Apple Is Buying Back Shares Like There's No Tomorrow
Tim Cook and Luca Maestri are literally buying back Apple shares as fast as they can. When comparing the pace of Apple buyback over the past six months to that of the program's previous three years, it is clear that management made the decision to be opportunistic to take advantage of Apple's languishing stock price. Apple management is showing an increasing level of confidence in its future.
While everyone quickly focused on iPhone unit sales growth guidance and clues about Apple Watch sales when Apple reported 4Q15 earnings last week, one data point that jumped out at me was the amount Apple spent on share buyback. Management bought more shares in the open market last quarter than any previous quarter. In fact, when looking at the past six months, including the most recent ASR (accelerated share repurchase program), Apple bought back $24 billion of its shares, which is a record for any six-month stretch. All of this is made even more remarkable when considering that Apple's stock price is more than 60% higher than when Apple began buying back its shares in late 2012. This shows management remains quite optimistic about Apple's future and value found in Apple shares at current price levels.
A closer examination of Apple's buyback activity is required to notice underlining trends. When looking at the pace of buyback on a very simple annual basis (Exhibit 1), nothing stands out from the ordinary. Apple has consistently repurchased shares since launching its repurchase program in late 2012, and it would appear that the pace of buyback slowed somewhat dramatically in 2015 due to a rising stock price and dwindling U.S. cash levels.
Exhibit 1: Apple Share Buyback (Annual - Fiscal Year)
However, if looking at the pace of Apple's share buyback on a quarterly basis, as shown in Exhibit 2, we arrive at a different conclusion as to how Apple has conducted its share repurchases. Apple's elevated pace of buyback over the past few months becomes apparent. As Apple's stock price declined this past summer due to a number of reasons including fears around slowing economic growth in China, Apple management increased its share repurchase activity. The $14 billion spent on share repurchases last quarter ranks as the fourth largest quarterly amount spent on buyback.
Exhibit 2: Apple Share Buyback (Quarterly - Fiscal Year)
However, looking at share repurchases on a quarterly basis still doesn't do the best job of explaining management's view on share buyback. The true extent of Apple's aggressive buyback activity only becomes apparent when looking at the pace of buyback on a trailing six-month basis, shown in Exhibit 3. This timeframe is able to capture management's changed attitude toward buyback this past summer. Over the past six months, Apple has spent more on buyback than any previous six month period.
Exhibit 3: Apple Share Buyback (Trailing Six Months - Fiscal Year)
When we look at Apple's stock buyback activity in FY2015, specifically the past six months, management's motivation becomes clear. As displayed down below in Exhibit 4, the yellow highlighted months (February, August, and September) represent the three busiest months in terms of management buying back shares in the open market. In FY2015, Apple spent $30B on share buyback in the open market, repurchasing 255M shares for an average selling price at $117.68. Looking back at the news flow from recent months, the pace of share buyback increased around the time Tim Cook emailed CNBC's Jim Cramer to say that business in China was holding up well. More interestingly, Apple maintained the pace of buyback through September up to the iPhone 6s and 6s Plus launch. These actions don't seem to come from a management team that is too worried about Apple's long-term trajectory.
Exhibit 4: Apple Share Buyback (Monthly Open Market Purchases in FY2015)
When thinking about the pace of future stock buyback, Apple's U.S. cash levels need to be addressed. The amount of cash held offshore cannot be used for share buyback (or quarterly cash dividends). I previously chronicled the dilemma this presents. Due to strong iPhone sales in China, Apple is earning more cash internationally than it can spend in the U.S. on share buyback and dividends. One near-term solution has been for management to issue debt in order to fund the capital return program. While this plan is not a long-term solution, it is likely the best near-term plan while management lobbies for U.S. corporate tax reform addressing repatriation tax on offshore earnings. In 4Q15, Apple issued $10 billion of debt to fund share repurchases in August and September (shown in Exhibit 5). This is the most likely reason why Apple didn't begin another ASR over the summer.
Exhibit 5: Apple Debt Issuance (Quarterly - Fiscal Year)
When looking at the pace of debt issuance, it is clear that Apple is only able to buy back its stock as fast as it can raise debt. Over the past nine months, Apple has issued $29 billion of debt while buying back $31 billion of shares. When taking quarterly cash dividends and Apple's routine cash needs into consideration, Apple is literally buying back shares as fast as it can.
While ASRs represent the quickest way to buy back shares, one requirement is to have the cash up front when the ASR is initialized, something that was likely not possible over the summer. Instead of beginning another "modest" ASR of a few billion dollars, Apple management likely wanted to be much more opportunistic with buyback. The second-best alternative was to issue debt across a number of weeks and then repurchase shares in open market transactions, buying a greater number of shares as the stock price continued to drop in August and September. In terms of open market purchases, highlighted in Exhibit 6, 4Q15 was the busiest month since Apple began its buyback program, exceeding the second most active quarter by 75%.
Exhibit 6: Apple Share Buyback (Quarterly Open Market Purchases - Fiscal Year)
When looking at the pace of debt issued and the resulting pace of buyback, I have doubts Apple management could have done much more to buy shares at a faster pace over the summer given the circumstances and share price. While Apple could have returned the $187 billion of foreign cash back to the U.S., paying the required tax on such funds would not be the most shareholder-friendly option. Stock buyback does not operate in a vacuum with management needing to weigh the costs of returning cash to the U.S. against raising debt.
It is important to remember that share repurchases, both open market and ASRs, are unable to keep Apple's stock price from declining in the future. There are a number of high-profile examples within the financial sector were management teams were buying back stock in 2007 and 2008 only to then need to raise capital in the subsequent recession as their companies encountered a more difficult operating environment. Instead, the main takeaway from Apple's buyback program is that management increased the pace of buyback as Apple's stock price declined nearly 30% from all-time highs. The striking aspect of Apple's buyback is how management is actually buying more shares as Apple's stock price increases. In 2015, Apple repurchased shares at a $118 average stock price, 25% higher than the average price paid in 2014. When looking back at 2013, Apple was buying shares at price levels that were 65% lower than the current stock price.
Tim Cook and Luca Maestri are likely becoming more confident in Apple's future when looking at iPhone's position in the smartphone industry. The ability to entice Android smartphone owners while serving as an aspirational brand causing consumers to strive to move up to iPhone's price layers represents a long-term positive. In addition, while this may be just a coincidence, Apple management increased the pace of buyback in February 2015, around the time reports came out depicting Project Titan and Apple's growing ambitions with electric cars. Then, over the summer, the increased pace of buyback once again seemed to correspond to new reports indicating new Project Titan hires and a WSJ report in September saying the project received the green light with a 2019 target. Management is now left with $36 billion of remaining share repurchase authorization with the board planning to update the capital return program in 2016. We are seeing a management team that is betting big on a future that the stock market is still unable to see.
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Apple's 4Q15 Earnings Preview
Apple's upcoming earnings report is set within a tumultuous market. We find ourselves in a changing environment with fears surrounding China's economy subsiding and optimism around the U.S. economy and the technology sector on the rise. Last week, large cap tech saw a resurgence as Microsoft, Amazon, and Google all reported strong 4Q earnings compared to expectations. Apple shares have traded up since bottoming at the end of August even though Wall Street continues to question iPhone sales strength. Apple's 4Q15 will provide the clearest read yet on how the global economy did this past summer as the iPhone has become the unofficial economic bellwether for China and global consumer demand.
The following table includes my estimates for Apple's 4Q15. Where applicable, I have compared my estimates to management's guidance.
iPhone
Investors remain nervous about iPhone sales. Upon closer examination, this nervousness has been around for close to a year, dating back to when the iPhone 6 and 6 Plus launched in September 2014. Since Apple's 4Q15 earnings reflect iPhones sales from July to September, results will primarily reflect how the iPhone 6 and 6 Plus did in China over the summer. In many ways, Apple's 4Q15 is a transitory quarter as attention will quickly move to FY2016 and iPhone 6s and 6s Plus demand.
Exhibit 1: iPhone Unit Sales Expectation Meter (4Q15)
I remain above consensus with my 50.5M iPhone unit sales estimate. Much of my optimistic stance rests on the belief that Apple saw continued robust iPhone sales in Greater China over the summer. I am also assuming Apple experienced an average level of iPhone sales seasonality in the weeks leading up the the new iPhone launch. I consider iPhone unit sales in the range of 46M to 51M as close to my expectations. If Apple reports iPhone unit sales of closer to 40 million units, I will need to readjust my FY2016 iPhone sales view as it is likely Apple saw decelerating iPhone unit sales growth in China at a much faster pace that I expected.
iPad and Mac
Similar to the past few quarters, the iPad and Mac will not make or break Apple's earnings report. When taking a step back from the quarterly fluctuations, Apple is still trying to find the iPad's normalized sales run rate where the pace of iPad upgraders and new customers will lead to stable growth trends. We are not there yet. The Mac continues to perform well in an environment where the laptop and desktop form factors are struggling in the face of smartphones.
Exhibit 2: iPad and Mac Unit Sales Expectation Meters (4Q15)
Apple Watch
As we saw with Apple's 3Q15 earnings report, due to Apple not disclosing Apple Watch sales estimates, we end up with an "inside baseball" back-and-forth debate among financial analysts trying to back into Apple Watch sales estimates. Consensus seems to have settled on Apple selling 2.5 million to 3.5 million Apple Watches last quarter (I estimated Apple sold 2.6 million). At last week's WSJDLive conference, Tim Cook all but assured us that Apple will have shipped more than 2.5 million Apple Watches in 4Q15. My official Apple Watch unit sales estimate is 3 million, bringing the five month total for Apple Watch unit sales to 5.6 million.
Guidance
Management's guidance will provide a clue as to how iPhone 6 and 6s Plus are selling. Unfortunately, Apple Watch revenue may make it more difficult to convert revenue guidance into an iPhone unit sales estimate. The debate surrounding iPhone is whether Apple can continue to grow the product category in FY2016. If revenue guidance comes in less than $75 billion, many investors will use that as evidence that Apple will struggle growing iPhone unit sales in 2016.
Exhibit 3: Revenue and Margin Guidance Expectation Meters (for 1Q16)
Summary
Expectations surrounding Apple are much more varied heading into Tuesday's earnings report. With iPhone sales expectations more subdued this time around compared to previous quarters, it may take less for Apple to please Wall Street. I will be looking for any signs as to how management looks at the pace in bringing new customers to iPhone. While a slowdown in new user acquisition from FY2015 should be expected, the market will likely look favorably upon evidence that suggests the iPhone 6s and 6s Plus are still effective in expanding the iPhone user base at levels similar to iPhone 6 and 6 Plus. Several analysts have already given up on the iPhone 6s and 6s Plus narrative and are now focusing on iPhone 7 in late 2016.
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Leasing Solves Apple's Cheap iPhone Dilemma
Apple is on track to sell more than 250 million iPhones over the next 12 months. When looking at overall sales share, the iPhone remains a small player, representing only 15% of overall phone shipments. However, on a profit share basis, the iPhone has rewritten the rules guiding the smartphone market, commanding upwards of 90% of the industry's profit. Even though Apple's mission has never been to sell the most of a product, there may be a way that Apple can grow iPhone's sales share rather significantly while retaining control of the smartphone industry's profits. An iPhone leasing model solves Apple's dilemma of how to address a larger portion of the smartphone market without diluting its aspirational brand and iPhone experience. Leasing will usher in the next major phase of the smartphone industry by solving Apple's cheap iPhone dilemma.
The Changing Smartphone Market
In the early days, the prevailing way consumers bought an iPhone was with carrier subsidies. Instead of paying the $649 up-front price for the base iPhone model, AT&T would "subsidize" $450 of the cost, which would later be indirectly recouped by charging higher monthly service fees. However, as time went on and additional carriers began selling iPhone, the subsidy model represented a declining percentage of overall iPhone sales. A growing share of iPhone buyers were now paying full price for iPhone but in return getting lower monthly service fees from their carrier. Over the past eight years, in an environment where the iPhone's full cost is either born by the consumer up front or the carrier through a subsidy and subsequent two or three year contract, the iPhone was able to grab a commanding share of the premium portion of the smartphone market (>$400) with much less success in the middle market ($200-$400).
Spurred on by competition and unsustainable growth in iPhone subsidy costs, U.S. mobile carriers began to move away from the smartphone subsidy model and are currently embracing a leasing paradigm. Consumers are now able to pay either nothing up front or a small initial payment and then pay back the rest of the iPhone across a number of months, usually 24. Since carriers are no longer on the hook to "subsidize" part of the iPhone's cost, monthly service costs have been reduced although data has continued to become more expensive over the years.
In an effort to retain the best customers, and as a sign of the iPhone's market power, carriers have included options for iPhone users to lease a new iPhone each year by simply turning in their old iPhone. The end result is a growing number of iPhone owners that lease their iPhone, paying the same price each month, but upgrading to the newest iPhone each year.
Apple has recently gotten involved in the mix by launching the iPhone Upgrade Program in conjunction with the iPhone 6s and 6s Plus launch. While currently only available at Apple Stores in the U.S., the program is designed for those who want a new iPhone each year with the added peace of mind provided by AppleCare+. Customers apply for a loan financed by Citizens to cover the cost of the iPhone, AppleCare+, and sales tax. After the initial payment is made, the loan holder then has to pay back the price of the iPhone and AppleCare+ in 23 equal installments. However, after the 12th payment, the loan holder can hand in his or her current iPhone at an Apple Store and then upgrade to the newest iPhone by signing up for another 24-month loan. The cycle then repeats itself until the next year. Similar to what is happening at the carriers, the iPhone Upgrade Program is creating a growing number of iPhone owners that lease iPhones which shortens the iPhone upgrade cycle, boosting iPhone sales.
While we are still early in the iPhone leasing movement, early survey results suggest there is interest in leasing programs, including Apple's iPhone Upgrade Program. Since so few iPhone sales occur in U.S. Apple Stores, any near-term impact directly related to the iPhone Upgrade Program will likely be moot. Citizens expects less than one million customers to use the iPhone Upgrade Program over the first 12 months. Longer-term trends, and more importantly, the learning experience Apple is receiving by leasing iPhones, bode well for the program. It would be surprising if Apple does not expand the program to new countries over time.
The Cheap iPhone Is a Myth
The call for Apple to release a cheap iPhone reached a fever pitch a few years ago when Apple first entered China with China Unicom and China Telecom relationships. Even though Apple has steadily grown market share and unit sales, a certain group of analysts and pundits continue to think the only way Apple would be able to do well in China and emerging markets would be to release a "cheap" iPhone. The problem with this thesis is that there were very few strategies Apple could realistically use to sell a genuinely low cost iPhone without undermining its business.
A base model iPhone 6s retails for $649 and has an gross margin of approximately 45%. In theory, Apple could sell such a device for $350 and break even, but with a business model dependent on making money from hardware, this isn't a viable long-term solution. Another possible way to sell a cheap iPhone would be for Apple to take a base model and strip out features and components. However, upon closer examination, this is much easier said than done. The iPhone's popularity is a result of the experience obtained from using it. Accordingly, it would be very difficult to maintain that experience by selling a stripped down iPhone with lower quality cameras, screens, and processors. Even then, a stripped down iPhone would still likely sell in the $300-$400 price range, which does not address the low-end of the market.
Another option to market a cheap iPhone would be for Apple to segment screen size according to price tiers. A 4-inch iPhone "mini" could sell for a lower price than bigger-screen options. However, recent iPhone sales trends would suggest a 4-inch screen iPhone would likely become a niche device as consumer preferences are overwhelmingly moving towards larger form factors like the iPhone 6 and 6s, with a growing number of users opting for the larger screens found with the iPhone 6 Plus and 6s Plus.
Apple would have much difficulty selling a low-cost iPhone at a price that would make it competitive in completely new market segments. The most likely scenario that many have not considered is that a cheap iPhone probably wouldn't be as popular as consensus assumes. In fact, I would go so far as to say a low-cost iPhone would likely disappoint on the sales front. The iPhone's success comes from the branding and aspirational feeling attached to the device. By selling a low-cost version of this experience, consumers would likely not value the device in the same way.
We saw a real-world example of this buyer aversion in 2013 when Apple unveiled the iPhone 5c. Instead of keeping the previous year's flagship phone, the iPhone 5, around and lowering the price by $100, Apple reconfigured the device by giving it a plastic shell. While the iPhone 5c did sell (I estimate approximately 40 million units were sold during its lifetime from 2013 to 2015), it was not enough to change the game. Instead, the device quickly gained the nickname "the cheap iPhone" as the device's colorful plastic shell easily signaled to people it was the cheaper iPhone version compared to that year's more expensive flagship, the iPhone 5s. It was never able to shake its cheap nomenclature. Many consumers buy iPhone for the intangibles that come with such a purchase such as being able to show it (and its high price tag) off to others. The iPhone 5c experiment is a preview of how an actual cheap iPhone would fare in the marketplace: not as well as many assume.
The much bigger question to ask with a cheap iPhone is what is even considered "cheap"? Even though the iPhone 5c was mocked, the device still sold for a not cheap $549. A stripped down iPhone selling for $300 to $400 wouldn't classify as a cheap iPhone either, especially with other smartphone manufacturers selling product in the $150 to $200 range. The cheap iPhone may be a myth, but Apple is able to recreate many of its benefits, as well as come up with new benefits, by embracing the leasing model.
Leasing is the Answer
A world in which iPhones are leased solves Apple's cheap iPhone dilemma. With leasing, multiple owners are able to value the same product differently. For some, there is value in being able to use the latest and greatest gadget while for others, the value is in low cost and being able to hold on to a device for a long time.
An iPhone leasing paradigm depends on a few variables including a functioning grey, or resale, market and healthy residual values. A grey market where buyers and sellers are able to transact in a low-cost, convenient, and safe manner is required for a leasing model to effectively move iPhone units from initial buyers to the next group of buyers. Since iPhones retain a good portion of their value as time goes on due to the device's build quality, popularity, and lack of lower cost models, the iPhone has high residual values. Accordingly, iPhones are able to be leased in a cost effective manner. If the iPhone did not hold on to its value well, leasing would prove to be a very expensive option as customers would end up paying most of the iPhone's retail price during the first year of ownership. As a result, the incentive to trade in an iPhone and upgrade would not be high. However, with a high residual value, an iPhone leasing model involves paying only 50% of the iPhone's retail price during the first year. In such a scenario, many would be willing to trade an iPhone in after a year for a new model since most owners currently hold on to their iPhones for two years.
