfect.
- iTunes music sales are down 10-15% in 2014.
- YouTube is seeing, in each month, 1 billion unique users and 6 billion hours of video watched.
- Paid streaming remains niche (Spotify has 50 million active users with 12.5 million paid users).
- Ad-supported and paid radio remains niche (Pandora has 76.5 million active listeners).
- Music discovery and curation is difficult.
- Artists lack vital information on their fans.
- Monetization beyond concerts and endorsements is difficult.
- Buying concert ticket sales is difficult.
- New talent faces difficulties when trying to “make it” without proper backing and support from established circuits.
For the past 4-5 years, I’ve turned to YouTube for all of my music despite having a paid song collection numbering in the thousands. Since the songs are in iTunes, I often find it easier to pull up YouTube in my web browser or on my iPhone rather than scroll through my music list on my phone or open up iTunes on my Mac. Others get their music from streaming services such as Spotify or Internet radio like Pandora and iTunes Radio. While a lot can be written about the business economics of companies like Spotify and music streaming in general, I thought Spotify CEO Daniel Ek's blog post this morning, especially the last paragraph, summed it up pretty well.
'We’re getting fans to pay for music again. We’re connecting artists to fans they would never have otherwise found, and we’re paying them for every single listen. We’re not just streaming, we’re mainstreaming now, and that’s good for music makers and music lovers around the world."
Last week Taylor Swift bolted from Spotify and within a few hours of the announcement, disclosed record album sales. Coincidence? It doesn’t take an expert to run the math: ad-supported streaming (in its current form) isn’t going to put the same kind of money in musicians' pockets as paid downloads. With Spotify, the money is an after-thought as musicians use Spotify to improve their visibility and then focus on making money in the future through concerts or branding/sponsorships. While YouTube has made it easier to get discovered, there are still plenty of roadblocks that prevent them from making it to the next level and actually distribute music, schedule a PR campaign, and book a tour. Add in Facebook, Twitter, and Instagram, and musicians are spending a lot of time (and money) simply managing their fan interaction.
How could Apple solve some of these problems? Eliminate or reduce points of pain or friction, including monetization, discovery, and interaction.
Acquiring Beats
My gut reaction to Apple buying Beats was one of branding and mindshare. Apple’s iTunes was losing relevance in pop culture, and paid download sales were beginning to decline. Meanwhile, Beats’ headphones were everywhere in advertising and social media. Apple’s white EarPods were losing their “cool” factor in the music scene. Jimmy Iovine wasn’t on my initial list as to why Apple bought Beats, but now it’s pretty evident that Iovine’s contribution should not be underestimated as demonstrated by his captivating speech at Revolt.
The Music Industry needs their “App Store” moment.
A good analogy for today’s music industry is how the software industry looked prior to Apple’s App Store. Before mobile app stores, a developer needed significant resources to distribute and then maintain software, leading to difficult entry barriers for new participants. Piracy was rampant. After the App Store was introduced, it was much easier (and cheaper) to work on software and then distribute product to millions of customers across the world. Similarly, for music, a platform built on software and features can make it much easier for new artists to reach fans while helping to monetize product by building brand equity. While I wouldn’t go so far as to think of a music artist as an “app”, mainly because I think the analogy stops way before that point, it is more appropriate to look at the music industry as needing a revolutionary update, its own “app store” moment, to set it on the right path. The music industry is still going off fumes from decisions made in the early 2000s following the Napster debacle and many are afraid the current indecision may handicap the industry’s next big decision.
Tomorrow's Music Landscape
Michael Vakelenko wrote an interesting post titled "To Understand Beats you Need to Understand Lady Gaga" back when Apple bought Beats. I highly recommend reading it. Vakelenko argues that the music industry needs an "Uber" - an entity that will "aggregate demand", simplifying the artist/fan relationship. Eliminating many of the music industry's friction points (monetization, discovery, interaction), results in a scenario where:
- Music is free, but delivered via a platform where artists rely on software to monetize the brand (image and personality) through merchandising, advertisements, sponsorships.
- Artists have access to information on their fans.
- Artists can set up their own tours including ticket sales, booking venues, and even PR circuits through third-party apps.
- New talent can transition from discovery to monetization quickly without many barriers.
- The definition of “music artist” becomes boarder to emphasize a wider range of content creators.
Musicians will be CEOs of their brand. The digital product known as music can be thought of as marketing where artists rely on the platform to monetize their brand to loyal fans. Musicians can easily integrate existing social media services (Twitter, Facebook) into this platform, although there could be built-in mechanisms to connect with paid, loyal supporters. There will be plenty of opportunities for musicians to make money from advertisements where appropriate. Maybe a new kind of streaming service can now enter the picture. Additional possibilities can go further into merchandising, concert tickets, branding. As Iovine put it so well, it will be the "business of music" and no longer the "music business."
