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Twenty Questions from Catalin Stelian Andrei

Catalin Stelian Andrei, Editor of The Day, INTERNET PROTV asked me twenty questions:

1. What phone do you have in your pocket right now? Why that model?

I carry the iPhone 5. The last iPhone I bought was an iPhone 5C which I gave to a family member.

2. Apple is going to launch, form all we know, an iPhone with a bigger screen, long after their market rivals. Is Apple one step behind, being forced to take this road in the fight with Android and Windows Phone devices? Because many smartphone users were hoping that an big screen iPhone, a redesigned model, will be lauched long time ago, and that didn’t happen.

Making bigger phones is easier than making smaller phones. First because miniaturization has always been the most difficult engineering challenge, and second, because a smaller phone has a smaller battery making efficiency much more important. The larger the phone, the simpler it is. The third reason smaller is more valuable is that it’s easier to carry and use. The largest phones cannot be put in pockets and cannot be used with one hand. In the history of consumer, electronics size reduction has been the most consistent measure of performance, and the most rewarding. Usually the most exceptional reductions in dimensions create the highest price and profit bands. There have been niches for larger portable devices but they are consistently a small part of the overall market. If Apple were to introduce a larger device I hope they will be able to solve usability problems and make the category attractive to a larger audience.

3. What do you expect from the new iPhone 6?

I expect it to run the latest version of iOS and, with the new apps developers will ship, that should make the most impact in people’s lives. I imagine health maintenance and home automation will become valuable new franchises. Of course iOS 8 will also run on older iPhones, but I suspect the newest iPhone will somehow run the new software better and have smoother integration with services.

4. What’s the “not to do” lesson that Apple needs to learn for the now iPhone from it’s own past experience or their competitors?

The biggest challenge is to move rapidly with scale. The company has managed to grow from zero phones a year to hundreds of millions. That’s great but it’s still frustrating to wait one year for major improvements. The “cycle time” of innovation for Apple remains one year. I wish it could be faster but perhaps this is also too fast for some. In some services like maps and iCloud and iWork, which are independent of hardware (mostly,) speed is of the essence.

5. The iPhone is the most expensive smartphone on the market right now. In Romania, it certainly is. But where does Apple gains it’s most money from, selling products to users or selling services, like iTunes, App Store? And having that in mind, what will be their next step: better – breakthrough products or bigger, more complete services?

The answer to where a company “gets its profits” is best answered by asking where a buyer “gets his value” from the product. For instance you might answer the question of where a car company gets its value by saying that it’s from making people be in more than one place in a day. So the “differentiation” of a car is in answering the question slightly differently. If it’s hard to see a difference to this answer between cars then it’s hard for any one company to make a profit. For a company like Apple, we need to ask what its users value about the experience and why they are willing to pay for that. My hypothesis is that the brand’s value is in making life a little bit easier. That’s what Apple competes on. Of course, some people are not willing to pay to have an easier life and some even want to make their lives more complicated so Apple’s proposal to make life easier, for a price, is not accepted by everybody—which is ok by them. But for many, paying for comfort, productivity and ease of mind is worth quite a bit. The reason Apple is able to gain a premium over the competition is that this value proposal (of paying for simplification) is either weak or non-existent for competitors. Indeed, many competitors compete on the basis of making life more complicated.

6. What does innovation means for Apple right now? What are their options for assuring a next decade of success? A new Steve Jobs person or a Steve Jobs tipe of group thinking. How hard is that to achieve?

Innovation is meaningful invention—bringing useful creations to a large number of people who then make use of that creation. The interesting aspect of making money from innovation is that it’s a rare phenomenon, requiring many disciplines to work together. It’s like a big movie that somehow works and becomes widely popular but costs little to make. Many movies are made, few are successful and very few of those which are successful are built at low cost. What we know about technology innovation is that it’s a combination that comes together under strong leadership but that leadership alone is not sufficient. The myth of Steve Jobs is that he was both necessary and sufficient to success. The truth is that he was necessary but not sufficient. To make successful innovations requires strong leadership and teamwork and a process of incentives and passion that is hard to create a formula for. How this works at Apple is its biggest secret.

7. Who are the key Apple employees right now? Do they need another Jobs or do they already have him?

All Apple employees are key. I would say that’s the magic formula. There is no chief magical officer (and there never was.)

8. What will be the next best thing for Apple? […]

I don’t know. It’s probably not knowable.

How close is the UK to smartphone saturation?

In How close to saturation is the smartphone I highlighted that the US is not nearly saturated at 68.8% penetration at the end of March. Since the US is not the highest penetrated, one may wonder whether other “developed” countries are far further along.

There is no data on all the countries in the world on the same resolution as that in the US, but thanks to Charles Arthur, Kantar shared data on the UK and we can have a clear trajectory for that country.

The most recent data for UK was as of February 2014 when penetration was 70%.

