Neil Cybart 8/12/20 Neil Cybart 8/12/20

Apple's Ecosystem Growth Is Accelerating

The two most recent Above Avalon articles took a look at how and why Apple’s ecosystem is giving the company a major advantage against the competition.

With Apple reporting 3Q20 earnings two weeks ago, there is value in quantifying how much Apple’s ecosystem is growing. The data should startle the competition. Apple is seeing a clear acceleration in its ecosystem growth as hundreds of millions of iPhone-only users move deeper into the Apple fold by subscribing to various services and buying additional products.

Measuring Ecosystem Growth

There are a number of ways one can attempt to track or measure Apple’s ecosystem growth.

Number of devices
Number of users
Number of devices per user
Amount of revenue per user
Number of paid subscriptions
Number of paid subscriptions per user

In covering Apple’s business from a financial perspective, my modeling work includes keeping up-to-date estimates for most of the preceding data points. However, there is one metric missing from the list that may come as a surprise: overall revenue. Considering Apple provides this data point every three months, such an exclusion may seem peculiar. Wouldn’t Apple revenue shed light on how the Apple ecosystem is performing?

Relying on overall revenue for analyzing Apple’s ecosystem growth will lead to faulty conclusions. In Exhibit 1, Apple’s revenue is graphed on a trailing twelve months (TTM) basis. This is done to smooth out the seasonality found in Apple’s business (i.e. sales are concentrated around the holidays). The takeaway from the exhibit is that higher revenue demonstrates Apple’s ecosystem continues to grow although the rate of growth has slowed dramatically.

There is one problem with such a takeaway: It’s wrong.

Exhibit 1: Apple Revenue (TTM)

Overall revenue trends are masking what is actually occurring with Apple’s ecosystem. In FY2019, the iPhone was responsible for 55% of Apple’s overall revenue. On its own, that’s not an issue for Apple. The iPhone is part of Apple’s ecosystem after all. However, Apple has become increasingly dependent on existing users upgrading their devices to generate iPhone revenue. This has resulted in Apple’s overall revenue being heavily influenced by iPhone upgrading trends.

During periods of robust iPhone upgrading, Apple’s overall revenue shows stronger growth. When iPhone upgrading slows, overall revenue growth also slows to the point that Apple’s ecosystem may appear to be plateauing or even contracting (as seen in Exhibit 1). This was a major issue at the end of 2018 and early 2019 as slowing iPhone upgrades led many to conclude that Apple was in big trouble in China and other geographies.

Since iPhone upgrading trends have little to no direct impact on Apple ecosystem viability or strength, a better approach to get insights on Apple’s ecosystem growth is to divide Apple’s revenue into two categories:

iPhone
non-iPhone (Services, Mac, iPad, Wearables, Home, and Accessories)

As seen in Exhibit 2, breaking Apple’s overall revenue into iPhone and non-iPhone revenue leads to a completely different view of Apple’s growth trajectory. Non-iPhone revenue (the red line) continues to demonstrate very strong momentum while iPhone revenue (the blue line) is trending at the same level that it was in 2015.

Exhibit 2: Revenue (iPhone vs. Non-iPhone) - TTM

A different way of looking at this data is to consider revenue growth rates. Using the revenue figures from Exhibit 2, we are able to create Exhibit 3, which displays year-over-year change in revenue for both iPhone and non-iPhone.

Non-iPhone revenue growth (the red line) has outpaced iPhone revenue growth (the blue line) for the past seven quarters. The higher growth rates for iPhone revenue in 2018 were due to higher iPhone ASPs caused by Apple unveiling the iPhone X. Excluding those quarters, non-iPhone revenue growth has been trending stronger than iPhone growth since 2016. This is a sign that Apple’s underlying ecosystem strength has been gaining momentum for years - it’s just been masked by people holding on to their iPhones for longer before upgrading.

Exhibit 3: Revenue Growth YOY (iPhone vs. Non-iPhone) - TTM

What is driving the non-iPhone revenue strength shown in Exhibits 2 and 3? The answer is found in the strong iPhone revenue trends from a few years ago. Years of strong new user growth driven by the iPhone is now contributing to hundreds of millions of iPhone-only users moving deeper into the Apple ecosystem. This trend began in earnest around the beginning of 2017.

The Services Myth

Some may look at the preceding exhibits and say that the data is still incomplete. Apple Services include a number of recurring revenue streams such as iCloud, Apple Music, and various paid subscriptions. Given the recurring nature of something like paid iCloud storage, it ends up being easier for Apple to report year-over-year Services growth. Apple’s Services business accounts for 40% of non-iPhone revenue. There is a different dynamic found with hardware revenue. Since hardware isn’t a recurring revenue stream, year-over-year growth ends up being that much harder to achieve as Apple is in effect needing to replace every dollar of revenue with new sales.

(One can argue something like the iPhone Upgrade Program is a recurring revenue stream for hardware. However, that ends up being a stretch. The Upgrade Program is a loan with a built-in upgrade optionality after the 12th payment. That is very different than something like an iCloud or Apple Music subscription.)

To address this issue, non-iPhone revenue can be broken out into Services and Products (excluding iPhone). In what will come as a shock to many people, Exhibits 4 and 5 show how Products revenue excluding iPhone (i.e. iPad, Mac, Wearables, Home, and Accessories) is now growing at nearly the same pace as Services. This represents a major narrative violation as consensus spent years positioning Services as Apple’s growth engine.

Exhibit 4: Revenue (Apple Services vs. Apple Products Excluding iPhone) - TTM

Exhibit 5: Revenue Growth YOY (Apple Services vs. Apple Products Excluding iPhone) - TTM

Based on Apple management commentary, we know that upgrading is not impacting the iPad, Mac, and wearables as much as the iPhone. Approximately half of people buying iPads and Macs are new to the product categories. For Apple Watch, the percentage is more than 75%. The new user percentage for iPhone sales is a fraction of those percentages. This tells us that iPad, Mac, and wearables sales are a very good indicator of Apple ecosystem strength.

