Tech-Thoughts

HTC Could be an Attractive Acquisition Target for Regional Smartphone Vendors

2013-05-24T10:00:00.000+05:30

HTC has seen its smartphone shipments and market share drop steadily over the past couple of years. The company had pinned its hopes on the HTC One, but production problems derailed the launch. This has led to a mass employee exodus, which has put the future of the company in peril. Most people think that this was a direct result of Samsung's deep pockets and vertical integration. However, HTC's own strategic missteps may have caused its decline and this could make them a potentially attractive acquisition target for regional smartphone OEMs.

Let's start out by taking a look at the major reasons for HTC's decline:

Failure to Establish a Recognizable Sub-Brand

I had written about HTC's marketing failures on a recent post about winners & losers among smartphone OEMs:

In the face of increasing competition from Samsung's Galaxy series and Apple's iPhone, HTC's biggest failure has been its inability to establish a coherent branding strategy for its Android-based smartphones - This is something that even Nokia has managed to pull off with the Windows Phone-based Lumia series. With multiple devices and weak sub-brands, consumers shifted away to stronger sub-brands from competing vendors.

In 2011, HTC had a hit on its hands with the Desire series, but it promptly added many other high-end products and sub-brands to its range (some of which had quality issues). At that point, it was difficult for a "hero" or "flagship" device to emerge which could generate consumer interest. HTC has been attempting to correct this with the "One" branding, but it has already lost a lot of ground.

Lack of Focus on Mid-Range Devices & Emerging Markets

HTC's marketing strategy has consistently focused on pushing its high-end devices. This worked very well in 2010-2011, when the US smartphone market was exploding. As HTC expanded its product line, they considered this to be a "winning formula" and put even more effort into marketing new high-end devices, which didn't have a recognizable sub-brand. At this time, its mid-range and low end products were fairly nondescript to mainstream consumers.

Meanwhile, Samsung and regional vendors were busy strengthening their low-end and mid-range portfolios. As mature, subsidized markets began to slow, emerging markets took over as the global smartphone growth engine and HTC lost another opportunity.

Panic-Driven Search for Alternative Platforms

The worst blow to HTC was the launch of the Windows Phone-based HTC 8X as the company's flagship product. The device sold poorly and did nothing to help HTC differentiate from competition. As I had previously shown, a different platform is never a long-term, sustainable, competitive advantage (just a hygiene factor) and commoditization is inevitable. But in this case, the weak Windows Phone platform put them at an immediate competitive disadvantage. During this misadventure, HTC lost crucial time that could have been used to focus on emerging markets and generating market awareness for its mid-range portfolio.

The company then followed up the HTC One launch with the Facebook Home powered HTC First. As I expected, Facebook never considered the HTC First to be anything more than a marketing vehicle for Home (although consumer response to Home was far worse than I expected) and the phone was a complete disaster.

What's Next: Acquisition Target?

Despite the production issues and the buzz generated by the Galaxy S4, HTC One sales have totaled an impressive 5 million. This suggests that HTC still carries some clout in the high-end smartphone market, if not in any other segment. However, HTC's position in emerging markets suggests that it will struggle to regain scale. This provides an opening for regional OEMs such as Lenovo to acquire HTC. Lenovo already has a firm foothold in emerging markets and acquiring HTC would give Lenovo access to higher value segments of the market. Given the fact that other potential targets in the smartphone industry (such as Blackberry & Nokia) face far greater challenges, HTC could be a particularly attractive target.

Windows Phone Inventory Build-Up: Bad Sign for Q2 Nokia Lumia Shipments

2013-05-21T10:00:00.000+05:30

The tech media has long been obsessed with the semantic differences between smartphone shipments and sales. In reality, all figures announced by companies, and those announced by IDC, are shipments (also known as channel sales or sell-in). Gartner is the only research house that tracks sales to end users (also known as sell-through). Comparing data from IDC and Gartner can give us good insight into channel inventory patterns across different smartphone platforms. This data suggests that Nokia & Windows Phone may be in for some trouble in the next few quarters.

The chart above shows the % of unsold inventory for each platform. The patterns are fairly predictable for Android and the iPhone. Android smartphones are sold across various price levels and from a wide variety of OEMs. As a result, inventory levels are fairly consistent at ~10% of shipments. On the other hand, iPhone demand is highly cyclical based on product launches. As the result, the inventory pattern is highly cyclical as well, typically peaking around the time of a launch.

The interesting data points are from Windows Phone: Windows Phone devices are only available from a handful of OEMs (Nokia is said to be responsible for 80% of shipments), and based on the ASP, most buyers are first-time or mid-range smartphone users. Therefore, product launches shouldn't have an out-sized influence on inventory levels. However, Windows Phone's inventory levels seem to be even more cyclical than the iPhone.

Shipments vs. Sales

First, let's take a look at the shipment vs. sales pattern for the iPhone & Android smartphones:

For these devices, shipment and sales figures are clearly in sync with each other and interchangeable for the reasons I already mentioned. Now let's compare this with the same pattern for smartphones running Microsoft's OS:

The chart above compares the shipments and sales pattern of Windows Phone/Mobile devices over the past two years. After Nokia's Lumia launch, the majority of shipments were of Windows Phone based devices. As the chart shows, Windows Phone has seen two inventory build-ups since the Lumia launch - The first was in mid-2012 after Microsoft announced that Windows Phone 7 devices were not forward compatible and the second was in Q1 2013. The sharp shipment boost in Q2 2012 saw limited growth in sell-through, which continued to be flat in the next quarter. This caused a sharp shipment decline in Q3 that hit Nokia hard. Compare this to the trend seen in Q4 2012 and Q1 2013 - Shipments saw sharp growth, but sell-through actually saw a slight decline.

Unsold Inventory vs. Shipments: Impact on Nokia & Windows Phone

The chart above reinforces the point I've made above. Windows Phone's shipment growth over the past two quarters has been, at least partly, a result of a build-up in channel inventory. It's extremely unlikely for OEMs like HTC, Samsung or Huawei to be shipping large volumes of Windows Phone devices, which just leaves Nokia.

In its Q1 filing, Nokia admitted that the channel inventory for its “Devices & Services” division (including both feature phones & smartphones) was above normal, while the inventory for “feature phones” had declined. Since Nokia’s feature phone shipments far outnumber its smartphone shipments, this implies that the inventory levels for Lumia smartphones saw large increases. Therefore, unless Nokia sees very strong growth in sell-through in Q2, they may find it extremely difficult to reach the targeted level of 7 million Lumia shipments. Considering slowing app growth on the Windows Phone platform, Nokia may have to resort to heavy price discounting to get closer to that figure.

Global Smartphone Market Share Trends - Q1 2013: Android Extends Lead Over iPhone, Windows Phone Performance Mixed

2013-05-17T10:28:00.000+05:30

It's time again for my quarterly review of smartphone market share trends around the globe. While I initially considered doing this semi-annually, I've been requested to make it a quarterly feature. As always, Q1 2013 data is sourced from Gartner and Kantar Worldpanel reports and complemented with reports from other research houses as and when available.

The chart above shows Gartner's global smartphone market share data for the last four years. The trend is unmistakable, as legacy platforms like Symbian and Blackberry have been practically wiped out. Android has continued to extend its dominance and now accounts for nearly 75% of smartphone sales. The launch of highly anticipated devices like the Galaxy S4 at the high-end and dropping price points at the low-end should help Android devices consolidate their position over the next two quarters. Meanwhile, as I had predicted, the iPhone's market share declined to ~18% (compared to ~23% in Q1 2012). The iPhone's growth slowdown has been driven by increasing cyclicality in sales as its target market has become more saturated. Finally, Blackberry and Windows Phone just managed to grab 3% and 3.5% of Q1 smartphone sales.

Now let's take a look at the state of the smartphone market in major regional markets:

US: Android Regains Lead Over iPhone

Thanks to the iPhone 5 launch, the iPhone had temporarily surpassed Android smartphone shipments in Q4 2012. As I expected, this trend lasted for just one quarter as Android regained the lead in Q1. Because of the unique pricing structure, the US smartphone market is very different and far more "launch driven" than the rest of the world. As a result, the US is the only remaining smartphone market in the world that can be considered a "duopoly" at this point. However, the nature of the market is also likely to cause a Galaxy S4-driven launch hysteria, giving a boost to the Android platform's market share until the next iPhone launch. Interestingly, Nokia & Windows Phone seem to have finally gained some traction in the US, breaking past 5% market share for the first time - However, this could also be a temporary, launch driven anomaly.

