iphone

Apple Numbers For Normals: It’s The 5C, Stupid!

 

Today’s unscientific and friendly castigation of Apple’s iPhone 5C costly stumble: misdirected differentiation without enough regard for actual customer aspirations.

Here’s a quick snapshot of Apple’s numbers for the quarter ending December 2013, with percentage changes over the same quarter a year ago:

307TABLE JLG

We can disregard the iPod’s “alarming” decrease. The iPod, which has become more of an iPhone ingredient, is no longer expected to be the star revenue maker that it was back in 2006 when it eclipsed the Mac ($7.6B vs. $7.4B for the full year).

For iPhones, iPads, and overall revenue, on the other hand, these are record numbers…. and yet Apple shares promptly lost 8% of their value.

Why?

It couldn’t have been that the market was surprised. The numbers exactly match the guidance (a prophylactic legalese substitute for forecast) that was given to us by CFO Peter Oppenheimer last October:

“We expect revenue to be between $55 billion and $58 billion compared to $54.5 billion in the year ago quarter. We expect gross margins to be between 36.5% and 37.5%.”

(Non-normals can feast their eyes on Apple’s 10-Q filing and its lovingly detailed MD&A section. I’m sincere about the “lovingly” part — it’s great reading if you’re into it.)

Apple guidance be damned, Wall Street traders expected higher iPhone numbers. As Philip Elmer-DeWitt summarizes in an Apple 2.0 post, professional analysts expected about 55M iPhones, 4M more than the company actually sold. At $640 per iPhone, that’s about $2.5B in lost revenue and, assuming 60% margin, $1.5B in profit. The traders promptly dumped the shares they had bought on the hopes of higher revenues.

In Apple’s choreographed, one-hour Earnings Call last Monday (transcript here), company execs offered a number of explanations for the shortfall (one might say they offered a few too many explanations). Discussing proportion of sales of the iPhone 5S vs. iPhone 5C. Here what Tim Cook had to say [emphasis mine]:

“Our North American business contracted somewhat year over year. And if you look at the reason for this, one was that as we entered the quarter, and forecasted our iPhone sales, where we achieved what we thought, we actually sold more iPhone 5Ss than we projected.

And so the mix was stronger to the 5S, and it took us some amount of time in order to build the mix that customers were demanding. And as a result, we lost some sort of units for part of the quarter in North America and relative to the world, it took us the bulk of the quarter, almost all the quarter, to get the iPhone 5S into proper supply.

[…]

It was the first time we’d ever run that particular play before, and demand percentage turned out to be different than we thought.

In plainer English:

“Customers preferred the 5S to the 5C. We were caught short, we didn’t have enough 5Ss to meet the demand and so we missed out on at least 4 million iPhone sales.”

Or, reading between the lines:

“Customers failed to see the crystalline purity of the innovative 5C design and flocked instead to the more derivative — but flattering — 5S.”

Later, Cook concludes the 5S/5C discussion and offers rote congratulations all around:

“I think last quarter we did a tremendous job, particularly given the mix was something very different than we thought.”

… which means:

“Floggings will begin behind closed doors.”

How can a company that’s so precisely managed — and so tuned-in to its customers’ desires — make such a puzzling forecast error? This isn’t like the shortcoming in the December 2012 quarter when Apple couldn’t deliver the iMacs it had announced in October. This is a different kind of mistake, a bad marketing call, a deviation from the Apple game plan.

With previous iPhone releases, Apple stuck to a simple price ladder with $100 intervals. For example, when Apple launched the iPhone 5 in October 2012, US carriers offered the new device for $200 (with a two-year contract), the 2011 iPhone 4S was discounted to $100, and the 2010 iPhone 4 was “free”.

But when the iPhone 5S was unveiled last September, Apple didn’t deploy the 2012 iPhone 5 for $100 less than the new flagship device. Instead, Apple “market engineered” the plastic-clad 5C to take its place. Mostly built of iPhone 5 innards, the colorful 5C was meant to provide differentiation… and it did, but not in ways that helped Apple’s revenue — or their customers’ self-image.

Picture two iPhone users. One has a spanking new iPhone 5S, the other has an iPhone 5 that he bought last year. What do you see? Two smartphone users of equally discerning taste who, at different times, bought the top-of-the-line product. The iPhone 5 user isn’t déclassé, he’s just waiting for the upgrade window to open.

Now, replace the iPhone 5 with an iPhone 5C. We see two iPhones bought at the same time… but the 5C owner went for the cheaper, plastic model.

We might not like to hear psychologists say we build parts of our identity with objects we surround ourselves with, but they’re largely right. From cars, to Burberry garments and accessories, to smartphones, the objects we choose mean something about who we are — or who we want to appear to be.

