It was AAPL earnings week, and analysis of the company dominated both the tech scene and stratechery. What has struck me in the analysis is the almost total disconnect between Wall Street and the blogosphere, to the detriment of everyone trying to understand the company and its prospects.
Bloggers and industry observers are deeply familiar with Apple products, know they are highly differentiated by software and ecosystem, and thus cannot understand why anyone would doubt Apple’s continued success.
Wall Street and many financial analysts are deeply familiar with Apple’s financials and market opportunities, but don’t understand how to classify the company. This article from the Wall Street Journal captures this clearly.1
The end result is extreme bears on one side, counting the days until Apple collapses, and extreme bulls on the other, saving up links to the naysayers until they can say “I told you so.”
As with most things, the truth is somewhere in the middle. I explore this most clearly in Friday’s article “Two Bears,” but plan to revisit this more fully soon.
In separate, yet related news, the Galaxy S4 reviews came in this week, and were surprisingly negative. I don’t think that will make much of a difference, as I detail here, but it’s surprising nonetheless. The success – or not – of the S4 will be an interesting test of my thesis that product is not the preeminent factor for success in mobile.
It was another great week on stratechery. As always, I greatly appreciate your spreading the word about stratechery and following @stratechery.
Bear Argument #1 is the imminent collapse of the iPhone in the face of significantly lower-cost alternatives:
As the industry moves on from converting featurephone buyers to fighting for replacement purchases, what happens to value? Growth for any given manufacturer necessarily becomes a matter of taking sales away from other smartphone manufacturers, not featurephone manufacturers (i.e. Nokia). Moreover, Moore’s Law is at work, driving down prices; you can now get a 4.5″ dual core Android phone from Huawei for just $200, and one from a generic Chinese manufacturer for $120-$150.
This is clearly a challenge for any handset OEM, but especially for one at the high end. There are fewer and fewer new high-end buyers coming into the market and the ones you sold to in the past may increasingly be tempted by ever improving cheaper phones. So a high-end phone maker risks losing sales if it stays at the high-end, or losing margin if it makes cheaper phones, or both.
In case it isn’t obvious, this is the essence of the bear story for Apple.
Bear Argument #2
Bear Argument #2 is the end of growth for the iPhone:
Smartphones sales may be approaching saturation (especially in the USA), but iPhone sales at the end of 2012 were just 10% of global phone sales – and 17% of global contract sales, which is more relevant since it reflects the subsidised market (of course, the possible decline of subsidies is another, rather separate bear story for any handset sold for over $200).
Is 17% the total potential market for a premium phone? Will market share only move from $600 phones to $300 phones, and never the other way? That might be the case if phones were fungible commodities, but they clearly aren’t – otherwise $600 Android phones wouldn’t sell at all. It is entirely possible that the premium phone market is here to stay, and that it could expand significantly.
In this case, the iPhone has saturated the high end, and while current iPhone users replace their iPhones, their overall numbers don’t increase significantly.
iOS Browser Share Roughly Tracks Carrier ARPU — Click for original article
The largest remaining carrier without the iPhone – China Mobile – is solidly on the right side of that graph, along with most of the other high-growth countries. Apple may need to produce a lower-cost iPhone to compete, which will of course put significant pressure on their margins. It’s fair to ask if iPhone profit growth has peaked.
Only Bear Argument #2 Makes Sense
Bear Arguments #1 rests on the assumption that the iPhone is competing on hardware, and is therefore susceptible to lower-cost alternatives. However, the iPhone is not simply a device. Rather, it’s a ticket into an ecosystem (characterized here as the Mobile Hierarchy of Needs):
The Mobile Hierarchy of Needs – click image for original article
Of those surveyed, 91 percent of iPhone owners intend to buy another iPhone, while 6 percent plan to switch to an Android device with their next purchase. In other words, more than nine out of 10 iPhone owners are loyal to the platform. Once you buy an iPhone, chances are high you’re going to buy another.
