Apple's Plan for iPad in an iPhone World
The iPad was introduced five years ago when iPhones were smaller and MacBooks were larger. Apple was able to market the iPad's larger screen as a reason to not only own a smartphone and PC, but also a tablet. In the past, Apple positioned products in separate silos geared for a particular buyer. Apple has begun taking a new direction where each device is merely a piece of the bigger puzzle in which a customer chooses products based on their personality and lifestyle. The change has significant implications not only for iPad, but also for how Apple looks at future product iterations, including wearables. The iPad was crowned the future of computing. In reality, iOS is the future of computing. The iPad is now positioned to take a supporting role to iPhone as Apple expands the iOS ecosystem.
iPad in 2010
When the iPad was introduced, many were unsure if a new product category was needed between a phone and a laptop. In very simple and plain language, Steve Jobs listed seven tasks that can be handled better with a device that sits between an iPhone and MacBook.
Exhibit 1: iPad Use Cases in 2010
Source: Apple
The expectation was for people to buy both a smartphone and a tablet, and that's exactly what happened for the first few years. Sales of the iPad over the first four years on the market exceeded iPhone's initial sales during the same period. With a 3.5-inch screen, the iPhone simply was unable to beat the iPad in terms of browsing the web, checking emails, viewing photos, watching video, and reading ebooks. Meanwhile, MacBooks lacked the magical multi-touch interface and apps that came with the iPhone and iPad.
iPad in 2015
Five years later, are there still things that iPad is better at than the iPhone and Mac? While I can look at Exhibit 1 and update that list, what has happened since 2010 is people have developed different habits and lifestyles around their gadgets. For some, an iPhone 6 Plus handles email better than an iPad, while others still prefer a larger iPad Air. Over the past few months, I've been thinking of a way to describe the iPad, and I think the product has become a bit awkward when considered as a stand alone product category independent of iPhone and the Mac. When considered as part of iOS, the iPad would appear to be simply finding its place (which may very well be at a lower sales rate). Apple sold 68 million iPads last year and while sales momentum has disappeared in recent quarters, Apple is still expected to sell 50-60 million units in FY2015.
Four-Quadrant Product Grid Drawbacks
The notorious Apple four-quadrant product grid introduced by Steve Jobs in 1998 has been well publicized and discussed. As depicted in Exhibit 2, to simplify the product line and realign focus, Steve wanted a product in each of the four boxes, representing different target markets.
Exhibit 2: Apple Four-Quadrant Product Grid (1998)
Source: Above Avalon
The same kind of product analysis no longer works.
1) Apps have blurred the distinction between the consumer and professional columns.
2) Screen size and mobility have replaced desktop and laptop as the primary differentiator. There is no longer a one size fits all description for what screen size is geared for a particular segment. Small-screen iPhones have infiltrated enterprise and education, while MacBooks can be found in consumer and enterprise.
Exhibit 3 was what many would have come up with analyzing Apple's current product line, and in such a grid, having iPad by itself in the upper left corner exposes the product to incomplete analysis because the product is no longer targeted to only one type of buyer or customer.
Exhibit 3: Faulty Apple Product Analysis Four-Quadrant Product Grid (2014)
Apple's New Personalization Product Analysis
Instead of product quadrants, a new type of analysis is needed to measure Apple's long-term objective and strategy. In Exhibit 4, I highlight how Apple views its current product line where screen size and mobility are the primary differences between products. Now each device can appeal to consumers in various segments of the market from education to enterprise to content creation and content consumption. Personalization is becoming a much bigger factor. In this table, the iPad's role is to serve as a placeholder for those who want technology with a slightly bigger screen than an iPhone or someone who wants a more simple and interactive device than a MacBook. While some may enjoy the iPad, there will be others that have no use for such a device.
Exhibit 4: Apple Personalization Product Analysis
Exhibit 5 depicts what I would call an Apple Product Screen Personalization analysis, which includes unit sales estimates for every major Apple product ranked according to screen size. Over time, while the peaks may shift left or right, I think the general shape will remain true as the iPhone remains the top seller and other devices fall in line.
Exhibit 5: Apple Product Screen Personalization Analysis (2015)
The primary takeaway from Exhibit 5 is that future product innovation will largely be based on Apple continuing to ship a product line that appeals to different lifestyles. The iPad is merely a part of the Apple product lineup designed to appeal to lifestyles where a touchscreen ranging from 7 to 12 inches makes sense. Looking at quarterly unit sales by total iOS devices may make more sense than looking at iPad sales down 25%, but iPhone up 35%.
Over time I would expect Apple to continue to refine screen sizes. For now, it would seem like consensus has landed on 4.7 inches for iPhone and 9.6 inches for iPad. In the future, the phone may continue to get bigger, which will force Apple to push a larger iPad Pro more, so the line in Exhibit 5 will shift to the right a bit, but the overall iOS product line stays intact. The Apple Watch at the far left may also see some interesting sales trends, causing another peak at that part of the line.
Apple visualized this analysis in a slide from the iPad keynote this past October, shown in Exhibit 6.
Exhibit 6: Apple Product Screen Personalization Visualized (2014)
Source: Apple
Here is Tim Cook describing the keynote slide from Exhibit 6:
“This is the strongest line-up of products that Apple has ever had. And we believe that each one of these play a very important role. People need different types of technology for the way they live their lives. We all do different things.
In fact, many of us and many of our customers use more than one of our products every day. Sometimes you want to sit at your desk in front of a huge beautiful immersive screen, packed with powerful technology. And we’ve made that much better today with the Retina 5K screen for iMac.
Sometimes you want to take that powerful technology with you wherever you go, and we’ve made our notebooks even better this year with MacBook Air and MacBook Pro.
Sometimes you want to be close to your content, touching it and we’ve made that experience even better today with the iPad Air 2, more powerful and incredibly thin.
Sometimes you want to hold that powerful technology in the palm of your hand and there’s no better thing for your hand than the iPhone 6 and iPhone 6 Plus.
And soon, you can wear that powerful technology right on your wrist...
They are designed to be incredible products individually but they are also designed to work together seamlessly.”
Apple has moved beyond product grids and quadrants as the combination of hardware and software have created a vibrant device ecosystem suited for various lifestyles.
iPad's Role Going Forward; Time to Reset Expectations
The iPad will likely be repositioned to appeal to consumers looking for that larger iOS companion device that may make video better to watch, Twitter easier to use, or ebooks more relaxing to read. In addition, a new iPad Pro would be geared toward content creators that may be unsatisfied with the Mac's capabilities. Accordingly, I suspect sales will likely reflect this new status. I don't view the iPad as on a trajectory to outsell iPhone, but at the same time, there will likely be buyers that need a computing device that is bigger than an iPhone with a 5.5-inch screen, but more nimble than a MacBook.
I see two factors serving as the primary buying variables going forward across the Apple product lineup: screen size and price.
Screen Size
We are still in the phase of figuring out which size of glass we want to carry in our pockets or hold in our laps in bed. I would expect continuing shifts in trends, especially once the Apple Watch goes on sale and consumers interact with a small screen on the wrist.
Price
As depicted in Exhibit 7, Apple now sells five iPad models at five prices, which isn't exactly the easiest thing to decipher when buying. Why is Apple doing this? The iPad does a great job at addressing price umbrellas.
Exhibit 7: Apple's Current iPad Line - This Is Getting a Bit Awkward (2014)
Source: Apple
By selling older iPad models for $249-$399, Apple is appealing to those consumers that value price over certain features or components. Apple doesn't want competitors to ship capable devices that may undermine some of these smaller iOS screens. The iPhone "subsidy" in many countries complicates this a bit for the iPhone line since there are already phones being sold for free (but with a monthly fee or a subsidy). As smaller devices continue to outsell Macs by multiples, I would expect this trend of Apple relying on iPad to address the low-end of the market to continue, and eventually the same strategy may spread to Apple Watch in a few years. Meanwhile, the MacBook and iMac lines don't have the same type of price umbrellas given that iPhones and iPads address the lower-end of the market.
Currently, the $199 iPod touch is likely selling around 1-2M units a quarter. Combined with the 2-3M older iPad minis, Apple is selling around 20M iOS devices a year, or roughly 8% of total iOS devices, for less than $300.
Software Moves to Middle
One likely theme going forward is that software differences between iOS and Mac will continue to move to the middle, which will call for some new and different things where the iPad meets the MacBook. What works great on an iPhone will likely not work great on a laptop, so a solution that takes the best of both worlds may be needed in that big tablet/small laptop area. Incidentally, Apple is rumored to have a new iPad and a new MacBook Air in the pipeline, so that intersection would appear to be an exciting one in 2015.