I often hear people claim they’re not interested in cars, that they just buy “transportation”, but when I look at an office or shopping center parking lot, I don’t see cars that people bought simply because the wheels were round and black. When you’re parking your two-year old Audi 5S coupe (a vehicle once favored by a very senior Apple exec) next to the new and improved 2014 model, do you feel you’re of a lesser social station? Of course not. You both bought into what experts call the Affordable Luxury category. But you’re self-assessment would be different if you drove up in a Volkswagen Jetta. It’s made by the same German conglomerate, but now you’re in a different class. (This isn’t to say brand image trumps function. To the contrary, function can kill image, ask Nokia or Detroit.)

The misbegotten iPhone 5C is the Jetta next to the Audi 5S coupé. Both are fine cars and the 5C is a good smartphone – but customers, in numbers large enough to disrupt Apple’s forecast, didn’t like what the 5C would do to their image..

As always, it’ll be interesting to observe how the company steers out of this marketing mistake.

There is much more to watch in coming months: How Apple and its competitors adapt to a new era of slower growth; how carriers change their behavior (pricing and the all important subsidies) in the new growth mode; and, of course, if and how “new categories” change Apple’s business. On this, one must be cautious and refrain from expecting another iPhone or iPad explosion, with new products yielding tens of billions of dollars in revenue. Fodder for future Monday Notes.

JLG@mondaynote.com

@gassee

 

Shameless Carriers

 

Wireless carriers used to rule smartphone suppliers. In 2007, Steve Jobs upended such rules. Why can’t the carriers accept the change and enjoy the revenues the iPhone generates for them… and why do tech journalists encourage their whining?

Until about two weeks ago, it seemed that our major wireless carriers had given up whining about the unjust subsidies imposed by a certain overly-confident (they said) handset maker. I hoped that their silence on the topic meant that they had finally realized that the extra revenue (ARPU) generated by these smartphones more than made up for the “subsidy burden”, for the exorbitant amounts of money that (they thought) ended up in the wrong coffers.

Then, I saw this this headline:

Everyone Pays No 5c

The article’s lede promises to reveal secret Apple deals that squeeze rivals and tax you. According to the piece’s “logic”, Apple’s one-sided agreements force carriers to swallow inordinate numbers of iPhones, an arrangement that produces all-around nefarious results. To meet their volume commitments, carriers allocate disproportionate amounts of shelf space to iPhones, thus crowding out competitors. And because the Apple contracts drain their finances, carriers are forced to price other handsets higher than they otherwise would. Hence an “iPhone Tax” that everyone must pay, even when using another brand.

In the same piece, we find dark suggestions that Verizon is threatened by a $12B to $14B shortfall in meeting it’s $23B commitment to purchase Apple handsets. A bit of googling led me to a pair of July 2013 articles (here and here) that back up the prediction by pointing to an anal-ist’s write-up of Verizon’s SEC filings (a medium that, as Regular Monday Note readers know too well, I happily wallow in, especially the always-rich MD&A [Management Discussion and Analysis] section where execs are supposed to help us navigate the filing’s sea of numbers).

I went to Verizon’s SEC Filings page and looked up quarterly and annual reports. The first mention of an Apple agreement appears in the 10-K (annual) filing of February 28th, 2011. Since then, no word whatsoever of any purchase commitment, whether for the iPhone or any other device. If you search for “purchase” and “commitment” in the latest October 2013 SEC document, you’ll only find talk of pension funding and share-repurchase obligations:

Verizon 10-Q Oct 2013 Commitments

One would think that a looming $12B to $14B shortfall — more than a third of Verizon’s $30B quarterly revenue — would be mentioned to shareholders. The worried articles fail to explain Verizon’s silence.

This is both novel and familiar.

The novelty is finding Apple guilty of forcing carriers to raise prices on competitors‘ handsets. I hadn’t seen this angle before.

The familiar is the carriers’ use of journalists who present themselves as independent observers/reporters when, in fact, these practitioners of access journalism carry water for their corporate connections. During a lunch conversation some years ago with a Wall Street Journal repentito, I pointed to a fellatious Microsoft article in his old paper and questioned the excessive reverence: ‘Access, Jean-Louis, access. It’s the price you pay to get the next Ballmer interview… ‘

We saw the process at work in a December 2011 WSJ article titled How the iPhone Zapped Carriers, a devotional piece that makes the key points in the carriers’ incessant complaint:

Carriers do all the grunt work while handset makers and software developers take all the money.
The $400 subsidy per iPhone (and now a similar amount for its best competitors as well) is clearly excessive and must stop.
We need a new business model to account (to monetize) the shift from voice to voracious use of data.

Let’s rewind the tape. Once upon a time, there was The Way of The Carrier. Verizon, Sprint, AT&T treated handsets makers the way a supermarket chain treats yogurt suppliers: We’ll tell you the flavors and quantities we want to carry, we’ll set the delivery schedule, dictate the marketing/branding arrangements, define the return privileges and, of course, we’ll let you know what we want to pay for your product — and when we want to pay it.

Then Steve Jobs hypnotized AT&T’s management. He convinced them to let Apple set the terms for iPhone distribution in exchange for AT&T’s “running the table”. This meant no AT&T fingerprints on Apple’s pristine iPhone, no branding, no independent pricing, no pre-installed crapware — content and software would be downloaded via iTunes, only.