Europe & Australia: Android Gains, iPhone Declines, Windows Phone Sees Modest Gains

The Android platform dominates both Europe (~70%) and Australia (>60%), with the iPhone in second place. The trend seen in both markets is fairly similar, as the iPhone gave back pretty much all of the market share gains from the iPhone 5 launch. Windows Phone has made some very modest gains and holds just 4-6% in these markets.

Now let's take a look at the market share trends each major EU5 country:

UK: Android Regains Previous Losses

Smartphone market share trends in the UK are almost an exact replica of those in Australia. The Android platform extended its lead to nearly 60% as iPhone sales weakened after the iPhone 5 launch. Meanwhile, Windows Phone has seen steady growth to reach ~ 7% of smartphone sales.

Germany: Android Strengthens Presence

Market share trends in the German smartphone market are, again, very similar to those in UK & Australia as iPhone sales predictably declined in Q1. However, the overall market share of the Android platform (>70%) in the German market is much higher than that in the UK & Australia. The interesting trend in the chart above is the state of Windows Phone – The platform had seen decent growth over the past few months, but saw a surprising decline in March. It will be interesting to watch the sustainability of Windows Phone’s market share over the next few quarters.

France: Android Sees Stronger Growth, iPhone Sees Strong Decline

The French smartphone market shows a far steeper market share trend for the Android platform than UK or Germany. iPhone sales saw a sharp sequential decline, while Windows Phone, again, saw steady growth to reach ~7% of the market.

Italy: The “Third Platform” Exists?

The Italian smartphone market is one of the “outliers” in Europe. Not because of market leadership (Android still leads with more than 60%, with the iPhone in second), but because of it is one of the only markets that has a semblance of a “third platform”. Windows Phone, surprisingly, holds more than 10% of the market here. However, Windows Phone’s market share has declined over the last few months (from ~15%). This may be another market to watch to gauge Windows Phone’s “staying power”.

Spain: The Tale of One Platform

Spain is the other “outlier” among EU5 nations, but for very different reasons when compared to Italy. The country is completely dominated by Android, which has cornered well over 90% of the market. All competing platforms, including the iPhone and Windows Phone, seem to fighting for scraps. Windows Phone’s struggles are especially interesting, given the price sensitivity in the market.

Urban China: Market Remains Remarkable Steady With Android in the Lead

China has consistently been dominated by Android devices, mostly without Google services. However, local Android appstores fill the gap admirably. The chart above shows the state of the smartphone market in Urban China, where Android has consistently held ~70% of the market. If we include data from across the country (from Analysys), the scales tip even more convincingly in favor of Android. Windows Phone's struggles in China are interesting, given the fact that their presence in other markets is purely driven by first time smartphone buyers. This is probably driven by aggressive pricing of Android devices by Chinese OEMs. This dynamic is beginning to make an impact in markets like China and India, but I expect it to be a global phenomenon soon enough.

Slowing Windows Phone App Growth Points to Weak Developer Interest

2013-05-14T10:00:00.000+05:30

Microsoft recently unveiled that the Windows Phone Store has about 145,000 apps available. Based on this figure, app growth for the Windows Phone platform seems to be slowing. Windows Phone 8 was supposed to help drive developer interest, but has done nothing to stem this slowdown after being on the market for 6+ months.

As the chart above shows, application growth in the Windows Phone Store (formerly the Windows Phone Marketplace) started off strong. Application growth was much greater than that for Android over the first few years (ignoring the population of mobile developers). However, while the application base on Android and iOS continued to grow, Windows Phone seems to have slowed.

App Addition by Platform

Since mid-2012, app addition on the Windows Phone platform seems to have flatlined. This is in stark contrast with app addition on Android & iOS over the same timeframe, even though the developer population at the time was smaller. iOS saw steady growth for the first 2-3 years, while Android has seen steady growth for the first 4 years.

The unmistakable conclusion from these charts is that developers are losing interest in the Windows Phone platform (or possibly Microsoft's "Metro" platforms in general). My guess is that this is caused by a mix of factors - limited install base, low user engagement, monetization challenges and regional developer restrictions. Given the trend of platform concentration in the mobile industry, this could be a very challenging situation for Nokia and Microsoft to overcome.

Mobile Platform Concentration Growing Twice as Fast as PC Industry

2013-05-10T10:00:00.000+05:30

Over the last few years, mobile platforms like Android & iOS have gained market share in computing systems at the expense of legacy WinTel-based devices, i.e. traditional PCs. The chart above gives us a great snapshot of the impact of Post-PC platforms. We can also use this data to compare how platform market share concentration changed over time in the PC industry and contrast it with the first few years of the mobile revolution.

One commonly used measure to gauge industry concentration is the Herfindahl index. It is essentially the sum of squares of market shares of all the players/platforms in the industry. The resulting value varies from 0 to 1, with the higher value indicating higher market concentration.

PC Industry Concentration - 1981-2000

The early years of the computing industry (1975-1980) were obviously very fragmented, with many vendors using mostly proprietary technology. Apple was one of the first innovators in the market to take the PC to mainstream users, but also followed a proprietary, integrated approach. Microsoft & IBM entered the industry with a modular approach and gradually increased their dominance.

Increasing industry concentration, in favor of a modular strategy, is consistently seen in various industries and occurs as products from a wide range of vendors become "good enough" for the market. This is usually driven by lower entry barriers for new (usually lower-end) hardware vendors, thanks to easy availability of an ecosystem/platform to plug into. Competing platforms typically fail to create long-term, sustainable differentiation because the market essentially accomplishes the same tasks/jobs using these devices. In addition to this, modular devices end up being far cheaper than those with proprietary architecture.

Mobile vs. PC Industry Concentration

In the mobile industry (both smartphones & tablets), Android was the first platform/ecosystem that provided low entry barriers to new hardware vendors. In the smartphone industry, the subsidized pricing structure initially created an unnatural pricing dynamic that favored high-end vendors, but lately lower-end vendors have been catching up. However, over the next few years, emerging market growth will favor low-end vendors. Meanwhile, the natural pricing dynamics in the tablet industry are an ideal fit for the trend we saw in the PC industry.

As we can see in the chart above, platform concentration in the mobile industry has grown about twice as fast as that in the PC industry. One reason for this is because the rise of mobile was driven by consumer adoption, as opposed to enterprise adoption. This trend should accelerate as smartphone & tablet penetration increases in emerging markets. This would also cause profit erosion for high-end vendors and a high volume, low margin becomes the only realistic strategy. The only questions that remain are these: How many companies will adapt and how many will perish?

Tablet Shipments to Overtake PCs by Q3/Q4 2013 (Revised Estimate)

2013-05-07T10:00:00.000+05:30

A few months ago, I had estimated that tablet shipments would overtake PCs by Q1 2014. This was based on the fact that the substitution rate pattern of tablets vs. PCs was similar to the one we saw in the early days of the modern vs. legacy smartphone battle. Let’s use the tablet & PC shipment data from Q1 2013 to revise our estimate.

The tablet vs. PC substitution rate in Q1 turned out to be much higher than my estimate. This was partially driven by quicker adoption of tablets in emerging markets, and a major decline in PC shipments (thanks to tablet adoption and consumer response to Windows 8). While tablet vs. PC substitution rate is currently considerably higher than that seen for modern vs. legacy smartphones, the two patterns show a correlation of nearly 95%.

In order to be conservative, my original estimate assumed that the deviation between the two substitution rate patterns would decline over time, i.e. the growth in tablet vs. PC substitution rate would slow over time. However, at least for now, it seems as though that assumption may not necessarily be correct. Therefore, it may be more prudent to consider two cases: One where the deviation between the two trends narrows and one where it doesn't.

Case-1: Declining Substitution Rate Deviation

The substitution rate pattern in the chart above assumes that the deviation between the two patterns narrows over the next year. Based on this pattern, and my previous assumption for the growth of the overall tablet + PC market (cyclical with low average growth), we get the following shipment projection for tablets and PCs:

As the chart above shows, Q4 2013 would be the first full quarter in which quarterly shipments of tablets would exceed those of PCs, as PC shipments drop to ~70-75 million and tablet shipments near 80 million.

Case-1: Consistent Growth in Substitution Rate Deviation

Here, the substitution rate maintains its current trajectory over the next year. In this case, using the same assumption for overall shipment tablet + PC shipment growth, we get the following estimate for tablet & PC shipments:

In this case, the crossover between tablet and PC shipments occurs earlier, i.e. in Q3 2013, as PC shipments drop to roughly ~65 million and tablet shipments cross 75 million.