Next Marginal Apple Product Buyer
Even though the probability is that Apple's next marginal buyer into iOS is likely an iPhone buyer from Greater China (looking at current sales), from Apple's perspective, it doesn't matter if a new user enters iOS by buying an iPhone 6, iPad mini, iPhone 6 Plus, or iPad Air. Devices have matured to such a degree and are now positioned in such a way that consumers don't need to buy 3-4 Apple products. While certain products are more universal such as iPhone, others are more personal, such as iPad. Accordingly, the shift to a more personalized product line based on screen size and mobility would suggest there will be continued effort and innovation across the product line, despite some products selling at a fraction of others. For iPad, the spotlight may continue to dim a bit, especially when compared to iPhone, as the product finds its place within the Apple ecosystem.
This report was produced by Neil Cybart on January 20, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.
Apple Rethinking the Pen: Initial Thoughts on 'Apple Pen'
Apple analyst Ming-Chi Kuo is out with a new report suggesting Apple will launch a stylus in a few months alongside a new, larger 12.9-inch "iPad Pro." Judging by the sheer volume (over 30+) of patents for a stylus going back to the iPad launch, I don't think the question has ever been about whether or not Apple has been working on such a device, but instead if Apple would ever release such a product. Would a stylus receive one of Apple's rare "yes" votes and make it to the marketplace?
A quick glance at Apple's patents for what I call the "Apple Pen" would suggest that such a device is not simply a stylus used to draw on an iPad, but a comprehensive solution for reinventing the modern-day writing instrument. Apple would be reinventing the pen. The use cases are broad and extensive:
- Enterprise. There are many situations in the corporate world in which a keyboard is not appropriate for taking notes. Whether it is used during a formal board meeting or a quick brainstorming session, a laptop often hinders discussion and interaction. In that same vein, an iPad doesn't offer any additional benefits and very often makes it even harder to record notes or thoughts. Instead, paper and pen continue to be utilized (or third-party styli with iPads) because it is much easier to record notes and thoughts in free-form on paper or a tablet. An Apple Pen would find a nice fit in this type of setting. Additionally, if the Apple Pen can be used to capture information such as distance, shape, texture, and angles, the implications expand into many different industries such as industrial and into various commercial settings from Fortune 500 companies to independently owned and operated businesses.
- Education. Obvious implications for an Apple Pen would include taking notes, but deeper applications involve content creation in the arts and sciences including math, chemistry, physics, and biology, where a keyboard (or finger) is less effective than a fine point writing instrument. As Chromebooks gain ground in education, a touch-screen device with an accompanying smart pen would stand out as adding to the classroom not only utility, but also new forms of creativity and imagination.
- Consumer. Imagine tasks for which a pen and paper are still used such as creating shopping lists and writing letters. In each of these cases, a smart pen can increase utility.
I still have more questions than answers regarding an Apple Pen. How much would an Apple Pen cost? Would the device be initially compatible with just an iPad Pro in order to boost sales of the device, or would the smart pen work with any iOS device? How many functions would such a device include in the first version?
I see an Apple Pen being positioned not only to replace the modern-day pen, but also to serve as a new way to gather and input data. I can see an Apple Pen eventually work without the need for even an iPad or iPhone as a screen isn't necessary to capture data. As sales of third-market devices show, there is already demand for a stylus. An Apple Pen would eventually be positioned as a device that we can't imagine living without. In reference to competing products that came with a stylus, Steve Jobs once said, "if you see a stylus, they blew it." He was right. An Apple Pen wouldn't be a stylus. It would be a data collector and interpreter that just happens to take quick notes and drawings on a screen.
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Apple Pay Enrollment Trends
Bank of America reported yesterday that 800,000 of its customers had registered with Apple Pay. Since Bank of America is the second largest bank in the U.S. according to assets (third in terms of deposits), this new data point suggests early Apple Pay enrollment trends look strong. I estimate 10-15% of iPhone 6 and 6 Plus owners in the U.S. (2-3 million people) have registered cards with Apple Pay.
Exhibit 1 highlights the top ten banks in the U.S., ranked by total assets. Total deposits are also included to get a better idea of customer base rank. The top four banks clearly have a larger asset footprint than peers, representing 40% of deposits in the U.S. Most of the larger banks in the U.S. now support Apple Pay.
Exhibit 1: Largest U.S. Banks - Total Assets
Exhibit 2 highlights the top banks in the U.S. according to branch footprint, which shows some slight reshuffling in rank from Exhibit 1, although the top players still support Apple Pay.
Exhibit 2: Largest U.S. Banks - Retail Branches
In order to reach Apple Pay enrollment estimates, I added the roughly 15 million iPhone 6 and 6 Plus units sold globally in 4Q14 to the expected 50 million iPhone 6 and 6 Plus units sold in 1Q15 (Apple is still selling iPhone 5s and 5c), implying Apple has sold around 65 million iPhone 6 and 6 units globally, with approximately 35% attributed to the U.S, or 23 million units. Running with that number, Exhibit 3 highlights three possible Apple Pay enrollment scenarios predicated on the percentage of total iPhone 6 and 6 Plus users represented by Bank of America.
Exhibit 3: Apple Pay Enrollment Estimates
Running with a conservative estimate of the percent of Apple Pay users Bank of America (50M total banking customers) represents, Apple Pay enrollment rates in the U.S. would stand at 8%. If using aggressive metrics, Apple Pay enrollment would be 16%. I estimate 10-15% of iPhone 6 and 6 Plus owners in the U.S. have registered with Apple Pay. As a reminder, this does not mean that 10-15% of iPhone 6 and 6 Plus owners are using the service at retailers or within apps. Having users add cards to Apple Pay is the first major hurdle Apple has to overcome to get Apple Pay usage off the ground. By adding a card (even if it's already included in iTunes), users demonstrate trust in Apple and the Apple Pay service. In the coming months, Apple's focus in the U.S. will continue to be on adding banks (close to 90% of card credit transaction volume is supported by Apple Pay) and additional retailers. International expansion is also expected in the coming months with reports indicating Britain and Canada as possible targets for the next Apple Pay rollout. It is still early, but Apple Pay enrollment trends in the U.S. look strong.
Apple Watch Isn't a Luxury Watch
Many people are trying to analyze Apple Watch with the assumption that the device is just another luxury watch only with additional customization and features. I think this type of thinking misses the big picture. An Apple Watch will be just as much a watch as an iPhone is a phone.
Last week, I discussed how I thought Apple will sell Apple Watch by positioning it as a watch with customizable faces and bands. By keeping the message simple, anxiety and uneasiness will be removed from the buying decision. Most consumers, even if they don't wear a watch, understand what a watch is and what it does. However, the comparsion of Apple Watch to a luxury watch needs to stop there as once a user begins to rely on Apple Watch for communication, health and fitness tracking, and mobile payments, the idea that it is just another luxury watch will no longer apply.
The Apple Watch and its strengths shouldn't be compared to luxury watches, and more importantly, luxury watch strengths. Timelessness, or lack thereof, seems to be at the top of the list of lingering questions about Apple Watch. If a luxury watch can last the test of time and be passed down from generation to generation, how would Apple Watch compete? Who would pay thousands of dollars for a device that won't stand the test of time? Timelessness won't matter for Apple Watch since the Apple Watch isn't a luxury watch. Instead, Apple Watch is a mobile computing facilitator worn on the wrist. The users will have just as much motive and desire to pass the device down to children or family as they would with an iPhone or iPad. By discussing price in context of luxury watches, I suspect many are jumping to the conclusion that the only reason someone will pay thousands of dollars for an Apple Watch is to wear it forever as a status symbol. Instead, people will pay thousands of dollars in order to have the opportunity to buy an Apple product that can be worn. The desire to upgrade to a newer, more advanced version in the future will likely be just as strong as it is with iPhone.
Apple understands its user base very well and correctly sees that there is a market for very high-end tech gadgets. This buyer takes an iPhone and its lack of personalization, puts thousands of dollars into the device to truly make it his or her own, and then will eventually upgrade to a newer iPhone just like everyone else. The Apple Watch Edition collection is Apple's first attempt at addressing this segment of the market.
Just as with fashion, technology evolves. The Apple Watch isn't a luxury watch, but rather a fashionable communication facilitator worn on the wrist.
