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Category Industry

(Much) Bigger than Hollywood

Eddy Cue seems like a nice guy. I can’t say that for sure as I’ve never met him, but he seems to be amiable enough. Maybe it’s because he has a seat on Ferrari’s board of directors. Maybe it’s because he enjoys dancing.

Or maybe it’s because he’s in charge of the only real “division” at Apple. All the other senior managers have functional roles. Eddy has a bona-fide business unit called Services.

Services is Apple’s division of many things. It has the iTunes stores (Music, Video, Apps and iBooks). It has Software with consumer bundles like iWork and iLife and Pro tools like Aperture, Final Cut Pro and Logic Pro. It still has OS X as a product, though revenues are pretty low as updates are now free. It also includes Services with iCloud, Apple Music and Applecare.

These things are not iPhones or iPads but they are many and all together they form a modest little unit. I say modest because not much is said about it. When seen in contrast to the other Apple product lines, it’s hard to be impressed. In the graph below it’s the purple area.

Screen Shot 2015-08-25 at 5.56.19 PM

Apple does not help much. Occasionally  Apple offers updates on iTunes/Services using various (rarely the same) metrics. For example, in early August, Eddy Cue offered an update during an interview with USA Today on Apple Music relating how many users there were one month after the service started (11 million).  It was worth a few headlines.

However he also noted in passing that the App store did $1.7 billion in transactions during July. If you convert that to a yearly run-rate it comes out to about $20 billion/yr. Digging through previous announcements, the equivalent figure for 2014 was about $13.7 billion. Nice growth.

But is $20 billion of “transactions” of any significance?

The Alphabet of Google A and Google B

For the last few years, I’ve been proposing that the way to conceptualize Google is as two separate entities: Google A and Google B.

Roughly speaking Google A was the R&D[1] organization and Google B was SG&A[2]. You can find the operating expenses of running each of these organizations in the company’s income statement.  In the last quarter R&D was about $2.8 billion and SG&A was about $3.5 billion[3]. The two entities are further distinguished as follows:

  • Google A was led by Eric Schmidt and Larry Page and Google B was led by persons unknown, but mostly represented by the “Chief Business Officer” Omid Kordestani.
  • Google A spends money. Google B collects money.
  • Google B sends a check to Google A while Google A sends data to Google B (which then sells it on to advertisers and collects money).
  • Google A communicates frequently with optimism and enthusiasm about the future. Google B remains quiet.
  • Google A solves problems of humanity, Google B solves problems for advertisers.
  • Google A has users, Google B has customers (to whom it sells users.)

In summary, Google A is altruistic, Google B is pragmatic. Google A engages in research, Google B engages in commerce. Google A operates in a structure similar to a Bell Labs for the good of humanity[4],  Google B operates in a structure similar to AT&T and collects monopoly rents but without any government oversight.

This was an effective construct for analysis which explained to me much of how Google operated and how it made decisions. So what do we make of Google’s new Alphabet? Is this a dissolution of the Google B/Google A dichotomy?

My initial answer is no. We don’t have a change in this core structure. What we have instead is a split of Google A into Google A and Google A+.

A+ is the crème de la crème of the altruistic Google A. It’s the stuff that really does not make money. It’s the laboratory of Bell laboratories. It’s the moonshot manufacturer. It’s the incubator where hobbies are hatched. It’s the funder of ventures.

After A+ is carved out, Google A and Google B remain exactly as they were, now under a new CEO. The previous CEO no longer has any day-to-day input in the running of Google A and is no longer soiled by association with Google B.

Alphabet is therefore the “holding company” of Google A+, Google A and Google B. I can only suppose that the separation of A+ from A (and the previous A from B) allows the founders to distance themselves even further from the purchase decisions which, through pricing signals, determine where value lies and how resources should be allocated. That must be a great relief.

Notes:
  1. Research and Development []
  2. Sales, General and Administrative []
  3. Sales and marketing was $2.1 billion and General and Administrative was $1.5 billion []
  4. Using a definition of Good as established by the founder []

Samsung’s profit center

Will there come a time when Samsung will earn more profits from the iPhone franchise than from its own Galaxy product line?

The problem for Samsung is that although it still sells the most phones[1], and the most smartphones, the price and margins for these products are collapsing. The pattern is shown in the graphs below:

Screen Shot 2015-07-30 at 7-30-8.20.29 PM

Screen Shot 2015-07-30 at 7-30-8.20.22 PM

Notes:
  1. over 80 million but we don’t have a precise figure []

How iPad Educates

The fact that the iPhone is contributing over 90% of the operating profits in mobile phone sales has penetrated even as far as the Wall Street Journal. However, it’s not yet commonly known that the Mac captures a majority of personal computer operating profits, at least when considering the sale of hardware.