Leasing creates supply of one-year-old gently used iPhones that can be resold to new customers for less than the cost of a one-year iPhone sold by Apple. If we continue with this example for another year, leasing would create a supply of two-year old iPhones that can be resold to new customers for much less than the cost of a two-year iPhone sold by Apple. With leasing, iPhones make their way down to segments of the market that are not addressed by Apple. Even in an environment without leasing, there is a thriving grey market due to resales. Leasing would only legitimize and expand the grey market. The following chart compares new iPhone pricing at Apple to used iPhone pricing at Gazelle and eBay. Notice how used iPhone pricing currently stabilizes around $200.
Notes: Pricing is for entry-level storage. Gazelle and eBay prices are for unlocked models.
While Apple would not make money on these iPhone resales, Apple would benefit by selling new iPhones to its installed base each year. Apple would therefore be able to address a larger portion of the smartphone market while not jeopardizing its profit share. The cheap iPhone dilemma would be solved.
The key reason someone would purchase a used iPhone that was previously leased instead of a cheaper iPhone with stripped down parts is that used iPhones retain Apple's aspirational brand characteristics. Instead of using a cheap iPhone that either looks or behaves differently than other more expensive iPhones models, used iPhones would appear and act the same as brand new iPhones. The iPhone user experience remains intact much more in a leasing paradigm. We see this play out in the automobile industry where premium brands such as Mercedes-Benz, BMW, and Audi each have vibrant leasing ecosystems where consumers can lease two to three-year-old automobiles for a much lower price rather than buy scaled-down, low-priced models that question premium car brand attributes.
Follow the iPhone
To better understand how leasing can help Apple address the low-end of the smartphone market, we can follow the path of an iPhone from original purchase to final destination a few years down the road, taking a look at the various owners and pricing along the way.
- Step 1: A customer buys a new iPhone 6s 16GB for $649 at an Apple Store using the iPhone Upgrade Program. A two-year loan was originated to finance the cost of the iPhone and AppleCare+.
- Step 2: At the end of the first year, the original owner returns the iPhone 6s to Apple. The original loan is then paid off. The one-year old iPhone 6s is then transferred to a third-party specializing in recycling or reselling used smartphones. The original owner leases a new iPhone from Apple with a new two-year loan.
- Step 3: The gently used one-year-old iPhone enters the grey market and is resold to a different customer for $450. A comparative one-year-old model would sell at Apple for $550.
- Step 4: A year later, the now two-year-old iPhone can still fetch $200 in the grey market. The second owner then decides to sell the device to someone on eBay for $200. A comparative two -year old model would sell at Apple for $450.
In this timeline, a $649 iPhone was able to be "bought" by three customers over the span of three years for a collective $1,299. The difference in prices helps facilitate the grey market transactions. A larger and more robust leasing paradigm would make this process much more efficient and legitimate, similar to how leasing used cars pretty much involves the same process and players as leasing a new car. Over time, used iPhones would be able to be purchased or leased at many of the same locations where new iPhones could be purchased.
One consequence of additional iPhone supply entering the grey market as a result of additional iPhone leasing is that resale prices may fall in order to match demand. However, there appears to be significant room for prices to fall without impacting the leasing paradigm, as displayed in the following chart. The black dashed line represents the point where iPhone resale values could fall to in order to still work with Apple's iPhone Upgrade Program.
Notes: Pricing is for entry-level storage. Gazelle and eBay prices are for unlocked models.
Financial Impact
Apple currently has an iPhone installed base of approximately 500 million users. When taking into consideration hand-me-downs and the resale market, the total number of iPhone users exceeds 500 million. If we were to assume leasing will be the only method by which iPhones will be purchased in the future, than theoretically, Apple would sell 500 million iPhones a year (every iPhone user would simply lease a new iPhone every year). A 500 million iPhone annual sales rate would be 98% higher than the current 253 million sales that I expect Apple to sell over the next 12 months.
In reality, we are still in the very early innings of the iPhone leasing model, and not everyone will want to lease their iPhone. However, running with conservative estimates of 20-25% adoption rates for iPhone leasing over time, it does not take much to begin seeing a tangible benefit to Apple's iPhone sales. At 20% adoption, Apple would sell an additional 50 million iPhones a year. Said another way, if 100 million iPhone users leased their iPhones each year, Apple would see a 50 million unit boost to unit sales each year. The other benefit from leasing would be that used iPhones would help expand the iPhone user base benefitting the iOS ecosystem which may come in handy as Apple continues to push on content deals (Apple Music, Apple Video in 2016) and services such as Apple Pay.
With iPhone leasing at 20% adoption, it is conceivable for iPhone's smartphone sales share to increase by 4-5% to 20% without even needing an entry-level low-cost iPhone to boost sales.
iPhone Leasing Momentum
Ultimately, the only reason leasing iPhones makes sense in the first place is that the iPhone is becoming the primary computing device for hundreds of millions of people. There is a significant need and desire to use the newest iPhone each year. This would be a new type of hardware paradigm compared to previous computer technology eras where consumers bought and then held on to gadgets for years. Another reason an iPhone leasing model works is that consumers have noticed Apple's iPhone development cycle and the company's ability to ship new iPhone features each year. Mediocre annual iPhone upgrades would likely make leasing a much harder sell as consumers would decide just to hold on to their new iPhone for a few years, a much cheaper alternative than leasing. Ultimately, leasing changes the smartphone game by expanding Apple's addressable market and solving the company's cheap iPhone dilemma.
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Apple Uses Good Design to Marginalize Industries
What makes a great product?
How can one product change an entire industry?
One of Apple's most significant accomplishments has been a dedication to design that borders on the line of obsessiveness. As people decipher the driving factors behind what makes a product like the iPod, iPhone, and iPad so successful, it is crucial to recognize how a product's design has the potential not just to alter industries, but go so far as to marginalize them. The iPhone relegated the mobile phone to a single app. Apple Watch is being positioned to turn the modern Watch industry on its head. Apple's ambitions with the automobile will be nothing short of a transformational shift in how we think and use automobiles. When a company places only a few big design bets every few years, the resulting bets need to be huge, and Apple positions good design as the guiding light with all of its bets.
What is Good Design?
Apple has thrust the topic of design into today's society. There is more cultural awareness of design than ever before. While this may sound like a good thing, the definition of design has seemingly expanded along with its growing popularity. The end result is growing confusion as to what design even means. Apple has always positioned design as a guiding principle even though consumer demand for such design is still a recent phenomenon. The world needed to see what the lack of design in the PC market looked like before craving Apple products born from the rebirth of the design-led process in the late 1990s.
With good design, a product is able to tell the world something about the person who created it. Good design is born during the product development stage when a fragile idea is allowed to advance and mature without compromises. So much of the corporate world is built in such a way as to stifle good design. The end result is that we are left with industries that play a crucial role in our lives but are susceptible to being altered by products that are created with additional care and intuition. The difficult part is looking at these legacy industries in a way that allows one to discover how they can be improved. While a handful of companies may realize the pieces to the puzzle for unlocking good design, there are even fewer companies that actually possess those pieces. An Apple led by Jony Ive is currently one of those companies, and Apple's $200 billion of cash is one tangible piece of evidence that Apple has possessed these pieces for years.
Software Represents Additional Design Tools
Software allows good design to posses a different dimension. Similar to how a new paint color added to one's palette can result in a completely different picture, software allows a designer to add something to a product and to accomplish what would otherwise be impossible. It's not that software should be looked at as completing good design, but it provides a set of additional tools to interpret the world. Software makes it possible for us to interact with products in new ways that once seemed unimaginable.
Turning Phones into Computers
When Apple executives began to seriously consider entering the cellphone industry, the motive was clear: come up with a phone that people want to use. Even though the iPhone is only eight years old, the world was a much different place in the mid-2000s. The cellphone industry was being built on a paradigm where phones were used to dial a long list of numbers in order to speak to someone. Innovation came in the form of a better keyboard; each button moved from having three letters to having its own letter. The world accepted these products with open arms because we were able to send and receive email when away from our computer.
A cellphone's keyboard was quickly turning into a limiting factor, a feature that was holding back the device's potential. Few saw this taking place, especially the phone industry leaders. Even more remarkable was the untapped potential for the phone form factor: a device that could be small and light enough to be carried around with us all day.
The iPhone ended up representing a simple question: Is there something better than a physical phone keyboard? The iPhone's design represented the answer. By removing the keyboard, a smartphone's potential was unleashed. Of course, those industry leaders clearly invested in the old paradigm not only did not understand the appeal of not having a keyboard, but also lacked an understanding of the potential now created by removing the keyboard as a limiting factor.
The iPhone's design doesn't just stop with the lack of a physical keyboard. Everything from hardware design elements like physical volume button placement to software features like pinch-to-zoom told us something about who created the device. The iPhone stressed intuitiveness above all else, and this goal ended up positioning the iPhone a good five years ahead of the competition. The iPhone was one product that was able to upend not just the mobile phone market, but the entire computer industry.
The iPad's Magic
The iPhone was a byproduct of research and development originally geared for a larger tablet device. With lessons learned from iPhone development, Apple returned to what ended up being unveiled to the world only three years after the iPhone: the iPad.
The iPad has since had a storied history, despite tallying only five years. It came out of the gate as the fastest selling consumer gadget in history, (Apple sold 19 million iPads in the first year on the market) but the device is now experiencing waning sales momentum as the entire tablet market has shown structural issues.
When the iPad was first introduced to the world, many called it a big iPod touch in an effort to discredit Apple's design foray into the tablet market. In reality, the iPad's greatness resided in it being "just" a big iPod touch. The device's intuitiveness was nothing short of earthshaking. The iPad's recent sales struggle isn't so much an indication that multi-touch computing has hit a saturation point or is being replaced by another computing paradigm. Instead, consumers are still experimenting with multi-touch screen form factors. For many people, a larger iPhone is a more optimal form factor than an iPad. Accordingly, we are left with a situation where smaller iPads are seeing weakening sales momentum while Apple moves faster at the high-end of the market. This is likely just the start of where the iPad is headed. Ultimately, the iPad was a computer designed to have the hardware melt away during use, leaving the software as the primary user interface. Apple's quest to make the most personal computers came to fruition.
Apple Watch's Mission
Good design was used to question a cellphone's keyboard, unleashing the device's functionality. Similarly, the Apple Watch is given a mission to redefine utility on the wrist. As both Jony Ive and Marc Newson have mentioned publicly, Apple Watch wasn't born out of disgust with the modern wristwatch. There was something else at play, and the Watch's design gives us clues about this driving motivation and why Apple Watch represents a pivotal turning point in the watch industry.
Apple Watch design represents a simple question: can a device worn on the wrist include additional utility? Giving Apple Watch a rectangular watch face, something that was steadfast from early in the Watch development process, emphasizes the device's purpose to display text in the most space-efficient manner possible. The Apple Watch's design does not imply that the device is trying to be a mini iPhone, but instead a device that is meant to take certain tasks once destined for the iPhone (checking the time, receiving notifications, tracking health and fitness) and display information in a location with proper line of sight to the wearer. Haptic feedback serves to replace line of sight for some users as well as create another form of notification.
Design is also found in the Apple Watch bands, demonstrating that the Watch is a fashion accessory worn on one's body and on display to the world. In a way, watch bands can be thought of as a form of software. It is perhaps fitting that with the Hermès partnership, Apple introduced leather watch bands in addition to software specifically designed for the Hermès collection.
The end result, and one that we find ourselves in the early innings of, is a watch industry coping with the prospects of adding additional utility on the wrist. The Apple Watch draws into question how timelessness and craftsmanship should enter the buying equation (both are now largely marginalized in their current form). While some still think certain segments of the luxury watch market will be able to ignore the smartwatch movement, the aggressive moves Apple is making in the fields of traditional luxury, including the Hermès partnership, should serve as an indicator that few watch makers will be able to avoid the future brought on by software on the wrist.
Marginalizing the Auto Industry By Looking Inside
With the automobile, Apple will once again look to position good design to marginalize a legacy auto industry that is more than 100 years old and has played a defining role in how we live our lives. The modern day automobile is not intuitive. Drivers need to learn to operate an automobile. Passengers have to conform to a car's existing seating arrangement with only marginal modification. Software has the potential to change all of these limitations.
While Tesla has become a pioneer in electric vehicles and BMW continues to slowly build momentum in the space, both companies have not actually altered the automobile's fundamental purpose. Nowhere is this seen more than inside the Tesla Model X and BMW i3. While the dashboards have seen a change, in Tesla's case most of the dials and knobs having simply been converted into software and placed on a large tablet. There is much room for improvement.
The way we think about automobiles today will be different than how we look at the automobile in the future. Good design is powerful enough to alter our prevailing attitudes and views of a product. Simply put, we are being held back by our prevailing attitudes of what an automobile is. With Apple Car, Apple would reposition the car as a connected room on wheels. The car interior is being held back by both legacy automobile design and the lack of software. Take into account how software holds the potential to add magic to a user's iPhone or iPad, and the same can apply to the experience in a car. We are still stuck in the era of trying to improve the smartphone keyboard when it's time to drop the keyboard altogether. This would mark a significant departure for an auto industry that has rode the combustible engine to the end of the road.
Good Design Is All About Taking Risks
The one recurring theme found with all of Apple's products unveiled over the past 15 years is they were all high-risk. The iPod, iPhone, and iPad were all bets that the consumer would place value in doing something in a different way. The Apple Watch is a bet that people want additional utility on the wrist. Project Titan will be positioned as nothing short of a bet-the-company play in the automobile industry. Failure would be measured not only in billions of dollars, but more importantly, in time.
Good design contains risk, the same risk that legacy companies did not want to take to move their industries forward.
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Apple Watch Is Being Severely Underestimated
The Apple Watch continues to show incredible promise although much of it is being masked behind an iPhone lens. Unrealistic expectations positioning Apple Watch as the next iPhone in terms of sales and popularity have now resulted in many people ignoring positive Apple Watch developments. When analyzing geographic and retail distribution expansion, product and market strategy, and the competitive landscape, it is clear that the Apple Watch is not just being severely underestimated but has quickly become one of the best-selling wearable devices.
Apple Watch Expectations Pendulum
With Apple Watch representing Apple's newest product category since the iPad in 2010 and the first genuine new product developed during the Tim Cook and Jony Ive era at Apple, the product launch received quite a bit of attention. Apple helped build the excitement as the Apple Watch debut in September 2014 was billed as one of the bigger Apple product keynotes in recent history, even beating the iPad's unveiling in 2010. Expectations were set high. In reality, these expectations were too high. The Apple Watch was being thought of as the next iPhone, a device that would quickly surpass the device we already carried with us all day, every day. Many compared the Apple Watch keynote to the iPhone keynote, looking for the device's three key features. For iPhone, it was a telephone, communication device, and iPod. Apple obliged with most of these requests, as they followed a similar playbook with Apple Watch, labeling the device as a communications and health & fitness device as well as a timepiece. Once again, expectations were likely mispositioned.
If Apple Watch expectations were a pendulum, right before the Apple Watch was launched, the weight on the end of the string was pulled all the way back to "the next iPhone" as expectations were quite high. However, in the weeks following launch, the overall feel towards the product took on a completely different tone. There was increased attention given to posts discussing how the Apple Watch was just a toy and not ready for prime time. One post went as far as being just a GIF of Apple Watch being thrown on top of a bunch of leftover and old chargers in a desk drawer. The word "flop" was being passed around with increased frequency. Sticking with the pendulum theme, Apple Watch expectations had quickly moved to the completely opposite end of its trajectory, now classified as a flop. Five months have since passed Apple Watch's launch and after looking at sales, usage patterns, and customer satisfaction surveys, it would appear that the Apple Watch is neither the next new iPhone (at least not in the near-term) or a flop. Instead, it is a fun and cool product with much promise and intrigue. The pendulum will eventually come to rest between both extremes.
Massive Launch for First Generation Product
The Apple Watch launch was unlike recent new Apple product launches. There were no lines outside Apple Stores, carrier stores weren't selling Apple Watch models, and there was much mystery as to how to sell such a personal device with so many different options. Some even wondered if Apple would be able to find a way to sell Apple Watch in the same setting that it used to sell desktops, laptops, tablets, and smartphones. With the launch now in the rearview mirror, we have a much clearer picture of the issues Apple faced leading up to the first Apple Watch sale. While all new Apple products suffer from supply issues at launch, Apple Watch supply was much more limited than most realized. Some blamed Angela Ahrendts for a "botched" Apple Watch retail launch while others even looked at Jeff Williams as holding some responsibility for confusion surrounding Apple Watch availability. The WSJ went on to report that faulty taptic engines in some Apple Watches led to Apple not being able to sell a certain percentage of assembled units, leaving the company with not enough stock to have the device available for in-store purchase. What had been billed as the largest Apple product launch in years seemed to miss the mark.
However, when Apple reported earnings at the end of July, a different picture began to appear. Even though Apple Watch revenue and unit sales were not disclosed, one is able to back into a fair estimate of such metrics using an accurate financial earnings model. Apple likely shipped 2.6 million Apple Watches from launch to the end of June. Taking into account that many of these shipments were ordered at or close to launch, we are then able to paint a picture as to what kind of launch the Apple Watch really had.
Apple likely sold around two million Apple Watches at or close to launch. On an absolute basis, this would classify as the biggest product launch in Apple's history despite there being no long lines. In the preceding weeks after launch, Apple Watch supply then improved rather dramatically. Apple just had completed its quietest record-breaking product launch in its history. When comparing the first quarter of Apple Watch unit sales to previous flagship products, the Apple Watch and iPad are closely ranked. The iPad had a few extra weeks of sales in its first quarter on the market, which distorts the numbers a bit. Regardless of timing, Apple sold more Apple Watches than either iPhones and iPods during the first three months on the market.
Geographic and Retail Point of Sale Expansion
With Apple Watch supply improving dramatically beginning in June, Apple has been expanding Apple Watch distribution at an unprecedented rate. From both a geographic and retail point of sale perspective, the Apple Watch is now available at many more locations across the world. While this doesn't necessarily suggest that Apple Watch demand has dramatically improved since launch, it does tell us that many more potential consumers are in a position to be introduced to Apple Watch. From Apple's perspective, the hardest part of selling Apple Watch is getting it in front of customers to try out and purchase. The more options and alternatives at the consumer's fingertips, the better. The Watch can now be bought not only at Apple Stores, but also at select third-party electronics stores in a few countries, including Best Buy in the U.S. A few mobile carriers have begun to sell the device, and we are now seeing the first big box retailers sell Apple Watch. It would appear the goal is to build out the Watch's retail availability in order to have a successful holiday shopping season beginning in November. The following two exhibits highlight the expanded geographic expansion for Apple Watch as well as the additional retail locations in the U.S.