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iPad Observations Heading into Apple Earnings
In connection with establishing iPad sales, margin, and average selling price (ASP) expectations for 2015, I complied a few observations, including thoughts on the iPad mini, upgrade cycles, and the iPad's placement within the Apple ecosystem.
iPad Mini
I'm increasingly becoming confident in my theory that the iPad mini was a product released with a mission: serve as a hedge against low-end Android tablets in the beginning years of the tablet market. With Apple still selling the original iPad mini for $249, a quick comparsion between iPad mini prices and the rest of the iOS lineup (Exhibit 1) would suggest that the iPad mini exists for more than just to sell more iPads, but instead serve as a defense for the iOS ecosystem. Steve Jobs infamous "price umbrella" quote, which was initially said with the iPhone in mind, can be used to describe the iPad mini. Apple is relying on the iPad mini as one of the lower-cost entry points into iOS (let's not ignore the iPod touch just yet) in order to prevent Android from establishing a position under Apple's prices. By not selling an inexpensive iPad, Apple risked mediocre Android tablets grabbing enough share of the market to squeeze Apple out. While Android tablets are selling for under $100, their use cases have proven to be more rudimentary than true table computing. Exhibit 1 depicts iOS device price levels in the U.S. as of January 2015. Note that the iPhone 4s (not included in table) is still being sold in select emerging markets, like India.
Exhibit 1: iOS Device Prices (Unsubsidized) - January 2015
With the iPad mini positioned at the low-end (grey columns in Exhibit 1), the lack of a significant update this past October shouldn't stand out as too meaningful given that the expected iPad mini buyer has different value priorities than an iPad Air buyer. There have been a few scattered rumors of a mid-cycle iPad mini 3 refresh. I am beginning to question my initial hypothesis from last year that the iPad mini would be discontinued in the near-term, unless Apple is planning to launch a new product that would fill the price layer that the mini currently occupies. While a revamped iPod touch with a 5.5-inch screen would surely sell, the price would suggest it wouldn't be an iPad mini replacement.
Data from mobile ad analytics company Fiksu suggest the iPad mini still represents approximately 30% of iPad sales. Reported ASP and margins will help confirm if the iPad mini is indeed selling as Fiksu would suggest.
Upgrade Cycle
One of the bigger questions plaguing iPad is whether the replacement cycle is to blame for slowing sales momentum, or if the tablet market is saturated. Tim Cook addressed the question on Apple's last earnings call:
“[I]if you look at our top six revenue countries, in the country that’s sold the lowest percentage of iPads to people who have never bought an iPad before that number is 50%. And the range goes from 50 to over 70. And so when I look at that number, our first time buyer rates in that area, that’s not a saturated market. You never have first time buyer rates at 50% and 70%. What you do see is that people hold on to iPad longer than they do a phone. And because we’ve only been in this business four years, we don’t really know what the upgrade cycle will be for people.”
Cook sounds confident that given roughly 50-70% of iPads are sold to new customers, the lack of unit growth is due to the dearth of repeat buyers. As a frame of reference, according to Apple, 25% of customers that bought iPhone 5s in the U.S. were buying their first iPhone. In that context, one can understand why Apple thinks slowing iPad sales momentum is more like a speed bump. What is iPad's average upgrade cycle? Using data from Fiksu, Exhibit 2 highlights the breakout of iPad devices currently in use, which leads to a 2.4-year rudimentary estimate as to the average life of an iPad. It is important to note one can not distinguish between new and used iPads using Fiksu data and with the iPad Air and iPad mini on the market for only 1.25 years, average life figures remain skewed. Another way to look at the data is approximately 1 out of 4 iPad users have owned their iPad for nearly four years (iPad 2).
Exhibit 2: Current Breakout of iPad Devices in Use as of January 5, 2015
Exhibit 3 charts the iPad's initial sales success compared to iPhone's more gradual sales levels. The iPad is now facing a leveling off of sales, while the iPhone is seeing accelerating sales growth. Based off of Tim Cook's comments on iPad upgrade cycle and new customers to iPad, Exhibit 3 depicts the big question for iPad: What is causing sales growth to slow?
Exhibit 3: iPhone vs. iPad Sales
Where do iPad sales go from here? Exhibit 4 highlights three possibilities: 1) increase and start to track iPhone adoption, 2) remain relatively steady to slightly down until a more sustainable sales level has been reached, 3) decline due to other reasons. My 2015 iPad estimates run with a scenario that falls somewhere between options 2 and 3.
Exhibit 4: Possible iPad Sale Trajectories
If iPad sales (red line in Exhibit 4) continue to trend down gradually, and do not fall precipitously, than there would be a higher likelihood that the extended upgrade cycle is the primary culprit impacting iPad. If sales decline momentum worsens rather quickly in 2015, than I would position iPhone 6 and 6 Plus popularity, including the Mac, as primary culprits for iPad's weakness.
Finding iPad's Niche Within Apple's Ecosystem
I continue to think we are in a period where the iPad is finding its niche markets, as well as its place within Apple's ecosystem. Recently, iPad has been included in Apple marketing campaigns like "Start Something New" alongside the iPhone and Mac, suggesting that management may have recalibrate iPad expectations over recent months and now position iPad as being able to fill certain demand holes that the iPhone and Mac are not able to fill on their own, such as an inexpensive video player and email machine (iPad mini) to high-end mac-like devices for creation (iPad Air and eventually iPad Pro). No longer is the iPad destined to the space between the iPhone and Mac.
In such a scenario, a larger iPad Pro continues to make sense for being able to stand out from an iPhone 6 Plus, while also setting itself apart from the Mac, especially the rumored new MacBook Air, due to a touch interface. While the device wouldn't seem to have characteristics of being a mass-market hit like iPhone due to a high price and large-screen form factor, the iPad Pro may help keep some customers interested in the iPad, and more importantly, iOS. On the low-end, iPad mini may in some ways represent the "cheap" iPhone for consumers that position price as the determining factor for a purchase.
Expectations for 2015
With Apple's upcoming earnings report in two weeks, and given the greater level of uncertainty when establishing iPad expectations for 2015, I asked myself two basic questions:
1) Will there be any catalysts that would change iPad's sales decline momentum from 2014?
2) What are Apple's goals with iPad?
The iPad's sale trajectory is not clear (Exhibit 4). In my Apple Questions for 2015 post, I mentioned looking at iPad average selling price (ASP) as a way of figuring out how the iPad mini is selling. I continue to think that data point will give hints as to what Apple will ultimately do with the mini. I'm also assuming that the iPad Pro will help maintain the current iPad trajectory, rather than improve it.
I estimate Apple sold 19.5M iPads for the three months ending December 2014 (FY1Q15), down 25% from 2014. As shown in Exhibit 5, my unit sales growth estimate improves through 2015 due to easier year-over-year sales growth comparisons (iPad sales were weaker in the back half of 2014), and a slight pick-up in demand related to an iPad Pro (reflected mostly in 3Q15). Obviously, if the iPad Pro does not materialize, my estimates would need to be adjusted a tad downward.
Exhibit 5: Above Avalon iPad Sales Expectations
My estimates were reached by a combination of analyzing Fiksu iPad model share trends from September to December, in addition to taking Apple's comments about expanding the supply chain (1.5M channel build estimate). Given the high degree of uncertainly, I would position Pad unit sales of 17-21 million units as my wider expectation range. If sales come in weaker than 17 million than it is likely that other iOS devices are being bought in place of iPad. If sales are stronger than 21M than the iPad is likely suffering more from a longer replacement cycle with core sales trends holding up well.
Another way to put my estimates in context would be comparing my growth expectations with iPad's historical growth rates, highlighted in Exhibit 6. After two years of strong growth, the iPad is now bouncing around double-digit unit sales percentage declines.
Exhibit 6: iPad Quarterly Growth Rates
As my 1Q15 quarterly sales decline estimate shows, the iPad is still in flux. Apple's upcoming earnings release on January 27 represents the next event that may provide additional clues and data points as to how to think about iPad.
This report was produced by Neil Cybart on January 12, 2015 and is not meant to be used as investment advice. Risks to my estimates primarily include customer demand. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.
Selling Apple Watch
Many people are overthinking Apple Watch. For Apple, the hardest part won’t be telling people why they should use the device, but rather getting people to use the device. There is a subtle difference.
One of Apple’s secret weapons for selling Apple Watch will be its retail stores and the ability to see and touch the device. Trying to appeal to a potential customer’s wants and desires begins by positioning the product so that they simply want to use it. While Apple certainly will rely on a more complicated marketing message that positions certain use cases over others, I don’t think that message will be the thing that sells Apple Watch. Apple’s goal is merely to get a potential customer to want to use the device. Only after the Apple Watch purchase does a revolutionary user interface and a few well thought-out features, shown through marketing, help nurture a user's relationship with Apple Watch.