In this arrangement, the iPhone helped AT&T steal customers from its main competitor, Verizon. When Verizon finally signed up with Apple in 2010, they were in a much weaker position than if they had obliged at the very beginning of the Smartphone 2.0 era.

Apple is master of the slow-but-steady, surround-from-below approach. First, sign up a weaker player who will accept Apple’s stringent control in exchange for the opportunity to take business away from the dominant player who balks at Cupertino’s terms. After enough customers have switched to the smaller competitor, the market leader changes its mind and signs up with Apple — on Apple’s terms.

The drill has worked in Japan. The smaller SoftBank signed up with Apple while DoCoMo, Japan’s largest wireless carrier, refused. DoCoMo wanted to install its own software on the iPhone; Apple wouldn’t budge. Subscribers migrated to Softbank in numbers significant enough to change DoCoMo’s mind. The happy ending is DoCoMo and its competitors now appear to sell large numbers of iPhones.

Turning to China, the same maneuver is at work. China Unicom and China Telecom have been selling iPhones with the expected result: They’re taking customers from the giant China Mobile. (There are rumors of an Apple-China Mobile agreement, but it’s unclear when this will happen. We should know soon.)

This only works if – and only if – the iPhone is a great salesman for the carrier. Apple extracts a higher price for its iPhone for two reasons: strong volumes and higher revenue per subscriber compared to other sets. In Horace Dediu’s felicitous words [emphasis mine]:

‘I repeat what I’ve mentioned before: The iPhone is primarily hired as a premium network service salesman. It receives a “commission” for selling a premium service in the form of a premium price. Because it’s so good at it, the premium is quite high.’

Carriers should stop whining; these are robust companies run by intelligent businesspeople with immense resources at their disposal. As explained in previous Monday Notes (here and here), there’s no rational basis for their kvetching. Assuming they bleed an extra $200 when subsidizing an iPhone (or a top Samsung handset, now that the Korean giant followed suit), they only need $8/month in extra subscriber revenue from the “offending” smartphone. And yet here we are: Randall Stephenson, AT&T’s CEO, predicts the end of subsidies because  “wireless operators can no longer afford to suck up the costs of customers’ devices”.

I don’t know if Stephenson is speaking out of cultural deafness or cynicism, but he’s obscuring the point: There is no subsidy. Carriers extend a loan that users pay back as part of the monthly service payment. Like any loan shark, the carrier likes its subscriber to stay indefinitely in debt, to always come back for more, for a new phone and its ever-revolving payments stream.

I was told as much by Verizon. In preparation for this Monday Note, I went to the Palo Alto Verizon store and asked if I could negotiate a lower monthly payment since Verizon doesn’t subsidize my iPhone (for which I had paid full price). Brian, the pit boss, gave me a definite, if not terribly friendly, answer: “No, you should have bought it from us, you would have paid much less (about $400 less) with a 2-year agreement.” My mistake. Verizon wants to be my loan shark.

In the meantime, AT&T has finally followed T-Mobile’s initiative and has unbundled the service cost from the handset. If you pay full price for your smartphone, an AT&T contract will cost you $15 less than with a subsidized phone on a 2-year agreement. This leads one to wonder how long Verizon can keep its current indifferent price structure.

All this leaves carriers with conflicted feelings: They like their iPhone salesman but, like short-sighted bosses who think their top earner makes too much money, they angle for ways to cut commissions down.

On the other side, Apple’s teams must be spending much energy finding ways to keep generating high monthly revenues for their “victims”.

JLG@mondaynote.com

Other carrier news: Sprint, now owned by SoftBank’s Masayoshi Son, is said to be preparing a $20B bid for T-Mobile. We barely avoided excessive concentration when the Department of Justice nixed AT&T’s attempt to acquire T-Mobile; now we again risk a three-way market and its unavoidable collusions. As much as I admire SoftBank’s founder and am happy he took control of Sprint, I hope our regulators won’t facilitate more concentration.

This might be the last Monday Note for 2013. I’ll soon be in Paris where jet-lag and various (legal) substances will conspire to make writing more difficult. If so, Happy Holidays to Monday Note readers and their loved ones. –

Apple Market Share: Facts and Psychology

 

Remember netbooks? When Apple was too greedy and stupid to make a truly low-cost Macintosh? Here we go again, Apple refuses to make a genuinely affordable iPhone. There will be consequences — similar to what happened when the Mac refused to join netbooks circling the drain. 

My first moments with the iPad back in April 2010 were mistaken attempts to use it as a Mac. Last year, it took a long overdue upgrade to my eyeglasses before I warmed to the nimbler iPad mini, never to go back to its older sibling.

With that in mind, I will withhold judgment on the new iPhone until I have a chance to play customer, buy the product (my better half seems to like the 5C while I pine for a 5S), and use it for about two weeks — the time required to go beyond my first and often wrong impressions.

