Above Avalon Podcast Episode 172: Hidden Acceleration
Apple’s underlying ecosystem strength has been gaining momentum for years - it’s just been masked by people holding on to their iPhones for longer before upgrading. In episode 172, Neil quantifies how much Apple’s ecosystem is growing. Additional topics include the problem found with using overall revenue trends to analyze Apple growth, the Apple Services myth, and why non-iPhone revenue growth matters so much.
To listen to episode 172, go here.
The complete Above Avalon podcast episode archive is available here.
Apple's Ecosystem Growth Is Accelerating
The two most recent Above Avalon articles took a look at how and why Apple’s ecosystem is giving the company a major advantage against the competition.
With Apple reporting 3Q20 earnings two weeks ago, there is value in quantifying how much Apple’s ecosystem is growing. The data should startle the competition. Apple is seeing a clear acceleration in its ecosystem growth as hundreds of millions of iPhone-only users move deeper into the Apple fold by subscribing to various services and buying additional products.
Measuring Ecosystem Growth
There are a number of ways one can attempt to track or measure Apple’s ecosystem growth.
Number of devices per user
Number of paid subscriptions per user
In covering Apple’s business from a financial perspective, my modeling work includes keeping up-to-date estimates for most of the preceding data points. However, there is one metric missing from the list that may come as a surprise: overall revenue. Considering Apple provides this data point every three months, such an exclusion may seem peculiar. Wouldn’t Apple revenue shed light on how the Apple ecosystem is performing?
Relying on overall revenue for analyzing Apple’s ecosystem growth will lead to faulty conclusions. In Exhibit 1, Apple’s revenue is graphed on a trailing twelve months (TTM) basis. This is done to smooth out the seasonality found in Apple’s business (i.e. sales are concentrated around the holidays). The takeaway from the exhibit is that higher revenue demonstrates Apple’s ecosystem continues to grow although the rate of growth has slowed dramatically.
There is one problem with such a takeaway: It’s wrong.
Exhibit 1: Apple Revenue (TTM)
Click / tap exhibit to enlarge.
Overall revenue trends are masking what is actually occurring with Apple’s ecosystem. In FY2019, the iPhone was responsible for 55% of Apple’s overall revenue. On its own, that’s not an issue for Apple. The iPhone is part of Apple’s ecosystem after all. However, Apple has become increasingly dependent on existing users upgrading their devices to generate iPhone revenue. This has resulted in Apple’s overall revenue being heavily influenced by iPhone upgrading trends.
During periods of robust iPhone upgrading, Apple’s overall revenue shows stronger growth. When iPhone upgrading slows, overall revenue growth also slows to the point that Apple’s ecosystem may appear to be plateauing or even contracting (as seen in Exhibit 1). This was a major issue at the end of 2018 and early 2019 as slowing iPhone upgrades led many to conclude that Apple was in big trouble in China and other geographies.
Since iPhone upgrading trends have little to no direct impact on Apple ecosystem viability or strength, a better approach to get insights on Apple’s ecosystem growth is to divide Apple’s revenue into two categories:
iPhone
non-iPhone (Services, Mac, iPad, Wearables, Home, and Accessories)
As seen in Exhibit 2, breaking Apple’s overall revenue into iPhone and non-iPhone revenue leads to a completely different view of Apple’s growth trajectory. Non-iPhone revenue (the red line) continues to demonstrate very strong momentum while iPhone revenue (the blue line) is trending at the same level that it was in 2015.
Exhibit 2: Revenue (iPhone vs. Non-iPhone) - TTM
Click / tap exhibit to enlarge.
A different way of looking at this data is to consider revenue growth rates. Using the revenue figures from Exhibit 2, we are able to create Exhibit 3, which displays year-over-year change in revenue for both iPhone and non-iPhone.
Non-iPhone revenue growth (the red line) has outpaced iPhone revenue growth (the blue line) for the past seven quarters. The higher growth rates for iPhone revenue in 2018 were due to higher iPhone ASPs caused by Apple unveiling the iPhone X. Excluding those quarters, non-iPhone revenue growth has been trending stronger than iPhone growth since 2016. This is a sign that Apple’s underlying ecosystem strength has been gaining momentum for years - it’s just been masked by people holding on to their iPhones for longer before upgrading.
Exhibit 3: Revenue Growth YOY (iPhone vs. Non-iPhone) - TTM
Click / tap exhibit to enlarge.
What is driving the non-iPhone revenue strength shown in Exhibits 2 and 3? The answer is found in the strong iPhone revenue trends from a few years ago. Years of strong new user growth driven by the iPhone is now contributing to hundreds of millions of iPhone-only users moving deeper into the Apple ecosystem. This trend began in earnest around the beginning of 2017.
The Services Myth
Some may look at the preceding exhibits and say that the data is still incomplete. Apple Services include a number of recurring revenue streams such as iCloud, Apple Music, and various paid subscriptions. Given the recurring nature of something like paid iCloud storage, it ends up being easier for Apple to report year-over-year Services growth. Apple’s Services business accounts for 40% of non-iPhone revenue. There is a different dynamic found with hardware revenue. Since hardware isn’t a recurring revenue stream, year-over-year growth ends up being that much harder to achieve as Apple is in effect needing to replace every dollar of revenue with new sales.
(One can argue something like the iPhone Upgrade Program is a recurring revenue stream for hardware. However, that ends up being a stretch. The Upgrade Program is a loan with a built-in upgrade optionality after the 12th payment. That is very different than something like an iCloud or Apple Music subscription.)
To address this issue, non-iPhone revenue can be broken out into Services and Products (excluding iPhone). In what will come as a shock to many people, Exhibits 4 and 5 show how Products revenue excluding iPhone (i.e. iPad, Mac, Wearables, Home, and Accessories) is now growing at nearly the same pace as Services. This represents a major narrative violation as consensus spent years positioning Services as Apple’s growth engine.
Exhibit 4: Revenue (Apple Services vs. Apple Products Excluding iPhone) - TTM
Click / tap exhibit to enlarge.
Exhibit 5: Revenue Growth YOY (Apple Services vs. Apple Products Excluding iPhone) - TTM
Click / tap exhibit to enlarge.
Based on Apple management commentary, we know that upgrading is not impacting the iPad, Mac, and wearables as much as the iPhone. Approximately half of people buying iPads and Macs are new to the product categories. For Apple Watch, the percentage is more than 75%. The new user percentage for iPhone sales is a fraction of those percentages. This tells us that iPad, Mac, and wearables sales are a very good indicator of Apple ecosystem strength.
Tying It All Together
One way of thinking about the Apple ecosystem is to view it as a pie. There are two ways for Apple to expand the pie: Bring in more customers and have existing customers spend more on services and products in the ecosystem (higher ARPU).
New users entering the ecosystem - The iPhone SE should not be underestimated as a successful tool for bringing Android users into the Apple fold.
Existing users moving deeper into the ecosystem - iPhone users are buying iPads, Macs, and wearables as well as subscribing to various Apple services.
Apple currently finds itself in an ecosystem expansion phase. Hundreds of millions of people with only one Apple device - an iPhone - are embarking on a search for more Apple experiences. We see this with non-iPhone revenue growing by 14% in 3Q20 on a TTM basis, which is higher than growth rates seen in the mid-2010s, as seen in Exhibit 6.
Exhibit 6: Apple Non-iPhone Revenue Growth Projection
Click / tap exhibit to enlarge.
Looking ahead, my estimates have non-iPhone revenue accelerating from 14% growth to 20% growth in the coming quarters. iPad, Mac, and wearables are a major source of that growth acceleration. Considering how Apple is working off of a much larger revenue base, for revenue growth percentages to actually increase this far along in the process is intriguing. The takeaway is that Apple’s ecosystem is gaining momentum at a pace that should frighten the competition.
Hundreds of millions of people will be buying their first Apple wearable device in the coming years. Given the inherent nature of wearable devices - new form factors designed to make technology more personal - it is very likely that one Apple wearable purchase will eventually lead to additional Apple wearable purchases. Apple can then leverage high-margin Services to run with more aggressive pricing on wearables (and other Apple devices) which only ends up boosting demand.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members in both written and audio forms. To sign up and for more information on membership, visit the membership page.
For additional discussion on this topic, check out the Above Avalon daily update from August 13th.
Above Avalon Podcast Episode 171: The Apple Ecosystem
Apple’s ecosystem ends up being about more than just a collection of devices or services. Apple has been quietly building something much larger, and it’s still flying under the radar. In episode 171, Neil examines what Apple’s ecosystem derives its power from and why loyalty and satisfaction rates increase as customers move deeper in the Apple ecosystem. Additional topics include The Grand Unified Theory of Apple Products, Apple as a design company, how non-Apple hardware can serve as a Trojan horse for Apple, and how Apple’s ecosystem can evolve.
To listen to episode 171, go here.
The complete Above Avalon podcast episode archive is available here.
The Secret to Apple's Ecosystem
Apple’s ecosystem remains misunderstood. While consensus has come around to accepting the sheer size of Apple’s ecosystem (a billion users and nearly 1.6 billion devices), there is still much unknown as to what makes the ecosystem tick. From what does Apple’s ecosystem derive its power? Why do loyalty and satisfaction rates increase as customers move deeper into the ecosystem? Apple’s ecosystem ends up being about more than just a collection of devices or services. Apple has been quietly building something much larger, and it’s still flying under the radar.
Products
No company is able to match Apple in offering a cohesive and strategically forward-looking product line. Computers small and light enough to be worn on the body are sold next to computers so large that built-in handles are required. More impressively, all of these products are designed to work seamlessly together.
The Grand Unified Theory of Apple Products outlines how each of Apple’s major product categories is designed to help make technology more personal - to reduce the barriers that exist between technology and the user.
Products are designed to handle tasks once handled by more powerful siblings. New form factors are then able to handle new tasks in unique and different ways. It is the pursuit of making technology more personal that ends up being responsible for devices like Apple Watch and AirPods. The same dynamic is also paving the way for Apple to eventually sell wearables for the face in the form of smart glasses. (More on The Grand Unified Theory of Apple Products is found in the Above Avalon Report, “Product Vision: How Apple Thinks About the World,” available here for Above Avalon members.)
With 1.6 billion devices in use, it may be natural to conclude that devices are the source of Apple’s ecosystem power. This has led some to position the iPhone as the sun in Apple’s ecosystem with other products being the planets revolving around the sun. However, this is a misread of the role Apple devices are actually playing in the ecosystem. Just because the iPhone is used by more people than any other Apple device, it is incorrect to assume that will always be the case, or more importantly, that other devices are in some way inferior to the iPhone when it comes to handling workflows. There is something much larger at play here than just a billion users enjoying Apple hardware.
Services
With a $55 billion revenue annual run rate and 518 million paid subscriptions across its platforms, there is no longer a debate as to Apple’s ability to succeed with services. However, there is still a lack of consensus as to what role services play in Apple’s ecosystem. Decisions like bringing Apple Music to third-party speakers and the Apple TV app to third-party TV sets have confused many with some going so far as to conclude that Apple’s future is one of a services company.
In such a world, Apple devices lose much of their value to cheap third-party hardware. This school of thought is responsible for claims that Apple gave up selling accessories like the Apple TV box and HomePod because customers can access Apple content distribution services on cheaper non-Apple hardware. It’s difficult to think of a bigger misread of how Apple thinks and operates as a company than to claim that Apple’s future is one of a services company.
There are now others who look at Apple’s financial success with services as a negative - a sign of Apple milking existing users of as much profit as possible. This school of thought positions paid services as a long-term liability to the Apple ecosystem.