Why people will buy an Apple Watch:
- It’s a cool watch. The Apple Watch is a watch with a customizable digital face and a selection of interchangeable bands.
- It looks nice. The Apple Watch has a clean, fresh, design that strikes a balance between luxury and technology.
- It’s made by Apple. The Apple Watch is designed in California by the same company that is responsible for the iPhone, iPad, and Mac.
Over the past few months, I’ve learned to change the way I explain Apple Watch to friends and family. Instead of starting out with a list of reasons why they may enjoy an Apple Watch, I now begin with a pretty simply explanation: Apple is making a watch with customizable faces and bands. I then let that person respond, and depending on their answer, I mention how Apple Watch can serve as a communication device, a health and fitness tracker, or a mobile payment facilitator. As a result, I now get a much more open response from people that want to see and learn more about Apple Watch. That is how Apple will sell Apple Watch.
We recently saw this play out with iPad and competing tablets, where Apple’s strength was having iPads available to play with in its retail stores. Meanwhile, competitors used advertisements to push all of the features their product had that the iPad lacked. In the end, people picked iPad.
There has been a tendency to mock people that want to buy products simply because a certain company makes them. Some will say this type of buyer is being guided by marketing, or is just a follower, but in reality it comes down to trust. Many people trust Apple. It is this very important connection with users that will likely get people to at least try the Apple Watch, and for Apple that is the best outcome they can wish for.
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Larger iPhones May Be a Game Changer
The latest phone sales share data from Kantar Worldpanel paints a bright picture for Apple with iOS gains in most countries, but diving deeper into a few countries would lead to some interesting questions. Are the iPhone 6 and 6 Plus game changers, propelling Apple past its "niche" smartphone status in developed markets such as U.S. and Great Britain? The answer may have far-reaching consequences for services like Apple Pay, Beats Music streaming, app developer innovation, wearables, smart home, and connected cars, not to mention other tech companies like Google and Amazon.
Some industry analysts have been pushing the idea that phone market share questions are yesterday's news with iPhone destined to the top niche of the market and Android representing everything else. I'm becoming increasingly uncomfortable with that assertion, especially given some underlying trends occurring in the smartphone market following the iPhone 6 and 6 Plus launch. I have little confidence that the current phone market as it appears today will look the same for years to come.
In the U.S., the iPhone nearly outsold Android during the three months ending November 2014, as seen in Exhibit 1, which also includes Android and iOS share of sales in the U.S. going back to 2012. Obviously an iPhone launch helps boost share as loyal iPhone users upgrade their phones, but the current upgrade cycle is different.
Exhibit 1: iOS and Android Smartphone Sales Share - U.S.
According to recent Kantar data, iPhone 6/6 Plus sales share in the U.S has surpassed iPhone 5s/5c and is now tracking very close to the iPhone 5. Up to now, this would not suggest that larger iPhones are a game changer as the sales patterns are following the typical iPhone upgrade effect. However, today's smartphone market is indeed different with Apple now selling a 4.7-inch and 5.5-inch iPhone. Large screens were the key differentiator for Samsung, the leading hardware manufacturer for Android, for the better part of the past three years. Add what seems to be a lack of innovation with Samsung's latest Galaxy offerings, including the company's recent comments about 2015 being another troubling year for Samsung phones in face of Apple's latest offerings, and the iPhone 6 and 6 Plus may represent a game changer for the U.S. smartphone market with iOS outselling Android.
In Exhibit 2, iPhone 6 and 6 Plus sales share can follow two primary routes: A or B. Route A would reflect increased sales share approaching 60% at the expense of Android as the iPhone 6 and 6 Plus are true game changers. Route B would reflect the typical decline in share following an iPhone launch as the iPhone upgrade cycle slows and Android users do not switch to iPhone. Next month's Kantar sales report will be quite telling as any continued share gain (or even flat share) at the expense of Android will stand out versus the iPhone 5, 5s, and 5c reiterations, suggesting that the upgrade cycle is indeed continuing to be strong and users are switching from Android to iOS.
Exhibit 2: iOS Smartphone Sales Share and Possible Share Trajectories - U.S.
Why is this important? Isn't market share an old topic? The ramifications of iPhone representing close to 60% of smartphone sales in the U.S. has dramatic implications in terms of Apple Pay adoption, Beats Music subscription services, and other areas including app developer focus, smart devices, and wearables. I continue to think that owning the most lucrative 30-40% of the smartphone market is enough to warrant sustainability as developers remain invested in the ecosystem. However, if iPhone can capture 60%+ share, the argument changes rather dramatically for services with which adoption is more easily assured by the sheer number of users and not just the top portion. For example, with iPhone representing 60% of U.S. smartphone market, Apple Pay has a significant leg up on CurrentC, Beats Music (if pushed to all iOS devices) would gain more power over competing streaming services, and Apple Watch would be even that more compelling as a communication medium. Not to mention, iMessage, FaceTime, and Photo Stream would serve as lucrative communication channels. In addition, iOS and the connected home and car take on more meaning if iOS becomes the dominant mobile platform in the U.S. in terms of volume.
Concerning U.S. mobile carrier pricing plans, in reality, as carriers move away from hidden built-in subsidy plans, and instead push $0 down, 24-month installment plans, the "iPhone subsidy boost" topic is losing relevancy as consumers are now more aware of how much their phone really cost. Despite this trend, iPhone sales share pre-iPhone 6 and 6 Plus has tracked very similarly to previous years, which would go against consensus that iPhone's strength was primarily dependent on full-blown subsidies masking the iPhone's high price. In retrospect, the ability to buy new iPhones sooner (which the new plans promote) may pose as another benefit to Apple as well.
In Great Britain, the iPhone 6/6 Plus would appear to already be a game changer, clearly reaching all-time smartphone share levels. While the iPhone refresh cycle is certainly helping, approximately 20% of iPhone buyers during the three months ending November 2014 had switched from Android according to Kantar.
Exhibit 3: iOS Smartphone Sales Share - Great Britain
Of course, China's smartphone growth potential cannot be ignored, and iOS sales share is indeed lower in China than other countries, including U.S. and Great Britain. As shown in Exhibit 4, iOS sales share has been on the rise recently and jumped 2.4 points from October to November, this despite the new iPhones launching in mid-October. China Mobile began offering iPhone in January 2014, but the delayed boost can be seen as iOS sales share started to pick up in June. I estimate customers are now buying 5-7 million iPhones a quarter through China Mobile. Tim Cook mentioned on Apple's earnings call that 80% of iPhone sales in China do not involve a subsidy. Despite the lack of subsidies, iPhone share is approaching 18-month highs and the iPhone 6 and 6 Plus will likely lead to continued share gains.
Exhibit 4: iOS Smartphone Sales Share - China
As many tech and mobile analysts focus on China, India, and emerging markets to determine how the next billion users will join the mobile era, some have said that the major questions surrounding mobile in developed markets have been answered. I disagree. The iPhone 6 and 6 Plus introduction has the potential to be a game changer as iOS nears a majority of sales in a few countries, a marked step-up from previous iPhone reiterations. Implications on ecosystem services dealing with payments, music, apps, cars, and connected devices cannot be underestimated. The big question now is as the iPhone 6/6 Plus upgrade cycle slows (which has been the pattern going 3-4 months out from launch), will Android converts drive iOS share even further? Sales share data over the next few months will be very telling. Samsung's smartphone troubles have been well publicized, but only now are we starting to see the impact, and Apple looks to be the primary beneficiary in many countries. Apple may be in a sweet spot here. If iPhone 6/6 Plus don't bring many from Android, the iOS ecosystem is now vibrant enough to be self-sustaining. However, if Android switching becomes a theme, the iOS ecosystem value increases in terms of messaging, communications, and services.
While China, India, and developing markets represent the unknown in mobile, I think we need to keep an eye on developed markets in which Apple is gaining strength.
This report was produced by Neil Cybart on January 7, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard.
The Next Marginal Customer
Being a niche player has led Apple to much success, as resources are funneled into the most profitable and lucrative segments of a market. However, this doesn't mean that Apple isn't focused on new customer acquisition. I suspect some of Apple's recent troubles with software quality over the past two years has been related to tradeoffs created by acquiring the next marginal customer.
Apple is a growth company. Accordingly, marketing takes on a more vital role at Apple than at a mature company where user acquisition is not a primary goal. Apple relies on marketing (and design) in an attempt to appeal to the marginal customer, the next user to buy into the Apple ecosystem. This drive leads to new and exciting software features shown in retail stores and in marketing campaigns. However, because of the tight schedule Apple has adhered to, as well as the sheer volume of change taking place, features are not receiving the needed attention. In this context, core users (the ones likely to use all of these new and exciting features) feel the downside, and become increasingly vocal with their complaints, while new users largely avoid much of the frustration. This dynamic may help explain how management is insulated a bit from some of the backsplash as financial trends depict no major issues. Former early Apple employee Bruce Tognazzini similarly discussed how Apple's user interface also suffers from management's focus on new users at the determent of power users.
