Neil Cybart Neil Cybart

Above Avalon Podcast Episode 162: The Apple Question

At the start of a new year, there is less value found in coming up with predictions than there is in looking at questions facing the company. In episode 162, Neil goes over his list of questions for Apple in 2020, and the discussion culminates with one overarching question that covers Apple’s largest challenge and opportunity. Additional topics include why predictions contain so little value, the number of Apple users, and Apple in emerging markets.

To listen to episode 162, go here. 

The complete Above Avalon podcast episode archive is available here. 

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Neil Cybart Neil Cybart

The Big Question Now Facing Apple

Predictions are nothing more than attempts at manufacturing clarity for what is inherently a sea of unknown. With New Year predictions, two things need to happen. The person issuing the prediction needs to come up with what may happen, and the predicted event has to occur within an arbitrary time period. The probability of finding value in such an exercise is low.

Instead of coming up with predictions for Apple at the start of a new year, there is value found in embracing the unknown and looking at questions facing the company. This has led to my annual tradition of coming up with a set of questions facing Apple at the start of a new year. The irony found with questions is that asking the right ones is equivalent to coming up with a surf board for successfully catching waves in the sea of unknown.

Previous year’s questions are found below:

Questions for Apple in 2020

The topics that serve as source material for Apple questions in 2020 can be grouped into two buckets: growth initiatives and asset base optimization.

Growth Initiatives

  • iPhone Business. The narrative facing the iPhone business has been off the mark for years. Skepticism and cynicism has continued to mask what has been a resilient business. There is now too much talk of 5G kicking off some kind of mega upgrade iPhone cycle. Such a focus ignores what is ultimately taking place with the iPhone: The business is maturing. This presents a set of challenges that will require a fine-tuning of strategy. This involves changes to the device lineup, release schedule, pricing, and feature set.

  • Paid Content Distribution. Following a very busy 2019 for Apple’s content distribution arm, all eyes are on whether or not Apple will bundle its new paid content services. Ultimately, bundling is a tool that Apple has at its disposal to support a weaker service while increasing the stickiness found with its services.

  • Wearables. Apple’s wearables business is a runaway train with the company selling approximately 65M wearable devices in FY2019. Based on my Apple Watch installed base estimate (available here), just 7% of iPhone users own an Apple Watch. Similar ownership percentages are found with AirPods despite the product having been in the market for less time. The question isn’t if Apple wearables momentum will continue but instead how fast will adoption grow.

  • Margins. Apple follows a “revenue and gross margin optimization” pricing strategy. This has led to Apple’s products gross margin percentage declining by 10% over the past two years while products gross margin dollars have declined by only 2%. Apple is willing to let products gross margin percentages decline (via lower product prices and higher cost of goods sold relative to revenue) if it results in stronger customer demand for those products. Attention will be placed at determining the level at which Apple product pricing is too low in order to maximize gross profit dollars.

  • R&D. There have been two general themes found with Project Titan and Apple’s efforts related to developing a pair of AR glasses: 1) Continued progress and 2) Extended timelines.

Asset Base Optimization

  • Leadership. With Jeff Williams officially serving as the link between Apple’s design team and the rest of Tim Cook’s inner circle, it will be interesting to see if Apple makes any refinements to its leadership structure.

  • China. The boogeyman known as U.S. / China trade has been put to bed, for now. With rhetoric having been dialed back in a very big way, attention will shift to the various decisions Apple still has to make regarding its long-term approach to China. The company can continue to rely heavily on China for its supply chain and manufacturing apparatus, accelerate a diversification strategy away from the country, or follow more of a status quo approach that recognizes the benefits (and weaknesses) of being so dependent on one country.

  • Capex. In FY2019, Apple reported just $7.6 billion of capital expenditures (capex). This was a significant drop from the $16.7 billion of capex in 2018. The most likely reason for the decline in capex was a decline in tooling and manufacturing machinery. The company also slowed spending on corporate facilities. By not providing capex guidance for FY2020, the variable is accompanied by a greater level of intrigue as to what it means about Apple’s near-term product pipeline.

