via 5by5 | The Critical Path #97: Squealing in Delight.

Is Apple Really Dominating the Tablet Wars?: Video – Bloomberg.

Although there isn’t much one can cover in 5 minutes, there were some good questions around tablets. The role of Amazon and Microsoft in particular.

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

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

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

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

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

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

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

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

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

You can see the instability in volume recognition in the graph as a clue. Product launches cause erratic changes in what was previously a seasonally stable business. This is, essentially, the company being thrown onto its back foot. It is staggering from an unexpected blow and resetting expectations.

Now note the contrast with Apple. Apple provides every quarter shipment data on all its products. This is consistent with generally accepted accounting principles and consistent with reporting from other companies.^[1]

Apple also offers “channel inventory” data on select products. This inventory data, when coupled with shipment data, offers insight into how many units are actually purchased by end users. If Apple runs a tight ship then its inventory is relatively low but if it has a reliable customer base that of its channel is also low. Moreover, if it can predict sales well then it avoids overfilling the channel and having to take a hit while draining it.

In that context the way the company reported the 5c/s launch is signaling optimism:

On September 23, 2013, Apple Inc. […] announced that it has sold over nine million new iPhone 5s and iPhone 5c models, just three days after the launch of the new iPhones on September 20.

Apple expects total company revenue for the fourth fiscal quarter to be near the high end of the previously provided range of $34 billion to $37 billion, and expects gross margin to be near the high end of the previously provided range of 36% to 37%.

The SEC filing language above refers to the following press release:

Apple® today announced it has sold a record-breaking nine million new iPhone® 5s and iPhone 5c models, just three days after the launch of the new iPhones on September 20

“This is our best iPhone launch yet―more than nine million new iPhones sold―a new record for first weekend sales,” said Tim Cook, Apple’s CEO. “The demand for the new iPhones has been incredible, and while we’ve sold out of our initial supply of iPhone 5s, stores continue to receive new iPhone shipments regularly. We appreciate everyone’s patience and are working hard to build enough new iPhones for everyone.”

The reporting of sales after a launch weekend has been a staple of Apple’s communications about product for a long time. Therefore the evaluation of this performance should be made in comparison with previous launches.

But it’s not necessarily a statement of end user purchases. Nor is it a statement purely of shipments. The term “sold” as used in a press release is not an accounting term and it is not something which is meant to be audited.

However, none of that matters. The signal is what should be observed. By deliberately and repeatedly using the word “sold” Apple is expressing confidence that demand for its products is strong. Sure, there is channel inventory in that 9 million unit number but there are also ordered devices which have not been shipped and thus are not counted as sales. There are also depleted store shelves and people angry about not getting their desired phone model. Apple knows this, Tim Cook is making it clear they know this. They have excellent visibility into the distribution of their products. They have excellent inventory management. They are typically conservative in their financial reporting.

So why would anyone interpret Apple’s release as a negative signal? If you want an example of a negative signal, look at how BlackBerry reported its launch performance.

When interpretation of a signal is very different from the literal statement, it says more about the interpreter than about the company.

1. Though many, e.g. Samsung, Google, refrain from reporting shipments any shipment data at all.

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Note that the data is normalized to units/day.

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

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

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

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

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

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

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

Horace Dediu on Asymco, Apple and Future of Computing | eTalks.

Full interview is here, excerpts below:

Niaz: Why do you study Apple?

Horace: Apple is an interesting company to study because its success comes from being a serial disruptor. This is a very rare type of success formula. I am trying to “reverse engineer” its operating model and I hope that such a model is one which others might learn from if they were to emulate it. The trouble is that very few others seem to want to emulate Apple. Why that is is also an interesting question.

Niaz: […] Do you think apple has lost its image that it has created over the years as a center of innovation and building excellent products?

Horace: I cannot comment on how Apple’s image is measured by people in the industry. I have been listening to commentary on Apple for about a decade and I have never seen any change in pattern. The company has always been perceived as a failure by a majority of observers. With respect to its products, I also do not see a change in the pattern established over the last decade.

Niaz: Are you optimist about the future success of Apple? Like after 10 years and then 20 years?

Horace: Let me put it this way: if there were no Apple then somebody will have to invent an Apple to do the same thing Apple does. In that sense I’m optimistic that there will be an Apple in some way in perpetuity.

Niaz: What will be the next big innovation from Apple?

Horace: I have no idea but it’s likely to involve refining new user interaction methods. Similar to the breakthroughs that came from the use of a mouse, a scroll wheel and a touch screen. It means making computers better at gleaning our intentions without our getting involved in explaining them.

Niaz: Will Apple, Google and Samsung be the major player for the future of computing? Or we can hope to see some new faces?

Horace: I am fairly sure Samsung will not be because they have not yet grafted software and services to their operating structure. I would give Amazon a higher probability in being a successful platform alternative.

Niaz: In 2011 you’ve written a blog post ‘Steve Jobs’ Ultimate Lesson for Companies’ on Harvard Business Review Blog and you have cited ‘A leader should aspire to do more. A leader should claim to have left a legacy not just on their company but on all companies.’ As you know Google, Amazon, Samsung, Facebook … all have learnt lifetime lessons from Steve Jobs. What do you think about the impact that Steve Jobs have created?

Horace: He led by example and like all great leaders sacrificed much as a way to inspire others to follow him. He also spent time in the wilderness and chose asceticism. This gave him authority. Many historical figures had the same quality. The problem is that few business leaders have it but I don’t see why they shouldn’t.

Much more on evaluating Tim Cook’s performance, the iPhone portfolio, the rise of Android, Microsoft/Nokia, wearable technology and disrupting Google. Check it out on eTalks.

The warmth and acceptance of new hires is brilliant. I was invited for chess, football, drinks, and even knitting, within a fortnight. Friday after work drinks can easily evolve into an adventure anytime. There’s always something to do in this city. And at Booking.com, there’s always someone who’s willing to join in. The many parties are just something that has to be experienced. Come join and I’ll show you around”

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Are cars sold or purchased? Horace Dediu and Jim Zellmer discuss automotive “ecosystems” vis-à-vis Apple and Tesla’s direct sales model. We further dive into the rigidity and risk of such value chains and divert a bit into automakers’ attempts at aviation. Finally, we consider the potential monetization of automotive metadata and what that might mean for new, perhaps “over the top” style entrants.

Also history lessons: Ford Trimotor, Ford production system, The Kaiser people’s car.

There were many causes. Some cultural, some historical, some economic and some policy-driven. The result was that it presented a challenge to any company with global ambitions and indeed it was rare to see the same company do well in every market. Japanese companies did well in Japan, European companies did well in Europe and US (and Korean) companies did well in the US. Nokia was most successful because it was able to apply an European model more broadly (but not in the US). Samsung succeeded by simply adapting to each and every market with hundreds of products. But it was a particularly “provincial” market.

My assumption was that when smartphones would become the majority of phones in use there would be a normalization of behavior and thus a homogeneity of preferences. This is, after all, what happened in other platform games. PC form factors are globally consistent, PC operating systems are equally preferred around the world, FaceBook, Google and Twitter are also, unless censored, uniformly popular. Apple’s iPod eventually also became a global phenomenon with no material difference in preference by market. Likewise for game consoles.^[1]

However, a decade after the broad adoption of smartphones, the relative popularity of various platforms is still unevenly distributed. Prior to the iPhone, Symbian was strong everywhere but the US and BlackBerry was very strong in the US but weak elsewhere. Windows Mobile had footholds in some markets but little traction in others. Today the picture has changed but it’s still a patchwork of preferences. Consider the following graphs.

They are the most detailed sets of data on platform phone purchases but they not the only data: We also know that Android is vastly more popular in India from web usage statistics. We know that BlackBerry is sensationally popular in Latin America and the Middle East. We know that within Europe there is a gap between North and South in iOS vs. Android and even more pronounced between East and West. We know that whereas iPhone was a huge hit in Korea upon its launch there, Samsung and LG swamped it in the last two years.

But the data shown above is the story of iOS being very popular in Japan and increasing its share in the US while being flat in EU5. Again these three markets are different but each contradicts the global picture.

Note the differences in trend not just absolute performance. This is what is puzzling. There seems to be a divergence between markets: Markets are become more islands onto themselves rather than one whole. This contradicts all the theories of how computing markets should behave (network effects, ecosystems, monopoly power, etc.) It implies that there is still a great deal of friction in the market; friction which I suspect to be due to the peculiar nature of telecom economics.

I wonder if this observation is, as usual, late on my part and that Apple’s iPhone product marketing has seen it years ago.

1. Although Japanese do seem to prefer Japanese platforms more.

An Interview With Horace Dediu: On Blogging, Apple And What’s Next

Q: Turning to Apple, where is it at right now as a company in this post-Steve Jobs period?