What's the solution? Time. Apple's approach to new customer acquisition is correct. Apple knows its next marginal customer very well. Instead, I suspect as we move past the Apple Watch launch, and the first few quarters of sales, Apple will be in a better position to address some of the recent software shortcomings. Apple would then have marketable features that new customers would enjoy, while still appealing to core users with reliable functionality. How can the two groups be satisfied with the same product or feature? Design. This is where Jony Ive's leadership and vision will need to be utilized. I hear some say, "if it just worked, it would be great," referring to Apple software, which tells me Apple is on the right track in terms of design implementation.
For Apple, the ability to shift directions and funnel resources into a new product is one of the most misunderstood and undervalued aspects of the company. In this context, Apple Watch, and all that remains untold and misunderstood about the device, and Apple's move into personalized hardware, may play a crucial role in understanding what Apple has been planning with its unrealistic pace of development in recent years. The game may have changed, but I suspect Apple wrote the new playbook, and has been away practicing. With the company nearly ready to return, with Apple Watch in tow, the question is will early adopters show up for the game? I suspect the answer may surprise some Apple critics.
1,000
Today's AAPL Orchard daily email went out to 1,002 subscribers. If there is a number worthy of its own post and reflection, I suspect 1,000 would be at the front of the line. My goal in writing AAPL Orchard is to provide a layer of context that sits on top of the Apple news and rumor world. While I have been quite surprised at how quickly the email has grown, the much bigger success measure has been the diversity found in the subscriber base. Not only do I have substantial representation from Wall Street and academia, but a growing number from the music and film industries, a solid representation from biomedical and mechanical engineering fields, and of course there are those in the technology sector (app developers, investors, VCs, executives, and journalists). Maybe most exciting to me is how despite many people having careers, hobbies, and lifestyles in fields completely unrelated to technology, everyone shares a commonality in wanting to both stay informed and to learn about Apple. It is that drive and demand for useful Apple information that represents the core of AAPL Orchard.
While I have crafted a particular process to scan and monitor many different content venues throughout the day, I am currently working on building up my ability to find interesting Apple-related content on smaller, independent sites or blogs. Readers have been submitting links/posts, and if you have something that would be enjoyed by AAPL Orchard readers, please keep me in mind. You can submit your story/link via Above Avalon or reply to any of the daily emails. For more information and to subscribe to AAPL Orchard, click here.
I'm excited to see AAPL Orchard grow and look forward to the future.
- Neil
Apple Watch's Potential Impact on Apple Earnings
While speculation as to how well the Apple Watch will sell is kicking into high gear, I wanted to frame the discussion a bit differently by publishing EPS matrices covering approximately 50 different Apple Watch sales scenarios. While the definition of success is largely subjective, and mostly dependent on how Apple frames the Apple Watch story, the device's impact on Apple's financial picture, given a set of parameters, is less open to debate.
The easiest way to read a matrix is to start at one axis (margin or average selling price), and then move down the column, or across the row, until aligned with the alternative metric (margin or ASP). For example, if I wanted to see the EPS impact from Apple selling 10M Apple Watch units at $550 ASP and 40% margin, I would start at the 40% margin column in Exhibit 1 and then move down until I reach the $550 row, leading to $0.28 of EPS.
Exhibit 1: Sample EPS Matrix
In Exhibit 2, the first set of matrices depict Apple Watch's impact on EPS assuming 10 million units are sold in the first 12 months. Depending on average selling price (ASP) and margin, Apple Watch would contribute $0.17 to $0.58 of EPS (add 2% to 7% to 2015 EPS).
Exhibit 2: EPS Matrices for 10 Million Apple Watch Units
In Exhibit 3, the second set of matrices depict Apple Watch's impact on EPS assuming 25 million units are sold in the first 12 months. Depending on ASP and margin, Apple Watch would contribute $0.44 to $1.45 of EPS (add 5% to 17% to 2015 EPS).
Exhibit 3: EPS Matrices for 25 Million Apple Watch Units
In Exhibit 4, the third set of matrices depict Apple Watch's impact on AAPL EPS assuming 40 million units are sold. Depending on ASP and margin, Apple Watch would contribute $0.70 to $2.23 of EPS (add 8% to 28% to 2015 EPS).
Exhibit 4: EPS Matrices for 40 Million Apple Watch Units
The easiest way to interpret these matrices is that at sales of 10M, Apple Watch's overall impact on AAPL EPS will be relatively modest (approximately 4% of 2015 EPS.) At 25M, Apple Watch would represent around 10% of 2015 EPS, still modest and easily overshadowed by iPhone sales fluctuations. If Apple shipped 35-40M Apple Watches, the impact on EPS becomes more sizable, potentially reaching 15-20% of overall EPS.
These matrices also make it easier to convert consensus Apple Watch unit sales into an estimated level of EPS "built" into consensus EPS. If consensus is around 20-25M Apple Watches sold in the first year (I'm at 20-30M), then that implies analysts have around $0.70-$0.90 of Apple Watch EPS built into consensus EPS estimates. If Apple were to ship 40M Apple Watches instead of 25M, this would lead to Apple Watch EPS of around $1.20-$1.30, $0.40-$0.50 higher than consensus. Vice versa, if Apple Watch sales are weaker than 20-25M and instead closer to 10M, then this would imply EPS is overstated by about $0.40/share.
Over the coming weeks as the debate regarding how many Apple Watches Apple could sell continues, I will be relying on these matrices to help frame how various sales scenarios will impact Apple.
For this exercise, 2015E EPS represents Above Avalon's FY3Q15 - FY2Q16 EPS to match the probable first 12 months of Apple Watch sales, and EPS figures are after-tax (assuming a 25% tax rate). I view R&D and SG&A costs as sunk costs in this report. I also include continued share buyback through 2015 to obtain shares outstanding estimates. This report was produced by Neil Cybart on January 5, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard.
Apple Questions for 2015
In recognition of the beginning of a new year, I want to share my running list of questions that I have been keeping for Apple in 2015. By no means is this an exhaustive list, but rather things that I know to be on the lookout for.
Apple Watch
Actual Usage. I'm most interested in seeing the device in use, and not just by initial reviewers. Will people be attracted to any particular feature? Will families buy a few Apple Watches at once for communication purposes? Will teenagers want to wear the device as a status symbol? Will athletes find the device appealing? How strong will word of mouth be?
Health Sensors. There have been consistent rumors that Apple has a bit more to show off in terms of health and Apple Watch. What does Apple have left to unveil about Apple Watch 1.0 and health tracking, and will medical professionals be interested in the device?
Pricing. What will be Apple Watch and Apple Watch Edition collections (the middle and upper tier) pricing, as those remaining data points will help estimate overall Apple Watch sales mix and average selling price (ASP). How much would individual watch bands cost?
Unit Sales. Will Apple release Apple Watch unit sales? Management is planning on lumping Apple Watch financials into "other products" for earnings, but there is still a possibility Apple will announce opening weekend sales or even quarterly sales figures, just not revenue numbers. Apple Watch unit sales estimates currently range from 10M to 40M in the first 12 months, which is the difference between selling like an Apple TV (a few million a quarter) and iPad (10M+ a quarter).
Sales Channel. Will Apple utilize new department store retailers, such as Macy's and Bloomingdale's, to sell Apple Watches next to traditional luxury watches? Apple would be able to reach a brand new target market with such a development.
Apps. Will independent developers support Apple Watch? What will WWDC 2015 look like in terms of WatchKit?
iPhone
ASP and Margins. I'm much more interested in iPhone's ASP and margin in 2015. The addition of a more expensive iPhone, along with reconfigured storage capacities, means that iPhone ASP may see a relatively substantial change compared to previous years while margins have room to expand.
