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Retail in 2020

This year’s Thanksgiving and Black Friday data from IBM shows a continuing pattern of growth for mobile devices. As the graph below shows, in the five years since 2010 mobile devices grew from 5% of the online shopping traffic to 50%.  Traditional computing (desktop and laptop) made up the difference.

Screen Shot 2014-12-01 at 10.34.30 AM

The graph also shows that sales value via mobile devices crossed over 25% of online spending. The fact that mobile shopping is not equal to mobile spending is due to the convenience factor of mobile. It’s more likely that users will spend idle time scanning for bargains or tracking down ideas from friends but wait until they are at home to make the final purchase decisions in front of a computer.

The transition to spending directly from a device is a slower process, but that process was also one that online had to undertake as buyers became comfortable with online commerce. When it comes to payment, buyers are understandably more cautious.

This does not change the prediction made last year that “the transition to post-PC consumption will also be practically completed by 2020″. That leaves six years for mobile saturation and a total transition time of one decade.

At that point I expect 90% of browsing and perhaps 75% of spending to be happening on devices. Some of this will undoubtedly be enabled by biometric authentication as shown by Apple Pay. Trust and ease of use in this technology will undoubtedly accelerate the transition making mobile payments more comfortable and secure than on the legacy computer.

What is less predictable is how much those devices will also be used to transact payments for the physical retail stores. In some scenarios it’s possible that by 2020 a majority of all shopping will be enabled by devices.[1] That would subjugate the retail segment to the power politics of mobile platforms.

It is interesting therefore to note the mix between the platforms in the graphs above.

Notes:
  1. There is also the matter of in-store discovery and advertising via NFC and bluetooth i.e. iBeacon []

Yet another billion dollar business

I tried to assess the opportunity of Apple Pay but found it to be mostly dependent on how quickly card payments will overtake cash. It seems that as payments move to a digital format they will move to a mobile device. The hurdle isn’t going from a card to a phone but from cash to card.

Data published in The Growth and Diffusion of Credit Cards in Society  shows that between 1970 and 2001 households with at least one credit card in the US grew from 17% to 70%. More recent data shows 82% of US consumers have at least one credit card and 77% have a debit card.

The Total Addressable Market for Apple Pay then is dependent on how quickly this pattern repeats over the markets where iOS devices are in widespread use. Once cards are in use they are used with higher frequency and quickly overtake cash for the user.

The only assumption that needs to be made is that the device then replaces the plastic card. This seems a safe assumption as the benefits of the device as payment authenticator are high and the costs are negligible given a penetrated market.

The following graph shows an extrapolation of transaction volumes where Visa and MasterCard and Amex are showing moderating growth with UnionPay showing 20% constant growth through 2019.[1]

Screen Shot 2014-11-28 at 12.58.21 PM

Two more assumptions are needed: the share of transaction value captured by Apple Pay and the Apple Pay fee. I used 15 basis points ($15/$10000) as the assumed Apple fee and a share schedule as follows:

Notes:
  1. Supporting these assumptions is a forecast from Nilsen showing total number of cards in circulation by issuer and a forecast of total transactions Screen Shot 2014-11-28 at 1.40.01 PM []

Faster Followed

Samsung’s smartphone ascent was breathtaking. From having essentially zero market share in the category in late 2010 to becoming the largest vendor took less than two years. In doing so it grew to become the largest phone vendor, smart or not–a goal which eluded them during the previous decade of effort. Samsung went on to capture not only the lion’s share of unit volumes, they also took almost all the profits in the Android mobile phone market.

And in a market filled with competitors. Literally hundreds of vendors and thousands of products were available at every conceivable price point. Samsung did away with HTC, LG, and Motorola. HTC, the first Android vendor (and first to market with Windows Mobile), Motorola, Google’s launch partner in the US and “Droid” brand partner (and future owner).  Google’s own Nexus products. Samsung Galaxy ruled them all.

Galaxy swamped the Chinese market and the Indian market, the largest in the world. They were so powerful that they were singled out both by Microsoft and Apple for IP royalties.

All within two years or the average life-span of one smartphone.

But something went wrong in 2014. Growth in shipments suddenly stopped. This was not a problem with the overall market, which kept growing. The slowdown did not affect other vendors, especially the up-and-coming Lenovo and Xiaomi and the second and third tier vendors whose names are  known only in the local markets they serve.

The result of this slowdown is shown in the following graphs:

One billion sold

In Q3 2014 Apple’s revenues were 5.3% higher than the upper end of their guidance. This is the highest error in guidance since the new range-bound  reporting regime started two years ago.