My calculations suggest at least 60% of operating margin in personal computing hardware is captured by Apple. This is mainly due to the fact that the average Mac sells for more than $1200 while the average PC sells for less than $450.That is equivalent to $1.5 billion per quarter for Apple vs. $930 million for all the other PC makers combined.

Screen Shot 2015-07-17 at 12.16.27 PM

If we are to consider the iPad as a “PC equivalent” computer[1] then another $billion/quarter is contributed to the profit pool. It increases Apple’s share of profits to 73%. As a result, Apple absolutely dominates computing profits.

Notes:
  1. for a substantial minority of tasks []

Apple management answers questions on the market performance of Apple Watch

Katy Huberty (Analyst – Morgan Stanley): You’ve said in the past that the watch may take longer to ramp given the new category and new interface to customers. Is that, in fact, playing out? Is the watch ramping slower than past product categories?

Tim Cook (CEO): Katy, when you use the word ramp, do you mean from a — I assume you’re talking about supply?

Katy Huberty (Analyst – Morgan Stanley): Yes. Pre-orders and first week in sales and any other data points that you track in terms of interest versus, say, when the iPad launched in 2010?

Tim Cook (CEO): Let me talk about supply and demand and sort of separate those two. Right now demand is greater than supply. And so we are working hard to remedy that.[1]

We’ve made progress over the last week or so and we’re able to deliver more customers an Apple Watch over the weekend than we had initially anticipated. We’re going to keep doing that. […] So I’m generally happy that the — that we’re moving on with the ramp.

It is a new product for us, and with any kind of new product, you wind up taking some time to fully ramp.

Having said that, I think we’re in a good position. And by some time in late June, we currently anticipate being in a position that we could begin to sell the Apple Watch in additional countries. And so that’s our current plan.[2]

From a demand point of view, it’s hard to gauge when you don’t have product in stores and so forth. And so we’re filling orders completely online at the moment.

The customer response from people that have gotten theirs over the weekend have been overwhelmingly positive. And we’re far ahead of where we expected to be from an application point of view.

To give you a comparison, when we launched the iPhone we had about 500 apps that were ready. When we launched iPad, we had about 1,000. And so our internal goal was to be able to beat the 1,000 level and we felt — we thought it would be great if we were able to do that by a little bit.

And as I’ve mentioned before, we now have over 3,500 apps in the App Store for the Watch. And so we couldn’t be happier about how things are going from that point of view.

We are learning quickly about customer preferences between the different configurations. There’s a much larger breadth of possibilities here for customers than in our other products. And in some cases, we called that well and some cases we’re making adjustments to get in line with demand.

But I’m really confident that this is something we really understand how to do and will do. And so I’m really happy where we are currently and happy enough that we’re looking forward to expanding into more countries in late June.

[…]

Gene Munster (Analyst – Piper Jaffray and Co.):  …question for Luca, in terms of any thoughts on what the margin impact from the Watch as that ramps over the next couple of years?

Luca Maestri (CFO): Apple Watch is, not only a new product, but it’s a brand new category with a lot of new features, a lot of new innovative technologies. And Apple Watch margins will be lower than the Company average.

[…]

Toni Sacconaghi (Analyst – Bernstein): I just wanted to revisit the watch.

Tim, I think you said when you were talking about your new products, you said we’re, quote, very happy with the reception. And in response to a previous answer you said, relative to demand, it’s hard to gauge with no product in the stores.

I would say relative to other product launches where your commentary around demand was characterized by superlative after superlative, that assessment feels very modest. And part of the reason that I ask is, A, are we reading you right in terms of that? But if we look at consensus, consensus is expecting that Apple will ship more watches in its first two quarters than it did iPads, despite, as you said, very limited distribution in terms of only selling through your stores.

So I’m wondering if you can talk a little bit about putting those demand comments in context, given that they do seem different from how you’ve characterized product demand for other products. And how, if at all, we should think about the modeling demand in the context perhaps of the iPad, which was your most recent significant new category? And then I have a follow-up, please.

Tim Cook (CEO): I’m thrilled with it, Toni. So I don’t want you to read anything I’m saying any way other than that. So I’m not sure how to say that any clearer than that.

And in any situation, whether it’s the watch or in the past on iPad or on iPhone, when demand is much greater than supply, it’s difficult to gauge exactly what it is. And so, as you know, we don’t make long term forecasts on here. We maybe forecasts for the current quarter. And so I don’t want to make any comment about the consensus numbers.

Honestly, I haven’t even studied those. We’ve got enough to think about here.

I feel really great about it. The customer response, literally from what I’ve seen, is close to 100% positive. And so it’s hard to imagine it being better.