While there isn't much variation in the point of crossover, the PC shipments drop much faster in the second case. These shipment estimates could be affected by the pace of of low cost tablet penetration in emerging markets and any changes to the Windows 8 operating system. However, given the scale of the figures, I can say with confidence that quarterly tablet shipments should overtake those of PCs by late 2013.

Tablet Market Share Trends: Android Leads, iPad Loses Ground, Windows Struggles

2013-05-03T10:00:00.000+05:30

IDC has just released their tablet market estimates and their figures are quite a bit off from my original Q1 estimate, but eerily similar to my revised estimate based on NPD's figures. Android tablets seem to have permanently stolen the tablet market crown from the iPad, while Windows tablets have continued to struggle. Let's take a deeper look at the figures.

Android now leads the tablet market, with a share of 56.5%, while the iPad's share has fallen below 40%. Windows tablets are still struggling, with a share below 4% and with struggling shipment figures, sell-through is always questionable.

Tablet Shipment Trends by Platform

As the chart above shows, Android tablets have made convincing gains over the iPad in the last couple of quarters. This growth is really impressive considering the fact that it occurred in the midst of Apple's hyped iPad Mini launch. This leadership shift is not unlike the one we saw in the smartphone market, which occurred around the timeframe of Apple's iPhone 4 launch.

Apart from the leadership change, the most important takeaway from the chart is that Android tablets did not see a sequential decline in Q1. I had earlier stated that seasonality in tablet demand (especially for Android tablets) would reduce as emerging market demand grows. Based on the figures, I would say that demand for tablets in emerging markets has seen an explosion - This is very good news for low cost tablet vendors, but not necessarily good news for Apple, Microsoft and the PC industry.

Tablet Shipments by OEM: Emerging Market Impact

As I had previously shown, the growth of Android tablets in Q4 2012 was far more broad based than it was in Q4 2011. Among leading Android OEMs, Samsung has seen strong sequential gains, Asus has maintained its position and Amazon's tablet shipments have seen a sharp seasonal fall (sharper than I expected). But the big story here is the performance of "Other Android Tablets" - These mid-range to low-end tablet vendors are mostly regional players, but will make more of a mark as we move forward. The Android platform has enabled these vendors to come out with products "good enough" for the masses at very low price points. This will be a major factor in slowing shipments of PCs and Windows 8/RT tablets over the next few years.

Outlook

Looking at the chart above, iPad shipments normally see strong growth in calendar Q2. However, this is always driven by a new product launch. Tim Cook's comments during Apple's earnings call suggest that any new products will only be launched in the fall, making Q4 the first full quarter after a new iPad/iPad Mini launch. This means that iPad shipments should see another sequential decline in Q2 (to ~17-18 million). This dynamic, combined with exploding emerging market demand for Android tablets, is likely to push Android's market share above 60% (with shipments above 30 million). This would essentially be a repeat of the iPhone vs. Android battle we saw in the smartphone market, over the past couple of years.

The Future of Google Glass: Developers & OEMs

2013-04-30T10:00:00.000+05:30

With Google shipping early explorer editions of Glass to early adopters, the buzz around the product has reached a fever pitch. Of course, this excitement is currently limited to Silicon Valley investors and tech enthusiasts, but it is unprecedented for a product that is still a prototype. Let's take a look at the future of Google Glass.

The success of any technology platform (yes, Glass is a potential platform, not just a gadget) hinges on establishing an ecosystem to support the interface. This ecosystem consists of developers/applications, manufacturers/distributors and, of course, consumers (think word-of-mouth, the most effective form of marketing).

Developers and Applications

I don't see Glass at the same stage as the iPhone was when it hit the smartphone market, but more like the original Blackberry Pagers/PDAs (without GSM radios). Therefore, any apps built for the platform, over the next year, are likely to be experimental as well, and will evolve as the hardware evolves. This also means that the adoption curve for this product category is likely to be far slower than smartphones and tablets.

The early buzz surrounding Google Glass is very encouraging, not because of positive reviews from early adopters (which is not necessarily a precursor to mass adoption), but because of initiatives like the Glass Collective. I haven't seen this level of excitement, among developers and the investing community, since the original iPhone launch (and that was certainly no prototype). Based on this support structure, my guess would be that applications written for Glass won't just be scaled from smartphones/tablets, but will be built to take advantage of Glass's unique abilities. In my opinion, this is the key developer-centric factor that drives successful technology platforms.

Manufacturers & Distributors

As of now, Google is the only company manufacturing and distributing Glass. At the prototype stage, this makes a lot of sense, as it's preferable to limit product availability to those (early adopters) who can appreciate the potential of a product that may not be ready for mainstream adoption. However, over the next few years, Google will have to make a decision to follow a proprietary/integrated approach vs. a partnership/modular approach.

Based on what we know about Google and Glass so far, my bet would be on the modular approach, i.e. Google is likely to license the platform to third party manufacturers to enable maximum reach. Apart from Google's advertising based business model (which would have to be overhauled to fit a world with Glass), using Android as the device's operating system ensures that it will be licensed. Since Glass apps (at least for now) will be cloud based, it will be easy for Google to block access to unlicensed manufacturers. In the event of a proprietary approach, this gives OEMs an incentive to fork the Android platform for Glass-like products - today's OHA members obviously lose access to Google services and the Play Store if they fork the OS.

The initial commercial launch of Google Glass, slated for 2014, will be from Google. However, over the next few years, I expect them to gradually transition to a licensing model. I believe Google's revenue model will remain advertising driven and hardware sales of test products are likely to remain a small revenue source.

Apple Q3 Results Highlight Slowing iPhone, 9.7" iPad Sales

2013-04-26T10:00:00.000+05:30

Apple announced results for its fiscal Q2 2013 on Tuesday. The company posted its first QoQ profit decline in years, amid slowing growth. iPhone shipments totaled 37.4 million and iPad shipments totaled 19.5 million for the quarter. Let's look at sales growth and ASP trends to benchmark our previous estimates regarding iPhone growth and iPad Mini cannibalization.

iPhone & iPad ASPs

iPhone shipments have totaled 85.2 million in H1 fiscal 2013, which is in the same ballpark as my full year estimate of 150 million. This implies a 20% growth over fiscal 2012, but is far cry from previous analyst estimates expecting 200-250 million iPhone sales. Declining QoQ growth trends over successive product cycles are important to understand here, as shipments over the next two quarters could drop to around 60 million ahead of a new iPhone launch.

Let's take a look at the ASP to get a handle on the product mix:

iPhone ASP has reached its lowest level in the past 6 quarters, which implies that older iPhone models are making up an increasing proportion of sales. This is an indication that the market may be unwilling to pay for further product improvements and signals the need for a lower priced iPhone. The same trend was seen in iPad ASPs before the launch of the iPad Mini, but subsidized pricing may have helped the iPhone hold out for longer. This could further hurt margins going forward.

iPad vs. iPad Mini Shipments

iPad ASPs have seen strong declines since 2012 and the launch of the iPad Mini accelerated this decline. In fiscal Q4 2012, the iPad's ASP was roughly $535, but this included revenue from iPad accessories. In fiscal Q1, Apple changed its reporting methodology and began reporting accessory revenue separately (roughly $25 per iPad). Using these figures, we can make a rough estimate of the minimum iPad Mini shipments (and hence the maximum possible 9.7" iPad shipments) required to match Apple's ASP and revenue figures:

Once the iPad Mini was launched, the ASP of the 9.7" iPad would have risen as price sensitive buyers moved on to the cheaper iPad Mini. A higher 9.7" iPad ASP would give us a lower shipment figure with the current figures, so let's assume a base case ASP of $520 (taking into account a previous $535 ASP, inclusive of $25 in accessory revenue per iPad). We can also safely assume that the iPad Mini's ASP stays within 10-20% of its base price ($360-$400).

At an ASP of ~$370, we get iPad Mini shipments of 7.6 million in Q1 and 8.7 million in Q2. I consider this to be the lowest possible figure of iPad Mini shipments, as the $520 & $360 ASPs for the 9.7" iPad and iPad Mini are very conservative. However, even this conservative assumption gives us an estimate of 10.8 million for 9.7" iPad shipments. Using an ASP range of $520-$535 for the 9.7" iPad and $360-$400 for the iPad Mini, we get a Q2 shipment range of 8.7-12.0 million for the iPad Mini and 7.5-10.8 million for the 9.7" iPad. As I predicted previously, even the highest possible number would be the lowest quarterly shipment figure for the 9.7" iPad since Q2 2011, i.e. the launch of the original iPad 2.

