Why I think Apple wants everybody to have an iPhone

In recent entries I asked: Can the iPhone reach 10% of the world’s 3G subscribers? and  Can iPhone reach 20% of global smartphone market?

These were rhetorical questions designed to demonstrate that a growth rate of 50% (compounded) over three years was clearly possible through reduction to absurdity of alternative scenarios.

The question of iPhone as iPod vs. iPhone as Mac businesses is at the crux of any investment in Apple today and the key strategic question facing Apple and all its competitors.  Anyone holding or considering buying AAPL shares should answer this question for themselves.

To the top-down market share scenarios above I add the following, more direct, signals Apple has made regarding their iPhone-for-all strategy:

  1. The fact that they entered the market at all.  When they were building iPods, Apple came to understand that to be a device company means to be a phone company.  The device business is much more sensitive to volume (i.e. economies of scale) than the PC business. Nokia proves this point every day.  You can’t be in the device business with low volumes and stay profitable for long. This is because you can’t get component pricing low enough to sustain margins that can afford you R&D sufficient to differentiate your product.  Therefore you cannot stay in the phone business with low volumes (see Palm).
  2. Apple repeatedly signaled that they will not permit a pricing umbrella for their products.  Although the product seems priced highly now it’s only because that’s what the market can bear and because of the possibility of taking a cut from service revenues.  The iPhone is not as expensive as it might seem relative to other smartphones, it just has a huge gross margin (50% at least).  Apple can keep their costs low through volume but they can also tweak pricing down if they need to.
  3. The platform approach.  Apple is putting in an enormous effort to orchestrating a mobile platform.  This is the most obvious signal.  Platforms are expensive to build. If the cost to build a mobile phone is x, the cost to build a mobile platform is 10x.  Platforms are expensive to maintain but generate enormous rents if volumes are built and users are retained.  The platform’s value grows as the n*log(n) of the number of users (Metcalfe’s law).
  • capablanca


    Could you please restate the question. I don’t understand your meaning, particularly your use of the “vs.”. Thanks.

    • Rephrasing the question: Is the iPhone going to be as important to the MP3 market as the iPod or as important to the PC market as the Mac?

      Or another way: Is the iPhone defining a market (the mobile computing market) and dominating it, or is the iPhone defining a market but ceding the volume and hence the bulk of profits to others?

      I could also frame is a question about iOS: Is iOS the market share leader in mobile computing (and hence of all computing) or is iOS a proof of concept to be implemented for the mass market by another company thus capturing the profits from the paradigm shift to the post-PC world?

      I consider these three questions to be analogous.

      • capablanca

        Yes, they are analogous. And combined they are strategically critical to Apple and all other companies in this space, as you point out.

        There are several reasons that point toward the iPod case and away from Mac. The PC owed much of its adoption to the name IBM being placed upon it. Until then, there was little confidence in any alternative of whatever OS. And consumers were not significant in the market until the war was all but over. It was corporate purchases that gave PC the market share to spur the avalanche of applications. There was likewise no practical means of distributing applications except for physical media. Prices for applications were measured in the hundreds of dollars and higher. Today distribution is a whole new world. First the internet and then iTunes made it so. IOS Apps enjoy iPod-like distribution.

        Cloud vs. device residence of apps will be an important battleground.

        I don't suggest the answer is in, but I do suggest that it is a different game in 2010 than in 1983. Another important thing to remember is that SJ was there; he knows the key elements of the respective models; and he has proven himself an astute businessman. Cook is no dummy either.

  • Adam

    I think you mean "Is the iPhone going to be as important to the mobile computing market as the iPod is to the MP3 market, or as the Mac is the PC market?" Or as might appear in the analogy section of an SAT test:

    iPhone will be to mobile computing as:
    a) iPod is to the MP3 market
    b) Mac is to the PC market

    Reading between the lines it's clear you believe the answer could quite possibly be a). I agree, insofar as it's at least plausible enough to be worth some serious consideration. But why don't I ever read any analysis of what the implications of this would be? I think people on both sides of the fence are afraid to look at this possibility, because it seems so outrageous.

    I'd love it if you would do a financial analysis of what this would mean for Apple. With 70% of the world's mobile device market, assuming a ~15 PE ratio, what would the numbers be (revenue, net income, market cap, stock price)?

    • I maintain a model that makes it possible to calculate the impact. It's currently using a 50% growth rate for the iPhone through 2013. This growth rate results in the 20% share of smartphones and 3 to 4 percent share of all phones. The assumptions for Mac and iPod growth are conservative (+15%, -8% respectively) but for the iPad they are aggressive (+100% growth).

      I am reducing the ASP for the iPhone to $350 and of the Mac to $1000 and the iPhone remains constant.

      This gives a share price of $464 by end of 2013 at 15x P/E (and $619 with 20x P/E).

  • Adam

    Well, then I guess I was wrong. You're expecting the iPhone to have a more Mac-like share of the market than iPod-like.

    • That is my current assumption for the 2013 time frame. Given another few years and a more aggressive price or portfolio, and the impact will be much more. Disruptions take time. They are devastating in their outcomes but almost imperceptible while under way. This industry is so big (in unit terms, there is no bigger) that I expect at least 10 years for an entrant to reach the status of share of an incumbent (40%).

    • Tom Ross

      Adam: That really depends on the market you’re looking at. Apple is hovering around 10 % market share in many developed countries right now.