While I wait to put my mitts on the new device, I’ll address the conventional hand-wringing over the 5C’s $549 pricetag (“It’s Too Damned High!” cry the masses).

iphone5c copie

Henry Blodget, who pronounced the iPhone Dead In Water in April 2011, is back sounding the alarm: Apple Is Being Shortsighted — And This Could Clobber The Company. His argument, which is echoed by a number of pundits and analysts, boils down to a deceptively simple equation:

Network Effect + Commoditization = Failure

The Network Effect posits that the power of a platform is an exponential function of the number of users. Android, with 80% of the smartphone market will (clearly) crush iOS by sucking all resources into its gravitational well.

Commoditization means that given an army of active, resourceful, thriving competitors, all smartphones will ultimately look and feel the same. Apple will quickly lose any qualitative advantage it now enjoys, and by having to compete on price it could easily fall behind.

Hence the preordained failure.

As a proof-of-concept, the nay-sayers point to the personal computer battle back in the pre-mobile dark ages: Didn’t we see the same thing when the PC crushed the Mac? Microsoft owned the personal computer market; PC commoditization drove prices into the bargain basement…

Interpret history how you will, the facts show something different. Yes, the Redmond Death Star claimed 90% of the PC market, but it failed to capture all the resources in the ecosystem. There was more than enough room for the Mac to survive despite its small market share.

And, certainly, commoditization has been a great equalizer and price suppressant — within the PC clone market. Microsoft kept most of the money with the de facto monopoly enjoyed by its Windows + Office combo, while it let hardware manufacturers race to the bottom (netbooks come to mind). Last quarter, this left HP, the (still) largest PC maker, with a measly 3% operating profit for its Personal Systems Group. By contrast, Apple’s share of the PC market may only be 10% or less, but the Mac owns 90% of the $1000+ segment in the US and enjoys a 25% to 35% margin.

After surviving a difficult birth, a ruthlessly enforced Windows + Office platform, and competition from PC makers large and small, the Mac has ended up with a viable, profitable business. Why not look at iDevices in the same light and see a small but profitable market share in its future?

Or, better yet, why not look at more than one historical model for comparison? For example, how is it that BMW has remained so popular and profitable with its One Sausage, Three Lengths product line strategy? Aren’t all cars made of steel, aluminium (for Sir Jony), plastic, glass, and rubber? When the Bavarian company remade the Mini, were they simply in a race to the bottom with Tata’s Nano, or were they confidently addressing the logical and emotional needs of a more affluent — and lasting — clientèle?

Back to the colorful but “expensive” 5C, Philip Elmer-DeWitt puts its price into perspective: For most iPhone owners, trading up to the 5C is ‘free‘ due to Apple’s Reuse and Recycle program. We’ll have to see if The Mere Matter of Implementation supports the theory, and where these recycled iPhones end up. If the numbers work, these reborn iPhones could help Apple gain a modest foothold in currently underserved price segments.

Still thinking about prices, I just took a look at the T-Mobile site where, surprise, the 5C is “free“, that is no money down and 24 months at $22 — plus a $10 “SIM Kit” (read the small print.) You can guess what AT&T offers: 24 months at $22/month (again, whip out your reading glasses.) Verizon is more opaque, with a terrible website. Sprint also offers a no-money-down iPhone 5C, although with more expensive voice/data plans.

This is an interesting development: Less than a week ago, Apple introduced the iPhone 5C with a “posted price” of $99 — “free” a few days later.

After much complaining to the media about “excessive” iPhone subsidies, carriers now appear to agree with Horace Dediu who sees the iPhone as a great “salesman” for carriers, because it generates higher revenue per user (ARPU). As a result, the cell philanthropists offer lower prices to attract and keep users — and pay Apple more for the iPhone sales engine.

Of course, none of this will dispel the anticipation of the Cupertino company’s death. We could simply dismiss the Apple doomsayers as our industry’s nattering nabobs of negativism, but let’s take a closer look at what insists under the surface. Put another way, what are the emotions that cause people to reason against established facts, to feel that the small market share that allowed the Mac to prosper at the higher end will inevitably spell failure for iDevices?

I had a distinct recollection that Asymco’s Horace Dediu had offered a sharp insight into the Apple-is-doomed mantra. Three searches later, first into my Evernote catchall, then to Google, then to The Guardian, I found a Juliette Garside article where Horace crisply states the problem [the passage quoted here is from a longer version that's no longer publicly available; emphasis and elision mine]:

“[There's a] perception that Apple is not going to survive as a going concern. At this point of time, as at all other points of time in the past, no activity by Apple has been seen as sufficient for its survival. Apple has always been priced as a company that is in a perpetual state of free-fall. It’s a consequence of being dependent on breakthrough products for its survival. No matter how many breakthroughs it makes, the assumption is (and has always been) that there will never be another. When Apple was the Apple II company, its end was imminent because the Apple II had an easily foreseen demise. When Apple was a Mac company its end was imminent because the Mac was predictably going to decline. Repeat for iPod, iPhone and iPad. It’s a wonder that the company is worth anything at all.”

