The iPhone's Turning Point
Later this year, Apple will unveil a 6.5-inch screen that runs iOS. Five years ago, such a product would have been introduced as the newest member of the iPad family. However, Apple finds itself on the verge of releasing its largest iPhone to date. In fact, the device will likely be one of the largest smartphones in the market. Upon closer examination, such a dramatic change in product strategy was ultimately driven by Apple's realization that iPad mini was the wrong bet. It marked a turning point for iPhone.
An iPad World
The iPad was a rocket ship like nothing Apple had ever seen. It's difficult envisioning a future Apple product that will outsell iPad out of the gate. Three million iPads were sold in the first 80 days. During the first year on the market, 22 million iPads were sold.
As seen in Exhibit 1, iPad sales outpaced iPhone sales by nearly 3x after three years of sales. The iPad made the iPhone look mediocre. Some people even thought the iPad would become a bigger deal than iPhone. One has to wonder if at least a few Apple executives viewed iPad, not iPhone, as the product most capable of changing the world. We were truly living in an iPad world in the early 2010s.
Exhibit 1: iPad and iPhone Sales Out of the Gate
There were a number of factors behind the iPad's astronomical rise overnight. One of the more obvious was Apple's success in making the case that a device like iPad was needed. Apple positioned iPad as a device that sat between an iPhone and Mac. The juxtaposition elevated iPad at the expense of iPhone and Mac. The iPhone was positioned as a small, mobile device that wasn't great for things like web browsing, email, and consuming photos and video. Meanwhile, the Mac was positioned as a heavy beast blown out of the water by iPad for certain tasks.
iPad Mini Rationale
Despite strong iPad sales out of the gate, the early iPad years were also a period of immense anxiety and worry for Apple. Much of this fear was born from Apple's paranoia around competition. A $499 9.7-inch iPad left a price umbrella, so manufacturers can potentially undercut Apple with cheaper and smaller tablets running Android.
In late 2010, Apple was so worried about these 7-inch Android tablets that Steve Jobs made a rare appearance on Apple's earnings conference call to downplay the threat. This is when he gave the now infamous comment about having to sandpaper your fingers to one quarter of their present size in order to use a 7-inch touchscreen. Much of this was posturing as other Apple executives were making the case to Steve that Apple should do a smaller iPad.
Ultimately, it was this fear of cheap Android tablets that pushed Apple to launch iPad mini two years later in 2012. While the product was a rare defensive move from Apple, management also saw something intriguing about the 6-inch to 7-inch screen form factor. Instead of pursuing that interest with a larger iPhone, Apple saw the iPad as the better-suited product. It was increasingly looking like an iPad world after all, and smartphones were all about mobility. This turned out to be a mistake.
Flat-Footed
Just as Apple launched iPad mini, something was brewing over in smartphone land. Samsung was grabbing buzz by shipping smartphones with larger screens. It caught Apple's attention.
In March 2013, on the eve of Samsung's Galaxy S4 unveiling in NYC, Apple SVP Worldwide Marketing Phil Schiller sat down for an exclusive interview with The Wall Street Journal to throw punches at Samsung and downplay the momentum found with larger smartphones. Here's Schiller:
"Given the iPhone 5 is so thin and light, the reason that people are making their devices bigger is to get up to the battery life the iPhone 5 offers."
According to Schiller, large smartphones were being sold simply because manufacturers were able to use the additional size to fit a bigger battery. The devices were not being launched because they provided a better experience, according to Schiller. In reality, Apple was worried. They had just placed a big bet on iPad mini as a way to prevent Android from gaining share in the tablet space. However, the competition wasn't found with smaller Android tablets. Instead, it was found with 5-inch and 6-inch smartphones running Android. Having just launched the 4-inch iPhone 5, Schiller knew that Apple wouldn't have an adequate answer to these larger smartphones for at least another year and a half. Apple was caught flat-footed due to betting on iPad mini.
Turning Point
At some point in 2013, Apple likely made the decision that iPhones had to become larger in a big way. Giving the next major iPhone a small step up in screen size wasn't going to cut it. While Apple was likely pushed in that direction by market forces, the realization that such a move was needed was still a crucial one for management to make. In particular, Apple had to accept the fact that the iPad mini may not have too bright of a future despite just being launched and seeing remarkable strong sales out of the gate. There wasn't going to be a compelling use case for a 7.9-inch iPad in a world with larger smartphones.
What Happened?