A: Still too early to tell. They seem to be cooking a lot of things and the great experiment of whether a company can be Jobsian without Jobs is still going on. I have been trying to put together a picture of how it operates. It’s hard because that’s their biggest secret. It’s also a picture that few people have ever seen, even those who worked there a long time. The glimpses so far are tantalizing but there is so much we don’t know and thus can’t assess how robust it is. One thing that is clear to me is that there is no absorption by mainstream observers of what makes Apple tick. It’s hiding in plain sight because what it is isn’t anything anyone can recognize. Case in point is the functional and integrated dimensions. It’s the largest functional organization outside the US Army and more integrated than Henry Ford’s production system. Just describing it sounds medieval and it’s so far outside convention that it’s not something reasonable people are willing to believe actually exists.

Q: Is Tim Cook the right CEO for the company at this time?

A: I hold the belief that he’s been CEO for much longer than it seems. Jobs was not a CEO in any traditional sense. He was head of product and culture and all-around micromanager. He left the operational side of the company to Cook who actually built it into a colossus. Think along the lines of the pairing of Howard Hughes and Frank William Gay. What people look for in Cook is the qualities that Jobs had but those qualities and duties are now dispersed among a large team. The question isn’t whether Cook can be the “Chief Magical Officer” but rather whether the functional team that’s around Cook can do the things Jobs used to do.

Look at it another way: I subscribe to the idea that any sufficiently large company is a system and needs to be analyzed using a lost art called “Systems Analysis”. This is a complete review of all parts and the way they inter-relate. However, since for most of its life Apple was personified as an individual, what came to pass for Apple analysis was actually the psychoanalysis of that individual. It makes for great journalism and best selling books. It’s also banal and almost certainly wrong. The proof is in the vastness of complexity and number of people involved. Engineers tend to think about constraints and the constraints on companies are innumerable.

Q: You’ve written extensively on the post-PC period, when will we come to the post-phone period – if ever?

A: I think less than 10 years. Maybe even five. A wristband today can have more processing power than the original iPhone. An iPhone has more power than a desktop did 4 years ago. The speed of change is incredible.

Q: What’s going to be the “next big thing” for Apple? Watches, TVs, something else?

A: I segment along “jobs to be done” which are basically unstated and unmet needs. Unstated because they are usually so deep and so pervasive that they’re taken for granted. We have the need to feel good about our lives, to be healthy and to be connected in meaningful ways to others. These jobs are very poorly served by technology today and there are many non-technology products that are hired as poor proxies to help. The speed with which technology changes means that the trajectory of improvement will undoubtedly intersect that of the job. Even a small job like losing weight and eating well is probably worth as much as half the mobile phone market. Imagine if someone gives us a magic tool that does that for us. How much would you pay? How many of us would pay? There are so many next big things that I cannot choose. (By the way think of the job Facebook is hired to do: make me feel good about myself because I can show others how good I am. Boom!)

Q: What’s your take on how they’re handling their expansion into China, India, and other emerging markets?

A: It’s depressing how slow things are moving on that front. We can draw lines on a graph but we don’t know the constraints. Again, the issue with adoption is that the timing is so damn hard. I was expecting smartphones to take off in mid 2004 and was disappointed over and over again. And then suddenly a catalyst took hold and the adoption skyrocketed. Cook calls this “cracking the nut”. I don’t know what they can do to move faster but I suspect it has to do with placement (distribution) and with networks which both depend on (corrupt) entities.

Q: As you look at the rest of the mobile internet competitive landscape, do you expect any big surprises from other players (good or bad) in the next 5 years?

A: The big question in my mind is the sustainability of the arbitrage models which underpin pretty much every internet business plan. Essentially we have two markets: one where everybody consumes but pays in metadata and another where everybody consumes aggregated analytics but pays in cash. An internet business is the arbitrageur who takes advantage of the inability of each market to price the other. History shows that arbitrage markets tend not be stable as information begins to leak across markets. Therefore what would blow the internet up is if consumers could become wiser about what they are giving up and advertisers would become wiser about aggregating consumer data. I imagine a system where each individual would allow bids on their consumption and a market mechanism where bidders competed for that data. This of course depends on users taking control and ownership of their own data. What might help is the realization of what mass state surveillance can do and the realization that internet giants have more information about us than the government could ever hope to possess.

It would create a new era which will have political dimensions. I imagine we’ll need an internet citizen’s bill of rights or some such movement which will reset expectations. Economically, could bode well for those who position themselves as protectors of the individuals and be a crisis for those who take advantage of consumer ignorance.

via 5by5 | The Critical Path #96: P is for Personal.

The reason a product deserves to exist is that it can do a job that needs doing and that few, if any others can also do it. This happens when the job is unstated and difficult to perceive. Put another way, the difficulty behind jobs-to-be-done based design is that jobs are never plainly evident. In contradiction to invention, where the problem being solved must be as clearly stated as its solution, value-creating innovation meets new and unarticulated needs. Even when created, the value is more subtly perceived, often only after prolonged use.

Which brings me to the M7. Apple chose to highlight a component (curious in itself) which it bills as a “motion coprocessor”. It claims to be measuring motion data via accelerometer, compass and gyroscope and processing the information in some way. By bundling the sensors and their management into one integrated chip battery consumption is reduced and these motion monitoring functions are performed more efficiently.

But what for? The examples given during the presentation for an iPhone with M7 don’t add up to a lot of benefit. An iPhone could be used as a fitness companion but it would not a very good one. Compared with, for example, a Nike FuelBand, an iPhone could not track your activity well. It’s often not moving, sitting on a desk or in a purse or pocket while you are doing exercise. It’s too big to take into a basketball game. It can’t “observe” your activity because it’s not worn during many activities and if it is worn it is in a position which does not inform much about what you’re doing. Phones are too big to be used as physical activity monitors.

Hence the question of what is the M7′s job to be done. As part of an iPhone, it does not seem to have one. Saving a bit of battery life is not a job, and certainly not one that needs to have billing in a media special event. The answer must be that the M7 was developed for some other, as yet unstated reason.

When the A series chips were created Apple leveraged the in-house design and cost reduction to make a wide range of products with more than 700 million examples built. Designing a chip needs a broad application domain.

Perhaps this is why Apple chose to describe the iPhone 5s as “forward-thinking”. The M7 and the Touch ID are like research projects whose actual value will be realized at some future time, in probably different contexts. The M series of chips may become Apple’s “low end” microprocessor as the A series climbs the trajectory into core computing tasks (read: phone, tablets, TV, laptops).

M might be the chip for the wearable segment, woven into a whole new fabric of uses and jobs to be done.

If you look at the graph below you might see the difference yourself.

First, note that the graph is logarithmic. A straight line on a log chart implies exponential growth (the y values are a constant to the power of the x value). However, none of the graphs show straight lines. None of the platforms follow exponential growth^[1].

Second, we can eliminate linear or logarithmic functions. They simply do not fit.

That leaves: polynomial or power. It’s easy to test these alternatives for all the functions and it becomes clear that most of the platforms split into one of these two classes.

Here are the classes^[2]:

Note that I added the formulas for the selected platforms.

I named these classes after their function types: “Power platforms” or “Second Order platforms”^[3].

This classification has two benefits:

1. It allows a clearer distinction in scope. Both may exhibit signs of network effects, but Power platforms seem to exhibit “global” or unlimited reach while Second Order platforms may have a strong upper bound on reach.
2. It allows more reliable forecasting. If a platform classifies as Power, the forecast could be created with fewer data points.
3. It allows us to guess at the causes of entry into each class for any potential platform challenger.

To illustrate the second benefit, I took the Android, iOS and Facebook power functions and modeled (i.e. extrapolated) them for a few quarters into the future. The result is shown below:

The forecast shows the following:

• Android will reach 10 billion activations 10 years after its release (mid 2018)
• iOS will reach 1 billion units sold by end of next year and 3 billion units by its 10th anniversary in 2017.
• Facebook will reach 2 billion users by 2015 after the end of its 10th year.

1. Except perhaps in the very early periods
2. Some of the platforms had to be dropped because there was no easy fit. My observation is that some of these platforms went through some crisis or change in strategy during their history which caused the pattern of growth to change
3. Note that all Polynomial functions found above are second order

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The obvious answer to why Apple asks so much is because it can. Anybody would if they could. That’s a poor question. So the right question should be: why does anybody pay this much? One could answer that few do and it’s not a mystery that some feel better paying more simply because they can. But those who pay Apple’s prices are, mainly, not consumers. They are operators. Exactly 270 of them.