Screen Shot 2014-05-08 at 5-8-6.31.48 PM

In February the US figure was 68.2%, so the US is 1.8% behind in penetration. The equivalent picture of the US is below:

Fortune 130

The increase in net sales of iTunes, Software and Services in the first quarter of 2014 compared to the first quarter of 2013 was due to growth in net sales from the iTunes Store, AppleCare and licensing. The iTunes Store generated a total of $2.4 billion in net sales during the first quarter of 2014 versus $2.1 billion during the first quarter of 2013. Growth in the iTunes Store, which includes the App Store, the Mac App Store and the iBooks Store, was driven by increases in revenue from App sales reflecting continued growth in the installed base of iOS devices and the expansion in the number of third-party iOS Apps available. Net sales of digital content, including music, movies, TV shows and books, from the iTunes Store was relatively flat in the first quarter of 2014 compared to the first quarter of 2013.

Apple Inc. Form 10-Q.

During the last quarter Apple changed the pricing for iWork and OS X to zero[1].

I estimate the net effect to have been a reduction in revenues from those software titles of about $350 million for the quarter. Nevertheless, increases in services and app revenues means that the iTunes total reported revenues increased to a new record.

The total with estimated contributions by media and service components is shown below right.

Screen Shot 2014-02-10 at 10.05.11 AM

Note that revenues do not reflect total billings. As Apple reports only the 30% of App transaction values, the full iTunes/Software/Services transaction values are shown in the above graph on the left.

Notes:
  1. OS X server is still priced at $20 and iWork for previously unlicensed devices and computers is still priced above $0 []

Of bits and big bucks

Exactly one year ago, on January 7th, 2013, Apple announced that the App Store reached 40 billion downloads[1]. Here are additional data points from that release:

  • 20 billion downloads in 2012
  • 2 billion downloads in December 2012
  • 500 million active iTunes accounts
  • 775,000 apps
  • sold in 155 countries
  • 300,000 native iPad apps
  • over $7 billion in developer payments

This year, on January 7th, 2014, Apple announced a new set of data points:

  • $10 billion spent on the App Store in 2013
  • $1 billion in December 2013
  • 3 billion app downloads in December 2013
  • 1,000,000 apps
  • sold in 155 countries
  • 500,000 native iPad apps
  • $15 billion in developer payments

The obvious:

  1. 225,000 apps were added in 2013
  2. 200,000 native iPad apps added in 2013
  3. App download rate for December increased by 50%
  4. No new countries were added in 2013
  5. $8 billion was paid to developers in 2013 (more than in all previous years put together)

The less obvious:

Notes:
  1. Unique downloads excluding re-downloads and updated []

When will the migration from PCs be complete?

IBM Digital Analytics Benchmark (report is here) has published, for the fourth year in a row, US online shopping traffic data with a split between mobile and fixed online traffic. It reveals a pattern of consumer behavior which is quite startling: people seem to prefer to shop using mobile devices.

The data is shown below:

Screen Shot 2013-12-02 at 12-2-6.45.34 AM

What’s an Active User worth?

Apple has sold 700 million iOS devices. Google claims one billion Android device activations. Microsoft has about 1.5 billion Windows users and Facebook about 1.19 billion. LinkedIn has 259 million users and Twitter has 232 million. Amazon has 215 active account holders and PayPal 137 million.

Markets place a value on these users implicitly when company shares are priced. For example, Twitter whose users are worth about $110 or FaceBook’s $98 and LinkedIn at $93.

This consistency suggests a universally accepted value per social media user but what is the value of an ecosystem user? Apple, Google, Microsoft and even Amazon aspire to enable ecosystems which should be seen are more valuable than mere communities. Ecosystems enable a higher level of economic activity because they are unbounded by the medium itself. Any number of media can be created. Or so the theory goes.

If we could determine a value for an ecosystem user we could test it against the going value of a social media user. Fortunately we have enough data to do so.

The total number of iOS devices sold per quarter allows us to measure the install base of device users. With some assumptions regarding the retirement and attrition rate we can get the following history:

Screen Shot 2013-11-11 at 11-11-11.52.34 AM

Since the total number of iTunes accounts is updated with some regularity I’ve added it to the graph. I’ve also shown on the same graph the total number of iCloud accounts. For calibration, I included survey data showing the number of iPhone users in two regions (US and EU5).

Owing how much to how few?

For the year ending October Apple’s R&D costs were $4.475 billion. These costs have been rising. Though, as the company explains, not faster than net sales:

The growth in R&D expense was driven by an increase in headcount and related expenses to support expanded R&D activities. Although total R&D expense increased 32% and 39% in 2013 and 2012, respectively, it remained fairly consistent as a percentage of net sales.

[My emphasis]

We can see this in the following graph:

Screen Shot 2013-11-01 at 11-1-4.37.48 PM

R&D has remained very nearly 3% of sales since at least 2005.

 

SG&A Expenses barely grew however:

The growth in SG&A during 2013 was primarily due to the Company’s continued expansion of its Retail segment and increased headcount and related expenses, partially offset by decreased spending on professional services.

The change in R&D and SG&A on a full-year basis is shown below.