A Toolmaker
While consensus credits products (hardware) as the source of Apple’s ecosystem power, services are increasingly viewed as a hidden risk factor that can crack holes in the ecosystem. Neither are true. Nearly a billion people are not using iPhones simply because they enjoy the hardware. Vice-versa, having 518 million paid subscriptions is not a sign of Apple users needing to pay some kind of tax or bounty to remain in Apple’s ecosystem.
From where then does Apple’s ecosystem derive its power? What makes a customer want to move deeper into the Apple ecosystem?
To answer these questions, we need to step back from any one product or service and instead look at Apple as a company. It is still common for people to call Apple by whatever is its best-selling or most popular product at any one time. This also applies to whatever product is responsible for revenue growth. As a result, we hear all too often phrases like Apple is an iPhone company, a services company, or even a wearables company. The problem is that Apple shouldn’t be defined by any one product, but rather the process that led to Apple having an ecosystem of products and services.
Apple is a design company selling tools that can improve people’s lives. These aren’t just any tools either. Instead, Apple is very selective in selling tools that are able to foster experiences that people are willing to pay for - something that has become increasingly rare in the consumer tech space. By having a design-led culture, Apple is able to put the user experience front-and-center during product development.
This experiences mandate ends up being responsible for Apple’s high loyalty and satisfaction rates. The 975 million people with an iPhone aren’t likely to remain iPhone users because of stellar hardware or compelling software powering that hardware. Instead, loyalty is driven by the experiences associated with using an iPhone.
An Experiences Ecosystem
The secret to Apple’s ecosystem is that instead of selling products or services, Apple ends up selling experiences made possible by controlling hardware, software, and services.
Instead of thinking of Apple’s ecosystem in terms of the number of people or devices, a different approach is to consider the number of experiences Apple is offering. This is where Apple’s true ambitions become visible. By using an iPhone, a customer doesn’t just receive one experience per day. Instead, nearly everything that is consumed on the device has the potential of leading to a good (or bad) experience. This is why Apple’s control of hardware, software, and services plays such a crucial role. Apple’s ecosystem likely consists of tens, if not hundreds of billions, of experiences in a single day.
Having an ecosystem of experiences ultimately represents the biggest challenge to Apple competitors. Coming up with an iPhone alternative isn’t good enough for enticing users to jump from the Apple ship. Instead, competitors need to come up with even better experiences than those found in the Apple ecosystem. As a user moves deeper into the Apple ecosystem - in pursuit of additional premium experiences - competitors need to figure out a way of recreating that growing list of experiences. Can it even be done? When looking at the wearables industry, the answer as of today is “no.”
Non-Apple Hardware
One of the most intriguing aspects of Apple’s ecosystem is how nearly half of Apple users still only use just one Apple device: an iPhone. The idea that every Apple user owns a multitude of Apple devices and services is wrong. The implication is that Apple’s billion users own (and use) quite a bit of non-Apple hardware. Today, non-Apple hardware used by iPhone owners include TV sets, cheap stationary speakers, and CarPlay-equipped automobiles.
Since Apple’s product strategy and organizational structure rewards saying “no” more than “yes,” there will likely always be opportunities for other companies selling hardware to participate in the Apple ecosystem. This ends up being a Trojan Horse for Apple.
Instead of needing to have a new customer jump with both feet into the Apple ecosystem from Day 1, something that isn’t likely especially as the next marginal customer will be coming from the middle tier of the market, Apple merely needs this customer to buy or use one Apple tool.
Management is confident that one tool will eventually turn into two tools and then three since humans gravitate toward premium experiences. As one’s Apple tool collection grows, the number of experiences made possible by those tools increases. This has the impact of increasing customer satisfaction and loyalty. And the flywheel continues to turn. In order to get this flywheel moving in the first place, Apple must build bridges allowing new customers to move deeper into the ecosystem. Decisions like making Apple Music available on non-Apple hardware and bringing the Apple TV app to Samsung TVs are examples of such bridges.
Evolution
When thinking about how Apple’s ecosystem will evolve, the focus shouldn’t be on which new devices or services Apple can come up with, but rather on how Apple can offer new experiences to its customers. The blueprint for creating such experiences is already known: leveraging control over hardware, software, and services.
Technology’s battle lines are currently being redrawn with the goal being to capture the most valuable real estate in our lives: our health, homes, and transportation. Bets on software that completely reimagines the way we approach these verticals will likely prove to be good bets. Timing remains the big unknown.
This raises a question: How will Apple approach new verticals and industries? Would Apple attempt to recreate entirely new device lineups for each industry? Will The Grand Unified Theory of Apple Products be torn apart?
Instead of selling a $80,000 electric car or moving head-first into selling a range of first-party smart home hardware, Apple’s current ecosystem provides clues as to how the company can approach these new industries.
The point of Apple entering transportation wouldn’t be to sell cars, mopeds, or bicycles. Instead, it would be to sell experiences that Apple customers can consume on the road.
The point of Apple moving deeper into smart homes wouldn’t be to sell a plethora of small home gadgets and trinkets, some of which may require an electrician to install. Instead, it would be to sell experiences that Apple customers can consume in the home.
Apple developing an autonomous car remains difficult for many to wrap their minds around. The idea of Apple one day getting into housing is still considered a fantasy by most. However, such ideas make a lot of sense when thinking about how we consume experiences during the day.
An autonomous car is nothing more than a room on wheels. A house is a series of rooms connected to each other. With each, Apple would be looking to create environments that can support new experiences.
This brings us back to Apple’s current suite of products and services. It is incorrect to assume that Apple entering new industries would result in the company throwing its current products out the window. Instead, those tools stand to play major roles in delivering experiences in new industries.
Apple’s interest with Project Titan isn’t to beat or copy Tesla, but rather to figure out a way to have personal gadgets provide compelling experiences on the road. Such experiences could include Apple Glasses being used to find the right autonomous Apple Car to enter while Apple Watches can be used as identification for entry. Once inside the vehicle, the digital assistant found on the wrist or in front of our eyes could then be used to convert the car’s hardware to suit our needs. A similar dynamic would be found with smart homes - relying on personal gadgets, especially wearables, to come up with premium experiences in the home. We are seeing the early stages of this with products like HomePod and the way the device can be seamlessly used with Apple Watch.
The idea that Apple would enter the transportation and housing industries simply to come up with more areas for its users to engage with wearables may seem preposterous today. However, the idea that a single company would be able to deliver hundreds of billions of experiences per day by selling tools consisting of hardware, software, and services was similarly once a fantasy.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members in both written and audio forms. To sign up and for more information on membership, visit the membership page.
For additional discussion on this topic, check out the Above Avalon daily update from July 23rd.
Above Avalon Podcast Episode 170: Pulling Away From the Competition
In episode 170, Neil examines how Apple is pulling away from the competition to a degree that we haven’t ever seen before. Given how we are just now entering the wearables era, implications of this shift will be measured in the coming decades, not years. Additional topics include WWDC 2020, Apple’s revised product strategy, the competitive landscape, and Apple’s lead in wearables.
To listen to episode 170, go here.
The complete Above Avalon podcast episode archive is available here.
Apple Is Pulling Away From the Competition
For the second year in a row, Apple held a developers conference that should frighten its competitors. Relying on a nearly maniacal obsession with the user experience, Apple is removing oxygen from every market that it plays in. At the same time, the tech landscape is riddled with increasingly bad bets, indifference, and a lack of vision. Apple is pulling away from the competition to a degree that we haven’t ever seen before. Given how we are just now entering the wearables era, implications of this shift will be measured in the coming decades, not years.
WWDC 2020
It speaks volumes that Apple held its strongest WWDC in years during the middle of a pandemic while two of its largest competitors, Google and Facebook, decided to skip their annual developers conferences. Just a few years ago, fortunes were reversed. Apple was coming under fire for WWDCs that appeared to be more reactionary to Google, Facebook, and Samsung. Apple was also struggling to contain growing unrest among its pro users who were tempted by Microsoft Surface hardware.
What changed?
The last two WWDCs stood out for two reasons:
A revised Apple product strategy. A few years ago, Apple was most aggressive with products capable of making technology more relevant and personal (iPhone and Apple Watch). As shown in Exhibit 1, in the pull strategy, the Apple Watch and iPhone were Apple’s clear priorities while the iPad, Mac portables, and Mac desktops ended up facing a battle for management attention as if they were located at the end of the rope that was Apple management was pulling.
Apple changed from a “pull” strategy in which some products like the iPad and Mac seemed to be having a hard time keeping up to a push strategy characterized by every major product category moving forward simultaneously. This shift appears to have been born in 2017, which would explain why we are still seeing the initial fruit of the effort. The iPad and Mac product categories have benefited the most from this revised “push” product strategy with more frequent and noteworthy updates.
Exhibit 1: Apple’s Changing Product Strategy
Apple has doubled down on its unique interpretation of innovation. During his opening remarks at the iPhone and Apple Watch event last September, Tim Cook said that Apple sells tools containing "[i]nnovations that enrich people's lives to help them learn, create, work, play, share, and stay healthy." Instead of defining innovation as either being first or doing something different, Apple looks at innovation as something that improves customers’ lives. A major consequence of this has been software and hardware releases that have prioritized feature quality over quantity. This year’s WWDC came in a full 20% shorter than previous keynotes. While having a digital format helped cut down on the timing due to quicker transitions, no clapping etc., there were also fewer new features announced. However, the features that were announced contained more significance when it comes to pushing the user experience forward.
A Stronger Apple
Unfortunately for Apple competitors, the combination of a revised product strategy and unique definition of innovation didn’t just make for strong WWDC keynotes. Consumers are noticing and wanting what Apple is selling. Consider the following trends:
Apple hasn’t just held its own in the smartphone space but rather is continuing to take share from Android. Of all the smartphone manufacturers, Apple saw the largest sales share increase in the smartphone industry last quarter, and that was during a pandemic.
Apple is adding approximately 20 million new iPad users per year despite the iPad being 10 years old and already having an installed base exceeding 300 million users.
Apple’s oldest major product category, the Mac, is adding 10 million new users per year.
Apple Watch and AirPods are quickly approaching 100 million user bases each.
Apple users are paying for 518 million subscriptions across Apple’s platforms, which is up 126 million in just a year.
All of the preceding items amount to an Apple ecosystem gaining momentum. A different way of highlighting Apple’s growing ecosystem over the past 10 years is to look at the number of people using at least one Apple device. As shown in Exhibit 2, Apple’s installed base recently surpassed a billion users.
Exhibit 2: Apple Installed Base (Number of Users)
While new user growth rates have slowed, Apple is still bringing tens of millions of users into the fold. Due to Apple’s views regarding innovation and its focus on the user experience, once someone enters the Apple ecosystem, odds are good that customer will remain in the ecosystem.
This is why one subtheme from last week’s WWDC keynote flew under the radar. (My complete WWDC 2020 review is available here for Above Avalon members.) It’s not just about Apple pushing multiple product categories forward at the same time. Instead, it’s about adding cohesiveness and commonality between product categories. Apple is making it easier for people to buy multiple Apple devices. As users move deeper into the Apple ecosystem, satisfaction and loyalty rates stand to go even higher. The end result is that Apple’s billion users aren’t just any billion users. Instead, they are a billion users less likely to use non-Apple devices and services going forward. For the competition, this is a highly concerning development.
More worrying for competitors, Apple is still in the early stages of bringing its users deeper into the ecosystem. According to my estimate, approximately 50% of Apple users still own just one Apple device: an iPhone. This group serves as a prime market for products like the iPad, Apple Watch, AirPods, and various Apple services. In a few years, that percentage may decline to something more like 30%. Such a development will remove much of the remaining oxygen from the markets Apple plays in.