That’s not quite as true for Android. Yankee found that 76 percent of Android owners intend to buy another Android phone. A big number, sure. But it means that 24 percent of Android phone users plan to switch to another platform. Guess where the majority of those professed switchers are going — 18 percent to iPhones.
Current iPhone customers aren’t going anywhere, even if Android continues to fall in price.
Almost all industries have two tenable positions: the differentiated high-end, and the low-cost low-end:
Sustainable Competitive Advantages
The iPhone faces little threat in the differentiated high-end of the market. Suggesting this market is limited in size is fair; counting the days until customers flee for cheap phones is silly.1
The Bear Argument for Samsung
That’s not to say that Bear Argument #1 is invalid; in fact, it’s the Bear Argument for Samsung.
There is precious little that differentiates high-end Android from low-end Android. The second, third, and fourth layers2 of the mobile hierarchy are identical; the difference is the hardware, and not only are low-end devices increasingly “good enough,” they’re also impossibly cheap.
Qualcomm and Spreadtrum Communications have both cut prices for their quad-core products to better compete against MediaTek, which controls half of the smartphone-chip market in China, according to industry sources.
Qualcomm recently quoted its quad-core solutions at less than US$10, slightly cheaper than MediaTek’s offerings, the sources indicated. Meanwhile, Spreadtrum has lowered its quad-core processor prices to similar levels. Both firms are trying to gain market share through aggressive pricing, the sources said.
Chinese OEM’s you’ve never heard of are making millions of smartphones using these chips. The largest of these is China Wireless. From Bloomberg:
China Wireless Technologies Ltd., the nation’s third-largest smartphone vendor, said it will eventually overtake market leaders Samsung Electronics Co. and Lenovo Group Ltd., helped by demand for low-cost phones.
A 50 percent surge in smartphone shipments will allow China Wireless to pass Lenovo for the No. 2 spot this year, while catching Samsung will take longer, Chief Financial Officer Jiang Chao said in a Bloomberg Television interview yesterday…
Total smartphone shipments in China will rise 44 percent to 300 million units this year, driven by handsets costing about 700 yuan ($113), researcher IDC forecast in December. Demand is surging as China Mobile Ltd., the world’s largest carrier by subscribers, aggressively encourages users of second-generation networks to upgrade to third-generation service with low- and middle-end smartphones. China Wireless, formed in 1993, has sold phones through China Mobile for a decade.
$10 chips, $113 dollar phones. No differentiation in software, apps, or services. Samsung actually sells most of their devices on the low end, but this low?
While the iPhone may have plateaued, it’s Samsung that should be worried about a cliff.
To be clear, from conversation, I don’t think Evans subscribes to this theory, but others do ↩
In fact, the fourth layer, especially in China, is very differentiated, but that is (mostly) to the benefit of users ↩
Apple, which has $145 billion of cash, said yesterday it plans to use debt to help finance a $100 billion capital reward for shareholders after a 42 percent stock plunge. Moody’s Investors Service and Standard & Poor’s responded by ranking the company a level below their top grades, with Gerald Granovsky of Moody’s citing “shifting consumer preferences” in a statement as a risk to Cupertino, California-based Apple’s business.
For the most part, I’m sympathetic to Wall Street’s concerns about Apple’s business (see Benedict Evan’s excellent write-up of the Apple bear case here). You can argue that Apple is a special case (I characterized it as a Black Swan) but history would suggest that Apple’s hyper-growth – and in simplistic terms, stock price is about expected growth – is probably over. All fair.
That said, credit ratings are about the stability of cash flow, not future growth. What the credit agencies are saying is that Apple is in a hits-driven hardware business and is at constant risk of customer defection to “The Next Big Thing.”
