Apple Watch: What Did Apple Just Roll out Here?
Reviewing an Apple Watch three days after launch in any traditional sense has as much long-term value as publishing an iPhone review on July 2, 2007 would have had. Instead, I am going to try a better approach. This post will be the start of what will become an ongoing series about my Apple Watch thoughts and observations with a focus on how the product will impact the world.
What is important?
What isn't important?
Financial implications.
Longer-term ideas and viewpoints.
I've already written a few words about Apple Watch, and I continue to think they provide a good foundation for beginning to analyze the device and wrist wearable product category.
The Apple Watch Journey Begins
42mm Apple Watch Sport with Solar watch face.
I am convinced Apple Watch is not a watch. Positioned as my personal assistant who just began on-the-job training, the Watch has potential. While it isn't quite able to monitor and guide me through the world, the product has a coolness level that makes me want to wear it all day and begin incorporating it into my lifestyle. From Apple's point of view, I suspect that is a best case scenario for a new product category.
I ordered a 42mm Apple Watch Sport with the white sports band. I knew almost instantly when the Apple Watch was introduced, back in September 2014, that I wanted that particular model. I am a long-distance runner so I knew a Watch collection named "Sport" would be up my alley. In addition, I've owned and worn a regular watch for years, so I wanted something that did not remind me of a regular watch.
UPS Delivery and Extensive Packaging
My Apple Watch experience started off with a memorable exchange this past Friday:
UPS delivery man [holding a "heavy" Apple Watch box at my door]: "What did Apple just roll out here?"
Me: "Apple Watch. You have a lot of these boxes?"
UPS delivery man: "Oh yeah. Couldn't figure out what it was."
I vividly recall the first time I first held iPhone and iPad. For iPhone, it was at an Apple store following a nightmarish visit to an AT&T store the day prior. For iPad, it was after picking up the device at the local shipping depot because I missed the delivery earlier in the day. I've always felt that the first time one sees and holds a product is quite telling as it can be used to judge not just the connection to a product, but also brand and company. There are companies besides Apple that have a similar ability to create such emotional connections, but it's rare for a company to mean so much to so many people.
Extensive packaging for Apple Watch Sport.
As part of that introduction, the packaging that a product comes in plays a crucial role as the experience begins at delivery or purchase. I've always been intrigued by Apple packaging because of the time and effort put into something that will never look as perfect as when it is first opened. The Apple Watch Sport packaging is no different. Weighing in at a pound, the box had a noticeable and substantial weight to it. I would go so far as to say Apple Watch packaging was the most extensive, and thought-provoking, I have seen out of any Apple product in a very long time. No wonder the UPS delivery man mentioned how heavy the Watch box felt. Most of the weight is due to the white elongated case that Apple Watch comes in. I'm still not quite sure what to make of it; is it a carrying case or a cradle for my Watch while charging? The one I have is a less fancy version of the Watch collection case and a very distant cousin of the Edition case. However, even this case represented a faint connection or similarity that Apple relied on between Watch and traditional watches. Only watch wearers would be able to discern the familiarity.
The Apple Watch came with a number of instructions, such as how to put the watch band on one's wrist, which I thought symbolized how people have tuned out modern-day watches to the point of not even knowing how to put one on.
The overall Apple Watch setup and pairing process with my iPhone will be fine for anyone comfortable using an iPhone. I did not encounter any issues. For those with a bit more hesitation, I think Apple holding special Apple Watch introduction sessions at Apple Retail locations is a smart move as it may be a bit overwhelming.
The Watch Band
One trend that has taken place over the past few weeks is the Watch bands getting the most attention out of the entire Watch discussion. The interesting aspect of that is the band has very little to do with technology. I don't think that is by mistake. Of course, the bands are indeed a byproduct of manufacturing technology and innovation, but for the average consumer, the Watch bands are about fashion and personalization.
Apple hit a home run with this initial sports band. It looks and feels great. Even putting the Watch on extra tight to see if there was any impact to my wrist's circulation, I was unable to have it leave any marks. I suspect the way the band connects to the Watch case, leaving a small amount of space between the case and skin on each side, is the primary reason I have a hard time having the band leave any marks. The slight protrusion at the bottom of the Watch where the heart rate monitor is allows me to enjoy the feeling of a nice tight band on my wrist without most of the negatives, such as perspiration, usually associated with such a thing. I can wave my arms and the watch will not move, which produces a certain kind of calm and relaxation. Even during a run, the Watch band performed well with no discernible markings while my previous running watch band would indeed leave marks because I had to wear it tightly in order to have it remain in place. I suspect the rubber band will change shape somewhat as time goes on, but with a small/medium band piece also included in the box, I am not concerned about the band becoming more loose as time goes on.
One interesting thing is that when I look at myself in a mirror with the Watch, the aluminum case melts away, and it looks like I have a white band with a black piece in the front of my wrist. It is hard to see that I have a watch case connected to a band. They just look like one piece. I suspect this is the primary reason why the Apple Watch doesn't look quite like a smartwatch even though it is a rectangular piece of glass attached to a watch strap. I have definitely become more doubtful in recent days that circular smartwatch faces are anything but a calculated bet to grab sales from traditional watch owners that are familiar with a watch's circular look.
Watch Faces and Notifications
I have long thought that the wrist is an interesting place for technology, breaking down some of the more complex tasks found in an iPhone to easier to digest bits of information. That doesn't mean that we take iPhone apps and shrink them down, keeping the same thought and design process, but applying it to a watch. Everything needs to be rethought. I've downloaded a few third-party Watch apps (or should I say extensions of iPhone apps?) and there really isn't much to write about. While some are adequate, I just couldn't find any that really got my imagination running. However, after only 12 hours of use, a few value-add uses for the Watch became apparent.
One thing I am discovering is I really don't want to look at my watch screen too much. I could very well go a full evening at home with barely looking at Apple Watch. I don't look at that as a negative. While things can (and certainly will) change, I have no desire to sit on the couch and play with my watch while my iPhone is somewhere else in the house. Instead, I am finding myself wanting to feel notifications, or at the very least just turn my wrist periodically and look at the watch screen and see what I need to know quickly. The information can be as trivial as time or temperature.
The Watch has two very valuable ways of displaying or giving information.
Watch faces
Notifications
Turning my wrist and being able to see my selected Watch face automatically means that the ability to customize Watch faces to put specific information on that initial screen would be an incredible value proposition. It is no surprise that third-party app developers (as well as Apple) sense the untapped opportunity. The iPhone home screen displays nothing until the home button is pressed, and even then initially just time, data, and the slide to unlock button are displayed. In contrast, the Watch face provides much more valuable information without the need to do anything besides look at the Watch. I could also open an app on Watch and it will remain displayed on the watch screen (like a running app), however the hierarchy is still built around Watch faces.
Modular, Solar, and Utility Apple Watch faces.
In addition, the tapping and sounds from notifications, followed by a prominent position on the Watch as someone goes to check the notification by looking at their watch, represent additional valuable attention and location for information. While Glances are indeed easy to reach with just one swipe up from the Watch Face, the sheer number of them may limit their value a bit. I consider the Glances to be equivalent to apps on an iPhone home screen: easy to reach, but still one among a few.
Apple Watch Use Cases
Apple is aware of this type of attention hierarchy and will act accordingly by, I suspect, retaining much of the power around Watch faces for the foreseeable future because it impacts the user's experience to such a degree. But the implications of this hierarchy are indeed interesting for what the Watch can be used for.
The Apple Watch will excel at:
Recording aspects of my behavior/movement and then providing feedback. Track miles run, sending me taps after each mile, or monitoring health vitals and then creating recommendations.
Real-world notifications. Notify via tap or sound that a shower or thunderstorm will be at my current location in ten minutes.
Identification. Use Apple Watch to enter my office and home, unlock a car, as well as contain information that is inaccessible when Watch is removed from the wrist.
While there are other devices, including the iPhone, that can do most of these tasks, it is the ability to have it on the wrist in a more ergonomic fashion, void of additional distraction, that makes things interesting. In addition, the aspects of maintaining identity once the Watch is attached to my body is, in a weird way, incredibly refreshing and reassuring.
A few hours after my Apple Watch arrived via UPS, I took it out on a seven-mile run. I don't take my iPhone on runs or any physical exercise that involves motion, so I was going to just use the Watch as a timer, knowing it didn't have its own GPS. Around eight minutes into my run, I received a slight tap on the wrist, I lifted my wrist up, and it said I had ran one mile. Having run this same route for years, I knew it was spot-on. Throughout my run I was getting accurate mile readings. How is this possible when the watch doesn't have GPS? Apple had previously asked me a few questions during the Fitness app set-up including my height, weight, and age. In addition, since I have been running for years, I have a pretty consistent stride. I suspect that consistency is what gave the Watch the ability to measure my stride to produce mileage and be so accurate without any iPhone calibration.
The ability for the watch to give me information (mile readings) without needing to look at it (taps) was incredibly valuable to me and my needs as a runner, especially with not having to carry a bulky iPhone. I actually found myself every so often lifting my wrist up to see other metrics such as my mileage pace. The Watch is essentially taking elements that I used to rely on a few devices for and combining them into a device where fitness and health is just one feature. This is why there is something more behind Apple Watch.
Early Signs of Behavioral Pattern Change
While it is early to reach any conclusions about long-term behavioral change, I have noticed that I have an urge to see why my Watch is tapping me or making a noise. I had very few vibration and sound alerts for my iPhone, so it may just be a realization that allowing some kind of notification through the filters could prove to be valuable. In addition, I have this weird urge to keep the watch on regardless of what I am doing once I put it on each morning. If I am washing my hands or am wrist deep in food preparation, I don't think twice about keeping my Watch on. It's not so much an annoyance to take it off that is the primary culprit, but I am starting to sense a little bit of connectivity as I am wanting to not miss something. Having it be so comfortable helps in this regard.
Apple Watch Is Definitely Not a Watch
There is no question in my mind that the Apple Watch is not a watch. The way I use the device is nothing like the way I would use a watch. While Apple is undoubtedly taking certain elements of the watch world to sell Apple Watch, much of that is merely due to providing some level of comfort and recognition to avoid consumer backlash and risk aversion. It is much easier to position the Watch as a better watch than an ancillary iPhone screen. The Watch is something different.
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Apple 2Q15 Earnings Preview: Another Strong Quarter Driven by iPhone in China
Apple will likely report a 2Q15 beat to consensus EPS of $2.14 this coming Monday on strong revenue growth (up 24% from last year) and margin trends (41.0% vs. 39.3% last year). The iPhone will be the primary focus as investors look for any indication of continued above average sales trends compared to previous iPhone cycles. While recent iPhone sales share in the U.S. and Europe appear slightly ahead of previous years, strong sales in China will be the primary driver behind 35% growth in iPhone unit sales. In addition to earnings, Apple is expected to announce an updated capital return program. The Mac and iPad are becoming less of a factor for earnings as those two product categories now represent a smaller percentage of Apple's overall business. It will be difficult to get Apple Watch sales expectations from guidance, but management may give commentary on how the Watch launch is proceeding. Similar to last quarter, the impact from a strong dollar will be reflected in management's revenue and margin guidance for 3Q15.
iPhone: The Big Story for the Foreseeable Future
Representing close to 70% of Apple's quarterly revenue and 80% of gross profit, the iPhone will likely remain the primary focus for Apple investors until new Apple products gain enough momentum to account for a bigger piece of the financial pie. While there is nothing inherently wrong with this situation, it does serve as a reminder that the iPad and Mac are becoming less of a factor on earnings day. The following exhibits highlight the changing revenue and gross profit mix over the past two years as the iPhone's share has grown, while iPad and Mac share have declined.
Exhibit 1: Apple's Shifting Revenue Mix (2Q13 vs. 2Q15)
Exhibit 2: Apple's Shifting Gross Profit Mix (2Q13 vs. 2Q15)
I estimate Apple sold 60 million iPhones last quarter, which would represent 37% growth from last year. On last quarter's earnings call, management noted that global iPhone supply/demand remained out of balance for most of January. Accordingly, I am assuming Apple sold as many units as it was able to produce for one-third of the quarter (24 million units in January). Once supply/demand was in equilibrium in February, I am running with a 20-25% reduction in shipments (19 million units in February and 17 million in March). Apple will need to ship millions of iPhones just to get channel inventory into an acceptable range, but management noted this will be done over time. As shown in Exhibit 3, I would consider iPhone sales between 57 million and 63 million to be relatively in-line with my estimate and not causing much change to my forward iPhone estimates.
Exhibit 3: iPhone Unit Sales Expectation Meter (2Q15)
Capital Return Program Revision Expectations
The board is expected to announce an increase to the quarterly cash dividend and additional authorization for the share buyback program. Last month, I went into detail on prospects for both the quarterly cash dividend increase and share repurchase program. I expect the quarterly cash dividend to be increased approximately 8% to $0.50/share to $0.51/share. The share buyback authorization will likely be increased $35 to $45 billion, bringing total authorization to $125 to $135 billion. It will be important to watch for any change in commentary and tone regarding the capital return program, especially as Apple is currently near the maximum buyback pace that it can sustain given its U.S. free cash flow and debt issuances. Consensus already expects a pretty significant change to the buyback ($30-$40 billion increase), so it may take an increase of more than $40 billion to move the stock specifically related to the buyback news.