Product Strategy & Marketing
There have been some subtle changes in the way Apple has been marketing and selling Apple Watch. One way of quantifying some of this difference is to look at changes seen with Apple's Watch mini site. While Apple is still relying on a few major use cases for why someone may want to buy an Apple Watch, there is much more attention given on some of the intangibles attached to the device. Watch bands and different watch cases are now emphasized as a way to demonstrate not only how the device is making technology more personal, but also how there is the ability to personalize the watch's appearance in many more ways than there was even at launch.
Apple's Apple Watch page - April 24, 2015 (Watch launch):
Apple's Apple Watch page - October 5, 2015
There is much more focus on some of the Apple Watch intangibles and different looks.
It is telling that after only a few months on the market, Apple released a plethora of new Apple Watch Sport Band options, along with Gold and Rose Gold Sport Watch case colors. Having used Apple Watch since launch, I am confident in describing the band as both the Apple Watch's most important aspect and most intriguing element going forward.
Apple Watch bands hold the potential of easily turning one Apple Watch into a number of different watches. While the technology and components found in one Apple Watch case may not change, buying a new watch band could lead to the feeling of owning a completely new watch. This is an intriguing aspect to the device considering how the watch bands do not contain any technology. Surveys indicate around 30-40% of Apple Watch buyers will likely buy more than one band, demonstrating some of the financial and marketing appeal of highlighting various bands available for sale.
When thinking about the future direction for some of the Apple Watch's design and features, it is likely that we will see much more change with watch bands compared to watch cases. Considering that some Apple Watch owners will have multiple watch bands, with some costing hundreds of dollars, it is not likely that Apple will frequently change the Watch case in such a way as to no longer work with previous watch bands. This may suggest that we will see more innovation found with the Apple Watch bands themselves, including options that contain sensors and technological components within the bands themselves. In the long run, it is not crazy to envision certain types of bands being sold where the entire band is one, long flexible display able to show certain notifications or alerts to the user.
Competitors
Despite much attention being put on the current watch industry as being the source of a true Apple Watch competitor, early indication would position Fitbit as Apple's most significant rival in the wearable market. Not only does Fitbit have a much better retail distribution than most watchmakers, including even Apple Watch (for now), but the combination of low prices and customer awareness gives Fitbit some advantages over Apple in the beginning. While Apple Watch and Fitbit wearables are not exactly direct competitors when looking at prices and feature sets, there is evidence that many consumers consider them to be rivals. I would go even further to say that many look at Apple Watch and Fitbit as the two primary pioneers in the wearable space, even though there were others before them. The following chart highlights Fitbit's annual unit sales, including 11 million units shipped in 2014. The company already shipped eight million devices in the first six months of 2015. The upcoming U.S. holiday quarter will be crucial for Fitbit.
There continues to be many questions as to the long-lasting effect wearables will have on health and fitness. Early indication would show that there is an element of interest in health and fitness wearables beginning to wear off after a certain time leading to customers discarding or no longer wearing the device. It is likely that fitness will remain a niche use case while there continues to be potential for health to be positioned as a long-term use case for a wearable device. There is evidence that future Apple Watch models will improve on the device's health applications.
Apple Watch Sales Estimates
Expanded Apple Watch distribution bodes well for improving Apple Watch sales momentum as more consumers are exposed to the device, not to mention that Apple is building the Apple Watch retail channel. While it may not be reasonable to expect continuously improving Apple Watch sales on a month-to-month basis, the upcoming holiday season (beginning in November for many countries and including February for China) will be crucial when expecting improving Apple Watch sales numbers. The following are my Apple Watch unit sales estimates for the next four quarters.
- 3Q15: 3M units (reported)
- 4Q15: 3M units (increased retail distribution)
- 1Q16: 5M units (holiday quarter)
- 2Q16: 3M units (Chinese New Year)
- 3Q16: 3M units
During the first 12 months on the market, I expect Apple Watch sales to approach 15 million units. When comparing this sales number to the total iPhone installed base, Apple Watch adoption would be approximately three percent. Fifteen million Apple Watch sales in the first 12 months on market would beat iPod and iPhone in terms of initial sales. The following exhibit highlights my trajectory for Apple Watch unit sales in the coming years.
Apple Watch sales trends also demonstrate some of the device's drawbacks. Apple Watch has to be paired with an iPhone. This requirement limits the target market for Watch to current iPhone owners. Even though there are more than 500 million iPhone users in the world, that is a smaller number than the number of people in a position to buy the iPad when it hit the market in 2010. In a rather remarkable sign of iPad's initial sales success, Apple sold 19 million iPads in the first 12 months on the market, which would be 4-5 million more than my Watch sales expectations for the same time period.
Additional Questions
A "cheap" Apple Watch. One question that may take time to answer is how the Apple Watch demand curve looks when plotted against price. Much of Apple Watch's appeal may originate around the fact that it is a premium mass-market luxury object with a starting price of $349. Would a lower-priced collection priced around $200 be a panacea for the product category or would we see something similar to the iPhone 5c phenomenon where the device was never able to shake its "cheap" nomenclature when sold alongside more expensive alternatives?
Retail Strategy. It is clear that Apple has been experimenting with the strategy used to sell Apple Watch. After a few months of sales, early trends would suggest that the way people buy Apple Watch Sport at Target will likely be quite a bit different than buying Apple Watch Hermès or Apple Watch Edition. When Best Buy began selling Apple Watch, the company reported much stronger than expected sales. The interesting part is that Best Buy was selling just a few models from the Apple Watch collection with only a few stores even having them on display. Most of these sales were Apple Watch Sport models and done on Best Buy's website. This would suggest that consumers look at the Apple Watch Sport as more like an iPod, iPhone, or iPad, a device that may not necessarily need the personal attention of trying it on.
Meanwhile, someone buying Apple Watch Hermès will likely want a more personal touch during the buying process. Apple's answer to this seems to be to segment Apple Watch collections to certain retail locations. Apple Watch Hermès is available at 70 locations worldwide while Apple Watch Sport is now sold in thousands of retail locations. When it comes to Apple Stores and selling Apple Watch, we will likely continue to see change in the coming years as Apple figures out what works best for selling various models of the same product, each with different intangibles that enter the buying process.
Don't Underestimate Apple Watch
The Apple Watch contains too much promise and potential to question it's long-term viability as a product category. It is becoming clear that the device was dealt a bad hand when it comes to early expectations, being compared too much to its very successful siblings - the iPhone and iPad. However, when looking at all of the various data points, estimates, and trends, it becomes clear that the Apple Watch is doing much better than it seems. We are living in an iPhone world with Apple expected to sell more than 250 million iPhones over the next 12 months. The iPhone 6s and 6s Plus position the iPhone that much closer to becoming someone's sole computer. In such a world, the Apple Watch likely has a role in handling some of the more simple tasks that were once given to iPhones, in addition to being given an expanding list of use cases that revolve around identity, monitoring, and personality. In a world moving towards more personal technology, Apple Watch has a place. It's time to stop underestimating Apple Watch.
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Apple Is Building Its Largest Startup Ever
What was once discussed within certain technology circles is now in mainstream news. Apple is building a startup focused on designing an electric car. When compared to previous product initiatives, Apple is embarking on its most ambitious project in its history. In recent years, there has been much debate surrounding the factors that have contributed to Apple becoming the most valuable company in the world. There is growing evidence that Apple is confident it still has the keys to success. The startup team Apple is putting together and the corporate values that support such a team will determine Apple's ultimate success in the automobile industry.
Project Titan
Apple wants to design a car and has formed its own startup to assemble a team of automotive and robotic experts. Apple's ambition with the automobile has been in the making for years, but only in recent months has Apple's outside hiring led many to conclude that development may be far more advanced than first thought. Unsurprisingly, most were skeptical of Apple designing its own car, especially if the untapped potential in the automative space was not clear. There continues to be many questions as to how Apple could position itself to come up with a new kind of experience on the road by designing the entire automobile.
This past February, the WSJ gave the most detail about Apple's Project Titan project, reporting that Apple's automobile initiative had managerial hierarchy and structure. On September 21st, the WSJ revealed additional information about Project Titan, including news that it had progressed to the point of being given the green light with managers now having permission to expand the team to 1,800 people. Recent reports have pointed to Project Titan's headquarters being located in Apple-leased office space in nearby Sunnyvale, a short distance from Apple HQ in Cupertino.
In recent months, there has been a running tally of employees believed to be working on Project Titan. Given that the team already includes hundreds of employees, the following list represents a small percentage of the total group. Nevertheless, a few trends become apparent.
- Project Titan is being led by long-time Apple managers dating back to the iPod development in the early 2000s.
- Apple already had numerous employees with automobile-related experience, including a few from the Industrial Design group.
- Apple has poached employees from a range of automobile manufacturers including Tesla, Ford, Volkswagen, Fiat Chrysler, and Mercedes-Benz.
- There is evidence that Apple is specifically interested in the areas of battery technology (A123 Systems hires) and autonomous driving (numerous hires).
- Outside hiring continues to ramp indicating an increasing level of advancement, importance, and priority.
As reported by the WSJ, Steve Zadesky appears to be playing a major role in Apple Car development. In addition, Jony Ive and Marc Newson will likely play a pivotal role in coming up not only with Apple Car's design, but also the materials and manufacturing processes involved in such a product.
A Startup Mentality
Apple's ultimate success with Project Titan will depend not on whether Apple can build autonomous features into an automobile or come up with a breakthrough user interface. Rather, those features are byproducts of the much bigger product that Apple is trying to build: the best team of automotive experts in the world. Even though Apple prides itself on a culture that puts the product first, the biggest risk factor to Apple Car is corporate politics and too many layers of management and decision-making. Success will come from allowing ideas to grow from the design labs to showroom without having interference. In addition, having a team comprised of members with various backgrounds and experiences could prove to be detrimental in making technology more personal. The following table highlights Apple's increased ambition with Apple Car compared to iPhone and Apple Watch development.
Using the Same Apple Playbook for Apple Car
Early Apple Car development shares aspects of previous Apple product development cycles. In the mid-2000s, hundreds of engineers working on the iPhone were separated from the rest of Apple. Adam Lashinsky detailed the thought process behind this move in his book "Inside Apple":
"By selectively keeping some employees from concerning themselves with colleagues elsewhere in a giant company, Apple creates the illusion that these employees in fact don't work for a giant company. They work for a giant start-up...The original iPhone team, for example, didn't interact with the people working on the iPod, then the dominant and fast-growing product at Apple. The iPhone organization was allowed to raid the iPod group and other areas of the company for engineering talent. That's because the iPhone was a corporate priority, driven from the top."
Evidence suggests Apple Car is Apple's growing priority. Project Titan leadership has reportedly been poaching employees from other divisions, and one should expect this trend to intensity in the coming years. This is not to suggest that the iPhone, iPad, and Mac will be put on the back-burner. Instead, Apple is only now finding its stride with those products. As seen with the iPhone 6s / 6s Plus, Apple did not settle for a "S" cycle update but is instead much more focused on shipping new iPhone features each year that help support the shift to a leasing paradigm where many iPhone buyers upgrade to the latest iPhone model every year. Take a look at iPod trends back when the iPhone was being developed; Apple actually saw increasing iPod sales on new and innovative models all the way up to 2008. It is important to not underestimate the breadth of talent Apple has dedicated to its current product lineup, even after taking into consideration losses to Project Titan.
The other element that Apple has used masterfully to build suspense for its products over the years is secrecy. This extends even to the actual team working on the product under development. It is very likely only a small number of Project Titan members have seen automobile prototypes. This would be similar to the way Apple allowed very few people to know the full story about the iPhone during development, as chronicled in Fred Vogelstein's "Dogfight: How Apple and Google Went to War and Started a Revolution":
"Engineers designing the iPhone's electronics weren't allowed to see the software it would run. When they needed software to test the electronics, they were given proxy code, not the real thing. If you were working on the software, you used a simulator to test hardware performance."
The end goal is simple: limit the number of people that have access to the most valuable information.
Adapting the Apple Playbook to the Environment
There are signs that Apple isn't just trying to repeat the path to success taken with past products, but rather is adapting to the current environment. In a sign that Apple is moving beyond its traditional comfort zone with automobiles, the company has needed to look outside to hire many Project Titan team members. The intriguing theme found with Project Titan recruitment is that Apple has hired talent from various industries and fields including the current automotive industry, software and technology industries, and even R&D labs in academia. All of this is in contrast to how the iPhone was developed. The Apple vs. Samsung patent trial revealed certain aspects as to how the iPhone team came into existence. Scott Forstall, head of iOS software at the time, described some of the parameters including looking within to hire all software people:
"Steve [Jobs] didn't want to hire anyone from outside of Apple to work on the software, but he said I could hire anyone in the company I wanted. So I'd bring recruits into my office. Sit them down and tell them, 'You are a superstar at Apple. Whatever you are doing now, you'll do fine. But I have another project that I want you to consider. I can't tell you what it is. All I can say is that you will have to give up untold nights and weekends and that you will work harder than you have ever worked in your life."
Talent Wars
Personal transport will be the next big battleground for technology companies. We are already seeing the early stages of this battle when it comes to retaining talent, not to mention intense recruitment battles. One benefit, and some say reason, for all of the reports on Project Titan is that Apple is able to inform the world, unofficially, that they are assembling a team tasked with producing an electric car. In a way it can be thought of as a casting call sent out not just to other technology companies, but to entire industries including automobile manufacturers and supply chain management experts. One can also include the mapping and augmented reality fields as being connected to the automobile space, from which Apple has been actively acquiring talent over the past year.
Apple, Google, Tesla, and Uber have shown a willingness to get involved in the transportation space, and it is not unreasonable to expect others to join in the coming years. At the same time, current automakers are quickly building up their own R&D labs in Silicon Valley with the focus being on the software side of the equation, including autonomous driving. The winners in this war will be those that are able to attract the best and brightest. One way of accomplishing this goal is to create an environment conducive to achieving results. This is one benefit from Project Titan where new employees are likely brought on with the premise that the team acts like any other startup but has the backing of a $650 billion market cap company with $200 billion of cash and cash equivalents on the balance sheet.
Tim Cook's and Jony's Role
Project Titan represents Apple's second new product category in the Tim Cook era. There are similarities in how the Apple Car and Apple Watch were developed which provide clues as to the type of leader Tim Cook is and how he thinks about Apple's values. With Apple Watch, Apple was willing to alter some of its outward appearance and take on slightly different goals involving wearables and luxury themes. This same philosophy will apply to Project Titan where Apple will need to change some of its practices, such as working with regulatory agencies more, in order to be able to ship a working product.
Tim Cook's role and value as CEO continues to come into focus: find the most talented people in a certain field, and get them to come to Apple by building the right kind of environment conducive to making the impossible seem in reach. Meanwhile, Jony is tasked with making sure the product always comes first, ranging from new iPhones and iPads to new Apple Stores and Apple Campus 2.
Cook and Jony are overseeing Apple's largest creation yet: an electric car startup called Project Titan.
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The Pixar iPhone
It is time to start questioning the iPhone "S" cycle, the often referred to development cycle theory in which a significant iPhone update is followed by a more minor, evolutionary update the following year. Instead, the best way to understand how Apple thinks about iPhone development is to look at Pixar. The film company has multiple films under development at any given time in order to ship at least one new film a year. Similarly, Apple is developing a number of iPhone features at any given time with the goal of shipping a more advanced iPhone at least once a year. As more people upgrade their iPhones annually using monthly leases, shipping iPhone features just to match a two-year iPhone "S" cycle begins to look like a dated theory.
The iPhone "S" Cycle Theory
"Which iPhone cycle are you on?"
This question has come to symbolize the iPhone development cycle. Partly due to Apple's own iPhone nomenclature, consensus has settled on the theory that Apple keeps its significant iPhone updates for whole numbered years (iPhone 3G, 4, 5, 6, and so on). Consequently, the odd years, or so-called "S" years, are characterized by more modest, evolutionary software and hardware upgrades (iPhone 3GS, 4s, 5s, 6s and so on). Exhibit 1 depicts the iPhone "S" cycle theory in which greater advancements in iPhone development are said to occur every other year.
Exhibit 1: The iPhone "S" Cycle Development Theory
The major implication from the iPhone "S" cycle is that Apple is guided by a two-year development cycle where the focus is on getting iPhone users to upgrade their iPhone not every year, but rather every two years. Much of this theory is based on the early days of mobile carriers subsidizing iPhones. By having carriers "subsidize" the iPhone's cost, customers agreed to be locked into a multi-year contract. With early iPhone upgrades being nearly nonexistent, it was often in the customer's best interest to upgrade their iPhone soon after their standard two-year contract expired.
As Apple expanded the iPhone into new geographies and carriers, this subsidized model began representing a smaller portion of iPhones sold. Today, the subsidy model is breaking apart as the up-front costs associated with such plans have weighed on carriers. In its place, carriers are embracing monthly lease plans which amount to nothing more than interest-free financing.
Annual iPhone Upgrades
The iPhone Upgrade Program was one of the more strategically important announcements announced at Apple's "Hey Siri" keynote. Apple's goal is rather straightforward: make it easier for consumers to upgrade to a new iPhone every year. Apple isn't reinventing the wheel with the iPhone Upgrade Program as AT&T, T-Mobile, and Sprint have similar iPhone leasing and upgrade options. The major implication from the move towards iPhone leasing is that millions of iPhone customers will be moving from a two-year iPhone upgrade cycle to an annual iPhone upgrade cycle. With these plans, not only are there no carrier penalties associated with upgrading to the latest iPhone each year, but in some ways such behavior is even promoted by the carrier. The incentive is no longer to wait to buy a new iPhone. In some ways, this trend is a byproduct of an iPhone development cycle that has been able to entice users to want the latest and greatest iPhone. If the iPhone truly followed an "on and off year" cycle, few would feel the need to want a new iPhone every year.
A Different Kind of iPhone Cycle
There are additional signs that the iPhone "S" development cycle may have ended years ago, if it ever existed. When looking at the last four iPhone updates, it's clear that Apple is using a different upgrade cycle. The following features were the tentpole features of that particular iPhone release:
- iPhone 5: Larger iPhone screen
- iPhone 5s: Touch ID / Gold color
- iPhone 6 / 6 Plus: Larger iPhone screens / Apple Pay
- iPhone 6s / 6s Plus: 3D Touch / Live Photos / Rose Gold color
Not only has there been at least one noteworthy new iPhone feature each year, but it could be argued that the updates seen in the "S" years (iPhone 5s and iPhone 6s / 6s Plus) are more strategically important than the cosmetic changes seen in the "non-S" (iPhone 5 and iPhone 6 / 6 Plus) years. Touch ID has become a crucial element of the iPhone ecosystem, and 3D Touch will likely follow the same path. Meanwhile, the iPhone's screen growing size, especially to 4.7 and 5.5 inches, has been a game changer across the world. The takeaway is that the "S" cycle concept where there are more important iPhone upgrades every other year is starting to look incomplete and not representative of how Apple thinks about iPhone development. Something else is at play driving iPhone development.