So then let’s re-ask the question: Why do so many operators pay so much for Apple’s phones? We can’t answer that with the psychological slurs usually directed at the brand. Surely Operators aren’t competing in beauty contests or need to soothe their collective egos. The decisions operators make on whether to range a phone are driven by hard economic realities: ARPU, churn, network costs, depreciation, ROI, etc. Some clearly can’t make the iPhone fit their economic models and indeed about two thirds of them don’t. But the most prominent^[1] do. DoCoMo, the largest in Japan just did after holding out for five years. Verizon held out for years, as did T-Mobile. China Mobile’s acceptance also seems imminent.

But that still leaves the question of why are those operators who do carry the iPhone willing to pay so much for it? I only assume that their decision process is likely to be rational. Mainly because we have a large enough sample but also because there is a lot of money at stake requiring quite a bit of internal consensus and vetting before committment. We have to conclude that operators place the orders because they obtain value from the iPhone even when it’s priced at a premium to the average alternative.

The question which follows then is how do they obtain value? I’ve argued that this follow-the-money process leads one to conclude that the iPhone helps in moving users to higher revenue data services. These are more profitable services for operators and the subsidy model creates more loyalty and thus reduces churn and creates a stable cash flow which can then be leveraged through debt to upgrade networks and attract yet more loyal iPhone users.

Therefore the iPhone is “a data service salesperson” receiving a large commission (in the form of a price- and hence margin premium) for doing what few others can do. In that sense the iPhone is hired by the operator to do a unique and valuable job and is paid well for doing it.

This answers the question of why Apple can get away with charging so much for its phone: because operators love it. The entire product depends on a reward system and for years we’ve heard fears that it’s going to end. But it hasn’t. Operators love subsidies and they’ve been honing them for long before the iPhone showed up.^[2]

But this is not the end of the money trail. The premium is initially paid by the operator but they tend to get most of that payment back from the consumer. In other words the subsidy that inflates the iPhone price is at least partly if not mostly paid by the consumer in the form of a higher phone bill.

You won’t see it itemized on your bill, but it’s likely that $10 to $15/month from a subsidized phone service plan goes toward paying for your phone.

So in a way, Apple has managed to place itself on many people’s monthly phone bills. It’s a nice place to be. It’s nice for the same reasons operators like post-paid customers: predictability. It’s also nice because recurring services are a better business model than products; they have higher levels of loyalty and are more “sticky”.

But this placement is not transparent. It smacks of misdirection. The link is not made in the mind of the consumer that they are paying for a phone through their service plan and many see it as a thinly veiled con. The value of the iPhone to the user may be evident through its use but the payment for that value is not.

But in many ways this is similar to how many services are valued: through bundling. We pay for the value of a great retail experience through a higher price on items purchased. But we still associate that price with the good sold not with the place where it was bought. We get great value from Google’s services but don’t know how to quantify the cost of their peering into our minds. In fact the whole Internet and all business plans that are built on it depend on a subtle “something for nothing” type of misdirection. The Internet runs on the arbitrage between a consumer service market where everybody consumes but nobody pays and a separate data market where nobody consumes and everybody pays.

The iPhone could thus be finally understood as a complex service business. It captures value through the phone bill but delivers value through a screen. A misdirection magic trick which many have tried to pull off. It’s essentially tapping into the $1.3 trillion communications market, skimming profits by delivering the “content” which lights up the wires.

It’s great except it does not work everywhere. Not yet at least. The complexity of services means that they are usually found in more advanced so-called service economies and rare in less developed so-called goods economies.

Economists have observed this process and even have a name for it: servitization: The process whereby almost all sufficiently advanced products are indistinguishable from services.

As a service, the iPhone’s strengths are easier to understand. Its weaknesses as well. Services simply don’t work in economies which don’t have robust institutions of credit, capital intensive infrastructure and distribution networks.

It’s also the reason why Apple is so slow to penetrate all markets. It’s not in the business of selling phones. It’s in the business of enabling and creating services.

1. Arguably the most important
2. Recall that the first iPhone was sold without subsidy and with a separate, secret revenue sharing plan. It did not last because it was cumbersome and because operators convinced Steve Jobs that their way was better.

By using the iPad as a template, my exercise in August was to forecast what the pricing^[1] might turn out to be for such a split-personality product.

I expected the 5C would replace the “low end” n-2 variant^[2] and the 5S would continue as the core product. This is reflected in the original graph as devised in mid-August:

The surprise was that the 5C was not “low end” in any way other than having a plastic case. It has a minor spec increase over the 5 but is otherwise a 5 feature set in a plastic skin. It also is priced as if it was the continuation of the 5, with a modest reduction in ASP.

In addition, the continuation of the 4S and 4 (in China at least) means that the old strategy continues more-or-less unchanged.

Knowing the line-up and pricing all that remains to understand is the positioning, or how the products are defined relative to each other.

This is where there might be a shift happening. Under the old model the n-1 variant was meant to be a modest volume contributor to the portfolio, being essentially a cognitive illusion which encouraged buyers to stick with iPhone n at the expense of competitors. However, the new n-1 product (the 5C) has a distinct positioning that makes it seem fresh and not a lesser, stale version of the flagship. It is designed to appeal as a legitimate upgrade for iPhone 4/4S users.  It is, in other words, not meant as an illusion, and not focusing attention on the flagship^[3]. Rather, it is meant to be a genuine, core product.

As a result, I expect the mix of iPhones to be more evenly split between the C and S variants. I expect the C to even become the most popular version in the mid-term. My expectations are shown in the following graphs.

There are several implications for this shift in positioning:

1. Apple is recognizing that the market is actually “segmentable”. This is the notion that one size does not fit all–a radical idea for the brand. Its mechanism to address it is a “good+better” portfolio. Note that this is not at all like the iPad where the Mini is actually suited to different tasks. The iPad can be thought of as a “small+big” portfolio. The iPhone shows a clear delineation within the same product.
2. It is signaling that the premium may be more than what the mainstream needs. This is a corollary to the segmentation implication above but stands on its own because it also implies that the iPhone C is “good enough” and the S is more than good enough (or, to spin it another way, it is for “more demanding” customers.) It also implies that the premium “S” version will be a lower volume contributor.
3. The third implication is that the basis of competition is shifting.^[4] The shift is toward competing for late adopters in advanced markets and with early adopters in trailing markets. The new C model is still not suitable for trailing markets as it still over-serves and is over-priced^[5], but it is at least signaling the “end of the beginning” phase in the smartphone market.

In summary I’d say that the C signals the beginning of the “good enough” phase which was also evidenced by the increasing mix of the older models during the last year. Financially it shows up as lower ASP, which, as the graph above implies, I expect to drop to $600 and lower during the next year.  Margins may not be affected much as the C is still very highly priced relative to its cost of production.

Finally, if the good enough alternative is being “pinned” by Apple as the mid-range it also begs the question of why there isn’t a specific “low end” version. It took six years for Apple to fork the product into two variants. Maybe it will take another year for it to stretch to a third.^[6]

1. Revenue/unit to be more precise
2. Older by two generations as the iPad mini replaced the iPad 3
3. It might still be an illusion for many but I’m suggesting that it won’t be for most.
4. It has always been expected to shift, but the timing is where all the value is captured
5. This post deals with the iPhone portfolio structure or the placement of iPhone models relative to one another. It does not deal with a separate question of why the overall pricing is so high. That question needs to be dealt with as a discussion about the jobs iPhone is hired to do and by whom. I’ll re-visit this job-based segmentation of the market in a future post.
6. For more on the subject see S is for Service.

via 5by5 | 5by5 Specials #22: Apple Event: iPhone 5c and 5s.

Horace Dediu interview on CNBC Asia Cash Flow show – 10th September 2013

Chloe Cho (CNBC): Take us through what Apple is exactly trying to do?

Horace Dediu: Well, this is the first time in the six years of this competition in the smartphone market that Apple has broadened its portfolio. We have seen only a single product launch every year–this is very unorthodox in the industry. Normally each competitor [ranges] dozens of devices. Apple’s entry has been asymmetric from the start, and now in its sixth year we are expecting to see, finally, a broadening perhaps into two separate products. The question will be whether [there will be] a significantly lower price point for the so-called 5C and whether that will change the average selling price overall for the portfolio. The average selling price has been remarkably steady, and remarkably high, typically around $600 for the duration of this products life. Something, again, unprecedented. My expectation is the new price point will be quite a bit lower than $600, starting with about $450, it might drop a bit further, [which] would cause the overall price range to come down as we have seen with the iPad; [where we] also had a price erosion happen as the smaller version came out.

Q: Horace, do you think they have got the timing right? Should they have done this a little bit earlier when the market wasn’t so saturated and filled with cutthroat competition?

A: Indeed, I think. As I said, as a product with six years in the market it’s a bit late; I expected this to happen last year. I think a lot of the momentum that has been lost in the past year in terms of sales growth has been because of the lack of low end. To note also will be whether they indeed expand their carrier footprint. We are expecting something new in Japan and possibly China Mobile. There is a second announcement happening with a few hours delay in China. This is again the first time that has ever happened.