This justification for Apple’s credit rating belies a fundamental misunderstanding of technology generally and Apple specifically. Apple may make money on hardware, but “customer preference” is absolutely not driven by hardware alone. Technology is about ecosystems, and the winner is the platform that best meets consumers’ hierarchy of needs:
The Mobile Hierarchy of Needs – click image for original article
Hardware is a part of the hierarchy, but it’s a baseline (and the credit agencies are right that it’s not particularly sticky). Apple’s strength is in software and apps, and because of that their current customer base isn’t going anywhere. The inability for the credit agencies to comprehend this illuminates why they were so helpful in submarining the entire financial system.
One more quick aside:
“With consumer technology, whenever we think that this is the greatest product ever, you wait five to 10 years and that company is no longer at the top,” Granovsky of Moody’s said. “Triple-A is reserved to companies where we believe the business is highly stable.”
Microsoft has a AAA rating; it’s an interesting thought exercise to consider who is more likely to be in better shape in five to ten years (and before you dismiss Microsoft, Windows is only about a quarter of their revenue; they’ve diversified in a way Apple never will).
China Mobile announced a minuscule 0.3 percent profit growth over the first quarter of this year and a rather terrifying 2.98 percent drop in monthly average calling compared to the same period last year.
China Mobile is China’s biggest telecom and has been one of the country’s fastest-growing state-owned enterprises. But the numbers coming out of the company over the past few months have made it clear that it and China’s other major telecoms face a grave threat from new mobile apps like WeChat. We already knew that Chinese people were texting less than they used to, and now it seems they’re calling less as well. With barely any profit growth over the past quarter and uses of its traditional services falling, China Mobile will likely have to up what it charges for internet services like 3G just to keep from posting losses.
The presumption behind smartphone usage is that it leads to more browsing which leads to more network usage which in turn, leads to more network revenues and, finally, more network investment. If there is no additional browsing then there is a far smaller economic incentive to network operators to invest in infrastructure. It is this link between usage and revenues which I hypothesize drives operators to carry, subsidize and promote the iPhone. And the resilience of this link indicates that it still works.
The ASP data seems to support this hypothesis and so does the ARPU data. The more iOS is in relative use, the higher the network revenue per user. Correlation is not causation, but when combined with data about Android, we can also say that the presence of the primary iOS alternative does not lead to more revenue. In other words, if a lot of iOS is present then revenues are higher and if there is little iOS present then revenues are not higher.
There’s reason to believe Apple is willing to compromise more in China than one might expect. Perhaps China Mobile is increasingly willing to do the same. Few things would have a more immediate impact on AAPL’s near-term potential.
I don’t like holding this phone, and I can’t overstate how much that informs the experience of using it. It makes an awful first impression, slippery and slimy and simply unpleasant in your hand. My white review unit is completely smooth and glossy, with a subtle checkered pattern that looks textured but is neither grippy nor textured anywhere on its body. Even the silver band around the sides, which is obviously supposed to look like metal, is plastic. Everyone I showed the GS4 to frowned and wrinkled their nose as if it smelled bad, before rubbing their fingers on the back of the phone and then handing it back to me — that’s the opposite of the standard reaction to HTC’s One, which everyone wants to ogle and hold. That’s going to be a huge problem for Samsung, because the GS4 and One are likely to be next to each other on store shelves, and at least on first impression there’s absolutely no contest between the two.
I urge readers looking for a new Android smartphone to carefully consider the more polished-looking, and quite capable, HTC One, rather than defaulting to the latest Samsung.
So the S4 is a hodgepodge of features, wrapped in an unattractive case (which, it should be noted, allows for more features like a removable battery). And it won’t matter one bit.1
The S4 will mop the floor with the HTC One. In fact, I wrote exactly that in my first post:
The Samsung Galaxy 4 reviews should be rolling in shortly. They will recount the screen, processor, camera, face detection tech — every speed and feed there is will be dissected, discussed, and scored. Said features will be compared, first to the recently released HTC One, and most certainly to the iPhone 5. And most of it will have little to no use in explaining Samsung’s success. Speeds and feeds don’t matter in the mobile value chain.