Tying It All Together

One way of thinking about the Apple ecosystem is to view it as a pie. There are two ways for Apple to expand the pie: Bring in more customers and have existing customers spend more on services and products in the ecosystem (higher ARPU).

New users entering the ecosystem - The iPhone SE should not be underestimated as a successful tool for bringing Android users into the Apple fold.
Existing users moving deeper into the ecosystem - iPhone users are buying iPads, Macs, and wearables as well as subscribing to various Apple services.

Apple currently finds itself in an ecosystem expansion phase. Hundreds of millions of people with only one Apple device - an iPhone - are embarking on a search for more Apple experiences. We see this with non-iPhone revenue growing by 14% in 3Q20 on a TTM basis, which is higher than growth rates seen in the mid-2010s, as seen in Exhibit 6.

Exhibit 6: Apple Non-iPhone Revenue Growth Projection

Looking ahead, my estimates have non-iPhone revenue accelerating from 14% growth to 20% growth in the coming quarters. iPad, Mac, and wearables are a major source of that growth acceleration. Considering how Apple is working off of a much larger revenue base, for revenue growth percentages to actually increase this far along in the process is intriguing. The takeaway is that Apple’s ecosystem is gaining momentum at a pace that should frighten the competition.

Hundreds of millions of people will be buying their first Apple wearable device in the coming years. Given the inherent nature of wearable devices - new form factors designed to make technology more personal - it is very likely that one Apple wearable purchase will eventually lead to additional Apple wearable purchases. Apple can then leverage high-margin Services to run with more aggressive pricing on wearables (and other Apple devices) which only ends up boosting demand.

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 in both written and audio forms. To sign up and for more information on membership, visit the membership page.

For additional discussion on this topic, check out the Above Avalon daily update from August 13th.

Neil Cybart 2/27/20 Neil Cybart 2/27/20

Don't Feel Bad for the iPad

Last month marked the tenth anniversary of Apple unveiling the iPad. The occasion took on a somber feel as the most common reaction in tech circles ended up being sadness and disappointment for what the iPad had failed to become. While some are convinced that the iPad is in some way a victim of neglect, mismanagement, or even worse, such feelings are misplaced. We don’t need to feel bad for the iPad.

Anniversary Reactions

Apple unveiled the iPad on January 27th, 2010. To mark the tenth anniversary of the unveiling, a few publications had articles recapping the iPad’s first decade. Some of the reactions were complicated, to put it gently.

Here’s John Gruber, over at Daring Fireball, in a post titled, “The iPad Awkwardly Turns 10”:

“[Steve] Jobs’s on-stage pitch was exactly right. The iPad was a new class of device, sitting between a phone and a laptop. To succeed, it needed not only to be better at some things than either a phone or laptop, it needed to be much better. It was and is.

Ten years later, though, I don’t think the iPad has come close to living up to its potential. By the time the Mac turned 10, it had redefined multiple industries. In 1984 almost no graphic designers or illustrators were using computers for work. By 1994 almost all graphic designers and illustrators were using computers for work. The Mac was a revolution. The iPhone was a revolution. The iPad has been a spectacular success, and to tens of millions it is a beloved part of their daily lives, but it has, to date, fallen short of revolutionary.”

Ben Thompson, over at Stratechery, agreed with Gruber and went further in his own article, “The Tragic iPad”:

“It’s tempting to dwell on the [Steve] Jobs point — I really do think the iPad is the product that misses him the most — but the truth is that the long-term sustainable source of innovation on the iPad should have come from 3rd-party developers. Look at [John] Gruber’s example for the Mac of graphic designers and illustrators: while MacPaint showed what was possible, the revolution was led by software from Aldus (PageMaker), Quark (QuarkXPress), and Adobe (Illustrator, Photoshop, Acrobat). By the time the Mac turned 10, Apple was a $2 billion company, while Adobe was worth $1 billion.

There are, needless to say, no companies built on the iPad that are worth anything approaching $1 billion in 2020 dollars, much less in 1994 dollars, even as the total addressable market has exploded, and one big reason is that $4.99 price point. Apple set the standard that highly complex, innovative software that was only possible on the iPad could only ever earn 5 bucks from a customer forever (updates, of course, were free).”

There were then tweets (lots of tweets), regarding the current state of iPad. Here are two:

Riccardo Mori: “What I believe is that the iPad and its OS could have been so much more than a reinvention of the computing wheel adapted for a touch interface.”

Loren Brichter: “[T]he App Store is what killed the iPad.”

You get the point. There was no shortage of writers, pundits, and industry analysts using the iPad’s 10th anniversary to give eulogies for the product in terms of its inability to be revolutionary, grab momentum, or even just meet expectations.

A handful of people talked highly of iPad on its anniversary. However, such perspectives were few and far between. Interestingly, the articles that were published still ended up including noteworthy disclaimers and qualifiers. For example, here’s Om Malik in “iPad at 10. An affair forever”:

“A decade after its introduction, I think the iPad is still an underappreciated step in the storied history of computing. If anything, it has been let down by the limited imagination of application developers, who have failed to harness the capabilities of this device.”

My Reaction

I hold a very different view of the iPad at 10 years old. In recapping the 2010s, I went so far as to position the iPad as one of two most important tech products of the decade (the iPhone being the other one). The iPad has become ubiquitous in various industries and sectors, and in the process, it has altered modern computing.

How can there be such a dramatic difference in opinion when it comes to iPad?

Different perspectives.

To see how important perspective becomes in this discussion, we need to go back to the iPad unveiling in January 2010.

Selling a Problem

A closer look at the iPad unveiling reveals it wasn’t that Steve successfully made the sales pitch for a new product category. Instead, Steve successfully sold consumers on a problem they weren’t even aware they faced.

