via 5by5 | The Critical Path #88: Siri in the Driver’s Seat.

via 5by5 | The Critical Path #87: De Gustibus.

The number of accounts has increased by almost a factor of six since late 2009. It amounts to an account growth rate of about 500,000/day or 44% compounded annually. Not bad, but along with this increase what happened to revenues per user?

Looking at iTunes revenue (gross) reveals a picture of revenues/account, shown below:

This can be read as: “Each of the current 575 million accounts generates about half the revenue of the 100 million accounts of 2009.” One would expect such a decline as an user base expands and this approximate 50% decline in revenues per account seems reasonable for a six-fold base increase. In absolute terms the graph shows that an iTunes account generates about $3.2/month in transactions.[1]  Put another way, during the last year, an average of $40/yr of economic value is generated by every iTunes account.

Stretching further, one could also use the 575 million iTunes accounts as a proxy for “the Apple customer base”. The assumption would be that iTunes accounts are attached to some Apple product, be it an iPhone, iPod or Mac. As a bounds check, a total of 865 million Apple devices (which interact with iTunes) have been sold since 2007. Assuming 575 million users does not seem to be a contradiction.

The logic deployed would be that it’s unlikely for a consumer to have an iTunes account without owning or using an Apple product. If we take this leap in logic then it would make sense to measure Apple (not just iTunes) revenues per iTunes account. In order to smooth out seasonality I took trailing twelve months’ average quarterly revenues and measured the following company revenues per iTunes account.

Note again the reduction in revenue per “customer” as the base grows. The reduction is less pronounced however, with about one third lower spending for a sextupling of the base. One can read this graph as “Three years ago an Apple customer used to spend $400/yr on Apple products but as the number of users increased six-fold the spending decreased to about $300/yr per customer.”

The practice of valuing a company by the rate of spending of its customer base is not uncommon, especially when the customer base is relatively loyal. Apple emphasized the importance of customer satisfaction (and, implicitly, loyalty) during its WWDC presentation. It was singled out as the most important metric they track. So perhaps valuing Apple itself on the basis of repeat purchase behavior should be considered.

When framing the value of of the company itself as a function of users (in the form of iTunes accounts) we get the following graph.

The graph measures the Enterprise Value (i.e. Market cap minus cash) on a per-customer (i.e. iTunes account) basis.

It shows that for a number of years—from 2009 until late 2012—Apple’s users were valued (implicitly by the stock market) as likely to create a net present value of about $1200 in earnings. The current value is about a third of that, or $440 in earnings. Today’s expectation is therefore that each current customer will buy the equivalent of 1.8 iPhones. And nothing more, ever. A few months ago it was expected that each customer would buy three times as much.

Although the rate of spending of each customer is decreasing, the number of new customers is increasing more rapidly. As this is happening the company’s equity is being priced such that an Apple user is considered less than half as valuable as she used to be—from 3.2x revenues to 1.5x revenues. This change in user value has been quite abrupt, happening only within the last nine months. What could justify a drop in user value would be a drop in customer satisfaction or loyalty. So far, I have seen no evidence of this happening.

–

Notes:

1. Note that these revenues include App Store, Music Store, TV Shows, Movies, iBookstore, Mac App store, and Services (including iCloud). Some of this revenue is not reported as part of Apple’s statement of operations since some content is treated with an agency model.

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The technical details were not released so it’s hard to know the protocol used to accommodate this interface. However it seems that it will be generic enough that a number of launch brands signed up for the launch. The list includes Honda, Mercedes-Benz, Nissan, Ferrari, Chevy, Infiniti, Kia, Hyundai, Volvo, Acura, Opel and Jaguar.

Is this a significant opportunity?

Before we get excited, it’s important to note that this will likely take a very long time. It won’t even begin until 2014 and the number of new models may trickle into showrooms quite slowly. Consider that the time it took for automakers to universally support external audio input (mostly the trivial line-in) was about a decade.

To also curb our enthusiasm we need to realize that the car industry does not produce many units. In 2012 there were over 60 million cars produced (with the following regional mix:)

In contrast, 60 million is about the number of phones sold every two weeks. In 2013 there will be more iPads sold than cars.

In particular the companies mentioned had the following production figures in 2011:

• Honda (including Acura): 2.9 million
• Mercedes Benz (Daimler): 1.44 million
• Nissan (including Infiniti): 4.5 million
• Fiat (Ferrari parent): 2.4 million
• GM (Chevy, Opel parent): 9.1 million
• Kia: 1.6 million
• Hyundai: 6.6 million
• Volvo: 315k
• Tata (parent of Jaguar): 1 million

Including the parent companies and all vehicle types they produce, the total is about 30 million units, or about half of the world-wide production. Obviously, not many of the cars produced will have iOS in the car capability.

Therefore the total unit opportunity is not very significant, perhaps less than 10 million a year. Is there a per-unit cost that compensates for this?

This is harder to answer. The way Apple has been licensing accessory makers is through the MFi (Made for i) program. There used to be a flat 10% fee off of the retail price of the accessory sold. However, there may have been changes. The licensing fees are not public and it’s quite possible that the price is a flat amount per unit and that it’s a negotiable. It’s hard to know what terms are being negotiated with automakers but my bet is that it’s not likely to be a significant source of revenue per unit.

So the total revenue from licensing the “Made for iPhone” trademark to automakers won’t be significant.

But it is significant for the car industry. The significance is that cars have finally risen to the role of being phone accessories. They have acquired the ability to participate in a computing ecosystem. During all these decades when the world has embraced the information society and intelligence has been embedded in the fabric of life, automakers have resolutely avoided being a part of it. Automotive information, connectivity and user experiences have remained in a Galapagos Syndrome-like isolation from reality. The reasons are rooted in the crisis of rigidity that plagues the industry, something I’ve touched on briefly in The Critical Path podcasts (e.g. Asymcar).

So this is a hopeful development. If.

If it actually moves at a slightly-faster-than-glacial speed.

If sufficient cars get display systems (billions are produced for the pockets of  young and old, poor and rich; but cars have to be considered “luxury” to be graced with an LCD)

If standards are adhered to.

If all brands (which operate individually as autonomous divisions irrespective of group-level strategy) accept the notion.

If these and many other conditions are met, it would allow, finally, the migration of autos to the status of information appliances and, eventually, to being hired for jobs that are currently left undone.

This pattern of gradual iPhone share gain in the US has been consistent for over two years even while Android has catapulted into an overall lead. The surprising thing is how Android seems to have peaked in share. There are still 95 million non-smartphone users and there seems to be headroom for growth even though the other platforms have been tapped out. But it does not seem that Android phones have any particular advantage over iPhone. My hypothesis remains that as price is taken out as a differentiation, the adoption of iOS is slightly higher than Android.

Another measure of market performance is the implied net platform user gains which is shown below:

It shows that iOS added more users in the last few months than Android.

The problem is that Kantar Worldpanel measures shipments and their share data shows a seemingly different picture.

In their data Android is shown as selling more units during January through April while Apple sold more during October through December. Of course we don’t have the absolute number of units so can’t see the effect of higher holiday overall sales volume. Nevertheless, the balance of growth seems to be disproportionately in favor of Android relative to the data from comScore.

To look at the situation more closely I measured the differential in user adds for comScore and the differential in market share for Kantar’s data. Then I overlaid the two differentials so that months are matching, as shown below:

There is a similarity to the frequency of oscillation with comScore data showing a delay (as would be expected since their data is sampling over a three month period). However, we are still facing a vertical offset where there is apparently more growth bias for iPhone in the comScore data.

Possible factors which might be explanatory:

• Methodologies used. comScore data excludes ages below 13 and non-personal devices (business expensed phones.) 
• Replacement sales are invisible in comScore data since the user base does not change when phones are replaced (and old ones are discarded.)
• Missing data from Kantar. Given their survey methods it’s possible that their panels miss some market segments.

 … most of the people around me were using their iPads exactly as they would a laptop – physical keyboard attached, typing away, connected to a network of some kind, creating a document or tweet or blog or article. In that context, it’s hard to distinguish between a tablet and a notebook or laptop. The form factors are different, but let’s be clear, each is a PC.