The following graph shows the guidances given since 2005 and the actual revenues. The error (as a percent of upper guidance) is given in the second graph.

Screen Shot 2014-10-23 at 10-23-10.44.28 AM

On the trajectory of successful companies

Samsung Electronics warned Tuesday that its third-quarter earnings would fall below market expectations. It did not cite a decrease in shipments but an increase in marketing expenses coupled with an unfavorable mix (i.e. more low-end units and fewer high-end units).

The headlines reporting the news emphasized the 60% forecast drop in operating income but the company also provided sales figures. Adjusting for exchange rates, the forecast revenues are shown in the following diagram:

 

Screen Shot 2014-10-07 at 8.51.05 AM

Note that I also included Apple’s revenue history and forecast. Samsung’s revenues are shown on the right and Apple’s on the left using the same scale (each horizontal gridline represents $10 billion/quarter.

The explicit cause for the drop is a decline in prices and “increased competition”.[1] However a few more questions need to be answered regarding long-term success in the markets Samsung competes in.

Namely:

  • The absence of a software platform fully within its control
  • The absence of control over an ecosystem of content and apps
  • The absence of services
  • The lack of integration of software, services and hardware
  • The absence of differentiation vis-a-vis other vendors
  • The indefensibility of its low end offerings from low end disruptors
  • The pattern of commoditization in all its markets

Samsung is a very big company but many very big companies came to become small companies. They all followed similar roads.

Notes:
  1. Though one can’t be sure when there was ever decreased competition in its markets. []

Apparel is next

If software can be injected into an industry’s product it will bend to the will of the software writers.

This theory expands on Marc Andreessen’s observation that “software is eating the world”. The evidence is that software, coupled with microprocessors, sensors, batteries and networking becomes applicable to an increasingly larger set of problems to be solved[1]. Software has “eaten” large portions of entertainment (e.g. Pixar, iTunes, video games), telecommunications (iPhone, Android, Messaging), various professions including journalism, management and law, and is entering transportation, energy and health care and poised over banking, finance and government.

As entry happens, asymmetries are enabled and disruption follows. This is the bending to the will of the writers–who tend not to be incumbents. The incumbents can’t embrace the changes in business models enabled by software without destroying their core businesses and thus, invariably, they disappear.

The pattern is easily observed but the speed and timing of it is difficult to predict and hence investment success is not certain.[2] There are many entrants who try and few succeed and there are many incumbents who will survive longer than a prophet can stay hungry.

Nevertheless, this process of software-induced turnover in wealth–and, incidentally, vast, additional wealth creation–is inevitable.

But can we predict anything other than timing? For example, can we predict the next industry to succumb to this force?

Notes:
  1. Or, put another way, is eligible to be hired to perform an increasingly large set of jobs []
  2. Which, ironically, means that the jobs of venture capitalists are still safe. At least until the theory develops to the point where it can predict with more accuracy winners and losers. []

Interview With Horace Dediu: What To Expect When Apple’s Expecting

My thanks to Eric Jackson for his thought-out questions on Apple. As published in Forbes, here is his Interview With Horace Dediu: What To Expect When Apples Expecting.

A few excerpts:

Q: Do you expect to see a sapphire cover on the new iPhone(s)? Is that material significant?

I expect Sapphire will become a signature feature across many products. I don’t know if they will have capacity to deploy on iPhone this year but on a watch it’s essential. Here’s a clue: if the screen has any curvature, especially around edges, it needs to be sapphire as glass can’t take strain in that shape. The scope of the plant they are building with GT implies that they will have massive volume potential with at least one major iPhone model using the material. It’s a significant material because it allows design freedom in new directions, especially curved (concave) touch surfaces that retain a jewel-like feel. This has Jony Ive all over it.

Q: Is it fair to conclude now based on the 5C and 5S that Apple will never launch a “cheap iPhone”?

Oscar Wilde said a cynic is someone who knows the price of everything and the value of nothing. When I see the word “cheap” I never know if it refers to price or value. And even when we talk about price, an iPhone is cheaper than buying all the things it replaces so it’s always been a low end disruptor in my mind. (I saw a tweet with an image of a Radio Shack ad from the 1980s and every single item available on that page is now a part of the iPhone. It would have cost thousands to buy all those things back then–and dollars were worth a lot more.) Furthermore, I think Apple holds a black belt in pricing. They seem to define their position in the market by anchoring certain prices and “owning” them. Given all that I would say that Apple is not going to move their price points much. They will expand the portfolio and offer some iPhones at $300 but they will be older models. The average selling price (ASP) I expect to remain constant on a year-long average.