Exhibit 2 shows a more likely representation of iPhone development. Instead of shipping the most advanced features every other year, Apple strives to ship at least one major, new iPhone feature every year. The goal is simple and straightforward: ship a more advanced iPhone that beats the previous year's model. Market analysts often debate Apple's biggest competitor to iPhone each year. In reality, the iPhone's biggest competitor is the previous year's iPhone.
Exhibit 2: A Revised iPhone Development Theory
Tim Cook recently talked with BuzzFeed's John Paczkowski about a number of topics, including the "S" iPhone cycle. His comments support the view that the tick-tock nature of an "S" cycle is no longer relevant. Speaking about Apple's latest iPhones, Paczkowski wrote, "Apple released the iPhone on a tick-tock cycle; with the 'tock' device typically being a modest refinement of the 'tick' device that debuted the year prior with a new form factor and other big upgrades. This is traditionally a 'tock' year, but [Tim] Cook bristles at this notion. '[The iPhone 6s / 6s Plus update] is clearly not an off-year issue,' he argues. 'This is a substantial change.'"
Cook went on to say, "[a]s soon as products are ready we're going to release them...There's no holding back. We're not going to look at something and say 'let's keep that one for next time.' We'd rather ship everything we've got, and put pressure on ourselves to do something even greater next time." Cook's comments describe a different iPhone development model than what is implied with the iPhone "S" cycle.
The Pixar Model of Product Development
One company that stands out for its superior product development is Pixar. Instead of putting all of its resources into working on one film a year, the film studio has multiple films under development at any given time since it takes longer than a year to bring a movie from concept to a finished product. The end result is a steady product release schedule that has moved from a new film every few years to soon two films a year. Exhibit 3 highlights the development timeline for each Pixar movie. The company went from developing one movie at a time in the early 1990s (Toy Story) to having at least seven films at some stage of development in 2015 (Inside Out, The Good Dinosaur, Finding Dory, Toy Story 4, Coco, Cars 3, and The Incredibles 2).
Exhibit 3: Pixar Film Development Timeline (click to enlarge)
For Apple, the iPhone is likely following a product development strategy and timeline similar to that of Pixar. At any one time, Apple has a number of iPhone features under development since it takes more than one year for many features to go from concept to finished product. Even though the iPhone 6s and 6s Plus were just announced, Apple has already been working on features for next year's iPhones and even the iPhones for the year after. The goal is to have a new iPhone with at least one major new feature at least every year.
We got a closer look at this development schedule with 3D Touch. Phil Schiller commented to Bloomberg that 3D Touch was in development for years. "Engineering-wise, the hardware to build a display that does what [3D Touch] does is unbelievably hard...And we're going to waste a whole year of engineering - really, two- at a tremendous amount of cost and investment in manufacturing if it doesn't do something that [people] are going to use. If it's just a demo feature and a month later nobody is really using it, this is a huge waste of engineering talent." The same could be said of Apple Pay, the new cameras, iOS features, not to mention the different iPhone colors."
Expanding iPhone Development Capabilities
Similar to how Pixar has grown its development capabilities over the years from being able to do one film every few years to soon two films a year, I expect the iPhone development cycle to accelerate in the coming years. In some ways, Apple has already been showing this level of expansion. We went from one new iPhone model a year to now having two new models a year (iPhone 6s and 6s Plus). It is not unfathomable to see Apple expand this to three new models a year and embrace a product line with different screen sizes corresponding to different models (iPhone Plus, iPhone, iPhone mini).
The era of a tick-tock development cycle for iPhone is over.
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iPhone Launch Weekends are Getting Silly - Above Avalon Premium Week in Review
Along with periodic Above Avalon posts available to everyone, I send out an exclusive daily email about Apple to members (10-12 stories per week). You can subscribe here. The following story was sent to members on September 15th.
iPhone Launch Weekends are Getting Silly
On Monday morning, Twitter went a bit crazy right around 8:30 a.m. ET as some began wondering if Apple would issue a press release disclosing how many iPhone pre-orders it saw this past weekend. Apple had done exactly that last year, reporting four million iPhone 6 and 6 Plus pre-orders.
We didn't get a press release this year, but instead an Apple statement disseminated through the press. It's rather short, so I've included the entire statement below:
"Customer response to iPhone 6s and iPhone 6s Plus has been extremely positive and pre-orders this weekend were very strong around the world. We are on pace to beat last year's 10 million unit first-weekend record when the new iPhones go on sale September 25. As many customers noticed, the online demand for iPhone 6s Plus has been exceptionally strong and exceeded our own forecasts for the pre-order period. We are working to catch up as quickly as we can, and we will have iPhone 6s Plus as well as iPhone 6s units available at Apple retail stores when they open next Friday."
There was a little bit for everyone in that statement, but the biggest takeaway I got from that is that this entire fascination with opening weekend sales feels old, a relic from a begone era. Essentially, its a leftover from the smartphone wars where opening weekend sales were a sign that your phones were popular.
As expected, Wall Street analysts quickly began trying to read in between the lines, figuring out a way of using Apple's 103-word statement to judge their 2016 iPhone sales estimate. This represents the fundamental problem Wall Street has with Apple. The focus is on the wrong thing. I even saw some analysts comparing this year's Saturday morning iPhone pre-order release to last year's Friday morning release and then making some guesses as to what it all means about year-over-year growth. It's getting silly.
This trend of Apple releasing iPhone opening weekend sales number goes back to the original iPhone and that is one reason why so many observers are so flummoxed with yesterday's statement from Apple. We were accustomed to very detailed iPhone and iPad opening weekend sales announcements and now we are getting less and less in the way of disclosure. In reality, the usefulness of these releases has steadily declined, but most people haven't noticed.
When you consider that we are effectively using 4-5 million iPhone pre-orders to try to discern how Apple will do over the next 12 months selling up to 270 million iPhones, the silliness becomes apparent.
My philosophy on Apple announcing sales numbers has been very straight-forward. If Apple thought it had something to gain from releasing sales numbers, then they should release them.
- Early iPod sales numbers? Tell the world that Apple actually has a product people want.
- Early iPhone sales numbers? Tell the world that people actually want a smartphone with no physical keyboard.
- Early iPad sales numbers? Tell the world that people really do want "just a big iPod touch."
By releasing sales numbers, Apple had something to prove to the world. That motivation is disappearing with iPhone. Opening weekend sales now represents just 4% of annual iPhone sales. Instead, analysts want Apple to release numbers in order to parse out if iPhone sales are growing or not. It's that simple. Of course, Apple ends up releasing iPhone sales numbers in financial filings anyways, but the short-term focus takes precedence.
In reality, Apple's language around opening weekend sales has become more vague over the years, especially last year:
- iPhone 1st gen (2007) = 1M in 74 days (U.S. only - AT&T)
- 3G (2008) = 1M in 3 days (21 countries)
- 3GS (2009) = Over 1M in 3 days (9 countries)
- 4 (2010) = 1.7M in 3 days (600,000 pre-orders on first day) (5 countries)
- 4s (2011) = Over 4M in 3 days (1 million pre-orders on first day) (7 countries)
- 5 (2012) = Over 5M in 3 days (2 million pre-orders on first day) (9 countries)
- 5c / 5s (2013) = 9M in 3 days (11 countries including China in launch window for the first time)
- 6/ 6 Plus (2014) = Over 10M in 3 days (4 million pre-orders on first day) (10 countries not including China)
- 6s / 6s Plus (2015) = Better sales than last year (12 countries including China)
The reason I say that the language is a bit unclear is that last year's "over 10M in 3 days" could very well have been closer to 11M iPhone units, but instead Apple felt "over 10M" would be good enough when compared to the 9M iPhones reported in 2013. Expectations weren't too high since China wasn't in the original launch country list last year. The market would understand if Apple didn't report too much of a sales increase from 2013. This point only goes to show how irrelevant iPhone opening weekend sales have become.
Over the past few years, iPhone opening weekend sales have been more a sign of how Apple has been able to ramp iPhone supply instead of demand. Without going into too much accounting detail, the only iPhone sales Apple includes in opening weekend numbers are those units that have been shipped to an end user. If you pre-order an iPhone, but need to wait a few weeks to receive it, you are not included in opening weekend sales. The pre-order numbers were therefore a bit clearer picture of demand since a pre-order is not the same thing as a sale. Of course, Apple started releasing pre-order numbers once opening weekend sales numbers started to look less attractive on a year-over-year basis.
I would not be surprised if Apple eventually moves away from announcing opening weekend product sales altogether. Apple has shown no interest in disclosing Apple Watch sales, and Apple stopped releasing opening weekend iPad sales right around when unit sales started to decline (another sign that disclosing opening weekend sales is one big game). Critics will say Apple stopped releasing sales because of weaker sales growth. While iPhone sales growth may very well slow, I rather look at it as Apple is now a much bigger company in a different landscape. The Android/iOS activation wars are over. There are other ways to convince the world that iPhones are popular and worth buying besides releasing opening weekend sales. In addition, opening weekend numbers aren't even a good measure of iPhone growth. If we compare the change in opening weekend sales to the corresponding iPhone growth over the following FY year:
- 2010: 70% growth in iPhone opening weekend sales (81% iPhone unit growth in following year)
- 2011: 135% (73%)
- 2012: 25% (20%)
- 2013: 80% (13%)
- 2014: 11% (38%)
I look at that discrepancy as reason for why opening weekend sales is not the most useful parameter to judge iPhone sales.
Over the years there have been ulterior motives to disclose opening weekend sales. Times change. It's making less sense these days to disclose arbitrary sales numbers spanning a few days.
Along with the preceding story, the full list of stories sent to Above Avalon members this week included:
- Apple Watch Hermès Collection is Intriguing
- 3D Touch is a Game Changer
- Thinking About the Big Picture for Apple
- Thoughts on the iPhone Upgrade Program (seven sections: The Details, History, Dollars and Cents, Short-Term Impacts, Long-Term Impacts, Overall Observations, Is It a Good Deal?)
- Making Sense Out of Apple's Mapsense Acquisition
- Kardashian/Jenner Sisters Take on the App Store
- Thursday Q&A: Why Would the iPhone Upgrade Program Lead to a Larger Grey Market for iPhones?
Become a member today to receive these stories (will be sent to you via email), and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.
The New Apple Era
We love our smartphones. Not only have they become our most used computer, but more importantly, smartphones provide an unimaginable amount of power at our fingertips. However, the smartphone form factor leaves opportunities for other devices to provide this same kind of incredible power only in even more personal ways. Apple is laying the groundwork for new platforms based on wearables, the connected home, and eventually the car that will combine to form one large encompassing ecosystem that ushers in a new level of personal technology. We are entering a new Apple era.
The Old Era
Apple's product line used to be thought of as a stool with each leg representing a different product. While a few legs were clearly more popular and financially lucrative than others, Apple was a technology company that sold a handful of hardware devices with iTunes (and increasingly iCloud) serving as the glue that held everything together.
Consensus was set on the iPhone, iPad, and Mac forming an ecosystem that will play a crucial role in our lives. In reality, these three product categories are much more similar than people have been thinking. New platforms are needed to help make technology more approachable and personal.
The New Era
The iPhone, iPad, and Mac are converging into one central "brain" while new platforms will be formed focused on key aspects of our lives including transportation, home, and body (wearables). In this new era, the iPhone is positioned as the center point of our digital lives with iCloud and Apple services representing the glue connecting everything together.
Earlier this year at WWDC, Apple unveiled watchOS, its first wearables platform. Last week, Apple added a new platform to the mix with tvOS. The two platforms serve as examples for how Apple will eventually embrace bigger themes like wearables and the connected home (and eventually the car). All the while, iOS is maturing and becoming a platform for a range of mobile devices with various screen sizes.
The Opportunity
iPhone. The iPhone, iPad, and Mac product categories will continue to merge. In the future, the three product lines will run the same operating system with the degree of mobility, as measured by screen size, positioned as the primary differentiator. The iPhone will always have the most power due to its mobility, while the iPad brings multi-touch (and eventually 3D Touch) to a bigger screen. All the while, the Mac includes the best keyboards for those jobs that require a significant amount of typing. The differences between the three product categories will continue to shrink.
Apple's new 3D Touch feature not only brings an additional user interface to iPhone, but should be thought of as the missing piece for allowing iPhone screens to become even larger without increasing the iPhone's form factor. 3D Touch begins to reduce the need for the home button, which has turned into a type of reset button used to switch between apps. By removing the iPhone home button and filling the additional space with screen real estate, the iPhone will only gain more power and capabilities when compared to devices like the iPad mini and Air. Less mobile devices, like the larger screen iPad Pro, will continue to become more like the Mac, with the primary difference between the two product categories continuing to be the keyboard. Bringing 3D Touch to the iPad Pro and supporting a tactile onscreen keyboard may be the next step to further blur the lines between iPad and Mac. At the same time, the Mac continues to move towards the iPad with a new revolutionary design that places mobility as a key value proposition. The end result is a world where iPhone can accomplish most basic computing tasks with iPad/Mac running the same operating system serving the high-end.
Wearables. In just a little over two months, Apple went from selling its first genuine wearable device to unveiling an SDK for native Apple Watch apps. While many have tried to think of Apple Watch as a mini iPhone on the wrist, in reality, the Apple Watch represents a different type of power requiring a complete rethink of what kind of jobs can be done on the wrist. Last week, Apple rolled out a significant update to Apple Watch in the form of a new Hermès collection and new Apple Watch sport bands. This update exemplifies how success in wearables is determined by much more than just the idea of putting technology on a wrist. There are different types of emotions and guiding principles that enter the equation when thinking about devices that are meant to be worn on the body.
Apple's new Hermès partnership is a game changer in that Apple is not just embracing the concept of luxury, but is set on showing the world a completely new type of personal technology. The entire luxury industry needs to take note of what Apple is trying to accomplish as software continues to move quickly into other elements of the luxury wearable market. Apple isn't taking the same page from its iPhone playbook and applying it to wearables. Instead, the strategy is being adapted to fit the environment. It is incredibly intelligent and bodes well for new platforms such as TV (home) and eventually the car. As for wearables, the much bigger concept of body and mind are brought to the forefront as health tracking will likely be positioned as a key value proposition in the wearables category. In addition, identity and geolocation themes will likely become popular. Each case is made possible by the fact that a wearable device does a better job of being carried and representing the user than a smartphone does.
Home. Apple TV is the start of a much broader move by Apple into the connected home category. The primary takeaway from the all-new Apple TV is that Apple is including a new user input in the form of voice. Siri not only took front and center stage when it came to Apple's September keynote invites, but the personal assistant is quickly being able to handle an increasing number of tasks beginning with content curation and discovery, and then eventually handling automation tasks. Apple TV may be focused today on delivering content to a big screen but will likely move to become a device able to turn spacial and facial recognition into a new realm of personal computing. Apple began controlling the living room years ago with the iPhone, but Apple TV will begin to better address the ideas of the connected room in a more direct way than the iPhone will ever be able to. Similar to wearables, Apple is relying on a new class of hardware (and user interfaces) to make technology approachable and personal.
Car. Apple wants to design its own self-driving car. This is a company that has no interest in just creating a platform so that less capable car manufacturers can ruin the user experience. We are quickly moving to a world where technology will take over the transportation industry, and Apple has no choice but be part of the mix. The Apple Car's key value proposition won't revolve around performance, but rather good design and an intuitive user interface (not having to drive at all is an entirely new level of intuitiveness). A self-driving electric vehicle is nothing more than a mobile room on wheels, which only emphasizes the concept of personal technology as we all won't want to ride in the same kind of room. Accordingly, the themes of connected home and self-driving cars become intertwined.
Apps Provide a Personal Touch
Apple wants to position apps as the guiding principle of its strategy to move from a company that sells a collection of computing devices to delivering a complete user experience that spans most tasks that make up our daily lives. The app ecosystem transformed the iPhone into an all-powerful device by allowing each device to become something unique to its user. Apple is looking to do the same with Apple Watch (watchOS) and now Apple TV (tvOS). The hardware remains a critical requirement for ultimate success, but apps complete the picture.
Looking back at Apple's WWDC keynote, the significance of the "The App Effect" video that was shown takes on a whole new meaning after seeing Apple unveil watchOS and tvOS. While the video was focused on iPhone apps, it is reasonable to one day replace "iPhone" with "Apple Watch," "Home," and even "Car." Apple looks at apps as the path to accomplishing its long term goals.
Apple's new platforms will be embraced by app developers because the categories that Apple is playing in are simply too large and lucrative to ignore. App developer characteristics may change as larger developers begin to control more of the app environment, likely continuing to push down the price of paid downloads with business models based instead on subscriptions and services. At the same time, Apple is in a prime position to embrace and help push its own suite of apps. The IBM partnership may be positioned today for iPad in the workplace, but such a partnership could one day embrace a range of new apps across product categories. Along similar lines, the Cisco partnership is already expected to begin embracing new product categories other than iPhone, iPad, and Mac.
The Long-Term Plan
The iPhone was launched in 2007 and in just eight years has gone on to not just change the world, but provide a framework as to how apps and software can begin to take over other key aspects of our lives. As we look much further into the future, it is likely incorrect to assume that an iPhone will always be required in order to get the most out of the connected world.
In the future, the iPhone may melt away, and a range of devices will be able to provide an unimaginable level of personal technology. Apple Watch will likely be able to stand on its own in due time. As the definition of work changes, more and more will be designated for the wrist, further strengthening the appeal of wearables. Transportation and the connected home will be looked at as providing the same kind of personal experience.
Targeting our Time
Apple's long-term goal is to bring personal technology into new parts of our lives. Looking ahead, the iPhone will not be able to bring this kind of technology to every part of our lives. Instead, Apple will rely on new platforms and devices suited to address our particular needs. The best way to predict where Apple is looking to expand is to look at the time. The aspects of our life that take up most of our time are the most likely opportunities as to where Apple will see if it has something to contribute.
Making technology personal entails moving beyond just simply combining hardware and software. Instead, the way the hardware (and software) looks, feels, and moves will become crucial factors, all of which are things Apple has been perfecting for years. The groundwork is being laid for an era in which the iPhone is just one piece of the personal technology puzzle.
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Above Avalon members have access to my full notes and observations from Apple's September keynote.
Bill Graham Civic Auditorium Intrigue & Above Avalon Premium Weekly Recap
Along with periodic Above Avalon posts, I send out an exclusive daily email about Apple to members (10-12 stories per week). You can subscribe here. The following story was sent to members on August 31st.
