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The Critical Path #155: The New Production Method

Horace and Anders discuss car production methods, the BMW i3, tubular and composite frame construction and how Uber could change the landscape.

Source: The Critical Path #155

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Samsung’s profit center

Will there come a time when Samsung will earn more profits from the iPhone franchise than from its own Galaxy product line?

The problem for Samsung is that although it still sells the most phones[1], and the most smartphones, the price and margins for these products are collapsing. The pattern is shown in the graphs below:

Screen Shot 2015-07-30 at 7-30-8.20.29 PM

Screen Shot 2015-07-30 at 7-30-8.20.22 PM

Notes:
  1. over 80 million but we don’t have a precise figure []

The one where I offer stock tips

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

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

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

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

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

Onward.

 

How iPad Educates

The fact that the iPhone is contributing over 90% of the operating profits in mobile phone sales has penetrated even as far as the Wall Street Journal. However, it’s not yet commonly known that the Mac captures a majority of personal computer operating profits, at least when considering the sale of hardware.

My calculations suggest at least 60% of operating margin in personal computing hardware is captured by Apple. This is mainly due to the fact that the average Mac sells for more than $1200 while the average PC sells for less than $450.That is equivalent to $1.5 billion per quarter for Apple vs. $930 million for all the other PC makers combined.

Screen Shot 2015-07-17 at 12.16.27 PM

If we are to consider the iPad as a “PC equivalent” computer[1] then another $billion/quarter is contributed to the profit pool. It increases Apple’s share of profits to 73%. As a result, Apple absolutely dominates computing profits.

Notes:
  1. for a substantial minority of tasks []

Apple management answers questions on the market performance of Apple Watch

Katy Huberty (Analyst – Morgan Stanley): You’ve said in the past that the watch may take longer to ramp given the new category and new interface to customers. Is that, in fact, playing out? Is the watch ramping slower than past product categories?

Tim Cook (CEO): Katy, when you use the word ramp, do you mean from a — I assume you’re talking about supply?

Katy Huberty (Analyst – Morgan Stanley): Yes. Pre-orders and first week in sales and any other data points that you track in terms of interest versus, say, when the iPad launched in 2010?

Tim Cook (CEO): Let me talk about supply and demand and sort of separate those two. Right now demand is greater than supply. And so we are working hard to remedy that.[1]

We’ve made progress over the last week or so and we’re able to deliver more customers an Apple Watch over the weekend than we had initially anticipated. We’re going to keep doing that. […] So I’m generally happy that the — that we’re moving on with the ramp.

It is a new product for us, and with any kind of new product, you wind up taking some time to fully ramp.

Having said that, I think we’re in a good position. And by some time in late June, we currently anticipate being in a position that we could begin to sell the Apple Watch in additional countries. And so that’s our current plan.[2]

From a demand point of view, it’s hard to gauge when you don’t have product in stores and so forth. And so we’re filling orders completely online at the moment.

The customer response from people that have gotten theirs over the weekend have been overwhelmingly positive. And we’re far ahead of where we expected to be from an application point of view.

To give you a comparison, when we launched the iPhone we had about 500 apps that were ready. When we launched iPad, we had about 1,000. And so our internal goal was to be able to beat the 1,000 level and we felt — we thought it would be great if we were able to do that by a little bit.

And as I’ve mentioned before, we now have over 3,500 apps in the App Store for the Watch. And so we couldn’t be happier about how things are going from that point of view.

We are learning quickly about customer preferences between the different configurations. There’s a much larger breadth of possibilities here for customers than in our other products. And in some cases, we called that well and some cases we’re making adjustments to get in line with demand.

But I’m really confident that this is something we really understand how to do and will do. And so I’m really happy where we are currently and happy enough that we’re looking forward to expanding into more countries in late June.

[…]

Gene Munster (Analyst – Piper Jaffray and Co.):  …question for Luca, in terms of any thoughts on what the margin impact from the Watch as that ramps over the next couple of years?

Luca Maestri (CFO): Apple Watch is, not only a new product, but it’s a brand new category with a lot of new features, a lot of new innovative technologies. And Apple Watch margins will be lower than the Company average.

[…]

Toni Sacconaghi (Analyst – Bernstein): I just wanted to revisit the watch.

Tim, I think you said when you were talking about your new products, you said we’re, quote, very happy with the reception. And in response to a previous answer you said, relative to demand, it’s hard to gauge with no product in the stores.