Therefore, given the gains made by competition and cannibalization of 9.7" iPad sales, Apple's launch of the iPad Mini cannot be classified as a successful offensive strategy. However, the iPad Mini can be classified as a good defensive product, as it prevented iPad revenue growth from slipping below estimates.

Microsoft's Q3 Results Not Really Good News

2013-04-23T10:00:00.000+05:30

Microsoft announced their fiscal Q3 (calendar Q1) results last week, and the figures were surprisingly stable given the steep decline in PC shipments this quarter. Microsoft announced Q3 revenue of $20.49 billion and an operating income of $7.61 billion. The Windows division revenue was flat sequentially, at $5.7 billion. However, a deeper look at the numbers show some worrying signs.

Microsoft's Windows revenue in Q4 and Q1 includes deferred revenue from Windows upgrade offers (from Q3), so the numbers themselves may be a tad inflated. However, this in itself is just a minor issue. Practically all of the revenue generated from the Windows division comes from sales of Windows licenses for x86 devices. Windows Phone revenue is practically non-existent as Nokia, the largest Windows Phone manufacturer by far, pays Microsoft just about as much as Microsoft pays Nokia in platform support payments. Windows RT tablets have barely had any impact on the market, so any revenue generated from that segment was probably just a tiny flash in the pan (in Q4).

As the chart above shows, Windows revenue is typically consistent with PC shipments. This is because the largest chunk of Windows revenue comes from licenses purchased by PC OEMs for manufacturing new PCs. However, the PC shipment crash in Q3 (calendar Q1) was not accompanied by a decline in Windows revenue. This suggests that OEMs continued to purchase Windows licenses for new devices, but these devices were not sold. However, Microsoft's explanation in the earnings conference call differed from this line of reasoning:

In the Windows division, revenue was flat this quarter. Within that, OEM revenue performance was in line with the underlying x86 PC market, which continues to be challenged as the PC market evolves beyond the traditional PC to touch and mobile devices. This quarter, inventory levels were drawn down as the channel awaits new Windows 8 devices.

Non-OEM revenue grew 40% this quarter, driven by sales of Surface and continued double digit growth in volume licensing. Businesses continue to value the Windows platform, and volume licensing of Windows is on track to deliver almost $4 billion in revenue this year, and nearly three-quarters of enterprise agreements that we signed this year include Windows.

Microsoft claims that the decline in Windows revenue from OEMs was made up by sales of the Surface and volume licensing. Given the low shipment estimates for the Surface RT & Surface Pro, the proportion of Windows revenue from Surface was probably low. Also, given low consumer interest, Surface shipments should continue to decline until a new product is launched. This leaves Windows volume licensing, which was driven by enterprises continuing the upgrade path from Windows XP to Windows 7 (driven by the closing support "windows" for Windows XP and probably discount offers to enterprises). Therefore, this revenue spike is likely to be a one-time event as upgrade cycles tend to be concentrated around OS launch timelines. In any case, a 40% revenue spike in non-OEM revenue could hardly be considered sustainable.

Microsoft also stated that Windows revenue from OEMs was in line with the drop in PC shipments. PC shipments should continue to decline throughout the year (a minimum 8-10% annual decline as per my most recent forecast), which should pressure Windows revenue over the next few quarters. With negligible revenue from Windows Phone (thanks to Nokia's platform support payments), little consumer & OEM interest in Windows RT and slowing volume licensing revenues as enterprise customers complete their migration cycles to Windows 7, the future of Microsoft and Windows looks murkier than ever.

Nokia Q1 2013 Results: Smartphone & Feature Phone Shipments by Region

2013-04-19T11:26:00.000+05:30

Nokia's stock price crashed by over 10% on mixed Q1 2013 results. Nokia's Lumia range finally seemed to be picking up some traction, with 5.6 million shipments, but this was offset by Symbian shipments dropping to just 0.5 million. However, Nokia's feature phone business seems to be collapsing, showing a 30% sequential decline and a 21% annual decline. Using Nokia's announced figures, let's attempt to estimate their smartphone and feature phone shipments by region and gauge their smartphone migration efforts.

Inputs from Nokia's Q1 2013 Results: Smartphones & Feature Phones

The performance of Nokia's Lumia portfolio was far above my expectations, as it showed 27% sequential growth with a modest sequential decline in ASP (to €182). Overall smartphone ASP still showed growth (to €191), as Symbian shipments were limited to high-end models (such as the 808 Pureview).

Interestingly, Nokia's has projected Lumia shipments for Q2 to be above 7 million. Given the launch of the Samsung Galaxy S4, the HTC One and the continued onslaught of cheap Android devices, I would expect heavy discounts in the coming months as Nokia attempts to hit that figure.

Meanwhile, Nokia's feature phone portfolio crashed to just 55.8 million shipments and the ASP declined to just €28. As I had predicted, shipments of Nokia's full touch Asha portfolio crashed by nearly 50%, thanks to low-end Android competition in emerging markets.

Shipments by Region: Methodology

Nokia's quarterly results include the region-wise performance of its "Devices & Services" division, which includes both smartphones and feature phones. The region-wise data includes revenue, total shipments and overall ASP. Unfortunately, it does not provide a break-up of shipments between smartphones and feature phones, but using the inputs above, we estimate those figures.

The first step in this estimate would be to create a rough region-wise smartphone & feature phone shipment estimate, by using the global average smartphone and feature phone ASP with the region-wise revenue. However, since the actual ASP by region is likely to vary, this would give us a figure for total smartphone & feature phone shipments that are inconsistent with the announced figures. At this point, we can find a "best fit", i.e. optimal solution, which gives us region-wise shipments that match the total shipment figures (with the region-wise ASP being the closest possible fit with the global ASP for smartphones and feature phones respectively).

Smartphone Shipments by Region

Using the methodology and inputs above, we get the following estimate for region-wise smartphone shipments:

The figures above seem to be consistent with Kantar's recent market share figures and Tomi Ahonen's thoughts. Nearly 50% of Nokia's smartphone sales seem to be from Europe, declining from more than 60% in Q4 (which I assume is Symbian-driven). The only other broad market in which the Lumia portfolio seems to have a significant presence is Latin America (~20% of Nokia's smartphone shipments). These markets and the ASP suggest that it is the mid-range Lumia portfolio that is driving shipment volumes.

The Lumia portfolio seems to have a very limited presence in China and the Asia-Pacific (apart from North America). While Nokia's shipments in China constitute roughly 15% of its total smartphone shipments, the size of that market implies that Nokia has an insignificant presence. This tells me that the Lumia portfolio is very weak in regions where low-end Android vendors have a strong presence. This means that any expansion efforts by Chinese vendors like Huawei, ZTE & Lenovo could be particularly dangerous for Nokia.

Feature Phone Shipments by Region

Using the same methodology, we get the following estimate for region-wise feature phone shipments:

As expected, Nokia's feature phone shipments are concentrated in the Asia Pacific region (notably, India), but it has been absolutely decimated in the Chinese market. A sequential decline in Europe is understandable because of seasonal factors, but the seasonal impact on markets like Asia Pacific and the Middle East should be much lower. This suggests that migration from feature phones to smartphones is responsible for this decline. If this migration is to Nokia smartphones, the corresponding rise in ASP would be good for Nokia. Let's take a look at the state of Nokia's migration efforts in Q1 2013:

The chart above should be very disturbing for Nokia's investors. The proportion of Nokia's smartphone shipments, out of total shipments, is considerably lower than most estimates of the average smartphone penetration rate in every single region (except North America). This means that Nokia is probably losing a major chunk of its feature phone customers to competing smartphone platforms. Even if the Lumia business shows sustainable growth, the loss of Nokia's feature phone business should be a major blow to any hopes of achieving long-term financial stability.

Will 7-Inch Tablets Help Windows 8/RT?

2013-04-16T09:55:00.000+05:30

According to recent reports, Microsoft is working on extending the Surface lineup with a 7-inch tablet. Micrsoft had previously altered the minimum hardware requirements for Windows 8 tablets, which could theoretically allow screen sizes as low as 7-inches. I have had a consistently bearish view of Windows 8's chances in the tablet market, but do 7-inch tablets change anything?