Bill Graham Civic Auditorium Intrigue
Apple keynotes are products in themselves. While it is easy to spot the immense level of training and practice that goes into delivering the keynote, the entire event plays a role in how Apple wants to explain itself to the world.
In today's media landscape, an Apple keynote has taken on a different role, maturing from the single most important way to drum up interest in a product, to one step in a series of events, interviews, and presentations aimed to keep Apple at the top of the ever-changing news cycle. Along those lines, an Apple keynote, all the way down to the venue choice, can be an incredibly useful and valuable piece for figuring out Apple marketing and strategy.
Over the past four years, Apple has relied on three primary locations for its keynotes: Town Hall at Apple HQ, Yerba Buena Center for the Arts in San Francisco, and of course Moscone West for WWDC. The one exception was last year's iPhone 6/6 Plus and Apple Watch event held at the Flint Center. That particular venue was noteworthy not just for its larger auditorium seating capacity, but also for the clear excitement and anticipation surrounding the event as Apple entered its first new product category since the iPad in 2010.
Past Apple keynotes:
- 2012 - February 22 - Yerba Buena Center for the Arts
- 2012 - WWDC - Moscone West
- 2012- September 12 - Yerba Buena Center for the Arts
- 2013 - WWDC - Moscone West
- 2013 - September 10 - Town Hall at Apple HQ
- 2013 - October 22 - Yerba Buena Center for the Arts
- 2014 - WWDC - Moscone West
- 2014 - September 9 - Flint Center for the Performing Arts at De Anza College
- 2014 - October 16 - Town Hall at Apple HQ
- 2015 - March 9 - Yerba Buena Center for the Arts
- 2015 - WWDC - Moscone West
Seating capacities for these locations ranged from the smaller Town Hall (301) and Yerba Buena Center (757) to Flint Center (2,405). WWDC has 5,000 total attendees although not everyone is able to have a seat in the main Moscone West keynote room.
Speculation over Apple's upcoming event started to take off last week when Hoodline, a San Francisco neighborhood news site, published a story about there being quite a bit of activity taking place at the Bill Graham Civic Auditorium despite nothing being publicly planned for the venue until mid-September.
Regulars began to notice security guards and police officers stationed around the building. In addition, there had been quite a bit of construction activity, including the installation of large power generators and AC units outside blocking a few lanes of traffic. One Hoodline reader commented that he saw forklifts bringing in what appeared to be temporary flooring. Apparently, whatever was being done inside had been going on for weeks.
Last Wednesday, Hoodline ran a story that said Apple was indeed the company up to something at the Bill Graham Civic Auditorium and that there were a number of street closures around the building planned for the week of September 8th to 10th. As a fun fact, the Apple II was introduced at the same location in 1977 at the West Coast Computer Faire. Back then it was called the San Francisco Civc Auditorium. My interest was piqued by the Bill Graham Civic Auditorium being the choice for Apple's next keynote.
After Apple sent out event invites this past Thursday, I took a closer look at the venue choice since it still stood out to me. The first thing that caught my attention was that the building is quite large with a 7,000-person capacity, which is nearly 10x larger than the Yerba Buena Center. The other aspect of the location that seemed a bit strange is its layout and floor plan. It is actually an arena with a high ceiling. Along with music concerts, the venue is used for trade shows and sporting events. There is a large flat seating area (similar to Moscone) surrounded by a significant amount of balcony seating in a U-shape. It is quite different from prior Apple keynote venues.
Using such a large venue for an Apple product unveiling obviously brings up the question if Apple is planning on having a large guest list including press and guests from a wide range of industries. Last year, Apple invited quite a few additional people to the Apple Watch unveiling at the Flint Center. Not only were there people from the fashion and fitness industries on hand, including more celebrities than normal, but there were also a significant number of Apple employees in attendance. Most of the Flint Center's 2,500 seats were filled. What could Apple possibly do with an area with nearly 4,500 additional seats?
After posting that question on Twitter, I didn't find much evidence to suggest that Apple had invited that many more people than was the case with previous events. However, I did start to get a few clues as to what Apple may have had in mind by choosing the Bill Graham Civic Auditorium. One Above Avalon member pointed me to a tweet musing that Apple may look to transform the inside of the building into a space that would be completely unrecognizable. Last year, Dot Party, an event series created by Markus Persson, creator of Minecraft, held a concert at the Bill Graham Civic Auditorium. After quite a bit of construction, the space was turned into a pretty interesting concert/music hall.
A few people have speculated Apple may in fact be building an entire structure within the arena (which explains all of the extra air cooling machinery). Think of something like an enclosed stage/audience seating area positioned next to another completely enclosed room housing the demo area. One large open space would be turned into a series of still-large rooms.
Putting all of the pieces together, it is likely that Apple chose the Bill Graham Civic Auditorium due to the ability to customize the space much more than what would be possible at locations like the Yerba Buena Center. In addition, the space is able to handle a more decent-sized crowd than Town Hall at Apple HQ. However, it does not seem likely that Apple is planning on having a record guest list numbering close to 7,000 people.
Judging by the Apple event invitation byline of "Hey Siri, give us a hint." one can deduce that Siri will play a pivotal role in the event. In addition, with rumors that Apple will unveil a new Apple TV, the prospects of a Siri-controlled Apple TV may require unique stage and demo areas. Don't forget how Apple constructed an entire temporary structure next to the Flint Center last year just to house a special demo area. The same level of construction seems to be occurring at the Bill Graham Civic Auditorium, only inside.
Eventually, Apple will host many of its product events at the 1000-seat underground auditorium being built at Apple Campus 2. However, I would not be shocked if Apple still goes elsewhere for a keynote from time to time (like WWDC and other locations). The ability to suit a particular site for a specific product can be incredibly rewarding.
A few weeks worth of construction at a new venue means that the location for this upcoming Apple keynote will add to the mystery and intrigue leading up to September 9th.
Along with the preceding story, the full list of stories sent to Above Avalon members this week included:
Apple Watch's Biggest Competitor
Apple's Original Programming Temptation
Global Smartphone Trends for July
Thursday Q&A: How is the premium email going? Spoiler: It's going great.
Become a member today to receive these stories (will be sent to you via email), and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.
Apple's Cheaper Stock Buyback
It is becoming cheaper for Apple to buy back its shares. Since Apple reported 3Q15 earnings, AAPL shares have been down by as much as 30%. Looking ahead, AAPL volatility will continue as the market continues to worry about slowing revenue growth in China. With $50 billion of share repurchase authorization remaining, Apple is in prime position to take advantage of stock market volatility and buy back its stock at a 15% discount to all-time highs resulting in up to $4 billion of "savings" over the next six months.
Apple Valuation
Stock valuation is a complicated subject. While finance textbooks explain how to take a series of numbers and assumptions and arrive at a stock's intrinsic value, the truth is market participants determine a stock's true worth. A stock price is merely the point at which a buyer and seller agree to exchange shares. Emotion and psychology play just as important of a role in determining a stock price as sales, earnings, and growth potential.
Apple is currently trading at a 11x forward earnings multiple (20% EPS growth), a 40% discount to the overall market's 18x forward earnings multiple. If excluding $35 of cash per share, Apple is trading at a 7x forward earnings multiple, a 60% discount to the overall market. If Apple traded with a 18x forward earnings multiple ex-cash, shares would trade at $225, a 100% premium to the current market price.
Growth Concerns
Many look at the valuation discrepancy as evidence that Apple is being penalized by Wall Street due to the lack of confidence in its ability to grow. However, nearly every sell-side Apple analyst is relying on higher earnings multiples, despite slowing operating income growth, to arrive at target prices that are well above the current market price. This doesn't strike me as overly pessimistic.
Instead, Apple continues to suffer from a lack of confidence and conviction on the part of current and prospective shareholders. Since growth concerns are a bit generic, more specific issues plaguing Apple continue to include doubt that strong Apple customer loyalty will continue and a business model that makes it difficult to forecast earnings.
Apple Customer Loyalty Doubt. It is no secret that Apple is the iPhone company. With the product representing 60% of revenue and 80% of operating income, the iPhone deserves the attention it is receiving on Wall Street. However, there continues to be a general lack of understanding over the dynamics underlying iPhones sales, including the impact that Apple customer loyalty has on sales.
Approximately 75%-80% of iPhones sold each year are to previous iPhone owners. Many on Wall Street look at the fact that Apple is relying on its existing user base to drive sales as a negative. Not only do repeat customers make up a significant amount of iPhone sales, but this actually describes Apple's business model. A company that sells not just products, but experiences, relies on repeat customers to offset any negative implications from the decision to not chase market share. This is one reason why Apple management has a tendency to focus on customer satisfaction rates whenever possible. High satisfaction is suspected to eventually turn into loyalty and repeat customers.
When thinking about iPhone sales growth in 2016, having approximately 75-80% of unit sales come from the 525 million iPhone user base is an indication that the Apple machine is functioning properly. The iPhone upgrade cycle is dependent on evolutionary features that do not over serve the customer base but instead entice upgrades. A high percentage of repeat iPhone customers is actually a strength for Apple, not a weakness. Apple would then need to focus on bringing in approximately 40 million new users to the iOS ecosystem annually in order to report ongoing iPhone growth. When considering the large market opportunity in China and ongoing troubles with Samsung, this 40 million new user target is achievable.
One of the concerns Wall Street has with Apple's customer loyalty is questions about how long the trend can continue. The ongoing debate over smartphone "subsidies" going away (they aren't), not to mention cheaper smartphone alternatives from China, are continuously positioned as factors that may cause iPhone owners to look elsewhere for their next smartphone.
A few Apple analysts have attempted to tackle this customer loyalty issue indirectly by coming at it from an ecosystem angle. By attaching a certain amount of revenue (and profit) to each iOS user over time, one can start to look at the iOS user base as a large annuity that will kick off profits each year. While the idea doesn't exactly rely on the most politically-correct analogy, the general idea is a fair one to make. The problem is that it does little to drive increased confidence that Apple's high customer loyalty will continue in the future.
Difficult Business Model to Forecast Trends. Apple has a business model that makes it very difficult to forecast financial trends 3-5 years out. While some of this is born from the company's thoughts on secrecy and surprise, the reasoning actually goes much deeper. Apple's business model is built on the belief that things will not remain steady over the long-run. Management is constantly looking to break itself, only enjoying key sales milestones for a short while before looking to do something else. In recent years that may have meant cannibalizing existing products, while in the future, it may be moving from its comfort zone into new industries. Compare this to something like Google's search business which had never been thought of to be in trouble by many on Wall Street until only recently or Facebook's recent announcement that 1 billion people went to Facebook in a single day. These businesses, while inherently more complex and confusing than Apple, are thought of as more sustainable over the long-run, while Apple's business comes across as more susceptible to market forces.
This lack of business model visibility boils all the way down to granular features found in Apple products. When Apple introduces a new user interface for iPhones next week, it will be difficult for many to envision such a feature becoming a crucial feature across the iPhone line one day, opening the door to significant design changes. Apple is well aware of the 3-5 year plan with features and products, often introducing certain features just to serve as a stepping stone to future revisions. Extend this exercise to nearly every Apple action, and the end result is Wall Street placing heavy reliance on short-term actions with little to no value attached to the long-term. It is tough to value something that will happen in the future when it is not obvious it will occur.
Even though this model of constantly looking to change the equation plays a key role in Apple's goal of remaining relevant over the long-term (what if Apple never moved past the iPod?), from Wall Street's perspective, such never-ending change is difficult to measure and value. Moving from counting iPod profits to iPhone margins, and soon financials behind monthly automobile leases, is not easy and results in low conviction. The end result is lower valuation multiples to compensate for this unknown. I suspect this has been one of the primary reasons over the years for Apple's valuation discount to the market.
Google and Amazon continue to stand out to investors as both companies share some similarities with Apple in terms of unknown futures. The difference is that while Apple is reporting strong profits on very disciplined expense management, Google and Amazon are considered founder-led companies that keep profits artificially low due to excess expenses and investment. As a result, Google and Amazon are rewarded with higher valuation multiples on what appear to be more mediocre profit and growth trends compared to Apple. Some may disagree with this treatment, but the thing to keep in mind is Wall Street will continue to think a certain way until it no longer wants to. It is impossible to predict when that moment will arrive.
Apple's Share Buyback Program
I continue to view Apple buying back its shares as the most appropriate use of excess cash that is not needed for organic growth and M&A.
As of June 27, 2015, Apple had $50 billion of share buyback authorization remaining out of a total of $140 billion of authorization. Theoretically, Apple could repurchase 8% of itself without any additional authorization from the board of directors. However, when looking at cash available for buyback, it becomes clear that Apple is not in a position to buy back that many shares at this time.
Apple is only able to use U.S. cash on hand to repurchase shares and as of June 27, 2015, Apple had $22 billion of domestic cash ($181 billion is held offshore). When forecasting earnings through the second half of CY2015 and taking into consideration debt issuance and U.S. free cash flow generation, Apple will have approximately $50 billion of domestic cash available by year-end. After adjusting for routine cash needs, including cash dividends, as well as the need for a cash buffer, Apple will likely be in a position to spend $20-$25 billion on buyback over the next six months (July to December 2015).
Apple management can make a dollar worth of share buyback go much further when Apple's stock price is depressed. With shares down 15% from all-time highs, Apple could theoretically buy back 15% additional Apple shares with the same amount of cash resulting in a "savings" of close to $4 billion over the next six months.
There are three likely strategies Apple can take in regards to its buyback:
1) Scheduled Share Repurchases. Apple could follow a very strict schedule as to when excess cash is spent on buyback. It would be equivalent to an investor buying an index fund the same day each month to gain market exposure, regardless of whether the market was up or down. As each quarter comes and goes, Apple will spend the same amount on buyback, resulting in additional shares being bought if the share price decreases. There is evidence of Apple following this type of repurchase schedule with $5 billion spend on share buyback in 4Q13, 1Q14, 3Q14, and 1Q15.
2) Opportunistic Share Repurchases. Instead of simply following a schedule, Tim Cook and Luca Maestri could take stock valuation and timing into greater consideration, resulting in an ebb and flow to the pace of buyback. Apple has shown the tendency of being opportunistic, such as in February 2014, when Tim Cook announced Apple had repurchased close $14 billion of shares over the span of two weeks (shares were trading around $70 at the time).
Beginning in 3Q15, Apple initiated a new accelerated share repurchase arrangement (ASR). The mechanics of such a program may at first seem a bit opaque, but they are actually relatively straightforward. The investment bank(s) handling the ASR borrow AAPL shares in order to deliver a large number of shares to Apple up-front. The banks then proceed to buy back shares over the span of weeks and months to cover their borrow. With AAPL shares having been weak since 3Q15 earnings, Apple will actually be able to take full advantage of its lower stock price by receiving cash back from the investment bank(s) in charge of the ASR.
3) Hybrid Strategy. Apple can combine the two strategies, and have both a scheduled buyback plan in place in addition to buying more shares during times of market weakness. Judging from historical trends, Apple management is following this strategy, suggesting there may be increased motivation to increase the pace of buyback during times of market weakness.
In reality, few companies take aggressive, bold moves with buyback programs during periods of market turmoil. Instead, capital management strategies tend to become more conservative as companies prepare for adverse capital market conditions. There had been a noticeable decline in the pace of Apple buyback recently, but it's difficult to know if it was due to a rising stock price, depleted U.S. cash reserves, or a combination of the two factors. Year-to-date, Apple spent $17 billion on buyback, 26% less than the $23 billion spent during the same time period in 2014. It will be important to see if this pace changes in the face of market volatility and lower share prices.
Volatility Will Continue
There is no evidence to suggest that AAPL volatility will decline anytime soon. The market will focus on slowing EPS growth in 2016 while in reality, there will be much deeper issues at play. Customer loyalty and Apple's eventual embrace of new product categories will likely continue to be ignored by Wall Street. One of the primary ways for a $640 billion market cap company to grow in terms of valuation multiples is for current shareholders to become more comfortable owning a greater share of the company. As long as there are still basic misunderstandings about how Apple thinks about the future, valuation multiples will remain range bound, and management will rely on the share buyback program to take advantage of any perceived market dislocation.
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Members have access to the Above Avalon stock buyback primer which can be used to become familiar with Apple's share buyback.
Apple's Plan to Destroy the Large Cable Bundle
The cable bundle is misunderstood. While analysts and pundits focus on when the cable bundle will finally succumb to Netflix, HBO, and Hulu, the reality is the future of television will be built on the video bundle's back. Due to attractive economics, video bundles are one of the best values in the media space and will remain the dominant way we receive premium video content. We are quickly approaching the point where Apple can capitalize on market dislocation to destroy the modern-day big cable bundle with a leaner bundle that is built to thrive in a mobile world.
Video Bundle Economics
The cable bundle has been one of the best consumer deals in the modern era. By subsidizing content's true cost, the bundle makes it possible for consumers to receive a vast amount of video content for an artificially low monthly price. The bundle works marvelously well as long as everyone pays into the system, and this has been the case for the last 20 years. Nielsen estimated there were 116 million homes with televisions in the U.S., of which approximately 100 million had some form of pay TV for the 2014-2015 TV season. ESPN is one of the most widely distributed cable networks, reaching 95 million homes. ESPN has a farther reach than Facebook, a testament to how much power the cable bundle holds.
While the video bundle will remain relevant for many years, the content associated with the bundle will change. New companies have relied on the old bundle parameter, namely, selling a wide range of content to as many people as possible to carve out a piece of the subscription video streaming market. Companies like Netflix, HBO, and Hulu sell video bundles. Instead of charging viewers by individual shows and series, these companies charge for access to a wide selection of content appealing to a range of consumers.
Most cable networks are in existence today because of the large cable bundle. Without the bundle, these networks would not be able to fund their current slate of programming. The mistake many people make when analyzing the bundle is to ignore the value of access. Having a window to nearly 100 million households is in many ways more lucrative than the pennies or nickels that the average channel receives from each household each month. This is a cable distributor's key selling point, and we often see fighting between content owners and distributors over access.
The Trickiness in Going Direct to Consumer
When contemplating the future of television, many have thought the strongest cable networks can one day bypass the large cable bundle and sell their programming direct to consumer. For simplicity's sake, I position ESPN and AMC as the poster children of this theory. In the current system, ESPN receives approximately $6 per month from every household subscribing to cable. AMC receives quite a bit less, approximately $0.50, although it is still well above the average $0.15 received. If ESPN and AMC were to leave the bundle and embrace the direct to consumer model, they would need not only to make up lost subscriber fee revenue, but also contemplate losing access to 100 million households. AMC relies on that access to sell new series, like "Fear the Walking Dead," to viewers. "Fear the Walking Dead" just became the highest-rated series premiere in cable TV history thanks to AMC's reach. ESPN also benefits from grouping sports programming into one channel, appealing to a much wider fan base, including those who may only watch a game or two each month.