4-Inch iPhone Mini. A new 4-inch iPhone model may be one of the more interesting iPhone rumors in 2015. I suspect there is indeed 15-20% of the iPhone target market that may enjoy the old iPhone 4-inch display form factor, and 15-20% of a big number is a big number.
iPhone 6s. It seems like a better screen, camera, and processor are the leading candidates for selling points for new iPhones in 2015. I generally like the idea of using the "S" refresh years to introduce practical and functional internal upgrades as well as cosmetic changes to the outside in terms of color and finish. Will Apple update the external color and finish beyond silver, gold, and space grey?
iOS 9. Along with WatchKit, it is assumed Apple will announce new features for iOS at WWDC 2015. What will be the primary selling features of iOS 9? At this point the list of leading candidates is comprised of wanted features that did not make it in iOS 8.
iPad
ASP. Similar to my thoughts on the iPhone, I'm much more interested in looking at iPad's ASP trying to decode how the iPad Air is selling versus the iPad mini as that will help shed some light on how much the iPhone 6 and 6 Plus are cannibalizing iPad. Stronger iPad Air sales and weaker iPad mini sales (shown by a higher overall iPad ASP) would support the thesis that iPad is similar to Mac with a longer refresh cycle. Sales trends would track accordingly.
iPad Pro. Will Apple introduce its rumored larger iPad model in the first half of 2015? Will it be geared towards specialized use cases in order to differentiate the iPad from iPhone 6 and 6 Plus? Will the device accompany any change to the way Apple thinks of iOS and iPad?
iPad Mini. Will Apple stop selling the iPad mini given that the iPhone 6 and 6 Plus may be reducing the demand for such a device?
Apple Pay
MCX. Will there be any signs that fringe members of the Merchant Customer Exchange (MCX) consortium have changed their mind and are now interested in supporting Apple Pay?
International Rollout. How fast will Apple Pay be rolled out to new markets?
Loyalty/Reward Cards. Will we see loyalty/reward cards, possibly related to Passbook, be incorporated into Apple Pay in some fashion as a means of getting more retailers to support Apple Pay?
Disclosures. Will Apple Pay retailers use the opportunity to publicize how Apple Pay has impacted their businesses?
Mac
12-inch Retina Macbook. Will Apple ship a new Mac form factor that may eventually replace the Macbook Air?
Beats
New Streaming Service. Obvious questions would focus on price, geographical boundaries for the service, and differences from current offerings in the marketplace.
Branding. How will Apple handle the Beats brand, including both the streaming service and hardware?
Jimmy Iovine. Does Iovine's role within Apple extend beyond just music?
Retail
Angela Ahrendts. What changes does Ahrendts have in mind for Apple retail stores, as well as third-party retailers, including how the Apple Watch will be sold? One can argue it is time for the Apple retail store concept to be rethought to better reflect Apple's product line and current customer base.
Apple TV
Apple TV Box. Will Apple update the Apple TV box with a newer processor?
Financials
Share Buyback Pace. Instead of wondering if Apple will increase its share buyback authorization in 2015, a more appropriate question would be to ask if there will be any significant change in pace in share buyback in FY2015 from FY2014 ($45B)?
Dividends. Tim Cook has mentioned cash dividends will be increased on an annual basis, but by how much?
Debt. Instead of wondering if Apple will issue debt, I think a better question is how much debt will Apple raise in 2015, especially if rates remain low?
M&A. Will Apple continue buying smaller, specialized companies in bolt-on acquisitions, or will a bigger opportunity present itself while still fitting into Apple's M&A criteria?
Random Musings
Marc Newson. Is it a given that Newson is working part-time on future Apple Watch designs, or is he working on a different product?
Jeff Williams. Will Apple SVP Operations Jeff Williams get more press exposure in 2015?
Management Turnover. With the Apple Watch launch in the rearview mirror, will Apple experience any high-level management turnover in the second half of 2015?
Scott Forstall. He still may represent a wildcard as to what he has to say about the circumstances leading to his dismissal in 2012.
iPod Touch: Apple is selling around 1-1.5 million iPod touch units per quarter. Will the device see one possible last major update in 2015?
Apple Pen. I have no doubt that Apple has some type of smart pen/stylus in the labs, but I have more uncertainty in determining if the need for such a product (in conjunction with an "iPad Pro") is enough to receive one of Apple's rare "yes" decisions for going to market.
I would classify the Apple news events that aren't reflected in any of these bullet points as the unexpected. Apple looks to have a busy year ahead.
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Apple in 2014: Thinking Differently
Apple spent 2014 marching to a different beat than the rest of the tech industry. While others spent the year publicizing research and development efforts and M&A quests to find future business models, Apple spent the year doing what it knows best: thinking differently. Several Apple highlights in 2014 included:
- Rethinking the wristwatch, a product that has been around for over 100 years.
- Rethinking how mobile payments can be made easier using the existing banking/payments infrastructure.
- Investing in brick and mortar retail with a high profile (and expensive) retail hire despite everyone moving to E-commerce.
- Funneling development efforts into Mac despite everything moving to mobile.
- Investing in music by acquiring Beats in an attempt to regain mindshare and rethink music.
- Listening to Wall Street and shareholders, while other tech companies have become more anti-shareholder in terms of voting structure and capital management.
The expectations game was set quite high for Apple in 2014, with Tim Cook predicting in 2013 that Apple would have new products across 2014. Most of the year was also filled with anticipation of Apple’s entry into a new product category, which turned out to actually be two categories: watches and mobile payments. Eddy Cue added to the buzz by going on stage at Re/code in May to say that Apple’s upcoming product pipeline was the strongest in 25 years. While time will tell if Cue was right, it's not up for debate that the Apple machine was fully operational in 2014. Yes, Apple still faces shortcomings in certain areas, and 2014 saw little in the way of improvement in those initiatives (I have my own theory on why this may be, but that is for another time), but Apple spent 2014 building a solid foundation for 2015 with updates across nearly the entire product line and new initiatives and products meant to skate where the puck will be, positioning Apple for the next phase of mobile. Apple spent 2014 thinking differently.
Tech Observations during the Holidays
I use holiday dinners, brunches, and gatherings to observe tech trends among family and friends. I’m convinced at times that anecdotal evidence is just as useful as a fancy “scientific” study. Since I am observing mostly the same people each year, sampling bias should be somewhat reduced. Here are some observations from the past two weeks:
- Phones. Within my social circle, it comes down to an iPhone, Samsung Galaxy phone, or feature phone. It has been like this for at least a year, but I am not exaggerating when I say I saw no other kind of phone. The iPhone 6/6 Plus upgrade cycle looks to be very strong, with older iPhone models (iPhone 5c) making inroads in families with 3-4+ phones. Phone personalization via various phone cases is also rampant.
- Phone Sizes. A Samsung Galaxy Note (5.7-inch display) was the biggest phone I saw in the wild, although iPhone 6 Plus (5.5-inch display) was somewhat popular among teenagers. There is still a yearning for the iPhone 5s display (4-inch).
- Apps. A few years back, I would hear conversation about the latest downloaded app or how a particular app was very cool. Not anymore.
- Cameras. Last year, I still saw a few instances of people using dedicated regular cameras. This year: no dedicated cameras. Most have switched over to smartphones given much easier sharing capabilities.
- Tablets. I didn't see as much enthusiasm for tablets in 2014. Tablets are primarily being used as video players (Netflix and YouTube).
- TV. Still popular with more than a handful of instances of upgraded TV sets.
- Wearables. Crickets.
- Smart Home Devices. Crickets.
- Other. Frustration with cable and home internet service providers is continuing to grow.
Summing up my 2014 holiday tech observations:
- The iPhone 6/6 Plus have ushered in the largest iPhone upgrade cycle Apple has ever experienced.
- Samsung is holding its own among its loyal users in the phone market, but newer users to the brand are opting for older and cheaper Samsung Galaxy models.
- Smartphones are basically turning into cameras with social messaging capabilities.
- App discovery (and sadly innovation) seems to be slowing with concentrated pockets of exception.
- People like watching video on big screens (i.e. televisions).
- Tablets continue to lose their cool factor, and bigger phones are taking over many use cases once held by tablets.
- The first wave of smartwatches flopped.
The iPhone Was Different
Apple is currently an iPhone company with ancillary iPad, Mac, and software businesses. Few would have expected the iPhone to not only represent 60% of Apple's overall revenue within a few years after launch, but also transform the mobile industry in the process. Steve Jobs' initial goal was for the iPhone to sell 10 million units (capture 1% of the phone market) in 2008. Six years later, Apple sold 169 million iPhones in 2014 (8% share of a much bigger phone market). With the Apple Watch launch a few months away, one question swirling around is how similar will the wearable device be compared to iPhone in terms of importance and popularity. While Apple may find success in positioning Apple Watch as a way to redefine certain aspects of mobile computing, the iPhone will always be known as the first mobile device that truly changed the world. A quick trip to the mall makes it very clear that the iPhone was different.