Guidance
I currently have $47 billion of revenue estimated for 3Q15. A revenue guidance range of $43-$46 billion would suggest that my estimates are on track. Apple's guidance will include Apple Watch revenue, although the data will be lumped in with the "Other Products" category. I still think it will be possible to arrive at some conclusions as to how many watches Apple sold since the Watch will make up a good portion of "Other Products". While it remains very difficult to judge Watch supply over the next two months (3Q15), I would expect the Watch to contribute around $2 billion of revenue from April 24th to the end of the quarter in June.
iPad and Mac: No Significant Changes
As discussed by management, there won't be much change to continued weak iPad sales momentum. The entire tablet category is facing increased competition from larger smartphones. The iPhone 6 and 6 Plus, in addition to a strong MacBook line-up, continues to pressure iPad sales. I expect iPad unit sales to decline 22% to 12.8 million, which would track close to the decline seen last quarter (18%). iPad channel inventory was already at sufficient levels coming into 2Q15. The iPad is still in the process of finding its normal sales run-rate, but that level may still be quite a bit lower than current sales levels. For perspective, the iPad is outselling the Mac by nearly three-to-one.
Exhibit 4: iPad Unit Sales Expectation Meter (2Q15)
Mac sales will likely continue to follow the 10-20% growth experienced over the past five quarters as the current product mix resonates with consumers that want a more powerful machine compared to the iPad Air or iPhone 6/6 Plus.
Exhibit 5: Mac Unit Sales Expectation Meter (2Q15)
Other Thoughts
Given the current point in the iPhone cycle, it's fair to assume the average selling price will decline a bit (to around $650 from $687), but some of this decline should be offset by an increase in profit margins. Apple's guidance will reflect the impact from the stronger dollar, but with trends stabilizing in recent weeks, management may be able to get a better handle on foreign currency trends.
Similar to last quarter, all eyes will be on iPhone on Monday. For every one million iPhones sold, Apple EPS is impacted by $0.04/share. The difference between 55M and 60M iPhone unit sales explains most of the Street's EPS estimate variation. It looks increasingly likely that China will once again prove to be the quarter's primary revenue driver.
This report was produced by Neil Cybart on April 22, 2015 and is not meant to be used as investment advice.
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Betting Big on the Camera
The camera's primary role has changed from capturing memories to becoming a full-fledged communication tool. Apple's recent $20 million acquisition of LinX serves as a reminder that the camera is positioned to be not only one of the most important smartphone components, but also a tool that will play a major role in how technology impacts society. Instead of betting on mobile platforms, a bet on the camera will likely pay more consistent dividends.
The Camera's Expanding Job Title
The camera's original use case was straightforward: capture memories. Moments in time ranging from a birthday party, graduation, or wedding were chronicled in order to tell a story in the future. Discretion was taken as to what subject or event should be captured as both film and the process of getting film developed were expensive. A week-long trip abroad would likely result in a splurge of maybe eight or nine rolls of film and a total of 200-300 pictures, of which a handful ended up being worth including in a photo album.
Everything changed in 2010 when Instagram was able to successfully position the photograph as a communication medium in the mobile era. Up to that point, phone cameras had been underwhelming with many people needing to carry both a phone and camera. In 2010, the world had just been introduced to the iPhone 4 and Android smartphones were starting to take off. In other words, it was the right time for something like Instagram to start pushing the camera beyond just memory capture.
Instagram's popularity was based on taking photographs with mediocre image quality and turning them into something cool by often making them look even older and grainier by applying fun filters. Users were then able to share their creations with others. In a world dominated by text-based Facebook and Twitter, Instagram represented a refreshing alternative.
Instead of using our smartphone camera just to capture momentous occasions in life, we began to use them to capture everything from the breakfasts we ate, to the magazines and books that we read. The camera was turning into another pair of eyes, and an internet connection allowed others to see the world through those eyes.
The camera's changing role wasn't confined to just software companies. With an initial mission to take photographs while surfing, GoPro was started as a way of have point-and-shoot cameras handle extreme environments. GoPro eventually experienced the same advancements in camera technology and social trends benefitting Instagram, where the camera was turning into a way of sharing unique vantage points and not just memory capture. The camera's expanded job title turned GoPro from a niche camera company into a $6 billion hardware and content company with even bigger plans of becoming a media powerhouse.
Apple and the iPhone Camera
We now find ourselves in a world where cameras are becoming ever more capable in a smaller footprint. Apple's LinX acquisition is all about multi-aperture cameras, suggesting the desire to fit more power in a smaller form factor using sensors and software to capture multiple images simultaneously. The result is better quality, and more importantly, depth and three-dimensional capabilities.
We have reached the point where the camera found in one's smartphone is likely to be the best camera they have ever owned. As Apple continues to push the boundaries on iPhone innovation, the camera will be positioned as one of the likely components that will not only drive iPhone upgrades, but expand the iPhone's use case. While the camera has been used by third-party developers to accomplish various tasks such as scanning barcodes in stores or using augmented reality to display travel directions or public transit, Apple's primary near-term goal will be to improve the camera's ability to take photos and video in various settings to foster an even greater reliance on non-text communication.
Cameras in the Future
Three primary use cases demonstrate how the camera will continue to change the world.
Memory Organization. While we will still use cameras to capture important moments in our lives, much of the focus will be on the software required to navigate the thousands of pictures found on our smartphones, likely taking up precious phone storage if we haven't signed up for a photo cloud service. New capabilities to catalog photographs as they are taken and then search through old digital photographs will serve as features deserving of a keynote slide or two. I suspect Apple and other software companies would be able to contribute much in this area in the coming years, assuming they give the topic enough attention and resources. One issue is that memory capture is simply unable to grab the hearts and minds like it once did. This area will not entice the high valuations from venture capitalists as memory capture has more of a connection to yesterday than the future. While we will still have start-ups trying to fill the niche, the camera's bright future isn't built around simply capturing memories.
Communication. The camera's new functionality as a communication tool is impacting billions of lives, drawing a great deal of attention from investors and users. It is all too obvious by Snapchat's success and the modern-day mobile video boom including Periscope, Meerkat, Facebook, YouTube, Twitter, and various messaging platforms, that the world has moved beyond text to tell stories. Photographs and video are occupying a larger role in our daily lives which by its very nature reduces the desire to hold on to so many reminders of relative mundane aspects of our day, summing up Snapchat's appeal.
Interpretation. While there is still plenty of innovation left with how we use cameras to communicate with others, the camera's most exciting role will be utilizing software to help us interact with and navigate the world. The camera will become an input device for software to interpret clues in various settings at home, the office, or school. The camera essentially becomes a pair of intelligent eyes that goes beyond simple image capture.
The camera's changing role has brought up important discussions concerning how technology impacts humanity. With some companies selling the idea to film one's entire day by wearing cameras on the face or body, questions around privacy and morality will need to be addressed. At what point does obtrusive technology do more harm than good?
The camera discussion has usually been about Kodak, and other camera companies from yesterday, missing the mobile bandwagon. We have now moved to a point where such a story is no longer relevant. The software that turned cameras into critical pieces of communication would have never have been created by traditional camera makers. The camera's potential was unleashed by mobile as smartphones were primarily cameras with a mobile connection. The camera's ability to not only capture the world around us, but begin interpreting that world, suggests the camera's impact on society is still being underestimated. There's still time to place a big bet that the camera will play a much bigger role in our lives in the future.
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Apple's Watch Strategy Embraces the 80-20 Rule
We are starting to get early reads on how Apple Watch pre-order mix is trending and there are a number of surprises. It is obvious why Apple will not disclose Apple Watch revenue data. By knowing which Watch collections are selling and at what price, it would be easier for competitors to reach conclusions on customer preferences. Using early pre-orders reports and a few long-standing theories, the Apple Watch will likely be loosely guided by the premise behind the 80-20 rule, where approximately 80% of Apple Watch profits will come from 20% of Apple Watch customers. In essence, the Apple Watch and Edition collections will likely account for a small portion of sales, yet play a much bigger role in terms of Apple Watch profit. The implications are significant when contemplating how management will treat the Apple Watch line in subsequent years.
Sport is the Most Popular Collection by a Wide Margin
The two most popular Watch models have been space gray aluminum with black sport band and silver aluminum with white sport band. Using U.S. pre-order data from Slice, and extrapolating across the world, these two models could represent close to 70% of Apple Watch pre-orders. There will be millions of wrists with a black or white sports band in the coming months. The sheer popularity of these two models suggest there may be something more at play, possibly related to customers not wanting to spend more than $400 and these particular options representing the most popular color choices.
Majority of People Are Not Valuing Stainless Steel and Sapphire Screen for $200
Most consumers are not valuing the stainless steel case and sapphire crystal screen at an additional $200. The easiest way to see this is compare the black and white sport band models in the Sport and Watch collections, with the only difference being the watch face (sapphire vs. Ion-X glass) and watch case (stainless steel vs. aluminum). When given the choice between a $399 Apple Watch Sport - black band and $599 Apple Watch - black band, pre-order data would suggest customers are overwhelmingly choosing the Sport by a magnitude of 5-10x.
This isn't to suggest that sapphire and stainless steel aren't worth the extra $200, but rather consumers are not reaching that conclusion. Apple Watch try-on appointments may give consumers the best opportunity to make a more informed decision between the two collections, resulting in a slight shift in sales trends.
One theory is that many consumers pre-ordered the Sport for the first version and plan on upgrading to a better watch in 2016 or 2017. This may be true, but the impact may be overshadowed by new Apple Watch buyers deciding to go with the Sport. In essence, the sales mix will likely remain the same, regardless of first-generation owners upgrading their watches over time.
Demand for Expensive Watch Bands is Niche
Even though much attention has been given to the higher-quality watch bands, it would appear that the majority of people are opting for the sports bands. At least judging by pre-order data from Slice, there is tepid demand for higher-end watch bands made of metal and leather. The Milanese Loop would appear to be the best selling watch band out of the non-Sport options, which may give Apple confidence that consumers will value band innovation that moves away from traditional watch bands. The leather band options will likely remain quite niche. My Apple Watch observations would back these claims as I actually thought the sport bands were more comfortable and bold than some of the leather bands.
Financial Impact from Watch Bands
The conventional wisdom is that Watch bands will play a crucial role in Watch financials. I think it will be a bit more complicated.
- One can make a strong case that customers will update their Apple Watches every 2-3 years. In this scenario, the Apple Watch will experience an update cycle that mirrors the iPhone more than iPad. Since each purchase will come with a new band, consumers may not see the need to spend money buying another watch band. Watch average selling price (ASP) and revenue will be driven more by case upgrades ($399+), not additional bands.
- With most people opting for the Sport over Watch, I have difficulty envisioning the majority of customers buying expensive additional watch bands. Instead, there may be demand for cheap, but fun, third-party bands ($29-$49). While such bands may have attractive margins, from a dollar perspective, Watch cases will still account for a majority of the Watch category's profit.
- I suspect 10-20% of Apple Watch owners may be willing to buy an additional high-quality watch band. This is the part of the market where watch bands may become an attractive revenue and margin proposition. Apple will likely want to compete in this lucrative segment of the market, which may include traditional luxury brands.
The 80/20 Rule
The Apple Watch is being sold as the most personal device with 25 distinct styles, yet four options (all with black or white sports bands) comprised a clear majority of pre-orders in the U.S. on the first day according to Slice. On the surface, that would suggest the other models aren't important and Apple should just concentrate on the sports bands. However, in reality, the exact opposite is true. When looking at profits, I suspect the 20% of customers opting for the Watch and Edition collections will likely represent 70-80% of Apple Watch profits. A few equations will help demonstrate what is happening:
- Revenue: One $17,000 Apple Watch Edition = 42 $400 Apple Watch Sport
- Profit: One $17,000 Apple Watch Edition = 75 $400 Apple Watch Sports
Karl Lagerfeld's custom Apple Watch with gold link bracelet. Source: Instagram
The implications from this are far-reaching. Apple will likely dedicate significant attention and resources to updating higher-end Apple Watch models and bands. Rumors had indicated a platinum option priced higher than the current gold Edition models. Karl Lagerfeld's custom Apple Watch with gold link bracelet will likely be available one day for more than $50,000. Marc Newson's schooling and experience with jewelry design will likely play a major role in this effort. In essence, Apple would be catering to the 20% of the iOS customer base that values exclusive personalization, which will boost revenues and margin.
Longer-Term Watch Implications
As long as the Watch is considered an iPhone accessory, I'm not convinced the majority of people are willing to spend more than $500 for one, which will position the Sport collection as the most popular option by a good margin. Meanwhile, the Watch and Edition collections will continue to represent approximately 20-25% of sales, but account for a clear majority of profits, and this ratio may even become more pronounced as Apple introduces additional high-quality bands with higher margins.
Apple is now a premium mass market luxury brand. The Apple Watch Sport is positioned for mass market consumption, reflected by the lowest entry-level price of any new Apple product category. Meanwhile, the Watch, and especially the Edition, are produced with luxury in mind, catering to the 20% of Apple consumers that have been craving personalization. Apple's Watch strategy will cater to both types of consumers, balancing well-crafted, yet practical mass-market items where price matters, and extravagant opulence where price doesn't factor into the purchasing decision. Welcome to the wearable market.
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Apple Watch is Cool, Just like iPhone
After spending time with Apple Watch, it became abundantly clear why people will like the device: it's new and cool. A device that can fit into one's life, but still seemingly blend away when not in use, shares many similarities to the iPhone. While coolness may not be enough to use as the conclusion of a 5,000-word product review, and it certainly won't cause the general public to run out to an Apple store and spend $400+ on a watch, it will lead to imagination. Apple Watch's long-term success will depend on the people pre-ordering the device today; the trailblazers who view the Watch's potential with the same eye that saw iPhone's potential in its early years.