Q: Horace, do you think they didn’t move down the value chain fast enough largely because they didn’t have a deal with China Mobile?

A: Well that’s always a good question whether they are driven more by carrier channels or are they driven more by consumer market expectations. I think it’s a bit of both. We do have this hybrid approach where they continue selling this older product for one or two years after the new product is launched–so the 4 and 4S are still available while the 5 is being ranged. This strategy is hybrid I say because this isn’t truly a low end product, it is a stale product that is being put out there. This [strategy] may be driven more by consumer demand, not so much what operators are asking for. With the 5C we might be looking at a solution for operators in particular.

Q: Horace, how much do some these incumbents like Apple and Samsung need to be worried about Microsoft approaching their space?

A: I believe Microsoft will not be competitive in the near term. I don’t think [during] the next year we are going to see a very impactful entry from Microsoft. What Microsoft is likely do is lower prices significantly on Nokia’s portfolio and their pipeline as it is. That might cause more pressure on the pricing, but the problem has been that consumers have not really been taking up the Windows Phone platform very aggressively. It has been somewhat successful in Europe but not taking off elsewhere. I think Microsoft will be in an integration mode with the Nokia assets into 2014, but I would expect in a year from now we might see some new entry product that would be exciting. I think 2-3 years down the road we might see something from Microsoft that would excite consumers as well.

Q: There has been a lot of focus on which companies have a more integrated house, Apple or Samsung. In light of the fact that they are having to move into lower price points, in your view which is doing the better Job, Apple or Samsung?

A: Well Samsung is a great industrial enterprise and they are doing very well by broadening as much as possible their portfolio, even before the smartphone race started for them, which was in 2010, they were known for being one of the most prolific product creators out there. They actually had over 100 different mobile phones, not smartphones, just regular mobile phones that they would range, and Nokia were extremely concerned by this pressure they were getting from Samsung.

What they have seen since 2010 is the same thing, except with smartphones, and so they’ve been really prolific and covering the spectrum of price and screen and every other possible variant that could be made. I think however that Samsung hasn’t got a software platform under its belt. They could become a software player by taking over some of the control of Android as we have seen Amazon do, and thus really establish themselves as a platform player. They are doing so to some degree with the “Gear” product, and they might be doing something like this by launching their development conference this year.

But they aren’t yet a platform player whereas Apple is, but then again we just don’t know what the politics of Android are with respect to forking it by an OEM as large as Samsung.

[UPDATE: Thanks to Danny Nemer cumulative sales of Sony's PlayStation 2 (using production shipments from FY 2000-05 and recorded sales for FY 06-12) is 155.81 million units]

However, that is an incomplete picture of the game platform business primarily because consoles are not the entirety of the business. Mobile (but dedicated) gaming platforms have been sold for some time.

To give a better picture of the game business we prepared the following graphs. The first shows Nintendo’s product lines with actual unit shipments (shown as colored dots in millions of units per quarter) and the trend (shown as trailing twelve months’ average trend lines).

Note that fixed and mobile products are both shown on the same graph. The picture that emerges is that for Nintendo, its mobile platforms combined are more popular than its fixed consoles with a total of 186 million mobile devices sold since 2003.

There is also a pattern of generational change. The GBA, DS and GameCube era was superseded by the DS Lite, DSi, Wii era. The Wii era (or generation) was significantly more popular than the GameCube generation. If there is a problem however, it seems to be that the new generation devices or consoles are not forming a new era. The Wii U and 3DS are not growing nearly to the level of the previous generations and have faded quickly.

To summarize, the unit volume graph for Nintendo is below.^[1]

To confirm that this is indeed disruption we should look at the pattern for another competitor in the console market: Sony.^[2]

The graphs above combine both Nintendo portable/consoles and Sony portable/console sales. Note the similarity in patterns of growth. It’s one thing to suggest that Nintendo consoles have “failed”, it’s another to show that Nintendo consoles and portables have failed, and yet another to show that two competitors in the games business seem to be failing in unison across all their product lines.  The cyclicality is also over a long period of time: The peak for the combined Sony/Nintendo was in 2008, five years ago.

The chief criticism to the industry-wide view of decline is that there is a new generation of consoles right around the corner. This is the eighth generation of consoles which, it is presumed, will bring growth back to the industry.

But the Nintendo 3DS, launched two years ago, was meant to kick off the eighth generation, and the PlayStation Vita was Sony’s response. Then the Wii U was also billed as the successor to the Wii. They have so far failed to re-ignite growth. One might reply that they were merely appetizers and that the main  course of the next gen are the PS4 and Xbox One.

Will they create growth again? Surely not for Nintendo, but I would argue that not for Sony or Microsoft either. There might be a burst of sales at launch as the hard core gamers upgrade, but they are unlikely to recruit new gamers the way the Wii did. In other words the PS4 and Xbox One are unlikely to win against non-consumption.

That is where mobile is the clear winner. More people will hire mobile devices for their primary gaming activity.  And as mobile devices get inexorably better, they will be hired for use in the setting where consoles have been king: the living room.

The implications are that Nintendo, Sony and Microsoft are beyond the point of no return in this industry. Gaming, as a business, cannot be sustained as a platform independent of a general purpose computer. Like other “applications” that used to have systems built around them conforming to their needs^[3] the dedicated-purpose solutions came to be absorbed into the general-purpose platforms. And the modern general purpose computer is the smartphone.^[4]

UPDATE: I added Microsoft console shipment data which became available after 2008.

1. This is a smoothed graph showing what sales would have been if they had been evenly spread out over a 12 month period. The actual sales would total to the same area but would be much more seasonal and thus noisy.
2. We would like to show the pattern for Microsoft but there is no regularly reported Xbox shipment data.
3. Applications such as word processing, financial calculation, media editing, music playback, etc.
4. One interesting question is why didn’t the general purpose personal computer absorb console gaming. My answer is that personal computers could not conform to the experiences around the “10 foot” interface and still function well at their main jobs. In contrast, mobile devices through screen sharing have the ability to be much more malleable.

via 5by5 | The Critical Path #95: Catharsis or Anticlimax?.

This one starts slow but ends with a flurry.

If we define the Race To a Billion to be bounded by a time limit of 10 years, then Windows does not qualify and Android is actually second. The race is shown in the following graphs (the one on the left is logarithmic scaled, the one to the right includes only a few contenders for illustrative reasons).

Android’s activations as reported are shown in the following graph:

Without qualification, Android has been a viral success story. It reached one billion activations in about five years, almost half the time it took FaceBook and far faster than Windows.

However, Android growth can be qualified. I added another set of data which is the number of US Android phone users as deduced from measurements by ComScore.^[3]

One way to read the two graphs is: Between March and August, of the 250 million Android devices activated, 4 million were to new Android consumers in the US. In other words, In the last six months, 1.6% of Android activations went toward new usage in the US. The equivalent figure for iOS is about 6%. Note that these are new users, not included are upgrades. It’s likely that more of the US buying goes toward upgrades because iOS has been in use longer.

So whereas Android is growing very rapidly, there is a question of reliability of that audience. Engagement is one thing, but in the market which shows highest penetration (and deepest distribution of an alternative) Android is peaking.

1. Although activations are not users, I’m assuming that usage is not far behind and the cumulative sales figures I gather are roughly comparable.
2. Separately, iTunes reports 575 million account holders.
3. ComScore surveys users on their primary phone. Survey includes only those aged over 13 years and excludes phones issued by businesses.

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Put another way: Why is it that everyone wants to copy Apple’s products but nobody wants to copy being Apple?

Being Apple means, at least:

• Insourcing all aspects of operations which affect the customer experience. Increasingly that has meant insourcing everything, a toxic idea to every MBA-trained professional since forever.
• Organizing functionally and having no product level P/L responsibility. That also means removing almost all incentives for employees to climb ladders and thus prove their worth.
• Developing products using integrated “heroic” efforts which shun  every best (or even adequate) process for product development.

I asked somewhat rhetorically because it’s an open question. Apple’s operating model and devotion to integration have been asymmetric to technology dogma for decades. To the casual (read: naïve) observer, pursuing the Apple way seemed also to be tied to one individual. You could not “be Apple” unless you were also Steve Jobs and there was only one of him.

But it seems I did not give enough credit to other observers.

According to Microsoft, they began negotiating the buying of Nokia assets in earnest (coincidentally) in February. It has, also since February, been planning a massive re-organization along functional lines. Thus, by owning significant hardware operations and organizing functionally, Microsoft might go about two thirds toward “being Apple-like”. The development process is the final hurdle and it may be a bridge too far, but my thesis that nobody wants to copy Apple is now in tatters.