Q: In the past, Apple critics were quick to dismiss the new iPad and 5C iPhone as failures upon their introduction.  You never judge. You just report the facts and data.  That said, is there anything about past new Apple products launches that we should look at as a predictor of how a new iWatch might be received by customers?

When the iPad was imminent the great debate was over whether it would run iOS or OS X. Many imagined a touch-based Mac rather than the “big screen iPod touch”. It was a tough call and one which Microsoft could not and still does not make. Therefore, the interesting question for me with respect to iWatch is: What OS it will run? I will be shocked to the core if it does not run iOS. It is my opinion that making iOS work on it is the entire reason Apple is sweating this segment. They are in it because they are trying to make a platform product with a novel user experience and all the power of an ecosystem run on a wrist. It’s as big a problem as getting a phone-sized device to run a touch UI was in 2007. That is the crucial contribution that Apple is making to this next generation of computing. Now you might ask what users are asking for in this segment. The answer is nothing. Nobody is asking for this. As nobody asked for the iPhone (or the Mac or the iPad). It’s a new computer form factor and how it will be used will be determined by the apps written for it. But it will work and be magical out of the box in version 1. This is in contrast to the single purpose or accessory model of wearables we see to date.

Q: As a student of disruption, where is Apple most vulnerable to being disrupted?

Apple is a new market disruptor but much of what is put forward as a threat to it is low-end disruption. I think Apple knows enough about how that happens that it can manage its way around it. The strategy they employ is one of attrition. If you wait long enough a low-end threat tends to wear itself out as it starves of profit and is constantly gnawed-at by alternatives. (You see, if the disruptor cannot manage a profit then they cannot climb up the trajectory to get on top of the incumbent. Being profitable is a key requirement for successful disruption in the long term.) The attrition strategy works as long as you have the fortitude to hold out and the deep pockets to keep improving your product as alternatives flame out. It is my belief that Jobs made sure that thinking is inculcated in the company. So if not low-end is the company vulnerable to new-market disruptors? This is more subtle and the threat here is what Google/FaceBook/Amazon and the other ecosystems are all about. It’s creating new usage models and shifting where consumers place brand value. I think this is more what keeps Apple’s management awake at night. They are not standing still however. iTunes and Software and Services (now with Beats on board) is the way they are staying on top of that threat.

Lots more here.

Beleaguered

Amazon’s recent disputes with publishers (Hachette and Disney) shows a degree of market power that is closer to monopsony than to monopoly but this power is nevertheless real. It may not not be something that requires intervention, regulation or even scrutiny but market power is evident in both how companies operate and in how they are valued.

If you look at the following graph, it’s easy to spot those with “monopoly” power. The graph shows a short history of revenues/operating income and P/E ratios. Modest or no growth in earnings coupled with extraordinary high P/E ratios indicate that the market understands the business is not threatened by competition.

Screen Shot 2014-08-14 at 8-14-1.40.47 PM

On Capital Allocation

One of the paradoxes of the “post-industrial” era is the aversion to application of capital to growth opportunities. Generally speaking, capital has become trapped in bank accounts as opposed to equipment which could be used to produce value. This aversion is rooted in many dysfunctions, chief among them being the misunderstanding of the purpose of the firm.

But there are exceptions. Illustrated below are the patterns of spending in property plant and equipment (capital expenditures) by companies that still recognize that there are opportunities to be obtained by investment in the means of production.

Screen Shot 2014-08-13 at 11.36.03 AM

Open always wins

ABI Research estimates that AOSP (or forked Android) is the fastest growing mobile operating system with a total share of units shipped of about 20%. This is not surprising considering that most Chinese vendors don’t include standard Android into their products. Indeed the current leader in China, Xiaomi has its own take on Android and includes a unique UI and set of services. This is also not a new pattern, Amazon’s fork of Android has been in development for many years and powers the second most used tablet in the US.

If one looks at the volumes of smartphones shipped by vendor, the most rapidly growing (Huawei, Lenovo, Xiaomi, ZTE, Coolpad and “others”) are likely to be using forked versions of Android.

Screen Shot 2014-08-07 at 7.06.09 PM

The reasons for this are many: a reluctance to deal with Google’s obligations,  Microsoft’s IP licensing costs[1] , potential litigation, politics (including bans on Google services in certain markets), etc. But the most likely reason is flexibility. Vendors competing on price and localization are looking to move quickly against each other and can’t wait for blessings from above. Belonging to some “Alliance” and all that it entails is just too much to ask for companies that are, so to say, delicate.

Notes:
  1. which even Samsung seems to be eschewing []