A few daily tasks like email, web browsing, video watching, and mobile games could be better handled on a large piece of glass with multi-touch than on a small piece of glass with multi-touch (iPhones) or a non-multi touch device (MacBooks). Such juxtaposition elevated the iPad at the expense of the iPhone and Mac. The iPhone was positioned as a tiny device designed for portability while the Mac was positioned as a heavy beast blown out of the water by iPad when it comes to handling simple tasks.

Consumers agreed with Steve that there was an indeed a problem and that the iPad was a genuine solution to the problem. The iPad became Apple’s best-selling product out of the gate with the company selling 22 million devices in just the first 12 months. Ten years later, it is difficult to envision a new Apple product that will be able to grab that kind of adoption so quickly.

The iPhone

In January 2010, the iPhone was more of an idea and a promise than anything else. When the iPad was unveiled, there were only about 30 million people using an iPhone. Apple now sells that many iPhones in about two months. In 2010, it was the iPad, not the iPhone, that was considered to be the more important product in the future.

Given such lofty expectations, maybe it shouldn't have come as a surprise that the iPad’s tenth anniversary was met with awkwardness, sorrow, and even sadness as some look at the product as a promise that wasn’t kept. However, the early promises found with the initial iPad were met. There was just an unexpected twist.

The iPhone ended up carrying the vision found with a larger piece of glass supporting multi-touch that Steve unveiled on stage in January 2010. As iPhone screens became larger over the years, the product leveraged the inspiration found with the initial iPad and turned it into something consumed by nearly a billion people. There are 32x more iPhone users in the world today than there were when the iPad was unveiled in 2010. The iPhone became an iPad that fit in one’s pocket. Based on the iPhone’s resounding success, it is fair to say that those early calls that the iPad would turn into something very big ended up being true.

A Pivot

Instead of raising the white flag and letting the iPad set sail into the sunset after being replaced by the iPhone, Apple pivoted the product category to accomplish two things:

Serve as a content creation machine (Apple Pencil for drawing / keyboard accessories for typing).
Represent a low-cost entry point into the Apple ecosystem ($329 starting price).

Those two changes gave the iPad a very successful second chapter. Unit sales have stabilized at 45 million per year with approximately 20 million new people entering the iPad installed base each year.

The iPad is currently shaping industries far more than some people are giving the product credit for. There are at least 350 million people using an iPad in some capacity. The iPad has indirectly added billions of dollars of market cap to companies ranging from Slack and Microsoft to Square when considering the product’s widespread adoption and influence in enterprise settings.

A Line in the Sand

The iPad has become a line in the sand between those who grew up on laptops and desktops and those who never felt comfortable with such devices. Apple finds itself walking a thin line when it comes to adding functionality to the iPad for some users while keeping the device’s simplicity and intuitiveness front and center for other users.

Multi-tasking is a great example of this battle. For instance, some Mac users are not pleased with Apple’s implementation of multi-tasking on the iPad. These users find multi-tasking on an iPad to be a mental exercise. Meanwhile, a portion of iPad users have no need or desire for multi-tasking on iPad. These users are also likely to view multi-tasking on a laptop or desktop as not intuitive. Going a week with no laptop or desktop usage will do interesting things to one’s perception about computing and intuitiveness. When returning to a laptop or desktop, the machines feel like taking a step back. Our brain has to be rewired to handle something that is inherently less intuitive.

The iPad’s Problem

Apple doesn't sell perfect products. There will always be room for improvement, refinement, and new thinking. In some ways, the lack of perfection is what serves as motivation for Apple to keep pushing. When defining the problems now facing the iPad, my criticism is a bit unconventional.

The iPad’s primary problem is that it is viewed by some as needing to be a laptop replacement in order to have any value. This unrealistic viewpoint has resulted in a type of expectational debt being placed on the device. The iPad is expected to become more like the Mac and macOS over time. This is problematic as the iPad is not a laptop replacement.

MacOS should not be positioned as inspiration for where to bring the iPad or iPadOS. This isn’t meant to belittle macOS. Instead, touch-based computing has blurred the line between consumer and professional devices. When debating content consumption versus content creation and the broader definition of work, there is a habit in tech circles to not consider how such terms have dramatically different meanings for hundreds of millions of people.

The takeaway is that the iPad has become a different kind of product, and it should be allowed to stand apart from the iPhone without being forced to replace macOS. Hence, there is iPadOS and things like Apple Pencil support. Instead of asking how best to handle multitasking on an iPad, a better question is to wonder what multi-tasking should even mean on an iPad. Such questions present new challenges regarding user interfaces and design.

Being Itself

Apple’s product strategy is to push all of its major product categories forward at the same time. This is different from pushing the iPhone forward and trying to have the iPad and Mac come along for the ride. Positioning the iPad as a content creation platform for the masses, designed to handle some tasks given to laptops and desktops while also handling completely new tasks, is a winning strategy. It allows the iPad to be itself while not forcing the product into a corner in order to satisfy certain segments of the Apple installed base.

A lot has changed during the iPad’s first 10 years. Some may be disappointed with how the iPad has evolved, even to the point of thinking Apple lost a great opportunity. However, I wouldn’t feel bad for a device that revealed the iPhone’s true potential and then became a different kind of content creation tool now used by more than 350 million 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.

For additional discussion on this topic, check out the Above Avalon daily update from March 2nd: The iPad’s First Decade, The iPad’s Second Decade.

Neil Cybart 12/11/19 Neil Cybart 12/11/19

The "Apple Tax" Died Years Ago

Two weeks ago, Business Insider caused a stir with a video titled, “Why Apple Products Are So Expensive.” The video was part of Business Insider’s “So Expensive” series, which takes a look at why certain items are priced the way they are.

The video was troubling for the number of inaccuracies, falsehoods, and outright lies it included about Apple and its pricing strategy. According to Business Insider, Apple products are expensive because loyal users are willing to pay an “Apple Tax,” or a higher price attached to products containing an Apple logo. A closer look at Apple’s actual pricing strategy reveals a fundamentally different explanation for why Apple products are priced the way they are. The days of there being an “Apple Tax” ended years ago.