Apple Watch's coolness transcends the much more complex and important topic of technology. The Apple Watch needs to become a better device. While this may sound like a stern warning, it is a necessity that simply describes the path of technology, exemplified by the iPhone over the past eight years. Not only did the iPhone become thinner and lighter over the years, but the fundamental way we used the device changed, thanks in part to more powerful components and third-party developers. From a device used to access the internet when we were away from our computer, the iPhone is now our computer.
The same process will occur with Apple Watch. Today, the Apple Watch is a cool device that can show the time when we look at our wrist, track how many steps we walk each day, and send tap messages to friends. As the device gains additional sensors, better battery technology, and revolutionary materials and components, the use cases will expand as developers utilize the device's potential.
Apple Watch will use coolness to sell itself until people find that utility. As developers understand what the Watch is, and more importantly isn't, apps will improve, taking information once destined for the iPhone and repackaging it for the wrist. In many ways this is what early adopters do, buy things that they think are cool and interesting and then spend time tinkering and thinking. Saying a product is for early adopters isn't an insult, even though many have equated the two in recent years.
Watching people of all ages try on and interact with the Apple Watch, the impression I got was that most saw it as an interesting watch. That is to be expected considering the wrist was ruled by the watch for decades and anything destined for the same spot on our bodies will likely be initially compared to a watch. This is one reason why I heard a few complaints about the screen turning off when not pointed at the wearer, or having to charge it each night. Regular watches don't have those "tradeoffs". The same was said about iPhone "drawbacks" such as not having a keyboard and needing to charge it more frequently compared to feature phones. Even though the iPhone was introduced as the best smartphone in the market, in many ways it made for a suboptimal phone. Over time, our demands for a phone changed. The same will occur with what we consider to be Apple Watch negatives, and ultimately, what we want out of a watch.
The bet that Apple is making with Apple Watch is that in an environment of smart glasses, virtual and augmented reality goggles, and other wearable devices, it is the wrist that has a long runway with an immense level of untapped innovation, and more importantly, void of many roadblocks to reach that innovation. Apple knew that consumers wanted to wear and play with something that looked cool, while every other smartwatch maker was too concerned about first answering the utility question. Why else are Apple Watch bands, which have little functionality besides being a fashion accessory, the most talked about Apple Watch feature?
The Apple Watch represents potential. I suspect that is one reason why Apple executives can't hold back a smile whenever Apple Watch comes up in conversation. With an iPhone, although there is still plenty of innovation left, exemplified by Apple's recent $20 million acquisition of LinX, people now understand the iPhone is a computer. The level of excitement or surprise will never be the way it used to be. We now demand our iPhone to take over the world. The Apple Watch possesses similar traits to when we first saw the iPhone. There isn't just a level of excitement around the device, but also intrigue and mystery. We don't know what will happen to Apple Watch in a few years. We are told Apple Watch will never work on its own. We are told it will always be an iPhone accessory and companion. People are buying it today because subconsciously they want to see if those statements are true. We want to know if the Apple Watch is the future. Just like the iPhone, a very good case can be made that the answer is yes and it starts with being cool.
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My Apple Watch Try-On Experience
For the past seven months we have been told how the Apple Watch is the most personal device Apple has ever created. This past Friday, the general public had its first chance to find out what Apple meant as Apple Watch try-on appointments were rolled out. I selected one of the first time slots at my local Apple store as in many ways I was more interested in the way Apple had set up these try-on appointments than actually trying out the device. Needless to say, I ended up learning quite a bit.
While I have some constructive criticism and suggestions, I found the entire try-on process enjoyable. Despite following the Apple Watch beat for the past seven months, I still found there to be surprises. I can only imagine how someone not familiar with Apple Watch would likely feel overwhelmed by this new gadget for the wrist.
Going into the try-on I thought the Apple Watch Sport will be the most popular model, possibly by a pretty wide margin, and the black and white sports bands will be the most popular bands by a significant number. That view was only reinforced after trying on all of the different options.
No Lines and Limited Try-On Models
Despite Apple encouraging customers to make an appointment to try on the Apple Watch, I ended up simply walking in and getting taken care of as there were open try-on slots available. The store had been open for an hour, but things still seemed pretty quiet. While my specialist was friendly, helpful, and approachable, there was little in the way of agenda or questioning. "Which would you like to see?" was the first, and basically the only question asked of me during my appointment. Fortunately, I was already well aware of each band choice. Unfortunately, the store only had one size of each available watch band, often with the smaller 38mm case, which I found odd. I asked one of the workers why so many models were missing, and he said that was all they had received. Strange, but honest answer.
Tough Choice Between 38mm and 42mm Watch Case
A 38mm Apple Watch on the left compared to a 42mm Apple Watch on the right. It was a close call between which one looked more appropriate on my 140mm wrist.
I came into Friday with the assumption that the 38mm Watch case was being sold just to push the 42mm version, with few people actually opting for the 38mm. After Friday, I actually think the 38mm is indeed the right size for a certain percentage of the buying population. Recent data from Slice would seem to support that view, with their analysis pointing to approximately 30% of pre-orders in the U.S. going with the 38mm. The Apple specialist even said the 38mm looked better on my 140mm wrist, although I responded I wanted the extra screen real estate that came with the 42mm. It honestly was a close call between the two, as seen in the attached image.
The Watch collection stainless steel cases certainly had the finish of a higher quality product compared to the Sport collection, but I actually didn't look at the aluminum Sport as cheap or a toy compared to its more expensive counterpart. Instead, I think Apple was successful in having the Sport give off a more active vibe. I'm not sure I would feel as comfortable running with a stainless steel Watch.
Sports and Leather Watch Bands Were Most Comfortable
In what I just label as first-time jitters, I had quite a bit of trouble putting on nearly every watch band, especially the Sport. I didn't come away with any lasting concerns from this, but rather just thought it was interesting.
The bands are truly all about personal preference. I enjoyed the fluoroelastomer (sports band) followed by the stone leather loop. I found both to be the most comfortable on the wrist and the easiest to forget I was wearing a watch. The Milanese loop and link bracelet definitely had a more solid feel to them, reminding me of a regular men's watch, something I actually was trying to avoid with Apple Watch. The modern buckle didn't stand out to me as something I would be interested in wearing. With fitness and exercise in mind, I would have little interest in wearing anything other than the sports band. I wouldn't label any of the bands as inferior, so I think Apple succeeded with this first round of watch bands. I would be interested to see where things go from here concerning the bands.
Random Trying-On Musings
Apple Watch try-on station, showing Apple Watch supply issues and the official Apple Watch rag.
Not following any agenda, I continued trying on every watch model that they had in stock, often wearing two at a time for comparsion. All the while, the specialist was super careful to not have any of the watches fall on the ground. I had to keep my wrist above the counter, especially when I was taking a watch on and off. My only thought was that Apple must be very nervous about tight supply as the store was probably told to make these first demo units last. The other noticeable activity was the near-constant wiping down of both Apple Watch try-on units and the Apple Watch display table that had a large piece of glass covering all of the Apple Watch models. There is something off-putting with seeing someone clean something you just had on your wrist right in front of you.
The Apple Watch security guard was also hard to ignore, making sure that no one ran off with a non-functional $399 Apple Watch Sport.
Apple Watch Demo Unit
After I ended my try-on session by declaring "I guess I tried every watch you have here," I preceded to use one of the Apple Watch demo units on the other side of the store. I was able to quickly observe what some had said was a interface that took some getting used to, but over the span of 15-20 minutes that awkwardness went away. To be completely honest, I am a bit disappointed that so many early reviewers from the Watch keynote demo made such a big deal out of this issue. I think it was blown way out of proportion.
The only thing that I needed help with was changing the utility watch face to solar. After being shown that a Force Touch was the answer, I then spent the next 15 minutes engulfed in the various watch face options. I actually found this feature to be the most interesting. There really is something mesmerizing about the various watch faces including the motion options.
As a sign of how ingrained my iPhone and iPad usage is, I gravitated towards using my finger on the Watch screen instead of the Digital Crown. While some of that may be due to the fact that the watch wasn't on my wrist, I was thinking that the Digital Crown was more of a required feature in order to use the watch, instead it would appear to just be one way of gaining more precision.
I found all of the demo apps worked flawlessly with no noticeable lag or hiccups. After 45 minutes of trying the demo Apple Watch, I noticed the store was getting more crowded and the available demo units were dwindling, so I moved over to play with the new MacBook.
Remaining Nimble
The thing that struck me the most during my try-on was that Apple was doing something completely new (selling a wearable product) with the same retail strategy that Apple Store has come to be known for. Instead of renovating each store or creating a special Apple Watch area with a new layout, Apple stuck with the well-known large rectangular wooden table scheme. This process even extended to Apple's store-in-a-stores in Tokyo, London, and Paris.
Apple Watch display table on left with try-on and demo table on the right. Additional try-on and demo spots were located alongside each wall.
The Apple Watch area in the store I visited comprised a demo/try-on station table, an adjacent Watch display table, and then additional try-on stations on one wall and demos on the opposite wall. In total there were eight try-on stations and eight demo stations. Considering this was one of the smaller stores in Apple's retail footprint, I would imagine bigger stores had multiple times the number of demo stations.
Ultimately, I view the effort to remain nimble as the guiding principle behind the Apple Watch try-on process. Apple had given us clues not to expect anything too dramatic with the way the stores would look with Apple Watch as Apple's recent financial filings indicated there wouldn't be many store renovations and we got a look at Jony's new Watch display table at Colette in Paris this past September, looking very similar to the now iconic wooden tables but with a cut out in the middle covered by glass.
I noticed that most of the Apple store employees were still somewhat in awe of the Watch display table, so I asked when it arrived. Just a little while ago was the answer. It is important to keep in mind that all of this Apple Watch try-on sales process was installed in nearly 400 Apple stores overnight, or in some cases that morning. I wonder if this gives us clues as to how Apple will sell new products in the future, relying on the same wooden table theme.
Would I Change Anything?
Having gone through the try-on process, I asked myself if there was anything I would have changed. Surely, each step was created by Apple's retail and marketing teams (not to mention Jony and his team), so I spent some time figuring out the pros and cons of the major decisions that went into the process.
The Apple Watch demo unit.
Apple is accomplishing two goals with these Apple Watch try-ons: having people test the various watch models and then being able to interact with a working Apple Watch. Apple chose to split these two goals, which I suspect is more related to practicality and timing. It would be hard to have people not only try various watch bands on, but also play with the device on their wrist. For example, I spent 15 minutes trying on various watch bands, but then 45 minutes playing with the demo unit. With the current layout, customers can also play with a demo unit while waiting for a try-on appointment, which is an added benefit of splitting the two. I really didn't have a problem with interacting with the watch on a table versus on my wrist. Having demo units on a table also made it easier for an Apple Store employee to help with any questions that I had about the Watch interface or an app, in addition to having more than one person look at the same watch demo unit.
As for the actual trying-on process, there are two fundamental preference tests: watch case sizes and watch bands.
- I would have liked to see a more formal process with answering which watch case (38 mm or 42mm) was a better fit for me. A few people on Twitter told me there is indeed a way to tell what is right or wrong for watch sizing. The specialist did comment on what he thought looked better on me after I showed a bit of confusion, but I was still left a bit unsure. While this comes down to personal preference, I would have liked a bit more help.
- As for the bands, I would have preferred a set up where I know more about the watch bands. Simply going up to a demo unit and being asked which band I wanted to see isn't going to work for most people. I was well aware of the watch going into the process, having memorized all of the models. I would suspect most consumers wouldn't know the first thing about the band options. While much of this process could be discussed by the specialist instead of having printed material or a display, I think there was room to explain the bands a bit more.
I suspect the whole concept of having the specialist stand next to me instead of across from me over a watch case like in every other retailer was a byproduct of Apple trying to make the try-on fit in with the current store layout. For the Edition, a conference room was used for demos in some cases while other stores simply relied on a quiet back corner, which doesn't exactly sound as an ideal option for a "luxury" experience. While having a "watch bar" with chairs and a team of Apple Store employees behind the bar sounds interesting, I think it all goes back to Apple simply being unable to incorporate such change into the current footprint without a lot of additional work. I also am not sure if a "watch bar" would make it easier to assist customers with putting on various watch bands.
Ultimately, I think Apple did a great job with my try-on appointment. While going through the process early Friday morning revealed some early jitters on the part of the Apple Store specialists, backed up by others who told me they were repeatedly given incorrect information about the watch, I thought the overall process worked fine.
Takeaways
Over the next two weeks, Apple will be in a position to give hundreds of thousands of consumers the chance to try Apple Watch. It cannot be overstated how important these try-on appointments are for Apple Watch's success. They give Apple a competitive advantage against others that will undoubtedly enter the wearable space. I would expect Apple to fine-tune the process over time, but at least on Day One, I had a great time trying on Apple Watch. It is rather amazing how the average Apple retail store employee's job description has changed with Apple Watch. The involvement and personal interaction required when helping people try on various Apple Watches supports the idea that the retail store employees play the most crucial role out of the entire experience.
Looking at the crowd, I actually didn't get an early adopter vibe that we have assumed would be the only ones interested in the device. Obviously, going on a weekday morning resulted in the lack of children and teenagers, but I would say the crowd interested in Apple Watch was generally in-line with any other day at the Apple store. I was able to talk with a few "non-early adopter" people about their first impressions about the device. Interestingly, their first comment was that it was a cool watch, with fun customizable watch faces. I go back to when Apple first introduced the watch and I was explaining the device to people, even then the watch faces were the primary talking point. I really think there is something to be said with how normal people look at Apple Watch as primarily a watch that can do other things. I also received a comment about going to see the device made them want it even more, an obvious goal that Apple had in mind with the try-on appointments.