Beats Wants to be that Unique Music Platform
I suspect Iovine, and quite a powerful supporting cast, are working on making Beats that unique music platform. With iTunes, Apple is no stranger to the music industry and continues to hold much sway (800 million credit cards), but with Beats, Apple is now positioned even stronger with many friendly (and better-aligned) relationships to music artists, and I would even argue industry insiders. While Apple makes a significant share of its profits from hardware sales (supported by software), a revamped Beats music platform would represent another service for Apple, similar to Apple Pay, which can represent a diversification item, but more importantly, the ability to eventually transcend hardware.
- Beats could set up a revenue sharing arrangement with music artists going as far as to include concert sales and merchandising.
- The Beats platform would be both “open” (available on competing mobile platforms), and yet “closed” (built-in curation and approval process).
- Beats could position music as a competitive advantage for Apple, guaranteeing that iOS users will never fall victim to competitors purposely limiting functions or usability like Google’s behavior with maps.
- Apple would use this as a learning opportunity for how to handle apps and video.
Bono and Trent Reznor have both made comments about working on a new digital music delivery product with the focus being on building fan excitement. While I wouldn't read too much into anything being said in interviews, the point is Apple is tugging at the strings behind the scenes.
Competitors
The obvious competitors to a new Beats music platform would be companies with current connections to entertainment, a diverse base of talented human capital, immense reach and distribution (YouTube, Facebook, and Twitter come to mind). Of course, each one of these companies is positioned differently to the music industry and have their unique set of strengths and weaknesses. Twitter is more likely preoccupied with its primary goal of how to get more subscribers to use the service than dedicating extensive resources on music. Facebook may suffer from brand fatigue, while YouTube may not mesh well with the music industry’s demands concerning product and monetization. Of the three, YouTube would appear to be most promising. One variable in this dynamic may be if artists and labels are interested in supporting only one platform versus spreading resources thin across platforms. Beats’ connections to the music industry could obviously be a strong obstacle for competing companies.
Making the Transition
This transition will not be easy and there are plenty of people and companies in the music industry with a vested interest to make sure this transition doesn’t occur smoothly, but as with many things in this digital era, ultimately all roadblocks are broken and it is better to embrace change rather than bet against it.
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Spotify CEO Comments on Recent Anti-Streaming Tone
After reading Ek's blog post, I was left wanting more since none of my questions were answered. Overall, Ek's defense of music streaming is that it's a better option than music privacy. While that may be technically true, it doesn't answer the big question: if paid downloads are on the decline, where will the "missing" revenue come from? Beats? iTunes Radio? YouTube? Spotify? Soundcloud? Garth Brooks' new site? Is the answer that it won't be made up by streaming? Listen to Jimmy Iovine and you get the sense that this problem will only get worse. Much worse.
Ek's last paragraph:
"We’re getting fans to pay for music again. We’re connecting artists to fans they would never have otherwise found, and we’re paying them for every single listen. We’re not just streaming, we’re mainstreaming now, and that’s good for music makers and music lovers around the world."
Music artists use Spotify to build their fan base, not make money. That's great for music artists, but is it great for music?
Finding the Message in Tim Cook's WSJD Keynote
Event: The WSJ posted the full Tim Cook keynote video from their WSJD conference.
I like watching Apple keynote videos instead of reading transcripts or notes because I consider tone, delivery, and body language as important aspects of marketing. Let's not beat around the bush, when an executive speaks in public, it's PR. They have chosen that particular location and keynote to deliver a message to a specific group of people. So what was Tim's message?
Apple is focused on the consumer.
A. People still want big screens along with their portable screens. Expect to see continued Mac innovation as well as a larger iPad.
B. People want easy, private, and secure transactions when shopping. Apple Pay.
C. People like to personalize their tech gadgets. Offer millions of Apple Watch variations (and play up Macbook Air stickers)
D. People want their personal data to be treated with respect. Apple follows strict protocol in terms of not collecting certain types of communication data.
E. People want a better way of watching television content. ______
F. People want to monitor their health. _____
Those last two items (TV and health) interest me. Cook has repeatedly mentioned how the television is still living in the 1970s and that it's an area of intense interest, but all we have seen to date is a steady, but somewhat slow, stream of content providers putting apps on Apple TV (not exactly thrilling since most still require a cable subscription). I'm becoming increasingly confident that Apple is indeed working on a video product/service meant to bring "TV" into the 21st century. Should we expect something in the next few months? No. Does Apple have talent dedicated on the effort? I suspect yes.
Apple is starting to stress personal health as a top Apple priority with Cook even saying personal health was "imperative" from a social point of view. This stands at stark contrast to reality where health monitoring holds a relatively low priority in society. It's becoming clear that Apple is positioning health as a selling point for Apple Watch due to its ability to capture certain metrics and tracking, but I get the sense that we are in the very early innings of health as an Apple initiative.