——-

Excerpts from Apple Earnings Report: Q2 2015 Conference Call Transcript, April 27, 2015.

Notes:
  1. This is still true today, three months later []
  2. This has been achieved according to plan. []

Selling Watch Sales Data

There is no reliable information on Apple Watch sales. None of the analysts which follow Apple or the phone, computer or watch markets have any insight into this. The only source of information is Apple itself and they have made it clear that they don’t intend to provide watch sales data for competitive reasons. I did not and do not expect any information from Apple on watch sales. They have placed the product within the “Other” category specifically to make unit data hard to discern and have explained why they do so.

The only estimate we have heard of is from a company that has no track record in market research and relies entirely on sampling of email receipts. I urge extreme caution when dealing with this type of data. We don’t know how representative these receipts are and how they are sourced or sampled. The methodology is not only unclear but it’s one not practiced by any other analyst. You would think that receipt sampling would be a phenomenal source of information about a lot of other products and yet we hear nothing about how predictive it is for anything except this particular new product as claimed by a company which never made any such prior claims.

It’s also a sampling of (presumably) US-only customers at a time when the product is undergoing a gradual roll-out through multiple countries and multiple channels. Consider that if sales were constrained internationally then buyers would be trying to arbitrage through the US market, meaning there would be many e.g. Chinese buyers/brokers booking sales through US online stores inflating that channel’s initial volumes. Furthermore as physical retail stores begin to receive stock, online sales (which are what is sampled) should decline as buyers opt for the instant gratification (and the option to see the product in real life.) To see US-only online purchases drop after a period of pent-up demand and as store inventory becomes available is not interesting and says almost nothing about the product’s performance.

The only way to be thoughtful about this new category is to understand the broad transitions underway in mobile computing. We are witnessing a pivot in human-computer interaction as significant as the initial iPhone launch.

[As a rule, be very careful with the premise of data salesmanship. All data is false, some is useful. Data you have to pay for is less useful than data that has been peer reviewed.]

iOS v. Windows and Immunity to Disruption

The pattern of Mac growth exceeding Windows PC growth (and overall PC growth which includes the Mac) is old news. It has been observed for at least 40 of the last 42 quarters.

Screen Shot 2015-07-10 at 12.47.04 PM

It’s a historically interesting contest, but the story of computing has moved on.  Starting with building computing, via floor computing, office computing and then to desktop computing and portable computing we are now in the era of mobile computing.[1]. The problem with observing mobility in general is that there are too many mobile computing options. Phones have a wide range of capabilities, tablets and various other form factors are positioned on differing jobs-to-be-done. Platforms and services are also scattered around jobs which have been carved from fixed computing or have been established with no fixed precedent.

So can we pinpoint with any accuracy the moment when the tipping point has been reached? We could point to all mobile phone shipments, or even the vaguely-defined smartphone shipments compared to all PC shipments. We could look at tablets alone. If we could get accurate measurements.

One measurement could be to look at operating systems alone. When comparing iOS shipments (iPhone, iPad and iPod touch) to Windows we can see that combined iOS shipments exceed all Windows PC shipments for all three previous quarters.

Notes:
  1. And as sure as the sun will rise tomorrow we will move beyond mobile computing []

What next for iPad?

ComScore suggests that there are 100 million tablet owners in the US. On a per capita basis that implies penetration of about 30%. As a percent of mobile phone subscribers (above age of 13) that implies 40%. As a percent of smartphone users that implies 43%. As a percent of iPhone users that represents 47%. As a percent of households assuming one device per household that implies 85% penetration. By another measure (Pew) household penetration is around 50%.

Regardless of the difficulty in defining what is the correct “addressable market”, the more important question is whether tablets will be an ubiquitous object. Perhaps what we are seeing in the US is something similar to the MP3 player market or video game console markets where penetration saturated at around 50%. Perhaps tablets will reach PC levels which are closer to 80% of population or perhaps they will reach phone levels which are above 90%. The reason we can’t answer the question of ubiquity easily is because competing solutions can carve the usage out of a category “disrupting” it with alternatives.

The idea that jobs are the segments into which products fit and not demographics or product attributes is key to understanding this migration. The reason phones have subsumed more jobs onto themselves is because they have a rapid rate of evolution and because they have larger scale of economy and because they are conformable to our life spaces. As phones get better they take on more jobs and some of those jobs are those of tablets. The MP3 did not become ubiquitous because the phone took its job. Same for the video game and same perhaps for the PC and tablet.

Where are Maps going?

At the 2015 WWDC Apple stated that it receives 5 billion requests per week for its maps service. It also said that Apple maps is used 3.5 times more frequently than “the next leading maps app.”