The Video

The following video was pushed out to Business Insider’s 2.3M YouTube subscribers on November 23rd, 2019. The video currently has a little more than 660,000 views.

The video included a long list of claims regarding Apple, its product pricing strategy, and the company’s overall positioning in the marketplace.

Apple was said to be bringing in huge profits by charging higher prices for its products. The progression of pricing from iPhone 6 to iPhone 11 ($649 to $999) and the Mac mini ($499 to $799) were used as examples of Apple charging more for basically the same product. These higher prices are said to be part of Apple’s strategy to squeeze as much profit as possible from loyal customers “unwilling to switch out of the Apple ecosystem.”
Apple products were said to contain components that are standardized and comparable to what is found in competing products. Accordingly, higher-priced Apple products are more expensive than products from competitors despite not including additional functionality. An iPhone’s bill of materials was positioned as a useful tool for tracking how profitable an iPhone is for Apple.
Apple was said to rely on “sneaky” tactics to grab additional profit from these loyal users by charging more for higher-end configurations and requiring users to buy expensive dongles, keyboards, mice, and cables.

When assessing the video’s long list of issues, the primary problem was found with how much long-standing narratives about Apple guided Business Insider’s talking points. Numbers and data were cherrypicked to support false narrative after false narrative while Business Insider ignored or brushed aside evidence that would prove its narratives wrong. For example, Apple’s downright aggressive pricing with Apple Watch and AirPods was ignored. Meanwhile, strategies that have proven to be flat out wrong, such as relying on a product’s bill of materials to figure out profitability, went unchecked.

In an effort to come off as more authoritative, Business Insider relied heavily on commentary from Mohan Sawhney, a marketing professor at Northwestern University. The problem was that Sawhney viewed Apple through a marketing prism - the company was said to be nothing more than a luxury brand selling nice-looking tech gadgets. Sawhney claimed the only reason Apple is able to extract so much profit from the industries it operates in is because people are willing to pay more for the Apple logo. There was no mention of Apple controlling much of the profit within an industry by purposely avoiding the low end of that market while also offering a wide range of devices with different amounts of technology.

Apple Tax

The theory of there being an Apple Tax has been around for more than a decade. The term was coined during the mid-2000s to refer primarily to Apple laptops (iBooks and then MacBooks). A MacBook was said to cost more money than a Windows laptop with similar specifications because of there being a premium built into the MacBook’s price. Said another way, the MacBook was more expensive than other products since it included an Apple logo.

The “Apple Tax’ phrase became a way to poke fun at MacBook users for their apparent cluelessness in paying more for a product despite cheaper alternatives being available. In recent years, the Apple Tax definition has morphed to merely refer to higher-priced Apple products like the iMac Pro and new Mac Pro.

There has always been a glaring hole in the Apple Tax narrative: Since Apple does not license its Mac operating system to OEMs, a MacBook running Apple software ends up being very different than a Windows laptop said to have similar specs. In addition, while Apple made a number of content creation applications available for free on the Mac, Windows laptops positioned as direct competitors lacked such free applications. It may be more correct to say that the Apple Tax reflected the price of Mac software instead of some kind of premium created out of thin air.

Apple’s Pricing Strategy

Apple’s pricing strategy is not based on the idea of forcing users to pay an “Apple Tax.” Instead, Apple follows a revenue and gross profit optimization strategy. Here is Apple’s CFO Luca Maestri talking about the strategy on various Apple earnings conference calls:

4Q17: “We tend to think about maximizing gross margin dollars because we think that's the most important thing for investors at the end of the day. When we look at our track record over years, I think we've found a good balance between unit sales growth and gross margins and revenue, and we will continue to do that as we go forward.”
2Q18: “Our primary consideration is always around maximizing gross margin dollars, and that is the approach that we take around pricing decisions.”
4Q18: “[W]e make our decisions from a financial standpoint to try and optimize our revenue and our gross margin dollars.”
1Q19: “It is important for us to grow gross margin dollars. And if at times we grow services that are at a level of gross margins, which is below average, as long as this is good for the customer and as long as we generate gross margin dollars we're going to be very pleased.”
2Q19: “[W]hat really matters to us and what we look at -- when we look at the elasticity of these [iPhone upgrade] programs is to see the impact on our gross margin dollars.”

While “revenue and gross margin optimization” may sound like loaded terminology, the idea underlying the strategy is straightforward. Instead of Apple including a certain amount of “tax” or premium in a product’s price to maintain a specific gross margin percentage, Apple prices its products in a way that maximizes gross margin and revenue on an absolute basis. Gross margin is cost of goods subtracted from revenue.

The strategy requires Apple to come up with forecasts for how a product’s price will impact customer demand for that product. Price a product too high, and the lower unit sales (as a result of weaker demand) may more than offset the higher amount of revenue and gross margin found with each device. Price a product too low, and the higher unit sales (as a result of stronger demand) may not offset the lower amount of revenue and gross margin found with each device.

Gross Margin Data

A closer look at Apple’s gross margins demonstrates this “revenue and gross margin optimization” strategy in action. Exhibit 1 highlights Apple’s gross margin percentage going back to 2000.

Exhibit 1: Apple Gross Margin (Percent of Revenue)

Apple Gross Margin (Percent of Revenue) - Above Avalon

As shown in Exhibit 1, Apple’s gross margin as a percent of revenue has been steady since 2013. On the surface, such stability would seem to validate Business Insider’s claim of there being some kind of price premium automatically added to Apple products - as if management determines a product’s price by adding a certain premium on top of the cost of goods sold.

However, Apple’s overall gross margin doesn’t tell the full story. There are notable shifts underway when looking at the two components that make up overall gross margin. A decline in Apple’s products (hardware) gross margin percentage is being offset by an increase in services gross margin percentage. This dynamic is seen in Exhibit 2.