The problem for HTC is that both Pierce and Mossberg make erroneous assumptions:
The HTC One and S4 won’t be next to each other on store shelves. Instead, the HTC One will be buried (as it already is – see the bottom picture here), and the S4 will have it’s own display stand (Samsung will pay).
The sort of person who reads this blog may “look for a new Android smartphone.” And, unfortunately, I don’t have that many readers…
To put it another way, if someone prioritizes design, they’ll likely buy an iPhone; if they prioritize features, they’ll buy an S4. And if they have no idea, overwhelming marketing and Samsung-incentivized salespeople will make the choice for them.
It is exceedingly rare for any mobile device to succeed based purely on product.2 The iPhone is one. I doubt there is room for another.3
Apple has shown less public interest in plowing money into projects far outside of their core expertise than some tech giants, in particular Google with its efforts to create driverless cars.1 So Apple’s stock price is essentially a minute-by-minute referendum on the ability of the company to find some big new thing that will drive profits over the coming years. At its current price of around $400 a share, investors are betting that the answer is “no,” that while Apple will still make plenty of money from making iPhones, Macs, and other products to come, there will be no explosive growth out of the company based on the new new thing…
Innovation is a curious thing. While of course it takes armies of engineers and programmers to make a product like the iPhone work, it was paired with the singular vision of a Steve Jobs to corral the work of those engineers into a product that transformed how people live their lives. The market’s pessimism about Apple’s future profitability is a bet that true, world-changing innovations like the ones that have the company wildly profitable in the last decade don’t come around every couple of years, and are more rooted in the brain of one exceptional individual rather than in the organization he created and led.
Apple’s string of success is effectively impossible. Yet it happened. They are a black swan.
Look at Taleb’s criteria:
It is an outlier — check
It carries an extreme impact — check
It is explained after the fact — in the case of Apple, the explanation is Steve Jobs. He was a genius, and now he is gone
And so, AAPL continues its downward descent; it was great to ride it on the upside, but now that Apple is a normal company, the probability of another hit are so remote, it’s best to assume it simply won’t happen.
This is the disconnect many of us in the blogosphere have with Wall Street. We actually believe that design matters, that taste is objective, and that culture can be developed. And, by definition, none of these can be measured or quantified — or modeled.
Throw aside all the talk of saturation, addressable markets, margins, etc. The fundamental question dividing bulls and bears is remarkably subjective:
Did Steve Jobs build an innovative company, or a company around his innovations?
“Driverless cars as stock price driver.” Interesting. Plausible. ↩
The presumption behind smartphone usage is that it leads to more browsing which leads to more network usage which in turn, leads to more network revenues and, finally, more network investment. If there is no additional browsing then there is a far smaller economic incentive to network operators to invest in infrastructure. It is this link between usage and revenues which I hypothesize drives operators to carry, subsidize and promote the iPhone. And the resilience of this link indicates that it still works.
The ASP data seems to support this hypothesis and so does the ARPU data. The more iOS is in relative use, the higher the network revenue per user. Correlation is not causation, but when combined with data about Android, we can also say that the presence of the primary iOS alternative does not lead to more revenue. In other words, if a lot of iOS is present then revenues are higher and if there is little iOS present then revenues are not higher.
This is true as far as it goes – critical, in fact – but I find it unsatisfying as a complete explanation for carrier behavior with regards to the iPhone.
Take three quick examples: Verizon, NTT DoCoMo, and China Mobile. If the iPhone as “Premium Network Services Salesman” is the only explanatory factor,2 then all three should have been clamoring for the iPhone from Day One. Yet Verizon resisted for years, and NTT DoCoMo and China Mobile have yet to give in. In fact, the iPhone has generally launched on the 2nd or 3rd-place carrier in any given geography.