Actually this “admission” that iPads are PCs is not something new. Steve Ballmer made the same assertion in 2010 pre-iPad (though calling them slates). Arguably, the notion that tablets are PCs has been dogma at Microsoft for over a decade and Windows running on all form factors has been a strategic guiding principle.

Which is why I’ve always added the tablet data to the PC data to create a picture of the “personal computing” market. And this is what that picture looks like today:

Note how the share of various platforms has evolved over this brief time span:

Seen this way, Windows has now reached 60% market share and it’s likely to dip below 50% during this year. What happens beyond then is harder to imagine. If Windows tablets start growing as fast as the tablet market overall then Windows could stabilize in share. But if Android and iOS tablets follow their phone brethren in growth then it will be far harder for Microsoft to maintain share. But is that cause for concern?

Not necessarily.

The total computing market[1] is likely to expand to over 4 billion users with 1.5 devices per user in the next five years. That expansion implies that 20% share equals more than one billion devices, making such an ecosystem “good enough” for the average developer. It certainly has been good enough for Windows developers to date and they have kept hiring it throughout the new mobile app revolution.

So even if Windows dips to only 20% of the world’s computing market it will still be perfectly “viable” for some time to come.

–

1. I define the computing market as the total number of devices which have (a) a CPU (b) a broadband connection (c) a native application execution environment which is open to third party apps. This definition implies the presence of an “ecosystem” which is bound specifically to a platform.

Not bad for a five year old medium.

With respect to attach rate, the total downloads/install base are currently 83 apps per iOS device sold and 53 apps per Android device activation. The history of this is shown below:

The sheer weight of Android units will generate more downloads but on a per device basis the iOS devices do seem to consume more apps and the gap is not narrowing. What would be valuable would be the revenue per app on Play (the figure for iOS is about $0.23). That, as far as I know, remains unknown.

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Since the launch of the iPhone Apple has spent $21.1 billion on the acquisition of property, plant and equipment. The company has already stated that they will spend another $10 billion or so for the current fiscal year. This has been mostly machinery and equipment used in manufacturing.

The result in asset value is shown below:

[The Net value, shown as a blue line, is after accumulated depreciation. The red line represents spending as reported on the cash flow statement.)

The change in spending year/year (fiscal) is shown in the following graph:

So these are very large numbers, even compared to other capital-intensive semiconductor manufacturers:

Given this enormous spending one could imagine it's the subject of intense scrutiny. However the only question on the subject that I've ever seen was from Steve Milunovich of UBS to which Peter Oppenheimer, CFO offered an explanation:

Steve Milunovich - UBS
…second question would be on CapEx, you spent almost as much Intel does. I think you guys have said you’re not going to become vertically integrated per se but in a sense you are since [you buy] equipment for your partners, could you talk about the strategy here and how much of a differentiator this gives Apple in terms of your ability to ramp new products over time? And maybe a little bit more about how deep you will go in terms of semiconductor components for you, etc.?

Peter Oppenheimer – Chief Financial Officer
Sure. Steve it’s Peter. We expect to spend about $10 billion in CapEx this fiscal year that will be up little under $2 billion year-over-year. We expect to spend a little bit under $1 billion in the retail stores. And the other $9 billion is spent in a variety of areas. We are buying equipment that we will own that we will put in partners’ facilities. Our primary motivation there is for supply, but we get other benefits as well. We are also adding to our datacenter capabilities to support all the services that Tim spoke about in answering Ben’s question and in facilities and in infrastructure. So, that’s where the capital is going.

I would say that this is not a very satisfying answer, which is why I thought it merits further questioning[2].

Alas, no.

Whereas there is a constant clamoring for Apple’s to use its cash to “acquire” or “buy” something, anything, maybe people not looking hard enough. If you need the satisfaction that comes from knowing that money is being spent, a glance at the Cash Flow statement and Balance Sheet shows that Apple buys the equivalent of one Yahoo! every three years[3].

The main difference with this type of acquisition is that there is less value destruction. Using the capital to ensure access to capacity, differentiation and hence a high margin is better than writing off the goodwill after a few years.

–

1. The term capitalism, in its modern sense, comes from the writings of Karl Marx
2. I am prepared to be alone in this quest as it seems to merit no mention from others
3. or 10 Tumblrs every year

We haven’t so far. That doesn’t shut off the future. Why? It takes a lot of really hard work to do a phone right when you manage the hardware and software and services in it. We’ve chosen to put our energy on doing that right. We haven’t been focused on working multiple lines.

Think about the evolution of the iPod over time. The shuffle didn’t have the same functionality as other products. It was a really good product, but it played a different role — it was great for some customers it was strikingly different than other iPods. The mini played a different role than the classic did. If you remember when we brought out the mini people said we’d never sell any. It was too expensive and had too little storage. The mini proved that people want something lighter, thinner, smaller. My only point is that these products all served a different person, a different type, a different need. For the phone that is the question. Are we now at a point that we need to do that?

…

At a macro level, a large screen today comes with a lot of tradeoffs. When you look at the size, but they also look at things like do the photos show the proper color? The white balance, the reflectivity, battery life. The longevity of the display. There are a bunch of things that are very important. What our customers want is for us to weigh those and come out with a decision. At this point we think the Retina display is the best. In a hypothetical world where those tradeoffs didn’t exist, you could see a bigger screen as a differentiator.

Full interview here, answer begins around minute 37.

Here is how I interpret the answer:

• The iPhone portfolio may still arrive. It hasn’t so far because the cost/benefit is not there for Apple. On one hand it would take a great deal more sourcing effort and risk while dealing with constraints in production. On the other it would not not offer meaningful additions to the customer base. At least so far. The economics and the demand may change (or have changed) and the time will come for a broader portfolio.
• The comparison to iPod is not entirely appropriate because as a music player, the iPod had a relatively small set of jobs to do. It was hired for exercise, escapism, isolation, etc. It was not hired for apps and services which extend the medium itself. In other words it was not a computer. As a computer, the iPhone has a near infinite set of jobs to be done and it’s the hundreds of thousands of apps which help it perform them. But as a result the iPhone needs to conform to the dynamics of ecosystems and that means consistency of APIs and user experience. It cannot vary in terms of input methods, or be below minimum requirements of screen size or memory and power.
• Because of the rapidly expanding job space, Apple believes the iPhone was not “good enough” for all these years. The improvements shipped for each generation were all “meaningful” in that they were valuable and absorbable. Users would use the new features (like better screens, cameras, battery, etc.) and they were willing to pay for them (as evidenced by the sustained high average price).
• On the question of what the extension might be, changing screen size is one dimension but it has to be balanced by performance gains that don’t detract from other dimensions. Engineering is all about compromise and consumers pay Apple to make these compromises in an intelligent way. Apple does not come to an answer to the question of balance by launching many products and seeing what works. It cannot afford to dilute its brand with a long list of failures. Other brands may not be affected by trial-and-error approaches to the market but they are discounted by the customer accordingly.

via 5by5 | The Critical Path #86: Staying Foolish.

Here are some questions I’m hoping they will ask:

1. Why is the iPhone not sold as a portfolio product? Meaning, why, after six years, is there no iPhone product range being updated on a regular basis. Having a portfolio strategy is not only followed by every phone vendor but also by Apple for all its other product lines, including the iPad, which came after the iPhone. In other words, please explain why the iPhone is anomalous from a product portfolio point of view.
2. There are more than 800 operators world-wide so why are there only about 250 of them carrying your phone? Competitors large and small (from BlackBerry to Nokia to Samsung) have cited relationships with more than 500 operators so Apple is being uniquely selective. My question does not stem from a lack of patience: this total number of iPhone distributors has not increased markedly for over a year. Are you limiting distribution through conditions placed on operators (like the availability of sufficient quality data services) or are operators finding the distribution agreement too onerous (e.g. too high a minimum order quota)?
3. In 2012 Apple’s capital spending has reached the extraordinary level of $10 billion/yr, higher than all but the most capital-intensive semiconductor manufacturers. This is unusual for Apple as it was less than $1 billion in the year before the iPhone launched. It’s also unusual for Apple’s competitors in phones, PCs or tablets. It’s on a level matched only by semiconductor heavyweights. What is the purpose of this spending and what should we read into it leveling off at $10 billion for 2013?
4. Depending on one supplier is an operational faux pas, and yet Apple has found itself in that situation with Samsung for mobile microprocessors. It may be excusable in PCs with Intel having an architectural monopoly but it’s not excusable for a chip that you designed yourself and purchase in massive quantities. Why did you give Samsung such a concession, especially knowing their potential as a competitor vis-à-vis alternative suppliers who had no such potential? Does the answer have something to do with the previous question?