Exhibit 2: Apple Gross Margin (Percent of Revenue) - Products vs. Services

Apple Gross Margin (Percent of Revenue) - Products vs. Services (Above Avalon)

In just the past two years, Apple products gross margin percentage has declined by 10% (350 basis points). That is noteworthy. This means that Apple hardware has become less profitable when looking at gross margin as a percent of revenue. The decline is due to two factors:

Apple is lowering product pricing which is eating into the delta between revenue and cost of goods sold. Most of these price cuts are designed to roll back the impact from foreign exchange. However, another factor is that Apple is willing to run with lower gross margin profiles for certain products with the goal of selling more products.
Apple is including more technology in its products while not increasing prices enough to maintain gross margin percentages. As with the first factor, Apple is becoming more aggressive on price in an effort to sell more products and generate more revenue and gross margin dollars.

The decline in products gross margin percentage doesn’t become apparent when looking at overall gross margin because Apple Services is offsetting the decline. Services gross margin is up a very strong 16% (870 basis points) over the past two years as services with naturally higher margins (licensing, AppleCare, paid iCloud storage) gain momentum.

While Apple’s products gross margin percentage has declined by 10% over the past two years, products gross margin dollars declined by only 2%. This tells us that Apple is willing to let products gross margin percentage decline (less profit found with each device) if it means stronger customer demand results in more units being sold. This is the epitome of Apple’s revenue and gross margin optimization strategy.

Implications

There are two major implications associated with Apple’s revenue and gross profit optimization strategy:

Apple’s product portfolio has become increasingly competitive from a pricing perspective. In the case of Apple Watch and AirPods, pricing is downright aggressive compared to the competition. A $159 pair of AirPods sent shockwaves around the industry as competing products were priced in the $200 to $300 range. Even today, it’s difficult for genuine competitors to come close to AirPods pricing. A similar dynamic is found with wrist wearables as Apple Watch pricing remains highly competitive.
Apple has embraced a bifurcation strategy in which product lines have been expanded to include a broader range of models and corresponding prices. This dynamic applies to most of Apple’s products including the iPhone, iPad, Mac, Apple Watch, and AirPods. The primary benefit of Apple becoming aggressive both at the low end and high end of the pricing spectrum is more choice for consumers. Products like the 10.2-inch iPad represent the gateway into the iOS ecosystem for millions of people each year. The MacBook Air remains the most popular Mac. The end result is that products with various margin profiles may end up offsetting each other.

Accessories

When it comes to how Apple prices various accessories like dongles, Watch bands, and iPad keyboards, the company isn’t relying on an Apple Tax. Instead, accessories by their very nature have high gross margins given that the items are sold to customers looking to personalize their experience. A similar philosophy applies to Mac memory and storage upgrades. While those upgrades are indeed profitable for Apple, the fact that Apple charges the prices they do is not a sign of Apple users being held hostage and forced to pay an Apple Tax. Instead, positioning certain items as accessories or upgrades plays a role in Apple keeping entry-level product pricing low for the mass market.

Narrative Violations

A new school of thought positions Apple as a monopoly not because it has significant market share, but because it has loyal and engaged users. The idea is that since these users would apparently face such a dreadful experience by moving outside the Apple platform, it’s as if they have no alternatives. Apple is said to be taking unfair advantage of this situation and its position as the only provider of a premium experience. A byproduct of this stance is that certain Apple actions, such as the way the App Store is managed, are viewed as uncompetitive.

There is no question that Apple has loyal, satisfied users. However, the premise that these users are in some way held captive or hostage by Apple, and therefore forced to pay high Apple prices, just doesn’t hold up to scrutiny.

Contrary to popular opinion, a new Apple product doesn’t sell simply because it has an Apple logo. Apple users are discerning when it comes to determining what products are worth buying. We see this when it comes to upgrade rates for existing products as well as adoption trends for new products.
Apple’s declining products gross margin percentage is driven in part by lower iPhone profit margin percentages. This has occurred despite iPhone ASPs rising, which goes against nearly every narrative that has been put forth about higher iPhone prices.
The App Store is run at just a 10% gross margin (my estimate). This goes against the idea that Apple is being unfair to developers when charging 15% or 30% revenue share. While some developers want Apple to charge them more like 5% to 10% of revenue, or nothing at all, such revenue share arrangements would likely lead to the App Store being operated at a loss considering that a majority of apps do not share any revenue with Apple.

It’s easy to look at Apple pricing and take a cynical view that management is trying to squeeze as much profit as possible from its users. However, Apple’s incentive isn’t to milk users for all they can but rather to expand the Apple user base and provide users great experiences. Apple’s ability to grab monopoly-like share of industry profits isn’t a result of there being an Apple Tax but rather a byproduct of Apple following a design-led product strategy that ultimately marginalizes industries.

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

Neil Cybart 6/19/19 Neil Cybart 6/19/19

Apple's Product Strategy Is Changing

This year’s WWDC felt different. While every WWDC keynote is filled to the brim with new features, this year’s announcements included highly anticipated items like a new Mac Pro and differentiated iPad software features. In addition, there were some genuine surprises such as SwiftUI (a big deal with wide-ranging implications for Apple’s ecosystem). Despite there being no discernible change to the grand vision behind Apple’s product development, there does appear to be a noteworthy change to strategy.

The Past

Apple had been following a product strategy that can be thought of as a pull system. The company was most aggressive with the products capable of making technology more relevant and personal.

One way of conceptualizing this product strategy is to think of every major Apple product category being attached to a rope. The order in which these products were attached to the rope was determined by the degree to which technology was made more personal via new workflows and processes for getting work done. Accordingly, Apple Watch and iPhone were located on the end of the rope held by Apple management. Meanwhile, Mac desktops were located at the other end of the rope while iPads and Mac portables were somewhere in the middle.

As Apple management pulled on the rope, the Apple Watch and iPhone received much of the attention while the Mac increasingly resembled dead weight.