This feels right, a legitimate analysis of the analysts’ fearmongering: Some folks can’t get past the “fact” that Apple needs hit products to survive because — unlike Amazon, as an example — it doesn’t own a lasting franchise.

In the meantime, we can expect to see more hoses attached to Apple’s money pump.

Next week, I plan to look at iOS and 64-bit processing.

JLG@mondaynote.com

iPhone Low-cost Numbers

 

For years, Apple’s been told its products were too expensive – and prospered mightily. Today, many suggest Apple should launch a low-cost iPhone. Will history repeat itself, or have the rules of the Smartphone Wars changed in ways that will force Apple to alter its strategy? 

Dismissing the prospect of a Low Cost iPhone isn’t all that difficult. Just look at Apple’s history. For years, the high tech pundits have hectored Apple for it’s inability to see the wisdom of the cheap. In the late eighties and into the nineties, they insisted that a low cost Mac was the only way the company could survive against the swarm of PC clones. Steve Jobs returned and righted the Apple ship, no LC Mac required.

A decade later, the netbook was cast as the killer torpedo that would sink the resurgent Mac business. Jobs famously dismissed the netbook as a cheap plastic device Apple would never stoop to make: “We don’t know how to build a sub-$500 computer that is not a piece of junk.”

At the September 2012 iPhone 5 launch, Tim Cook announced that the MacBook is the #1 selling notebook in the US (5:30 into this video). Couple that with the success of the iPad, and the netbook is dead. And thus, by analogy, there will be no iPhone LC. Apple doesn’t do cheap. The company will focus on a premium customer experience and enjoy a high profit margin. The race to the bottom will be left to Android clones. Move along, nothing to see.

Not so fast.

Using Apple’s history — and particularly the sorry netbook story — to dismiss the iPhone LC makes questionable assumptions. As Marx (Karl, not Groucho) liked to say: ‘History doesn’t repeat itself, it stutters’. Smartphones aren’t PCs, only smaller; the rules of the Macintosh game don’t apply to the iPhone. The Smartphone Wars are waged by markedly different laws, and are waged well by Google and Samsung, unencumbered by a PC past.

But let’s back up: What would a Low Cost iPhone look like, whom would it serve, and just how “low” is Low? The easiest way to picture the thing is to drag out your old iPhone 3G or 3GS. A plastic body, an “original-resolution” screen (no Retina here), a slow processor and even slower wireless connection. It’s not today’s iPhone 5, with its metal body, lovingly machined chamfers, Gorilla Glass, high-speed A6 processor, and 5 megapixel camera.

The phone would serve the prepaid market, it addresses customers with little or no credit. Everything is paid for with cash up front: You pay the full, unsubsidized price for the phone and you buy “minutes” (let’s call them units of wireless network utilization) in advance. Buying units for these devices is a simpler experience than I imagined: Go to the neighborhood drugstore, pick out a phone card by a (virtual) carrier such as TracFone, and the cash register prints an activation code you then enter into the phone. Simple, pervasive, and very successful — even in a “rich” country such as the US.

So far, Apple has avoided the prepaid approach. When we give $199 to Verizon for a $650 iPhone, the $450 subsidy is an act of faith by the wireless carrier. The philanthropic organization assumes we’ll pay our bill every month for two years, by which time the carrier has recouped the subsidy. This is the postpaid world that Apple understands.

As for the pricetag, let’s assume that an iPhone LC would cost about $100 to manufacture — that’s half the cost of the basic iPhone 5. If we apply a 60% margin percentage — the same as today’s iPhone 5 — the unsubsidized iPhone LC would sell for $299.

That’s too high. Let’s try lower numbers: 50% margin gets us down to $199; 30% to $149. To get to the magic $99 unsubsidized retail, with an un-Apple 30% margin, the iPhone LC would need to be manufactured for less than $75, about one third of today’s iPhone 5.

And even $99 may not be low enough. Go to Amazon and look for prepaid cell phones. The first models start at $6.99 (not recommended, I tried one at $8.99 for my visiting Mother-in-Law, that was a mistake). Real smartphones running Android 2.2 start at $49.99 – today! For another $10 you get 2.3. The $80.73 Kyocera Rise runs the much more modern 4.0 (Ice Cream Sandwich) version. (I checked prepaid prices in other countries and the situation is similar.)

In his earnings release conference calls, Tim Cook constantly refers to Apple’s interest in the vast prepaid market segment but so far it’s been all talk. The reason for the gap between words and deeds sits in plain view on Amazon’s prepaid cell phone page. As more devices enter the market, we can only imagine what the page will look like a year from now.

The prepaid market, without carrier subsidies, is already in a PC-like race to the bottom. For Apple to enter and prosper in this segment, it has to determine two things: What sort of premium can it get for a low cost iPhone, and what would the device mean for the rest of the product line?