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via 5by5 | The Critical Path #85: Achilles' Heel.

The latest quarter showed a 7% growth in visitors and a new record revenue of $57.6 per visitor.

As a result, the average revenue per Apple store per quarter reached $13 million, the highest level for a non-holiday quarter.

Here are some additional metrics:

Average visitors per store has steadied to 250,000 per store per quarter (average for trailing 12 months). This is a quantum increase from about 170,000 per store per quarter in the twelve months ending Q1 2010. The reason for this might be the increase in floor space of newer stores and the renovation of older stores. The new store throughput rate might be an upper bound due to fire regulations.

Employment has steadied at about 110 per store. This is a remarkable increase from less than half this level in 2007.

Hiring remains closely correlated with visits with visitors per employee per quarter holding to slightly more than 2000.

Profit per visitor also holding steady at about $12/quarter.

Retail performance remains constrained by store size (hence maximum number of visitors) and the number of stores. The strategy seems to be expanding US stores while opening new stores outside the US.

That would allow growth in visitors and hence in achieving the primary purpose of the stores: maintaining the brand’s relationship with customers.

You can read each bar in the graph as the total “ARPU” or average revenue per iTunes user[1].

I overlaid a graph showing the total number of accounts as reported by Apple to the (retroactively) estimated revenue structure. Account totals are measured with the right axis and ARPU with the left.  Note that I also broke down each component of iTunes as currently defined (Music, Video, Apps, Books, Software and Services.)[2]

The time frame covered is from Q2 2007, or the quarter prior to the iPhone launch. A few patterns emerge:

• When there were no iOS devices (and hence no iOS apps) the revenues of iTunes consisted mostly of music sales. Those revenues were, on a per account basis, roughly comparable with Apple’s Software revenues.
• As iOS devices proliferated, the number of accounts (and users) grew. They doubled in the first two years (2007 to 2009) and doubled again in the following year (2010) and doubled again the following year (2011) and doubled again in the following 18 months. This rate of growth was accompanied by a reduction in the iTunes ARPU of about 50% (from $99 to about $45).
• The reduction in ARPU has moderated in the last few quarters. ARPU fell 10% from $50 to $45 during the last doubling of accounts (from 225 million iTunes accounts to  500 million accounts.) In contrast ARPU fell 20% from $74 to $58 during the penultimate doubling (from 100 million to 200 million)
• However, growth in accounts is broadly inversely proportional to growth in ARPU. In other words, the faster the growth in users the faster the decline in ARPU. The recent moderation in ARPU erosion is also coupled to a moderation in user growth (most recent doubling took 18 months vs. 12 months for previous doubling.) This is as would be expected as a broader, later user base tends to consume less than a narrow, early base. This can be seen in the following scatter plot:

• When seen as a percent of mix, Apps have grown to be the largest component of iTunes spending. Apps have 35% “share of wallet” while music has dropped steadily from 40% to 27% (or $39 to $12/yr.) This is shown in the following graph.

As apps have grown to consume more and more of users’ time it stands to reason that they should consume more and more of users’ wallets.

And as accounts reach one billion, we can begin to think about the disruptive impact on other media types. Whereas video, books and music are targeted to smaller user bases, apps are broadly consumed. Developers like Rovio or Supercell can offer their products to billions while TV producers can only hope for millions. Apps are becoming the universal medium for entertainment and iTunes the universal distributor.

Talent is catching on to this faster than those who manage and distribute their work. The inevitable result will be a mass migration of talent away from the established content industries. Old media won’t fade due to a loss of users. It will fade due to a loss of talent.

–

Notes:

1. An account is not necessarily a user so perhaps more appropriately the acronym should be ARPA (average revenue per account). Unfortunately that acronym is taken.
2. The complete model is available for purchase through Asymco Store.

via 5by5 | The Critical Path #84: Blessed Are the Apps.

• Quarterly revenues topped $4 billion (a new high) and the company suggests that this rate is maintainable by stating it has a “$16 billion annual run rate”. The pattern of revenues is shown below.

• The content portion of iTunes revenues was $2.4 billion, up from $2.1 billion sequentially. Growth into Q1 is not unusual as many holiday iTunes gift cards are redeemed during January.
• Revenue growth has been surprisingly steady, averaging 29%/quarter for more than six years.

• Music is now available in 119 countries.
• The Music catalog now consists of 35 million songs.
• Movies are available in 109 countries. 60,000 titles are offered.
• iBookstores are present in 155 countries offering 1.75 million iBooks.
• There are iTunes App Stores in 155 countries whose residents make up about 90% of the world’s population.
• iOS developers have created more than 850,000 iOS apps, including 350,000 made for the iPad.
• Cumulative app downloads have surpassed 45 billion and are on track to reach 50 billion at time of writing (estimated to be reached mid May).

• The company reports that over 800 apps are downloaded per second. Including all media, the download rate is now above 1000 items per second. Estimated download rates by media types are shown below (note: first graph is plotted on a log scale):

• App developers have been paid over $9 billion for their sales through the App Store including $4.5 billion in the most recent four quarters. I estimate the split between media types as follows:

• Canalys estimates that sales from iTunes App Store accounted for 74% of all app sales worldwide in the March quarter.
• iOS app revenues more than doubled year-over-year.

Including all (gross[1]) content revenues, the sales rate is now nearly $5 billion per quarter ($4.94 billion). Including services, the iTunes consolidated business cleared over $5.5 billion.

In March Apple reported that they have 500 million iTunes so one way to think about the iTunes business is to say that  iTunes users purchase content and services at the rate of about $40 per year.[2]

Bless them.

—

Notes:

1. “For third-party applications sold through the App Store and Mac App Store and certain digital content sold through the iTunes Store, the Company does not determine the selling price of the products and is not the primary obligor to the customer. Therefore, the Company accounts for such sales on a net basis by recognizing in net sales only the commission it retains from each sale. The portion of the gross amount billed to customers that is remitted by the Company to third-party app developers and certain digital content owners is not reflected in the Company’s Consolidated Statements of Operations.” From Apple SEC filing 10-K, October 2012.
   
2. Apple users spend about $1/day for each Apple device in use making the iTunes franchise an incremental 11% marginal revenue source (assuming one device/user.)

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I join forces with Pixxa, makers of Perspective, to present a workshop on the future of presentation.

After giving dozens of talks in the last year using an iPad with Perspective I’ve learned a few things. Having also spent years using Powerpoint to try to do the same thing, I’ve experienced first hand how slideware has gotten in the way of great storytelling.

So we teamed up to understand how stories come alive using data and drew inspiration from Aristotle, Welles, Tufte and Rosling to build a new theory of presentation.

We believe that we have summoned up enough cohesion in the theory to put it forward to an audience and tell the story of storytelling; practicing what we preach, so to speak.

Here are some of the questions we are putting forward:

• How and why are presentations different from one-on-one interactions?
• Can mobile technology help tell stories better than the Powerpoint metaphors?
• Is motion and interaction effective, and if so how can it be choreographed and directed?
• Does “camera position” affect the focal point of a story? In other words, should the presenter think of the camera as a character in the story?
• Can presentations be built more quickly and can the presenter obtain confidence without rehearsal?
• What are some of the constraints of venue and legacy AV equipment that perpetuate ancient dogma? How can the presenter eliminate or mitigate these constraints?

At a minimum, the workshop is designed to recruit and equip a new cadre (no more than 50) with a new algorithm of presentation built on rhetorical, theatrical and cinematic foundations.

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via 5by5 | The Critical Path #83: The Analyst Taxonomy.

The next milestone I have pencilled in is the 80% mark which I extrapolate to be achieved by October 2014. 80% could be considered “saturation” which would signify a rapid slowing of new user addition. However, that might still not happen until 100%, depending on the availability (or lack thereof) of non-smartphones to buy.