When I left the Apple Store, I asked myself how would I describe the device in one sentence. Without much thought I said, "It's cool." I've been very adamant that people have been overthinking the watch for the past seven months. When it comes down to it, the watch is simply a cool device and my try-on experience reinforced that view.
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I went into more detail on my trip to the Apple Store for Apple Watch on Above Avalon Podcast Episode 20.
Product Reviews are Broken
Apple Watch reviews were published yesterday. The majority of reviewers thought the Apple Watch was a great device and has potential to be a game changer in how they use technology. The problem is that unless you read every review, you wouldn't have known that. Instead, the collective conclusion from the web yesterday was that the Apple Watch flopped with early reviews. There were 21 Apple Watch reviews published, but the 4 reviews that were more critical of the device got the most attention, leaving the 14 glowing reviews behind. Meanwhile, most of the important features of the Watch such as watch bands and durability were either not included or buried within lots of other text. Simply put: product reviews are broken. There needs to be a better way to review products.
Product Reviews Have Lost Their Luster
I couldn't help but think how the product review has changed over the years. Whereas a company's primary benefit from a product review was to win precious space in newspapers and magazines, product reviews are still mostly a marketing ploy, but the review itself has become a commodity, with people pulling the most interesting and juicy quotes (using iPhone screenshots) from various sites, and combining them into a new "Review Round-Up" post. The rest of the narrative, and the actual review, is left far behind. This process has been occurring for a few years, but lately it is getting much worse. This is the primary reason why so many people thought the Apple Watch was panned by reviewers while in reality, most people enjoyed the product. Out of thousands of words written about Apple Watch, most will only remember a small fraction and even a smaller fraction will be included in these problematic "review summary" posts.
We now get our news and information from social networks where the desire to be noticed in a sentence or two has led to much more noise with sporadic bouts of greatness. In the process, the product review has lost its luster. Whereas in the past we may have turned to the WSJ for the definitive Walt Mossberg product review, we now are exposed to 20+ reviews that are all trying to be the one to stand out from the pack. While we still have talented people writing most of these reviews, they are increasingly gearing them toward their core audiences. Apple realized this long ago and expanded the number of review units accordingly, effectively watering down the review and in doing so, diffusing the voice of a few into a dull rumble of many.
In a quest to stand out, we now have some reviews turning into full-fledged productions. The Verge's Apple Watch review involved 31 people. Meanwhile, other reviews have remained largely unchanged from yesterday, basically a few paragraphs of generalized statements.
There is still a Place
I still think the world needs independent product reviews. There is enough prior misbehavior on behalf of companies to suggest such third-party reviews can serve a purpose by giving consumers value. The problem is that many reviewers don't know what kind of value that is. The move into personalized wearables has largely turned the traditional tech gadget review into an artifact from a begone era. The nature of the tech review should have changed, but many tech reviewers haven't adapted their review process to this new wave of technology. While adding video may represent a new dimension to the review, the underlying premise of the review needs to be rethought.
Path to Fixing the Review
There are two ways to start putting the review on the right path.
1) Embrace the Current Environment. Video. Video. Video.
One of the more effective Apple Watch reviews came courtesy of Mashable. It wasn't their couple thousand word review intertwined with various high-quality photos but their six-second Vine clip that didn't include any words. I found the clip to be amusing and interesting because it: 1) showed Apple Watch packaging 2) briefly revealed watch bracelets being resized 3) revealed the mechanism of how the watch bracelet worked. I wasn't able to get that information from any other Apple Watch review. Of course Apple could have had the same video on their website, but this is where the independent product review's value shines: legitimacy. There is value in seeing someone not connected to Apple show off its technology in a real-world setting.
Video is an effective medium for much of this to take place because it's 1) easily shareable 2) able to retain its message. One of the biggest's problems facing text reviews is the ease in simply taking a few words out of context. But a six-second Vine? It would be pretty hard to shrink that down any further.
Pharrell Williams published his seven-second Apple Watch "review" Tuesday on Instagram. Similar to Mashable, it showed one aspect of the watch that most people would actually find interesting: how the watch face turns on when one's wrist is turned.
I think one of the better Apple Watch reviews would have been comprised of 10 Vine or Instagram clips that highlight features of Apple Watch that would likely show how we would use the device. Johanna Stern at WSJ did a four-minute video for her Apple Watch review which was entertaining but ultimately too long and missing the larger point of Apple Watch: it means something different to each user. The answer to that isn't simply to do every single thing possible with the watch and then complain at the end that the watch does too many things.
2) Redefine a Review. As technology products become more personal, it is becoming more critical to redefine what a product review should be. Instead of videotaping oneself doing 20 different things with Apple Watch during a typical day, focus on aspects of the device that are universal: quality, craftsmanship, durability, and the simple tasks everyone will have to do.
- Does the Apple Watch screen scratch easily?
- What happens if you get grease on Apple Watch? What about sweat?
- What if you keep the Apple Watch on for long periods of time? Any rash?
- Is it easy to charge?
- How do you replace bands?
Very few reviews addressed those talking points, with only a few even mentioning watch bands, arguably one of the more important deciding factors when it comes time to purchase the watch. Each one of those questions could be answered with a six-second Vine. The product review essentially becomes a test as to whether a company's claims about a product are true. There is a different time and place to talk about the larger implications of how Apple Watch will or won't change the world. A product review isn't necessary the right place to go into theories about technology or nit-pick on why turning on all notifications results in too many notifications being sent. People are going to buy Apple Watch if it looks cool. The review should try to help answer that question.
Taking into account Apple's changing retail strategy, reviewers will need to understand how Apple.com and the Apple Store iOS app are going to become more crucial information sources for consumers. It is important to embrace the change and not brush it off. Apple will have 10 Guided Tours for various Apple Watch features. How about using Instagram video to compare the most important parts of Apple's multi-minute videos to real-life reenactments?
Apple's New Apple Watch Guided Tours
The product review will be rescued when it is understood that the consumer should make the final decision of whether a product is good or bad. The product review should be one variable in the much bigger buying process that likely will involve family, friends, time, and a bank account. The product review has a bright future for giving valuable information and insight to consumers. It just needs some help getting there.
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It's Time for the Watch
"Apple decided to make a watch and then set out to discover what it might be good for..." - Wired
With one sentence, Wired perfectly described the Apple Watch, Apple's first product designed specifically to have a purpose dependent on the user. Today it is a watch. Tomorrow it will be something else. Next year it may be completely different. After years of development, the next phase of Apple Watch has arrived with preorders beginning on Friday. Just as was the case when the product was introduced in September, many are overthinking the watch, turning Apple's refrain about making great products into a complex business theory that risks missing the obvious keys to success. By overthinking the watch and ignoring the clues we received over the past few years, it is too easy to miss what Apple Watch actually is: freedom to do different things with technology.
iPod Nano
Phil Schiller announcing new clock faces for iPod nano in 2011.
While it is hard for any outsider to pinpoint when the idea for Apple Watch first started to percolate, according to Apple executives, the project had its official beginning in late 2011, soon after Steve Jobs' death. However, it was clear at a much earlier time that Apple was at least thinking about a watch.
Back in 2010, Apple shipped an "instantly wearable" new iPod nano that had a multi-touch user interface. Possibly due to some inclination that people may use it as a time piece, Apple included a few watch faces. Steve Jobs even said one of Apple's board members was going to clip it on an arm band as a watch (which got chuckles from the audience). Soon enough, people began to use the device as a wrist watch. Apple embraced the trend and in 2011 went so far as to create new clock faces. It was fun and cool. There were limiting factors for a more advanced gadget at that time, including a new user interface and better battery, but that didn't matter. Apple was a different company in 2010, having just launched the iPad and iPhone 4. Simply put, Apple had more important things to focus on than a watch, but the idea was there. There was something about the wrist.
Tim Cook Gave Us Clues
One of the key questions after Tim Cook became CEO was if Apple would be able to come up with new product categories. The question took on renewed vigor given a few years of evolutionary iPhone and iPad updates. While product secrecy continues to be a very important intangible asset for Apple, the company has historically given a few clues as to areas of interest, and Cook was no different judging by his public appearances in the years leading up to the Watch launch.
2012: Tim Cook at D10 conference. "I think there's some cool things that can be done [with wearables] and I think it's an interesting area...The book hasn't been written on that yet. If it's just a cool thing to know, it will fade, but if it can really drive someone to act differently, to behave differently, then I think it can be pretty cool, and so I think the verdict is out. It will largely be determined by how much innovation is in that area. I think there are some good companies that are working on this."
2013 : Tim Cook at D11 conference. "I think wearables is incredibly interesting, and I think it could be a profound area for technology...there's lots of things to solve in this space, but it's an area where it's ripe for exploration. It's ripe for for us to get excited about...I see it as something, as another very key branch of the tree...I'm interested in a great product...The wrist is interesting."
The Apple Watch Sales Pitch
Tim Cook introducing the three main marketing tentpole features for Apple Watch: a timepiece, communication device, and health/fitness tracker.
As 2014 began, it was becoming increasingly likely that Apple was indeed up to something with a wearable, if nothing else due to the fact that so many other companies were coming out with subpar smart watches. Each device had severe limitations lacking fashion or personalization cues.
In September 2014, Tim Cook introduced the Apple Watch with the following sales pitch: a personal device that could be used to tell time, communicate with people, and track one's health and fitness.
In the preceding weeks and month, the official Apple Watch marketing campaign took shape with the main refrain remaining largely the same, focused on the three primary use case tentpoles. In addition, it gave more insight as to the overall design process behind the Watch and Apple's product-first culture.
2014: Tim Cook during interview with Charlie Rose. "The Apple Watch is the most personal device we've ever created. I think it takes us into a whole different area. We had an intense team working on this for three years...As the product came to fruition it became not only the timepiece that you would expect, but a device that can do many different things include really a whole new way of communicating and connecting with people and also it has a health and fitness component that we think could be profound."
2014: Jony Ive at Vanity Fair. "One of the advantages of being part of the design team that's been around for a long time is that we haven't the luxury and opportunity to develop out process, and so one of the things we do is we meet religiously as the creative team three or four times a week...I'm still so excited about just the nature of the process. I feel so absurdly lucky to be part of a creative process where you know on one day, on Tuesday, there's no idea. We don't know what we are going to do. There's nothing. And then on Wednesday, there's an idea that was created and invariably the idea is a thought that becomes a conversation, and so that we design to start with is to talk and it's fairly exclusive..involves a few people...and a remarkable thing happens in the process, and it's the point in the process where there is the greatest change and it's when we give form to an abstract idea."
2015: Tim Cook at Goldman Sachs Technology Conference. "We want to change the way you live your life. And just like this iPad has changed the way you work, and hopefully the way you live, and the iPhone has done that. We see the Apple Watch doing that...There's just an enormous number of things that it will do, and I think you're going to find it something that you're going to think, 'Wow, I can't live without this anymore!'"
2015: Jony Ive in The New Yorker: "We always thought that glasses were not a smart move, from a point of view that people would not really want to wear them. They were intrusive, instead of pushing technology to the background, as we've always believed...We always thought it would flop, and, you know, so far it has...[Apple Watch] isn't obnoxious. This isn't building a barrier between you and me..."
2015: Alan Dye in Wired: "There was a sense that technology was going to move onto the body...We felt like the natural place, the place that had historical relevance and significance, was the wrist."
The prevailing message illustrated in the above comments was that Apple looked at the wrist as something special with the primary idea of a watch that could change your life serving as the start of everything. More refined use cases and ideas around watch bands came at a later time.
Apple's New Marketing Strategy
Judging from Apple's Watch marketing strategy over the past seven months, it is clear that Apple is taking a new route. The Katie Cotton era of public relations is over. With most new things, there are risks, and I suspect we are seeing one of those risks play out as some company observers are having trouble with an Apple that gives out so much information. If Steve Jobs represented a firewall for Apple marketing, Apple's primary risk now is not filtering the message enough.
Apple's new marketing strategy has relied heavily on positioning Jony Ive as leader of an industrial design team that uses collaboration to create products. Photo: Vogue
Apple is relying on a new marketing strategy because it no longer has the showman that introduced the iPod, iPhone, and iPad to the world. Instead, Apple is forming the narrative around a range of individuals involved with product development, led by Jony Ive and Tim Cook. Apple likely feels it has reached a point where its size and social awareness make it difficult for just one person to control the entire marketing campaign, and management is right. Apple is different today. The news cycle is ever more busy and filled with noise. While it is critical to make sure that the narrative stays on point and coalesces, Apple's strategy is fundamentally the same: get people to want to use the product. To accomplish that goal, Apple is relying on a shock and awe type of public relations strategy to elevate Apple Watch awareness to extreme levels.
It's All about the Product
One theme that management has taken very seriously with Apple Watch marketing is that Apple strives to make great products, and that is the primary theme Apple has tried to showcase with its marketing by using interviews and various high-profile write-ups. I suspect many technology observers have simply gotten used to Apple executives repeating the refrain, ignoring what that phrase really means. One secret to Apple's success is keeping product development behind closed doors, leaving the final, well-polished product to be seen in a retail store. While much strategy is involved in determining what products to work on or what industries to get involved in, strategy alone will lead to failure. At the end of the day, if the product isn't good, nothing else matters, even if the strategy is on point.