And it gets worse. We can see a similar, though far weaker, example in Google’s approach to integration. Their purchase of Motorola did not result in an integrated business, with Motorola being kept at arm’s length and allowed to wither on the vine. Crucially, while Google bought Motorola’s IP, Microsoft only licensed Nokia’s. Microsoft clearly valued Nokia for something different than  what Google valued Motorola for.

Nevertheless there is a semblance of similarity. We can generalize enough and say that Apple (iOS), Google (Android/Chrome) and Microsoft (Windows (Phone)) are all becoming near facsimiles of each other. They are all producers of Software, Services and Hardware. Each came from a different basis but expanded into areas which were missing.

• Google started with a service, expanded into systems software and bought into hardware.
• Apple started with hardware running its own software, expanded into application software and is developing services.
• Microsoft started with software, expanded organically into services and bought into hardware.

All three major platform companies are now racing to offer that which completes them as an integrated producer and eliminates the dependencies on others as a modular producer.

This is re-integration of the computing industry–a reversal of the dis-integration brought about by the personal computer. Mobility, it turns out, was as important to the evolution of the computing value chain as microprocessors were to the previous era. It just had the opposite effect.

I should point out that Apple was more lucky than enlightened through this sea change. Having always been integrated, Apple was out of favor during one period of the computing epoch, but, simply by surviving, its model came back into favor in the next. I don’t think anybody there foresaw just how dramatic the shift would be and how important their structure was to being successful.

But there is one company which seems left out of this discussion. Samsung is absorbing a large part of the available profits in computing today and it’s not an integrated hardware/software/services player. Does this mean that there is room to be a module in an interdependent world?

I argue that no, there isn’t. Samsung must either stretch into becoming one of the ecosystem contenders or be relegated to a commodity hardware company–a path clearly visible when looking at Chinese entrants. Samsung itself benefited from disrupting from below and should be aware of the threat it faces as it races up-market. More importantly though there is the ability of creating new markets altogether. This new market creation and rapid iteration due to integration is what the Google/Microsoft/Apple trio are seeking.

Without the components of software (ecosystems included[1]) and services, Samsung will depend on the good graces of suppliers. They may not be as keen to share when profits accrue to the whole rather than the part.

—

Note:

[1] e.g. BlackBerry

Here’s how to think about it. A company is defined as the sum of three values: resources, processes and priorities (RPP). Everything of value can be classified into these three categories.

When one company buys another it’s the equivalent of one set of RPPs trying to engulf or swallow another set of RPPs. The simplest (naïve) interpretation is that an acquisition is the purchase of Resources in terms of customers, sales, profits, etc. It might be of assets like employees, intellectual properties, brand etc. I say this is naïve because Resources are the easiest to value because they can be measured and valuing only what can be measured while ignoring what can’t be measured is deeply mis-pricing.

So most people look for the “R” value or the value of Resources in an acquisition. It’s may be naïve but it is what markets typically value because it’s what they can price. But what happens when the “R” is flimsy or fleeting?

The answer has to be that it’s  the processes or even priorities which are valued by the acquirer.

These are difficult to value which, as I’ve argued in The Innovator’s Curse, is why they are not reflected in a share’s price. When there is a price paid for these fuzzy assets, they are often interpreted as a “premium” to the market price. But that may not be the way a buyer sees it.

When buying a set of Processes, a buyer may see a bargain because their costs for building a similar process could be enormous, even infinite. In the case of Nokia, the process of building hardware may be infinitely valuable to Microsoft as they have had dreadful luck doing it themselves. But they’re seen as value free to the market because it seems that there are many others who are building hardware.

The trickiest thing to perceive though is the value of a set of Priorities. Priorities are the answers to the “Why” question as much as Resources are the answers to the “What” and processes are to the “How.” If you were to think in terms of software engineering Priorities are the “Specifications” where the Resources are the data and Processes are the algorithms. They determine the direction and reasoning of why a company even exists. If you have bad specs, it never matters whether the algorithm is efficient and you have all the data: you are building the wrong thing.

Acquiring Priorities is also fundamental in that they are usually exclusive. A company typically only has room for one set. If there are conflicting priorities, they need to be sorted out else the company can end up in a state of internal conflict and dysfunction. So if you’re acquiring a set of Priorities, it’s likely that you’ll have to discard your own. It makes most sense when a company which might otherwise be prosperous needs to change direction.

So, in a way, an acquisition of Priorities is almost a reverse acquisition. The acquired is actually “buying” the acquirer. The acquired company’s Priorities (and hence Processes and Resources) become the guiding principles in the acquirer. It’s what happened when Apple bought NeXT and may have happened when Disney bought Pixar.

Some companies are “Resource-heavy”, some are “Process-heavy” and some are “Priority-heavy”. Great companies tend to have great sense of priority. They may also have greatness in the other asset classes but it’s rare to find a great company without a great sense of purpose.

So the question for the Microsoft Nokia deal is what is Microsoft buying?

Resources? Sure, there is IP and a team. But the chances are that not all the team members will be kept on. See what happened to Motorola after it was acquired by Google.

Processes? Absolutely. Microsoft needs device development processes desperately.  They may seem a commodity but it turns out that running great hardware businesses is hard, very hard.

Priorities? Here we have to pause. To acquire Nokia’s priorities means acquiring its business model; its belief system. Perhaps they will be discarded and they’re not valued. Perhaps, as is often the case, the acquirer becomes allergic to the new priorities.

But Microsoft has made it clear that they are now a “Devices and Services” company. As much as Apple changed its name to exclude “Computer,” Microsoft is almost changing its name to exclude “software”. It will still make software, to be sure, but for it to get paid it needs to integrate that software into hardware and services.

My first thought on this is that Nokia’s priorities are not sufficient for the company that Microsoft wants and needs to become, but there are some priorities which are necessary and which it values.

It may be too much to say that with respect to Priorities, Nokia acquired Microsoft, but insofar as Microsoft is having to transform its business model, what Nokia devices brings is an integral component of the new.

The list at the time consisted of 13 phone vendors who either merged, were liquidated or acquired after this trigger point was reached. There were no examples of vendors who recovered. Since then two more vendors reached the threshold (Nokia and RIM) and a third will do so this quarter (HTC). One vendor (LG) may be recovering but Nokia has just been acquired and RIM has put itself up for sale. Some Japanese vendors like Panasonic have also called it quits since then. So the score so far is about 18 triggers, 15 exits and three pending.

Some of this data is summarized in the following graph:

It shows that post-trauma life expectancy is now running at about 2.5 years. As RIM is only in its second year, one could perhaps expect another 6 to 9 months of independence. HTC could go on until 2015 but the smaller the company, the more vulnerable, so HTC’s exit time should be shorter.

The exception might be LG which seems to be recovering. As a conglomerate, LG is much less vulnerable and might have the resources internally to sustain the phone business indefinitely.

via 5by5 | The Critical Path #94: The Limits of Executive Power.

So how can I back this up?

To start, this is partially evidenced in this graph of Apple’s price to earnings ratio since 2006 vs. the S&P 500′s. The S&P reflects the 500 largest companies in the US and is thus a proxy for the “average” company.

[I added Apple's P/E excluding cash for additional perspective.]

The graph shows that during the period of time when iPhone and iPad changed computing and telecommunications, Apple was mostly held in contempt: the profits it was generating were not considered of “sufficient quality” relative to an average company. Since markets look forward, not backward (one assumes), the vote cast is decidedly that success cannot be repeated. Put another way: you can trust that a soft drink maker like Coca Cola (P/E of 19) or a utility like ConEd (P/E of 18) will continue in the manner we’ve seen them perform in the last year more than Apple (P/E of 12) will.

I can offer yet another way to consider this curse. Apple’s iOS business is designed to capture profits through the sale of hardware. That hardware is manufactured through a process where, while not being the manufacturer, Apple purchases tooling in a capital-intesive strategy to control the means of production.  I’ve discussed this at length before.

But Apple’s business is more complex than just enabling manufacturing. Tooling allows for production and production allows for supply but supply is nothing without demand. And demand of the product is driven by investments in software and services and design and marketing and countless details.

In other words, for Apple’s modus operandi, if anything should correlate with value it’s opex, not capex. It’s the investment in the people Apple employs not in the tools it buys.

And yet consider this graph:

It shows how the market (though its pricing of Apple shares) values the company overlaid with a Apple’s spending on capital equipment (PP&E capex).

The relationship is uncanny. I’m not suggesting causality—that capex (which is publicly pre-announced) determines the share price level—but I am suggesting that there is a valuing of Apple as a producer of goods (for which tooling is a handy proxy). There is no sophistication to this formula. The more iPhones are built, the more the company is valued. Obvious.[1]

But it’s not obvious that prior to the iPhone there was iPod, which was a different business (and prior to it was the Mac, ditto.) The stock did not reflect the transitions nor does it assume that anything else will follow. It is, in other words, looking backward, not forward.