Competition Is Weakening
While Apple sails forward with a strengthening ecosystem made possible by a clear product vision and a functioning organizational structure that prioritizes design (i.e. the user experience), the competition is rudderless.
Apple competitors have been striking out with one bad product bet after another. Few have long-term vision as to where computing is headed. Consider the following events, developments, and observations. By no means is this an inclusive list.
Samsung remains rudderless from a product vision perspective. With no clear direction as to where to go, the company aimlessly launches new products and features for no other reason than to say they are first. The strategy is no different than throwing things against the wall and hoping something sticks. Even worse, the products and features that Samsung is announcing aren’t even ready for public usage.
Google continues to prioritize technology over design. While new software features may seem compelling on paper, the lack of attention given to the user experience quickly becomes apparent. It has also become difficult to miss the growing enthusiasm gap between Android and iOS. On the hardware front, Google is struggling to match such efforts with its ambient computing future (which doesn’t make much sense to me).
Amazon’s massive bet on voice with Alexa and Echo was the wrong one. The stationary smart speaker space was a mirage. Amazon should have instead bet on wearables with voice as a user input. However, the company doesn’t have the corporate culture to excel with computers worn on the body.
Microsoft appears to be running into growing trouble with the consumer when it comes to Surface. What had been a genuine chance to rip into the iPad and Mac stronghold due to growing user unrest looks to have been successfully crushed by Apple. Microsoft Surface revenue is increasingly being driven by commercial clients (i.e. Microsoft is taking share from its OEMs rather than Apple).
Facebook ended up placing the wrong social bet. Instead of going after our closest social network, Facebook evolved to offer a curated version of the web via the News Feed. The company’s pivot back to a privacy-focused social platform built around messaging emphasizes this wrong bet. A message sent through Apple’s Messages is a message not sent through a Facebook property.
Snap, the company considered to have the best odds of competing with Apple on AR, botched its first major foray into AR hardware with Spectacles. The company has backed itself in a corner by management’s refusal, and then failure, to appeal to older demographics. This will serve as a headwind for mass market AR successes.
Spotify was not able to prevent Apple Music from gaining critical mass despite Apple Music not having a free tier. The same is now taking place with Netflix, which is unable to stop new entrants into paid video streaming from gaining traction. This ends up diffusing near universal praise in the press for first movers.
For an industry that was expected to put Apple in its place, that sure is a lot of fails, flops, and disappointments. When looking outside the U.S., the overall picture isn’t dramatically different. While some companies still have pockets of strength where Apple is not a major player, in geographies Apple is playing in, the company continues to see growing ecosystem momentum while the competition flounders. The number of paid subscriptions being run through Apple’s platform points to increased services and app adoption outside the U.S.
The never-ending tales of Apple being crushed by the local competition in China have been met with Apple seeing existing users move deeper into the ecosystem as measured by App Store, iPad, and wearables momentum. Huawei’s struggles in Europe appear to be benefiting Apple at the premium end of the market.
Changing Narrative
If there was still doubt about Apple’s momentum in the marketplace, one doesn’t need to look any further than the dramatic change in narrative facing Apple in the press.
For years, Apple was positioned as one iPhone update away from implosion. Low market and sales share were paraded around as signs of an incompetent product strategy. Simply put, Apple was framed as being weak and vulnerable, dependent on revenue sources that could disappear overnight due to consumers fleeing to the competition.
The narrative has completely shifted. The press is now infatuated with Apple’s power, its ironclad grip over the App Store, and the idea that Apple users are stuck or imprisoned in a massive walled garden where things like iMessage, Apple Watches, and AirPods force people to remain within Apple’s walls. Government regulators are viewed as the only entity capable of protecting Apple users from Apple.
If competitors actually believe this narrative, they are setting themselves for more failure. Thinking that Apple users are somehow being forced against their will to buy products like Apple Watches and AirPods is nothing more than looking for someone to blame for market failures when the problem is found internally with a bad vision, inadequate corporate culture, and lack of understanding as to what makes Apple unique.
Risks
On a list of risk factors facing Apple, greater regulation is far from the top. The same can be said about things like App Store policies and employee retention. While these items make for juicy headlines capable of grabbing people’s attention, they won’t play a major role in Apple’s future. Instead, Apple is where it is today by saying “no” more than “yes.” By remaining focused on making technology more personal, which is inherently about using a design-led culture to push the user experience, Apple is able to develop a dynamic, yet nimble, ecosystem of tools that people are willing to pay for. lf it were to lose focus, Apple would move that much closer to its competitors.
Apple ends up being its toughest competitor as it releases products that surpass the previous version. This is where betting on the user experience and taking a unique stance on innovation is critical.
Next Ten Years
When the iPhone was unveiled in 2007, Steve Jobs claimed that Apple had a five-year head start against the competition. He ended up being mostly right. By 2012, Samsung and Google were shipping credible iPhone alternatives, thanks partially to ruthless copying that led to time in the courtroom.
With wearables, my thinking has been that Apple has a lead that is closer to 10 years. This estimate reflects not just software or hardware advantages, but also the byproduct of Apple controlling both items and its resulting achievements with custom silicon.
As time passes, Apple has been facing less competition in wearables. This is remarkable considering how Apple Watch has already ushered in the next paradigm shift in computing. We are seeing the future today. Yet most companies either don’t see it or even worse, see it but are unable to respond.
Giving Apple a 10-year head start against the competition with wearables may end up giving too much credit to the competition. Excelling in wearables requires a corporate culture, product development process, and business model that few companies other than Apple possess. In many ways, Apple was built to excel in wearables. Apple should probably get used to being its own toughest competitor.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.
Above Avalon Podcast Episode 169: The Business of Predicting Turns
Financial market commentators have been stumped by the stock market’s resiliency during the pandemic. Maybe they shouldn't be so surprised. In episode 169, Neil examines the question of whether or not Wall Street tried to predict the pandemic’s turn without actually knowing what such a turn would look like. Additional topics include two truths when it comes to how Wall Street functions, the various predictions for Apple, lessons found with Wall Street’s nature of predicting turns, and how predicting turns ends up being about predicting when calmness will enter and leave the market.
To listen to episode 169, go here.
The complete Above Avalon podcast episode archive is available here.
Predicting Turns on Wall Street
Wall Street got the pandemic right. Or did it? For the past two months, financial market commentators have been stumped by the stock market’s resiliency. The common refrain has been that the market is too optimistic given what seems to be crisis after crisis. With a pandemic still ongoing, Apple and a growing list of companies are trading at all-time highs. The NASDAQ just hit a record high while the S&P 500 is nearly up for the year. Fixed income markets remain shockingly robust. A closer examination of how the past three months transpired shines light on the idea that Wall Street tried to predict the pandemic’s turn without actually knowing what such a turn would look like.
Market Truths
There are two truths when it comes to how Wall Street functions:
1) Markets are forward-looking. A company’s stock price is not based on how that company performed in the past. If a company reports stellar earnings for the quarter that just ended but then reveals bankruptcy is on the horizon, the market is not going to make sure the strong results that occurred in the past are valued appropriately. Stock prices are determined by expectations of what will happen in the future, and more specifically, a company’s future cash flow stream.
Fixed income markets are based on economic trends going forward, not where the economy was in the past. Valuation multiples used for M&A are based not on how a target performed last year, but rather on expectations for future performance.
The implications found with forward-looking markets are immense. Two months ago, unemployment claims data suggested 16 million people had lost their jobs in just a three-week span. The stock market went on to register its strongest weekly performance in decades that particular week. This led to the following tweet from U.S. Congresswoman Alexandria Ocasio-Cortez:
Many looked at such juxtaposition as a sign of Wall Street’s corruption or brokenness - as if the market was actually applauding 16 million people losing jobs. This was not the case. Instead, since the market is forward-looking, the focus had already shifted to the May and June jobs reports. A more accurate tweet would have compared the market’s 11% down week in February with news of 16 million Americans losing their jobs in March.
2) Markets are comprised of participants with different perspectives and viewpoints. The idea that there is one person or entity determining whether equity markets move up or down on any given day is fantasy - something portrayed by the press in an attempt to add clarity to what is inherently a lot of unknown. Instead, financial markets are comprised of different viewpoints, often at odds with each other, that must come together so that price discovery can occur.
Contrary to what financial and business news publications would lead you to believe, it is impossible to know why stocks move up or down on any given day. In order to figure out why a stock is behaving a certain way, each market participant buying and selling shares of that stock would need to be questioned as to their reasoning and motive. Since such an activity isn’t feasible, it is impossible to know the reason(s) why a stock moves in a particular direction.
It may be easy to look at an S&P 500 price chart for the past few months and determine that Wall Street made one big bet around the end of March: that there would be a turn in the pandemic - a point at which the health crisis would bottom and then begin to improve, bringing with it better economic trends.
This would be an incorrect assessment of how the stock market, and Wall Street in general, operates.
There was never one large bet made by “the market” in March regarding the pandemic since there isn’t one market participant. Instead, there were millions, even tens of millions, of smaller predictions made. Some predictions were that the pandemic would just disappear. Others called for the pandemic to become increasingly bad as 2020 progressed.
The participants making these predictions considered asset prices and, using their own expectations of what may or may not happen, made a determination as to whether or not prices reflected their expectations. Exposure and risk appetites were then judged.
Another truth when it comes to the stock market’s performance over the past three months is that there was never one set of predictions guiding price action. It’s easy to think that the market is simply moving off of the same months-old mindset that existed in March, but that is faulty logic. The market is in a very different place today than it was just a month ago, or even a week ago for that matter. Predictions have been constantly evolving, both to the upside and downside, as new information comes to light.
Consider the following noteworthy events that occurred since the stock market bottomed in March:
End of March. It became clear that U.S. policymakers on both sides of the aisle were going to respond to the economic impact from the pandemic in a very big way.
Early April. After a shaky few weeks, fixed income markets returned to stability due, in part, to unprecedented commitments from the U.S. Fed. A wave of bankruptcies hitting major corporations that had seemed likely just a few weeks prior to this time was not going to materialize.
Mid to Late April. The 1Q20 earnings season was characterized by management commentary being more upbeat than analyst expectations. It also became clear that the pandemic was going to impact some industries more than others.
May and early June. The coronavirus epicenter in the U.S. (the NYC metro area) saw a complete turnaround on the health front with clear improvement in most coronavirus-related trends.
Early June. A surprisingly strong May jobs report reflected the positive impact from government stimulus programs and states beginning to reopen.
Market participants had plenty of opportunities to test their predictions made in March with the preceding developments and adjust viewpoints accordingly.
Business of Predicting Turns
Since the market is always forward-looking, the inherent nature of Wall Street is to be in the business of predicting turns - assessing when good economic times will turn sour and when bad economic times will turn positive. This practice was not unique to the pandemic.
Sometimes the collective nature of Wall Street’s predictions ends up being wrong. In late 2018, fears of the U.S. falling into a recession didn’t materialize. Back in late February, predictions that the pandemic would be quickly contained and not lead to major economic interruptions obviously ended up being wrong.
If consensus is wrong on a prediction turn, asset prices adjust and Wall Street participants regroup to make yet another prediction about a potential turn.
Apple as Example
This turn predicting occurs not only at the stock index level, but also at an individual company level. We can use Apple as an example.
Back in February, some market participants bet Apple would find itself in major trouble as the pandemic would impact both supply and demand. However, there were other market participants betting that Apple wasn’t going to suffer much on the supply side and demand would simply be delayed into the second half of 2020 and 2021.