My hypothesis is as follows:
The carriers see the iPhone as a strategic threat because Apple owns the customer relationship; the carrier is reduced to a utility. Therefore the leading carriers do not carry the iPhone
Customers strongly prefer the iPhone; in fact, they prefer it so much that they switch carriers to get the iPhone (something that is very difficult and rare). Second-and-third place carriers add the iPhone in order to steal customers from the leader
The leading carrier is forced to choose between losing the customer relationship to Apple or losing the customer completely
The fact that iPhone users are fabulously profitable makes this situation (and the associated subsidies) tolerable.
To put it in theoretical terms, the Bargaining Power of Buyers (i.e. wireless consumers) drives iPhone carrier adoption:
In 2010, Verizon acceded to the iPhone because customers were leaving for AT&T — Ben Thompson
In this view, instead of carriers hiring the iPhone to attract high use/high revenue wireless buyers, the lack of iPhone repels wireless buyers and drives them to rival carriers, forcing the holdouts to give in to Apple’s demands.
UPDATE: Unsurprisingly, Dediu himself best made this case with respect to Verizon back in 2010. Worth a re-read.
I find this very illuminative. If we assume ARPU is a good proxy for subsidization, then this strongly supports the idea that the iPhone is highly competitive1 versus Android in subsidized markets (the left side), but is simply too expensive in non-subsidized markets (the right side).
The right side of this chart is the visual case for a low-cost iPhone.
In fact, the iPhone mostly wins on the left; the trend line is dragged down by the right ↩
The world of technology often seems all-encompassing, occupying all of one’s time and attention. But not this week. A bombing at a marathon. An industrial explosion that devastated a town. Poison in the mail. A city deserted. Another devastating earthquake in China.
At the risk of being crass, the real world news was useful perspective for a tech industry that didn’t have the best week either. AAPL plummeted on discouraging supplier earnings, and multiple earnings reports missed. As the industry becomes increasingly consumer-driven, it also becomes increasingly seasonal. No one expects retailers to have good first quarters; should we expect anything different from tech companies?
It was a good week on stratechery, and I appreciate the support shown by for several of the articles written this week. As always, I greatly appreciate your spreading the word about stratechery and following @stratechery.
App Annie posted their quarterly app report this week, and there were three big-picture trends that jumped out at me.
1. Google Play is getting over the monetization hump, and it’s likely due to in-app purchase
From the report:
Over the past quarter, Google Play has achieved higher growth rates than the iOS App Store for both downloads and revenues. While Google Play reached close to 90% of the iOS App Store downloads in Q1 2013, the iOS App Store maintained its strong lead in monetization, earning about 2.6x the app revenue of Google Play. In comparison, the multiple was roughly 4x for Q4 2012 overall.
The iOS lead may still be strong, but 4x to 2.6x is a pretty substantial decrease. Unsurprisingly, most of that revenue growth comes from games.
Games remained the leading growth driver, even more so for revenue. By Q1 2013, the category had grown to cover approximately 70% of revenue in the iOS App Store and 80% in Google Play.
I think Play is closing the gap because of in-app purchase.
Over the last year in-app purchase has become the preferred app store business model, especially for games. This makes sense: it’s much easier to spend money on something you are already engrossed in than it is to spend on an unknown quantity. The small-picture consequence is that free games with in-app purchases dominate the top-grossing charts in both stores. A bigger result, from a strategic standpoint, is that in-app purchase seems to be solving the Play Store’s attach problem.
One of Apple (and Amazon’s) biggest advantages is their huge base of attached wallets. It is so much easier – and thus, so much more likely – for customers to simply enter a password to make a purchase than it is to find their credit card and enter their information, especially when free apps are widely available.