There is no question that the best networks will have loyal fans ready to pay top dollar for a direct to consumer option. However, that won't be enough since these networks are simply not built to support such a model. It will be very difficult for ESPN and AMC to stop subscribers from signing up for their content only to watch their favorite series or sports season and then cancel their membership afterwards. With the cable bundle, such month-to-month volatility does not exist.
I am very skeptical that a cable network will be able to go 100 percent direct to consumer. The economics are just not in their favor. Instead, a hybrid approach may work although in many instances, the best case scenario would be to just get to a point that matches the current large cable bundle. There is much incentive on the part of cable networks to make the bundle work.
Time for Action
The mobile revolution has weakened the large cable bundle's fundamental underpinning. Mobile hasn't changed just the way we communicate, but also the way we create and consume content. Having new types of video content in our pocket has led us to no longer sit in a particular room at a particular time to watch a particular show. As smartphones continue to grow in screen size, all other pieces of smart glass in our lives, including our television sets, will lose value and importance.
The old definition of TV doesn't do justice to the much wider array of available content that we now have at our fingertips. As smartphone adoption grew, the idea that anyone could be a content creator became reality. While YouTube may still lead in terms of mindshare when thinking of user-generated content, we also have plenty of interesting content found on video-sharing networks like Vine, Snapchat, and Periscope, not to mention premium content from the likes of Netflix, HBO Now, Hulu, and Amazon.
One example of an entirely new form of content that people are increasingly turning to is vlogs, which is short for video blogs. The following Google Trends chart highlights vlogging's expanding popularity. The vlogging industry, notorious with young people chronicling their daily activities, is still in its infancy. Vlogging combines elements of reality TV with scripted television as many vloggers record real-life situations although the heavy use of editing and some pre-planning suggest there are also elements of a regular sitcom.
Exhibit 1: Google Trends for Vlogging
All of this new and entertaining content made available due to mobile and new video bundles suggest that the large cable bundle is a house of cards held together by cable distributors. We have evidence that the large cable bundle is fraying a bit at the edges although collapse is not imminent. Disney CEO Bob Iger started a panic on Wall Street a few weeks ago when he disclosed on Disney's earnings conference call that ESPN had continued to see modest subscriber losses. Anyone following ESPN's recent cost cutting initiatives, including a move away from expensive on-air talent, would have seen this news coming. Assuming Iger's comments about ESPN subscriber loss trends remain unchanged for the rest of the year, ESPN will likely report a 2-3 million decline in subscribers in 2015, which may actually represent a slight improvement in the rate of decline compared to last year.
Exhibit 2: Change in ESPN Subscribers
Although ESPN is experiencing recent weakness, there is no evidence to suggest an exodus from the bundle is taking place.
I suspect cable subscriber trends are being impacted by cable distributors. As anyone trying to cancel his or her cable can attest to, it is not the easiest process, and very often consumers receive discounts or other promotions from their cable company to keep the bundle instead of completely canceling cable. The problem for many cable content owners is that if things remain status quo, we will enter a vicious cycle where weaker cable viewer ratings will result in less ad revenue, leading to inferior programming, which will only drive weaker ratings over time. Instead of there being a quick implosion, the cable bundle would deteriorate over time. The cable industry needs that one factor that will not only cause the house of cards to fall, but also address fundamental issues plaguing the large cable bundle.
Apple's Plan
The modern-day cable bundle is now vulnerable. Apple's strategy to destroy the large cable bundle would entail taking the best parts of the current bundle and creating an improved bundle. Essentially, Apple would be using a slimmer cable bundle to kill the large cable bundle. This may not seem too innovative. However, it is one way of addressing the biggest issue people have with their large cable bundle: finding and watching content at a time of their choosing.
As has been previously reported by the WSJ and Re/code, Apple's slimmed down cable bundle would include 20-30 channels and be delivered over the internet to iOS devices. These channels could be considered as home to the best content found within the current large cable bundle. Similar to the modern cable paradigm, the combination of monthly subscriber fees and advertising revenue would represent the primary funding sources for networks included in the bundle. Add in live programming like sports, which come with a hefty price tag, and local news, which depend heavily on advertising revenue, and a new kind of bundle begins to take shape.
Why would networks work with Apple? Having a customer base of nearly 90 million iPhone users and rising in the U.S. is very appealing to content owners. In an era where content bundles obtain their economics by having the widest access, 90 million users represent great opportunity. Similar to how Apple Music will be available on Android, it would be in Apple's best interest to make this new video streaming bundle available to Android as well.
With a rethought cable bundle, Apple would be appealing to the 95 million households that still subscribe to cable, not those who stopped paying for cable. To destroy the large cable bundle, Apple will need to have current cable subscribers be willing to go through the hoops of canceling their current cable with their distributor. The house of cards would then collapse.
Sling TV
On paper, Sling TV, an over-the-top video service owned by Dish Network, sounds similar to the bundle Apple would be looking to put together: a collection of 22 channels, including ESPN, for $20 per month. The problem is Sling TV is designed for those who aren't subscribed to cable, the exact opposite target market for an Apple streaming video service. Sling TV has limitations that cable payers would simply not be able to put up with such as only being accessible on a single device at a time and not including broadcast networks or stations. There are also valid questions over the quality of Sling TV's streaming with many reports of inferior viewing experience during popular shows.
Video Bundles on a Smartphone are the New TV
Mobile will determine not just television's future, but also video's future. Any company or producer that thinks otherwise will likely be left behind to fight over legacy remnants of a bygone era. Instead of some truly revolutionary video streaming service that leaves all prior ideas about cable and TV in the dust, we are headed towards a future that has distinct similarities to the past, namely a handful of companies subsidizing a vast amount of content by offering video bundles to tens of millions of people. The large cable bundle's demise will occur when the 95 million U.S. households that still pay for cable each month are presented with an attractive alternative that takes the best parts of the bundle, adds better discovery and curation, and finally embraces mobile.
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Apple Scouting a Self-Driving Car Testing Area - Above Avalon Premium Week in Review
Along with periodic Above Avalon posts, I send out a daily email about Apple to members (10-12 stories per week). The following story was sent to members on August 17th.
Apple Scouting a Self-Driving Car Testing Area
In an article with quite the intriguing title of "Documents confirm Apple is building self-driving car," the Guardian became the latest publication to add their take to the ever-growing Apple Car debate.
Here's the Guardian:
"Apple is building a self-driving car in Silicon Valley, and is scouting for secure locations in the San Francisco Bay area to test it, the Guardian has learned. Documents show the oft-rumored Apple car project appears to be further along than many suspected.
In May, engineers from Apple's secretive Special Project group met with officials from GoMentum Station, a 2,100-acre former naval base near San Francisco that is being turned into a high-security testing ground for autonomous vehicles."
The Guardian published certain parts of correspondence between Apple and GoMentum Station, obtained under a public records act request. The language would seem to show that Apple was interested in doing something at the testing location.
Frank Fearon, an Apple engineer wrote: "We are hoping to see a presentation on the...testing grounds with a layout, photos, and description of how the various areas of the grounds could be used." Additional correspondence from Apple included: "We would...like to get an understanding of timing and availability for the space, and how we would need to coordinate around other parties who would be using [it]." Meanwhile, Jack Hall, a program manager at GoMentum Station responded saying a tour of the facility needed to be postponed along with saying: "We would still like to meet in order to keep everything moving and to meet your testing schedule." In reference to Apple showing interest in the site, Hall told the AP, "We don't know. [Apple hasn't] said what they want to test. It could be an iPhone."
In a rather comical confirmation that Apple did in fact reach out to GoMentum, an executive director at the Contra Costa Transportation Authority, owner of GoMentum Station, told the Guardian: "we had to sign a non-disclosure agreement with Apple...We can't tell you anything other than they've come in and they're interested." So much for that non-disclosure agreement.
The first thing that stood out to me about this report is that it was indeed a great find by the Guardian. It would seem that the GoMentum Station project was thrown back in the public spotlight a few weeks ago when the town of Concord and the Contra Costa Transportation Authority reached an agreement for how the space will be governed. GoMentum Station won't just be a testing site for self-driving cars, but also vehicles with self-driving technology and "smart" traffic signals and other technologies. Up to five automakers and 15 other companies may use the base with Honda and Mercedes-Benz having already agreed to test autonomous vehicles there.
Before then, the only confirmation that this site was going to be used to test self-driving cars seemed to come from a press release from this past October saying Mercedes signed up as a test partner. Considering that Apple communicated with GoMentum Station officials from this location only a few months ago, it's likely that the Guardian may have been the first outlet to find this scoop, or certainly unveil the details of correspondence between Apple and GoMentum.
The other aspect of the article relates to the seemingly definite title and byline in which the Guardian said: "Correspondence obtained by the Guardian shows Project Titan is further along than many suspected and company is scouting for test locations." There was nothing found in the correspondence published in the article that showed Apple was looking to test an actual Apple-branded self-driving car. Instead, we have information indicating Apple showed interest in using the testing area.
Instead of Apple looking to test a complete self-driving car in the near-term, it is much more likely that Apple is interested in using GoMentum Station to further advance its self-driving technologies. Think more along the lines of the cameras, sensors, and software that would make up the navigational brain of the car rather than a full car with carbon fiber and battery. Being able to test a self-driving rig in a real-world scenario with weathered roads, railroad track crossings, and tunnels would be an essential stage for Apple to take before getting to the point of testing the "Apple Car."
With nearly all evidence pointing to Apple giving the Apple Car project the green light approximately a year ago, I'm skeptical that Apple has a fully functional prototype ready to hit the road. The timing for something like that so soon after a team had been assembled (and is still being put together judging by recent hires) just doesn't sound right.
Apple is unable to test its self-driving technology on public roads in California without going through the permitting process which would serve as confirmation that Apple was indeed testing self-driving car technology. While Apple wouldn't need to disclose much information as part of the permitting process in California, aside from any information related to accidents, the mere confirmation that the company was looking to test self-driving car technology wouldn't exactly fit with Apple's model of placing an incredible amount of value in secrecy and surprise. If public roads are out of the question, that would mean that the only other option is GoMentum Station, another privately owned plot of land, or an Apple-owned location. There are plans to have other fake towns built around the U.S. to test self-driving cars, like Mcity, which is a 32-acre fake town in Michigan that opened last month. Ford, GM, Delphi and Toyota have all shown interest in using Mcity for testing. Considering GoMentum Station's proximity to Apple's resources and staff, this particular location in Concord would seem to be too good to be true.
Recall the WSJ article from this past February which explicitly made the claim that Apple's Titan project did not include a self-driving car. I think that was a head-fake, purposely passed down the grapevine to throw off competitors. There is increasing evidence that self-driving capabilities may in fact be positioned as an eventual selling point for an Apple-branded car. Self-driving technology, or even just the beginning stages of it, would go a long way in positioning such things as safety and convenience as attractive value propositions to consumers.
If you're Apple, a 2,100-acre former naval base lined with barbed wire would certainly seem to be a testing site worth checking out.
Along with the preceding story, the full list of stories sent to Above Avalon members last week included:
- The iPhone's Future (six sections - Too Much Focus on the Near-Term, the iPhone's Changing Role in Our Lives, Form Factor Optimization, Addressing Price Layers, Changing Resource Allocation, About that Watch...)
- Samsung's Unpacked Event
- Comcast's Latest Investment in BuzzFeed and Vox is Significant
- Abysmal Cable Network Viewership Trends
- More Evidence Apple Music is Doing Just OK
- Sprint is Betting the Company on iPhone
- Free Cash Flow 101 (a key AAPL valuation metric)
- A Closer Look at iPad Financials
- A Closer Look at Mac Financials
- Thursday Q&A (Why U.S. mobile carriers seem to love the iPhone all of a sudden?)
Become a member to receive these stories (will be sent to you via email), and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.
U.S. Watch Sales Collapsed in June - Above Avalon Premium Week in Review
Along with periodic Above Avalon posts, I send out a daily email about Apple to members (10-12 stories per week). The following story was sent to members on August 11th.
This story flew under the radar late last week. Watch sales in the U.S. seem to be collapsing. Here's Bloomberg:
"U.S. watch sales fell the most in seven years in June, one of the first signs Apple Inc.'s watch is eroding demand for traditional timepieces. Retailers sold $375 million of watches during the month, 11 percent less than in June 2014, according to data from NPD Group. The 14 percent decline in unit sales was the largest since 2008, according to Fred Levin, head of the market researcher's luxury division."
A 14% year-over-year drop in unit sales is a pretty significant drop. According to NPD, timepieces priced from $50 to $999 saw declines in June, with the $100 to $149.99 range seeing the biggest drop, registering a 24% decline in unit sales. Just a few notes about NPD's data: they rely on consumer surveys along with point-of-sale data collected at individual retailers. NPD doesn't include sales from boutiques owned by watch brands, supermarket chains like Walmart, and online retailers. Think of it as if you are willing to share your sales data with NPD, you will then get much more comprehensive data from NPD in return.
Let's get the obvious out of the way first: we don't know if the Apple Watch is the reason for this watch implosion. Consider that Fitbit's earnings implied that the company sold at least 1 to 2 million devices in June, most of which were in the U.S. I think it is much safer to say that something is going on in the "wrist wearable" market because this watch sales decline is just too significant.
Apple could very well have been the top watch manufacturer in the U.S. during the month of June when looking at revenue. While NPD pegged U.S. watch revenue in June at $375 million, it is likely Apple sold around 1.5M Apple Watches in the U.S. during the same period bringing in somewhere around $700 million of Watch revenue. This estimate comes from the fact that Apple sold between 2 and 3 million Watches last quarter at an average selling price (ASP) of around $475. My theory is that the U.S. represented an outsized portion of Watch sales because of the number of U.S. Apple retail stores, which were important locations for showcasing the Watch to consumers. In addition, Watch sales were backloaded in June due to supply/demand imbalance.
There is evidence to suggest that much of the collapse in U.S. Watch sales was segmented to the low-end of the market. Swiss watch export trends did not show a similar level of collapse in June with U.S watch revenue actually up 5% in June.
When you add Apple Watch U.S. sales to those of other wearables like Fitbit, you likely had 2-3 million "smart wrist devices" being sold in June, which would come very close to outpacing the number of watches sold in the U.S.
It is an understatement to say we are still the early days of wearables (I have only seen one Apple Watch in the wild, although I am seeing more Fitbits these days), but I would look at NPD's watch sales data as one of very first pieces of evidence that there could indeed be deterioration in the traditional watch market caused by smart devices in the form of watches and fitness trackers with Apple and Fitbit being the market leaders.
Since owning Apple Watch, I'm more confident in saying the device may be a bit much to get used to at first if you are a luxury watch owner. It's not due to any particular inferior aspect of Apple Watch, but instead just the fundamental difference between wearing a computer on your wrist that tells time and so much more and a luxury watch that is worn for other reasons besides just giving you the time.
I do think it is more likely that Apple Watch will initially impact the low-end watch industry, which I will call "casual watch owners," those who may buy a $99-$299 watch just to have something on the wrist. This may explain why, according to NPD, the $100 to $150 space saw the biggest drop even though the Apple Watch retails for a good 3-4x the cost. In addition, watch loyalty at the low end is likely to be weak, and these consumers would be continuously on the lookout for new things to wear. Said another way, buyers in the $100 to $150 Watch range are more likely to experiment.
Given June's awful U.S. watch sales data, it is important to monitor if this is the start of a trend throughout the summer. If there are continued sales declines, then we are in a much stronger position to make more solid declarations about smart wrist wearables.
Along with the preceding story, the full list of stories sent to Above Avalon members this week included:
- China's Yuan Devaluation and Apple (2,500-word story broken into various subtopics: What Happened?, Brief Background, Apple's China Growth Story is Cracking, Continued Yuan Devaluation Headwinds, Where Does This Leave Apple?, Final Takeaways)
- The Smartphone Subsidy Myth
- Thoughts on Alphabet
- Finding iPad's Future
- Apple Music Family Membership Strength
- Jimmy Iovine on Curation
- Cable's Problem
- Fossil is Seeing Issues in the Watch Market
- Thursday Q&A (AAPL valuation metrics)
Become a member to receive these stories (will be sent to you via email), and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.
Finding iPad's Future
The iPad raises interesting questions in terms of Apple strategy. A product that carries so much brand relevancy that it still represents the entire tablet market now finds itself the leader of a category that has lost all momentum as other product categories marginalize the tablet form factor. Although Apple is still selling more than 10 million iPads per quarter, there is something about the iPad that just doesn't sit right with me. We have gotten to the point that the status quo will likely lead to the iPad and the modern-day tablet becoming irrelevant over time. A new direction for iPad is needed based on a fundamental rethink of tablet computing.
The Current Tablet Market
The tablet market is in complete disarray. Only five short years ago, the iPad helped jumpstart the category, ushering in multi-touch computing and the modern-day app revolution to large-screen devices. Today, there has never been a time when the tablet market faces so much unknown.
A quick look at iPad and tablet shipment data would show that things have gotten bad in recent quarters. However, in reality, things are much worse than quarterly shipment data would suggest. The seasonality found in the tablet segment makes it difficult to see these long-term problems. A much better way at understanding what has been taking place is to look at the year-over-year change in shipments on a trailing 12-month (TTM) basis, highlighted in Exhibit 1. This smoothing effect highlights that the iPad and tablet have been on the decline for years and things continue to worsen with the overall tablet market hitting negative territory for the first time. All momentum has been lost.
Exhibit 1: Change in Trailing 12-Month (TTM) Tablet Market and iPad Shipments
After kicking off the tablet market in 2010, Apple went on to sell a cumulative 84 million iPads in just two years. The iPad's initial success was simply unprecedented, with unit sales outpacing the iPhone's relatively "slow" start by 2.5x. I suspect Apple wasn't just caught off guard by the iPad's success, but was led to believe that the iPad represented the future of computing. Many thought the iPad would outshine the iPhone.
In relatively short order after launching the category, Apple uncharacteristically expanded the iPad line to include a completely different form factor known as the iPad mini. The motive was primarily based on price, making sure there wasn't a repeat of the Windows vs. Mac battle from the 1990s in the tablet market due to Apple letting competitors underprice iPad. The iPad mini was soon called the best tablet ever, evidence that the larger form factor was losing a bit of its luster in just two years. Many didn't see it, but tablets were quickly turning into content consumption devices where price was a leading purchase decision.