How can such different viewpoints exist for the same company? It all comes down to how Apple is viewed. Looking at Apple as just an iPhone maker will lead to different predictions than will viewing Apple as a toolmaker with a billion engaged users who aren’t likely to go elsewhere for computing tools. This is often why commentary from those who don’t know much about Apple is prone to error. It may be easy and tempting to think that iPhone users will choose less expensive alternatives during a recession. However, one will be more accurate looking at the situation in terms of ecosystems and iPhone users not having much desire or incentive to leave Apple’s ecosystem.
Apple’s FY2Q20 earnings at the end of April marked a turning point as management disclosed that recent trends reflected demand improving “across the board.” A logical explanation was that government stimulus programs were starting to hit while product categories like the Mac and iPad were actually seeing improved results from developments like distance learning and people working from home.
Lessons
Is there a way to get ahead of Wall Street’s nature of predicting turns? Knowledge is power when it comes to achieving proper perspective. Less time should be given to topics like where markets may be headed or what is driving markets up and down on any given day. Both topics are bound to be guided by entertainment-led directives. Instead, time and attention should be given to people with unique perspectives that are able to analyze news events separately from daily stock price moves. These perspectives come from experts relying on years of experience in their respective field which allows historical context to be added to the news.
Caution is needed when determining where to turn for financial market news. I stopped watching CNBC during the pandemic because of inadequate coverage.
At the end of February, CNBC invited Jeremy Siegel, professor of finance at the University of Pennsylvania, to talk about the collapsing stock market at the time. Siegel, a CNBC regular, discussed how the vast majority of a stock price is not derived by earnings over the next 12 months, but instead by cash flow further out.
As shown in the video below, Siegel didn’t make a direct short-term call on either the market or the pandemic. Instead, Siegel was trying to add some calm to a market that was increasingly getting out of hand. The CNBC hosts didn’t want anything to do with Siegel’s comments.
Each of the hosts’ initial responses were to go after Siegel’s remarks and try to get him to say something more hysterical. The exchange was just one example of what ended up being weeks of fear-led coverage based on whatever the tone of the news was that morning. One day the end of the world was near, and the next day a random vaccine trial meant the market was undervalued by 30%.
Looking ahead, there isn’t going to be much change in the way financial markets are covered unless there is a fundamental change in business models. Finance news publications and outlets that are ultimately based on advertising will continue to being incentivized to get as many people as possible to click articles and watch videos. Said another way, financial news outlets will continue to do better when markets are in turmoil.
A Turn in the Pandemic?
This brings us back to the original question: Did Wall Street get the pandemic right?
While some market participants will be quick to say that their own (rosy) projections about the pandemic ended up right, the truth is that the situation was much more complicated.
My thinking is that most people probably haven’t changed their viewpoints regarding the pandemic over the past two months. Those who tended to be on the optimistic side of the spectrum remain optimistic. Those who were pessimistic, remain just as pessimistic. There is still a wide spectrum of viewpoints in this market regarding how the pandemic will trend for the rest of 2020.
What can explain the market’s strong performance over the past two months?
There were a number of factors that came together to impact equities. However, one of the more glaring changes was that calmness entered the market. The Chicago Board Options Exchange’s CBOE Volatility Index, known as simply the VIX, is commonly referred to as the market’s fear gauge. It measures the expected or future volatility of the market based on S&P index options. The higher the VIX, the greater the level of fear. The VIX has collapsed over the past three months (although it remains elevated).
In February and early March, the market saw the most volatile price action it has seen since the 1987 crash. Simply put, humans don’t react well to that kind of volatility. Over the subsequent three months, the news flow has in many ways allowed a level of calm to return to the markets.
Not having debt markets implode will have a material impact on one’s view on equities.
Having some of the largest companies in the world talk about a bottoming in demand in April will get attention.
Signs of improvement in the employment situation due to stimulus programs and states reopening won’t go unnoticed.
All of those developments amount to stability reentering the market. One can still have a negative viewpoint of the health impact arising from the pandemic. But when it comes to transcribing that viewpoint into thoughts about asset prices and equity valuations, emotion inevitably plays a major role.
Predicting turns on Wall Street ends up being about predicting when calmness will enter and leave the market - when market participants will be guided more by emotions and feelings or numbers and facts. Given the way humans behave, we can have a high degree of confidence there will be plenty of future turns to predict on Wall Street. In some ways, that’s why Wall Street exists in the first place - for there to be a marketplace where the economic and financial ups and downs associated with human emotion can be allowed to play themselves out.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.
Above Avalon Podcast Episode 168: The Paid Membership Model
This past week marked the fifth anniversary of Neil launching Above Avalon membership. Above Avalon continues to thrive with a sustainable business model based solely on paid memberships. In episode 168, Neil gives a behind-the-scenes look at Above Avalon’s business model. Additional topics include: Above Avalon’s history, Neil’s “secrets” to success, and his largest challenges found with a paid membership model.
To listen to episode 168, go here.
The complete Above Avalon podcast episode archive is available here.
Above Avalon Membership Turns Five Years Old
Above Avalon membership was launched five years ago this week. I am happy to report Above Avalon continues to thrive with a sustainable business model based solely on paid memberships.
Those who became Above Avalon members on May 13th, 2015 will enter their sixth year of membership tomorrow. A big thank you goes out to these early adopters who have played a pivotal role in financially-supporting Above Avalon from the literal beginning.
Reflection
Above Avalon membership’s fifth anniversary is a good time to reflect on milestones, challenges, and successes.
While membership-supported websites have grown in popularity over the past five years, Above Avalon remains on the forefront of testing just how niche a site can be and still thrive. By focusing on Apple and its ecosystem, Above Avalon is an example of how sustainability can be reached by dedicating all resources to covering one topic (company).
Since Apple doesn’t operate in a vacuum, an “Apple focus” includes analysis of other companies including, but not limited to Alphabet, Facebook, Amazon, Microsoft, Spotify, Netflix, Disney, Fitbit, and Sonos. In addition, industries that Apple competes in receive my attention. This ends up being my secret sauce for covering Apple - start with a company focus and then move outward to cover an entire industry while keeping Apple at the central point. This is the opposite of what is typically done as many start with an industry focus and then analyze specific companies.
It’s never been easier to get a paid membership site off the ground, which means it’s never been harder to find success. Start-ups focused on handling much of the back end needed for paid membership sites have reduced the barriers that traditionally prevented writers, journalists, analysts, podcasters, and videographers from monetizing audiences. This has increased competition as everyone is ultimately fighting for people’s attention. However, outsourcing the back end ends up being the simple part. Based on my experience over the past five years, the technical details of starting a membership site (creating a website / finding a payment and membership system / managing a mass email - all of which I built piece by piece myself instead of relying on a one-stop shop) pales in comparison to the time and effort spent on offering analysis and perspective on a daily basis. Your perspective is ultimately what people will be paying for, and there isn’t any outsourcing of that critical ingredient.
Successes and Challenges
The “secrets” to success with paid membership sites are multifaceted. What has or hasn’t worked for me may or may not apply to others. With that said, here are my keys to success.
Keys to Success
Focus. As most entrepreneurs who have started businesses can attest to, a constant stream of opportunities arise along the way. These opportunities take the form of ideas such as “maybe should I do this" or “that would be an interesting feature." However, saying “yes” too much will result in dilution of both one’s time and effort. Said another way, being able to retain focus by saying “no” more often than “yes” has been one of my primary keys to success. The cornerstone of Above Avalon membership hasn’t changed in five years: four daily updates per week (each having about 2,000 words and covering three stories). To date, approximately 1,000 daily updates have been published.
Sustainability. It’s an interesting phenomenon but success brings on more success in this industry, and it all has to do with consistency. Above Avalon members have come to expect an exclusive daily email in their inboxes, and that is exactly what they get on a daily basis week after week, month after month, and year after year. Of those members who have chosen to step away from membership at some point over the past five years, a good percentage have returned to find that my daily discussion with members via the updates hasn’t missed a beat. Such consistency wouldn’t be possible if I spent years throwing things against the wall and constantly reinventing membership in attempt to find financial sustainability.
Membership quality. Every paid membership site must weigh the relationship between pricing and membership growth. Many news sites that have recently entered the realm of paid subscriptions are pivoting to chasing subscriber growth with drastic promotional offers and unsustainably low monthly pricing. Such a strategy doesn’t have many paths for success. With Above Avalon, I made the decision to focus on long-term, high-quality membership relationships. This has resulted not only in reduced churn (a good thing), but also continued subscriber growth as my priorities have allowed me to remain focused on adding value to membership (versus trying to boost subscriber numbers). The end result is membership that offers more value than its cost with these two variables not being anywhere close to each other.
Strive to be the best. One of the loudest criticisms surrounding paid subscription sites is that people are experiencing subscription fatigue. There is truth found with the statement. However, there ends up being much more going on behind the scenes that is rarely mentioned. There is no such thing as an “average” subscriber or subscription load. The top three subscription sites for one person will likely be different from the top three sites for someone else. To succeed, a paid membership site doesn’t have to earn a spot on everyone’s top three list. Instead, the site has to resonate with only a “few” people. This involves embracing a “be the best” mantra that entails making sure you are at the top of your game in your respective beat. After five years, I am confident in saying that this thinking has played a role in Above Avalon membership success.
There are variety of challenges found with paid membership business models, especially for one-person shops. Here have been my largest challenges:
Challenges
Exposure. While those who work at massive media outlets with teams numbering in the hundreds or even thousands have built-in amplification apparatuses for sites like Twitter (where everyone retweets each other’s articles), Above Avalon has to fight for exposure. At times this can be challenging, especially given my niche focus. I depend primarily on word of mouth for new Above Avalon weekly article readers and podcast listeners. Those two products remain my primary funnels for member acquisition. This is why having Above Avalon readers, listeners, and members (and there may be overlap among those three groups) share articles, podcasts, and daily update links is highly appreciated.
Workload. Simply put, I work a lot, to the point of being embarrassed some days by how long a daily update took to write (up to 12 hours). However, I’m happy to say that every update that I’ve published to date has met my publication standards. A consequence of this reality has been scaling back on the number of articles and podcast episodes that are published as there is only so much time in a day. Instead of rushing ideas out via shorter pieces or rushed podcast episodes, I decided to simply publish and record less often and instead dedicate the vast majority of time to Above Avalon members. My estimate is that 90% of my time in any given month is dedicated to membership with the remaining 10% going to weekly articles and podcasts (which are accessible to everyone).
Hesitation. As many artists can attest to, there is a difference between creating something with the expectation that people may or may not ever see it and creating something knowing that it will be seen. As Above Avalon readership has grown over the years, I’ve struggled at times with hesitation when hashing out certain ideas or theories. A daily update format ends up alleviating some of this hesitation as I end up talking with people who are likely to be more aware of my theories and perspective.
Other Items:
Reading habits. One debate that continues to be waged online is over people’s changing reading habits and the trend of people writing shorter pieces. For example, it has been said that blog posts are replacing books while tweets are replacing blog posts. My honest opinion of this is that it’s hogwash. Having tried my hand at tweet storms for a period, there is no question that shorter snippets of text composed in a style meant to grab one’s attention can lead to more Twitter followers, retweets, and likes. Why else would people publish tweet storms? However, the tweets comprising such storms are forgotten within a few hours and to be frank, lack depth. Meanwhile, I can easily recall certain blog posts and books that I read years ago. That isn’t a coincidence or just a result of blog posts and books being longer. Instead, writing is a powerful art that shouldn’t be manipulated just to chase social media engagement. The trend of shortening blog posts into what is just a series tweets is ultimately a growth hack.