This time frame is important because it would imply that essentially all mobile users in the US (some 234 million) would be a part of one ecosystem in about 2 more years. That’s less than the life cycle of the typical mobile contract (and thus the life of one phone). Put another way, by the time a new buyer today is ready to buy the replacement to their phone the market will be saturated.

This implies the mode of competition will be changing to smartphone replacement rather than smartphone adoption. To some degree this is already happening but as the net user gains data shows only BlackBerry and Windows platforms have had any net user declines in the last two years. “Platform churn” is still a relatively rare phenomenon.

How that will change post-saturation will be a crucial determinant to platform growth. The data today points to a higher degree of loyalty for iOS users and potential erosion in the Android user base as a result. There are ways of forecasting this on the basis of survey data as Carl Howe did. However, the data from comScore has already begun to show that Android may have peaked around 54% share. Android share is now at the same level it was in July while iPhone share has grown by more than 6 points since then.

There is a pattern of higher growth into the end of the year and an iPhone plateau into the first quarter, undoubtedly due to holiday buying favoring the iPhone. I don’t want to discount the possibility of some change in this pattern but so far there seems to be a plausible reason for it: with iPhone pricing and availability in the US offering no advantages to alternatives, Apple’s product is the most popular. Nearly more popular even than all the other competitors combined.

To read more see Horace Dediu on the bad habits of Apple analysts and why Tim Cook shouldn’t be fired – The Next Web

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Note the “boundary layer” of pale blue Macs between the brown-hued Windows and the green-hued tablets.

Including tablets of all kinds, here is the market share growth in Windows PCs.

As the post-PC disruption evolves, Microsoft has made an effort to shift its business model. I discussed this some time ago and there remain quite a few questions about the sustainability of the strategy.

However, there might already be evidence that it’s working. The clue is in the growth in Windows revenues at a time when PC shipments (at least traditional ones) are declining rapidly. Some of that might be due to deferrals and software assurance revenues which are insensitive to shipments. However some have to be due to the Surface.

Remember that Surface launched with an RT version priced starting at $499 (which did not sell well) but received a boost in Q1 with the Pro version priced at $899 to $999. If we assume a 80:20 mix of Pro to RT and an average price of $950 for the Pro and $550 for RT, 3 million units would generate at least $2.5 billion in gross revenues. Accounting for retail margins of 20%, Microsoft could still be recognizing $2 billion in revenues. That’s a significant portion of $5.7 billion in Windows revenue.

We can back into this figure from another direction: Prior to Surface launch, the Windows revenue per PC shipped (combining Microsoft’s revenues and Gartner’s estimates) was about $50. After the Surface Pro shipped the revenue climbed to $73/PC.

Assuming the same pre-Surface revenue/PC and given the shipment figures for Q1 we would get about $3.7 billion for Windows. The difference to actual revenues is about $2 billion.

So the extrapolation of Windows royalties approach yields $2 billion in Surface sales and the Price x Units estimate also yields $ 2billion. It would suggest that Surface has had a significant impact already: More than a third of Windows revenues depend on it.

[UPDATE: I’ve been informed that not all the Windows tablet sales reported by Strategy Analytics are Surface products. As many as 1 million might not be. That would reduce the revenues as calculated to about $1.4 billion. In addition, not all Windows revenues are current with much of that deferred. Actual revenues were $4.6 billion. With both of these adjustments considered, the impact of Surface might be only 30%.)

5by5 | The Critical Path #82: Adding Rows.

• Cumulative app downloads have surpassed 45 billion
  
• Payments to developers reached a cumulative total of $9 billion
• Payments to developers were $4.5 billion in most recent four quarters
• Now paying $1 billion to developers every quarter
• 800 apps are downloaded every second
• iOS app revenues doubled since year-ago quarter
• App Store accounted for 74% of all app sales in the quarter (citing Canalys)
• App stores reach customers in 155 countries (850k Apps, 350k iPad apps)
• iTunes music downloads are available in 119 countries (35 million songs)
• Movies are sold in 109 countries (60k titles)
• iBookstore is available in 155 countries (1.75 million titles)

This data allows for a few inferences:

• Nearly 70 million apps are downloaded every day
• The average revenue per game is about 23 cents
• Gross app revenues are about $16 million per day (of which 11 million is paid to developers.)
• Gross iTunes revenues were $5.4 billion last quarter of which I estimate:
•  …App revenues were $1.6 billion
•  …Music revenues were $2.2 billion
•  …Video revenues were $287 million
•  …Book revenues were $312 million
•  …Apple’s software generated $1 billion
• In addition, I estimate that Services generated $100 million

Note that there is a difference between the amounts transacted through the store and what the company reports. The difference is shown in the following graph

To mark it’s 10th year, I wrote a segment for Billboard Magazine describing what iTunes has become. I suppose it’s easy to become numb to these numbers, but there is perhaps one way to look at iTunes that is still compelling:

Selling $20 billion a year would put iTunes in the top 20 US retailers and top 50 Global retailers.

Not bad for a 10 year old.

In the March quarter, our gross margin was 37.5%. It was at the low end of our range. We had a few items that on balance resulted in us reporting at the low end. They included mix, in particular, selling more iPads than we had planned, including getting iPad mini into our four- to six-week channel inventory range, some changes in our service policies that required us to make provisions for prior quarter sales, and we had some unfavorable adjustments.

- Peter Oppenheimer, Apple CFO, FQ2 2013 Earnings Conference Call

[my emphasis]

Thanks to Philip Elmer DeWitt for bringing this quote to my attention in the comments to Margin Call 2.

I was curious about the “changes in service policies” and what that might have meant, especially since they seem to have been retroactive (provisions for prior quarter sales).

The 10Q offers more details:

Accruals for product warranty for the three months ended March 30, 2013 include $414 million associated with product sales in prior fiscal periods reflecting the impact of changes to certain of the Company’s service policies and other estimated warranty costs. Of this amount, $224 million is associated with product sales in the first quarter of 2013, and the remainder is associated with product sales in 2012.

- Apple 10Q, Note 6, Page 17, second paragraph.

These service policy changes were made around April 1st and were in response to editorials in the People’s Daily, the official paper of the Chinese Communist Party. Though seen as a PR issue, their impact goes beyond the company’s image. Changes in warranty policy implies setting aside some of the revenues as an expense, increasing the cost of sales and reducing margins.

The 10Q says that $190 million of the additional warranty set-aside was for prior quarters and that $224 million was for the March quarter.

If we were to subtract the $190 million from the cost of sales the gross margin would increase from 37.50% to 37.93% and if we subtract the full $414 million the gross margin would increase to 38.44%.

The calculations are shown in the following table:

If we read 2012 and 2013 as meaning fiscal years then the entire $414 amount is for prior periods (i.e. not for the current quarter) and the gross margin for Q1, excluding one-time items, would be nearly 1 percentage point higher than reported.

The effect of the change in policy would have been very difficult to anticipate when estimating the gross margin, even for Apple’s own team three months ago.

It’s also important to note that this does not say much about the supposed effect of competitive pressures on Apple’s margins. 38.44% gross margin is not as good as last year’s, but they’re pretty good.

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For a company selling hardware these are extraordinarily high margins. They are higher than those of Google and have narrowed the gap with Microsoft,  neither of which has a high proportion of hardware sales:

But they are not growing and the reason is to be found in the reason they grew in the first place: because of proportion of iPhones making up the total sales.

As a reminder, the iPhone is a uniquely profitable product. I estimate that it obtains about 50% gross margins. The history of these estimates is shown below:

It remains in stark contrast to the margins Apple obtains for its other products. Much of that is due to the pricing power of the product as shown below:

Notice that even after the launch of the iPhone 5 and the persistence of two previous generations of iPhones (and their lowered pricing) has barely put pressure on pricing.

Contrast that with the iPad. As its breadth of offerings increases, it causes a lower price per unit.  The iPhone is now at $613 per unit, even with two older generation products available. (The lowest price was in Q2 2012 when the average price was $608.) The iPad is at $449 per unit, down from $662 at launch three years earlier.