Over the weekend I ventured out to do some light shopping. Since it was still early in the morning, I decided to go past my usual turning point in the mall and walk the length of the complex. It was the first time I was seeing the other side of this particular mall in years. While there is always some level of attrition with mall retailers, I was quite surprised to see a series of storefronts that had bucked the trend. Instead of closing or reducing square footage, these stores had a larger footprint, merging a few storefronts, leading to a formidable presence in the mall's upper level. These stores started out as smaller kiosks near the food court, and now they were among the bigger stores in the mall. The growing footprint of these mobile carrier retail stores symbolize how the iPhone was different than other Apple products, riding the much bigger wave known as mobile.
Only 10 years ago, the mobile carriers were selling a few dozen "feature" phones, packed with the latest keyboard innovations. After a few minutes of figuring out how many night and weekend minutes would be acceptable, the new cellphone owner would run to find an area in the mall with good reception (that last part is still true today). With much higher foot traffic on any given day (U.S. smartphone penetration moved from 10% in 2009 to 70% in 2014), mobile carrier stores now serve as places to not only buy a more narrow range of gadgets, but also attend to monthly bills, and receive tech support (including cable and home internet for some). Since I buy my phones online, walking past the much-larger AT&T and Verizon stores in the mall reminded me how mobile computing has matured since the iPhone was introduced. While the iPhone is a great device enjoyed by millions, the mobile rocket it strapped itself to certainly helped drive cumulative sales of more than 550 million iPhones.
Instead of transcending the mobile carriers, new Apple products in the near-term will likely be positioned to supplement the iPhone, improving on the device's initial breakthroughs in mobile. The iPhone was truly different; it only took a short walk in the mall, and a quick glance at the mobile carrier stores, to serve as a reminder.
Apple SVP Operations Jeff Williams on BBC's Anti-Apple Documentary
One of my stories in today's AAPL Orchard email was the BBC going undercover into Pegatron, one of Apple's iPhone assemblers. This morning after publication, Apple's head of operations, Jeff Williams, wrote a memo to Apple's UK team addressing BBC's "Apple's Broken Promises" documentary. BBC sent three reporters undercover to work in a Pegatron iPhone factory. I was able to watch the documentary last night. I would recommend watching the video as I thought the first 30 minutes were relatively fair from a journalistic standpoint, including observations and recordings from inside Pegatron. I thought the documentary started to lose credibility in the second half when the discussion turned to the very bottom of Apple's supply chain, focused on tin mining. I wasn't alone as Apple's Williams dedicated a good portion of his memo to that part of the documentary.
Apple SVP Operations Jeff Williams:
“Panorama showed some of the shocking conditions around tin mining in Indonesia. Apple has publicly stated that tin from Indonesia ends up in our products, and some of that tin likely comes from illegal mines. Here are the facts:
Tens of thousands of artisanal miners are selling tin through many middlemen to the smelters who supply to component suppliers who sell to the world. The government is not addressing the issue, and there is widespread corruption in the undeveloped supply chain. Our team visited the same parts of Indonesia visited by the BBC, and of course we are appalled by what’s going on there.
Apple has two choices: We could make sure all of our suppliers buy tin from smelters outside of Indonesia, which would probably be the easiest thing for us to do and would certainly shield us from criticism. But it would be the lazy and cowardly path, because it would do nothing to improve the situation for Indonesian workers or the environment since Apple consumes a tiny fraction of the tin mined there. We chose the second path, which is to stay engaged and try to drive a collective solution.
We spearheaded the creation of an Indonesian Tin Working Group with other technology companies. Apple is pushing to find and implement a system that holds smelters accountable so we can influence artisanal mining in Indonesia. It could be an approach such as “bagging and tagging” legally mined material, which has been successful over time in the Democratic Republic of the Congo. We are looking to drive similar results in Indonesia, which is the right thing to do.”
I thought the entire memo, but in particular that particular section, was well-written. It was tough watching children work in tin mines, but I knew that the BBC positioning these awful situations as being somehow approved by Apple was unfair and not trying to actually help these people. Williams did a good job at clearly explaining what Apple has been doing to address the situation, instead of simply telling its suppliers not to buy tin from those mines. The weird part about the BBC documentary was that the undercover reporters did notice a few protocols not being met inside Pegatron, which I assumed have already been addressed, but BBC went further and started to frame Apple as simply not caring about what was going on in its supply chain, or insinuating the more disingenuous claim that Apple approved of shortcuts or cheats meant to meet certain safety benchmarks or ratios. I thought the BBC reporter had an interesting story idea and took some risk to get the unique footage, but I suspect the conclusions were stretched too far in order to find a juicy story.
Apple Will Save $3 Billion in 2015 by Selling the 16GB iPhone 6/6 Plus
Apple's decision to keep the entry-level storage tier at 16GB for the iPhone 6 and 6 Plus, despite doubling the other capacities to 64GB and 128GB, continues to raise eyebrows. Daring Fireball's John Gruber called it "the single-most disappointing aspect of the new phones." By not doubling the entry-level storage tier to 32GB, I estimate Apple will save $3 billion of profit in 2015. I suspect Apple's bigger concern was the long-term balance between customer's storages needs and maintaining the iPhone's aspirational brand.
Apple's near-term motive behind keeping the 16GB capacity option is pretty clear: get people to buy the 64GB option. From Apple's point of view, consumers would benefit as Apple didn't raise the price of the middle-tier or upper-tier iPhone storage options, despite doubling storage to 64GB and 128GB, respectively. I suspect the issue is a bit more complicated and involves setting precedence for future iPhone revisions, as shown in Exhibit 1. The problem with having three storage tiers in an environment where the lowest storage capacity will soon be able to outstrip customer needs is that Apple risks permanently moving users from higher-priced to lower-priced models, where the cumulative change starts impacting iPhone average selling prices (ASPs) by hundreds of dollars, representing a significant portion of the company's net income.
Exhibit 1: iPhone Storage Scenarios
With Option A, if Apple kept a 16GB storage tier for an additional year (as they are doing now) and got people to upgrade to 64GB (represented by the red arrow), in subsequent years, consumers will likely develop a dependency on that storage level and remain in that middle tier, even after Apple increases the lower tier to 32GB in the future. With Option B, by upgrading all three storage capacities at the same time in Year 2, some consumers will downgrade to the lower storage capacity (represented by the red arrows) as their storage needs would be met with a less expensive model. With both Options A and B, the most popular iPhone model by Year 3 would be the same: 64GB, only with Option A, consumers are paying an additional $100.
Calculating the financial impact from keeping the 16GB model includes a few steps and calculations, highlighted in Exhibits 2 and 3. I have combined the financial impact from the iPhone 6 and 6 Plus in order to not miss the main point of this exercise; finding the difference in iPhone margin, both with and without the 16GB storage capacity tier.
Exhibit 2: Estimated iPhone 6/6 Plus Sales Mix and Margin Data Given Two Case Scenarios
By doubling the middle tier storage capacity to 64GB, while maintaining the price, and keeping the 16GB storage capacity at the bottom tier, I estimate that approximately 30% of previous 16GB iPhone owners will upgrade to 64GB to take advantage of the better deal, resulting in the 64GB being the best selling storage option (48% of sales mix), just slightly outpacing the 16GB version (43%). With the iPhone 5s/5c, I estimate the 16GB tier accounted for 60% of sales. If Apple upgraded the 16GB option to 32GB without changing the price, then it would have continued to be the most popular tier, even enticing some who had previously paid extra for 32GB to downgrade and buy the lower tier.
I estimate Apple's cost to upgrade the 16GB tier to 32GB to be approximately $15/device, leading to a little less than a 100 basis point weighted average decline in iPhone margin (to 48% from 49%).
Exhibit 3: Estimated iPhone 6/6 Plus Sales, ASP, Revenue, and Net Income Data in 2015 Given Storage Scenarios from Exhibit 2
All else equal, I estimate that doubling the iPhone's lowest storage capacity tier from 16GB to 32GB would lower Apple's profit by $3 billion. While the storage differences would likely not have an impact on overall iPhone sales, ASP would decline as users opt for the less-expensive model. iPhone revenue would decline by an estimated $5 billion, leading to an after-tax decline of $3 billion in net income.
While some may say this discussion of purposely limiting storage capacities to help maintain profitability is anti-consumer and a money grab, observers need to look at this process as a bit more than just greed. Apple is able to manage iPhone's brand and image by maintaining the device's high price. A case can be made that Apple is looking to get users dependent on higher storage capacities (at some point in the near future, 64GB will likely seem inadequate), by carefully guiding customers into a particular iPhone model each year. I suspect Apple kept the 16GB iPhone 6/6 Plus around in order to make future storage jumps, across all three tiers, a bit more manageable.