These two data points are the total number of data points we have about the global maps market. Neither Google nor Nokia provide usage or share or performance data. Regardless, commentary on the usage, share and performance of Apple Maps has been abundant for the three years since its inception.

The data presented allows us to make a few estimates for the first time and we can hope that additional data can allow a picture to emerge of where maps are going.

With these first two data points we can finally make some estimates. But some assumptions are still needed: We need to assume that the “next leading maps app” is Google Maps. Although there are other maps apps on the iOS platform they are probably insignificant and it’s a two-horse race between Google and Apple on iOS.

This means that the 3.5:1 split in usage results in a 78% share for Apple Maps and a 22% share for Google. If we assume that there are about 400 million iOS users of maps[1], it leads to about 90 million Google Maps users on iOS and about 310 million Apple Maps users on iOS.  This includes iPad.[2]

Given that Google also reported 1 billion downloads in 2014[3] we can assume between 25% to 33% Apple Maps “market share” of usage.

Notes:
  1. Note that not all iOS users are maps users. Maps are not used by all users []
  2. We are excluding OS X use of Maps. []
  3. though not necessarily all of these downloads lead to active use, obviously []

Is Tesla Disruptive?

To the analyst, the car industry is a wonderful study. Unlike some other “high technologies,” whose market births and deaths are separated by a few changes of the seasons the automobile industry has been around for well over a century. It has been sustained through dozens, perhaps hundreds of innovations. Almost everything about the car of a century ago has been improved.

Not only improvements to the product itself but improvements to the infrastructure that supports it: roads, gas stations, services, insurance, regulation. At the same time, its numbers have increased steadily as the car has spread to all corners of the world through waves of increased production and distribution. Although invented in Europe, the production system that allowed it to reach the mass market took hold in the US. That production system was then exported to Europe then to Japan and then to Korea and now to China.  Screen Shot 2015-05-28 at 5.30.54 PM

Figures 3.3.9 and 3.3.10 from Arnulf Grubler’s The Rise and Fall of Infrastructures

However, throughout this century of improvement, the business structure—the way money is made—has not changed. Even with the arrival of Volkswagen in the 1960s and Japanese automakers in the 80s, the network of incumbents has not been displaced. Newcomers have taken share, but there have been few exits suggesting that classical disruption has not taken place.

When we look at the reasons for the share displacement that did take place, we see innovation in production systems and distribution as the core causes. We see new manufacturing processes and competition against non-consumption. What we don’t see is new technologies. We don’t see diesel engines or anti-lock braking or crumple zones or fuel injection or radial tires or airbags or automatic transmission or air conditioning or electronic ignition or safety glass, or any of the other hundreds of technologies that have been adopted as causing any change in market share.

Screen Shot 2015-05-28 at 5.32.41 PM

Every innovation tends to diffuse rapidly throughout the industry, being widely adopted by all manufacturers. Production systems such as the ones from Ford and Toyota have been much slower to be adopted which has offered those innovators an advantage for a few decades, but they too have eventually been widely copied and created normative behavior. The opening of new markets like Asia, Eastern Europe, Latin America, Africa and China have created opportunities for local manufacturers but eventually those advantages too have or will be diminished with time.

So, given this, we have to ask if the the availability of new power storage technologies would allow an early mover to displace and move aside these established makers. To answer in the positive would imply that the challenger has an asymmetric business model—one which causes the incumbents to flee in the opposite direction. But Tesla is manufacturing cars using the same JIT processes and ramping quite slowly. Toyota-style process-driven innovation does not seem to be even in the works. There is no shortage of manufacturing capacity, indeed there is too much.

Furthermore, Tesla is selling cars in established markets competing against existing consumption. Volkswagen Beetle or Model T style competition against non-consumption does not appear to be on offer.

Tesla’s product introduction rate is relatively sedate, so a higher rate of product development which might let them “turn inside” the incumbents, does not seem likely.

Finally Tesla is introducing products priced well above average appealing to the wealthiest of customers, again causing us to ask how this might cause a luxury company to look at their solution and exclaim “Not for us!”.

Looking from every angle I am unable to find the way that Tesla is asymmetric. Disruption theory suggests that whatever causes it to survive or prosper will be embraced and extended by competitors precisely because it will also cause those competitors to survive and prosper.

The auto industry may be a lot slower than the computer industry to respond. But once the industry embraces battery-based power, it will convert a world-wide production and distribution system to sustain itself.

That does not mean Tesla is a bad business. They may carry on with Porsche-like or even BMW volumes for a long time. But that’s not a disruptive outcome, it’s a niche strategy.

There is one more point. As Tesla has chosen to share its intellectual property and as Elon Musk has stated publicly, they welcome others to build the same cars they do. So by their own admission the company does not seek to disrupt. Disruption is a competitive stance.