The preceding exhibit may make it seem like all of Apple’s product categories moved in sync with each other as Apple management pulled on the product “rope.” In reality, the quicker Apple pulled on the rope, the more chaotic the end of the rope moved. The following exhibit does a better job of demonstrating the chaos found at the end of the rope.

The Apple Watch and iPhone were Apple’s clear priorities while the iPad, Mac portables, and Mac desktops ended up facing a battle for management attention. The iPad seemed to have the clear advantage in that battle, at least when it came to capturing mindshare among Apple’s senior ranks. Recall Tim Cook’s comment about the iPad being the clearest expression of Apple’s vision of the future of personal computing.

Today

Over the past two years, we received clues that a major change was beginning to take hold in Apple’s product strategy. This change was on display during this year’s WWDC. Consider the following announcements:

The Apple Watch continues to gradually gain independence from iOS and the iPhone with its own App Store and the ability to create watchOS apps without an iPhone app.
iPadOS is a promise from Apple that iPad will be given unique software features versus iPhone. Features like multitasking and Apple Pencil support give iPad differentiation from its more popular sibling (iPhone).
The new Mac Pro is clear evidence of Apple industrial design, along with the engineering and product design teams, attempting to come up with a long-term solution for the most powerful computer in the product line.
SwiftUI is the kind of foundation Apple needs to properly leverage a thriving iOS developer ecosystem in order to benefit other product categories.

Apple no longer appears to be relying so much on a pull system when it comes to advancing its product line. Instead, a push system is being utilized, and every major product category is being pushed forward simultaneously. The change was designed to reduce the amount of chaos found at the end of the “rope” that Apple was pulling. Accordingly, the primary benefactors arising from this new strategy are the iPad and Mac. This explains why this year’s WWDC announcements felt more overwhelming than those of previous years. Apple was able to move its entire product category forward at the same time.

This revised strategy ends up supporting a core tenet of my Grand Unified Theory of Apple Products - a product category's design is tied to the role it is meant to play relative to other Apple products. (A deep dive into Apple’s product vision and the Grand Unified Theory of Apple Products is available here for Above Avalon members.) By pushing the products geared towards handling the most demanding workflows, Apple has a greater incentive to push the products capable of making technology more personal and relevant.

It’s not that every product category in Apple’s line is now on equal footing in terms of importance and focus. Some products will receive updates every few years while others require more attention due to needing annual updates. In addition, Apple’s revised product strategy likely won’t change the sales ratios between product categories (iPhone outselling iPad by four times while iPad outsells Mac by more than two to one). Instead, the change from a pull to push system manifests itself with each product category being given a defined and unique role to handle within the Apple ecosystem.

Wearables are tasked with handling entirely new workflows in addition to a growing number of workflows that had been given to iPhones and iPads.
The iPhone is the most powerful camera and video player in our lives.
iPads and Macs are content creation tools.

Implications

There are a number of product-related implications arising from Apple’s revised strategy:

Mac Desktops. Despite being in the post-PC era, desktops are experiencing some kind of renaissance. Some of this isn’t entirely surprising given how the desktop has always been viewed as an antidote to some of the ideals found with mobile. However, what is new is the realization of the desktop’s role in the AR era. Mac desktops are niche in terms of the number of users relative to other Apple product categories, albeit a very powerful and crucial niche.

Mac Portables. It is time to take Apple management at its word when it says the Mac is important to Apple’s future. Mac portables will likely retain a place in Apple’s product line for the foreseeable future. A few years ago, low-end Mac portables seemed to be on a dead-end path thanks to iPads. There is no longer any evidence that such thinking is widely held in Apple’s senior ranks. An ARM-based Mac portable seems inevitable at this point.

iPad. Just a few years ago, some in the tech pundit world thought the iPad lacked a future. Such thinking was due to slowing iPad sales combined with larger iPhones being able to handle many of the use cases originally given to iPad. While the iPad has always been viewed as the future of computing within Apple, we are starting to see that vision materialize. iPad sales are now routinely surprising to the upside as Apple adds a “pro” layer to the iPad category in terms of powerful hardware and software.

iPhone. The iPhone as a product category continues to mature, as seen with a longer upgrade cycle. Going forward, the iPhone will primarily be known as the most powerful camera in our lives and a video consumption device. Many of the less intensive use cases and workflows currently given to the iPhone will naturally flow to wearables over time.

Wearables. Apple is the wearables leader. Fitbit would arguably be the closest from the perspective of unit sales but even then, the company is quickly losing momentum. Lessons that Apple learned with iPhone and iPad are now giving the company a wearables advantage that is likely at least five years. An independent Apple Watch not requiring an iPhone to set up is inevitable. The move would increase Apple Watch’s addressable market by three times overnight. In addition, Apple is well on its way to establishing a wearables platform as it competes for prime real estate on our wrists, in our ears, and in front of our eyes.

Will It Work?

Is Apple making the right product strategy decision moving from a pull to push system? It’s too early to tell. At first, the revised strategy may seem like a no brainer as each product category ends up benefitting from more attention. However, it’s not a given that such a dynamic is in Apple’s best long-term interests.

The source of my hesitation in Apple’s new product strategy is that the company’s long-term success is dependent on one item: making technology more personal. Anything that takes away from that goal ends up being a hurdle. Is Apple supporting legacy workflows to the detriment of Apple’s long-standing mission of making technology more personal and relevant?

One reason Apple decided to change product strategies in the first place was to avoid an all-out uprising among the 1% of the user base creating content consumed by the other 99%. The mistake Apple made over the past few years was pulling the product “rope” too fast and in the process, leaving many of its pro users, defined by the workflows needed to be supported, behind.

For a company that is resource constrained when it comes to time and attention, there is no guarantee that Apple’s functional organizational structure and design-led culture can realistically scale to push an endless number of product categories at the same time. This was the key benefit found with Apple’s pull system. The focus was to advance the products capable of making technology more personal and relevant while trying to bring as much of the broader product portfolio along for the ride. The move to a push system is inherently more complex. Apple finds itself doing a whole lot more that it did just a few years ago.