7-Inch Windows RT Tablets (ARM Architecture)

The biggest reason for Microsoft to move to 7-inch tablets would be to target lower price points. This would make ARM-based tablets the obvious choice. However, Windows RT tablets would never be price competitive with Android tablets because of Microsoft's minimum hardware requirements and the license fee Microsoft charges OEMs. Based on this, my guess is that 7-inch Windows RT tablets would be priced around $299, which is in the same ballpark as the iPad Mini. However, this price would be too high to appeal to low-end Android tablet buyers, while high-end buyers would stay away because of the lack of a vibrant application ecosystem. The only other draw for this product category would be Microsoft Office, which I've covered in the section below.

7-Inch Windows 8 Tablets (x86 Architecture)

Thanks to the x86 processors, the price of these tablets would be prohibitively high compared to other 7-inch tablets. The only reason to even attempt to use x86 processors on 7-inch tablets would be to market compatibility with legacy applications. Unfortunately, as I've previously explained, legacy applications are not touch optimized and are practically unusable on touchscreens. Attempting to use legacy applications on 7-inch touchscreens would be as bad as Microsoft's early attempts to squeeze Windows 7 onto tablets.

What about Microsoft Office? Based on early sales of Microsoft's Surface RT and Surface Pro, it isn't a stretch to say that Microsoft Office hasn't been a big draw in the consumer market. Enterprise buyers would surely be interested in MS Office, but if a tablet with MS Office was a big priority, they would be purchasing Windows 8/RT tablets in droves. This is certainly not the case. Given the lower level of functionality, enterprise buyers would be far less interested in a 7-inch tablet running MS Office.

Based on these points, it is fairly clear that 7-inch Windows 8 tablets are a result of Microsoft jumping onto a market trend without understanding it. Windows 8/RT tablets have many problems, but screen size is not one of them.

Tech-Thoughts Listed Among Top 100 Gadget Blogs

2013-04-15T13:08:00.000+05:30

I wouldn't exactly call Tech-Thoughts a gadget blog, but it's great to see how far it's come in a year. We're ranked at #65.

An infographic by the team at CouponAudit
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PC Shipments Crash in Q1: Smartphones, Tablets and Windows 8 to Blame

2013-04-12T10:02:00.000+05:30

IDC has just released their PC shipment estimates for Q1 2013, and the numbers don't look pretty for Microsoft and the PC industry. PC shipments posted their largest YoY decline in history, reaching their lowest level since early 2009.

The consumer spending shift to smartphones and tablets has been extending the PC replacement cycle for some time now, so a decline isn't really a surprise. What's surprising is that IDC seems to have finally noticed the negative impact of Windows 8 on the PC ecosystem. Here are a few comments from IDC's report:

At this point, unfortunately, it seems clear that the Windows 8 launch not only failed to provide a positive boost to the PC market, but appears to have slowed the market. While some consumers appreciate the new form factors and touch capabilities of Windows 8, the radical changes to the UI, removal of the familiar Start button, and the costs associated with touch have made PCs a less attractive alternative to dedicated tablets and other competitive devices. Microsoft will have to make some very tough decisions moving forward if it wants to help reinvigorate the PC market.

I have to point out that Q1 PC shipments are far worse than those I had projected in my substitution rate based estimate. Since that estimate was based on the substitution rate we saw in the early days of the legacy vs. modern smartphone battle, there was no way to incorporate the destructive potential of a "Windows 8" (would probably need to be updated once other Q1 figures are announced). Ironically, the closest equivalent in the collapse of legacy smartphones was Nokia's transition from Symbian to Windows Phone, but even that had a milder impact compared to the "Windows 8 effect".

Android Engagement: Active Devices vs. Active Google Play Users

2013-04-09T10:00:00.000+05:30

Google recently released an update to its monthly Android version distribution data, which showed Jelly Bean making strong gains at the expense of Gingerbread. Google also announced a change in the data collection methodology. The new methodology tracked active usage of the Google Play Store as opposed to measuring just active devices, i.e. devices pinging Google servers. The new data is obviously more useful to developers, but it could also help us understand the proportion of Android users who actively use Google Play.

Let's begin by defining the terms we will be using in this post. "Active Devices" refers to all Android devices (with Google services) in use, while "Active Users" refers to Android users that have visited the Google Play Store over the data collection period.

Active Google Play Users as a Proportion of Active Android Devices

The two data sets (active devices vs. active users) are not particularly useful without a connecting link. Luckily, Android 4.2 may be just that. Google's "Active User" distribution data was collected in the two weeks leading up to April 2nd, 2013. In this period, the only major devices using Android 4.2 were Google's Nexus line of devices (Galaxy Nexus, Nexus 4, Nexus 7, Nexus 10) and possibly certain devices running custom firmware. Early adopters and tech enthusiasts probably make up the vast majority of the user base for these devices and all of them should fall under "Active Users". However, to be safe, we can consider that proportion to be 90-95% of "Active Devices" running Android 4.2.

As the chart above shows, Android 4.2 has seen linear growth over the past 3 months. Sales of Nexus devices shouldn't be radically different running up to April, based on which I've estimated Android 4.2's share of "Active Devices" to increase to 1.8% in April. However, Google's data on "Active Users" showed Android 4.2 share at 2.0%. Using our "Active User" assumption for Android 4.2 devices, we can estimate that "Active Users" form 81-86% of all "Active Devices", across all Android versions.

Active Users by Android Version

We can also estimate the share of "Active Devices" of various Android versions in April, on similar lines as our Android 4.2 estimate. Android 1.6 (Donut), Android 2.0/2.1 (Eclair) and Android 3.x (Honeycomb) are all minor versions (with a share of less than 2%) and we can assume that shares stay in line with their respective linear trends. Attempting to use linear trends to project major versions throws up more "Active Users" than "Active Devices", which is clearly incorrect. This suggests that Gingerbread and Jelly Bean did see greater movements than expected. It is unclear if this was driven by new devices sales or by long-awaited firmware updates; my guess is a combination of the two. The optimal solution from these inputs and constraints (proportion of "Active Users" on Android 4.1 should be less than that on Android 4.2) gives us the following figures:

As the chart shows, the "Active User" shares of Android 2.3 (Gingerbread) and Android 4.0 (ICS) are more or less in line with their estimated "Active Device" shares. However, the respective shares for Jelly Bean and FroYo show wide variance. This suggests that the proportion of "Active Users" on Gingerbread and ICS are in line with the Android average (81-86%), but Jelly Bean is above average and FroYo is below average. Using these figures, we get the following estimates for "Active User" share by Android version:

Unsurprisingly, Jelly Bean (incl. both 4.1 & 4.2) has the highest share of "Active Users", with 94%. The proportion of "Active Users" on ICS and Gingerbread is practically the same (marginally above the overall average for Android). This reinforces the fact that showed that the widely quoted engagement issue on Gingerbread was a browser engagement issue and not a user engagement issue. User engagement, as measured by visits to the Google Play Store, doesn't seem to be a problem for devices on major Android versions.

Home: What's Facebook's Android Strategy?

2013-04-05T11:03:00.000+05:30

Facebook just introduced Home, a homescreen replacement for Android smartphones, which will be pre-loaded on the HTC First. The suite of apps will be exclusive to the Android platform, as other platforms don't allow the level of customization required for Facebook Home. Let's take a look at the potential of this strategy.

Objectives & Strategic Options

In order to understand Facebook's strategy, we first need to list out their objectives and strategic options:

Objective: Facebook was concerned with the prospect of being relegated to one among many apps on a user's homescreen. Facebook's objective was to become one of the core drivers of the smartphone experience.

Option 1: Facebook could launch a phone using a proprietary OS or forked version of the Android operating system.

Option 2: Facebook could develop a proprietary OS or create a forked Android, and make the OS available to OEMs.

Option 3: Facebook could co-opt Android by launching a homescreen replacement that would put Facebook front and center on a user's device.

In both option 1 & 2 above, Facebook-driven smartphones would be at an inherent disadvantage since they had no access to a viable application ecosystem. In addition to this, Google would prevent any existing OHA (Open Handset Alliance) member from launching any device with a forked Android OS (see: Acer and Aliyun). The Kindle Fire was an exception because of the circumstances in the tablet market and because Amazon was not an OHA member. Therefore, it obvious that forking Android is not likely to be a winning strategy. Strangely, despite all the evidence against forking, some analysts continue to harp on the idea.