Viability. Is it possible for other “Above Avalons” to exist (one or two-person shops focused on companies other than Apple)? Sure. The more important question comes down to how long it will take someone to find an audience. For example, if someone wants to dedicate his or her career to covering Coca-Cola, there is no question 1,000 to 10,000 people in the world would be interested in paying for top-notch analysis and perspective on the company. However, can someone find those 1,000+ people within a reasonable time period before the groceries and other household bills take over? That’s much less clear. As for covering other popular companies like Amazon and Tesla, my theory is that a company needs to have a defined and storied culture in order for an outside observer to properly analyze the company. Covering Tesla in the Above Avalon style ultimately comes down to analyzing Elon Musk, and that is an entirely different job. Meanwhile, covering Amazon presents its own challenges as the company is all about throwing things against the wall and seeing what sticks. With Apple, there is a decades-long track record of a corporate culture and mission that ultimately makes it possible to analyze the company’s strategy, actions, and future.
Gratitude
In the blog post announcing Above Avalon membership back in 2015, I began with the following:
“Above Avalon will be 100 percent supported by its readers, and I'm very excited about that model. I am confident this will assure that Above Avalon will continue to serve as a vibrant, independent source of unique perspective on Apple for a very long time.”
While I had a good hunch that the model was going to work, I ultimately had no way of knowing for sure. Over the subsequent days, weeks, months, and then years, I passed certain thresholds like the point of first reaching financial sustainability or the time that the first annual memberships came up for renew. Those milestones ended up being validation markers more than anything else - signs that I was on to something.
This fifth-year anniversary feels different in comparison to those previous milestones. Instead of seeking validation, it’s a time for being grateful by taking a moment to think about and recognize those who have helped Above Avalon get to this point.
At the end of every Above Avalon podcast episode, I usually say a variation of “I am proud to say that Above Avalon is fully sustained by its members.” That pride is born out of a gratefulness that there are people out there who allow me to share my perspective on the world.
To all Above Avalon members: Thank you.
Here’s to a great first five years and to many more.
Listen to the corresponding Above Avalon podcast episode for this article here.
Above Avalon Podcast Episode 167: A Stock Buyback Poster Child
Share buyback is one of a handful of tools that boards and management teams have to properly manage balance sheets. However, economic fallout related to the pandemic has led to a new round of criticism aimed at buyback. In episode 167, Neil discusses how Apple has become the poster child of responsible share repurchases. Additional topics include: Apple’s recent stock buyback activity, Neil’s expectation for Apple’s upcoming update to its buyback program, the latest criticism surrounding buyback, repurchasing shares in a pandemic, and the harsh reality found with stock buybacks.
To listen to episode 167, go here.
The complete Above Avalon podcast episode archive is available here.
Apple's $460 Billion Stock Buyback
Share buybacks have once again come under fire. Some companies that were recent buyers of their shares now find themselves in financial distress and seeking bailouts due to economic fallout from the pandemic. Set within this environment and backlash, Apple is scheduled to provide an update next week on its capital return program, including its share buyback program. The announcement will provide clues for how the poster child of responsible share repurchases is financially navigating the pandemic.
Buyback Pace
Since kicking off its repurchase program in 2013, Apple has spent $327 billion to buy back 2.5 billion shares at an average price of $131 per share. The following exhibit shows Apple’s buyback activity on an annual basis:
Exhibit 1: Apple Share Buyback Pace (Annual - FY)
The pickup in Apple’s buyback pace in FY2018 and FY2019 was due to U.S. tax reform and Apple utilizing cash that had been in non-U.S. subsidiaries. Last year, Apple spent $55 billion buying back 283 million shares (at an $194 average price) in open market transactions. Adding this total to $12B of accelerated share repurchases, Apple spent a total of $67 billion on share buyback. To put that total in perspective, it’s more than the market capitalization of 85% of the companies in the S&P 500.
Buyback Authorization
Every April, Apple’s board of directors, in consultation with management, assesses business trends, the operating environment, and Apple’s financial position, to arrive at an appropriate level of capital return (share repurchases and quarterly cash dividends).
The board has authorized seven consecutive increases to Apple’s share buyback program since the program launched in 2012:
2012: $10 billion buyback authorization
2013: $60 billion (increase of $50 billion)
2014: $90 billion (increase of $30 billion)
2015: $140 billion (increase of $50 billion)
2016: $175 billion (increase of $35 billion)
2017: $210 billion (increase of $35 billion)
2018: $310 billion (increase of $100 billion)
2019: $385 billion (increase of $75 billion)
At the end of December 2019, Apple had $59 billion of share repurchase authorization remaining. Assuming Apple bought back at least $10 billion of shares in FY2Q20 (January to March 2020), the company likely had somewhere closer to $50 billion of authorization remaining at the end of March. This means that without additional authorization, Apple would have about seven months worth of share repurchases remaining. Accordingly, there is a strong likelihood of Apple’s board announcing the eight consecutive increase in share repurchase authorization next week.
My expectation is for Apple’s board to announce a $75 billion increase to buyback authorization next week. This would allow Apple to continue buying back shares at the same pace that it has for the past 24 months. Such an authorization would bring Apple’s total repurchase authorization since 2012 to $460 billion. In order to add flexibility to such authorization, especially given the current environment, Apple will likely have more than 12 months to utilize the authorization. This means that if operating conditions continue to deteriorate over the next 12 months, Apple will have the ability to slow down its share buyback pace and run with a higher level of untapped repurchase authorization.
Although companies are not under obligation to utilize share repurchase authorization, Apple has approached its authorization differently. Many companies announce a new share buyback program in order to benefit from the near-term stock price bump often associated with the announcement. These companies never actually intend to utilize the full buyback authorization. Meanwhile, Apple has been an aggressive repurchaser of its shares, which require material increases in buyback authorization every year.
Buyback Criticism
In recent weeks, share buyback has once again been put under a microscope. The act of taking cash on the balance sheet to buy back shares from shareholders willing to sell is no stranger to criticism. Prior to the pandemic, the most recent uproar regarding buyback occurred during the U.S. tax reform debate as some felt it wasn’t right for companies to use repatriated cash to repurchase shares (and pay cash dividends).
With passenger airline travel coming to a near halt, the airliners find themselves in a dire financial situation. Delta is burning through $60 million of cash a day. The airlines were quick to seek U.S. taxpayer-funded bailouts in the form of grants and loans. The entire episode has left a bad taste in many mouths as the airlines had been aggressive share repurchasers. Instead of establishing some kind of rainy day fund, the airlines used free cash flow to fund share repurchases at prices significantly higher than current stock prices.
Past financial crises have also provided examples of share buyback gone wrong. Some insurers who were busy buying back their shares in 2007 ended up needing to issue shares at significant discounts not long after due to holding toxic mortgage investments. The gas and energy industry turned to share repurchases when oil was at $100 a barrel.
With each example, we have boards and management teams who felt it was prudent in good economic times to buy back their shares. It’s fair to ask if some of these companies used share buyback primarily to hide financial and business shortcomings elsewhere. Bad actors can utilize share buyback for near-term manipulation either through improper signaling to the market or financial engineering. Reducing the number of shares outstanding via buyback results in higher earnings per share figures and return on equity percentages, all else equal.
The Poster Child
And then there is Apple. A very good argument can be made that Apple has become the poster child of responsible share repurchases. The company has relied on its stellar free cash flow to fund share repurchases over the years. Prior to U.S. tax reform and Apple keeping cash generated outside the U.S. in foreign subsidiaries, Apple issued debt at roughly the same pace as foreign cash generation. This resulted in Apple having $285 billion of cash, cash equivalents, and marketable securities on the balance sheet at the end of 1Q18. After two years of aggressive share repurchases, Apple’s cash total is now closer to $200 billion.
By funding buyback with free cash flow, share repurchases have had zero impact on the amount of cash Apple wants to spend on organic growth initiatives including R&D, M&A, and capital expenditures. Apple is using truly excess cash that it has no use for to repurchase its shares.
Partly to provide a buffer against adverse market conditions and to retain M&A flexibility, Apple is following a net cash neutral strategy which means that the amount of cash held on the balance sheet will eventually equal the amount of outstanding debt. Given Apple’s current debt holdings, this amounts to holding approximately a $100 billion cash cushion in the event of a rainy day. On top of that, given Apple’s unique capex-light business model, the company is able to generate tens of billions of dollars of free cash flow each year even with lower sales due to a global recession.
Since share buyback makes financial sense when repurchases are done at a share price that is less than a company’s intrinsic value, it is much harder to assess a buyback’s effectiveness, or the amount wealth transferred between shareholders selling and holding shares.
The Above Avalon Report, “Share Buyback 101: An Examination of Apple’s Share Repurchase Strategy” contains much more detail on the wealth transfer dynamic found with share buyback. The report is available exclusively to Above Avalon members.
In theory, management teams are in the best position to estimate their company’s intrinsic value. However, it’s easy to see hubris enter the situation with management teams overestimating their strengths while ignoring or downplaying weaknesses and risks. Since Apple is a design company tasked with making tools for people, having an inside view of the product pipeline plays a major role in estimating Apple’s intrinsic value. This may end up giving Apple management an advantage when it comes to assessing buyback’s effectiveness.
Buybacks and the Pandemic
The pandemic has changed the buyback discussion for every public company. Using Apple as an example, it’s not that the company’s intrinsic value, which reflects Apple’s cash flow generating capability in the future, has changed because of economic fallout related to the pandemic. Instead, market dislocations in credit markets have led to a renewed focus on liquidity and balance sheet preservation.
Apple has shown the willingness in the past to pause share repurchases based on adverse market trends. It is possible that Apple paused the buyback last month while credit markets were acting abnormal or the situation in China didn’t bode well for the rest of the world. However, given its stellar balance sheet, there likely is no company in a better position than Apple to buy back shares during a pandemic.
Harsh Reality
The harsh reality found with share buyback is that not every company should buy back their shares. While we can debate just how much of a financial cushion a company should keep in case of a pandemic or natural disaster, it’s much easier to say that overextending a balance sheet in order to buy back shares is unwise.
As the airline industry shows us, additional considerations that should be prioritized when assessing a share repurchase program are the company’s business model, ability to access capital in adverse market conditions, and difference between share price and intrinsic value. A company’s intrinsic value should reflect the sustainability, or lack thereof, of the future cash flow stream.
Share buyback is one of a handful of tools that boards and management teams have to properly manage balance sheets. While some companies have no purpose using the tool, others can benefit immensely from the same tool. Instead of simply casting off share repurchases as ineffective, inappropriate, or even dangerous, attention should go to assessing how a company is using share buyback.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.
Above Avalon Podcast Episode 166: Uncharted Territory
Apple and its peers find themselves in the most difficult operating environment they have ever faced. In episode 166, Neil discusses Apple’s strategy for navigating the coronavirus pandemic. Additional topics include the various challenges Apple is currently facing, Apple’s toolmaking mission, how society doesn’t stop during a pandemic, and why strong brands get stronger during difficult times.
To listen to episode 166, go here.
The complete Above Avalon podcast episode archive is available here.
Moving Forward in a Pandemic
More has happened in the past month from a global economic and health perspective than in the past ten years. We are in uncharted territory as 200 million people in 21 U.S. states find themselves facing “stay at home” directives while a growing list of countries including Italy, Spain, France, Australia, the U.K., and India are in complete lockdowns. Travel around the world has essentially come to a standstill.
Although it may be natural to search for comparisons between the coronavirus pandemic and prior crises, such an exercise will prove inadequate. Silicon Valley finds itself in the most difficult operating environment it has ever faced.
Apple’s strategy for navigating the coronavirus pandemic is centered around continuing to move forward, however difficult that is proving to be. Along those lines, management is taking recently learned lessons from how coronavirus trended in China, South Korea, and Japan to come up with a blueprint for what to do around the rest of the world.
Key Developments
Over the past two weeks, Apple has announced a number of initiatives and actions related to slowing the coronavirus pandemic in the U.S. and around the world. This includes helping those workers on the front lines.