The Big Question

Taking a closer look at the preceding list of unknowns facing Apple, the product categories that have served as the primary engines for Apple’s new user growth are quickly maturing while new product categories have been more ARPU (average revenue per user) drivers. There are more than 500 million people who own just one Apple product: an iPhone. This group represents a prime target market for Apple when selling additional tools. Apple is ending one growth phase and is about to enter into a new one.

Exhibit 1 shows the growth trajectory for the number of Apple users, also referred to as Apple’s installed base, over the past 10 years. Based on my estimates, the Apple installed base grew from approximately 90 million people at the end of 2009 to a little more than a billion people at the end of 2019. Apple’s new user growth has slowed dramatically. Thanks primarily to the iPhone, Apple saw spectacular new user growth in the range of 25% to 60% in the early to mid-2010s. More recently, new user growth has been trending in the mid single-digit range.

Exhibit 1: Apple Installed Base (Number of Users)

The methodology and math used to reach my estimate for the number of Apple users is available for Above Avalon members here.

Reaching a billion users is quite the accomplishment for Apple considering how the company doesn’t give away its products for free. It’s one thing to reach a billion users with a “free” service. However, to get a billion people to pay directly for a service or tool is an entirely different thing.

When thinking about Apple’s future, the big question facing the company isn’t about how it will sell additional tools to its existing user base. Instead, the major unknown facing Apple is found with management’s ability to continue expanding its installed base. This raises one overarching question that covers Apple’s largest challenge and opportunity:

How will Apple find its next billion users?

It may be tempting to classify Apple’s first billion users as the “easy” growth or low-hanging fruit. In reality, those billion users primarily came from the premium segments of the various industries that Apple competes in. This means that to find the next billion users, Apple will inevitably need some strategy adjustments.

The Strategy for the Next Billion

The major building blocks for Apple’s plan to find its next billion users are already in place. Apple will come up with tools capable of making technology more personal. This pursuit will involve new user interfaces and inputs that allow people to get more out of technology without having technology take over people’s lives.

Taking a look at the geographical makeup of Apple’s current installed base, developed markets still contain plenty of new users for Apple to target. However, the potential found with emerging markets is a completely different story. Indonesia, Brazil, the Philippines, and Vietnam have a total population that is twice that of the U.S. Meanwhile, there are more people in China and India (2.6 billion) than the next 20 most populated countries combined.

It may be easy to think that Apple can just cut product pricing in order to grab its next billion users. However, the situation ends up being more complicated. Socio-economic trends will contribute to tens of millions of people moving into Apple’s addressable market each year. In addition, relying on the gray market for allowing gently-used Apple products to flow to lower price segments is a more effective strategy for Apple. Not only does the gray market reduce the need for Apple to come up with low priced products lacking in features, but Apple can also benefit from continued product focus in terms of its supply chain and manufacturing apparatus.

As for some of the granular initiatives that stand to promote continued growth in Apple’s installed base:

  • A truly independent Apple Watch. Advancements such as a truly independent Apple Watch that doesn’t require another Apple device to activate and use will expand the device’s addressable market by nearly four times overnight.

  • Continuing to run forward with wearables. New product categories that allow Apple to break down the barriers between users and technology will allow the company to target a wider audience. New form factors such as glasses will be designed to make technology even more personal than what is possible with Apple Watch and AirPods.

  • Longer device longevity. By giving Apple devices longer lifespans via more durable hardware and additional years of software updates, devices will be able to have more owners over time. This will have a direct benefit on the gray market for Apple devices as more devices are recirculated and eventually able to reach customers in lower price segments.

  • Expanding device repair and support networks. Apple’s current retail store footprint is not capable of handing the additional product servicing and support associated with having another billion users in its ecosystem. This is especially true in developing markets. By building out a device repair and support network to include authorized third-parties, Apple will go a long way in ensuring the next billion users have access to many of the same experiences that are valued by Apple’s current users.

The path to two billion users won’t be easy for Apple. The trajectory may very well end up looking quite different than the path to a billion users. However, there is nothing found with Apple’s long-standing mission to create products that can change people’s lives that limits its reach to a billion people.

Listen to the corresponding Above Avalon podcast episode for this article here.

Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.

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Neil Cybart Neil Cybart

Apple's Billion Users

Apple’s ecosystem is massive. Approximately a billion people are using more than 1.4 billion Apple devices. Even as iPhone sales decline, Apple is bringing tens of millions of new people into its ecosystem each year. However, we are getting to a point where it is prudent to begin thinking about what user growth actually means to Apple.