  • Adam

    Why is it so crucial that Apple investors answer the Mac-like vs. iPod-like question then? Apple doesn’t need to reach anywhere close to an iPod-like share to give its investors returns that are way beyond the market average.

    I think this all could be answered more quickly than you think. Platform shifts tend to reach an inflection point after which transformation happens rapidly. That’s why Apple and Google are in such a desperate land-grab right now. They both know that if the other reaches a critical threshold, the game will be more or less over. Numbers generate momentum, which generates MORE numbers, which generate MORE momentum, etc. etc., before there’s no stopping it. This is what happened in the case of both Windows and iPod. It happens fast once the inflection point is reached. Maybe it will be slower in mobile devices due to sheer numbers, but 10 years to reach 40% seems like a long time.

    • Tom Ross

      "This is what happened in the case of both Windows and iPod."

      I don't think the Windows example is correct. Windows was merely parlayed on the existing 90 % market that MS-DOS had. MS-DOS won 30 % of the PC/home computer market in its first year, not by its own merits but by virtue of IBM already dominating corporate IT. Microsoft's operating systems never grew from zero on their own, like the iPod or Android.

      To your main point I don't have an opinion, I like to just watch and hope that quality wins. I would like to point out though that both as a hardware manufacturer and vendor Apple has certain limits of growth. They probably could not triple their iPhone sales within a year because it would overburden their stores and support, and lead to component shortages (which, by the way, have already depressed the iPad launch and are depressing the iPhone 4 launch right now) and generally risks of over- or undersupplying which can cost billions.

      Android can just fish from the existing pool of 200 million phones that Google's partners are already shipping every quarter. Google had no growing pains whatsoever as Android grew from 1 million to 10 million shipped per quarter within 9 months. That's why, in theory, Apple has immediately lost once Android quality is up to par. If Samsung & Co. went all in on Android there could be 50 or 75 million Android phones shipped in Q4 2010. I just happen to believe that quality is not up to par and, crucially, consumers are not asking for Android. The momentum is only with carriers and manufacturers, and that's not a virtuous circle.

      • Adam

        You make a good point. I guess there is an upper limit to how much they really can grow a year. It was amazing, though, to watch the iPod growth curve from 2004 to 2006 — 800k units/quarter to 14 million in just 6 quarters. I wonder how much of a problem this really is. Customer support staff can be expanded extremely rapidly these days with all the outsourcing companies out there. Stores, not so much, but that's a pretty good problem to have and won't stop people from buying iPhones.

        As to components, I believe the free market will step up and deliver if the money is there. These components are commodities at this point. If one company can't make enough, another will. There may be times where there are shortages, but this imbalance will correct itself relatively quickly, and is due to not-enough-ordered rather than lack of raw materials or capacity. How else is Nokia shipping 400 million phones a year or whatever it is? These manufactures of course don't want to over-manufacture and cause a glut in the market, but neither do they want to under-manufacture. If payment is guaranteed, they will deliver, much as what happened when Apple pre-paid for flash memory for iPods a few years ago. This is where having $40 billion in the bank and Tim Cook running operations comes in handy. I would be surprised if Apple DIDN'T announce another pre-payment deal for components in the next year. If they suddenly get 50 million orders when they expected 10 then of course there are going to be delays, but only for a quarter or two until the manufacturers, buttressed by the cold, hard cash Apple has deposited into their bank accounts, step up their operations.

        But your point about how this is a non-issue for Android is a good one — it's a big advantage Android has. It's a double-edged sword, though, because no single Android vendor is going to have nearly the volumes, and therefore pricing power of Apple. Now if Nokia suddenly switched to Android…

      • Indeed, if Android's business model is valid then so would Windows Mobile have been and so will Windows Phone be. These alternatives are all assuming that iPhone over-serves–i.e. is more than good enough and their non-integrated approach is good enough in experience but better in scalability. In other words their good enough alternatives will win with better distribution. However, saying the mobile computing market is good enough today implies that it cannot get better in meaningful ways. We can test this thesis: the way you measure good enough is with usage. If users are neither willing to pay for new features, nor using them then you can say the market is overshot.

        I think quite the contrary is happening. Every iPhone version is better in meaningful ways and new features are relished by users and they are clamoring for more. Thus, iPhone as a complete, integrated product, is still not yet good enough to be disrupted by modular component-oriented or horizontal players.

  • Rou

    Subsidized phones make a huge difference.

    When Steve Jobs one more thinged the iPod Mini in 2004 he divided up the US market as 30% Apple, 30% low end Flash memory, 30% high end Flash memory and said Apple is going after the 30% high end Flash.
    2005 for the shuffle he showed the graph again and showed that they'd double their marketshare in a year to 65% and were going after the low end Flash.

    However, this time, there is no chain to go down, at least in pricing. All smartphone competitors are equally expensive due to the subsidy.
    Looking forwards though, I'm expecting Apple to at least be ready to make the move in case of operator revolt or competitors start a race to the bottom and the market segments itself.

    4×3 icons always landscape iPhone is a doable if they're going for a cheaper (smaller screen) iOS device. Size of the circuitry is not a problem at all.
    Also, when the iPods negative vector escalates I expect them to become dumbphones sold to operators and leverage their relationship with them.

    • Apple has almost every lever of control at their disposal right now. A typical company would try every option and broaden their reach. In contrast, I think Apple is being very structured in their approach. They are making deliberate chess moves.

      • Tom Ross

        Exactly, but it's nothing short of nerve-racking. 😉