I would say relative to other product launches where your commentary around demand was characterized by superlative after superlative, that assessment feels very modest. And part of the reason that I ask is, A, are we reading you right in terms of that? But if we look at consensus, consensus is expecting that Apple will ship more watches in its first two quarters than it did iPads, despite, as you said, very limited distribution in terms of only selling through your stores.

So I’m wondering if you can talk a little bit about putting those demand comments in context, given that they do seem different from how you’ve characterized product demand for other products. And how, if at all, we should think about the modeling demand in the context perhaps of the iPad, which was your most recent significant new category? And then I have a follow-up, please.

Tim Cook (CEO): I’m thrilled with it, Toni. So I don’t want you to read anything I’m saying any way other than that. So I’m not sure how to say that any clearer than that.

And in any situation, whether it’s the watch or in the past on iPad or on iPhone, when demand is much greater than supply, it’s difficult to gauge exactly what it is. And so, as you know, we don’t make long term forecasts on here. We maybe forecasts for the current quarter. And so I don’t want to make any comment about the consensus numbers.

Honestly, I haven’t even studied those. We’ve got enough to think about here.

I feel really great about it. The customer response, literally from what I’ve seen, is close to 100% positive. And so it’s hard to imagine it being better.

——-

Excerpts from Apple Earnings Report: Q2 2015 Conference Call Transcript, April 27, 2015.

Notes:
  1. This is still true today, three months later []
  2. This has been achieved according to plan. []

Selling Watch Sales Data

There is no reliable information on Apple Watch sales. None of the analysts which follow Apple or the phone, computer or watch markets have any insight into this. The only source of information is Apple itself and they have made it clear that they don’t intend to provide watch sales data for competitive reasons. I did not and do not expect any information from Apple on watch sales. They have placed the product within the “Other” category specifically to make unit data hard to discern and have explained why they do so.

The only estimate we have heard of is from a company that has no track record in market research and relies entirely on sampling of email receipts. I urge extreme caution when dealing with this type of data. We don’t know how representative these receipts are and how they are sourced or sampled. The methodology is not only unclear but it’s one not practiced by any other analyst. You would think that receipt sampling would be a phenomenal source of information about a lot of other products and yet we hear nothing about how predictive it is for anything except this particular new product as claimed by a company which never made any such prior claims.

It’s also a sampling of (presumably) US-only customers at a time when the product is undergoing a gradual roll-out through multiple countries and multiple channels. Consider that if sales were constrained internationally then buyers would be trying to arbitrage through the US market, meaning there would be many e.g. Chinese buyers/brokers booking sales through US online stores inflating that channel’s initial volumes. Furthermore as physical retail stores begin to receive stock, online sales (which are what is sampled) should decline as buyers opt for the instant gratification (and the option to see the product in real life.) To see US-only online purchases drop after a period of pent-up demand and as store inventory becomes available is not interesting and says almost nothing about the product’s performance.

The only way to be thoughtful about this new category is to understand the broad transitions underway in mobile computing. We are witnessing a pivot in human-computer interaction as significant as the initial iPhone launch.

[As a rule, be very careful with the premise of data salesmanship. All data is false, some is useful. Data you have to pay for is less useful than data that has been peer reviewed.]

Breaking the Law

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

Screen Shot 2015-07-13 at 12.21.00 PM

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

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

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

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

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

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iOS v. Windows and Immunity to Disruption

The pattern of Mac growth exceeding Windows PC growth (and overall PC growth which includes the Mac) is old news. It has been observed for at least 40 of the last 42 quarters.

Screen Shot 2015-07-10 at 12.47.04 PM

It’s a historically interesting contest, but the story of computing has moved on.  Starting with building computing, via floor computing, office computing and then to desktop computing and portable computing we are now in the era of mobile computing.[1]. The problem with observing mobility in general is that there are too many mobile computing options. Phones have a wide range of capabilities, tablets and various other form factors are positioned on differing jobs-to-be-done. Platforms and services are also scattered around jobs which have been carved from fixed computing or have been established with no fixed precedent.

So can we pinpoint with any accuracy the moment when the tipping point has been reached? We could point to all mobile phone shipments, or even the vaguely-defined smartphone shipments compared to all PC shipments. We could look at tablets alone. If we could get accurate measurements.

One measurement could be to look at operating systems alone. When comparing iOS shipments (iPhone, iPad and iPod touch) to Windows we can see that combined iOS shipments exceed all Windows PC shipments for all three previous quarters.

Notes:
  1. And as sure as the sun will rise tomorrow we will move beyond mobile computing []