Apple execs are fond of saying they’d cannibalize their products themselves rather than let competitors do it. Even if exquisitely executed and priced just so, it’s hard not to see the (putative) iPhone LC as the augur of a new era of lower Apple margins. In other words, the iPhone LC wouldn’t be born of a tactical decision to add a new set of customers, it would be a strategic move that signals a new phase in the Smartphone Wars.

Apple loves to control the game. So do Google, Microsoft, Samsung, and everyone else, of course, but Apple’s love is an unusually intense, deeply seated drive that stems from Steve Jobs’ own (carnal as opposed to deliberate) need to master and direct every aspect of the game.

In the PC business, Jobs pushed vertical integration down beyond hardware and software, and into its retail chain of Apple Stores, thus ensuring a tightly controlled delivery of the product experience. The same applied to the iPod and its integration with iTunes. The well-controlled media delivery and novel micro-payment system was a huge win: In 2006 iPod revenue outpaced the Macintosh line.

The iPhone started with Apple fully in control. AT&T stood aside and let Apple run the table, handle all aspects of the customer experience (except for call quality). Later, the App Store extended Apple’s control of the game. The iPhone became an app phone and a phenomenal success.

(We also have the counterexample of Apple TV, an exception that proves the rule. TV content owners, distributors, and carriers haven’t let the Cupertino company seize control of the customer experience, and thus Apple TV remains a “hobby”.)

Apple is still in control of its iPhone ecosystem… but things have changed. Now the company faces Google and Samsung. Google isn’t just Android, it’s also a provider of a wide set of services such a Google Maps, Gmail, Google Docs and Drive, Google Voice, and on and on. Samsung is more vertically integrated, makes its own smartphones components, and spends more marketing money ($13B last year) than anyone else.

In today’s smartphone scene, can Apple still enjoy the control — and the ensuing profit potential — it craves? And if not, how will it react? Tactics or strategy?

JLG@mondaynote.com

The Carriers’ Rebellion

Before the Steve Jobs hypnosis session, AT&T ruled. Handsets, their prices, branding, applications, contractual terms, content sales…AT&T decided everything and made pennies on each bit that flowed through its network. Then the Great Mesmerizer swept the table. Apple provided the hardware, the operating system, and “everything else”: applications, music, ringtones, movies, books… The iTunes cash register rang and AT&T didn’t make a red cent on content.

In the eyes of other carriers, AT&T sold its birthright. But they didn’t sell cheap. The industry-wide ARPU (Average Revenue Per User per month) is a little more than $50. AT&T’s iPhone ARPU hovers above $100. Subtract $25 kicked back to Apple, and AT&T still wins. More important, AT&T’s iPhone exclusivity in the US “stole” millions of subscribers from rivals Verizon, Sprint, and T-Mobile—more than 1 million per quarter since the iPhone came out in June, 2007.

(Legend has it that Jobs approached Verizon before AT&T, but Apple’s demands were deemed “obscene”. If the story is true, Verizon’s disgust lost them 10 million subscribers and billions in revenue—much more than it would have made in content sales putatively under its control. Another theory, unprovable but preferable, is that Apple went for the worldwide “GSM’’ standard, hence AT&T.)

To the industry at large, the damage had been done. Jobs disintermediated carriers. Consumers woke up to a different life, one where the carrier supplied the bit pipe and nothing else. Yesterday’s smartphones became today’s mobile personal computers and carriers devolved into wireless ISPs, their worst fear.

Enter Android.

Android is like Linux, it’s Open Source, it’s free. And it’s very good, and rabidly getting better. But with two important differences. Android is Linux with money, Google’s money. And Android is Linux without a Microsoft adversary. There’s no legally—or illegally—dominant player in the smartphone/really personal computer space. Nokia, Palm, Microsoft, and RIM were and still are much larger than the Disintermediating Devil from Cupertino.

Handset makers and software developers love Android, new handsets and new applications are released daily; see the Android Market here. The current guess is that Android will grab the lion’s share of the handset market by 2012. Nokia, RIM, and Microsoft may disagree with that forecast, and Apple is certain to stick to its small market share/high margin, vertical, bare-metal-to-flesh strategy.

Carriers get excited about Android, too. For two reasons. First, Android (and the very good bundled Google apps) allows handset makers to make inexpensive devices. Carriers and Google both encourage a race to the bottom where handsets are commoditized, but smart.

Second, because Android is an Open Source platform, carriers can work with handset makers, they can dictate the feature set and, as a result, revitalize the revenue stream. They can promote their favorite apps, content, and services sales that have been choked by disintermediation.

But it’s not a straight shot. Android lays out the playing field for a contest between Google and carriers. More

Science Fiction: An Apple-Curated App Store

In an alternate universe, Apple has announced the App Store Guide and Blog. Choice morsels from the PR material follow.