–

Notes:

1. One could suggest looking at CapEx months in advance and predict the stock price, but who would believe such an absurd idea?

The Parable of Microsoft

–

Show Notes & Links:

Stratechery

Written by Ben Thompson (@monkbent)

via AsymCAR 3: Road Trip | Asymcar.

So the failures of Microsoft to move beyond the rapidly evaporating Windows business model are attributed to the personal failings of its CEO. The calls for his head have been getting loud and rancorous for years. Taking this theory further, now that he’s leaving, the prosperity of the company depends entirely on the choice of a new (smarter) CEO.

It’s all nonsense of course.

Microsoft is composed of people, processes and priorities. And nothing else. The CEO is but one person, admittedly one with a high degree of authority. However, that authority is not unlimited. A change of leadership in a company may have some impact on a larger set of people, at least in the short term, but the bulk of existing resources, institutionalized processes, and priorities set by customers and cash flows limit what any one person can do.

What really causes a company to fail is disruption. The business model around which all products, customers and priorities are built; the culture, the skills and “DNA” of the company; is vulnerable. This vulnerability is why companies have considerably shorter lifespans than the people who work there. They are one of the most fragile of organisms: high infant mortality, with short, unpredictable lives.

Microsoft ascended because it disrupted an incumbent (or two) and is descending because it’s being disrupted by an entrant (or two). The Innovator’s Dilemma is very clear on the causes of failure: To succeed with a new business model, Microsoft would have had to destroy (by competition) its core business. Doing that would, of course, have gotten Ballmer fired even faster.

Steve Ballmer’s only failing was delivering sustaining growth (from $20 to over $70 billion in sales.) He did exactly what all managers are incentivized to do and avoided all the wasteful cannibalization for which they are punished.

If anything, Steve Ballmer avoided The Innovator’s Curse. Being successful with new market innovations would probably have led to an even shorter tenure. Destroying prematurely the pipeline of Windows in favor for a profit-free mobile future would have been a fireable offense. Where established large companies are concerned, markets punish disruptors and reward sustainers.

Steve Ballmer will not be remembered as favorably as the man who created Microsoft. But at least he won’t be remembered as the fool who killed it. That epitaph is reserved for his successor.

But one assumption that underlies this narrative is that innovation is good. Or more precisely, that innovation is rewarded–making its goodness desirable through market mechanisms. The happy ending to the story is that the innovator solves the dilemma, delivers the great innovation, perhaps more than once, and then basks in glory.

But my observation is that the way markets behave often contradicts this measure of worth of innovation.

Here’s the problem: If a company produces a string of successes, the conventional wisdom is that the chances of another success are precisely zero.  A company is valued based on its cash flows and foreseeable improvements to them. What it’s not valued on is its innovation flows (and foreseeable improvements to them).

In other words, if you’ve succeeded in the past, the only certainty is that you will not be able to succeed again. This assumption exists even if you’ve succeeded more than once. The wisest will offer as many excuses for being lucky more than once as they will for being lucky once. In fact, just as the illusion of a run of heads means the next coin flip must surely be a tail, a string of random successes is deemed to increase the probability that the next attempt will end in failure.

This discounting of repeatable success means that the reward for a process of innovation is zero and therefore that innovation itself is a priori value-free.[1]

This means that an innovator not only has to struggle with getting an organization to create something new (the gist of The Innovator’s Solution) but also to do so without the benefit of capital markets. When trying to raise financing for a sustainable innovation engine, the markets speak unanimously: you haven’t got a chance.

Therefore the only way an innovator can finance the next innovation is to use proceeds from a previous innovation, having faith in his engine of creation. Listening to the market would only convince the innovator that the new thing is pointless. In fact, the best idea is to stop trying.[2]

I call this The Innovator’s Curse: that building repeatable innovations provides the innovator no respite. There shall be no basking in glory, only expectations of imminent failure and attribution of success to good fortune.

When I first realized this I thought I chanced upon a remarkable paradox. That this must be some new insight into human nature. That realizing this will change everything.

But just like Disruption Theory is beautifully illustrated through the ageless David vs. Goliath parable, The Innovator’s Curse is but a retelling of this fable:

A cottager and his wife had a Goose that laid a golden egg every day. They supposed that the Goose must contain a great lump of gold in its inside, and in order to get the gold they killed it. Having done so, they found to their surprise that the Goose differed in no respect from their other geese.

Even if the cottagers were naive enough to have faith in the replicating miracle of golden egg laying geese, wise men would quickly advise them to kill it and get the gold more quickly. The Goose is doomed no matter what.

–

1. A company will be priced according to products it created in the past, and that price might be significant, but as competitive pressures increase, the value itself is discounted. What is certain to be worthless however is the ability of any company to come up with something new.
2. When managers give in to the temptation to stop trying they build great sustaining companies which are subject to disruption and invariably fail.

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We can put all of our products on the table you’re sitting at. Those products together sell $40 billion per year. No other company can make that claim except perhaps an oil company.

For those of you laughing, that was three years ago. The revenues quadrupled since to a total of $170 for the last four quarters. But the more interesting thought is that the table has not gotten bigger. When Tim spoke the iPad had just been announced but was not yet for sale. So we can’t be sure if he thought it should be on the table or not, but it does not take up that much space.

It would be fun to actually lay out all the Apple products on a table to see how big it would be. The trouble is that there are many things Apple sells which take up no space at all. Things like iTunes content or services and AppleCare.

So rather than trying to imagine a table full of Apple products (some of which are non-phyisical) I thought a more fitting analogy would be to allocate the revenues from these products to a table and thinking about how much space relative to each other the products would take.

To make conversion easier, I picked a rather large table; 10 feet long, big enough to fit a small conference room. What would this table covered in product revenue look like?

My estimate is that it would look like this:

I color coded the product lines as shown in the legend: Greens for iPhone, Browns for iPad, Blues for Mac, Yellow for iPod, Red/Purples for iTunes and Grey for Accessories.

At this categorization the table would allocate the following space to each category:

• iPhone (Greens): 60 inches or about half the table.
  

  Product	Inches
  iPhone 4	4.7
  iPhone 4S	11.4
  iPhone 5	44.5

• iPad (Browns): 21 inches
  

  iPad 2	1.4
  iPad 4	9.6
  iPad mini	10.3

• Macs (Blues): 5 inches
  

  Desktops	2.7
  Portable	13.6

• iPod (yellows): 2.5 inches
  

  touch	1.8
  iPod	0.7

• iTunes (reds), software and services: 15.5 inches
  

  music	4.1
  video	1.6
  Apps	5.6
  Books	0.8
  Pro SW	1.4
  OS X	0.5
  iWork	0.5
  iOS Apps	0.2
  Serv.	0.9

• Accessories (Greys): 4 inches.
  

  Apple TV	0.3
  Acc	3.6

If this colorful table were used to support the actual products, where each product would have to fit within its color band, then the truth of one saying would become apparent: good things come in small packages.

The graphs each show trailing four quarter average of shares of units shipped, revenues, operating profits and smartphones shipped. I also averaged the four shares into a single share number called the AMP index (Asymco Mobile Performance).

Note that this data ignores those “other” vendors whose financials are not available.

I placed all AMP indexes on the same graph and looked for some patterns. The result is shown below.

It’s not much to go on, but there seems to a pattern where each vendor reaches a peak share, though that peak varies greatly in value. If the pattern holds, we could perhaps anticipate a peak for Samsung in one year or so.

I’m searching for some hypothesis of what is happening and what is causing this pattern, if it is a pattern. The instability of the market is certainly a pattern. (Many markets would show horizontal lines for many years rather than what we see here.)

But the constant turnover and the periodicity of success and failure is a characteristic of either a market where there is a hidden hand (operators? regulation? etc.) or one where disruptive change is extremely consistent and rapid.

Canalys suggests that China’s top five vendors make up 20% of the world’s smartphone shipments. This is mostly due to the rapid rise of the category in China and the advantages local vendors have in that market. Absent this large segment, a complete picture of the market is simply not possible. Nevertheless a fuzzy picture of the entire market can be still be painted.

What I see in this graph is that competition with smartphone non-consumption is still fierce. Non-smart phones are still shipping at the rate of about 200 million per quarter. Not as many as the smartphone units, which are nearly 225 million, but their numbers have not so much plummeted as not risen. Smartphones meanwhile have expanded greatly.

The other observation is that these non-smart units are increasingly being made by no-name brands and sell in emerging markets through grey markets. Nokia’s non-smart business is contracting and Samsung, the only other branded vendor with any material non-smart volumes is fleeing upmarket.

Consider that India, a market of 700 million users purchased barely 9 million smartphones last quarter. Contrast that with the Chinese market where 1.1 billion users purchased 88 million. The preference in India is for super low cost products of dubious progeny.