Facebook's Android Strategy

Based on the points above, it is clear that Facebook made the right decision. Using Option 3 would help Facebook reach the widest number of Facebook users. Facebook is no longer dependent on device sales to generate a user engagement. The HTC First is merely a marketing vehicle for Facebook Home, and is unlikely to be critical to its success. While the Facebook homescreen may not appeal to enthusiasts and early adopters, it could find an audience among heavy Facebook users. While the user base may not be large compared to the total Android user base, it is likely to be much larger than any alternative strategy.

Also, access to a user's homescreen would give Facebook an additional avenue to grow mobile advertising revenues (of course, Facebook could lose a few users in the process). My guess is that Facebook will also use Home to push Graph Search onto smartphone users. This may not have a short-term impact on Google, but it constitutes the only real long-term threat to Google's mobile search advertising strategy.

Impact of iPad Mini on iPad Revenue: Neutral

2013-04-02T10:07:00.000+05:30

By now, it is fairly clear that the iPad Mini has been cannibalizing sales of the 9.7" iPad. Even though the iPad Mini has been a success on a standalone basis, it stands to reason that it should be called a success only if it has boosted revenues (and hence, profits) for Apple, after taking cannibalization into account. Let's take a look if that is the case.

Let's begin by taking a look at the iPad's sequential revenue growth over the past couple of years:

The iPad's revenue growth, much like the iPad's shipment growth, is remarkably cyclical and has remained consistent for the past 5-6 quarters. iPad revenues over the past few years have peaked in the product launch quarter (Q2) and in the holiday quarter (Q4), while remaining weak in the other quarters. The iPad's sequential revenue growth in Q4 2012 (after the iPad Mini launch) basically matched that from Q2 (after the 3rd gen iPad launch). For Q1 2012, using my iPad shipment forecast of 17 million and a 5% decline in ASP (as the product mix continues to shift towards the iPad Mini), the $7.5 billion revenue forecast matches Q3 2012 revenue and the Q1 2013 sequential revenue decline matches that from Q1 2012.

Based on previous forecasts, this suggests that revenue from the iPad Mini has merely replaced revenue from cannibalized 9.7" iPads. However, Apple has stated that the iPad Mini's margins are lower than those on the 9.7" iPad. This implies that the introduction of the iPad Mini has had a neutral impact on revenues and consequently, a negative impact on profits. In fact, given these figures, it seems that the only scenario in which the iPad Mini could be deemed a success is if previous iPad forecasts (including mine) were over-optimistic and had not taken rising tablet competition into account. Given recent figures from research houses like IDC and NPD, that scenario may very well be unfolding.

Blackberry Surprises With Q4 2012 Results: Z10 Shipments Match Lumia Launch

2013-03-29T11:03:00.000+05:30

Blackberry just announced their financial results for Q4 2012 and made a surprising return to profitability. This was achieved thanks to cost cutting measures combined with strong average selling prices (ASP) on devices. The spike in ASP was driven by the Blackberry Z10, shipments of which reached 1 million.

As the chart above shows, Blackberry's revenue has remained relatively stable over the past few quarters. Revenue from devices received a boost from the Blackberry Z10 launch, while the service fee declines haven't yet kicked in.

Blackberry 10 Shipments

Blackberry Z10 shipments were just a tad below the consensus analyst estimate of 1.1 million, but much higher than my own expectations. These figures match Nokia's Lumia 800 launch, which also saw a staggered release.Even though the Lumia series isn't exactly a rousing success, this does help Blackberry remain financially stable for now.

Going forward, the prospects of the Z10 are difficult to predict. Sales have been slowing in UAE, one of Blackberry's strongest markets and in other regions as well. In addition to this, the US launch has been fairly muted so far. Once the early pent-up demand from Blackberry loyalists is exhausted, the company may struggle to sustain sales growth. However, the upcoming launch of the Blackberry Q10 may generate a fresh demand cycle from loyalists holding out for a QWERTY device.

Overall Blackberry Shipments vs. Subscriber Base

Blackberry shipments (incl. the Blackberry Z10) totaled 6 million this quarter, which is the lowest since Q1 2008. The Blackberry Z10 launch did not help Blackberry stabilize its subscriber base, as it declined by 3 million sequentially. This is the largest subscriber decline the company has ever seen. This is a direct outcome of competition from low cost smartphones in emerging markets, as Blackberry has been quickly losing ground in erstwhile strongholds like India and South-East Asia. I have been extremely critical of Blackberry's strategy with BB10 because it does not address these markets. Delaying the launch of low-end to mid-range Blackberry 10 devices will do nothing to slow this subscriber drop. I expect this decline to continue accelerating over the next few quarters.

Outlook

I expect ASPs and margins on Blackberry 10 devices to decline over the next few quarters, but the launch should give the company enough ammunition to remain stable. This could help drive acquisition interest in the company as well. In the absence of an acquisition, service fee changes to be implemented with Blackberry 10 could put considerable pressure on the company's finances over the next few years.

Samsung's Galaxy Series May Overtake Apple's iPhone in Battle for Smartphone Supremacy

2013-03-26T10:00:00.000+05:30

The battle for smartphone supremacy between Apple and Samsung is a hotly debated topic these days. Unfortunately, since Samsung does not unveil smartphone shipment figures, little is known about the state of competition between the two technology giants. However, recently revealed research data from Raymond James's research may shed some light on the situation.

As the chart above shows, the Galaxy series narrowly edged the iPhone's shipments in Q3 2012, but the launch of the iPhone 5 put Apple back in the lead with 48 million shipments as compared to Samsung's 38 million. iPhone demand has been remarkably cyclical after the launch of the iPhone 4S in Q4 2012 - this seems to be an outcome of increasing market saturation in the US. In contrast, demand growth for the Samsung Galaxy smartphones, while accelerated after the Galaxy S3 launch in Q1 2012, has remained remarkably stable.

iPhone vs. Samsung Galaxy - Outlook for 2013

What sort of shipment trend can we expect over the next year? Let's take a look at the YoY shipment growth chart:

As we can see, the iPhone's growth has been slowing over the past year, something that has spooked Apple investors. On the other hand, Samsung's growth in the same timeframe has been staggering. With the incredibly hyped Galaxy S4 launch, I expect demand and growth for the Samsung Galaxy series to peak and become more cyclical over time. More importantly, these charts strongly suggest that the shipments of Samsung's Galaxy Series will overtake iPhone shipments this year, possibly as soon as Q2.

Raymond James data also shows that the majority of all Samsung Galaxy shipments are driven by the flagship Galaxy S and Galaxy Note series. This, combined with the fact that Samsung owns roughly 40% of the high-end smartphone market, suggests that this change of guard is not an outcome of a "low-end strategy". Ironically, the only way for Apple to retake this lead may be through the launch of a cheaper iPhone, to spur demand in emerging markets.

Long-Term Outlook for Apple & Samsung

Beyond this year, I still expect both Apple and Samsung to come under more competitive pressure as smartphones become more commoditized. Challengers like Huawei, ZTE, Lenovo and Sony are improving their high end offerings and branding efforts which could soon help them challenge the current market leaders. T-Mobile's efforts in pushing unsubsidized smartphone plans in the US and the increasing scrutiny on Apple's European carrier contracts could accelerate this trend and help break Apple & Samsung's smartphone dominance.

Windows 8 App Growth Already Slowing

2013-03-22T10:22:00.002+05:30

According to data from MetroStore Scanner, the growth of Windows 8 apps has noticeably slowed in Q1 2013. According to the data, the Windows Store is expected to top 50,000 apps by the end of March, but MoM growth has slowed to just 10-15%. In response, Microsoft has launched a promotion, offering developers $100 to publish an app on the Windows Store. Let's take a look at the reasons for this surprisingly early decline in growth.

Paying developers to build apps for a platform isn't likely to build genuine developer interest in a platform and seems like a desperate move. To Microsoft's credit, they seem to understand this:

We believe the best apps come from those partners who are invested in the platform and own their experience now and in the future. Of course, we are always working to spark creativity with new developer audiences and sometimes try limited incentives or contests, like Keep The Cash. However, it is not representative of an ongoing program.

$100 is unlikely to attract large developers, so I would have to assume that this promotion is meant for small, independent developers. But the timing of this promotion, combined with the chart above, tells me that Microsoft is feeling some pressure.

In a recent post, a former Microsoft employee explained just how Microsoft managed the early app surge in the Windows Store - Microsoft employee moonlighting, Pushing the size of the Windows PC base and Developer tools. The first two reasons may have a lot to do with the current slowdown:

Microsoft Employee Moonlighting - Not a Permanent Solution

Microsoft has apparently used this approach for Windows Phone as well. Unfortunately, getting employees to build apps in the spare time was never likely to be a long-term solution. At a certain point, those employees would run out of time, motivation or simply ideas to continue building apps. As this artificial boost is lost, it becomes more difficult to add apps to a fledgling platform.

