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Going where the money is

The bank robber Willie Sutton did not say, when asked why he robbed banks, “because that’s where the money is.” He did agree with the idea however saying “Go where the money is…and go there often”.

Regardless of it being apocryphal, this idea came to be called Sutton’s Law and is often taught to medical students. It’s similar to the notion of Occam’s Razor: when an obvious or simple answer competes with an obscure or complicated answer, pick the obvious one first.

These are sound analytical rules of thumb. When thinking about what products and services could arise in the immediate future, those most obvious and with fewest assumptions should be put forward first. The what part is relatively easy. The tough question is more about when will they emerge?

We now know that Apple will announce new products on September 9th[1]. This gives us an idea of when something will happen, answering the tougher question. It leaves the simpler question of what will emerge.

I put forward my predictions as follows:

  • Regarding iPhone, a tweet on product mix and pricing.
  • Regarding an “iWatch”, an answer to a question from Eric Jackson.
  • Regarding the potential for wearables, a post on the subject.

One more item has surfaced on the potential of payments processing which I want to address now.

Handling payments, to me, is a perfectly plausible activity for Apple mostly because the company has made quite a few comments on the value of their “customers with credit cards” and the effort that went into Touch ID (which seems to be extravagant relative to the value of rapid unlocking).

But one word of caution: if Apple does enable payments it’s important to realize that being a (payment) bit pipe is not a particularly profitable business. It will undoubtedly bind value to the iOS devices which make it possible, but I don’t think there will be a direct capture of profit from the transactions themselves.

Notes:
  1. I’ll be there and will report via Twitter and a special session of The Critical Path podcast []

Apparel is next

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

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

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

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

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

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

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

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

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

A few excerpts:

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

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

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

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

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

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

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

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

Lots more here.

Asymcar 17: 27 Quadrillion BTUs

Part I is a review of the “automotive stack” and note how there is no singular event that seems to affect disruptive change. From changing jobs to be done, modular design and manufacturing processes, powertrain evolution, urbanization, environmental interests, regulation and taxation.

Part II is a review of a framework of analysis based on sources and uses of energy.  Inputs, efficiency/losses, network effects and inertia, what can change and what can’t change.

For a shot of theory, Horace reflects on the dichotomy of efficiency vs. efficacy when it comes to predicting change in the sector.

via Asymcar 17: 27 Quadrillion BTUs | Asymcar.

The Critical Path #119: Creativity and Engineering

Predictions of the iPhone Portfolio, big screen phones and what they are good for, and a tentative review of Ed Catmull’s “Creativity, Inc”

5by5 | The Critical Path #119: Creativity and Engineering.

Cash exceptionalism

Prior to implementing a dividend and share buyback plan, Apple had accumulated about $120 billion in cash and marketable securities. In the eight quarters since implementing the cash return plan, Apple has paid about $21.5 billion in dividends and spent another $53 billion of its shareholder’s money buying its own shares and retiring them. That’s $74.5 billion in cash that’s been removed from its balance sheet.

To avoid some repatriation taxes it also borrowed about $29 billion.

Of course, in the meantime, it also generated cash from operations.

Before the plan’s implementation, eyeing the cash allowed for easy tracking of the accumulation of retained earnings. After the plan it’s become a bit more complicated. The following graph shows all the quantities involved:

Screen Shot 2014-08-18 at 8-18-2.09.00 PM

The graph lets us answer the question “What would have happened if Apple had not paid any dividends, bought back shares and taken on debt?”[1]

The answer is in the blue line. It would be about $210 billion today. There are about a dozen companies other than Apple worth more than that amount.

As the company is not growing as quickly as it used to, the slope of the blue line is constant (i.e. it’s nearly linear.) Though that might be seen as evidence of failure, it’s more useful to treat this vast quantity as a recognition of past successes. The company’s beleaguered status needs to be carefully preserved.

Notes:
  1. The grey and black area of the last column is the total “cash returned to shareholders” and sums up to the $74.5 billion mentioned earlier. The grey area is only theoretically valuable as it depends on the outstanding (i.e. not retired) shares retaining their value. In this case, the value of the shares grew, making this an actual gain for shareholders []

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Beleaguered

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

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

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

On Capital Allocation

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

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

Screen Shot 2014-08-13 at 11.36.03 AM

Best guess for how many iOS devices will ship in 2014

In October 2013, at the end of its last fiscal quarter, Apple stated:

The Company’s capital expenditures were $7.0 billion during 2013, consisting of $499 million for retail store facilities and $6.5 billion for other capital expenditures, including product tooling and manufacturing process equipment, and other corporate facilities and infrastructure. The Company’s actual cash payments for capital expenditures during 2013 were $8.2 billion.

The Company anticipates utilizing approximately $11.0 billion for capital expenditures during 2014, including approximately $550 million for retail store facilities and approximately $10.5 billion for other capital expenditures, including product tooling and manufacturing process equipment, and corporate facilities and infrastructure, including information systems hardware, software and enhancements.

These 10K (fiscal year annual) forecast figures for capital expenditures are shown in the following graph. Note that they also include the fiscal years from 2006 to 2012. Note also that the graph includes the actual expenditures (in green).

Screen Shot 2014-08-12 at 5.37.57 PM

From 2006 through 2013 the sum of the forecasts was $23.445 billion while the sum of the expenditures were $24.662 billion. With the exception of a carry-forward in 2012, the forecasts are broadly in-line with expenditures, with about 5% more spent than forecast.

This pattern of accuracy in spending makes a $10.5 billion expenditure during the current fiscal year believable. In other words, taking the forecast at face value, and given that three quarters of the fiscal year have already passed, what does it imply for the current and last quarter? The following graph shows what Q3 spending should be relative to previous quarters (and 2011, 2012 and 2013).