Some will push back at the claim that Apple is resource constrained considering the company has $113 billion of net cash on the balance sheet. However, such a view doesn’t take into account how Apple functions. Apple could have thrown together some components in a big box and shipped a new Mac Pro shortly after realizing that the previous Mac Pro design was a dead end. Instead, Apple’s industrial designers, working in close collaboration with various teams, took a little over two and a half years to come up with what is marketed as a long-term solution for handling the most demanding content creation workflows. Similar questions now plague Apple pertaining to its approach to “pro” Mac portables.

My concerns regarding Apple’s revised product strategy would be alleviated if Apple came up with a plan to push legacy platforms forward by doubling down on future initiatives involving making technology more personal. This is why SwiftUI is intriguing. Apple is positioning SwiftUI as a way to improve a developer's productivity by requiring less code, resulting in better code. What if that is only scratching the surface as to Apple’s ultimate objective? What if the Mac is being repositioned as an AR creation platform while iOS is gradually positioned as a platform for developing wearables apps? Using a billion iPhones to develop apps consumed on billions of wearable devices is the type of goal that would require years of work, foundation building, and periodic changes to product strategy.

Neil Cybart 9/18/12 Neil Cybart 9/18/12

Marketing a Smaller iPad

Marketing is an art, not a science. We were fortunate to see this art first-hand on January 27, 2010 as Apple unveiled the iPad. Technological and engineering marvels aside, Apple faced the daunting task of marketing a disruptive product that had to grow into its role of replacing the modern-day PC. Jump ahead 33 months and it appears Apple has had some initial success, selling 84 million iPads. Within weeks, the world will see Apple’s second test marketing iPad, but this time it will be a new form factor, a smaller iPad.

Marketing; Portraying the Product

The most important aspect of marketing is the product; the look, feel, and sound (fortunately iPad’s smell and taste aren’t a major factor in this discussion). Apple eloquently marketed the iPad as a sexy device that could do a few things extremely well, all the while feeling great in your hand. The consumer was left focusing on iPad’s strengths, and not its short-comings, or mysteries, such as if its weight becomes an issue after extended use. In subsequent years, Apple began the task of marketing the iPad as a device capable of content creation, in an effort to begin cementing its path to replacing the modern-day PC. When unveiling a smaller iPad (7.85-inch screen) in October, Apple will be given 60 minutes to tell a story; why a smaller iPad should exist.

Apple may take two paths:

1) Positioning a smaller iPad as a replacement to the current 9.7-inch iPad. Apple’s presentation will include all of the features a smaller iPad could do well, such as web surfing, content consumption and creation, but in a smaller form factor and at a lower price point. Consumers will have to decide between a small or large iPad.
2) Positioning a smaller iPad as a companion to the current 9.7-inch iPad. Apple’s story will include the few things a smaller iPad could do extremely well, such as content consumption, in a more convenient form factor for extended passive use, such as reading or watching movies. Consumers will understand the differences between a small and large iPad and come away from the event wanting both, not one or the other.

Apple will most likely choose the second path, positioning the smaller iPad as a companion device to the current iPad line-up, and in doing so will not only sell a lot of small iPads, but keep the large 9.7-inch iPad as the powerhouse in the tablet market.

The Tablet Story

On January 27, 2010, Apple could have unveiled an iPad with a 7-inch screen, or 8 inches, or maybe even 12 inches, but settled on 9.7 inches. Apple knew there would be plenty of television commercials marketing iPad, but the biggest marketing ploy would be the product itself, a device capable of eventually replacing the modern-day PC as the primary form of computing. Apple wanted (or needed) consumers to begin thinking of an iPad as a possible laptop replacement from the start. The “iPad as your new laptop” thought didn’t need to be completely formed on Day 1, or even by Year 3, but Apple needed to plant the seed on Day 1 and a 9.7-inch device was an easier sell than a smaller 7-inch device.

Fast forward a few years, and the tablet market is now flooded with smaller 7-inch tablets. Besides not being given an adequate reason for their existence, consumers are confused by these 7-inch tablets labeled as a “full tablet” despite failing in comparison to a laptop’s immense feature list.

So why should Apple introduce a smaller 7.85-inch tablet now? It is time because the 9.7-inch iPad is a success.

A Smaller iPad; Companion to the Current iPad

The iPad is now well established as a successful tablet and cornerstone to Apple’s product line-up. While many have fallen in love with iPad, the device does have some minor drawbacks, namely form factor for extended use and price. The device tends to feel heavy in hand after extended use, such as reading or movie watching, while the $499 entry price is still unattainable for a large swath of the population, including education and business, leaving wiggle room for competitors to try something at the bottom-end of the price ladder. Are these two factors (heavy form factor and price) enough for Apple to introduce a smaller iPad?

In October, Apple will address the space between an iPhone and a 9.7-inch iPad and most likely market a 7.85-inch iPad as a companion to the 9.7-inch iPad. Books, movies, TV shows, podcasts, and games will be shown as more enjoyable given a smaller iPad form factor. Apple will need to walk a delicate line though positioning a smaller iPad as the best way to consume content, as many will continue to enjoy content on their large iPads (as well as on their iPhones).

More importantly, Apple needs to portray a small iPad not as a 9.7-inch iPad replacement, but as an iPad companion. If consumers begin to think of a smaller 7 to 8 inch device-great at content consumption but not so great at other aspects-as an iPad replacement, the effort of positioning iPad as the disruptive force will be in jeopardy since wide-spread adoption would come under pressure and laptops would continue to appear superior to the average 7-inch tablet.

For those who would buy a smaller iPad due to price, proper marketing will position the smaller iPad as a gateway drug to a larger iPad. If a consumer enjoys content on a small iPad, the thought of not only consuming the same content, but also creating content on a larger iPad will only be enhanced.