My theory as to how all of this came together is that Apple executives were initially mesmerized by iPad's rocket sales out of the gate. It seemed like consumers would own and use both a smartphone and an iPad. Even if iPhone's market share remained on the low side, Apple would be able to sell iPads to feature phone, Blackberry, Windows, and Android users. This outcome would materialize as long as two factors were true:
iOS was the tablet platform of choice for developers. This is why Apple was so concerned about 7-inch Android tablets.
Smartphone screens were small. Larger smartphones would throw a wrench in Apple's strategy as the iPad would lose quite a bit of its value proposition.
Apple had an incentive to keep a sizable screen size differentiation between iPhone and iPad. As a result, Apple downplayed the phablet threat while dragging its feet in terms of shipping larger iPhone screens.
Based on Jony Ive's recollection of events, Apple tested larger iPhone prototypes with screens ranging from 4 inches to 6 inches as early as 2011. Apple designers thought a 5.7-inch screen felt good for iPhone, but the size was later deemed too large. It would end up taking another three years for Apple to launch iPhone 6 and 6 Plus with 4.7-inch and 5.5-inch screens, respectively.
Annual iPad sales peaked at 74M units at the end of 2013. According to my estimates, strong iPad mini sales played a big role in establishing that sales peak. In fact, iPad mini sales likely exceeded 35M units on an annual basis at their high point. However, the realization that the most formidable competition was found with larger smartphones rather than smaller tablets pushed Apple. The company was no longer hesitant to run with larger iPhones even if it meant weaker iPad fundamentals weren't too far behind.
As seen in Exhibit 2, which breaks out 7.9-inch iPad sales, iPad mini sales were decimated following Apple's move into larger iPhones.
Exhibit 2: iPad Unit Sales (TTM)
We now see Apple becoming extremely aggressive with larger iPhones. A 6.5-inch screen iPhone will launch less than a year after a 5.8-inch screen. A 6.5-inch iPhone would have been unfathomable during the early iPad years. Such a device would have decimated Apple's iPad strategy. Today, Apple is comfortable ceding a much larger portion of the market to iPhone at the expense of iPad. This has led to a much stronger iPhone franchise.
Earlier this week, Samsung unveiled its latest flagship smartphones, the Galaxy S9 and S9+. Unlike five years ago, when Schiller nervously tried to upstage Samsung's keynote, it is doubtful Apple even blinked an eye this time around. Apple removed Samsung's key advantage when it began to ship larger iPhones in 2014. The iPhone versus Samsung dynamic has never been the same since.
Lessons
There are a few lessons to be taken from this situation.
Cannibalization is OK. Cannibalizing a product is OK as long as you are the one doing the cannibalizing. For Apple, the thought of severely damaging iPad mini, which looks to be the best-selling iPad size out of the gate, wasn't easy. It would be the equivalent of Apple deciding to give AirPods health and fitness monitoring even if it meant Apple Watch would be permanently impacted as a result. However, Apple found itself with a much stronger iPhone business as a result of cannibalizing a portion of the iPad line. A 6.5-inch iPhone will likely sell for $1,199 while the original 7.9-inch iPad mini retailed for just $329.
Admit Mistakes and Embrace Change. There is this attitude that Apple doesn't make mistakes and instead the company needs to possess the right strategy out of the gate to be a winner. Reality is quite different. Apple is willing to admit to mistakes and then make needed changes to get back on course. Apple's decision to set aside iPad cannibalization fears and launch larger smartphones fundamentally changed both the iPhone and iPad businesses.
Get Rid of Dogma. Throwing away the dogma that smartphones derived value from small screens was crucial in uncapping iPhone's potential. In what may be hard to believe, we are likely still underestimating the trend found with larger smartphones. Apple has seen growing momentum with its 5.5-inch iPhone Plus models over the years. In fact, the iPhone 8 Plus is the best-selling 5.5-inch iPhone relative to its 4.7-inch sibling. Meanwhile, Apple will sell tens of millions of the 5.8-inch iPhone X in 2018. A 6.5-inch iPhone may outsell an iPad mini despite selling for 4x more.
Ultimately, the iPad mini's demise at the hand of larger iPhones led Apple to view the iPhone and iPad as siblings on the same computing spectrum. In such a vision, smartphones are allowed to possess increasingly large screens (6+ inches) while iPad screens trend larger (10.5-inch and 12.9-inch) in an attempt to stand out from increasingly larger smartphones.
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