While most companies like to say they are focused on the consumer, I think what sets Apple apart from the pack (and why they are a very polarizing company) is that they feel they have been given the mission to give consumers what they should be wanting, often times before consumers even realize it.
Some Housekeeping Items After Day 1
Thank you to all those who have shared words of encouragement today. I appreciate it. Since there are some new moving parts and things may have been lost in translation, I just wanted to touch on a few topics.
1) Subscribe to the AAPL Orchard email. I'm really excited to launch this new email product. I'm currently working on tomorrow's issue right now. On average, the email will include 2-5 Apple-related links followed by some commentary for each story. Some topics will be things that I haven't discussed yet on Above Avalon. All topics will contain more concise conclusions versus what would be included on Above Avalon. My main goal with the email is to get you all caught up with the Apple news cycle (with the right context and insight) in only a a few minutes each day. The plan is to get the email out by 7AM EST each weekday.
2) Podcast. I have a weekly podcast called Above Avalon. RSS is here (this should work for Overcast). iTunes link is here. Pretty straight-forward concept: a new Apple topic each week. The first episode is up and includes a few introductions and Apple Pay comments.
3) Twitter. Follow @aboveavalon to get every story published on this site. Follow @sammywalrusIV (that's me) for the "director's cut" of those posts and more broad tweets on tech, news, business, society, etc. For those familiar with my twitter feed...you already know what to expect.
4) Above Avalon is also on Facebook if you prefer to get your news through that avenue.
Thank you, Neil
Walmart SVP Publicly Argues with Visa Executive over Apple Pay
Walmart SVP Mike Cook (MCX and CurrentC was his idea) used the Q&A portion to publicly grill Visa's Global Head of Innovation (interesting title). Basically, Cook didn't like that Visa was being so complementary to Apple Pay boosting about it's lower card-present rates (applies when a card is actually being swiped) when such a large portion of brick-and-mortar (in-store) purchases already qualify as card-present.
The video is embarrassing. It's not too common to see such a public confrontation between two executives. Recode's take away is that Walmart will never accept Apple Pay. I disagree. Companies change their minds on large corporate initiatives all the time. The video does show what the Apple Pay vs. CurrentC boils down to: principles (and we know how hard it is to move past principles). Mike Cook has been beating the MCX drum for years. A few months of Apple Pay success won't change much for Walmart. I wonder though about the fringe MCX members; the companies who don't have as much invested in MCX and CurrentC. Will they jump ship in 2015? It remains to be seen. For Apple (who has skin in the game as a successful Apple Pay launch has immense tangible and intangible benefits), the battle is being fought day-to-day, bank-by-bank, retailer-by-retailer.
Apple Supplier Pegatron to Boost Cap Ex in 2015
Event: Apple Supplier Pegatron To Boost Capital Expenditures by 50% in 2015 Likely due to iPhone 6 and 6 Plus
I have a pretty simple policy when it comes to Apple supplier news. 1) Don't focus on the details, 2) Look for actual numbers and not just year-over-year percentages, 3) Put more weight on larger suppliers, especially the assemblers (those at the top of the supplier chain). As a reminder, Pegatron was rumored to have won a contract for assembling somewhere between 30-50% of iPhone 6 units, which traditionally had been Foxconn's expertise. Judging by Tim Cook's comments during last month's earnings call and the popularity of the larger iPhone 6 Plus, I would assume Pegatron's capital expenditure boost represents new iPhone production capacity coming online versus simply reshuffling the deck between Foxconn and Pegatron. Demand is still outpacing supply in the U.S., and it's even worse in China. Apple will sell every iPhone it can produce this quarter so the rush is on to ramp up production.
Microsoft Band Review Hits A Snag
This review stood out to me, not because I'm interested in the Microsoft Band, but because of how negative a tone it had toward the device (and Microsoft). Very reminiscent of the old Microsoft that we all are still familiar with. I don't think Microsoft has passed the litmus test for this device - why does it exist? For Apple, Apple Watch hits a couple of "why it exists" points: iPhone notifications, a new form of communication, Apple Pay, personalized watch-faces (shocking how many people have mentioned this to me), and of course third-party app support.
Taylor Swift Flees Spotify
Event: Taylor Swift pulled all of her songs from Spotify.
We have been hearing the theme that artists aren't getting paid using Spotify. Every once in a while someone will come out and try to refute the claim but to no avail. Paid downloads on iTunes have been on the decline, while paid streaming has been on the rise. This Taylor Swift news reinforces the theory that Spotify isn't about making money for artists, but rather building exposure for content creators. If other big-time musicians leave Spotify, one has to assume the streaming model is put into question.