Windows PC Base - Not Focused on App Downloads

I had touched upon this earlier, in my post on the PC replacement cycle - The average Windows PC buyer is not as sophisticated as an average Mac buyer, and therefore, the usage of the average Windows PC would never involve downloading apps. This has already proved true for the Mac App Store, and app engagement on Windows 8 PCs is likely to be even lower. Low consumer interest in Windows 8/RT based tablets has done nothing to rectify this situation.

Goal of Microsoft's "Keep the Cash" Promotion

Microsoft's promotion is primarily aimed at low-end publishers. Their prime concern at the moment isn't app quality, but quantity. Unless the app growth on the Windows Store remains strong, Microsoft has very little chance of attracting many major developers to the platform. Of course, strong tablet sales would help, but that seems like a pipedream at this point.

What's Wrong with the US Smartphone Market?

2013-03-19T10:00:00.000+05:30

The US smartphone market has long been dominated by the iPhone, at least compared to the rest of the world. The latest figures show a US-Global market share gap of more than 30%. Analysts have attempted to explain this disparity by pointing to carrier subsidies and the strength of Apple's brand in the US. The goal of this post is to study pricing models prevalent in various markets and compare those to the iPhone's market share in that market.

It is a bit unfair to compare the position of the iPhone in the US market, emerging markets where prepaid smartphone sales are the norm and per capita income is lower. So let's restrict our analysis to developed markets, specifically the UK and Australia, which are more iPhone-centric as compared to other developed (& subsidized) markets.

Let's begin by comparing the iPhone's market share in the US with that in the UK and Australia:

As we can see, over the past year, the iPhone's US market share has outpaced that in the UK and Australia by 10-15%. This began in late 2011, with the release of the cheaper iPhone 3GS & 4 (in all markets). So what is the cause of this disparity? Let's attempt to explain this by taking a look at the 24-month contract pricing models (for unlimited voice + minimum data plans) of a sample carrier in each country:

AT&T (US) - 24-Month Contract Prices by Model

The above prices are from AT&T's website, from which I sampled a set of 7 devices. Unsubsidized priced of these devices range from $379 for the Samsung Galaxy Exhilerate to $649 for the iPhone 5 and Samsung Galaxy Note 2. Even though the unsubsidized price shows wide disparity, the highest contract price (for the Galaxy Note 2) is just 14% higher than the lowest (Samsung Galaxy Exhilerate). The difference between the iPhone 5 and Galaxy Exhilerate is even lower at ~10%. This is because the pricing model followed by US carriers insulates the monthly price of a data plan from the upfront subsidized price of a device. As a result, one data plan costs the same on a Samsung Galaxy Exhilerate or an iPhone 5, and the natural relationship between price and demand is artificially suppressed (upgrade policies have made this even worse). This gave high-end smartphones (including the iPhone) an unnaturally high share of the smartphone market.

The rationale for pricing strategy was that carriers wanted to spur higher data usage by lowering the relative cost of owning a high-end smartphone. However, the results have been questionable. As CIRP's data shows, ARPU is a function of data plans and not of data usage. Smartphone data plans are driven more by income demographics and less by the device used. So a price-sensitive iPhone 4 or 4S buyer may in fact be likely to opt for a cheaper plan.

O2 (UK) - 24-Month Contract Prices by Model

The chart above probably does a better job explaining the iPhone's market share in the UK than most analyst theories. UK carriers vary the monthly cost of a contract, based on the cost of the device itself. As a result, the unsubsidized prices of devices are far more in sync with the relative contract pricing (the contract price of an $820 iPhone 5 is 91% higher than that of the $224 Samsung Galaxy Ace 2), which leads to a far more natural price-demand relationship. This is also the pricing model followed by most carriers in Europe, which explains the iPhone's relatively lackluster market share in those regions.

However, as the chart shows, the prices of comparable data plans, and consequently ARPUs and carrier profits, are far lower in the UK (and the rest of Europe) as compared to the US. This is a direct outcome of high competition in Europe, as compared to the dominance of a few carriers in the US.

Optus (Australia) - 24-Month Contract Prices by Model

At first glance, the contract pricing model in Australia seems very similar to the one followed in Europe. But, in actuality, the model is a blend of the US & European models. Australian carriers vary the monthly price of contract based on the device until the contract value reaches a certain point. So for high-priced plans, the price of the contract is independent of the device. This ensures that the price-demand relationship isn't overly disrupted (the contract price of the high-end iPhone 5 is 66% higher than the mid-range HTC Desire X), while encouraging potential high-end users toward high-end devices, that could potentially lead to incrementally higher usage.

Outlook

As the data above shows, the iPhone's market share in the US is a direct outcome of a pricing model that encourages purchases of high-end devices over mid-range or low-end devices. Some analysts have theorized that the extension of the US pricing model to other countries will lead to an increase in the iPhone's market share. It certainly would, and as per the data above, it's also extremely unlikely to happen. But can a form of the European contract pricing model find its way to US shores? T-Mobile seems to be attempting just that:

T-Mobile is moving to an unsubsidized, but financed, smartphone sales model this year. As per this model, consumers will have to pay a portion of the smartphone's cost upfront (similar to existing upfront costs) and pay a portion of the price in monthly installments, in addition to a cheaper data plan. This essentially varies the total monthly cost based on the device purchased - The contract price of a $599 Galaxy S3 is about 32% higher than a $369 LG Optimus L9. As more devices are added, this price gap could increase leading to more price sensitivity. If consumers find these plans appealing, and the churn rate among T-Mobile's value plan customers does seem lower, other carriers could rush to emulate this model. As a result, over the next few years, the prospect of US carriers moving to a European pricing model may be far more likely than overseas carriers moving to a US pricing model.

Galaxy S4: A Sign of Shrinking Smartphone Development Cycles

2013-03-15T10:25:00.003+05:30

With the launch of the Samsung Galaxy S4, the first major smartphone announcement of 2013 is now behind us. Samsung's strategy with the Galaxy S4 is reportedly aimed as a direct assault against Apple. Their starkly different smartphone product cycles point to different approaches to managing a business that could soon be commoditized. However, as history has taught us, commoditization could threaten the prospects of both companies.

Let's begin by plotting the announcement cycles of flagship smartphones from Samsung & Apple:

While Apple primarily follows an annual release cycle with the iPhone, the company has been known to stick to bi-annual cycle for major upgrades (an iPhone 5S is expected this year). Meanwhile Samsung has moved to a semi-annual flagship release (with the Galaxy S Series and Galaxy Note Series). While we don't have direct information about product development cycles, the shrinking release cycles point to shrinking development cycles for Samsung (and the Android ecosystem in general). These shrinking cycles are an outcome of the integrated vs. modular design principles followed Apple and Android vendors respectively.

Apple develops both hardware and software internally, which allows its product design philosophy to be more "coherent". This led to initial performance which was far above what competitors could offer, but the downside is that the product development cycle tends to be long. On the other hand, Android vendors had the advantage of Google taking care of the bulk of software development efforts. This allowed vendors, particularly Samsung, to focus on hardware development (and a few software gimmicks to assist in differentiation). This modular design philosophy limited initial performance and introduced "fragmentation", but sped up the product development process. Over the last few years, the rapid product development cycles and hardware focus helped make Samsung products more competitive compared to the iPhone in the high-end smartphone market (particularly in developed markets), while flawed marketing strategies limited other vendors (like HTC). Samsung's rapid improvements seem to have caught Apple's attention - this may even force Apple to skip the iPhone 5S and speed up the launch of an iPhone 6 "phablet".

However, the very modular design philosophy that helped Samsung challenge Apple could now threaten its prospects, particularly in emerging markets. Local Chinese and Indian vendors like Huawei, ZTE, Micromax and Karbonn have been rapidly pushing out higher end smartphone devices that are comparable with Samsung's product portfolio and at far lower price points. This is very similar to what we saw during the maturation of the PC industry in the 90s (in a much more accelerated time frame). As competing vendors flooded the market with cheaper, but capable devices, commoditization threatened erstwhile leaders.

Given that modular product design is already prevalent, commoditization is a foregone conclusion in the smartphone industry. As price-based competition increases, profits move from OEMs to other segments of the value chain (primarily key component suppliers). Therefore, once commoditization sets in, the only solutions are to diversify into other industries, become a supplier to the commoditized industry (Intel & Microsoft in the PC industry, during the 90s), or to disrupt a new industry. Luckily, Samsung is already a diversified enterprise and component supplier, but disruption is the only option available to Apple.