In other words, the preference in India is about what it used to be in China two years ago.

Will India follow China out of non-consumption? It’s hard to say. There are many factors beyond market forces at work. Although that’s true in most phone markets, India is particularly byzantine. Not only is distribution different (retail only and very fragmented and multi-level distributed) but there are few 3G users and networks are notoriously difficult to scale. For a vendor trying to apply a global strategy in India the odds are very poor indeed. And there are few vendors more uniform in their approach than Apple.

The Indian market is not yet “cracked” as Tim Cook would say.  One wonders if it ever will be.

via 5by5 | The Critical Path #93: The Innovator’s Curse.

Seating is limited but there are still 25 20 3 available.

This will be the third Airshow, having started in June in San Francisco and rolling into Chicago in July. The event keeps getting better with a plan to introduce a hands-on module allowing participants to build cinematic data-driven presentation during the afternoon.

Airshow is intended as both an exhibition of technique and as an explication of   the methods for creating persuasive presentation enabled by new technologies.

Without revealing too much, the gist of the theory espoused is that presentations can benefit from:

• The use of directly manipulated visuals
• Cinematic effects honed by cinematographers over a century
• Aristotelian presentation principles

Together, these techniques solve the “job to be done” of persuasion—a job universally in demand but deeply underserved by current tools and techniques.

The participant should come away from the event with the ability to:

• Use the iPad as their primary presentation tool, with or without a projector to large and small audiences
• Use a cinematic technique of presentation where a layer of implicit yet easily sensed meaning is overlaid upon the words spoken and images viewed
• Appeal with empathy, logic and credibility to all audiences.

You can register for Airshow New York here.

See also: The end of the projector.

Q: Will noise from Icahn distract the Cook from focussing on product?

A: Investors may think that they can influence management but they do so only when companies are in distress. It’s only then that shareholders can affect some change with their votes as they have a common purpose. The voice of investors carries little weight or distraction when a company is successful. At first glance it seems that Icahn thinks he can unlock value in Apple by getting management to accelerate share buybacks. That’s a modest goal and not one which needs to distract managers.

Q: What will do most for the share price – a buyback or a blockbuster new device?

A: Neither. What will do most for the share price is a change in the perception that Apple is not going to survive as a going concern. At this point of time, as at all other points of time in the past, no activity by Apple has been seen as sufficient for its survival. Apple has always been priced as a company that is in a perpetual state of free-fall. It’s a consequence of being dependent on breakthrough products for its survival. No matter how many breakthroughs it makes, the assumption is (and has always been) that there will never be another. When Apple was the Apple II company, its end was imminent because the Apple II had an easily foreseen demise. When Apple was a Mac company its end was imminent because the Mac was predictably going to decline. Repeat for iPod, iPhone and iPad. It’s a wonder that the company is worth anything at all.

The only data in these graphs that is provided by Apple are the dashed purple lines. They represent the average selling prices (ASP[*]) for the two product lines. I added assumptions about product mix (shown in the lower set of graphs) and thus generated prices for each product variant at a given point in time shown as  line graphs.

If you look at the iPad, ignoring the legacy iPad 2 (which I presume sells mostly to educational institutions) the replacement of the iPad 3 was with a “bracketed” portfolio of the higher-priced iPad 4 and the lower-priced iPad mini. Note also that the mini reflects similar pricing to the legacy iPad 2.

My second assumption is therefore that the 5S and 5C will form a similar bracket as the new iPads did. I also assume that the iPhones 4 and 4S will be retired. This means that the 5C will take up the trajectory of the 4S while the 5S will take up the upper bracket around $650.

The average pricing for the entire portfolio will depend on the mix. This is still highly speculative since we can’t predict how the end-user (operator) pricing will be set for the 5C. Aggressive promotion and new market growth might skew the 5C considerably. On the other hand, upgrade promotions might move the 5S in existing markets.

—

Notes:

• These prices reflect blended average prices of all SKUs to the channel and do not necessarily reflect prices offered to end-users.

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ComScore’s previous such survey showed that Android had 52.4% of about 141 million users. This amounts to 73.88 million Android devices in use. It also means that Android usage in the US went down for the first time.

The difference is surely within a margin of error so it’s not something to declare definitively, but the pattern of Android “peaking” has been evident for some time.

Even though share stopped growing about a year ago, Android continued to gain users as overall smartphone consumption increased. The last few months however have shown a slowing of new smartphone users and therefore we have this first instance of Android appearing to lose usage.

Note that this has not been the case for iPhone as usage over the last six months is up by 11 million users vs. 6.6 million for Android.

Indeed, iPhone gained more users than Android for the last 6 out of 8 months.

The presumption that companies can shift business models at will is usually false. Businesses are balanced on a knife’s edge of dependency on multiple variables. Almost all resources are expended on preserving this balance.

This being my observation, I take issue with assumptions that large companies can “pivot” on a dime or that they can change their business models “when conditions are right”. Consider Microsoft’s dilemma. They have all the resources in the world and yet they could not pivot to take advantage of a change so mundane as a low power microprocessor (which enabled a mobile computer and hence a new ecosystem and profit model for software.)

Or consider the dilemma of Apple which after building a successful computer business which included system software, could not pivot to license that system software so others could build computers with it.

Or consider the dilemma of Nokia which had an early and large leadership in smartphones including having its own OS and platform and large volumes and users bases. It could not pivot to allow into an ecosystem and had all its advantages disappear.

Each company thought they could manage change but none of them actually did.

It’s with this thinking about inertial navigation that came to consider the idea that Amazon has a flexible business model which, though unprofitable today, will be profitable some day.

The premise that Amazon can, on a whim, change its business model from selling other people’s products at a razor thin margin while investing in capital-intensive distribution to selling other people’s products at a large margin while not investing in capital-intesive distribution is not credible.

I would argue that Amazon’s existing business model is a direct consequence of the market it’s in: that it could not be anything else given the circumstances it finds itself in. Enlightenment may be an illusion.[*]

That’s not to say that there is no wisdom in the management of Amazon. Quite the contrary; recall the respect that’s called for in creating a great business. Managing the business to this point was a work of decades of vision and creativity.

What I take issue with is the premise that Amazon is the “anti-Apple” in its hunger for growth and patience for profits. Apple has its own “Amazon-like-business”: iTunes has been growing at a steady 25% or more and it also has its ancillary zero-profit hardware analogue to the Kindle called Apple TV.  iTunes is a great business in the Amazon vein, harvesting hundreds of millions of users (and their credit cards.) Presumably iTunes could also some day “flip the switch” and become profitable, but something magical needs to happen. Something like becoming a payments processor or retailer of other things. Analyst beware however. There might be conditions that make such switch flipping extremely difficult.

At an even deeper level, Apple and Amazon are much more alike than they are different. They are both hired for similar jobs (convenience, ease of use and a controlled, predictable environment for average users interacting with technology). They both focus on delighting customers and controlling all the variables which come into contact with that delight. They both have long-term views and are driven by vision rather than competition.

Where they differ is in others’ perception of sustainability. Whereas Apple is perpetually given an expected lifespan of less than a decade, Amazon is expected to have an indefinite lifespan. This is because Amazon is seen as having no competition and Apple is seen as having infinite competition. In other words, Amazon is perceived as a monopoly and Apple is perceived as the  innovator that is in a permanent state of being disrupted by the low end.

I disagree with both assumptions. I’ve always thought Apple fragile but dedicated to moving into new markets as older markets are disrupted. It’s a tough strategy and one which (literally) nobody believes possible. But I’ve also thought Amazon’s monopoly status fragile. This too is not a popular idea but the company depends on many variables.

Retail is hard and it is being disrupted by technology wielded well by Amazon. But it’s also subject to further disruption. Amazon’s job to be done can be done by alternatives. Buyers are typically hiring Amazon for convenience, not just price and ease of use is where the value is. But again, new information technology which makes shopping, discovery and delivery of products directly from the vendor, bypassing the aggregator (i.e. retailer) could shift value along the value chain yet again.

By the time Amazon reaches some point of monopoly in distribution it could be too late to make the switch to profit generation.

I don’t want to suggest that failure is inevitable, but I want to point out that success is not certain by any means. Disruption happens.

–

* It’s possible that Enlightenment is also an illusion at Apple. Even if they once had it, there are forces which act on companies that make them lose their wisdom.

