Category Theory

What it means to be great

What makes a product great? I struggle with this question because being great is not just being better than good. Greatness is to goodness as wisdom is to smarts. Just like getting smarter and smarter may never make you wise, getting better and better does not mean ever becoming great.

Greatness is transcendental. It’s hard to pin down. It inspires debate. It divides as much as it unites. It creates emotions as much as thoughts. It builds legends. It engages and persists. It lives in memory and penetrates culture. It implants itself in our consciousness persistently, to linger and dwell in our minds while we are bombarded with stimuli.

We use words such as “iconic” or “epic” to capture this permanent “mental tattoo” that we get from greatness. As important as this notion is, we struggle to define it. We don’t even have a proper word for it. Perhaps it is what art tries to be, or what drives us to achieve beyond surviving. As vague a notion as it may be, it is one of the most important notions I can think of. Greatness is the cause, perhaps, of our ascent.

In the absence of any measurement of greatness, how do we spot it?
It may just be down to “knowing when we see it”. But not everybody does.[1]

  1. Language is another indicator. When people attach brands to entire categories we get an indication of ubiquity and permanence. As much as the brand owner fears it, the genericization of a trademark is very probably an indication of greatness in consumer products. Aspirin, iPod, xerox, jell-o and app are examples where brands became words. []

Meaningful Contribution

What if Apple did make a car? How significant could their products be? What would it take to influence the industry’s architecture?

The global market is forecast to reach 88.6 million vehicles in 2015 and there are many ways to segment it. One could look at geography or at product configurations or the emergence of new powertrain technologies.

One could also look at the participants.

In 2014 Toyota was the top selling automaker with a total sales volume of 10.23 million vehicles. The following graph shows the leading 15 producers and the percent of total production.

Screen Shot 2015-09-25 at 9-25-2.19.47 PM


Soft Underbelly

Executives at car companies have suddenly had to answer questions about potential entrants into their business. This is a big change. I don’t recall a time when this was necessary for over 30 years. For decades the questions have been about labor relations, health care costs, regulation, recalls and competition from other car makers. To ask questions about facing challengers posing existential questions must seem terribly impertinent.

For this reason, Bob Lutz, in his dismissal of Apple’s entry, is not alone. The has a century of history and has seen little disruption in the classic sense. I wrote a long piece on the fundamentals of the industry titled “The Entrant’s Guide to the Automobile Industry” which explained why this industry has been so resistant to disruptive change. At best a massive effort over multiple decades usually leads in a small shift in market share.

However, one should read that post as a thinly veiled threat. Just because disruption seems hard does not mean it isn’t possible. Indeed, the better you understand the industry the more easily you can observe its vulnerability and the more rigid the industry seems the more vulnerable it may be to dramatic change.

The formula for successful entry is the same for all industries: compete asymmetrically. This means introduce products which change the basis of competition and deter competitive responses by making your goals dissimilar from those of the incumbents. This is classic “ju-jitsu” of disruptive competition.

Here’s how it would work.

Bob Lutz suggests that there is no profit to be gained from selling cars on the premise that costs are very high while pricing will be held down by competition. That may be true but entrants could deploy new processes that lower the costs of production. Traditional car making is capital intensive due to the processes and materials used. There are however alternatives on the shelf. iStream from Gordon Murray Design proposed switching to tubular frames and low cost composites.  BMW has an approach using carbon fiber and other composites. 3D printing is waiting in the wings. All offer a departure from sheet metal stamping.

With new materials, costs for new plants can be reduced by as much as 80% and since amortizing the tooling is as much as 40% of the cost of a new car, the margins on new production methods could result in significant boosts in margin.

There is a downside however. What is usually compromised when using these new methods is volume and scale of production. So that becomes the real question: how many cars can Apple target? 10k, 50k, 100k per year? Could they target 500k? That would be 10 times Tesla’s current volumes but only a bit more than the output of the Mini brand.

Now consider that the total market is 85 million vehicles per year. For Apple to get 10% share would imply 8.5 million cars a year, a feat that is hard to contemplate right now with any of the new production systems. On the other hand selling 80 million iPhones and iPads in a single quarter has become routine for Apple and that was considered orders of magnitude beyond what they could deliver. Amazing what 8 years of production ramping can offer.

So the answer to the operating margin might be in a combination of new processes and new ramp strategies.

But there are more levers of change.

How quickly will ads disappear from the Internet?

I was always bemused by the notion that the Internet was able to exist solely because most users did not know they could install an ad blocker. Like removing Flash, using an Ad blocker was a rebellious act but one which paid off only for early adopters. But like all good ideas, it seemed obvious that this idea would spread.

What we never know is how quickly diffusion happens. I’ve observed “no-brainer” technologies or ideas lie unadopted for decades, languishing in perpetual indifference and suddenly, with no apparent cause, flip into ubiquity and inevitability at a vicious rate of adoption.

Watching this phenomenon for most of my life, I developed a theory of causation. This theory is that for adoption to accelerate there has to be a combination of conformability to the adopter’s manifest needs (the pull) combined with a concerted collaboration of producers to promote the solution (the push). Absent either pull or push, adoption of even the brightest and most self-evident ideas drags on.

Ad blocking offers a real-time example of this phenomenon. On desktop or even laptop computers ads were tolerable and the steps required to naviagate in order to implement effective[1] blocking were non-trivial. In addition, no platform vendors were keen to promote products which hindered revenues for their most important ecosystem partners.

Ad blocking as an activity had neither the pull nor the push.