When David Pierce talked about Apple deciding to produce a watch first and then thinking of use cases second in his Wired piece, he correctly described Apple's product-first strategy. One theme that has become apparent in mobile is that a product's use case changes over time. It is much more important to focus on the big picture first, positioning a product that can take advantage of major computing themes, not something that checks off a few use cases on a list.
- Apple wants to make a product that has the potential to change the way we live our lives. Management is interested in owning the core technologies that underlie such a product. Management has commented that much time, and anxiety, is spent on this part of the equation.
- The wearable space had become interesting, not because of smart watches, but due to fitness bands. Meanwhile, phones were becoming more powerful as time went on, to the point of being able to replace laptops and desktops for some. Was there room for a simpler device able to turn the complex into the simple?
- Judging from decades of watch use, and now fitness bands, it was clear the wrist contained some value. However, watches were not able to unlock that value due to their lack of utility. It was reported that Jony started to research the history of the watch, including the reasons the wrist was so valuable. The focus was first on the device itself.
- With the idea in mind (don't forget about lessons learned from the iPod nano), it was then time to develop use cases for a device destined for the wrist. With a workable user interface, there can be attention given to what can be done with the device. Taking a look at the iPhone and iPad, it's clear the initial use cases designed for a device aren't even that important. Instead, the technical capabilities (and the runways of such technologies) are much more important.
In the future, the watch may begin to take on more iPhone functions, or it may not. The much more important goal for Apple is to make sure that each new model is better than the previous one. Looking at the iPad, although sales momentum has stalled, Apple is still concerned with shipping the best iPad each year. Market dynamics may not always work in an Apple's product favor, but management hopes to be the reason such market changes impact its product line.
Too Busy Finding a Story
One problem that is becoming a theme in the ever-increasing news cycle is overthinking things by needing to add a new twist or take. While such overarching theories may make for an interesting weekly column or Medium post, in reality, I suspect the truth is much more simple and rudimentary.
Looking back at the iPad and iPhone, many have developed elaborate stories around those products in order to address the mystery. In reality, they were simply great products that relied on a revolutionary multi-touch user interface. After launching at a too-high price (and different business model based on mobile revenue sharing) and without an app store, it took Apple and the iPhone three years and additional features and changes before hitting mass-market awareness. However, the legend was that Apple foresaw the coming mobile app revolution. Stories are told to provide answers to the unknown. The problem occurs when those answers are fabricated. Apple is launching the watch as a fun, personalized iPhone accessory with different use cases dependent on the user. If one doesn't leave the complicated stories and theories at the door, it will be difficult to see the Apple Watch for what is and, more importantly, isn't.
Judging Success
Apple's goal is to make a great product. With Apple Watch, success will be straightforward. Will people want to use it? A few days ago, I asked on Twitter what will be Watch's likely "-gate" controversy, similar to iPhone 6 and "Bendgate." As expected, I got responses ranging from waterproofing issues to scratching and rashes. One of the more serious public relations problems that could impact the watch is drawer-gate or nightstand-gate. If people forget to wear the Watch, not seeing a point in putting it on for their run, the trip to the grocery store, or to attend parent teacher night, the device won't be able to impact someone's life. One of the reasons the iPhone has done so well, including having a strong upgrade cycle, is that it is literally on us all day, every day. If people enjoy wearing Apple Watch, the product will be a success.
Freedom
The Apple Watch is the first Apple product designed from the beginning to be worn and have a purpose dependent on the user. For some, it is the best way to listen to music on a run. For others, it is a revolutionary way to communicate with the kids or keep track of appointments. This is the primary reason why so many people are struggling to understand the Apple Watch. The Apple Watch doesn't mean the same thing to everyone.
We don't know what the Apple Watch will become as we have never experienced personalized technology worn on the body. Personalization doesn't just mean getting to choose between a white or blue wristband, but having a product mean something different and special to each user.
The Apple Watch is an attempt at giving users freedom to do various things with technology suited to their lifestyles. It has been three years since Apple came up with the idea for a cool device for the wrist. On Friday, the era of personalized technology will enter the next phase as Apple Watch pre-orders signal the start of something new.
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Apple's Music Strategy Looks Increasingly Risky
Apple is late to the music streaming game. In what could be seen as a rare sign of Apple ignoring a product for too long, Jimmy Iovine and company are still putting the finishing touches on their shift from paid downloads to paid music streaming. While Apple will most likely have a specific marketing plan in place to become the biggest paid music streaming service in the world, the overall risk to the strategy remains elevated. Being forced into something is a new experience for Apple and one has to wonder if becoming the most popular paid music streaming service is just a near-term prerequisite for a company with much bigger music initiatives.
The sea change in music continues unabated. Paid music sales are declining as music streaming is growing in popularity, built primarily on a freemium model where advertisements are used to annoy listeners to the point of driving paid upgrades. Spotify has 15 million paid members, equivalent to less than 5% of the overall iPhone user base, while YouTube serves billions of songs, masked as videos, for free. In such a volatile landscape, Apple's rumored plans for music streaming seems rather simple and, to a certain degree, refreshing. One tier, charged at a monthly rate, with users able to listen to music across a range of products and even operating systems.
Apple's strategy with music streaming continues to be a work in progress, but from what we know, curation and discovery will be two main tenets of a service that uses music exclusives as a carrot to entice users. In what could be a major negative, Jimmy Iovine reportedly was unable to get the cost for this music streaming service down to $5/month, with record labels demanding Apple remain steady at the "me-too" $9.99/month price. The primary problem with this chain of events is that music executives are hardly in a position to be dictating pricing and business strategy in an industry that may be fundamentally broken, yet again, by technology.
Music streaming is split into free and paid and there is risk that without a free offering, Apple may not reach enough scale to force consolidation among streaming services. A $5/monthly price was thought to alleviate some of this risk, but with Apple possibly needing to ship at $9.99/month, one has to wonder if management is pleased with how the product is shaping up.
One theme that permeates this discussion is Apple's forced hand. With iTunes Radio, a seemingly "me-too" product compared to Pandora, Apple has seen moderate levels of success, but nothing that would jump out to an observer as ground-breaking. Apple risks a very similar fate with a paid music streaming service: garnering enough success to warrant respect with the endeavor (mostly because the bar is set so low), yet unable to capture the music industry like it was 2005 again. In essence, Apple would be stuck in catch-up mode.
At $9.99/month, Apple will still likely be able to sign up millions of iOS users (and a few Android users) to its music streaming service. However, the elephant in the room would remain untouched: YouTube. What are the longer-term implications if Apple is unable to fundamentally change the music industry with its paid streaming offering? Is additional M&A for streaming mindshare the answer? Using less than 0.1% of Apple's cash to force extra long music exclusives? Does any of this resemble the "Apple way" of putting the product first?
Being forced into something presents problems as one is not able to skate to where the puck will be, but instead focus resources and attention in trying to simply make sure it is indeed a puck that is being chased. Set in this backdrop is Jay Z's recently purchased Tidal music streaming service, which is relying on his publicity to boost membership numbers. The venture is actually based on a few solid ideas, despite not having a viable business model. Jay Z spoke to Billboard about Tidal and his thought process towards artist exclusives:
“You know, there’s a thing now, it’s called the album cycle. You put your single out, promote it, then another single — I think that now for an artist an album cycle doesn’t have to end. They’re on Instagram and Twitter and all these things, so we’re talking about ways of extending that album cycle, and it could be anything. What if it’s a video offering tickets to the next concert, or what if it’s audio or video of the recording process? If could be anything. It could be them at home listening to songs that inspire them. Anything they want to offer, you know; just be as creative as possible, that’s the only charge, really. Make it look really good and make everyone that consumes it think, ‘Man, I got something really great.’ Treat the people with respect; make it memorable.”
I continue to see Apple wanting to get to a point that takes some of what Jay Z described (and which has been talked about for years by others, including at Above Avalon) and then build a viable and sustainable business model around it. Such a place may very well include paid and free streaming, in which case Apple's rumored paid music streaming is considered more of a stepping stone to a bigger initiative where music is mostly free, but listeners obtain value from a breakthrough user interface (think: App Store, but for music).
Over the next few months, many will position the music streaming battle between Apple and Spotify. Instead, Apple will be going up against free music streaming. The irony in this whole saga is that Apple's longer-term initiative may very well embrace free music streaming, but only when music artists and fans will be able to use software to monetize content beyond music sales. Apple is being forced into music streaming and the question remains if Apple can once again harness the music industry in a such way as to form a strong enough stepping stone to begin mapping where the music puck is headed.
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The 4-Inch iPhone 6c
Rumors of a new 4-inch iPhone 6c are once again making the rounds. The idea of Apple expanding the iPhone line to include simultaneous development of three different screen sizes is intriguing because it may be the missing piece that allows Apple to reposition the iPhone line for a more sustainable future. Given current smartphone market dynamics, it would be in Apple's best interest to continue expanding the iPhone line as the product matures. Not only would an updated iPhone with a 4-inch screen appeal to a certain segment of the market, but Apple could position the new model as a way to begin differentiating the iPhone line according to it's primary distinguishing feature: screen size.
Current iPhone Line
The current iPhone line is effective in selling Apple's flagship phones (iPhone 6 and 6 Plus). Apple currently sells two-and-a-half iPhone 6 units for every iPhone 6 Plus sold. With the iPhone 5s and 5c, Apple relied on its existing strategy of taking last year's models and reducing the price by $100. Apple continues to have each price segment covered ranging from a contract-free $749 to $450. Apple's current pricing strategy is also supportive of the carrier subsidy model as the $450 differential between a 2-year contract price and contract-free price is upheld across the product line.
Current iPhone Line
iPhone Line with iPhone 6c
A new iPhone with a 4-inch screen (the "iPhone 6c") would have several longer-term implications for the iPhone line. For the first time, Apple would have three different-sized iPhone models under development (5.5-inch, 4.7-inch, and 4-inch) as the iPhone 6c would see an update from the iPhone 5s and iPhone 5c, including possibly a different design. More importantly, Apple would be able to position iPhone screen size, and not product age, as the primary pricing differentiator going forward.
Apple wouldn't reduce the iPhone 6 and 6 Plus by $100 this year, but instead sell a new iPhone 6s and iPhone 6s Plus for the same $649 and $749, respectively. The iPhone 6c would be positioned as the device for those who want to spend less money on an iPhone while the iPhone 5s would occupy the "free with carrier contract" bucket.
Expected iPhone Line with iPhone 6c - Year-End 2015
Note: Apple may change the case colors for 6s Plus, 6s, and 6c
Benefits of Selling an iPhone 6c:
- Drive consumers to iPhone 6s Plus and iPhone 6s. An iPhone 6c could be positioned to drive consumers to purchase the flagship models, the iPhone 6s and 6s Plus. After looking at the various options, including the iPhone 6c, consumers may be more willing to pay the extra $100 for the iPhone 6s. Apple relied on a similar strategy in 2013 with the iPhone 5c. While some thought the iPhone 5c would sell well, it ended up driving people into buying the more expensive iPhone 5s. This is a smart marketing decision by Apple designed to maintain the integrity of the iPhone line by getting consumers to buy the latest model, even though they may be satisfied with an older model at a lower price. Apple would benefit from earning additional revenue if consumers chose an iPhone 6s or 6s Plus over an iPhone 6c.
- Provide a good 4-inch screen experience for consumers. I suspect there is a certain segment of the population that would still prefer an iPhone with a 4-inch screen. While the larger 4.7-inch and 5.5-inch screen options would outsell an iPhone 6c, the ability to use an iPhone comfortably with one-hand, store the device in small pockets, or use the device during workouts make a 4-inch screen desirable for some consumers.
Segmenting Price (and Buyers) by Screen Size
Apple has relied on reducing the price of previous year's flagship models to address price-sensitive consumers. Such a method has been successful in maintaining an "Apple-like" experience at lower prices. However, with Apple now selling two flagship models with different screen sizes, a new strategy is needed in order to set the iPhone on a more sustainable path. If Apple sticks with it's current strategy, within three years there would be an iPhone with a 5.5-inch display selling for anywhere between $299 and $0 with a two-year contract as Apple reduces the price by $100 each year. Not only would this be confusing from a customer's point of view, but Apple may be jeopardizing the iPhone's average selling price and the important iPhone upgrade cycle as consumers decide to buy older, less expensive models.
Instead, the iPhone 6c would be the first sign that Apple is moving to a different strategy where specific screen sizes occupy set price tiers. To better view this strategy, replace each iPhone model nomenclature with its screen size. Apple now has three Phone tiers (5.5-inch, 4.7-inch, and 4-inch screens) designated for the $749, $649, and $549 price layers. This structure would remain unchanged from year to year with new models replacing the previous year's model. Meanwhile, older 4-inch screen models retain some of the old iPhone heritage of seeing price reductions over time.
iPhone Line Based on Screen Size as Primary Price Differentiator
Note: Apple will likely change iPhone case colors.
With the iPhone 6 is outselling the 6 Plus by roughly a 2.5 to 1 margin, I suspect many look at 5.5-inches as too large for an iPhone display. Taking a look at Android options, the best-selling phones also seem to come in less than that 5.5-inch range. Even in the scenario where screen sizes become a bit larger, Apple can adapt the strategy by simply relying on the concept of plus, regular (or just "iPhone"), and mini to denote three different screen sizes. The smallest screen option would then be the model to see price reductions over time.
iPhone Line Based on Screen Size as Primary Price Differentiator
Note: Apple will likely change iPhone case colors.