We now find ourselves with a tablet market where Apple and Samsung are losing share to "Others," which is represented by dozens of firms selling mostly generic tablets used to consume media, depicted in Exhibit 2.
Exhibit 2: Global Tablet Market Sales Share
On a profit and mindshare perspective, Apple continues to lead the way. Instead of wishing for smart television sets, the future of TV watching is taking place with $99 tablets.
When looking at iPad's declining ASP trends, consumers continue to choose older, less costly iPads, another indicator that tablet computing is shaping up to be something different than we have been led to believe. A product category with a use case summed up by Netflix watching is quite problematic since it is that much harder to sell a differentiated product, leading to a rush to the bottom in terms of pricing, quality, and features.
Momentum is not on the side of iPad. Larger screen iPhones have been in the market for only 10 months. The latest Macbook, which effectively gave us a look at where the MacBook is headed, has been out for only a few months. These two products are game changers not just in their categories, but for tablet computing. It is becoming that much easier to recommend an iPhone or Macbook over an iPad.
Tablets Are Being Used for Consumption
When the iPad first started to show signs of trouble, many market observers were shocked, thinking Apple must be losing to low end Android tablets. In reality, one reason sales momentum was slowing was iPad owners weren't upgrading their device. Using Fiksu data and my own estimates, consumers have held onto their iPad, on average, for three years, which is longer than the iPhone's 2.6-year upgrade cycle. Since the tablet category is still young, the iPad's three year upgrade cycle is still extending and will likely go out as far as 5-6 years. The theory that a longer upgrade cycle was impacting iPad sales began to be used in the press and conference calls.
Exhibit 3: Current iPad Mix (model and model year)
While there is nothing inherently wrong with a long upgrade cycle, as seen with the Mac, which continues to report solid sales momentum, the reasoning behind holding on to tablets for years is much more troubling. There are currently approximately 3 million units of the original iPad still in use, or 20% of the devices Apple sold. For the iPad 2, it is possible that close to 60% of the units Apple sold are still being used. These two devices are not superior tablets. The initial iPad lacks a camera, while the iPad 2 has a mediocre camera. When compared to the latest iPads, these first two iPads are simply inferior tablets with slow processors, heavy form factors, and inferior screens. But none of that matters with owners. This is problematic and quite concerning, suggesting that many of these tablets are just being used for basic consumption tasks like video and web surfing and not for the productivity and content creation tools that Apple has been marketing.
There are signs that Apple believes there may be some kind of iPad revival around the corner. Since the average iPad upgrade cycle is three years and counting, does this mean that Apple may benefit from some sort of upgrade cycle? I'm skeptical. Why would someone upgrade an iPad that is just being used to watch video?
Potential Isn't Reality
On the surface, the iPad's declining sales momentum is difficult to comprehend. There seem to be so many use cases for larger-screen multi-touch computing devices across a number of industries. We hear about "iPads in the classroom," new and interesting enterprise apps resulting from the Apple/IBM partnership, plenty of anecdotal evidence of children loving to play games on iPad, and of course, iPads replacing desktops, laptops, and televisions. Apple has consistently referred to superior iPad satisfaction rates on earnings calls which support the idea that people love their iPads. Yet in the face of all this potential, we are just using iPads for Netflix and YouTube.
On closer examination, there are cracks in the iPad story. School districts have seen mixed results with iPad adoption programs. We have seen a few high-profile disasters where the combination of a lack of curriculum built for the iPad, along with high costs, made the iPad not the magical device in the classroom once thought. The idea of replacing student books with iPads never materialized due to poor incentives in the textbook industry, not to mention technological limitations found with the device.
The scope of iPad in enterprise still remains mostly a dream. We are seeing more stories about enterprise embracing Macs, not iPads. Meanwhile, consumer usage on iPad has moved away from content creation apps. Take a look at the iPad App Store to see the lack of compelling apps for larger screens for additional evidence of iPads being used much more for basic content consumption.
Things are Getting Worse, not Better
Back in October 2014, I wrote a post titled "Thoughts on iPad," in which I explained the iPad's ultimate sales trajectory would be much more modest as Apple was selling large-screen iPhones and thinner Macs. While I received an incredible amount of pushback at the time, trends have largely materialized as I expected. The continued migration of smartphone manufacturers to 5+ inch screens was not just a game changer for the smartphone market, but will come to represent a watershed moment for the tablet market. Many of the use cases once destined for the iPad are permanently gone, now taken up by the iPhone and MacBook.
Another consequence of growing large-screen smartphone popularity is that it is becoming increasingly difficult for Apple to market the iPad Air and iPad mini. Features such as cameras and even Touch ID simply don't make as much sense on a device that can't be comfortably held in one hand or carried in a pocket. Apple has tried to position the iPad as a mobile device, emphasizing its ability to take photos and video on the go, but it's not realistic to assume people will prefer an iPad to an iPhone in such settings.
Not only are tablets being used for more rudimentary purposes, but smartphones and laptops are crippling the odds of tablets being used for much more. The iPad market is in trouble and if there are no changes made to the lineup, Peak iPad is on the table. Peak iPad is a simple concept driven by the belief that underlining structural changes to the tablet market would result in the iPad losing most of its value propositions, leading to a permeant decline in sales. For example, Peak iPod is alive and well as even though Apple is still selling iPods, the product category will never reach record quarterly sales. Meanwhile, while some argued that we had seen Peak Mac, we instead were just in a sales slump that quickly reversed itself with a revamped product line. The Mac's value propositions were still alive and well. In a world where smartphones are getting larger and laptops are getting smaller, the Peak iPad theory is starting to look more likely as time goes on. Something needs to be done to create new tablet value propositions, redefining its role in the mobile revolution.
Apple's Plan for iPad
It is time to fundamentally address the problems with multi-tech tablet computing. The answer is to introduce a new product subcategory at the high-end of the tablet market. With video consumption taking over at the low-end, it becomes that much harder to sell a differentiated product at a low price. Apple has better chances of pushing the tablet market forward by looking at the high-end of the market where a superior experience is able to be sold at a premium price.
By selling a device that is truly designed from the ground-up with content creation in mind, the iPad line can regain a level of relevancy that it has lost over the past few years. In every instance where the iPad is languishing in education and enterprise, a larger iPad with a 12.9-inch, Force Touch-enabled screen would carry more potential. Simply put, the iPad needs to stand out from the iPhone and Macbook. The iPad Air and iPad mini aren't doing it.
Education. Instead of pushing the idea of every student having an iPad, which is difficult when considering costs and the fact that most students already have a smartphone and laptop at home, school districts could set up "iPad Plus" rooms with 20-30 of the larger iPads reused throughout the day by various classes. A new larger iPad with nearly 80% more screen real estate than the iPad Air, dedicated accessories like a smart pen, and better covers and stands can go a long way. It can become part of art and design classes, not to mention a number of different disciplines, including those where writing is involved. Writing a term paper on an iPad mini or even iPad Air is not fun. A larger tablet with full-size on-screen keyboard using Force Touch to resemble the haptic feedback of a real keyboard may be a game changer.
Enterprise. A larger iPad could be positioned as a laptop replacement whereas today's iPads are stuck in a weird place as a secondary computer. Any design-oriented field would instantly see value in using these larger iPads while traditional industries such as finance and banking would see a much easier adoption rate if legacy products like Excel are made that much more easier to use.
Consumer. A large iPad could continue down the path of replacing old laptops and desktops, becoming a user's primary computing device. The much easier ability to type means that nearly every possible computing use case would be covered. This 12.9-inch iPad Plus will begin to look much like the Mac in terms of sales with a slow and steady sales uptick, followed by an orderly upgrade cycle. The key for such a device will be once again redefining where a tablet should sit in someone's product portfolio. We know everyone will have a smartphone. The question would be if a new type of device can exist between an iPad Air and MacBook.
Over the years, we have come up with differing degrees of the "perfect combo" for computing. It used to be an iPhone and iPad. Then it became an iPhone and iPad mini. Now many say iPhone and MacBook. The question will be whether or not a product can be created that will serve as a high-end creation device that compliments an iPhone.
What Does Success Look Like with a New iPad?
An iPad Plus does not need to sell like an iPhone or even like an early edition iPad to succeed. As long as the product has use cases that are sheltered from other products, Apple would be able to reposition the iPad line for a more sustainable path not just for growth, but ultimately for outright survival. If the end goal is to ship devices that help solve users' problems, Apple will have a winner on its hands. A more capable iPad Plus has a much better chance of becoming relevant in a world where the iPhone is already the all-powerful device everyone owns. The early days of the iPad era provided many opportunities to see how the definition of work is changing. A new tablet subcategory that does a better job of pushing the definition of work forward is needed. Tablet computing has a much brighter future than just being used to watch Netflix and YouTube.
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Apple Watch is Coming to Best Buy - Above Avalon Premium Week in Review
Along with periodic Above Avalon posts, I send out a daily email about Apple to members (10-12 stories per week). The following story was sent to members on July 28th.
Apple Watch is Coming to Best Buy
The Apple Watch continues to throw us curve balls. The latest is courtesy of a Best Buy press release:
"The Apple Watch, one of the year's most talked about and innovative products, is coming to Best Buy.
Starting Aug. 7, Best Buy will be the first national retailer, other than Apple Stores, where customers can buy the Apple Watch. It will begin to arrive in more than 100 Best Buy stores and will also be available on BestBuy.com. Another 200 of our stores will have the Apple Watch in time for holiday shopping."
The first thing to note is the relatively slow roll-out. Even though August 7th is next week, it sounds like it will take some time for Apple Watch to be in the first 100 stores. The U.S. holiday shopping season is still four months away, and there are 1,050 Best Buy stores in the U.S. For there to be only 300 stores to have the Watch by November suggests that there will likely be special Watch display areas set up in the Apple areas within Best Buy stores. Will Apple utilize Watch display tables similar to the ones in Apple retail stores or will Apple build special (smaller) tables just for Best Buy?
It's clear we should expect the Watch to be sold in a refined way, even at Best Buy. That is one reason why the Apple Watch display tables are so great, representing a new take on how luxury watches are displayed to the public. Traditionally, you think of a watch display case in a Bloomingdale's where dozens of watches are packed together in glass cases. In terms of other smartwatches, the display method is nothing short of a mess with some Android Wear devices attached to tables like a pen chained to the table at a bank.
Best Buy detailed the Watch models that will be available in its stores: "[C]ustomers will be able to see, try and buy 16 Apple Watch models - including Sport and Watch models in both 38mm and 42mm sizes - and nearly 50 accessories, including watch bands, screen shields, stands, chargers and more."
Does "try on" mean I would be able to wear the Watch or simply play with the device while it is stationed to the table? There are still questions left unanswered.
The much bigger stories here are the expanding Watch retail distribution and the delicate balance Apple has to manage between selling luxury and premium mass-market items.
Apple Watch is currently sold in 266 Apple retail stores in the U.S., so this Best Buy deal effectively doubles the retail presence in the U.S., which should not be underestimated. It's important to remember that there are millions of people that don't live near an Apple store and have not had the opportunity to see or play with Apple Watch. I would expect other retailers to sell Apple Watch in time for the holidays as Apple management stressed that key shopping time frame on last week's earnings call.
Over the past few weeks, because there has been so much attention given to whether the Apple Watch has been a flop or not, many have forgotten that Apple is now a premium mass-market luxury brand. By selling Watch models ranging from $349 to $17,000, Apple needs to rely on a particular kind of retail strategy in order to not alienate certain customers.
As I wrote a few months ago, the answer seems to be segmenting the Sport and Watch models from the Edition. Such segmentation makes it possible to sell the Sport and Watch in more mainstream retailers while not hurting the appeal of the Edition, or at least that would be the theory.
Here's a snippet from a post I wrote back in March titled, "The New Apple: Embracing Personalized Technology with a Luxury Twist":
"Even though Apple has mastered the art of selling mass-market goods at premium prices, catering to a luxury clientele comes with new risks, including alienating core users who may be turned off by management's focus on the high-end at the detriment of the 'low-end'...There will likely be very few instances of $349 Apple Watch Sports being sold next to $17,000 Apple Watch Editions."
We are in unchartered territory, not just because we are talking about a personal luxury tech gadget, but because Apple is actually pushing a different kind of luxury with all of the watch models having the same fundamental functionality, the only difference being aluminum, stainless steel, and gold watch cases.
While some may poke fun at Apple Watch being sold at Best Buy, in reality the decision makes perfect sense and will not hurt the luxury image that Apple is going after because of the Watch collection segmentation that is present.
Along with the preceding story, the full list of stories sent to Above Avalon members last week included:
- Apple Talked with BMW About Electric Cars
- The Unknown Tablet Market
- Elon Musk is Experimenting (with electric car retail)
- I Saw My First Apple Watch in the Wild
- New Apple Watch Ads
- Apple Music Subscriber Numbers
- Apple Music's Problem
- Motorola's New Phones
- Why There's Nothing Quite Like iPhone
- Thursday Q&A - Media Edition (Disney, Snapchat, and Vine)
Become a member to receive these stories and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.
Apple Car Development is Advancing - Above Avalon Premium Week in Review
Along with periodic Above Avalon posts, I send out a daily email about Apple to members (10-12 stories per week). The following story was sent to members on July 21st.
Apple Car Development is Advancing
The Apple Car development project appears to be on track. The WSJ is out with a new report indicating Apple continues to hire auto-related executives and researchers. The latest are Doug Betts, one of the highest auto executives confirmed to now work at Apple, and Paul Furgale, a researcher involved in autonomous vehicles, mapping, and robotics.
Since the Apple Car project remains unconfirmed, the primary evidence we have to judge the project's progression (or lack thereof) is hires and fires that are likely related to Apple's efforts with automobiles.
Here is the WSJ:
"Mr. Betts could be the first major automotive executive to join Apple with experience leveled more at the manufacturing side of the business.
For nearly two decades, he has worked in product quality and manufacturing at an auto company, first as a general manager at Toyota Motor Corp. and later as a vice president at Nissan Motor Co. and Chrysler Group LLC, now FCA US LLC.
In 2009, when Fiat SpA took over Chrysler, CEO Sergio Marchionne tapped Mr. Betts to lead the company's quality turnaround, giving him far-reaching authority over the company's brands and even the final say on key production launches.
Mr. Betts abruptly left Fiat Chrysler last year to pursue other interests. The move came less than a day after the car marker's brands ranked poorly in an influential reliability study."
The WSJ is being pretty kind here in describing Betts' departure. Most industry watchers think Betts was fired this past November due to Fiat, Jeep, Ram, and Dodge taking the bottom four slots on the influential Consumer Reports reliability survey, with the Chrysler brand not far behind.
Obviously, news of Betts being fired due to poor quality performance wouldn't seem to sit right with this latest news from the WSJ that Apple hired him. What is going on?
Industry watchers say Betts was likely used as a scapegoat as the quality problems facing Fiat due to acquiring Chrysler were simply insurmountable and indicative of much bigger company and culture issues, things that one person would not be able to solve on their own. The Daily Kanban, a site dedicated to covering news and analysis from the auto industry, with a focus on Toyota, summed up Chrysler's problems well:
"Chrysler's quality problems seem to be coming from nearly every possible corner. In just a few of the most recent issues to hit the media, FCA [Fiat Chrysler Automobiles] has shown it has problems with everything from a lack of development testing (vibration leading to cracks in Ram Ecodiesel exhaust coupling), to assembly problems (Hellcat fuel leaks). Supplier problems have also featured heavily in FCA's quality snafus, most recently in a recall of Chrysler 200 transmissions due to 'inconsistent assembly procedures at a supplier's plant,' even as [FCA CEO] Marchionne has targeted supplier profits. But perhaps most troubling is the evidence that FCA simply isn't able to catch quality problems before cars go out to customers...
[A] fired executive scapegoat and a snarky [YouTube] ad were deemed a solution to a long-term quality problem. Little wonder Chrysler still finds itself at the bottom of Consumer Reports recommendations."
When you take a step back, Betts' hire at Apple makes much more sense. Betts is a senior level auto executive with stints across a number of companies, including time as head of product quality and supply chain for the Tundra, Sequoia, and Sienna at Toyota in Indiana, where manufacturing techniques are still the envy of the auto industry. This may just be coincidence, but all three of those Toyota vehicles are either SUVs or trucks, and Apple's car project was rumored to include a larger, minivan-type vehicle. Even though he was not able to turn around FCA's fortunes, it is very well possible that Apple sees value in applying his skills and experience to their current project.
One other aspect of Betts that many may not catch is that he has previous experience as Head of Total Customer Satisfaction for Americas at Nissan, which in car lingo means controlling the experience a customer has with a car brand, including everything from how a car is built, to it being bought at a dealer. Betts was overlooking the Nissan experience. Now recall how Apple is all about selling experiences. It sure does seem to fit in my mind.
On his LinkedIn [update: his profile has been deleted], Betts is likely using misdirection, simply saying he is working in Operations at Apple, similar to how former Mercedes R&D head, Johann Jungwirth, lists his job duty at Apple as Director of Mac Systems Engineering.
Betts would seem to be a senior-level hire for the Apple Car group, overseeing an entire team or division within the larger initiative led by Steve Zadesky. It is this type of structure that makes me much more bullish of a full-fledged product under development.
The WSJ has more on Apple apparently hiring Paul Furgale:
"Earlier this year, Apple hired Paul Furgale a well-regarded autonomous vehicle researcher in Switzerland, and has begun recruiting other robotics and machine vision experts to work on a confidential project."
Just to give you a few examples of the type of research Furgale was previously involved in as late as last year, here is a sampling of the publications listing Furgale as a co-author:
- Keyframe-based Visual-Inertial Odometry Using Nonlinear Optimization
- Lighting-Invariant Adaptive Route Following Using Iterative Closest Point Matching
- Infrastructure-Based Calibration of a Multi-Camera Rig
- Self-supervised Calibration for Robotic Systems
Here's more from the WSJ:
"Mr. Furgale had been deputy director of the Autonomous Systems Lab at the Swiss Federal Institute of Technology, or ETH. Mr. Furgale previously had led a European Commission project called V-Charge that sought to develop self-parking vehicle technology...
Mr. Furgale has begun recruiting students and researchers to work with him. Apple has hired a graduate student studying at the University of Michigan and has quietly recruited others."
Two points that I get from this news: 1) Compare Betts to Furgale. While one is a senior-level auto manager, the other is knee-deep in technology and research. Apple is hiring a mix of talent from both the legacy auto industry, as well as academia. 2) I look at the earlier reports back in February saying that Apple wasn't researching autonomous vehicles as a head fake, or misdirection. Evidence suggests they are. Of course, we need to take a few steps to get from Point A to Point B, including semi-autonomous features like better parking and highway travel, but like with any product, I suspect Apple is looking farther in the future, at a world where autonomous vehicles are much more likely to control the road.