Number of Users

Estimating the total number of Apple users is a relatively straightforward exercise. This past January, Apple disclosed that there were more than 900 million iPhones in the wild. Given that iPhones are not typically shared, Apple’s disclosure implied that there were approximately 900 million people using iPhones. Since the exact number of iPhones in the wild likely now exceeds 925 million, there is some wiggle room in that 900 million user total for the rare instances of people using more than one iPhone.

Apple also disclosed that there were 1.4 billion active devices in the installed base as of January 2019. The total was up by 100 million devices over the preceding 12 months and up by 400 million devices over the preceding three years. This tells us that there are 500 million Apple devices being used that aren’t iPhones. A majority of those 500 million devices are iPads. The Mac represents another 110 million devices, and a collection of wearables and home accessories make up the remaining devices. Given my Mac and iPad installed base estimates, a conservative estimate is that there are at least 100 million people who use either an iPad or Mac but not an iPhone. Adding these 100 million users to the 900 million people with iPhones leads to a billion Apple users.

A billion users is quite the accomplishment for Apple considering how the company does not give away or subsidize hardware. For context, Amazon has approximately 100 million Prime users. Twitter sells a “free” product and has 125 million daily users. A “free” Google service is widely considered a success once it surpasses a billion users. WeChat recently surpassed a billion daily users. Facebook sells a “free” product and has 1.6 billion daily users.

Revenue Per User

Using Apple’s current revenue run rate and my estimate for the total number of users, the company earns on average $258 from every user per year. There are limitations found with relying on averages. Apple’s ecosystem strength is dependent on geography. In addition, other factors like the gray market distort averages. Accordingly, it makes sense to segment Apple’s user base to gain additional insight into revenue per user figures.

There are approximately 200 million Apple users who have never purchased a new product from Apple or a retailer. Instead, these users rely on Apple products acquired or obtained via the gray market. The overall contribution to Apple’s revenue from these users is likely not too great - a few dollars per month, if that.

On the other end of the spectrum, the U.S. represents Apple’s stronghold when it comes to ecosystem strength. Add to hardware revenue various subscriptions such as Apple Music, paid iCloud, and various third-party subscriptions through the App Store. It is not unreasonable to assume that approximately 50 million to 75 million users spend an average $500 per year on Apple products and services. There are then other pockets of “core” Apple users in various countries including China, Japan, the U.K., and Australia.

Based on Apple’s installed base disclosure, we know there are at least 400 million Apple users who use only one Apple device: an iPhone. The actual number could be much higher. Given an iPhone upgrade cycle of four years and an iPhone ASP of approximately $750, this tells us that at least 400 million people are likely spending somewhere around $200 per year.

Accordingly, Apple’s billion users can be broken into the following groupings:

  • 200 million people spending an average of $25 per year (people in the gray market).

  • 620 million people spending an average $260 per year (includes 400M iPhone-only users upgrading every four years).

  • 180 million people spending an average $500 per year (Apple’s core users in the U.S. and a handful of other countries buying a number of Apple products and paying for various services and subscriptions).

Growth Driver

The iPhone has been Apple’s primary vehicle for bringing people into the ecosystem. No other Apple product has come close to the iPhone in this respect. Exhibit 1 includes my estimates for the number of users purchasing their first new iPhone directly from Apple or a third-party retailer. This serves as a rough proxy for the number of people entering Apple’s ecosystem.

Exhibit 1: Number of Users Buying Their First New iPhone

More information and discussion behind how I derived the preceding estimates is available here.

Based on recent iPhone sales trends, there is evidence of fewer users buying their first new iPhone. For example, my expectation is for 52 million people to buy their first new iPhone in 2019. This total is 60% less than the peak number seen in 2016.

After the iPhone, the iPad has been the second-largest driver bringing new users into the Apple ecosystem. However, given that the iPad installed base is a third of the size of the iPhone installed base, the new user totals just don’t compare to those of iPhone.

Putting all of the pieces together, Exhibit 2 includes my estimates for how Apple’s overall ecosystem has grown in terms of the number of users.