The "Cheap" iPhone
By segmenting the iPhone line according to screen size and shipping an iPhone 6c, Apple would eventually be in position to ship the notorious "cheap" iPhone, a two-year old iPhone with 4-inch display that sells for less than $400 contract-free. Such a device would not be sold in areas with carrier subsidies, but instead be focused on emerging markets. Even though $400 is still a premium price for a smartphone, Apple's strategy would continue to focus on slowly, but surely, lowering the iPhone's entry level price. This plan represents a much more realistic option than taking a 4-year old iPhone 6 Plus and eventually selling it for less than $400.
Apple is Getting Better at Making iPhones
Apple is likely doing a much better job at producing new iPhones at attractive margins. In the past, Apple's margin would suffer when there was a new iPhone form factor introduced, reinforcing the need to continue selling that device (with no changes) in subsequent years to recoup some margin. With manufacturing processes improving, Apple no longer has this need to continue selling the same flagship phones for years. Instead iPhone 6 and 6 Plus margins are much better to begin with and Apple can simply shift production to new models each year, while the 4-inch screen model (which Apple has already been producing for years) is the one to see price reductions over time. iPhone storage configurations are another way of Apple will be able to continue boost ASPs and margins. As the iPhone line matures, the current screen sizes will likely be around much longer than smaller iPhone screen sizes found with the iPhone 3G and 3GS, emphasizing the need for a more sustainable strategy of keeping prices stable.
Think About the Future
While the iPhone 6c is still a rumor, I'm confident that Apple management has been toying with the idea of changing its iPhone strategy in order to assure that the iPhone upgrade cycle remains robust. In addition, Apple would look to expand the iPhone line, both in terms of available models and price points. It is important to remember that there is much more to the equation than simply price. Apple could reduce the price of iPhone 6 and 6 Plus over time and its phone market share will increase. However, such a scenario may contain longer-term negatives that outweigh any near-term positives. Instead, by positioning screen size as the primary pricing differentiator, Apple is able to sell great iPhone experiences at different price layers without much in the way of collateral damage. An iPhone 6c makes a lot of sense.
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Setting the Stage for a Larger Apple Share Buyback Program
Apple will announce an update to its capital return program next month (likely in conjunction with its 2Q15 earnings release). Earlier this week, I took a closer look at Apple's quarterly cash dividend. Turning to share buyback, I expect Apple's board to approve a $35 to $45 billion increase to the buyback program, bringing total authorization to $125 to $135 billion. With Apple stock currently trading at a 13x forward P/E multiple, management will continue to look at buyback as an appropriate way to return excess capital to shareholders. Assuming the share price remains in the current valuation range, Apple will likely continue buying back shares at a $45 billion/year pace.
Share Buyback Authorization History
Apple initiated the stock buyback in fall of 2012. In the subsequent two years, Apple's pace of buyback exceeded its own timeline. As shown in Exhibit 1, the initial $10 billion authorization had a three year horizon, but Apple had bought back $10 billion of stock within a few months. The same can be said for the year-end 2015 target for completing the $60 billion of cumulative buyback authorization announced in April 2013. Apple spent $60 billion on buyback a full year ahead of schedule.
Exhibit 1: Apple's Capital Return Program Updates
While some companies are notorious for announcing share buyback programs, only to never finish them, Apple would appear to be aggressively following its stated repurchase authorization. Management is showing confidence in the future product lineup as well as the belief that Apple's current share price remains attractive for buyback. Last year, the board announced a $30 billion increase in buyback authorization but not did provide a timeline for the buyback completion. Apple ended up buying back approximately $30 billion of shares since that time. By not providing any stated timeline for its authorization, the board may be giving management a bit more leeway to judge the proper pace of buyback given the stock valuation.
Estimating the Share Buyback Authorization Increase
Apple currently has $90 billion of cumulative buyback authorization, of which $17 billion was remaining as of December 27, 2014. For a better understanding of how much the board will increase buyback authorization, it is crucial to estimate how much cash Apple will have at its disposal for capital return.
Exhibit 2 highlights the main ingredients of cash for calendar year 2015. Even though Apple has $178 billion of total cash, only $20 billion was located in the U.S. at the start of 2015. Add in U.S. free cash flow and cash proceeds from expected debt issuances, and Apple will have approximately $75 billion of cash before taking into account share repurchases and dividends. Keep in mind, free cash flow already reflects payments made for acquisition of property, plant and equipment.
Exhibit 2: Projected Apple U.S. Cash - CY2015
Assuming Apple will spend $11 billion on share dividends, there will be approximately $65 billion of cash available for share repurchases in 2015. Since Apple entered 2015 with $17 billion of share repurchase authorization remaining, it is reasonable to assume some cash has already been used to repurchase shares in the first quarter, leaving approximately $50-$55 billion of cash for buyback. This range forms the basis for my $35-$45 billion authorization increase estimate. Apple would likely still have buyback authorization left at the end of 2015, in which case it would roll over to 2016.
There are three scenarios to look for in terms of Apple's share buyback authorization increase:
Scenario A: Increase authorization by more than $40B. An authorization increase of $40 billion or more would mean either that Apple intends to increase the pace of buyback or the board is willing to give management more leeway in determining the best time for buyback with the expectation that most of the program will occur in 2016. However, since management had indicated it would assess the capital return program each year, there may not be much sense for the board to give authorization with a 2-3 year time horizon as that would leave less room for an increase in subsequent years. Evidence would seem to support the view that the board (and management) continue to think short-term in terms of its buyback authorization.
Scenario B: Increase authorization between $30B and $40B. An authorization increase between $30 billion and $40 billion would be considered the middle ground, leading to a buyback pace similar to 2014.
Scenario C: Increase authorization by less than $30B. An authorization increase of less than $30 billion would signal that share buyback may be slowing, unless the board is preparing to authorize additional increases later in the year (unlikely). One reason this may be an unlikely scenario is that the board would want to build flexibility into the program in case of sudden stock price swings.
Exhibit 3: Apple Share Buyback Authorization Increase Scenarios
I view Scenario A and Scenario B as the most likely outcomes given the board's preference to give management a bit more share repurchase authorization in case of stock price opportunities. Given the current amount of cash in the U.S. and a slightly higher stock price valuation, a $35-$45 billion increase to Apple's share buyback authorization is the most likely outcome next month. In such a scenario, Apple's cumulative share buyback authorization may reach $135 billion.
This report was produced by Neil Cybart on March 27, 2015 and is not meant to be used as investment advice.
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Members have access to the Above Avalon stock buyback primer which can be used to become familiar with Apple's share buyback.
Protecting Balance Sheets from Paranoia
Google made waves yesterday announcing Morgan Stanley's CFO, Ruth Porat, will be its next CFO. Many were quick to point out Twitter CFO Anthony Noto also came from Wall Street in an attempt to frame Google's hire as evidence of the ongoing battle for talent between Wall Street and Silicon Valley. Instead, Google's hire deals more with paranoia than a battle for talent. Today's tech leaders are paranoid about becoming irrelevant. Such anxiety does not bode well when contemplating more practical business affairs, such as managing a company's finances and balance sheet. Companies may find success in a structure that combines the best of Silicon Valley with Wall Street. As technology minds worry about the future, financial minds are focused on managing the present.
Technology companies are more paranoid about everything these days. Larry Page seemingly wants to get rid of his day-to-day job to focus on the next big thing. Tim Cook constantly refers to the nonstop worrying that Apple executives go through in terms of competition and what products to work on. Mark Zuckerberg is always on the lookout for the next big thing before it negatively impacts Facebook. Jeff Bezos is continuously looking for ways to keep Amazon relevant in the booming ecommerce renaissance. Paranoia isn't an inherently bad thing when coming up with strategy, however, one complication enters the equation if paranoia begins to creep into the financial aspects of the business such as cash management, capital structure, and cash flow. A certain level of sanity and rationality needs to preside in terms of a company's financial management.
While a CFO has slightly different roles depending on the company and industry, the overall job description in tech is pretty straight-forward: manage the balance sheet and capital structure, in addition to giving input on the income statement and cash flow. The product remains the pinnacle while financial management takes on a supporting role. We are seeing a new breed of tech giants sitting on cash levels that will likely have implications on the operating environment for many years, assuming the cash is well managed. Enter Wall Street. I suspect Google hired Morgan Stanley's CFO for her knowledge on how to manage $64 billion of cash, including the best ways to structure M&A deals, handle more shareholder-friendly capital management actions, and make sure the financial statements are receiving proper care and attention. Porat will likely not be involved in figuring out Google's next big computing platform, just as Apple CFO Luca Maestri isn't designing an Apple Car.
All of of this paranoia combined with keen sense to separate such anxiety from a company's financial management would represent a change from the past. In 2004, Microsoft's answer to holding $56 billion of cash was to issue a special one-time dividend of $32 billion, which is another way of saying they didn't know what to do with the cash and thought MSFT stock was too expensive to buy back. Today, management teams are looking at excess cash much more carefully, and in some cases, too conservatively, which is evidence for more in the way of thoughtful financial management. Instilling a sane lookout over the cash fortress will only pay dividends for years to come.
While Apple's capital return program has been well publicized, others have not participated in such shareholder-friendly alternatives, instead using cash (and stock) to continue buying the future. While there is nothing inherently wrong with such a strategy as long as value creation remains a priority, there will likely come a time when cash levels reach such a point (if that time has not already arrived) that CFOs will play a role in setting expectations and the narrative about a company's philosophy for holding excess cash.
While Google is still trying to figure out the next big thing, Facebook continues to rely on its network and reach to consolidate power and information. Meanwhile, Apple is focused on using design to create products that impact our lives and society, while Microsoft is trying to find its place in mobile. Regardless of what the next few years will bring in terms of how things shake out, those companies valuing long-term fiscal responsibility and stability are already thinking of the future. Paranoia is good for a company, until it brings on ruin. Placing safeguards in place to prevent this ruin from reaching the balance sheet is a smart move.
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Analyzing Apple's Expected Cash Dividend Increase in April
Since Apple began its capital return program in 2012, share buyback as rightfully received most of the press and attention compared to quarterly cash dividends. Apple has repurchased $73 billion of its stock, nearly three times as much as the $27 billion spent on cash dividends. However, from a signaling effect, cash dividends may do more than share buyback in portraying management's opinions and views about future business prospects.
Management included language in its financial filings that Apple intends to increase its quarterly cash dividend each year. Next month, during the annual review of the capital management program, Apple's board will likely approve an increase to Apple's quarterly cash dividend to approximately $0.50 to $0.51/share, up 8% from the current $0.47/share dividend, which would represent a 1.6% dividend yield at the current stock price. The board approved a 8% dividend increase last year. While dividends have historically signaled a maturing company with slowing growth prospects, Apple looks to be a rare exception where its financial and capital capabilities are being decoupled from a product lineup that continues to see growth and momentum.
Much of the significance underpinning Apple's buyback and dividends has been lost on market observers as the focus remains on the near-term trade, ignoring capital management's long-term signaling effect. While share buyback and dividends (both cash and stock) do not guarantee positive stock price moves in the future, market observers can use such activity as an indicator for how management views the future. By issuing a cash dividend, management is showing confidence that the business is supportive of a recurring cash expense going forward in the form of the dividend.
Exhibit 1 highlights Apple's dividend payout ratios over the past two years in addition to the expected payout ratios through 2016. A dividend payout ratio is simply the cash dividends paid each year divided by annual earnings. The lower the dividend payout, the less of a burden the dividend payment is on overall earnings (and cash flow). A high dividend payout ratio would signify that the company either doesn't see much need to hold on to its earnings, or the dividend is too high.
Exhibit 1: Apple Dividend Payout Ratio
While it is hard to come up with direct peers, if comparing Apple's 28% payout ratio to companies with similarly valuable brands like Disney (20% payout ratio) and Nike (30% payout ratio), Apple is indeed running with an in-line divided payout ratio. Interestingly, given the strong expected earnings growth in 2015, Apple's divided payout ratio is expected to decline to 20% in the near-term.
From management's point of view, it makes more sense to increase the dividend each year at a rate that smooths out earnings volatility. This strategy would imply that even though Apple is experiencing 40% EPS growth in 2015, the dividend increase would likely remain less than 10%. If the situation was flipped and Apple's earnings were declining, the expectation would be that Apple wouldn't need to cut the dividend, but instead continue maintaining an orderly, gradual increase.
Exhibit 2 takes a look at the amount of capital spent on dividend payments, which is found simply by multiplying dividends paid to shareholders by the number of shares outstanding. The data can also be found in Apple's cash flow statement. The key takeaway is that dividend expense is benefitting from Apple's aggressive share buyback program. As excess capital is spent on share buyback, Apple no longer needs to pay dividends on repurchased shares, reducing its dividend obligation. As a result, Apple is able to increase the dividend per share rate, while the total cost of the cash dividends increases at a much slower pace. This is yet another example of how current shareholders benefit from share repurchases. There is a possibility that management will take a look at this data and conclude that Apple can increase the quarterly cash dividend further, but the market has shown no expectation that such a sizable increase is required.
Exhibit 2: Apple Cash Dividends (Per Share and Total)
From an investor's point of view, cash dividends give off much more in the way of long-term management signaling when compared to share repurchases. With a dividend, management is unofficially tying the company to a long-term, recurring use of capital since any shareholder-friendly management team and board understands the negative consequences following a dividend cut. With share buyback, companies are not obligated to complete the program and have a much easier time slowing or ending the buyback without a significant market backlash. While there are few companies that purposely increase their dividends knowing they will need to be cut in the near term, there are some companies that find themselves in cyclical industries, such as energy and mining, where drastic swings in either pricing or demand may bring about the need to cut dividends. Apple's goal when setting its dividend would be to avoid this type of adverse situation where a dividend cut is required to maintain financial health during a more difficult operating environment.