Other Musings

Price. If given three $5 casino chips and told to guess the small iPad’s price, the $199, $249, and $299 squares would be occupied with a chip. If given one $15 casino chip, the $249 price point would be occupied. Not only is the product itself a form of marketing, but a device’s price can say a lot. Priced too low, a small iPad may have a hard time losing the “just a content consumption” tagline, while priced too high and the small iPad becomes an iPad competitor as consumers assume the two devices must be similar in compatibility. A $249 price point would be the best of both worlds; a device $150 less expensive than the entry-level iPad 2, but still more expensive than other 7-inch tablets.

Future iPads. One could replace any mention of “small iPad” in this piece with “larger iPad” and the same overall thesis would apply. A larger iPad (greater than 9.7 inches) for content creators (movie makers, artists, designers, etc.) would certainly make an interesting proposition.

iPod touch. The updated 5th generation iPod touch (and all of its amazing features) is sold for just $299, which could very well be more expensive than a 7.8-inch iPad. Apple is positioning the iPod touch as that powerful guard, awake all night, preventing any Trojan horse from causing havoc.

Product Quality. It says a lot that throughout this entire discussion, the idea of Apple selling a small iPad with superior quality and craftsmanship is simply assumed to occur. Anything else would be a disappointment. High expectations can be both a blessing and curse.

Neil Cybart 12/19/10 Neil Cybart 12/19/10

iPhone Can Still Beat Android in Smartphone Market Share

On smartphone battlefields where iPhone hasn’t yet arrived, Android is winning the battle.

It is premature to declare Android the eventual winner in the smartphone market share race, even with Google now activating 300,000 Android units/day. Steve Jobs noted on Apple’s recent quarterly earnings call that there is "no solid data" on Android phone shipments. For this argument, let me assume Google is actually selling 300,000 Android units/day (27 million/quarter). Apple sold 14.1 million iPhones in the most recent quarter and is on track to sell 15-16 million iPhones/quarter.

How can iPhone outsell Android if these sales numbers are correct? Here are the reasons why I think iOS can still beat Android in terms of smartphone unit market share:

1) iPhone (4 and 3GS) is outselling Android (dozens of models) in markets where both iPhone and Android are competing face-to-face on the same carrier.

iPhone dominates European mobile ad market

Mobile OS usage; iOS #1 in North America, Europe, and Australia

When a customer has the choice between iPhone and Android, side by side, they are choosing iPhone.

(I recognize that these links rely on data that carries a number of disclaimers and is often based on some sort of survey, to which I say, show me clearer evidence. With Google, mobile carriers, and phone manufactures not releasing actual Android unit sales figures, what other type of evidence can be obtained on a regional basis? The only surveys and evidence that even try to depict OS mobile market share continuously point to iOS leading Android in regions where both are sold on the same carriers)

2) Verizon. Android has received a ton of attention and mind share due to its strong hold on Verizon’s 90 million customers. While a few million Verizon subscribers have jumped ship over the past three years to buy iPhone on AT&T, the majority haven’t due to high carrier switching costs, including termination fees, sticky family plans, and differing coverage areas.

Why are Verizon customers buying Android phones?

A) Coming from a feature phone, any Android phone will appear amazing. The ability to use the internet or check email on a touchscreen is truly amazing for someone coming from a basic phone.

B) Android phones are in front of Verizon customers. Most Verizon subscribers pick a phone from the selection that they see in a Verizon store or kiosk. If the only thing a customer sees is Android, chances are good that they will buy an Android phone.

C) Verizon customers have few options: stay with a feature phone, buy Android, or leave Verizon and buy iPhone on a network that doesn’t support phone calls due to their awful coverage and service. Which option would you choose?

In addition, with Sprint and T-Mobile not selling the iPhone, Android has the perfect incubator to flourish - a market of about 180 million subscribers with no access to iPhone (AT&T has 90 million subscribers).

3) Interesting Android developments in recent weeks have actually supported my thinking that iOS isn’t in as bad shape as some may say. For example, the Samsung Galaxy Tab has sold 1 million units in its first 28 days - nearly as fast as the iPad - pretty remarkable.

Although the Galaxy Tab is a tablet computer and not a smartphone, I think there is an interesting development to be seen from this data. The Galaxy Tab has done well thanks in part to its sales in South Korea, a country where android has 80% market share, a country where Samsung is a source of national pride. Reports indicate that approximately 50,000 - 70,000 Galaxy Tabs were sold in South Korea in the first 28 days (the Galaxy Tab went on sale in a total of 30 countries). What about iPad? In South Korea, the the iPad just went on sale three weeks ago and initial sales are already on par with Galaxy Tab and I imagine iPad sales will soon exceed the Galaxy Tab. The Galaxy Tab entered a market that was void of iPads, with people eagerly wanting to get their hands on iOS.

Google VP of Engineering Andy Rubin recently said, “After the US, (Android) saw Asia go crazy” with sales in South Korea going “berserk” in the past four months. Once again, it’s funny how Android is doing so well in South Korea. How about iPhone? Well, South Korea recently decided to allow iPhone sales in South Korea. So Android was doing great in South Korea, a country where iPhone was banned. A true battle is one where both sides are present.

China is another interesting story. China Unicom, China’s second largest mobile carrier with approximately 175 million customers, is the exclusive provider of iPhone in China. Last year, the iPhone unveiling was a disaster in China due to restrictions imposed on the device by the Chinese Government. In 2010, iPhone 4 is a complete success with over 200,000 pre-orders being taken for the device and curbs having to be put in place to control the buying frenzy in Apple stores. Overall though, Apple still has a small presence in China with only four retail stores and the largest mobile carrier, China Mobile and its 570 million customers, still not carrying the iPhone. A true battle is one where both sides are present.

My thesis will be validated, or disproven, by Verizon iPhone data in 2011 (and possibly by China Mobile carrying iPhone in 2011). If Verizon sells the same number of iPhones as AT&T (somewhere in the neighborhood of 10-15 million in the first year), my thesis will most likely hold true and iOS will be the top selling smartphone platform in the U.S.