The lack of credit card attach was a significant factor in the Play Store’s poor monetization record, and I don’t think it’s an accident that the rise of in-app purchase as a monetization model is correlated with the Play Store making significant gains in revenue vis a vis the iOS app store. The incentives for in-app purchases are so powerful that it overcomes the attach challenge. Users will go to the trouble of adding a credit card if they are already committed and invested in a game. They did it for Facebook games, and now they’re doing it for Google Play. And, you only need to get over the attachment hump once.
This is a significant development.
2. Google Play is not very sticky
While Play is monetizing significantly better, the vast majority of that spending is going towards games – 80%, as opposed to 70% for iOS.
That’s fine as far as it goes, and it may increase the incentives for games developers to build for Android sooner, but I don’t know that it is making Android users more loyal to the platform.
The idea that software purchased for a particular platform raises switching costs is an old one; it was certainly a factor in Windows dominance. However, I don’t think that all apps are created equal. Games are much more “faddish”, for lack of a better word. Users engage in them very deeply for a short period of time, and then move on to the next title. They are unlikely to return to an old game, or even notice when it’s gone.
This means that when users are considering a new phone, they’re unlikely to be swayed by the number of games they have purchased for their current platform. Thus, given that most of the purchases on Play are games, I would argue that Android is not achieving much lock-in, despite the increase in revenue.
On iOS, on the other hand, only 70% of revenue is from games, and both productivity and education are in the top 4. Productivity and education both feature higher-priced apps that are more likely to be used for an extended amount of time. They are the sorts of apps that quickly become indispensable: think of your favorite to-do, sketching, or calendar app.
These types of apps are much “stickier” and significantly increase switching costs.
They are more expensive
The user experience is much more important to the app, and much more dependent on the underlying OS
The best productivity apps are often made by individual or boutique developers, and thus less likely to be cross-platform
They are much more ingrained in every day life, meaning the thought of going without your favorite productivity app is much more disconcerting than going without the flavor of the day in gaming
iOS clearly has a significant revenue advantage in these types of “sticky” apps, and there is little sign of this advantage decreasing, especially as apps like Mailbox continue to launch on iOS first.
3. Some observations on markets
The country rankings are of particular interest:
iOS Downloads
iOS Revenue
Play Downloads
Play Revenue
1
U.S.
U.S.
U.S.
Japan
2
China
Japan
South Korea
South Korea
3
U.K.
U.K.
India
U.S.
4
Japan
China
Russia
U.K.
5
France
Australia
Russia
Germany
A few observations:
Much has been written about Google’s China problem. There, Android is dominant but is sold as the base layer with a plethora of Chinese services on top; Google services are nowhere to be found. And so we see in these rankings: for Play, China is nowhere to be found.
For iOS on the other hand, China is impressively strong (and growing). This gives further credence to the idea that China Mobile is the single greatest opportunity for iPhone growth.
Japan is strong for both stores; the iPhone’s second greatest opportunity for growth is NTT Docomo.
Samsung has an incredible home court advantage in South Korea.
India is very high for Play; it’s increasingly difficult to understand Cook’s dismissal of the country, although the complete absence of carrier subsidization surely played a part. It’s a poster child for the “Apple needs a low-cost iPhone” idea.
Android’s customer base in the U.S. is clearly inferior to the iPhone when it comes to monetization. This jibes with data showing little cyclicality in Android purchases. US Smart Sales – Benedict Evans
It seems increasingly clear that Android purchases are people who need a cell phone, go to their carrier, and pick out what appeals to them (or is pushed on them). They may download some games, but that’s about it.
iPhone users, on the hand, want the iPhone, and are highly driven by launch dates and seasonality. They are much more likely to see the iPhone as a central object and invest accordingly, both in time spent on the device as well as money spent in the app store.
It’s not surprising the U.S. is unique: the carrier subsidization model means an iPhone is cost-competitive to Android. Probably the single biggest question for iPhone growth (beyond the distribution deals noted earlier) is:
Will Apple make a low-cost iPhone?
Will customer response to a low-cost iPhone in the rest of the world mirror customers in the U.S.?