Apple and its corporate peers were early in embracing social distancing and allowing employees to work from home.
Apple was the first major retailer to close its retail stores in the U.S. The decision wasn’t a light one as Apple stores are vital sources for customers looking to get help and service for their communication devices. A third of Apple store visitors are there for service.
Apple has joined most of its peers in donating medical supplies that had either been stockpiled to protect employees from California wildfires or were in some way connected to the company’s extensive supply chain and manufacturing apparatus.
The preceding actions are desperately needed and should be applauded and serve as a model for others to follow.
There were two other announcements from Apple that spoke volumes as to how the company planned to navigate the coronavirus pandemic:
Unveiling a reimagined and revised WWDC. With Apple historically holding its annual developer conference in June, the company had the time to turn misfortune into something positive by turning the cancellation of an in-person conference into a reimagined online-only WWDC (still scheduled to take place in June).
Unveiling a number of new products. Apple announced updates to the MacBook Air, Mac mini, iPad Pro, a new Magic Keyboard (with trackpad) for iPad, 20 new Apple Watch bands, and iPadOS 13.4 which brought system-wide support for cursors, trackpads, and mice.
As large portions of the U.S. hunkered down to combat the coronavirus and Apple’s board likely invoked certain provisions of its business continuity plans given the sudden deterioration in market and operating conditions, Apple went forward with plans for its biggest event of the year and its spring product release.
Along with doing its part to help combat the virus, Apple is also recognizing the reality that society doesn’t stop, even during a pandemic. That decision may come off as distant, or even careless, as if Apple isn’t willing to recognize the seriousness of the matter. However, this is a misreading of the situation.
By continuing to move forward, even during a pandemic, Apple is being true to itself. Apple is a toolmaker developing products capable of improving people’s lives. Such a mission never stops, even during a pandemic plaguing 180+ countries.
Anecdotal reports out of China point to sustained demand for iPads, despite lockdowns and quarantines, as families look for education tools to supplement children’s time away from the classroom. The U.S. now finds itself in a similar situation with some states having closed schools indefinitely. Employees are finding that work obligations haven’t disappeared, even in the face of new challenges in the form of closed schools, daycares, and the need to keep families safe.
In such trying times, we still need functioning tools in the form of smartphones, laptops, desktops, and even wearables, not to mention accompanying services and software powering those tools. One has to imagine FaceTime usage is at record highs as video calls replace face-to-face interactions.
Challenges
It would be an understatement to say that Apple faces challenges in its quest to continue moving forward in the midst of a pandemic.
Consider the following developments:
Stay at Home Directives. California is currently in a “stay at home” directive under which residents are urged to stay at home and only leave the house for essential needs such as food and medicine. California’s governor doesn’t think there will be any significant change to the order through at least mid-April.
Tim Cook, along with most other Silicon Valley CEOs, is following the order and working from home (as shown in the video clip below).
Google positioned the order as a key factor for canceling I/O, its annual developer conference, altogether. Apple’s announcement of running with a revised WWDC this June was announced prior to California’s stay at home order. It’s not entirely clear how Apple can create an online-only WWDC while employees are urged to stay at home. In a worst case scenario, will we see executives give presentations and product demoes from their homes?
Social Distancing. There is irony found with how social distancing efforts, which have been proven to be very effective in slowing the virus spread, stand at odds with the vision and goal behind Apple Park as a place for spontaneous collaboration. Even when stay at home directives are rolled back, Apple still faces a massive challenge in keeping employees safe from the virus at Apple Park and other corporate offices.
Retail Closures. Apple’s 460 stores outside Greater China have been closed indefinitely with most of Apple’s 70,000 retail employees unable to help hundreds of millions of Apple users. While Apple has announced plans to slowly reopen stores, the company is taking a localized (and cautious) approach to such openings.
Travel Restrictions. Apple’s massive supply chain and manufacturing apparatus require Apple employees to spend time with partners on the ground and to collaborate on product development. Last year, an unintentional leak from United Airlines showed that Apple was responsible for 20% of all business seats that fly between San Francisco and Shanghai. It’s an astounding percentage that speaks to the degree to which Apple’s design, engineering, and operation teams spend time in Asia. The coronavirus pandemic has resulted in a near halt in global travel, and it is logical to assume this will have an impact on product development timelines.
Operating Environment
A scenario that many people may not want to admit to is that the next 12 to 18 months may be the most difficult operating environment Silicon Valley will ever face. Even if the U.S. is successful at slowing the virus spread in hot spots, ongoing travel restrictions around the world will cause long-term headaches. There are then the possibilities of additional virus waves in the fall and winter. This may end up leading to permanent changes in how companies get work done.
Some of the challenges found with the coronavirus pandemic may very well lead to product launches being delayed. Despite having one of, if not the, most formidable supply chains in the world, Apple isn’t immune to disruptions. The products Apple unveiled last week were mostly ready to go prior to the coronavirus pandemic spreading around the world. As a general rule, the products Apple is working on today are targeted for release 12 to 18 months from now.
Despite having $40 billion of cash and cash equivalents and another $167 billion of marketable securities on the balance sheet, is it imperative that Apple recognizes market dislocations in short-term lending markets. There is then the potential financial fallout from a prolonged period of subdued customer demand. No one knows for sure whether or not customer demand will snap back in the U.S. and Europe once stay at home directives and lockdowns have been rolled back. China, South Korea, and Japan provide hope that the demand answer is yes. However, the U.S. is clearly attacking coronavirus differently and that may mean that the rebound will trend differently as well. Even stellar balance sheets can turn south in a prolonged pandemic.
While the preceding challenges are daunting, a realization that is only now starting to sink in is that the top five giants (Apple, Amazon, Microsoft, Alphabet, and Facebook) have business models that aren’t dependent on the public leaving their homes. It’s an observation that will have implications for decades to come.
Strong Brands
Apple finds itself at an advantage to most of its peers as it saw firsthand how China, South Korea, and Japan handled coronavirus (and are now working to keep the virus at bay). In terms of the supply chain, Tim Cook and his inner circle were at the company during the SARS outbreak in 2003. Jony Ive reportedly spent three months quarantined at Foxconn during the SARS outbreak, working on the Power Mac G5 Tower. The current executive team was also at Apple during the aftermath of September 11th, 2001 when Apple unveiled the iPod six weeks later. There are then the natural disasters that Apple’s supply chain works around. However, there is something about the coronavirus pandemic that is different. It’s a challenge like Apple has never faced.
Earlier this week, Nike reported earnings (which were better than consensus expected). Nike’s new CEO, John Donahoe, of eBay fame, said “We know it’s in times like these that strong brands get even stronger.”
He’s right. The best brands will come out of this challenging time stronger than ever. Why? The companies with the best brands always strive to continue moving forward.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.
For additional discussion on this topic, check out the Above Avalon daily update from March 30th.
Above Avalon Podcast Episode 165: The iPad's First Decade
There was no shortage of writers, pundits, and industry analysts using the iPad’s 10th anniversary las month to give eulogies for the product in terms of its inability to be revolutionary, grab momentum, or even just meet expectations. In episode 165, Neil discusses his perspective on the iPad’s first decade and why we shouldn’t feel bad for the iPad. Additional topics include a different way of looking at the iPad unveiling in 2010, how the iPad foreshadowed iPhone success, how Apple pivoted the iPad, the iPad’s primary problem today, and how the iPad’s value is found in letting the product be itself.
To listen to episode 165, go here.
The complete Above Avalon podcast episode archive is available here.
Don't Feel Bad for the iPad
Last month marked the tenth anniversary of Apple unveiling the iPad. The occasion took on a somber feel as the most common reaction in tech circles ended up being sadness and disappointment for what the iPad had failed to become. While some are convinced that the iPad is in some way a victim of neglect, mismanagement, or even worse, such feelings are misplaced. We don’t need to feel bad for the iPad.
Anniversary Reactions
Apple unveiled the iPad on January 27th, 2010. To mark the tenth anniversary of the unveiling, a few publications had articles recapping the iPad’s first decade. Some of the reactions were complicated, to put it gently.
Here’s John Gruber, over at Daring Fireball, in a post titled, “The iPad Awkwardly Turns 10”:
“[Steve] Jobs’s on-stage pitch was exactly right. The iPad was a new class of device, sitting between a phone and a laptop. To succeed, it needed not only to be better at some things than either a phone or laptop, it needed to be much better. It was and is.
Ten years later, though, I don’t think the iPad has come close to living up to its potential. By the time the Mac turned 10, it had redefined multiple industries. In 1984 almost no graphic designers or illustrators were using computers for work. By 1994 almost all graphic designers and illustrators were using computers for work. The Mac was a revolution. The iPhone was a revolution. The iPad has been a spectacular success, and to tens of millions it is a beloved part of their daily lives, but it has, to date, fallen short of revolutionary.”
Ben Thompson, over at Stratechery, agreed with Gruber and went further in his own article, “The Tragic iPad”:
“It’s tempting to dwell on the [Steve] Jobs point — I really do think the iPad is the product that misses him the most — but the truth is that the long-term sustainable source of innovation on the iPad should have come from 3rd-party developers. Look at [John] Gruber’s example for the Mac of graphic designers and illustrators: while MacPaint showed what was possible, the revolution was led by software from Aldus (PageMaker), Quark (QuarkXPress), and Adobe (Illustrator, Photoshop, Acrobat). By the time the Mac turned 10, Apple was a $2 billion company, while Adobe was worth $1 billion.
There are, needless to say, no companies built on the iPad that are worth anything approaching $1 billion in 2020 dollars, much less in 1994 dollars, even as the total addressable market has exploded, and one big reason is that $4.99 price point. Apple set the standard that highly complex, innovative software that was only possible on the iPad could only ever earn 5 bucks from a customer forever (updates, of course, were free).”
There were then tweets (lots of tweets), regarding the current state of iPad. Here are two:
Riccardo Mori: “What I believe is that the iPad and its OS could have been so much more than a reinvention of the computing wheel adapted for a touch interface.”
Loren Brichter: “[T]he App Store is what killed the iPad.”
You get the point. There was no shortage of writers, pundits, and industry analysts using the iPad’s 10th anniversary to give eulogies for the product in terms of its inability to be revolutionary, grab momentum, or even just meet expectations.
A handful of people talked highly of iPad on its anniversary. However, such perspectives were few and far between. Interestingly, the articles that were published still ended up including noteworthy disclaimers and qualifiers. For example, here’s Om Malik in “iPad at 10. An affair forever”:
“A decade after its introduction, I think the iPad is still an underappreciated step in the storied history of computing. If anything, it has been let down by the limited imagination of application developers, who have failed to harness the capabilities of this device.”
My Reaction
I hold a very different view of the iPad at 10 years old. In recapping the 2010s, I went so far as to position the iPad as one of two most important tech products of the decade (the iPhone being the other one). The iPad has become ubiquitous in various industries and sectors, and in the process, it has altered modern computing.
How can there be such a dramatic difference in opinion when it comes to iPad?
Different perspectives.
To see how important perspective becomes in this discussion, we need to go back to the iPad unveiling in January 2010.
Selling a Problem
A closer look at the iPad unveiling reveals it wasn’t that Steve successfully made the sales pitch for a new product category. Instead, Steve successfully sold consumers on a problem they weren’t even aware they faced.
A few daily tasks like email, web browsing, video watching, and mobile games could be better handled on a large piece of glass with multi-touch than on a small piece of glass with multi-touch (iPhones) or a non-multi touch device (MacBooks). Such juxtaposition elevated the iPad at the expense of the iPhone and Mac. The iPhone was positioned as a tiny device designed for portability while the Mac was positioned as a heavy beast blown out of the water by iPad when it comes to handling simple tasks.