  1. By effective I mean a combination of whitelists and customizations []

Apple Assurance

Apple is categorized as a vendor of consumer electronics. More specifically, a member of the “Electronic Equipment” industry in the “Consumer Goods” sector. If indeed this is what it’s thought to be selling, there is a problem because it isn’t  what its customers are buying.

Apple’s customers buy a mix of hardware, software and services under a brand that assures a certain quality of experience. This bundling and integration of otherwise disparate things is why the brand is such a success.

This anomaly between what Apple is thought to sell and what buyers actually buy can leave the casual observer confused. As a result the company’s categorization as vendor of hardware deeply discounts its shares. It is, in other words a less valuable business. This is because a seller of consumer electronics does not benefit from “system valuation” since there is minimal loyalty to the product after the sale.

The consumer electronics vendor has no network to leverage, no ecosystem adding value after the sale, no platform and works through multiple levels of distribution to reach the customer. In contrast, a system vendor can expect benefits from network effects, ecosystems, and a coveted relationship with the end user.

The result is that the valuation of a consumer electronics vendor is based on the momentum of individual products. Apple has always been valued this way. Each hit product is considered to be a stroke of luck/genius and the chances of recurring are discounted to about zero. Regardless of the fact that it has a track record of “home runs”, Apple’s hit rate is not considered sustainable.[1]. Certainly Apple is not valued as being able to generate reliably recurring revenues.

But what if we were to value Apple on the basis of what people are buying rather than what it’s thought to be selling?

The model is simple enough: determine the number of users, estimate the lifespan of the products, and figure out the services attached to the products; then, given the price, obtain a price per product per day. You then can get a recurring revenue figure.

I did just that and the results are in the following table:

Screen Shot 2015-09-15 at 5.13.27 AM

  1. The P/E ratio is the primary indicator in this analysis []

The one where I offer stock tips

Let’s say I offered you the option to invest in a monopoly or in a hit-driven company whose survival depends on always finding the next big thing? Which would you invest in?

Before you answer, let’s say I offered you the option to invest in a person who has a large inheritance or a person who is poor but is hustling for any opportunity. Whom would you invest in?

Before you answer, let’s say I offered you the option to invest in real estate of a city which depends on a stable, capital-intensive manufacturing base or one where they make nothing but movies. Where would you buy land?

Each of these reflect the same choice: stability vs. instability, the known vs. the unknown.

Historically, capital has always gone toward the stable and away from the unstable. Wealth has gone the other way.



Breaking the Law

For the first time in many years I feel that there is some potential uncertainty in the results Apple will announce. After a period of excellent accuracy (shown in graph below), the company’s guidance has begun to diverge dramatically from reality and the trend might continue this quarter. The cause might be unanticipated demand for the iPhone 6/6 Plus. The growth rate for the product was 46% in Q4 and 40% in Q1. This is unanticipated because growth rates have been below 20% for five quarters and below 50% for eight.

Screen Shot 2015-07-13 at 12.21.00 PM

This slowing of growth was explainable given the rate of diffusion of smartphones in the global population. Within the US and some other early adopting economies the market is reaching late stages where most people have switched to smartphones. Globally we are at a more modest 30% or so but in many of the late adopting economies Apple does not have wide distribution.

Of course this thesis is thinly supported. There are many reasons to think that late adopters would still start with iPhone and that earlier adopters of Android would upgrade to iPhone after a few purchase cycles. Thus, the iPhone could prosper in later-adoption or even in post-saturation states of the market.

Indeed, in the post-saturation PC market, Apple is doing very well with the Mac and in the late to post-saturation MP3 player market the iPod did extremely well. This suggests that when it comes to value capture brand, experience and satisfaction trump function, price and share considerations in almost all consumer markets[1]

With so many assumptions put asunder the iPhone business suddenly looks downright lively. I adjusted my own growth assumptions and the resulting figures are shown below.

  1. Enabled by design for jobs to be done. See non-technology markets for abundant evidence of this. []

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.

  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.


Unicorns typically are valued on the basis of number of users. While they are not yet monetizing those users, their growth and engagement metrics are expected to be off the charts. As there are no revenues (or profits) the $billion valuation hinges on a nominal value of $/user. That figure is based on comparable companies (e.g. Facebook) which do monetize their users.

Since the unicorn’s capitalization/user defines its valuation, which company should be considered comparable? Unfortunately they range widely. There are many alternatives. The graph below shows a few Market Cap/Mobile User rates ranging from $45 for Yelp to $747 for Alibaba.

Screen Shot 2015-05-15 at 5-15-2.47.16 PM


Note that I’ve also added companies which may not be considered as unicorn comparables because they are not usually valued on a per-user basis. Apple, Microsoft, Google and Amazon are priced by product sales, typically. However, most of them operate and self-define as service organizations. Microsoft has been “monetizing users” for decades using a recurring revenue model. It has a “SaaS” business logic for most of its revenues. Google[1] likewise. Amazon reports its active users every quarter and obviously is measuring itself by that metric.

Apple[2] is the least likely to be seen as a company whose value is a function of user base. Nonetheless it behaves entirely on that basis. The company’s entire strategy depends on satisfying its customers and building its brand which can only have one outcome: loyalty and repeat purchases. The services and software they offer can be seen as supporting that brand loyalty which is converted to profit through an above-average selling price.

Being mature of business model therefore does not exclude a company from being valued like all the kids are these days.

So, if we do look at the value/user metric we might as well look at the revenues, operating profit and growth data.

  1. Google users are estimated at 2 billion active Android/GMS devices []
  2. The assumption here is that Apple has 520 million active users which is based on iOS devices in use estimates []