The other benefit of paying a cash dividend is that Apple's investor base is expanded as some institutions only invest in dividend-paying entities. While it is hard to quantify the impact this may have had on Apple's valuation, it is clear that with a $743 billion market capitalization ($605 billion enterprise value), it would be in Apple's best interest to not exclude any large shareholder group due to specific capital return strategies.
Apple is in an interesting situation as fast-growing technology companies have traditionally not embraced paying cash dividends due to the signaling it may give concerning fewer growth opportunities. Apple management seems to be decoupling its financial philosophies concerning excess capital from a product lineup continuing to see growth. In a few weeks, Apple's board will approve an updated capital return program, including a dividend increase, that will align with management's view on Apple's long-term business prospects.
This report was produced by Neil Cybart on March 24, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.
An Illusion in Switzerland
It's a good time to be a ultra luxury watchmaker. Consumers across the world continue to value the craftsmanship and timelessness found in engineered works of art worn on the wrist. Young professionals continue to enter the luxury watch world with open arms (and wallets) looking to wear accomplishment and success. Watchmakers remain excited about the future as consumers associate luxury watches with ideals that go beyond price, materials, and marketing.
Just like a soothing sunset can be ruined with a particular cloud cover forewarning of an upcoming storm, there are signs that the luxury watch industry is about to experience the closest thing it has ever faced to an extinction level event. Only a few luxury watchmakers, including TAG Heuer and a handful of others, have bothered to even wake up and take in the lawn furniture. Switzerland is under the spell of a widespread illusion.
The upcoming storm is called utility, and Apple is at the front line of bringing it to the wrist. With Apple Watch, Jony Ive and company are looking to change the way we interact with technology, utilizing what some may say is the most efficient region of the body for a wearable device: the wrist. With proper line of sight and ergonomics, the wrist is arguably a better solution for a good portion of computing and communicating compared to carrying around 5-inch pieces of fragile glass in our hands and pockets.
The wrist's potential was discovered long ago as the modern day watch has been around for decades, yet we are now finding that the watch was only scratching the surface of what is possible for the wrist. Much of the luxury watchmakers' disregard for the upcoming utility storm relates to how the modern luxury watch industry has become complacent. Few watchmakers envision a world where consumers begin to look at the wrist as more than just a place for well-crafted jewelry made out of various alloys of precious metals and moving parts. Jewelry provides us a way to stand out from the crowd, be different, and show our personality, likes, and dislikes. Watchmakers are correct in assuming this type of emotion and feeling is hard to replace as price is largely removed from the equation entirely, leaving only the factors that Switzerland simply excels at: quality, care, timelessness, and prestige. The problem with this logic, however, begins to appear when considering that consumers desire only what they know. Today's wants and needs for the wrist are not good indicators for what will be in demand tomorrow. The world has never experienced personalized wearable computing.
The Apple Watch will likely change what consumers demand out of a device worn on a wrist. The convenience and ease of interacting with technology will just be too much to forgo, similar to how smartphones became the preferred phone over a device that merely handled voice calling. While nothing will change with the desire to stand out and represent one's personality to the world through objects worn on the wrist, the ability of those objects to not only monitor and record data, but simply help its wearer use technology will change the buying equation. Everyone will want utility on the wrist.
After initially dismissing Apple Watch as nothing more than a design student's class project, Jean-Claude Biver, President of the LVMH Watch Division and leader of TAG Heuer, has at least publicly shown concern that Apple may indeed be on to something with a device that puts utility on the wrist, although he continues to think the impact will be contained to the low-end, with ultra luxury watchmakers remaining relatively untouched. Swatch's co-inventor, Elmar Mock, who was responsible for positioning Swatch to address the Quartz Revolution in the 1970s, once again sees the sea change coming and describes it as nothing short of the most significant shift the watch industry has seen to date. The low-end of the watch market is worried, and rightfully so, but the ultra high-end continues to think that enough gold and craftsmanship will weather the storm.
Critics have said that luxury watchmakers have lost touch with their customers. In reality, luxury watchmakers have lost touch with themselves. Watchmakers stopped giving the wrist the imagination it deserved.
The transformation that the luxury watch industry will experience over the next few years will most likely occur much more quickly than people expect as desire can be a powerful motivator. Eventually, all watchmakers will be aware that the world has changed. By then, the first movers will have been relying on buzz and marketing to drum up support for mediocre products that may handle a few key tasks found in more complete utilitarian devices. The problem facing the luxury watch industry has been decades in the making: complacency and the illusion that the wrist would forever be a place for jewelry. The Apple Watch changes the equation by which quality will be judged. We will likely look back at this era with interest and intrigue, and wonder why luxury watch makers didn't see the upcoming storm approaching.
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Setting the Stage for Two Million Apple Watch Demos in Two Weeks
Apple's relatively nimble retail footprint will play a crucial role in selling Apple Watch. Mark Gurman over at 9to5Mac reported yesterday that Apple is planning on setting up Apple Watch demo areas where 10 customers can receive personalized 15-minute demos. I suspect a decent number of Apple Watch pre-orders will likely take advantage of Apple's offer, and get a demo/fitting, since choice and comfort are important watch elements. It is conceivable that over the two week preview period starting April 10th, including launch day, Apple will be able to give more than two million Apple Watch demos, which will not only help drive a successful product launch, but begin the process of explaining the device to hundreds of millions of customers.
The Apple Watch will launch in nine countries (a record for a new product category launch):
- US (265 Apple retail stores)
- UK (38 stores)
- Canada (29 stores)
- Australia (21 stores)
- China (18 stores)
- France (18 stores)
- Germany (14 stores)
- Japan (8 stores)
- Hong Kong (3 stores)
The only countries to have more than three Apple retail stores and not make the initial launch list are Spain, Italy, and Switzerland (no surprise there). It would seem obvious that Hong Kong's proximity to China was a much more important factor than store count. Therefore, the Apple Watch launch country list is essentially the top countries within the Apple retail network, reinforcing the idea that Apple is positioning the demo as key to selling the device.
Exhibit 1 takes a look at the number of Apple Watch demos that I estimate could be given at each Apple retail store per hour, starting at 40 for the typical small Apple store in a mall to over 150 for a hi-profile store. The various store types are based off of store footprint estimates from Gary Allen of ifostore. Gurman's report indicated each store will receive one Apple Watch demo table, with the ability to have more tables dependent on demand. I am assuming some medium/large Apple stores in mall and non-mall locations will indeed get additional demo units (reflected in the 1.5 Apple Watch demo table figure in Exhibit 1), while hi-profile stores get four tables to handle higher demand.
Exhibit 1: Theoretical Number of Apple Watch Demos by Store Type
Exhibit 2 takes the per store data from Exhibit 1 and expands it for the entire preview period across the retail footprint. It is conceivable that Apple will be able to give 22,000 Apple Watch demos per hour, leading to nearly 180,000 demos a day and over one million demos a week. Of course, school and work patterns during the week will likely result in Apple giving fewer demos than these totals, but the takeaway is Apple's built-in capacity for giving such a large number of demos. During the entire preview period from April 10th to April 24th, including launch day, Apple may be able to give upwards of two million Apple Watch demos.
Exhibit 2: Theoretical Number of Apple Watch Demos by Store Type During the Preview Period
Earlier this week, I established my Apple Watch sales expectations, including a 2.5 to 4.5 million unit sales estimate range for opening weekend. I feel more comfortable that Apple will be able to ship at least one to two million units for opening weekend as consumers will have had the opportunity to experience the watch during a demo and place an order. My estimate then assumes additional sales from in-store demos on launch day.
Many observers are underestimating the impact that a 15-minute demo will have on selling Apple Watch. Those interested in an Apple Watch will likely already own an iPhone and be familiar with the Apple ecosystem. The sales pitch will not look to answer "why Apple?" but instead focus on "here's what you can do with this watch." That message is difficult to get across in traditional advertising, so the ability to offer an in-store demo and control the entire sales message, will go a long way in selling Apple Watch to these early adopters.
The importance of a demo and the broader sales environment can also be seen from the way Apple Watch is displayed in stores compared to that of an Android Wear smartwatch (shown below). Apple's "glass-topped Apple Watch display cabinet, accessible to staff from below, via a descending, motorized flap, like the ramp at the rear of a cargo plane," as Ian Parker described it in his Jony Ive profile published last month, helps to build an experience around the device that will go a long way in nurturing desire. Simply opening retail stores is only the beginning in being able to create the right kind of atmosphere that is conducive to brand building and strong sales on a square footage basis.
Apple retail was one of the key reasons that the iPad became a phenomenon. Once customers held the device, and were able to experience software that allowed the hardware to melt away, the sale was made. I have a feeling the same will occur with Apple Watch as the demo will go a long way in turning interest and curiosity into a sale.
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Apple Watch Sales Estimates (Video)
With an aggressive nine country launch into a user base of more than 400 million iPhone owners, the Apple Watch will likely represent the largest new product category launch, according to sales, in Apple's 38-year history.
Apple Watch topics discussed in this video include: opening weekend sales, 2015 and 2016 sales outlook, ASP and sales mix, and the overall impact on Apple revenue and EPS.
The full report can be found here.
Apple's Plan to Rethink Television
Television is broken. The era of smartphones and tablets continues to alter the way we consume and interact with video content. While video watching was once a sedentary behavior with little in the way of third-party distraction, video is now increasingly consumed throughout the day across multiple screens. Yesterday, the WSJ reported that Apple is looking to launch a service that repackages a certain amount of television channel programming into a more appropriate form for the mobile era. Apple has likely earned the benefit of the doubt that such a service would be worth people's time and money. However, ultimate success with rethinking television will be dependent on ignoring the mirage of simply getting television content broken out into more granular form sent over the internet. Apple will likely head in a new direction where all video creation is embraced and distributed through curation and personalization.
The primary issue concerning television isn't that there is too much content being delivered to our homes. Instead, televisions's fundamental problem is that it doesn't include the wide variety of new content born out of mobile. While our smartphones may have changed the way we consume content, the ability to record and capture almost anything in the world with little in the way of time or money commitment has changed the way content is created. Channel surfing on a large screen television has been replaced by YouTube surfing on a computer or smartphone as well as consuming video content from shared links on Twitter and Facebook. Short video clips, which at first seemed more like a gimmick, are increasingly containing more in the way of news and information than many would never have imagined. "I saw it on Vine" is increasingly becoming a more common phrase than "I saw it on CNN." Such a shift in content consumption and creation from many of the "old" players to a new breed of content companies reinforces the need for Apple (and any competing service interested in rethinking video) to start anew and build a service that combines both the old and new content creators. The strategy would be strengthened by the concepts of mobile, decentralization, and differentiation.
Source: Above Avalon
A truly revolutionary video streaming service would include all video content, relying on curation and personalization to deliver an engaging user experience.
It is reported that Apple's Plan A for rethinking television was to take a page from the iPhone playbook and work with a key partner, in this case, Comcast. In such a scenario, there would be room for both parties to win as consumers ultimately pay more for a better product. However, due to continuing setbacks and roadblocks, Apple may indeed be looking now at Plan B, a more hostile plan involving TV programmers including ABC, CBS and Fox. It is not hard to see Apple's ultimate goal to create a service that includes various "channels," or maybe a better word would be "video lengths," that provides easy access to different video content mediums. Getting the "old" players involved would be the first step on a long journey. All of this may indeed be too utopian as various parties may not want to go down the iTunes/music industry path where Apple holds too much control.
Apple's rumored scaled back TV network bundle would reportedly cost $30-$40 a month. Add this cost to Netflix's or Hulu Plus's monthly rate and a user's monthly bill is once again approaching $50 a month for what essentially comes down to traditional cable, repackaged. A whole other side of the video equation is still missing: the new players. While apps on an Apple TV may suffice for some, a suboptimal user interface and the much bigger implication on video consumption behavior stand out as barriers that would need to be overcome. Unsurprisingly, cable companies aren't as clueless as many think and are in a great position to begin increasing internet-only prices following a customer's awkward "I no longer want to pay for cable" call to customer service. In addition, companies such as Netflix and Amazon are using video content as bargaining tools to enrich their own platforms and sales pitch to consumers in an ultimate desire to buy relevancy in people's lives, no matter how small the window (or screen) may be. Walled gardens built around established social networks don't scream ease of use and interconnectivity either.
In a perfect world, I would use a streaming video content service that has had some element of curation applied, resulting in a completely new experience that would be the linchpin of dropping my cable plan. Add elements of search, discovery, and social media and this hypothetical video service would combine elements of yesterday in the form of push content such as live sports, news, and tentpole events like the Oscars and in addition have the ability to pull content from vast libraries, similar to what can be found on Hulu. Some type of classification and delivery system based on video length and subject matter represents interesting possibilities for how a smartphone user can consume a wide selection of video content. Apple's role in such a product would be to serve as a gatekeeper, providing differentiation through curation and discoverability. If this sounds similar to the music streaming strategy Apple will likely utilize, it is because they both would rely on the same themes of providing a better user experience through the way content is consumed by the end user. The entire iOS ecosystem is involved in taking advantage of streaming content services.
The most challenging barrier to overcome before seeing this new video era is related to business and economics. Combining content built on a very specific method of revenue (fees and advertisements) with new era content that may not have set parameters around monetization makes it that much more difficult to truly combine everything into a easy, digestible format. Not to mention, the sheer number of licenses and rights that would need to be obtained would make the weak of heart feel overwhelmed. Add in complexities of international expansion, and bringing services like Apple Pay to additional countries would look like a walk in the park.