Consumers agreed with Steve that there was an indeed a problem and that the iPad was a genuine solution to the problem. The iPad became Apple’s best-selling product out of the gate with the company selling 22 million devices in just the first 12 months. Ten years later, it is difficult to envision a new Apple product that will be able to grab that kind of adoption so quickly.
The iPhone
In January 2010, the iPhone was more of an idea and a promise than anything else. When the iPad was unveiled, there were only about 30 million people using an iPhone. Apple now sells that many iPhones in about two months. In 2010, it was the iPad, not the iPhone, that was considered to be the more important product in the future.
Given such lofty expectations, maybe it shouldn't have come as a surprise that the iPad’s tenth anniversary was met with awkwardness, sorrow, and even sadness as some look at the product as a promise that wasn’t kept. However, the early promises found with the initial iPad were met. There was just an unexpected twist.
The iPhone ended up carrying the vision found with a larger piece of glass supporting multi-touch that Steve unveiled on stage in January 2010. As iPhone screens became larger over the years, the product leveraged the inspiration found with the initial iPad and turned it into something consumed by nearly a billion people. There are 32x more iPhone users in the world today than there were when the iPad was unveiled in 2010. The iPhone became an iPad that fit in one’s pocket. Based on the iPhone’s resounding success, it is fair to say that those early calls that the iPad would turn into something very big ended up being true.
A Pivot
Instead of raising the white flag and letting the iPad set sail into the sunset after being replaced by the iPhone, Apple pivoted the product category to accomplish two things:
Serve as a content creation machine (Apple Pencil for drawing / keyboard accessories for typing).
Represent a low-cost entry point into the Apple ecosystem ($329 starting price).
Those two changes gave the iPad a very successful second chapter. Unit sales have stabilized at 45 million per year with approximately 20 million new people entering the iPad installed base each year.
The iPad is currently shaping industries far more than some people are giving the product credit for. There are at least 350 million people using an iPad in some capacity. The iPad has indirectly added billions of dollars of market cap to companies ranging from Slack and Microsoft to Square when considering the product’s widespread adoption and influence in enterprise settings.
A Line in the Sand
The iPad has become a line in the sand between those who grew up on laptops and desktops and those who never felt comfortable with such devices. Apple finds itself walking a thin line when it comes to adding functionality to the iPad for some users while keeping the device’s simplicity and intuitiveness front and center for other users.
Multi-tasking is a great example of this battle. For instance, some Mac users are not pleased with Apple’s implementation of multi-tasking on the iPad. These users find multi-tasking on an iPad to be a mental exercise. Meanwhile, a portion of iPad users have no need or desire for multi-tasking on iPad. These users are also likely to view multi-tasking on a laptop or desktop as not intuitive. Going a week with no laptop or desktop usage will do interesting things to one’s perception about computing and intuitiveness. When returning to a laptop or desktop, the machines feel like taking a step back. Our brain has to be rewired to handle something that is inherently less intuitive.
The iPad’s Problem
Apple doesn't sell perfect products. There will always be room for improvement, refinement, and new thinking. In some ways, the lack of perfection is what serves as motivation for Apple to keep pushing. When defining the problems now facing the iPad, my criticism is a bit unconventional.
The iPad’s primary problem is that it is viewed by some as needing to be a laptop replacement in order to have any value. This unrealistic viewpoint has resulted in a type of expectational debt being placed on the device. The iPad is expected to become more like the Mac and macOS over time. This is problematic as the iPad is not a laptop replacement.
MacOS should not be positioned as inspiration for where to bring the iPad or iPadOS. This isn’t meant to belittle macOS. Instead, touch-based computing has blurred the line between consumer and professional devices. When debating content consumption versus content creation and the broader definition of work, there is a habit in tech circles to not consider how such terms have dramatically different meanings for hundreds of millions of people.
The takeaway is that the iPad has become a different kind of product, and it should be allowed to stand apart from the iPhone without being forced to replace macOS. Hence, there is iPadOS and things like Apple Pencil support. Instead of asking how best to handle multitasking on an iPad, a better question is to wonder what multi-tasking should even mean on an iPad. Such questions present new challenges regarding user interfaces and design.
Being Itself
Apple’s product strategy is to push all of its major product categories forward at the same time. This is different from pushing the iPhone forward and trying to have the iPad and Mac come along for the ride. Positioning the iPad as a content creation platform for the masses, designed to handle some tasks given to laptops and desktops while also handling completely new tasks, is a winning strategy. It allows the iPad to be itself while not forcing the product into a corner in order to satisfy certain segments of the Apple installed base.
A lot has changed during the iPad’s first 10 years. Some may be disappointed with how the iPad has evolved, even to the point of thinking Apple lost a great opportunity. However, I wouldn’t feel bad for a device that revealed the iPhone’s true potential and then became a different kind of content creation tool now used by more than 350 million people.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.
For additional discussion on this topic, check out the Above Avalon daily update from March 2nd: The iPad’s First Decade, The iPad’s Second Decade.
Above Avalon Podcast Episode 164: Competing with Spotify
We are entering a new chapter in music streaming. In episode 164, Neil discusses how Spotify’s attempt to evolve from a dedicated music streaming service to an audio company ends up reflecting broader changes in the music streaming space. Additional topics include Spotify earnings, the music streaming war between Spotify and Apple Music, the problem with Spotify’s current business, roadblocks / advantages facing Spotify as it evolves into a different kind of company, and why Apple shouldn’t ignore Spotify’s evolution.
To listen to episode 164, go here.
The complete Above Avalon podcast episode archive is available here.
Spotify Is Evolving
Spotify sees the writing on the wall: It’s going to remain difficult to make a profit from streaming music. Despite years of remarkably strong user growth, the high variable costs found with music streaming continue to serve as a financial headwind. Spotify co-founder and CEO Daniel Ek isn’t standing still, however. Spotify is evolving, partly out of necessity, with the long-term goal of becoming the largest audio platform in the world. While the transition includes its fair share of challenges, Spotify has a few things going for it that should force competitors like Apple to take notice.
Spotify Earnings
Spotify's quarterly results have become predictable. Strong subscriber trends are offset by nonexistent profit and mediocre operating cash flow. Last week, Spotify reported 4Q19 earnings, and the results mostly fit the pattern. The company grew its subscriber total by 23 million in just three months (a very good number). Spotify’s cash flow showed a little bit of improvement although the numbers still don’t seem to reflect a company that grew its subscriber base by a whopping 65 million people in 2019.
As shown in Exhibit 1, the growth of Spotify’s ad-supported monthly active users (those on the free tier) and premium subscribers (those on the paid tier) is not showing any signs of slowing. Although ad-supported MAU growth had underperformed premium subscriber growth, that dynamic has reversed. This reflects that Spotify is seeing success in growing the streaming music pie by attracting new people into the fold. These new customers are more likely to enter through the ad-supported tier and then possibly migrate to the paid tier over time.
Exhibit 1: Spotify Subscriber Growth Trends
In taking a closer look at Spotify’s subscriber base, it becomes evident that the company continues to see much of its growth in geographies where Apple has little to no presence. This suggests that recent subscriber growth has resulted from Spotify becoming a preferred choice for Android users looking to free, ad-supported music.
The Music Streaming War Has Quieted Down
For years, the music streaming war between Spotify and Apple Music was fought over subscriber totals. The back-and-forth subscriber disclosures between Spotify and Apple Music were closely monitored. At first, consensus thought Spotify had received too large of a first mover advantage for Apple Music to find any traction. Once that theory was busted, attention turned to the pace of new subscriber growth.
In 2019, Spotify grew its premium subscriber total by a little more than 2.0 million per month while Apple’s paid subscriber growth figure for Apple Music was closer to 1.3 million per month. Given how Apple Music now has more than 60 million paying subscribers, we can confidently say that both Apple Music and Spotify have “won” in music streaming. Each company has enough scale to matter.
Spotify’s Problem
Even though Spotify continues to see strong subscriber growth, the additional scale hasn’t resulted in dramatically improved financials. The problem is found with the high variable costs associated with music streaming. For every dollar that Spotify brings in the door, only 25 cents is left to cover the costs of running the business after accounting for music rights and other cost of goods sold. For context, here are the most recent gross margins (on an annual basis) for the big five:
Facebook: 82%
Microsoft: 66%
Alphabet: 56%
Apple: 38%
Amazon: 20%* (estimated)
*Although Amazon may have a lower stated gross margin than Spotify, the numbers are misleading as the company is generating close to $40 billion of operating cash flow per year. The underlying business is kicking off cash although much of it has to be put back into the business to keep things running.
When considering the amount of R&D and marketing that is required to stay competitive with the giants, Spotify’s gross profit picture isn’t encouraging. As for attempts to improve its gross margins, Spotify has stressed items like charging content creators for various tools and trying to negotiate content cost savings. However, the elephant in the room is Apple Music. By having a successful alternative in the paid music streaming space, music rights holders are in a better position to retain their negotiation power when up against Spotify.
Music rights holders have been the big winners in the current music streaming landscape. Nearly 200M people are now paying somewhere between $5 and $10 per month for music between Spotify and Apple Music. Unfortunately, it has become harder than ever for music artists to find financial sustainability. Expectations regarding how music as an art form will be valued likely need to be reassessed.
An Evolution
In early 2019, Spotify began betting big on podcasts. Since the start of 2019, Spotify has spent more than $600 million buying Gimlet Media, Anchor, Parcast, and most recently, The Ringer. By getting into podcasts in a big way, Spotify is trying to evolve from a dedicated music streaming service dependent on music rights holders for achieving profitability to an audio company with a platform delivering audio entertainment to as many people as possible.
Spotify’s financial picture stands to improve if the company can better monetize its 280M subscribers. One of the primary goals in developing an audio platform consisting of podcasts is to generate higher gross margins by having subscribers spend time listening to something other than music. With a captive audience of hundreds of millions of people, Spotify is in an interesting position to be more of an advertising company. In the future, Spotify’s long-term strategy may include having third-party developers create new kinds of audio experiences.
The timing for such an evolution looks good for Spotify as we are in the midst of a headphones renaissance set within a wearables revolution. With the removal of wires, headphones are being transformed. We see Apple expand its wireless headphones portfolio to include various AirPods models and Beats headphones. According to my estimates, Apple is bringing in $9 billion of revenue per year from headphones. That is 25% higher than Spotify’s annual revenue. Apple’s $3 billion acquisition of Beats in 2014 is looking smarter by the day when thinking about the headphones piece of the acquisition. Beats headphones are now bringing in approximately $2 billion of revenue per year for Apple.
Roadblocks
Spotify faces an uphill battle while evolving into an audio company. The biggest obstacle is the lack of first-party hardware and other services like video streaming. The never-ending rumors that Spotify has been tinkering with hardware likely have merit. The company is at a severe disadvantage by not having first-party hardware solutions including stationary speakers, and more importantly, wearable devices.
Last year, Spotify declared war on Apple. Instead of fighting the battle in the marketplace over exclusive songs and albums, Daniel Ek wants to go after Apple in the courts and regulator backrooms with the goal of weakening Apple’s grip on the App Store and the broader Apple ecosystem. If successful in its pursuit, Spotify would find itself in a better position to leverage Apple’s ecosystem for its own ambitions versus the other way around, which is currently the case.