“We came to realize that a quarter million apps meant worse than nothing to Apple users”, said Apple’s CEO. “I get confused too! Reviews are often fake, lame, or downright incompetent. PR firms have been caught astroturfing reviews, publishers have resorted to flooding the App Store with shameful clones of successful applications. I won’t let one of Apple’s most important, most imitated innovations sink into anomie.”

[Remember, this is sci-fi.]

“So…Today we’re proud to introduce the Real App Store Guide, written and maintained by Apple experts. We’ll review new and existing iOS apps. We’ll tell you which ones we grok (and that grok us) and give you the straight dope on the offerings you shouldn’t touch, even if they’re free. In our Guide, you’ll find a series of paths: For the Traveler, the Gamer, the Music Lover, the Graphic Artist, the Oppressed Enterprise Windows User, Teachers, Parents, Doctors… The Guide will also feature a blog, a running commentary on the iOS App landscape with intelligent answers to cogent questions. And in keeping with our usual standards for decorum and IQ, the blog will be moderated…”

And so it is, the App Store is fully curated, at long last.

As always, this doesn’t please everyone…at least on the surface. In reality, the usual naysayers are thrilled: More pageviews! Ryan Tate jumps on the opportunity and frenetically fires at Steve Jobs’ inbox, trying to start another late night email séance. But this time the Emailer In Chief doesn’t bite.

Customers, on the other hand, like the Real App Store Guide. Users can finally find their way through the twisted and confusing maze of programs. They learn to adjust for a particular writer’s opinions, much as we’ve all learned to compensate for the biases of, say, movie reviewers. The blog gives civilians a forum where they can argue (politely) with the named authors of the reviews—there’s no anonymous corpospeak here.

App authors…some of them aren’t so keen on the idea. The ones that get tepid reviews are understandably furious and threaten lawsuits (in vain…their attorneys are told to re-read the App Store T&Cs). With a modicum of care with words, that’s what the Guide’s editors are for: Safe negative opinions. More

Droid and Android

Last Friday November 6th, the much-awaited Motorola Droid came out. Powered by the latest version of Google’s smartphone OS, Android 2.0, the new handset is exclusively distributed by Verizon. The carrier backs Motorola’s handset with an aggressive marketing campaign on its website and on TV ads.

For such a “gifted” (Motorola + Verizon + Google) product, the reviews came fast and… furious, that is very opinionated.
One gent rejoiced: Droid, was going to free him from the iPhone – at last! Small detail: as you’ll see by clicking on the link, writing on October 19th, a couple of weeks before the Droid came out, the “reviewer” helpfully admits he hadn’t used the product: “I haven’t seen the phone, but I’ve talked with someone who has worked directly with it”.
That’s why I prefer playing customer, buying the product, getting the everyday usage experience.
More “facts-based” reviews are available from MacWorld, quite positive, Endgadget, very detailed, Business Insider, with a crisp conclusion: If you don’t buy an iPhone, buy a Droid. The very geeky, well connected Gizmodo, comes to the same “if not iPhone then Droid” result. I’d be remiss if I didn’t link a summary of Walt Mossberg’s review, that’s how you know you’re an über-geek, when your reviews are reviewed. See also the Wall Street Journal’s gadgetmeister’s original oracular blessing.
A deeper discussion of OS platforms and voice applications is available here at TechCrunch. [Disclosure: one of the protagonists, British Telecom’s JP Rangaswami, bought Ribbit, an Internet phone company, imagine Skype with an API (Application Programming Interface). The venture firm where I currently work, Allegis Capital, was an investor in Ribbit.] I’ll end the procession with a vigorous critique of Verizon’s punchy ad campaign by Andy Ihnatko, another respected, witty industry columnist.

With this in mind, unlike most opining individuals above, I went to a Verizon store and paid my own money to get a Droid. I did this on the very Droid-day, Friday November 6th, at the University Avenue Verizon store in Palo Alto, around 11:30 am. No line, I waited two minutes for a salesperson, a simple transaction as I already have a Verizon account. The activation turned out to be just a bit more problematic: ‘Too much traffic’ said the sales gent. I left the phone with him, went back to my office one block away. When I returned by lunchtime, everything was in order. Easy enough. More

One Bit

This is going to be a busy week. Monday we have Apple’s earnings and, later in the week, Windows 7’s release. The deafening noise will make it hard to understand the real, lasting consequences of these events. Fortunately, deep into the bowels of a server, a smaller happening, a bit flipping from 0 to 1 portends more fun, more intelligible things to come.

The Apple Q4 (fourth quarter) 2009 numbers matter less than the volume of comments will make it appear. If the numbers are good, fans will sing ‘I told you so’ and naysayers will object the good times won’t last. If the revenue and profit indicators are less than stellar, the ‘I told you so’ and ‘it won’t last’ will switch sides.

A similar pattern applies to Windows 7’s launch: this is the greatest thing since Vista, just kidding; this is disappointing; this works; this doesn’t; this threatens Apple; this is very good for Apple. (Apparently, Apple is intent on channeling the Windows 7 noise to its own uses with an aggressive campaign, likely targeting the pain Xp users who, supposedly, will endure a particularly arduous upgrading experience. We’ll keep this for later: I’ll upgrade a few computers from Xp, Linux, Vista Ultimate and Vista Home Premium and report back.)