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Putting Apple's 20 Million Facebook Video Ad Views into Perspective
Last night I was surfing my Facebook News Feed, and up came Apple's recently released holiday commercial, "The Song." Facebook had it on muted autoplay. A screenshot is included:
The commercial has received 20.7 million total views. Last night around 9:00PM ET the video had around 18M views and was averaging nearly 1.3M views an hour. It would appear that it was showing up on News Feeds up until 11PM ET judging by the frequency and timing of new comments. Along with 20M+ views, the video has 210,000 likes and 8,800 comments, most of them positive (see Exhibit 1), so the engagement was definitely there despite the video being on autoplay.
Exhibit 1: Comments Posted to Apple's Facebook Ad
At 20 million views, I was curious how that compared to Apple's typical advertisement venue; television (the video has 2.4 million views on YouTube where it doesn't seem like it has been part of a YouTube advertisement campaign). While an apples-to-apples comparsion would be tough, I looked at viewership data for Tuesday night's network TV lineup.
Exhibit 2: U.S. Network Television Viewer Data - Top Shows - December 16, 2014
The obvious caveat is that viewer data for the networks includes both live and same day (DVR usage up until 3AM the following morning), while I can only estimate when the Apple ad first appeared on my News Feed. I'm sure there are additional subtleties that matter to marketers, such as 18-49 share, but the takeaway is clear: Facebook video ads matter. With a daily reach roughly on the same scale as prime time network television, not to mention all of the viewer interaction and targeted campaign possibilities, I expect to see future Apple video ads in my Facebook News Feed.
Fitbit's Ongoing Skin Irritation Issues and Lessons from "Antennagate"
Fitbit is once again in the news as early adopters are reporting the Fitbit Charge wearable is causing skin irritation. A similar thing happened earlier this year with the Fitbit Force, which resulted in Fitbit issuing a voluntary recall after consulting with medical experts. Turns out some users experienced an allergic reaction to the adhesive holding the housing and band together. What's going on with the Charge? Fitbit's official response is some of the irritation is a result of the device "staying in contact with the skin for extended periods" and likely due to sweat, water, or soap.
Fitbit's response reminded me a bit of Antennagate and Steve Jobs' initial "just avoid holding it in that way" reaction concerning iPhone 4 reception issues when touching the steel antenna bands. With Apple about to enter the wearable space with Apple Watch, I wonder if we are seeing a future "-gate" in the making where users complain about wrist irritation or discomfort. I thought it was appropriate to look back at Antennagate and compare the lessons learned from that public relations crisis to Fitbit's current issues and the upcoming Apple Watch.
- Not Letting Design Trump Engineering. Antennagate was the result of design trumping engineering as Jony wanted to use a non-coated steel rim for the iPhone 4 despite the obvious drawbacks in terms of signal strength. The end result was problematic signal loss if the gap in the steel rim was covered. Obviously this issue of design being more important than engineering continues to be a risk factor with Apple Watch, especially with its design playing such a crucial role. Having the product be in contact with skin for hours at a time doesn't help matters, although having to take it off to charge each night may actually be Apple's saving grace as people won't wear the watch for days at a time. By having periodic breaks in usage, Apple may not need to worry about users not cleaning or washing the skin underneath the watch band leading to irritation issues, similar to what Fitbit is experiencing.
- Conduct Proper Testing. Apple did not properly test the iPhone 4 due to fear that its redesign would be seen in public. With Apple Watch, executives have been wearing the devices for a few months, which should help catch any obvious long-term use problems. However, it is hard to have a large-scale test program due to fear of an unit getting into the wrong hands.
- Don't Initially Downplay the Problem. Apple initially downplayed any problem with the iPhone 4 with Steve Jobs even going so far as to blame Google, according to Walter Isaacson. While it does seem like Fitbit may be handling the current skin irritation reports better than last time, it is important to not give off-the-cuff remarks about an issue people, no matter how few, are indeed talking about.
- Gather facts. Take the time to gather the needed data, studies, and opinions that will help determine the exact problem and steps needed to address the problem. In a world where an instant response is demanded, taking time to gather the facts is often the hardest step.
- Bring in Public Relations and Advertising Experts. A response to a crisis is just as important as the crisis itself. Tim Cook appears to have mastered the art as seen with Apple's response to the Maps fiasco and, to a lesser extent, Bendgate.
- Appear Firm and Confident in Decision. Steve Jobs did not apologize for Antennagate, but he didn't come off as arrogant during the press conference. Tim Cook did apologize for Apple Maps.
The main lesson learned from Antennagate was to reframe the issue. Apple explained how all phones have antenna issues. Even if the press disagreed with Apple's claim, the discussion has now shifted away from just Apple's antenna issues. For Apple Maps, Apple said they were trying to improve maps for its users by building a new version from the ground up, and with the recent Bendgate, Apple said only nine customers contacted Apple with a bent iPhone, which took a lot of wind out of the conspiracy theorists. Fitbit seems to be pushing the argument that only a few people have complained of an irritation, and all wearable devices show similar reactions if worn for extensive periods of time. If true, I wouldn't be surprised if Apple Watch has few new "-gate" controversies soon after launch, but I expect Apple to be much more prepared this time around.
Apple's iPhone Strategy: Selling Shovels to Miners
When Steve Jobs unveiled the iPhone in 2007, few expected the camera would become one of the device's most popular features, positioning photo as a primary communication medium. While social networks have embraced the growing popularity of taking and sharing photos, and a cottage industry of camera accessories have thrived, Apple is positioned to benefit from the current photo renaissance by selling the software and hardware tools needed to sustain the movement. In essence, Apple is the hardware store selling shovels to gold miners in 1849 dazzled by the prospect of striking it rich. Apple's best strategy continues to be utilizing its hardware and software capabilities to introduce tools that allow users to push the envelope on new forms of communication including photo, video, and eventually haptics.
People use a camera to accomplish different tasks. While some like to capture moments spent with family and friends, others use a camera to take and share class notes, or accomplish daily chores like making a shopping list. Technology writer Om Malik wrote an essay on how the photograph represents a new visual language for the web, making it easier to consume content by removing language barriers and appealing to our senses. We like photos and are able to share and consume images much easier and quicker than text.
Most people now freely send and receive photos using messaging apps, like WhatsApp and iMessage, and social networks to communicate with others. Instagram's 300 million users sending 70 million photos and videos a day serves as the poster child of this movement. Meanwhile, Snapchat is quickly gaining popularity and relevancy in how media and content are distributed through photos and videos, while Pinterest adds a bit of an enterprise angle to the mix.
Apple is positioned quite well in terms of benefitting from this photo renaissance. In many ways, Apple helped kickstart the movement as the iPhone was the first mass-market phone to include adequate cameras capable of taking pictures worthy of sharing, while larger mobile data plans and faster data speeds made photo sharing possible. Even though the first front-facing phone camera was unveiled years before the iPhone was introduced, when two cameras were included in the iPhone 4, millions of people began to take photos of themselves without turning the phone around. A few years later the selfie was born, which I suspect will go down as a movement within the much bigger photograph renaissance. Selfie sticks are becoming popular across the world, and new ways of taking selfies are being introduced, such as the Donut Selfie, which I classified as "selfie innovation." GoPro represents yet another offshoot from the trend of technology changing the way we communicate and record the world.
I like using the current photo renaissance as a easy to understand case study on how Apple should approach M&A. While some want Apple to use its cash to buy a few of the larger social networks, the changing dynamics behind what guides a social network's popularity is often ignored. Facebook correctly bought Instagram, despite having the means to build its own photo-focused social network. Meanwhile, Twitter has seen success with short Vine video clips, but in terms of embracing photos, the solution has not been as smooth as Instagram. If a different form of communication takes off, all of these social networks will need to adapt once again either by buying smaller start-ups or building a organic solution. For Apple, a company with a maniacal goal on staying focused and placing very few big bets, this scenario doesn't seem to fit with the company's mission statement. Instead, a more appropriate strategy for Apple is to sell the tools needed to support and encourage new communication standards and mediums, such as embracing touch and haptics in Apple Watch. As another example, by selling both the hardware camera components, as well as the software, Apple is able to stand out from the crowd in terms of its mobile camera solutions, which helps iPhone and iPad unit sales.
Like a gold rush, while few will strike it rich with photos, like Snapchat and Instagram, many will flop or miss out on the significant upside. Meanwhile, the shop selling the tools (software and hardware camera solutions) will make out like a bandit.
Video - December 15, 2014
I'm trying something new here. I made a short video about my Thoughts on Apple's $155 Billion of Cash article from last week.