Additional newly reported items:

• Quarterly revenues dipped slightly to $4 billion (second highest after $4.1 billion last quarter).
• iTunes Stores billings (i.e. gross content revenues) were $4.3 billion
• Reached the best month and best week ever for App Store billings at the end of the quarter.
• iTunes billings translated to quarterly revenue of $2.4 billion, up 29% from the year ago but flat q/q. Company reports “strong growth in revenue in both content and apps.”
• New content added includes HBO GO and WatchESPN available on Apple TV. Apple TV catalog now includes over 60,000 movies and over 230,000 TV episodes.
• Users have downloaded more than 1 billion TV episodes and 390 million movies from iTunes to-date. They are purchasing over 800,000 TV episodes and over 350,000 movies per day.
• iOS developers have now created more than 900,000 iOS apps including 375,000 apps made for iPad. Apps created grew by 50,000 overall and 25,000 iPad apps.
• Cumulative app downloads have surpassed 50 billion.
• App developers are being paid at the rate of $1 billion per quarter.
• App developers have been paid over $11 billion for their sales through the App Store (half of which was earned in the last four quarters.)
• There are now over 320 million iCloud accounts
• There are 240 million Game Center accounts
• Almost 900 billion iMessages have been sent
• Over a 125 billion photos have been uploaded and over 8 trillion notifications were sent.

Some observations and estimates:

• Music revenue growth remains at around 15% while video revenue growth remains around 25%
• Apps continue to accelerate with a near doubling of revenues
• Book revenues are contracting as pricing pressure is being felt
• The software group grew moderately at 15% as Apple’s apps are reaching saturation within the iOS user base and as Mac sales stagnate.

As a reminder, you can order the iTunes Business Review from the Asymco Store.

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Horace Dediu and Jim Zellmer discuss the odds of disrupting the present automotive club via Tesla. We further dive into the regulatory and cultural environment that sustains the current players, while reflecting a bit on Segway, Toyota’s Winglet, organ donors and the Fiat “multiair” engine. Finally, we preview a larger discussion on apps in and around the car. [24MB 57 minute mp3]

Bill, I think the smartphone market has always been competitive. [Only] the names have been changed.

Tim Cook responding to Bill Shope’s question on the competitive landscape, April, 2013.

Indeed, over the years, the companies considered Apple’s primary competitor have been many.

In years gone by in the phone market there were RIM and Nokia and Palm and HTC. In the iPod era there was Creative and Sony and innumerable others long forgotten (not to mention the tyranny of DRM).

Even today we struggle to decide whether Apple competes with Google first or Samsung. Or perhaps with the iPad it’s with Amazon or  Microsoft. Or maybe iTunes is threatened by Netflix or Spotify. The Mac surely competes with HP and Dell and Toshiba. What about iCloud? Clearly it’s Dropbox or Google Drive. iWork? Both Office and Google Docs.

Doing a competitive analysis for Apple is then mostly a struggle of whom to compare it to. So forgive me that I only track the few challengers shown below.

Note also that these companies all may compete with Apple to some degree but they may not compete with each other. Competition, it seems, is not transitive.

There isn’t much that I can observe in the data that hasn’t already been observed. Google shows steady but not spectacular growth in revenues with decreasing margins. Microsoft shows even more modest growth in revenues with flat earnings. Apple growth is moderating from near vertical while earnings pause. Samsung has great growth but there is a similar set of doubts about its sustainability and finally, Amazon continues to grow the top line by 20% and  has nothing to show for it.

Operating margins have mostly fallen with the exception of Samsung whose increasing reliance on smartphones has led to a modest increase, though not nearly to the level of the others. (Amazon, lacking in profits, cannot be compared.)

In summary there is little change to report.

Except that it’s been reported that in the last quarter Samsung managed to “dethrone” Apple from the phone operating profit crown. This is a matter of estimates and for that we need to understand clearly the assumptions.

I estimate that this is not the case. That indeed Apple remains most profitable phone maker by a wide margin.

To estimate operating margins you need to estimate gross margin and the allocation of operating expenses (SG&A and R&D) to a particular “division” or product line. The problem is that Apple does not operate as a divisional organization so its marketing and R&D budgets (i.e. people) are not assigned permanently. You have to move them around based on whatever is being worked on at any given time.

What’s more, we need to account for the huge SG&A costs associated with iTunes and Retail. They both consume vast resources which cannot be allocated directly to any product. There are 41,000 people working in retail.  Also, some of the expenses for iTunes are overhead and cannot be considered cost of sales. That’s also SG&A. Then there’s corp research and design (Mansfield and Ive), which are not allocated to any particular product. When you slice out these costs, there is very little to apply to iPhone, etc.

So if (and it’s a big, sanctimonious if) you want to cast iPhone out as a separate business unit, it would be wildly profitable. There is a huge gross margin of 46% (this assumes a cost per unit of $316) and only another 5% of sales spent on engineering and marketing leaves a 41% operating margin or $7.4 billion. (Why only 5%? Because there’s only 10.8% to allocate and after taking out iTunes, Retail you’re really only left with 4.49% for SG&A and 3.3% for R&D or 7.79% so 5% is about two thirds of the operating budget).

If you take all of Samsung’s IM division which is PCs, Tablets and phones their operating profit was only $5.6 billion.

You can see the difference in the grey areas of operating profit in the first graph above.

Bear in mind that this is still an artificial comparison. The split of profit between product groups is not only an estimate by the analyst, it would be an estimate for Apple itself since it has only one P/L.

Stores Open and Visitors

Visitors per employee,Visitors per store, Revenues per store and Employees correlated with Visitors.

Employment and Profitability (per Employee and per Visitor)

The pattern that seems to appear is one of a plateau or peaking of sales, especially when values are seen on a per-store basis. Revenues, employment and visitors per store are all flat or slightly down when seen on a seasonally adjusted basis (trailing four period average).

Profitability has been more steady over a long period, though more volatile in a short-term window.

Seen in isolation, Apple Stores would appear to be coming to a point of quiescence.  But they should not be seen in isolation. Apple Stores mainly sell Apple products, so if Apple products slow then retail sales should also slow.

Indeed, in 2007 Steve Jobs told Fortune that the Apple stores had been built to sell the iPhone and in 2010 Ron Johnson said the Apple stores had been built to sell the iPad. These statements were meant metaphorically but they are literally true when looking at what is actually sold. The following graph shows the relationship between iOS device sales and Retail revenues.

The first chart shows the relationship plainly enough and the r-squared coefficient of 0.96 puts a finer point on it.

So at the end of the day, the performance of the Apple stores depends on the performance of Apple’s portfolio of products. It stands to reason that as iOS units slow, Apple stores should as well.

This is something Apple management should be well aware of. Therefore, if Apple were confident in the future of iOS it would be investing in retail (as it would in other capital projects like manufacturing.)

And that answer would be here:

Management explains:

In late April we executed a very successful debt offering issuing 17 billion of debt across 3, 5, 10 and 30 year maturities. We paid $2.8 billion in dividends in the quarter and we also utilized a total of $16 billion in cash on share repurchase activity through a combination of a new accelerated share repurchase program and open market purchases. $12 billion of the $16 billion was utilized under a new ASR program initiated with two financial institutions in April.

An initial delivery of 23.5 million shares was made under this program with the final number of shares delivered in average price per share to be determined at the conclusion of the program, based on the volume weighted average purchase price of Apple’s stock over the program period, which will conclude in fiscal ‘14. In addition to the new ASR, we executed $4 billion of open market share repurchases, resulting in the retirement of 9 million additional shares.

Later, during Q&A:

Tavis McCourt – Raymond James: Thanks for taking my question. Peter, first a clarification on the share buyback and can you tell us what the ending basic share count was in the third quarter?

Peter Oppenheimer: All of that is on the income statement, so you got the ending basic and diluted, but let me give you a couple of points that I think could be helpful for you. During the June quarter, we concluded the first $2 billion ASR program that we started in December and then so we got the final shares in on those, and we did our second ASR program of $12 billion, that started at the end of April and we received 23.5 million shares initially on that. And I went through in my prepared remarks, at some point during fiscal ‘14 that program will close and we will get the final number of shares. We also bought back $4 billion of stock in the open market during the June quarter and received about 9 million shares. So, the impact of those in the June quarter lowered our diluted share count in the quarter by about 22.9 million shares. And as you look forward into the September quarter before any further buybacks or any issuance to employees we would expect to see an additional approximate 11 million share benefit from the things that occurred during the June quarter.

This is a bit convoluted, but it seems that Apple has committed to buy $16 billion worth of its shares but has not completed the retirements. They see an additional 11 million shares being retired from activities conducted in the June quarter. (Nota bene: when calculating future EPS, take these shares out of consideration.)

If we add the 11 million yet-to-be-retired to the 21.7 million already retired and assume $16 billion was paid for them then the average price paid was $488.25.

Not a bad price. Share re-purchases are valuable only if the price paid is low (a determination that is usually beyond the scope of management to make.)

But what is even more interesting is that if we consider the $16 billion expenditure as an acquisition, then Apple has made what amounts to its biggest. It’s more than some familiar companies are worth:

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