The Curious Case of the iPad Shipment "Collapse"

2013-03-12T10:00:00.000+05:30

My last post on NPD's display shipment estimate seems to have kicked up quite a storm. Some didn't seem to buy the production cuts argument as a rationale for a drop in sales. The goal of this post is to show that the potential collapse in 9.7" iPad sales is not just realistic, it should be expected.

The Production-Sales Relationship

Apple's supply chain is typically a well-oiled machine. The company's supply chain practices are geared towards minimizing working capital requirements and therefore, attempt to avoid any channel stuffing issues. However, the only possible cause of sudden drop in display shipments (even for a month) is an inventory build-up at some point in the supply chain. Let's take a look at the possible reasons for this inventory build-up:

1) Rising Yield Rates - Yield rates have not been an issue for the 9.7 inch iPad or its displays, so it seems to be an unlikely cause of the drop in production. If this crash was related to the iPad Mini, we would probably need to look at this more closely.
2) Change in the iPad's Screen Size - There's very little reason to do so (fragmentation concerns, etc.), and even if such a move was being considered, there would have been numerous supply chain leaks about the change.
3) Change in Display Manufacturers - There have been many reports of production cuts of the iPad's display, but NPD's data is different because of one crucial reason - Previous reports only gauged production cuts at a single or a few suppliers, while NPD's data tracks the industry as a whole. Therefore, we can eliminate this possibility.
4) Drop in Sell-Through - The only other possibility is a drop in sell-through rate of the 9.7" iPad. This would have resulted in inventory build-up in the channel, which would have necessitated a production cut. Since the drop in display shipments was sudden and not gradual, it implies that Apple had forecasted higher sales for the 9.7" iPad.

Signs of the Shipment Collapse from Q4

Now that we know that NPD's data clearly hints at a drop in sell-through rate. Let's take a look at the signs of this collapse in Apple's historical shipment data:

Most iPad Mini shipments estimates, for Q4 2012, range between 7-10 million. Using a mean figure of 8.5 million, I've constructed the shipment chart above. As we can see, the iPad's QoQ growth pattern over the last two quarters really highlights the impact of the iPad Mini. Q3 sales were depressed as consumers held out for the iPad Mini, but strangely, the shipments of the 9.7" iPad didn't really recover in Q4 (from an already low base). This wasn't an industry-wide phenomenon as shipments of the iPad Mini and Android tablets remained strong. This is something I had predicted in my cannibalization estimate, although not to this degree.

As the chart shows, Q1 tablet shipments tend to be considerably weaker than Q4 shipments. Based on last year's figures, I expected the market to shrink significantly. NPD's data suggests that rising emerging market demand (which is relatively less cyclical) is beginning to make up for cyclicality in mature markets. The overall market will still decline, but possibly not as much as it did last year. Based on my previous Q1 iPad shipment estimate of 17 million, the iPad Mini is likely to make up 7-8 million units (for a 10-15% QoQ decline). This implies that 9.7" iPad shipments would drop below 10 million units - the lowest figure since Q2 2011, i.e. since the launch of the original iPad 2.

The primary issue is that the iPad Mini seems to be too expensive to take a large chunk of sales away from cheaper Android tablets, but is still a good value proposition to potential iPad buyers. This limits market expansion potential, while increasing cannibalization. The iPad's ASP in Q1 was a very strong hint of this dynamic and NPD's data suggests that the iPad's ASP in Q2 could be even lower.

Microsoft Cutting Windows 8 OEM License Fee to Boost Demand

2013-03-08T10:33:00.002+05:30

Microsoft has decided to cut Windows 8 license fees to OEMs, in an attempt to lower prices and boost lackluster demand for Windows 8 devices. The $20 discount will apply only to 11.6" and below touchscreen devices. For devices below 10.8", Microsoft will also offer free copies of Office 2013.
Data from NetApplications has shown that Windows 8 has struggled to gain traction in the market, as adoption levels seem to be lagging behind the unpopular Windows Vista:

Source: NetApplications

NetApplications data is skewed towards the US, so global Windows 8 adoption should be considerably worse. This is fairly consistent with the pre-launch metrics I had detailed and is the natural outcome of a flawed product strategy.

A $20 discount in license cost is unlikely to reduce prices by a meaningful amount, so this is move is really just an incentive for OEMs to increase promotions. Microsoft's move to give away Office 2013 for free could theoretically generate some interest, but I still don't see a concrete value proposition to consumers to upgrade their PCs. Any consumer interested in this offer obviously is already an Office user and most likely a PC owner. A few early adopters may be swayed by this offer, but I don't expect it to have much of an impact.

The most interesting part of this promotional campaign is that Microsoft seems to be restricting it to touchscreen devices. While Microsoft may be pushing the touchscreen paradigm as the future, touchscreen PCs are still targeted at the high-end market. Microsoft seems to be completely ignoring the low-end of the market, where tablets seem to be taking over. The existential threat to the PC industry & Microsoft has its roots at the bottom of the market, and it is impossible to defend that by focusing on the high-end of the market. Any rumored Windows 8/RT-based 7-inch devices won't truly be targeted at the bottom of the market as even the reduced license fee is inconsistent with the required cost structure. Microsoft seems to be fighting the wrong battle here and the consequences could be dire.

Android Tablets Take Over in Q1: iPad Shipments Collapse

2013-03-05T10:00:00.000+05:30

Shipments of Android tablets overtook those of the iPad this holiday quarter. After this surge, I expected all players in the industry to see a major sequential decline in Q1. However, NPD's display shipment data suggests that the full-sized iPad is taking the biggest hit. Let's use this data to revisit our tablet market share projection for Q1.
The chart above shows NPD's tablet display shipments estimates for December 2012 and January 2013, by display size. Display shipments are delivered to OEMs as an input to the tablet manufacturing process, so they are a leading indicator of tablet shipments, i.e. displays are likely to be used in manufacturing and shipped in the following month(s). So display shipments in December and January should explain ~70% of tablet shipments in Q1 2013, assuming yield rates remain constant across all tablets.

Tablet Display Shipments by Platform

The problem with NPD's data is that it gives us a view of shipments by display size and not by tablet platform. Luckily, OEMs using specific platforms have consolidated around a few popular screen sizes. The full-sized iPad is responsible for the vast majority of 9.7" display shipments, while the iPad Mini may be the only tablet with a 7.9" display. Similarly, most Windows 8/RT tablets are sized at 10.1" and above, while Android tablets make up the rest (Shipments of the 7" Blackberry Playbook can be considered negligible). Since the bulk of Android tablets are sized at 7" and 10.1", Windows 8/RT tablets may be responsible for just 2-3% of 10.1" display shipments based on Q4 figures. This gives us the following shipment pattern by platform:

As we can see, iPad display shipments seem to have dropped by about half from December to January. This fall can be attributed to a ~80% drop in shipments of full-size iPad displays. Meanwhile display shipments for the iPad Mini have remained strong. Unless Apple has a new full-size iPad on the way with a 10.1" display, this strongly hints at a collapse in sales because of cannibalization from the iPad Mini. My iPad Mini cannibalization estimate was far more aggressive than others, but actual cannibalization seems even worse.

Meanwhile, shipments of Android tablet displays have remained strong (in stark contrast with Q1 2012). Since developed market sales peak during the holiday quarter, this strongly suggests that emerging market demand for cheaper tablets is picking up. This also explains why shipments of 7" Android tablet displays are growing faster than 7.9" iPad Mini displays. In fact, 7" Android tablet displays (in January) seem to be outpacing all iPad displays (9.7" and 7.9") by themselves.

Tablet Market Share Projection - Q1 2013

Using the data from December & January, we get the following market share split by platform (approximation for Q1 2013):

This projection is likely to be somewhat conservative for Android tablets. Display shipments in February are likely to be closer to January's figures, as compared to December, which puts the iPad's market share under even more pressure (although this could be balanced out by a new product launch in March). In addition to this, rising demand from emerging markets is likely to continue to boost Android tablet shipments. Meanwhile, Windows 8/RT tablets seem to be following in Windows Phone's footsteps. Based on these figures, emerging market demand seems to be forcing the tablet market in the same direction as the smartphone market, with Android firmly in the lead.

Follow-Up Post: The Curious Case of the iPad Shipment "Collapse"