An Apple streaming video service would do more to increase the value obtained from iOS devices that truly represent mobile, including iPhone and Apple Watch.
What may have initially been considered another leg on the stool, rethinking television for Apple is increasingly looking more like a much broader video service with the goal of increasing the value of the Apple ecosystem, similar to Apple Pay and Apple's upcoming music streaming service. By building additional functionality and usage into the ecosystem, Apple is continuing to go down the path of addressing key elements of our life that can be controlled, or improved, by iOS devices.
While there is no doubt that Apple has various sizes of glass in the labs, including large screens bigger than an iMac, the value from a video service may inherently be found in smaller screens and devices, including iPhone and Apple Watch. To truly rethink television, Apple needs to address the much harder task of figuring out the best way to consume content born from the modern day video renaissance.
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Establishing Apple Watch Sales Estimates: Expecting a Big Launch
With an aggressive nine country launch into a user base of more than 400 million iPhone owners, the Apple Watch will likely represent the largest new product category launch, according to sales, in Apple's 38-year history. Given my opening weekend sales expectations, the Apple Watch launch may be upwards of 12x as large as the iPad launch. I am establishing calendar year 2015 and 2016 Apple Watch unit sales estimates of 19 and 33 million, respectively.
Apple Watch is a different kind of product for Apple with 30 unique watch models curated into two collections, not including eight Edition models that will have a limited release. While I would still expect initial sales to be constrained by supply, the somewhat wide launch window (Australia, Canada, China, France, Germany, Hong Kong, Japan, the UK, and the US) suggests Apple is confident in an opening weekend unit sales number that is at least 2 million, but not likely more than 5 million. Exhibit 1 compares Apple's previous new product category launches. The Apple Watch's nine country launch stands out as an outlier.
Exhibit 1: Apple's Recent New Product Category Launches
Opening Weekend Sales
I am establishing a 3.5 million opening weekend sales estimate based primary on the list of launch countries and what I consider to be a realistic amount of available supply. It remains to be seen what supply will look like on launch day at Apple retail stores for those who don't preorder online. I expect many to take advantage of Apple's preview window to try out their watch selection after pre-ordering the device. Exhibit 2 highlights my expectation range for opening weekend sales with a wider expectation range of between 2.5 and 4.5 million units.
Exhibit 2: Above Avalon Estimate for Apple Watch Opening Weekend Sales (millions of units)
It is important to note that Apple may not release Watch unit sales numbers related to opening weekend or quarterly results. Management had indicated that Watch revenue would be combined with "Other Products" for reporting purposes, which includes Beats headphones and speakers, iPod sales, Apple TV, and peripherals and accessories for iPhone, iPad, Mac and iPod. There may still be a possibility that Apple discloses overall unit sales numbers if they are strong.
Unit Sales Estimates
Back in November 2014, I published my initial estimates for Apple Watch sales. Since then, I have not discovered any new information that significantly altered my view. Exhibit 3 contains my Apple Watch unit sales estimates for 2015 and 2016. It is important to note there are a number of different holding periods discussed in the press related to Apple, primarily calendar year (CY) and fiscal year (FY). Apple reports earnings according to its fiscal year.
Exhibit 3: Above Avalon Estimate for Apple Watch Unit Sales
Watch production will likely represent the biggest bottleneck for stronger initial sales. Since the Apple Watch will launch in nine countries, it would seem that Apple is confident supply would at least be large enough to support such a wide release for a first generation product. Within the nine launch countries, Apple's retail network will play a crucial role as hands-on demonstrations and previewing may be desired by a sizable portion of potential buyers. I assume the gradual rollout to other countries will take months, with the product likely to reach an iPhone-like distribution sometime in 2016.
With a target market of approximately 400 million iPhone users, I continue to view initial Apple Watch demand will be determined by a consumer's interest and passion with Apple products. Those individuals who have a long history of owning Apple products, and are interested in having the latest and greatest, will likely be first in line, while individuals who may be new to iOS and likely just getting use to their iPhone may not even consider buying an Apple Watch in the first few years. My previous note on Apple Watch sales estimate suggested that 15% of the iPhone user base (approximately 60 million) represents early adopters, the ones likely to buy the product early in the life cycle. With that in mind, 28 million unit sales during the first 12 months on the market would seem relatively plausible.
As shown in Exhibit 4, I am establishing a sales mix estimate that favors the Sport collection over the Watch collection. I relied on a combination of an opt-in Twitter survey that I conducted with early adopters, adjusted to reflect non-English speaking countries and more mainstream buyers.
Exhibit 4: Above Avalon Estimate for Apple Watch Unit Sales Mix for 2015 and 2016 (CY)
Average Selling Price (ASP) Estimates
Taking into account the sales mix, as well preferred watch face sizes and styles, Exhibit 5 highlights my estimate for Apple Watch ASP. Band revenue represents approximately 5% of Apple Watch Sport collection, while I would expect bands to represent a larger portion of Watch collection sales (8%).
Exhibit 5: Above Avalon Estimate for Apple Watch ASP
Revenue, Operating Income and EPS Estimates
Combining unit sales estimate with ASP, Apple Watch has the potential to bring in $8 billion of revenue in fiscal year 2015, which would be around 3% of Apple's total revenue. In 2016, Apple Watch has the potential of representing close to 7% of Apple's revenue. In terms of EPS, Apple Watch may represent up to $0.44/share for 2015, increasing to $1.13/share (12% of total EPS) in 2016. While the iPhone's popularity overshadows many of these strong Apple Watch estimates, one aspect to keep in mind is the Apple Watch would likely represent the second biggest product in terms of revenue and profit momentum. The iPad and Mac show no signs of similar levels of growth monetum.
Exhibit 6: Above Avalon Estimate for Apple Watch Financials (FY)
Going forward, I would label Apple Watch and iPhone as the two priorities at Apple in terms of products with both sales and structural (mobile and wearables) momentum. The ingredients are in place for a strong Apple Watch launch.
This report was produced by Neil Cybart on March 16, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.
The MacBook Paradox
The new MacBook is quintessentially Apple. Everything from the reimagined keyboard and butterfly mechanism to the new Force Touch trackpad and reconfigured battery, the new MacBook represents Apple at its finest. Years of hardware engineering culminating in a product that literally pushes the definition of the product category it has resided in for close to a decade.
However, despite representing classic Apple, the new MacBook is inconsequential to Apple's bottom line. Even in a best case scenario, the new MacBook would struggle reaching 5% of Apple's operating income. As more portable (and cheaper) alternatives, mainly in the form of iPhone, continue to replace the need for laptops and desktops, the Mac's overall influence will continue to decline.
A paradox is formed as this product that best represents Apple (even down to the way it is introduced to the public by Phil Schiller), is increasingly playing a smaller role in Apple's future. This paradox represents one of Apple's long-term risks. If Apple is faced with supporting a growing list of still-loved, but increasingly inconsequential, legacy products, will Apple be able to completely focus on the future? The iPod turned out to be a blessing in disguise as the product line ran its natural course, peaking in 2009 and then steadily declining to an asterisk on the income statement. In the future, Apple may not be so lucky, and instead have legacy products with a much longer life cycle where sales remain too high to completely ignore, but too low to move the financial needle.
In the near-term, this risk appears to be dormant. Apple is able to effectively focus on a narrow product lineup that still fits on one of Jony's infamous design studio tables. We will continue to see innovations with the Mac and iPad, while the iPhone and Apple Watch become a bigger piece of Apple's future plans. Tim Cook and company constantly talk about being paranoid about competition. I suspect this MacBook paradox also registers with management as something to keep them up at night. The fear is that one day Apple may unknowingly find itself chained to the past, unable to completely focus on the future for too many resources are being spent maintaining products from yesterday.
There are signs that Apple is aware of, and taking steps to alleviate, this risk. Management's claim that they don't think about money when creating products is exemplified by not only the new MacBook, but also the low-margin iPad mini and the lack of a large screen iPhone until 2014. By simply focusing on making, and shipping, great products, the impact a product may have on the bottom line does not represent the main driver behind management's decisions.
One of Apple's secrets has been doing very little in order to put all of its attention and resources on a few, big things. For that to continue, Apple may need to make the tough decision to stop updating product lines earlier than would otherwise be the case. Apple may continue to be lucky and have products follow the iPhone/iPod path, where new products cannibalize old products in an orderly fashion. Navigating the MacBook paradox may one day represent a tough task for Apple, but with challenges come opportunities, and in the near-term, management will marvel at the new MacBook for a few days before moving on to the next big thing.
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Marketing Implications from BuzzFeed's Apple Watch Demo Video
It is no secret that tech gadget review trends have changed over the years. What was once ruled by articles filled with jargon and specs are now led by videos that contain first impressions and interesting commentary. BuzzFeed sent two reporters to the Apple Watch event. Their demo video, which was light on detail, but heavy on emotion, was published yesterday. Unsurprisingly, many people are not happy with the video.
The official iTunes Twitter account retweeted the video to its 7 million followers. BuzzFeed did the same to its 2 million followers. The video has around 750,000 views on YouTube, so no where near viral material, but starting to reach some mainstream circles.
The BuzzFeed video talked about things that most people will think about when determining if Apple Watch is something worth buying. The two reporters discussed potential use cases in their daily lives where the watch would come in handy. There was no mention of the Digital Crown (which Apple also didn't discuss on Monday), screen specs, memory, pricing, or even the fact that the watch requires an iPhone. Instead, the video showed two Apple Watch users saying things like:
- "Already this feels amazing."
- "[Apple Watch] changes the game for messaging I think...and it's right on my wrist. That's so easy. I love that."
- "It feels very classy. It's almost kind of like vintage like old Hollywood feeling. Kind of feel like a movie start mixed with an astronaut."
- "I like that when you turn [your wrist], the face comes up."
- "I think it's going to change the way we talk to each other."
After watching the BuzzFeed demo, the viewer would understand that Apple Watch is a product that is clearly different than just an iPhone on your wrist, with many different features. Interestingly, that is the exact message Apple was going after. Accordingly, some people weren't too happy with the BuzzFeed demo and started to question its authenticity.
AdAge asked Apple about the BuzzFeed video and whether it was a paid advertisement (it wasn't), and then goes into a discussion on how Apple never did something like this under Steve Jobs. Yes, they actually said that. Joshua Topolsky, a media editor at Bloomberg, was not pleased with the video, publicly calling the whole ordeal "embarrassing". The YouTube comment section for the BuzzFeed video was filled with negative reaction asking if the video was some kind of marketing job from Apple. People are still uncomfortable with where tech gadget reviews are headed.
The goal in product reviews is to recognize that viewers have an endless amount of information and resources at their disposal and are merely looking for things that can't be learned from visiting websites, namely emotion and real-world experiences. Giving viewers that in a well-edited video, filled with personality, like what BuzzFeed did, will be popular going forward. For additional evidence, look at all of the people Meerkating in the Apple demo event. The primary point in doing that was to connect with viewers and give an inside look at the room and some initial early impressions of the products. I doubt a livestream where someone is just running off spec after spec would be as interesting to watch as someone casually chatting away about how the Apple Watch may fit in their life, and just happening to let 100 people look on over Meerkat.
The Verge's Apple Watch demo video (200,000 views on YouTube) was obviously different than BuzzFeed's video because The Verge has a different reader base, with specific needs and values.
The contrast between the BuzzFeed and The Verge demo videos are noteworthy, demonstrating the much bigger trend in technology: personalization. While there is still demand for videos that go into a gadget's specs, the momentum is clearly found with videos that simply discuss the emotion behind the product and if it is something worth people's time to learn more about. Gadgets are becoming extensions of ourselves and that is only intensified with wearables. While some may be interested in the assumptions included in stated battery life claims, many more will be mesmerized by an animated Mickey Mouse watch face.
Incidentally, Apple has been placing emotion ahead of tech specs in its marketing campaigns for a long time. We saw this once again at Monday's keynote where the takeaway message was to drum up interest in the Watch and not focus on specifications or even how the Digital Crown works. This makes the Apple online store that much more important as a source of information, in addition to brick-and-mortar retail establishments. Taking a look at Apple's recent retail hires, it would seem that Apple is betting its retail arm will become more crucial to the overall business as time goes on. Apple is also introducing a new type of watch preview system at its retail stores where the goal is to educate customers on Apple Watch.
Tech sites will have a very difficult time adopting a model where emotion is the primary focus of their gadget reviews. If The Verge tried to do an Apple Watch demo like BuzzFeed, their users would rise up in revolt and the reviewer would probably be dismissed (or told to correct the video).
Tech reviewers like Marques Brownlee, who is already somewhat of a YouTube sensation with 2.3 million subscribers, are resonating with viewers because they represent the hybrid between The Verge and BuzzFeed (while also being purely video based). Brownlee's high-quality videos are concise, filled with relevant information and personality. I suspect a good portion of Brownlee's viewers are also tech site readers. Apple's "Spring forward" keynote was Brownlee's first Apple event. His MacBook video demo from the Apple event has 650,000 views on YouTube in one day.
As technology becomes more personal, emotion will need to play a bigger role in explaining how a particular device can fit into someone's life. While some felt uncomfortable with the BuzzFeed video and its lack of detail, there are many others that genuinely got something out of it and will now take time to research the product. The gadget review continues to evolve and personalized gadgets like Apple Watch are only accelerating the process.
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