Betts and Furgale are both interesting auto-related hires that further strengthen the theory that Apple's ambitions in the automobile industry have no bounds.
Along with the preceding story, the full list of stories sent to Above Avalon members last week included:
- Apple Earnings Summary - Big Picture, Stock Price Reaction, iPhone: Relatively Quiet (Which is Good), Apple Watch: It's Very Early and Things Look Okay, iPad Sales Growth: Fact vs. Theory, Share Buyback: It's Slowing, Additional Earnings Call Notes
- The Day After Apple Earnings on Wall Street
- The Wild Ride on Wall Street
- Judging Apple Watch Success/Failure
- Beme and the iPhone Ecosystem
- Apple Music - A Few Thoughts Three Weeks In
- Washington Looking at Foreign Cash Tax Reform
- Thursday Q&A
Become a member to receive these stories, including my full AAPL 3Q15 earnings recap (will be sent to you via email), and future stories in a daily email containing 2-3 stories (10-12 stories/week). For more information and to sign-up, you can visit the membership page. A weekly option is also available if you prefer to receive one email instead of four each week.
Flops, Winners, and Outliers
When is a product a flop? What does a winner look like in consumer technology? How can outliers complicate our thought process? The Apple Watch is getting us to ask all of these questions while failing to provide the instantaneous answers that we crave. Not only has Apple's recent success led market observers to put value in short-term thinking and cynicism, but we have lost all context for how to properly measure product success and failure. It is clear that instead of thinking of flops, winners, and outliers as meaning the same thing across products and companies, context and discernment are needed to properly assess reality.
Flops
Apple has single-handedly morphed the definition of a flop. What once referred to products that were never able to make a lasting impression in consumers' minds (e.g. HP TouchPad, Blackberry Playbook) has now expanded to include product sales that are less than the best selling Apple products of all-time. Some of this aggressiveness to slap the flop label on new products so quickly comes from the proliferation of products not ready for prime time. It remains a mystery why the Amazon Fire Phone ever saw the light of day. Similarly, tech companies positioning their R&D efforts into the public sphere with products like Google Glass have gotten us trained to look for and expect instant flops: products that are never able to find a niche due to a plethora of reasons. Flops aren't just kept for hardware products as a number of Facebook apps, such as Poke and Camera, never were able to find an audience before being thrown aside.
Set in this somewhat confusing environment is Apple, a company that has relied on a strategy of placing very few hardware bets in order to focus attention and resources on a handful of products. In some ways, this rare and unique strategy, which other companies look down upon as being too risky for their own taste, would seem to necessitate a different kind of analysis when it comes to flops. Consensus opinion has landed on the stance that if Apple gave the green light to a new product, that must mean Apple expects it sell in numbers like an iPhone and iPad; anything short of this threshold should earn the flop label.
The primary problem with that thinking, and flops in general, are that they require context, both in terms of setting and timing. There is simply too much diversion in company resources and strategy to use the same flop brush across products, not to mention companies. Even though Apple releases very few products, not everything that comes out Apple HQ is positioned to reach tens of millions of users. Going further, certain models or SKUs may be geared toward a very specific niche that doesn't add up to more than 100,000 customers (think: Mac Pro). This introduces confusion and complexity into what is a flop.
Winners
There is still much disagreement over how to quantify winners in consumer technology. Is market share leader the title one should strive for? In the phone industry, the feature phone master, Symbian, was cast aside in a few short years. Blackberry's early smartphone power was decimated within roughly the same time span. While some may point to profit market share as the more suitable choice for determining success, Apple's monopoly on profits in markets that it plays in doesn't sit well with some people. How about year-over-year growth being used as a litmus test for success? There was a time when Microsoft being able to grow its smartphone market share from one to two percent was classified as a resounding success.
Similar to how flops require context for proper judgement, a product's success is also relative. For a smaller company like GoPro or Fitbit, if the latest camera or fitness wearable registered one million unit sales in a quarter, Wall Street may reward the company with accolades and rating upgrades. For Apple, the same sales rate for a more mature product would be a disappointment, and surely earn a flop badge. There is nothing inherently wrong with this differing rating system and one could argue that is exactly how it should work. The problem with that line of thinking is that success for a company like Apple begins to take on mythical proportions. Everything to come out of the design labs would inevitably be compared to iPhone, a product that Apple is on track to sell 250 million units per year.
How should a winner be defined? Ultimately, the easiest and most universal definition may involve measuring a product's trajectory and looking for signs of momentum.
Outliers
If it wasn't already difficult to figure out how to define a flop or winner, outliers may lead us to continue to struggle trying to find answers to these questions. The iPad is a great example of an outlier, a product that had impeccable market timing and an environment ripe for early sales success. The end result is 280 million units being sold in five years. Today, the product is facing questions as to its long-term trajectories with much of its functionality now being met with other products. When the iPad was launched, the running joke was that it was just a big iPod touch. In retrospect, it was that label that likely indicated why it sold so well, so quickly. It was a product that shared most of the allure of iPhone, only with no contract and a much larger and attractive screen. Once the iPhone screen got larger (and the Mac got thinner and lighter), the iPad was squeezed. The much longer life cycle for the product hasn't helped sales either as consumers hold on to their iPads for much longer than their iPhones.
In our attempt to quantify Apple Watch success, comparisons to the iPad may lead to faulty conclusions, both from a positive and negative angle. It may be too optimistic to assume that a new Apple product can see the same adoption rate as iPad. Just as the iPad is now facing a sales plateau, such a barrier may represent an incorrect conclusion as to how well a new product could do over time.
Another outlier question that undoubtedly needs to be asked involves the iPhone. Is Apple's juggernaut truly a one-of-a-kind product? With such a short upgrade cycle, aided by Apple's relationship with mobile carriers across the world, will it be extremely difficult for another product to meet similar annual sales rates?
What to do?
Taking into account the complications and difficulty in defining flops and winners, set within a sea that contains a few outliers, how should one go about measuring a product's performance?
1) Establish Context. What kind of product is being measured? A $99 fitness wearable that requires no other device to do its job or a $3,500 Mac Pro designed for movie makers? Does the product require a monthly contract or other recurring cost? Will a decaying battery over time require the product to be replaced in a few years, or is the product designed to last many years?
2) Establish Parameters. How should success be defined? Obviously there are major differences when discussing hardware and software initiatives. On one hand, quarterly unit sales may suffice while on the other hand, reaching scale in the form hundreds of millions of users may be the only way to reach success. Even within the same product category, different parameters may exist. For a phone, should we measure success in terms of sales share, profit share, or mind share?
3) Look for Momentum. Rather that merely thinking about a product's long-term potential, it is important to find momentum or signs of life. App developer involvement, early success within a specific demographic, or increased word of mouth may all signal that a product has life and potential to grow over time.
4) Measure Results. It is important to find ways of quantifying parameters and momentum. It is not a coincidence that many technology companies have adopted policies that revolve around providing little to no product sales disclosure. While some of this could be related to competitive reasons, the much more likely reason is to hinder Step #3 from above, making it difficult to know if a product is failing in the marketplace. While Amazon is known for its lack of disclosure, the company has not been shy when disclosing the number of Prime memberships. Along similar lines, Samsung was quick to reveal smartphone sales as the company was consolidating power within the Android OEM space, but when facing struggles at both the low-end and high-end of the smartphone market, the company has now adopted a policy of not disclosing smartphone sales. Even Apple is known to partake in the "tell the world good numbers" party while keeping mediocre results private.
These four steps indicate that measuring flops, winners, and outliers is not easy and likely involves much effort and time: attributes that are seemingly in decreasing supply. The iPhone and iPad may have spoiled us when it comes to thinking about what failure and success mean in consumer technology. In order to get a better grasp of what is happening close to the ground, more effort will be required to bypass the rhetoric and rely on logic and processes to guide the thought process. It won't be easy, but we need to start somewhere.
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AAPL 3Q15 Earnings Preview
Apple is positioned to report another quarterly earnings beat when reporting 3Q results on July 21st. Apple continues to benefit from attractive year-over-year sales comparisons in China. Overall revenue growth is tracking close to 35 percent, with earnings growth exceeding 50 percent. With the iPhone now representing close to 70 percent of Apple's operating income, the product category has become the single-most important factor driving earnings, and that trend will continue in the near-term. With lingering Apple Watch demand questions, many will use earnings as the first opportunity to back into Watch unit sales. Apple guidance should be informative, reflecting not only a new iPhone launch, but also an early read on July sales and any impact from ongoing economic turmoil in China.
Earnings Preview Reading
Over the past three months, the major stories impacting Apple financials have centered around three topics: the iPhone's growing power, Apple's cash, and China Mobile. The following stories serve as good background reading in the lead-up to Apple earnings.
- The iPhone is Taking Over Apple - Apple will be the iPhone company for the foreseeable future. The iPhone's gravitational pull is simply too strong for any new product or service to reach escape velocity and become the next big thing for Apple in the near-term.
- Apple's Cash Dilemma - Apple is unable to keep the pace of share buybacks and dividends in line with its foreign cash generation.
- China Mobile is a Game Changer for Apple - China Mobile has become Apple's most important business partner.
iPhone: No Change in Momentum
Strong iPhone sales trends in China, Europe, and emerging markets will continue to offset lackluster smartphone growth in the U.S. Last quarter, I estimated China Mobile accounted for nearly 40% of Apple's year-over-year iPhone growth, which was certainly boosted by the Chinese New Year in February. China Mobile's importance cannot be stressed enough as the largest mobile carrier in the world will soon account for 20% of all iPhone shipments. Given lower smartphone adoption rate in China compared to U.S. and Europe, I would expect China to continue representing a majority of iPhone growth for the next few quarters.
Exhibit 1: iPhone Unit Sales Expectation Meter (3Q15)
Mac and iPad: No Longer Earnings Factors, but Still Interesting
Due to the iPhone's elevated share of earnings, the Mac and iPad are no longer relevant from an earnings day perspective. There are still interesting trends at play within each category. The Mac is continuing to take share in a category that is pretty much being decimated with overall PC shipments forecasted to be down 5-10% year-over-year this past quarter. The iPad continues to struggle as the product finds a normalized run rate where the combination of first-time buyers and upgraders results in roughly flat growth. We are not there yet.
Exhibit 2: iPad and Mac Unit Sales Expectation Meters (3Q15)
Apple Watch
Even though Apple is not expected to disclose Apple Watch sales, keen observers with an Apple earnings model will be able to back into a relatively good approximation of Apple Watch sales. I am expecting Apple to have sold 4.25 million Apple Watches from April to June. While there has been much debate as to how the Apple Watch has been selling, more time will be needed to gauge normalized demand; there was evidence of pent-up demand at launch as would be the case with any new Apple product category.
Guidance
Management's guidance will be useful for a few reasons. Since we are quickly approaching the new iPhone launch, guidance will help determine what Apple has seen so far in the month of July in terms of iPhone demand. While there shouldn't be much spillover just yet from the volatile Chinese stock market, any caution built into China sales due to economic concerns may become apparent in guidance. In addition, next quarter will present a more informative view on Apple Watch sales as we move away from launch.
Exhibit 3: Revenue and Margin Guidance Expectation Meters (for 4Q15)
Wall Street Concerns
The biggest headwind facing Apple continues to be fears of slowing iPhone growth in 2016. As has been the case for the past few conference calls, analysts will look for any new commentary on Android switcher rates and iPhone penetration in China and other developing markets. If 2015 was the year of China Mobile and large screen iPhones, company observers are becoming skeptical that the new iPhones will be able to sustain the same type of growth rates next year.
For additional commentary and perspective on Apple's upcoming earnings, become a member to receive my premium emails from this week (Tuesday, Wednesday and Thursday). To receive these emails and future daily emails containing Apple analysis (10-12 stories per week), sign-up here.
The iPhone is Taking Over Apple
One theme has become clear in 2015: the iPhone's gravitational pull is simply too strong for any new Apple product or service to reach escape velocity and become the next big thing for Apple in the near-term. From a financial and business perspective, the iPhone is the only product that matters. The iPhone is amassing so much power at Apple, it is difficult to imagine any product being able to dramatically surpass the iPhone in terms of importance over the next five years. Apple will be the iPhone company for the foreseeable future, and that classification introduces opportunities and risks that Apple will need to navigate over the coming years.
Perspective
This past month, the iPhone celebrated its 8th anniversary. It is easy to forget how significant of a factor the iPhone has been to Apple's business since launching in 2007. Taking a look at cumulative data over that time span helps to put the iPhone's one-of-a-kind product status into perspective.
- 726 million iPhones sold
- $443 billion of revenue (50% of total)
- $200 billion of gross profit (60% of total)
- $120 billion of net income (60% of total)
As a sign of continued iPhone momentum, Apple is now selling up to 250 million iPhones a year, or close to a third of total iPhones sold to date.
iPhone's Importance to Apple's Financials
Everyone knows the iPhone is a crucial part of Apple's business, but few realize the extent to which the iPhone is literally taking over Apple's financials. In the first half of FY2015, the iPhone accounted for 69% of Apple's total revenue, up from 57% of revenue during the same time period last year. In terms of gross profit, the trend is even more pronounced, with iPhone accounting for 81% of Apple's gross profit over the past two quarters, up from 68%. Much of this change is related to strong iPhone sales in China following the iPhone 6 and 6 Plus launch in addition to China Mobile beginning to sell the iPhone last year. It has gotten to the point that Apple's quarterly earnings reports should be renamed "iPhone sales updates" because no other part of Apple's business is able to impact the financial statements quite like iPhone.
Exhibits 1 and 2 highlight the iPhone's overall contribution to Apple's revenue and gross profit.
Exhibit 1: iPhone Revenue as Percent of Total Apple Revenue (Fiscal Year)
Exhibit 2: iPhone Gross Profit as Percent of Total Apple Gross Profit (Fiscal Year)
The iPhone's strong margins and short upgrade cycle contribute to the device's significant share of Apple's revenue and earnings as iPhone users are likely to upgrade their high-margin phones every two or three years.
One example of how important the iPhone is to Apple's earnings is a hypothetical scenario in which Apple missed iPhone unit sales quarterly expectations by 10%. Such a scenario wouldn't necessarily be too much of a stretch considering Samsung misjudged demand for the Samsung Galaxy S5 by 40% last year. If Apple missed iPhone sales expectations by 10%, or five million units, EPS would have fallen by 10%. If we then assumed iPad or Mac sales missed expectations by 10%, the resulting EPS impact would be a rounding error.
It is getting to the point that the iPad or Mac are nothing more than asterisks on Apple's quarterly earnings reports which is saying a lot given their influence and sales numbers. Even the pace of Apple's capital return program is starting to be controlled by the iPhone given the product's significant contribution to U.S. cash flow and consequentially available funds to spend on buyback and dividends. Over the course of eight years, the iPhone has earned more than $100 billion of cash for Apple, which has gone a long way in buying back shares and paying dividends.
iPhone's Importance to Apple's Business
From management's point of view, the iPhone's significant power presents both business opportunities and risks. The iPhone's success has given Apple a formidable presence in mobile in terms of market power and positioning. Across the world, the iPhone 6 and 6 Plus have helped Apple grow market share, with a total iPhone user base close to 500 million. This environment remains quite appealing to developers and third-party companies willing to invest in the iOS ecosystem.
Besides funding the capital return program, the cash flow produced from iPhone sales has also been used to help develop new products and initiatives. While iPod sales helped fund iPhone development, iPhone sales will help fund Apple Car development.
Nevertheless, very strong iPhone growth trends do present some risks. From Apple's point of view, it is in their best interest to keep the iPhone user base vibrant and engaged. Such efforts go a long way in preventing fragmentation or stagnation. Accordingly, a situation may arise in which Apple finds itself with such a large iPhone user base that a growing number of users do not upgrade to the latest OS version, weakening the iPhone ecosystem.
In iOS 9, Apple included a series of features to address and turn around slowing iOS adoption rates likely due to users not having enough iPhone storage. As one example, users will receive a pop-up when trying to install iOS 9 on a device with insufficient space and offer to temporarily delete apps in order to make room for the update. The deleted apps would be reinstalled once iOS 9 has been installed. In addition, app thinning, app slicing, on-demand resources, and bitcode are all designed to maintain the vibrant nature of the iPhone user base, especially those who may be using older models.
Another risk created with strong iPhone sales is the difficult part of needing to push the iPhone forward in terms of hardware or software design while facing a growing amount of pushback from users opposed to change. The theory here is that the larger the user base, the more heterogeneous the composition including variation in taste and desires. The end result may be that changes alienate a group of iPhone users. One example of this is Apple changing the iPhone dock connector. A software example is how iOS 7 brought a new look to everyone's iPhone. The fear of embracing change due to potential user pushback or revolt has led to disaster at other technology companies since the lack of change gave competitors room to offer a better product. Evidence would suggest Apple has no intention of following a similar path. Take a look at the newest Macbook for evidence of Apple not being afraid to push design forward even if it meant alienating some users.
One of the biggest risks that Apple faces from a strong iPhone is that the product's importance leads management to ignore other opportunities that may seem too small to matter and are unlikely to reach the iPhone's stature in terms of revenue and profit. In reality, it is those kinds of risks that need to be taken in order to be in a position to eventually ship a product that will one day surpass the iPhone in terms of importance. Once again, Apple seems to be aware of this risk as the Apple Watch certainly contains attributes that may one day lead to people being able to accomplish a good portion of their computing needs with just a device worn on their wrist.
Strengthening iPhone's Value Proposition
The next five years for Apple will likely focus on new products and services positioned to increase the iPhone's value proposition instead of become the next big thing that will eventually surpass the iPhone. On some level, that may sound like Apple is operating in a lower gear than it did in the 2005-2010 period, and in some ways that is true for the simple fact that it is incredibly difficult to ship a product that is more important than the iPhone within a few years of its birth. This dynamic raises some interesting questions including whether this is one reason for Jony Ive's promotion to Chief Design Officer, which frees him from day-to-day managerial duties and instead allows him to look at more strategic tasks in terms of Apple design. These tasks include adapting the company's retail infrastructure to embrace luxury wearables.
It is impossible to say Apple will never ship a product as important and profitable as the iPhone because "never" is quite a long time. Most consumers spend $600-$700 on an iPhone every two or three years which means there is plenty of opportunity to have people spend more money on new Apple products and services. However, over the next five years, the iPhone will remain the most important product that Apple sells, and it would seem that Apple wouldn't have it any other way.
One of Steve Jobs' quotes that has been displayed at Apple HQ sums up Apple's long-term plan with the iPhone really well: "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."
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