So overall, margin is a function of three things:

1. Price changes: iPhone had a small reduction (from $635 to $613) but the iPad has had a moderate reduction in price (from $531 to $449).
2. Cost of components: This is reflected in product-line gross margins which can only be estimated. Compared to last year I estimate that iPhone gross margin dropped from 58% to 48%. iPad margins also fell from about 38% to 27%. The reasons were given by management as “Last year, our business benefited from …a more favorable foreign currency environment, and historically low costs.”
3. Mix of high and low margin products. The iPhone units grew at 7% but the iPad units grew by 65%. A year ago iPhones were 58% of revenues and this year they were 53%. The iPads were 17% and now they are 20%.

The result is seen in this one graph showing the allocation of revenues and margins by product:

So what is surprising? My expectations were met in terms of iPhone units (and exceeded in terms of iPad units). The mix was also something that falls out of the unit expectations. The pricing is also not  surprising.

My guess is that the largest contribution to the “reduction of margin” is the increased cost of components. Note that the graph implies that even though iPhone revenues were nearly flat at 3% growth, the cost of those revenues went up by 29%! In addition, the iPad revenues grew 40% while costs went up 65%.

Unit pricing (and implicitly competitive pressure) is still not the primary cause of the reduction in Apple’s margins. Indeed, the curious thing is that margins are now at levels seen for most of 2009 and 2010, a time when the iPhone (and iPad) were seen as near monopolies in their respective categories.

I will be in Australia in May and thought to invite local readers to join me for a few hours of in-depth discussion on the future of our industry.

I plan to have an event in Sydney on the 3rd in the morning (9:00 to noon at the Radisson Blu 27 O’Connell. Press Room) and in Melbourne on the 6th in the afternoon (1:30 to 4:30 PM at Victoria University City Flinders Campus: Level 12, Function Room 4, 300 Flinders Street, Melbourne, VIC, 3000).

Nominally, the topic will be: The history and future of computing using disruptive analysis.

I will present recent material (including the latest data from Apple) and we will have a few hours of Q&A.

Tickets are $120 and seating will be limited to 100.

You can register here: Asymco Workshops Australia 2013.

via 5by5 | The Critical Path #81: Continuous Flow.

I repeat what I’ve mentioned before: The iPhone is primarily hired as a premium network service salesman. It receives a “commission” for selling a premium service in the form of a premium price. Because it’s so good at it, the premium is quite high.

The job the iPhone is hired to do 

The original post on the hiring of the iPhone by operators was anchored in data about the revenue per unit (or price) that the product was able to obtain. The remarkable resilience in the exceptionally high average price showed that the iPhone was still getting a premium for moving users to higher levels of spending on network services.

The evidence was circumstantial however: By knowing the price and knowing it was far higher than competing products and knowing that much of it was paid by the operator and not the consumer (at least not up-front) implied that it was the iPhone, and only the iPhone, that was hired as a network service sales tool.

Now we have more evidence thanks to Ben Thompson (@monkbent). I illustrate the data here as an x-y scatterplot.

The data consists of ARPU (Average Revenue per User) ITU data from 2010 for 60 countries combined with browser share data on a country-level from the current period (sourced from StatCounter).

The first observation is that there is a modest correlation between iOS usage and ARPU. It may not be particularly interesting by itself but it is interesting when compared with the lack of correlation between Android usage and ARPU.

The presumption behind smartphone usage is that it leads to more browsing which leads to more network usage which in turn, leads to more network revenues and, finally, more network investment. If there is no additional browsing then there is a far smaller economic incentive to network operators to invest in infrastructure. It is this link between usage and revenues which I hypothesize drives operators to carry, subsidize and promote the iPhone. And the resilience of this link indicates that it still works.

The ASP data seems to support this hypothesis and so does the ARPU data. The more iOS is in relative use, the higher the network revenue per user. Correlation is not causation, but when combined with data about Android, we can also say that the presence of the primary iOS alternative does not lead to more revenue. In other words, if a lot of iOS is present then revenues are higher and if there is little iOS present then revenues are not higher.

I’m not suggesting that Android users use less bandwidth—the share data is after all relative—but rather that Android use itself does not seem coupled to paying more (or less) for service.

If there is something to be concluded it’s that not all usage is created equal. The data regarding how apps and ads are consumed is consistent with a qualitative difference between iOS and Android. This data is more of the same.

It’s something of a cliché to say that audiences vary in terms of quality, but that does not make it less true. Indeed, network operators depend on it being true.  And so does Apple.

1. What are the truth and false about the ‘Apple shock’ currently? In what perspective should we see this?

First, I’d point out that during Steve Jobs’ time the company suffered many such shocks. The stock fell many times far further than it just did for trivial and irrational reasons. Recently Warren Buffett himself pointed out that his own company had 50% drops in value four times in the past. Share prices are not always good indicators of potential and markets are not always efficient. I catalogued the dramatic share price declines in Apple during the last decade here.

Second, I’d point out that the number of people watching and commenting on Apple has grown almost as fast as its sales and earnings. When Apple was small the people who studied Apple were few. (You could see this today for other, modest tech companies. There aren’t 50 analysts writing reports every day and 2000 bloggers tweeting about Lenovo even though it’s a successful and growing PC company.) Because of this growth, I would guess 80% of the observers have not observed Apple’s prior painful episodes first hand. For them this is the first time a “dominant” Apple has slowed. The amplification of so many voices raising alarm makes it seem truer, but it isn’t.

Third, the failures being cited are not significant. In terms of increased competition, before Samsung there was Nokia and Motorola and the mobile Operators and Microsoft and Dell and many others long forgotten. They were all about to “defeat” Apple. As a quick example when Apple was “the iPod company,” iTunes was considered vulnerable and fragile due to DRM concerns or the Beatles not being on it. Microsoft was launching “Plays for Sure” and Zune and Creative was suing Apple over patents. These battles are long forgotten. Before those there were concerns about the viability of the Mac that go back decades. At the time those were actually very valid concerns. At the time Apple did not have half a billion users. It depended on one product. But what saved them was a process of development of new products not the products themselves. iPod faded, Mac faded. What mattered is that they created new things to replace them.

Finally, what is not commonly understood is that the mechanism for creating things at Apple is unchanged. Its functional organization is inherently unstable and chaotic, sometimes looking like it will derail. But that’s the way it was designed to be. You just have to have faith that it’s a system that works. Those who did in the past were well rewarded.

2. What possibilities out of 1~10, do you think, Apple will suffer the same downfall as Steve jobs has left the company in the past in current?

The threat is negligible. During the first departure of Jobs, the intention of management was to make the company into “a proper company.” The plan was, essentially, to remove the chaotic model that Jobs had put in place and replace it with something more “rational” and “grown up.” After he returned he set about not just returning the company to the way it was but to also codifying and identifying exactly what that was so that it did not happen again. You have to appreciate that the greatest thing Jobs ever created was not a product but Apple itself.

Note that Apple managers stay in their roles the whole time they are there, sometimes for decades. There is no “general purpose” manager and the whole company has been organized along these functional lines. The way to think about it is that during his first departure the new management tried to undo what Jobs had built which is why it became dysfunctional: the DNA did not match the body it was operating. His return re-aligned the culture and operations to what was originally developed. As long as new management does not try to undo that, they’ll be all right.

3. Apple is now defined by some people, as ‘the company who modifies well’, not ‘the company who innovates’ well. What they made was ipad, ipod, iphone, apple tv and all the modifiers of the original products. Do you agree? If you do why?

Innovation is not invention. Innovation is the application of invention in ways that solve new needs. I’m always amazed at how misunderstood this term is even though the definition is easy to understand:

(“Innovation differs from invention in that innovation refers to the use of a better and, as a result, novel idea or method, whereas invention refers more directly to the creation of the idea or method itself.”)

Apple is an innovation machine. It does invent but that’s not valuable in itself. Not all inventions are applied and not all innovations depend on internal inventions. Innovation is applied invention just like engineering is applied science. A better way to think about Apple is to think about Pixar. It’s a blockbuster manufacturer. It makes blockbusters and nothing else. That means it does not make many of them and not always regularly and that the ideas may not be original, but the results are always very popular. Pixar is not like any other studio that makes some hits and some flops. Pixar is also a functional organization. It’s not an accident that they were both built by the same person and that they are both successful after he left.