MCX is Doing More PR and It's Just as Bad as it Sounds
Event: MCX gave an interview with USA Today.
It's becoming clear that MCX was caught off guard by the sheer velocity and passion of backsplash aimed at the retailer consortium following the Apple Pay launch. While MCX has tried to do some PR in the past, the result has been nothing short of a disaster with confusing and conflicting answers. It seems that MCX is learning as they go. I continue to think MCX's fundamental purpose was made void by Apple Pay's ease and security focus. When Apple brings loyalty programs to Apple Pay and retailers have the ability to track purchases and know more about who is shopping in their stores, I have a hard time seeing retailers stick with CurrentC. In the meantime, we have a waiting game, and I assume more PR opportunities for MCX.
Finding the Middle Ground between Apple Pay and CurrentC
We have a legitimate battle in the mobile payments arena as Apple Pay goes up against a powerful consortium of retailers, collectively known as MCX, and their payments solution, CurrentC. A mere few weeks ago, we didn’t even know a battle was going to occur, which underscores how complicated mobile payments are and how various parties have different goals in mind. Apple Pay is guided by ecosystem lock-in and privacy, while CurrentC is about better competitive positioning in terms of payment processing while collecting customer information. I suspect we are seeing the beginning of back and forth negotiation between Apple and the MCX consortium to find a middle ground focused on how to track customer information while keeping payment transactions secure.
I’ve long felt that Apple Pay adoption is dependent on universal acceptance as using Apple Pay, instead of credit card swiping, requires behavioral change and if Apple Pay is only accepted at a handful of retailers, the overarching impact will never go mainstream. Gas stations, fast food restaurants, and supermarkets are among the most frequently visited retail establishments, sometimes more than once a week, and Apple Pay’s current mind share in that space is low. While it is early in the game, many of these “convenience” retailers are already part of MCX and look at Apple Pay with caution as the service doesn’t put data collection as a priority and relies on credit cards (and we know how Americans love their credit cards).
Among the biggest complaints about MCX’s CurrentC is how information is collected about consumers, but there may be beneficial aspects of collecting such information, including reward points and loyalty sales. However, well-publicized recent data breaches have reinforced the view that there should be a clear limit as to what kind of information is tracked or shared with the retailer. Can Apple Pay’s treatment of credit card information be combined with opting-in to retailers loyalty programs in order to satisfy user’s privacy demands while supporting retailers’ business models?
In order to get a different look at the current mobile payments battle, Starbucks and Panera Bread represent interesting case studies. Starbucks is embracing Apple Pay by letting people use the service to reload the Starbucks mobile app, which is then used to pay at kiosks. Starbucks has previously said that roughly 15% of sales are done through the Starbucks app (not a trivial number). Panera is trying something a bit different with customers either required to hand the cashier a popular loyalty card, or providing a phone number, to receive benefits, and then using Apply Pay for payment. Starbucks and Panera are two restaurant chains that value timely ordering and payment, while relying on data utilization to improve offerings. Is this a pattern for other retailers to follow? Whole Foods has announced plans to rollout its own rewards program in 2015, which may involve downloading an iOS app. With Apple Pay rumored to eventually include loyalty programs via Passbook (I assume this would make a great home for these loyalty apps?); will this new feature entice MCX fringe members to jump ship?
I suspect the MCX consortium is positioning itself to gain leverage for getting technology companies, and their respective mobile offerings, to be more hospitable to retailers’ business models. This may be a longer-term issue with shifting credit fraud liability in the second half of 2015 representing another twist to this battle. While “power in numbers” may not work in some fights, for mobile payments it’s a formidable near-term strength for MCX. It’s clear that CurrentC is an inferior answer to Apple Pay, and even to the payments system consumers rely on now, so the question isn’t, “Will CurrentC beat Apple Pay?”, instead the question should be, “What elements of CurrentC are worth salvaging and then reworked to be included in Apple Pay?” Consumers like their credit cards, but dislike using credit cards. I think the credit card is here to stay and Apple Pay’s usage of credit card data is the way forward, voiding CurrentC, although Apple’s acceptance of loyalty programs is still a work in progress, keeping many retailers from moving away from MCX.
Friction exists between Apple and retailers as Apple Pay is focused on privacy while retailers have spent the better part of the last decade building their businesses on collecting the information that Apple Pay doesn’t value. I suspect Apple and MCX will eventually find some middle ground pertaining to tying in loyalty cards or rewards programs into Apple Pay, thereby enticing many MCX members to embrace Apple Pay.
Quote of the Week
- Jean-Claude Biver's comments, published in a WSJ Digits post, do a great job of highlighting how the high-end watch industry views Apple and the Apple Watch. While many in the watch industry expect Apple to send an all-start lineup into the game, Apple is busy reinventing the game.