In the event of video and music bundling taking off, Spotify will find itself at another disadvantage as the company has limited financial resources that would allow it to get into video ($1.9 billion of cash, cash equivalents, and short-term investments). The company would need to continue relying on partnerships for bundling opportunities, which is far from ideal. Although Spotify has easy access to capital, the amount of cash flying around for original video content is daunting. This is another reason why Spotify hasn't been shy running into podcasting. While some of the valuations that Spotify has been willing to pay for podcast startups and talent may make people in the industry blush ($250M for The Ringer), on a relative basis to the video space, Spotify is able to make its cash go further with podcasts. Much of this is due to the podcast industry not being as developed a video from a monetization standpoint.
Advantages
Instead of cash or video, Spotify has something else going for it in its evolution: the ability to focus. Audio is commanding all of Spotify management’s attention as it represents everything for the company. Spotify is likely betting that the giants will continue to treat audio (not the same as voice) as a money-losing ancillary business.
Another way of thinking about this dynamic is that Apple’s $1.4 trillion market cap is 56x larger than Spotify’s $25 billion market cap. A doubling or tripling in Spotify’s market cap would be considered a huge validation in the company’s evolution strategy while Apple’s market cap fluctuates $25B to $50B on any given day.
Apple’s Perspective
In its current form, Spotify doesn’t pose much of a long-term threat to Apple. Spotify is a service that is consumed by a small percentage of Apple users mostly on Apple’s platform. However, Apple can’t and shouldn’t ignore Spotify’s evolution. One of the more effective ways for Apple to compete with Spotify over the long run is to figure out where the company is headed and get there first.
Success at building an audio platform with millions of engaged developers could give Spotify a beachhead in audio apps and make it an App Store alternative in a wearables world. In such an environment, audio stands to be a key ingredient capable of augmenting our surroundings.
It is in Apple’s best interest to recognize the threat that Spotify could pose and beat the company in establishing an audio platform. Apple can empower iOS developers to come up with new forms of content and workflows designed to be consumed on a range of wearables (along with mobile devices). Along with music and podcasts, there could be room for new mediums and experiences, many that can’t even be envisioned yet. In such a dynamic, Apple could then leverage its biggest advantage over Spotify: hardware and a broader platform with various services.
If consumers end up viewing an evolved Spotify as something consumed on Apple’s platform instead of looking at Spotify as a platform in of itself, Apple will have successfully countered Spotify’s evolution.
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.
Above Avalon Podcast Episode 163: A Revolution on the Wrist
In addition to being a sales success, the Apple Watch has ushered in a paradigm shift in computing. In episode 163, Neil discusses how the Apple Watch is fundamentally changing the way we use technology. Additional topics include paradigm shifts, Apple Watch sales, Apple’s new Apple Watch Connected initiative, stationary smart speakers as extensions of existing products, and Neil’s new framework for recognizing paradigm shifts in computing.
To listen to episode 163, go here.
The complete Above Avalon podcast episode archive is available here.
Apple Watch and a Paradigm Shift in Computing
Despite being only four years old, the Apple Watch has fundamentally changed the way we use technology. Due to the sheer number of Apple Watches now seen in the wild, those claiming the device is unpopular have been silenced. However, there continues to be a good amount of cynicism thrown at the computer found on 65 million wrists around the world.
Many tech analysts and pundits continue to look at the Apple Watch as nothing more than an iPhone accessory - an extension to the smartphone that will never have the means or capability of being revolutionary. Such a view is misplaced as it ignores how the Apple Watch has already ushered in a paradigm shift in computing.
Paradigm Shifts
The idea of paradigm shifts was born in the sciences to describe a scenario requiring a new way of thinking in order to explain the world. One of the more fascinating aspects of paradigm shifts is the accompanying social component. Due to the discomfort found with letting go of legacy thinking, society has a built-in aversion to acknowledging when a paradigm shift has occurred due to the discomfort found with letting go of legacy thinking. This makes it likely that paradigm shifts will often be born wrapped in skepticism and doubt.
In terms of computing, no one now questions the shift that took place from desktops and laptops to mobile devices. However, reality was messier as it took nearly a decade for consensus to view the smartphone as a laptop or desktop alternative. For years, smartphones were viewed as merely laptop and desktop extensions. What was initially viewed as a superior email machine for executives marked the start of a paradigm shift in the making.
We are seeing a similar dynamic take place with Apple Watch. Legacy thinking is masking Apple Watch’s transformational attributes. The product is misunderstood as Apple competitors are unsure of the answers to basic questions such as, why are consumers buying Apple Watches?
A Wrist Revolution
While pundits and analysts question what an Apple Watch is for, tens of millions of consumers around the world have recognized how the device can improve their lives. The product category is a sales success.
Apple has sold more than 90 million Apple Watches to date with 29 million sold in calendar year 2019. With an average selling price of more than $400, the Apple Watch is bringing in $12 billion of revenue per year, and that total is growing by 30% per year. After taking into account upgrade trends, the number of people wearing an Apple Watch has crossed 65 million. Based on my forward projections, the Apple Watch installed base will surpass 100 million people in 2021.
The preceding numbers are my estimates obtained by utilizing more than four years of financial clues and insights provided by Apple management in earnings calls, interviews, and presentations. More information on my methodology and the math behind these numbers is found in the Above Avalon daily update from December 11th. Above Avalon membership is required to read my daily updates.
Apple Watch and Paradigm Shifts
In addition to being a sales success, the Apple Watch has ushered in a paradigm shift in computing by making technology more personal in a way that other devices have failed to accomplish or replicate. The Apple Watch allows people to get more out of technology without having technology take over people’s lives. The device is able to accomplish this in three ways:
Seamless tracking and monitoring. The Apple Watch tracks one’s fitness and more importantly, health, in a nonintrusive and intuitive way that isn’t possible with non-wearable devices.
Intelligent assisting. Wearing a computer on the wrist has shown the value found in having a digital assistant push small amounts of information and data to the user throughout the day instead of having the user pull data from pieces of glass (smartphones and tablets).
Contextual awareness. A device that is always on us can enhance our surroundings by utilizing our location and activity to deliver contextual experiences. This is a valuable proposition when developing new experiences.
These three items combined allow Apple Watch to handle some tasks that we already give to existing devices like smartphones and tablets as well as jobs and work that cannot be supported by mobile devices.
Apple Watch Connected
Apple Watch’s ability to usher in a paradigm shift in computing isn’t about what ifs or hypotheticals. It's something that is already taking place. We have a growing list of ways Apple Watch is a different kind of computer, the likes of which we have never seen. The latest example is an initiative Apple soft launched two weeks ago with four fitness brands called Apple Watch Connected.
The initiative originated out of feedback shared with Apple from health and fitness clubs looking to better connect the Apple Watch with their own customer experiences.
There are four requirements for a health club or gym to be part of Apple Watch Connected (which is free for both the health club and Apple Watch wearer):
Support Apple Pay. Apple Watch wearers must be able to purchase items like water, classes, or even personal training on the wrist with Apple Pay.
iOS and watchOS Apps. Businesses must have apps that allow for things like signing up for classes.
Earn with Watch. Businesses must offer rewards and incentives to Apple Watch wearers for remaining active. Such incentives have proven to be an effective way to motivate Apple Watch wearers.
Support GymKit (if applicable).
Apple Watch Connected ends up being a tool that enables third-party gyms and health clubs to build stronger relationships with customers. This is accomplished when businesses leverage seamless activity and fitness tracking on the wrist to reward their customers for staying active.
The key ingredient for getting this initiative off the ground is having people wear an Apple Watch throughout the day. Trying to recreate this type of comprehensive experience on a dedicated fitness tracker used only during workouts, or even on a smartphone or tablet, would be the equivalent of trying to use a laptop or desktop to accomplish tasks that are simpler and more intuitive on an iPhone. There is no good or easy way to track our daily activity with a large piece of glass that may sometimes be in our pocket or strapped to our arm. Having to grab and hold this piece of glass when using mobile payments or checking location-based notifications and reminders would lead to an overall experience that is subpar.
The most intriguing aspect of Apple Watch Connected is how entrepreneurs can use Apple Watches to launch new business models. With legacy gyms, the idea was to have people pay for monthly memberships but then not show up so that fewer workout machines would be needed. Apple Watch Connected turns that idea on its head by allowing a gym or health club to establish a new kind of long-term relationship with customers that encourages continued workouts and activity. This kind of business model shift is an example of the new paradigm shift unleashed by Apple Watch.
Instead of simply taking the existing app model and applying it to the wrist, a new way of consuming “apps” has developed. Subscriptions are naturally more applicable to something like an Apple Watch as customers find value in long-term targeting, monitoring, and data curation.
A New Framework
I’m introducing a new framework for recognizing paradigm shifts in computing. This theory borrows heavily from my Grand Unified Theory of Apple Products which positions a product category's design as tied to the role it is meant to play relative to other Apple products.
More information on the Grand Unified Theory is found in the Above Avalon Report Product Vision: How Apple Thinks About the World. Reports are available to Above Avalon members at no additional cost.
Paradigm shifts in computing can be determined by monitoring the degree to which products are able to make technology more personal. This framework positions design (i.e. how we use products) as the catalyst for paradigm shifts in computing.
Over the past few decades, we have seen two such primary paradigm shifts in computing:
Laptops/desktops to smartphones.
Smartphones to wearables.
Neither shift was about a new product replacing an older product. Laptops and desktops are still used by hundreds of millions of people in a mobile world. Similarly, there will be billions of smartphones found in a wearables world.
Instead, the move from desktops and laptops to smartphones and tablets was ultimately about using design to remove barriers that existed between the user and technology. One way this was accomplished was using multitouch as a new way to interact with a device. However, mobile devices are not able to remove all barriers. Increased smartphone and tablet usage has revealed an entirely new set of barriers that we never knew existed. A device like Apple Watch relies on design to remove some of those recently discovered barriers.
One reason this new computing shift has not been universally accepted is because the Apple Watch still uses “training wheels” in the form of requiring an iPhone to set up. This iPhone reliance has led some to view Apple Watch as nothing more than an extension to the iPhone. However, such a claim focuses too much on the technology and not enough on how design is leveraged to alter the way we use technology.
As for an example of a genuine extension of the smartphone, stationary smart speakers are at the top of the list. Grand prognostications of stationary smart speakers ushering in a new era of computing have faded (which doesn't come as a surprise). The primary value found with a stationary smart speaker is being able to take up the physical space needed to house speakers for delivering better sound. In this way, the speaker ends up being a smartphone amplifier that comes in handy for consuming sound as a group activity.
Nearly every other task or role given to a stationary smart speaker could be given to an Apple Watch. The wrist ends up being a better solution given the presence of a screen. In addition, whereas stationary speakers are confined to a finite area (the inside of a room), Apple Watch has greater mobility than even smartphones and tablets as it is literally strapped to our wrist at all times.
Voice in and of itself is not a paradigm shift as the medium is incredibly inefficient for transferring large amounts of data and information. It also creates a massive wall that prevents us from getting more out of technology without having technology take over our lives. Meanwhile, the Apple Watch has become a bridge to the future by containing a screen.
Apple Watch in a Wearables World
Apple Watch isn’t alone in ushering in this new era of computing. Other wearable devices designed to leverage the unique attributes of the body (wrists, ears, and eyes) have a role to play. The attributes that have allowed the Apple Watch to flourish on the wrist are being translated to allow AirPods to become a platform for bringing augmented hearing to the masses. In the future, a pair of eyeglasses will be able to add visual context to our surroundings.
In each example, we have a fundamental rethink of how people use computers to improve their lives. The “training wheels,” or early technological bonds that may exist in the early reiterations of these devices should not be taken or viewed as permanent chains. Rather, they are early support systems designed to give wearables the power to change the way we use technology.
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For additional discussion on this article, check out the daily update from February 6th: A Paradigm Shift on the Wrist. The update goes over an example of how the Apple Watch isn't just addressing tech barriers that have been around for years, but also newer barriers that only recently became visible.