4. Google is forecasted to release lots of products this year, but Apple isn’t really looking forward to so many innovations. Inside Apple, is the innovation team really making a new innovative product? what are their longterm plans to fight with Google, or Samsung and the rest of the competitors?

People outside of engineering organizations, especially large ones, don’t appreciate the time scales involved. Products you see today were designed, planned and developed many years ago. We see plenty of evidence of this but we tend to ignore it. Consider that some prototypes end up on ebay showing they were built years before launch. It is the same with evidence presented in trials proving work on the product 4 to 5 years before it was launched. This is not the case just for Apple but all other technology companies.

For this reason, what is happening in the market and what is happening inside the company are two completely different universes. The tendency is to assume a direct relationship between market momentum and current management decisions. These are connected but with many years in-between.

For example, globally accurate Maps require a minimum of five years of development. Decisions on what ended up being Apple Maps had to have been made by Jobs himself. Namely, he must have decided whether to buy or build Maps. Contrast with Nokia’s decision in 2007 to buy maps for a cost of $8 billion; instead Apple licensed and then decided to build later. In 2007 Jobs decided that it was more important to work on the product itself, meaning the iPhone (while Nokia didn’t prioritize product innovation.) The results are visible today: Apple is behind and needs to accelerate with Maps and Nokia with its great maps must find a way of staying in business.

Apple is not only working on the next product but probably 15 new products, of which 14 will be discarded. Again, I cite Pixar. Each movie is produced with multiple stories, multiple character decisions and different plots in parallel. Much ends up being thrown away. We don’t see any of that.

Apple is extremely “myopic” in that it is very concerned with execution and there is no visible “strategy plan”.  That’s by design. The product comes first and then comes the market and then comes strategy. To create great products you need to tune out almost everything else. However, they do have a “strategy” and that has to do with which problems they should attack and which they shouldn’t. Usually they are successful because what they can attack nobody else can. That is due to their integrated, functional approach.

5. Isn’t Apple, relying too much on semiconductor manufacturers? Meaning, isn’t Apple only try to be ‘stable company’ to supply their products on time? sometimes when companies have disruptive technologies, they have hard time supplying products.

You’re touching on the question of the problems of integration. Yes, there are vulnerabilities but that’s the way it has to be. To mitigate this Apple is increasing its integration of the value chains. For example developing its own chip design and owning a lot of capital equipment.

6. If you were Tim Cook, what would you do?

I’d buy Intel and turn them into Apple’s microprocessor design and manufacturing group. They won’t have much to do in a few years and they’ll be cheap.

7. what are the reasons that Apple try to make a ‘apple watch’, ‘apple bicycle’? How do you define these products, since, watchs and bicycles are a total different paradigm which is a totally different industries? Is Apple realizing that smartphone industry is hard for them to innovate?

Computers are becoming more personal, intimate. It’s a natural evolution from large to mini to micro to portable to handheld. I don’t see this slowing and Apple should re-define the user experience during every such shift. Here again integration is essential.

8. what are some of the stuff that we don’t know about Tim Cook?

I can’t help you there. Only thing I can say is that people who know him have told me he’s not soft and gentle as a manager. He’s tough.

9. How will Samsung and Apples patent fight come to conclusion?

Again, I can’t add much to this. Litigation is often a decision made outside of market conditions so it can be arbitrary.

10. how does employees or executives inside apple think about their company?

It’s hard to describe this without sounding soft, but the employees at Apple tend to love the brand. You can’t measure that but I can think of one proxy: the number of applicants to retail jobs are in the hundreds for each opening.

[Update: Bono made an important observation regarding Jony Ive which was published after this interview: What the competitors don’t seem to understand is you cannot get people this smart to work this hard just for money. Jony is Obi-Wan. His team are Jedi whose nobility depends on the pursuit of greatness over profit, believing the latter will always follow the former, stubbornly passing up near-term good opportunities to pursue great ones in the distance]

Lumia sales have increased to 5.6 million units last quarter. Up from 4.4 during the previous quarter. Symbian devices have nearly disappeared from the market with only 0.5 million shipped.

This puts an end to Symbian sales after over a decade since sales start and two years after it was declared that sales would end.

The bad news remains that smart devices as defined by Nokia are still not profitable. If volumes grow it’s possible that the cost structure (without further cuts) can be sustained and perhaps the business will get its footing.

The level of 6 million units/quarter is about where HTC and RIM are today but only half of what ZTE and Huawei are probably shipping. As a hardware business it might work, barely. It certainly helps to have $250 million as platform support payments from Microsoft.

As a platform it’s still a very long haul for Windows Phone. Even if we assume a nominal $15 revenue/ Windows Phone license and ignore the kickback, at this level of sales the platform generates less income than what Microsoft gets from licensing IP to Android vendors.

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The best and brightest are usually put to work on optimisation, and asked to improve the way things work. ‘Can you make it better, faster, and stronger?’ They will then go forward and solve the inefficiencies, and that’s where 99% of most energy is spent on. But, at some point you run out of room to improve things, and that’s when you have step aside and ask, can we make it different?

via Horace Dediu: Asymco Interview – Why Businesses are more Fragile than People.

Be sure to check out my “Favorites”.

via 5by5 | The Critical Path #80: Functional Structure.

What remains undocumented however is how the market looks when considering economic value. A more complete picture would be to show revenues, average selling price (or revenue/unit), operating margins/unit and percent of profit capture.

The data is not beyond reach however. It involves combining the shipment estimates from e.g. Gartner with financial reports from the companies themselves. Some analysis is required to estimate margins but they are also not hard to obtain (e.g. from third parties.)

So here is a view of the market for the fourth quarter 2012:

The only inference I made was with respect to Apple’s margins for the Mac. These are based on deriving a gross margin of 26% and adding an estimate of the SG&A and R&D “overhead” of 7.1% of sales, a figure which applies to the entire company. This yield an operating margin of 18.9%.

If this estimate is considered then the operating profits from PC operations imply that Apple generates more profit than all the top 5 PC vendors combined.

Assuming further that “other” vendors have the same profitability ratio as the top 5 combined yields a figure of 45% “profit capture of PC market” for Apple. This is not as good as its performance in the phone market, where Apple has about 72%, but it’s not bad.

The real problem for the PC vendors is not that they have such low margins–they’ve had low margins for decades. It’s that the volumes which “made up for” low margins are disappearing. Apple is not immune to a gradual erosion of Mac volumes, but they have positioned themselves for growth with devices and content commerce and services. They have essentially “escaped” PCs and indeed caused the need to escape in the first place.

The problem is what could the others do? It seems all they can do is depend on Microsoft getting their strategy right.

Sounds risky.

(I added Q1 2013 estimate based on company guidance.)

One can understand why, from a practical point of view, they want to consolidate what amounts to at least twice as many people back into one place.

But there is also a more subtle reason and it has to do to a fundamental distinction: Apple is a functional organization. Unlike almost every other large company it’s not organized in “divisions” which have responsibility for “a business” in the sense of profit or loss. At Apple most people or teams are assigned a function like “design”, “engineering”, “sales” etc. When a product is being built, they are assigned to that effort. When the product is complete, they go to another product.

This is not a matter of hypothesis. Not only have we heard rumors of how one product was delayed (e.g. OS X) because the teams were busy finishing another (iOS), but Adam Lashinsky’s work (sanctioned by Apple as it was) revealed the structure almost two years ago.

This structure may seem obvious to those working in small companies, but it’s completely unheard of in large companies. The nearest comparison to this structure is a military organization. There you have Infantry, Armor, Aviation etc. These groups are assigned (in a combined fashion) to a particular effort or battle and then go back to the barracks when done.

Another example is the way movies are made. Disney famously built his company around the same principle.

Seen from this perspective, the architecture of their proposed campus makes perfect sense. If it was a divisional structure then each division could live in its own building or campus. In fact, each division would not have much to talk about to any other division. But as a functional organization Apple needs to move people quickly between projects. It needs to re-configure itself frequently. Being in the same building means they can do this much more efficiently.

This is why there needs to be one building and this is why the shape chosen is probably optimal: each point within can be reached with minimal routing. The fact that it’s aesthetically pleasing is a coincidence.