Screen Shot 2013-11-01 at 11-1-4.42.06 PM

I emphasized the mention of increases in headcount. We cannot know with any precision what portion of last year’s $15 billion in operating expenses went toward wage expenses since there are other costs such as advertising[1] commissions and public relations in the case of SG&A and outside services, equipment leases, in the case of R&D. However, it’s more likely that wage expenses are a far larger proportion of total R&D than they are of SG&A.

My estimate, based on wage rates, is that there are approximately 15,000 R&D staff at Apple.

Screen Shot 2013-11-01 at 11-1-4.42.49 PM

If we divide sales by this number we get $11.4 million in sales per engineer.

Notes:
  1. Apple’s advertising expenditures for fiscal 2013 were $1.1 billion or 10% of SG&A or 0.64% of sales. []

How many smartphone users will there be in the US?

In yesterday’s post forecasting smartphone penetration I neglected to mention the exact subset of the US population being sampled. The analysis is based on comScore’s sampling which covers only those devices which are the “primary phone” for users  over 13 years old and not provided by an employer.

In other words, the population being sampled is not meant to identify how many phones will be in use but rather what is the primary phone for those non-children who choose their own phones.

So the measurement that can be obtained from the S curve analysis is a subset of all phone users and will not identify exactly how many phones will be in use. Given that, this is what that subset looks like:

Screen Shot 2013-10-08 at 10-8-9.41.00 PM

I drew a line showing the census data (and projection) for the US population and estimated what percent of that population might be

The figurative sales of iPhones and BlackBerries

The most interesting juxtaposition in market data happened this week.

Apple announced 9 million units of the iPhone 5s/c sold in their opening weekend while BlackBerry recognized 3.7 million smartphones sold in the three months ended August 31.

I will state these data points with a different emphasis:  while Apple explicitly reported, both in a press release and in an SEC filing, Sales of 9 million units, BlackBerry reported recognition of revenues on 3.7 million units.  At the same time BlackBerry also reported sales to end users of 5.9 million units.

So, did Apple sell 9 million iPhones in three days? What about units ordered and not delivered? Which of these units will show up in the company’s income statement? Conversely, did BlackBerry sell 3.7 million or did it sell 5.9 million smartphones in three months?

The answer is dependent on what constitutes a sale. I suggest re-reading the Sold and Shipped: A Brief Introduction post from last year. Understanding is complicated by many factors, not least of which could be intentional signaling by management. We may never come to a perfectly matched comparison of the two companies’ situations but our job as analysts is to see through the signals and obfuscating language and interpret a pattern. A pattern that extends over a time and helps us learn.

My observation is one of contrast. The juxtaposition this time is that Apple emphasized sold and not shipped while BlackBerry sold more units to end users than it recognized revenue. These signals reflect precisely the inverted fortunes of the two companies.

For BlackBerry the higher sold than shipped recognition was due to a product launch failure. Units which were shipped (and recognized as revenue) last quarter did not sell and the company is not only writing off the inventory but has drastically reduced its deliveries of new units in order to drain inventory. The company explains:

During the second quarter the company recognized hardware revenue on approximately 3.7 million BlackBerry smartphones. Most of the units recognized are BlackBerry 7 devices, in part because certain BlackBerry 10 devices that were shipped in the second quarter of fiscal 2014 will not be recognized until those devices are sold through to end customers. During the quarter, approximately 5.9 million BlackBerry smartphones were sold through to end customers, which included shipments made prior to the second quarter and which reduced the Company’s inventory in the channel.

The company is essentially saying that due to the unusual circumstances of a product launch failure, they will change how they account for their business. They don’t have the confidence that units shipped will actually sell and will not recognize them since they fear they will have to write some off. They are signaling: They are being far more conservative, not reporting shipments alone because those shipments could essentially be value free.

When seen as a pattern, the new figure on recognized revenue units needs to be shown relative to the history of recognized revenue units.  

iPhones 5c and 5s launch performance illustrated

Apple today announced it has sold nine million new iPhone 5s and iPhone 5c models in the first three days after their launch. This performance is illustrated in the following graph:

Screen Shot 2013-09-23 at 9-23-7.12.13 PM

Note that the data is normalized to units/day.

The launch countries this year differed from last year in that they include all of China whereas last year only Hong Kong was included.[1]

The absolute number of 5x devices sold (not just shipped) seems to be an 80% increase from the 5 launch (9 million vs. 5) but accounting for China the increase is a more modest 29%.  ((The China launch event last year may have had a different dynamic as it occurred later and nearer to holiday season, but I’ll go with the unqualified data.))

However, perhaps the more relevant comparison is between different “S” generations of phones.

The data shows that the 3GS was 3x more rapidly purchased on launch than the original iPhone. The 4S was 4x more rapidly purchased on launch than the 3GS and now the latest 5s/c are 2.3x more rapidly purchased than the 4S.

The growth is certainly lower but from a much higher base. This should not be surprising.

UPDATE: Galaxy S 4 launch data is updated to show weekend performance. Previous graph showed performance over the first 27 days.

Notes:
  1. I am assuming that this year China includes Hong Kong. It would be good to confirm this. []