Exhibit 2: Number of Apple Users

Slowing New User Growth

There is no question that Apple’s user growth is slowing. Much of this is due to Apple running out of premium smartphone users in key markets like China and India.

Some people are convinced slowing user growth represents a warning sign for Apple. The concern is that Apple will once again look to milk existing users with higher-priced products and services in an effort to offset slowing hardware sales. Much of this fear is based on how lack of new user growth nearly killed Apple in the 1990s. Instead of focusing on new user growth, Apple milked existing Mac users for as much money as possible. The end result was a complicated product line that lacked focus and vision.

In my view, this is an incorrect way of thinking about today’s situation.

Much has changed with Apple over the past 25 years. During the mid-1990s, Apple’s user base was a fraction of the size of today’s user base. Apple had around 25 million users in the mid-1990s. Simply put, Apple’s user base wasn’t large enough to reach sustainability. Instead of focusing on bringing in new users, Apple took the easy route and simply kept selling to existing users. Today, Apple has 40 times the number of users and is bringing in 25 million new users roughly every six months. Apple’s billion users comprise a self-sufficient ecosystem. The company is in a strong position to sell additional devices and services to these billion users without jeopardizing the long-term health of the ecosystem.

New User Plateau

While new user growth is slowing, it’s not a given that Apple will reach some type of user plateau. As Apple continues to move into more personal devices such as wearables, the company’s addressable market will expand, especially in emerging markets. In countries like India and Brazil, products like iPhones, iPads, and Macs may not be the best tools for bringing new users into the ecosystem. Instead, lower-priced wearables may eventually open the doors to tens, if not hundreds, of millions of new Apple users in markets that up to now have been largely out of reach.

Opportunity

Apple is a design company tasked with developing tools capable of improving people’s lives. Such a mission plays a critical role when figuring out how best to judge Apple.

Apple doesn’t think about financial items such as revenue or profit margins when developing products. The same principle applies to new user growth. Jony Ive and the industrial design group don’t sit around a table and come up with products for the purpose of bringing new users into the ecosystem or increasing revenue per user. Such motivation would have manifested itself in a less focused product line over time.

However, Apple does consider and think about how new products may fit within the existing product line. For example, Apple Watch was launched out of the gate as an iPhone accessory. A pair of smart glasses will likely be similarly positioned as an accessory out of the gate as well. These considerations are part of Apple’s long-standing goal of making technology more personal and having new products serve as simpler alternatives to existing products.

The implication found with this product strategy is that one of Apple’s key opportunities going forward is found with developing and then selling new tools to existing Apple users. A feedback loop can then be created as new tools and services drive higher user loyalty and engagement and subsequently even higher tools and services adoption. This will likely manifest itself in higher revenue per user over time as Apple users rely on additional Apple tools in their lives. As Jony has said in the past, financial items like revenue and profit end up being byproducts of a successful product strategy.

This brings us back to the Apple revenue per user calculations from up above.

  • 200 million people spending an average of $25 per year (people in the gray market).

  • 620 million people spending an average $260 per year (includes 400M iPhone-only users upgrading every four years).

  • 180 million people spending an average $500 per year (Apple’s core users in the U.S. and a handful of other countries buying a number of Apple products and paying for various services and subscriptions).

With wearables, Apple is in a good position to drive a portion of the 400 million users who likely only have an iPhone to begin using another Apple device. One way of measuring this opportunity is that if 200 million people spend more like $350 per year versus $260 per year, Apple could see an additional $18 billion of revenue per year. Another opportunity is found with the 200 million users who are part of the Apple ecosystem via the gray market. Assuming Apple can sell additional tools to a portion of those users, Apple would see something in the neighborhood of $12 billion of additional revenue per year (100 million people spend more like $150 per year versus just $25 per year). These are huge numbers that speak to how much room the company has for existing Apple users to become more engaged with the ecosystem. In the mid-1990s Apple simply tried to milk its limited number of users of more money. Apple is now engaged in expanding its users’ tool arsenal while continuing to add new users to the ecosystem.

While Apple will continue to face various risks when it comes to maintaining user loyalty and engagement, especially when it comes to factors outside of its control like economic and geopolitical developments, the big picture is that Apple’s billion users is a game changer. The company has reached a level of ecosystem strength that still hasn’t been fully digested by the marketplace.

Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.

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