Or perhaps not. Some say that in beauty there is truth. At least to me, the design looks to be pure logic.

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That number is 74.8 million units. In the first quarter of 2012 the corresponding calculation yields 85.1 million units. That makes Windows PC rate of decline -12%.

The historic shipment data and growth rates are shown below:

Note that tablet data is not yet included in the shipments summary. Windows shipments are shown in shades of Brown and tablets in shades of Blue/Green.

The decline in PC shipments is persisting and even accelerating.

Coming only a week after the iPad’s launch birthday, it’s perhaps a fitting testament to its impact.

—

I’m going to try to put together an analogy together here that maybe will help us think through the Facebook Home and the Google Fiber issue.

I’ve been thinking a lot about how to illustrate Google’s business model. The problem is that discussion has been polarized: Two camps have formed. One camp suggests that Google is a benevolent entity that does great things and only asks that we indulge their hobby of a business model called advertising. Fundamentally they are about pushing the envelope on technology, making wonderful things happen.

That is one camp. I call them the utopians. It may not be a nice thing to call them but I frame it as being exceedingly idealistic.

The anti-utopian camp is one that suggests that Google is an advertising company primarily, and fundamentally and overwhelmingly. And anything they do technologically is in support of that. The implication is that Google is sinister and manipulative, bent on getting away with as much privacy extraction as possible.

I believe that the anti-utopians dismissing Google as an advertising company sounds a bit incomplete. It’s not incorrect. It’s not erroneous. It’s just not a complete story.

And also the utopian view that they do everything for us out of the goodness of their hearts and that advertising is something that they are reluctant to do, saying in effect, “We only do it because it earns us enough money so that we can do good deeds.” That too is not an accurate picture. Google is a business and its business management team is hard nosed and knows what they’re doing and they are not purely idealistic in that sense.

And so the question could be where across this spectrum does Google lie? Possibly it moves around between these points. Where they are becomes a question of motivation and what they want to become.

But this is only one dimension. It does not help us answer the question of Home, or Fiber or Reader or Blink. Their actions seem contradictory. Holistic or selfless in one case, greedy and capricious in another.

Let’s step out of this spectrum and try to think of different ways which can describe the situation.

I propose a way to think about it as: Google tries to make a business succeed through having a huge amount of _flow_ in terms of data, traffic, queries and information that is indexed. So think about this idea of them tapping into a vast stream. The more volume that is flowing through the system the more revenue they generate.

As so given this very rough analogy I try to sharpen it up by saying: imagine it more as a river. And even more than a river, as a watershed, a river basin. Perhaps a giant basin the size of a continent. The business is, let’s say, capturing fish at the mouth of the biggest river, before it exits into the ocean at its delta.

And so your job (as Google) is to catch fish mostly at one point. It’s the most efficient way to catch fish because you have the most flow of water at that point and building nets is not trivial.

But in order for you to improve your business, to create more opportunity, presumably, you want to essentially have more water flowing.

And so how would you do that? Think of the Mississippi river. If you’ve got a net down at the bottom of the river, the question is how would you engineer, through civil engineering, or shaping the earth itself, a way of catching more fish.

The answer I think, in terms of the way Google might be thinking, is that they want to create more sources of water. So they would look to connect tributaries and lakes. “How about having another river join our river?” Let’s make sure that we have “everything east of the Rockies” flow into our river system.

Now, think of it this way: After you’ve gotten all the tributaries, what are the remaining sources?

First, you’ll want to make sure that no-one can dam or stop the flow of water into your main channels. And so you become extremely anxious about people building dams. That’s the number one concern.

So your strategy becomes one of “how do we avoid dam building”?

That’s one part of your strategy.

The other thing you could do to improve your business would be to make it rain more. So there’s the question in your mind of: If we had more rainfall, then everything will flow more rapidly and we’ll get many more tiny rivers forming and joining together into our main river.

Android and the Fiber business and even Facebook fit into this analogy rather well. In this context more rainfall means more people using the Internet. If you have more people you’ll have more rivers and you’ll have more water and hopefully more fish. Fiber means the water will flow more rapidly: you’re essentially dredging the riverbed.

But the two are very disconnected (rain, dredging and fish). So your strategy amounts to not really worrying about the ratio. You don’t create incentives to people who make rain in the form of fish catch quotas next quarter.

In other words, your performance as a manager of cloud seeding efforts should not be measured in fish.

Leadership should instead simply put out the mandate of “Go out and make it rain”.

So that’s the notion of Google going out on these projects and doing all these “great things” for us. They make it rain. The Internet expands. There is minimal censorship.

By the way, censorship is a dam. Being blocked out of a country is a huge dam. It’s actually more like building a mountain range that diverts water flow away from your watershed.

And so they have these notions of how to prevent these things from happening.

So it sounds like they are doing good things. It sounds like asking for it to rain; they want to make sure that people don’t divert resources; they want to make sure that there are no barriers between the raindrop and getting access to the channel to the ocean.

So it sounds like they’re doing all the good things like a good civil engineer. Like the US Army Corps of Engineers who developed the irrigation, flood control, energy generation and waterway transportation of the United States.

Google seems to be the world’s “internet civil engineer”. They are building all these things to make sure that we have good water (i.e internet) supply. That we have plenty of navigable channels. That’s the analogy.

But let’s not forget that the only reasons those things are happening is because they are catching fish at some point down the Mississippi.

From that point of view you have to ask yourself: do they deserve this concession? Because they are ultimately affecting the environment to such a degree; and the environment is the internet; and the whole scope is how the world operates.

That is where people have to step back and ask themselves: Even a group of civil engineers that have all the best intentions may realize that they didn’t think of all the consequences of their actions. A lot of the criticisms may come decades later. From people who’ll note an effect on the environment. Dams get silted, a lack of floods reduces nutrients to crops which then need fertilizer, which has a whole other set of problems.

That is when you have to reflect more deeply on what is right and what is wrong. So saying, as the City Council of Austin might: thank you for coming and paying for installing broadband for us. Fine, but we just don’t know what the unintended consequences might be. It all _sounds_ good but we don’t know if it _is_ good.

And similarly, in the case of Facebook, there is a subtle hijacking going on where Android creates more rain, and Facebook and Amazon are essentially putting down nets and catching fish upstream. They’re not damming the tributaries. They’re not putting up mountain ranges and saying they’ll make sure the water flows away from the Mississippi. But rather they are putting nets and saying “Thanks for the rain”. They took advantage of what amounts to a public resource. Here the failure of anticipating consequences falls on Google. But they could not have possibly foreseen all that? Or could they?

Then there is the question of measuring success. It’s complicated and hard to measure performance. Even Google’s own performance. We don’t really know if the cloud projects work. We don’t get to run this as an experiment that can be tweaked as data comes in.

Google does not report performance. When they go off on these rain making projects, it’s natural to ask how many fish were caught as a result. Is that incremental new rainfall causing more fish to get caught. And Google won’t say anything about the profitability of rain making. They will never give you a profit and loss statement for all these projects: the dam eradication project, the project dredge a channel, the project to seed clouds. They will say that these are projects that will result in only one thing, which we do measure, which is the number of fish we catch in the delta of the Mississippi down by New Orleans. But so far although rainfall seems to be increasing exponentially there are not that many new fish.

So that’s where we struggle as analysts: is rainmaking good? Is the dam destruction process working? We can’t answer these question. And we don’t even know if Google themselves can. They might think of it as a strategic thing: it’s always better to have more rain than less and more water flowing. End of discussion.

To borrow a phrase from Zuckerberg, it’s above my pay grade to know what all the consequences are. I have opinions as environmentalists have opinions and sometimes they have some data to back up those opinions. For instance whether a dam project is a good thing on balance. But they are bound to have partial answers because the cost/benefit analysis is definitely missing a lot of the costs and missing a lot of the benefits as well. You can’t put a number on a lot of these things.

That’s where we are today. Google and Android are forces which are are very powerful but which are, to a large degree, uncontrolled, even by their own managers.

via 5by5 | The Critical Path #79: Make It Rain.

This was a good one.

Q: Why is Samsung creating Tizen?

A: I believe they are collaborating on Tizen development because they want an alternative to Android and because Bada was not good enough to meet that goal. Tizen’s roots include contributions from Intel, Nokia and several Japanese companies so it’s not Samsung’s OS per se. Historically it was the “open” alternative operating system for embedded and mobile systems. See https://github.com/kumadasu/tizen-history/blob/master/tizen-history.pdf for a historic perspective.

In some ways Tizen seems to be a blend of several pieces of code including proprietary Samsung user interfaces. Samsung is presumably interested in having a unique, differentiated experience. This is something every device maker seeks. Put another way, if they did not seek this then it’s unlikely that they would be profitable which would also imply that they would not invest in marketing and development of products. As Samsung invests both in marketing and development it can be concluded that they seek to offer a unique value proposition and, in today’s market, that means a unique experience.

Does it make sense to create a new mobile OS when it has had so much success with Android?

Samsung would argue that the success it’s had is not due to Android but to its products. Arguably they are right because if Android were the valuable component in a phone then buyers would buy the absolute cheapest device that runs Android regardless of brand. That is not the case. People still seek out a particular brand of phone because of the promise it offers. Consumers have been buying more Galaxies than no-name Android phones.

Why is Samsung the most successful company between the Android devices makers?

In my opinion it’s due to three reasons:

1. Distribution. Success in the phone business depends in having a relationship with a large number of operators. Samsung had these relationships prior to becoming a smartphone vendor [because it sold all other kinds of phones]. Few alternative Android vendors have the level of distribution Samsung has. For comparison Apple has less than half the distribution level of Samsung and most other vendors have less than Apple.
2. Marketing and promotion. Samsung Electronics spent nearly $12 billion in 2012 on marketing expenses of which $4 billion (est.) was on advertising. Few Android vendors (or any other company) has the resources to match this level of marketing. For comparison, Apple’s 2012 advertising spending was one quarter of Samsung’s.
3. Supply chain. Samsung can supply the market in large quantities. This is partly due to having their own semiconductor production facilities. Those facilities were in a large part built using Apple contract revenues over the years they supplied iPhone, iPad and iPod components. No Android competitors (except for LG perhaps) had either the capacity to produce components or the signal well in advance to enter the market in volume as Samsung did by being an iPhone supplier.

Tizen was being treated as an OS for low and mid level devices, but recently Samsung said that it will launch a high-end device with Tizen on Q3, an area where it’s very successful with Android. What has changed? What does this announcement mean?

Planning for these product launches is done a few years prior to launch. I believe alternatives to the Android line (i.e. Galaxy) have been planned for a long time. Note that Samsung also has a line of Windows Phones and historically has supported Bada, Windows Mobile, Symbian, PalmOS and LiMo smartphone platforms. Samsung’s involvement with Android is only about three years old, and arguably only enjoyed two years of prominent growth. That’s less than one product launch cycle and far less than a platform or OS development cycle.

I believe the company has a long term perspective and that includes a time span beyond the likely lifetime of Android [Note that platforms do have finite lives]. Keep in mind that phones last less than two years. If users are not loyal to a platform then they will very quickly move on. The “stickyness” of a platform depends on media or software consumption by the user. That level of consumption is not particularly high for most Android users. The same phenomenon happened with Symbian and BlackBerry and Windows Mobile users. Hundreds of millions switched or will switch out of those platforms. This happens far less with iOS, Mac OS X and Windows because of the significant investments users make in the ecosystems above the OS.

Is Google dependent on Samsung’s sucess with Android? Or Samsung is more dependent on Android since its the most popular mobile OS nowadays?

Google is not dependent on Samsung because it’s not dependent on Android. Samsung is not dependent on Google because Samsung is not dependent on Android. Android is valuable in theory but in practice its value is hard to identify. Historically it was planned as a defense against the hegemony of Windows, BlackBerry and iOS. In that respect it has succeeded. But playing defense is not enough to win a game. For Google to truly succeed in mobile it needs to define a better business model.

So far its profitability from mobile is very weak and has not shown up in the bottom line. Furthermore, it’s probable that Google has ‘control’ over only about 40% of Android devices in use. Control here means a guarantee that users will use those devices for the benefit of Google, and, more importantly, not for the benefit of its competitors.

You can also think of it this way: If they “divorced” there would be minimal to no impact to their fortunes in the foreseeable future. Buyers of Samsung phones will still buy Samsung phones because they will look and feel very similar and Google services will still be available through browsers or apps (e.g. Google maps on iOS). Conversely, users of Google services will continue to use them because they will be available on Samsung devices, no matter what OS is running. The services Google offers are independent of Android and are cross-platform. They will make sure they are available on all major platforms (as they were before and during Android). Google is far more loyal to Search and Maps and Gmail and YouTube than they are to Android.

Do you think Google is going to merge Android with Chrome OS?

Google’s chairman said they would so I assume they will.

If so, how this could make an impact on Samsung?

It depends on how the new OS would enforce licensing terms. If the result would be a restriction on Samsung services like S Pen, AdHub, Samsung Wallet, SmartTV, ChatON etc. then Samsung might reject the OS and either fork Android or move to Tizen more broadly.

Overall penetration increased to 57% with nearly 2% of the population switching in one month. Using the average growth rate for the last six periods, the US could see 80% penetration in another 19 months or by Q3/Q4 2014.

It remains to be seen if the consistency of growth which was preserved from 20% to 60% is maintained between 60% and 80%, but all indications so far are that it will be.

The growth in smartphones has been driven by the two dominant platforms: iPhone (iOS) and Android. Together they now make up 91% of the user base with about 40% for iPhone and 51% for Android.

Android alone gained 17 million users in the last 12 months while iPhone gained 21 million users.

iOS user gains have out-paced Android for the last four periods which resulted in a decrease in Android share of users. A reduction in Android share was also visible in the spring of last year but the current decline is not only longer but more pronounced.

The reason iOS is growing more rapidly may be due to three factors:

1. Broader distribution with three out of four major operators carrying the phone
2. Availability of three product variants with $0 starting prices.
3. Increasing awareness and use of apps and content ecosystems due to network effects.

As distribution is about to increase with T-Mobile being added to the carrier list the growth in iOS share is likely to continue even as the market expands.

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In 2012 Samsung spent around $20 billion while Apple spent about $10 billion (excluding leasehold improvements or Apple stores but including real estate).

Compare these figures with Intel at $11 billion, Google at $3.2 billion, Microsoft about $2.8 billion and Amazon $3.8 billion (including presumably new distribution centers.)

What each company spends on differs depending on its business model, but as the graph above shows it’s easy to see that there is a class of “big spenders” who spend so much that it makes it hard to imagine just what $10 billion/yr could actually buy.

To get an idea of just how big that figure is consider that a Nimitz class aircraft carrier costs about $4.5 billion to build and it takes several years to do it. Or consider that the largest data center in the world probably costs about $1 billion or that the largest office building will cost between $4 and $5 billion. Either of these infrastructure projects are massive multi-year projects. Apple, Intel and Samsung spend well more than this every six months.

So it’s a special class of equipment which falls in the multi-billion dollar range: semiconductor process equipment.

Whereas in the case of Intel it’s the obvious target for the funds, how can we assume it’s the case for Apple and Samsung.

We don’t have proof but there is a remarkable correlation between CapEx and Semiconductors in Samsung’s divisional financial reports:

We also have the historically reported allocation of CapEx as reported prior to 2008:

Therefore I consider it safe to assume that the bulk of Samsung’s Capital Expenditures are in support of semiconductor production (note that this does not include display panels).

Note however that in the first graph, Samsung’s expenditures seem to be declining. Measured in Won, the level in Q4 ’12 was about the same as that in Q1 2010 and down 30% y/y. Apple’s spending also dropped sequentially in Q4 but was up 75% y/y. It’s also nearly ten times higher than what Apple spent in Q1 2010.

So the question I would ask is whether Samsung’s reduction CapEx (which is safely assumed to be supporting semiconductor production, and which, in turn, is, to a large degree, supporting Apple) is being picked up by Apple.

If so then then this would be evidence of the re-alignment of role and control in the value chain of a terribly important industry.

Whereas the launch of the mobile phone was probably an obscure event, the launch of the iPad was greeted with derision.

It is perhaps with irony that we should greet this auspicious confluence of anniversaries.