Sages have already offered their obligatory contributions to each part of the libretto. And, things on the Web being immortal, wags have dug up equally authoritative 2 1/2 years-old claims from the same business and tech gurus when Vista was launched. Said wags invented a term, “claim chowder”, for such an amusing or embarrassing confrontation between past and present pronouncements. If you google the phrase, you won’t get much because the ever-obliging search engine thinks you mean New England’s “clam chowder”. Fortunately, Google Reader, the blog-reading engine, is more forthcoming and offers a bevy of examples such as this one, or this one.

The confusion and contradictions are understandable: I believe the computer industry is in a transition that makes divining the future by reading today’s tea leaves more difficult than usual. For example, how and how much will Cloud Computing really change the landscape? Or, what about netbooks, a fad or a lasting trend encouraged by a bad economy pushing consumers and business towards the bottom of the price range? Will smartphones continue to eat into PC “face-time”, into out use of desktop and laptop computers and, if so, how quickly? More

A Blinding Flash of The Obvious

In the US, if Apple gave up on the AT&T exclusivity, the iPhone’s market share would double. So says Morgan Stanley’s anal-yst Kathryn Huberty. See this PC World piece here. And a CNN/Fortune Magazine piece here.

Let’s not throw stones at Ms. Huberty but, instead, question her bosses’ wisdom, work ethics or wakefulness. Is anyone editing the firm’s publications? Isn’t Morgan Stanley missing the real fight, the big struggle between Apple and carriers for mobile Internet content billions?’

First, Huberty’s thesis: If AT&T no longer had an exclusive distribution agreement for the iPhone, if, for example, Verizon also “offered” Apple’s smartphone, the device’s market share would more than double from about 4.9% to 12.2%. (In passing: what’s the last digit’s significance? Those are estimates, not measurements, good within a ± 10% margin of error, at the very best. Spreadsheet follies…)
Morgan Stanley’s seer bases her prophecy on French market share numbers after Orange lost its exclusivity and the other two carriers, SFR and Bouygues, gained access to the iPhone. The legend is the iPhone’s market share shot up by 136% as a result.

I’m sorry but that’s a lot of BS; there are no facts to substantiate such a claim.Readers probably know I’m a French-born Silicon Valley-based venture investor; I travel to the old country four or five times a year and keep reasonably close tabs on industry and political goings-on there.
Clouding the discussion with facts: The iPhone has been available from Orange since October 25th, 2007. The other carriers sued and local regulatory authorities subsequently nixed the Orange exclusivity. As a result, SFR started shipping iPhones in April of 2009, about six months ago. And Bouygues did the same about five months ago. Since 2007, Orange alone sold about 1.5 million iPhones. If Bouygues and SFR sold a generous 500,000 units since April 2009, how does this constitute a 136% market share increase?

More

Kremlinology For Fun and Profit

I’m quite fond of kremlinology, the metaphorical one, not the literal sort. For me, it started as a hobby and ended up making me decades of fun and money. Allow me to explain before we proceed with an attempted decryption of recent Apple events and statements.

Working in Paris in the seventies, I struck an acquaintance with a Gideon Gartner analyst called Aaron Orlhansky. He came to lunch with a bunch of markitecture papers from IBM and I had fun untwisting the real meaning behind sonorous statements coming from “The Company”. That was my amateur kremlinology stint. One day, he casually mentioned his acquaintance with Tom Lawrence, Apple’s top gun in Europe. And he added: ‘Tom’s looking for someone to start Apple France’. I said I was that man, an introduction was made, Tom and I “clicked” immediately and I was hired on December 12th 1980.
Almost three decades later, I’m in the Valley, a kid let out in the candy store, watching wave after wave of exciting entrepreneurs, ideas, technology, products, cultural changes…

On to a bit of Apple kremlinology.

The biggest news was Steve’s appearance at the iPod event last week: ‘I’m vertical’, he said and proceeded to acknowledge his gratitude to the liver donor who allowed him to be there. He also thanked the Apple teams who kept the ship going while he wasn’t so even-keeled. And he encouraged us to become donors. In California, you do that with a code on your driver’s license. Nothing to decode here, everyone is happy to see Dear Leader back in the saddle. He was met with a heartfelt standing ovation.
Now, we hear complaints he’s back lording over details, putting people under tremedous pressure. Good.

Let’s turn to the iPod announcements and to the howls of disappointment over the lack of camera in the new and improved iPod Touch. How could He do this to us, His faithful followers? When questioned, the spinmeister lets its be known the absent camera makes a lower entry price possible, $199. The iPod Touch has emerged as a major game console, you see, and you don’t need a camera on such a device.
I’d say two out of three.
Yes, the games on the 20 million iPod Touches (and 30 million iPhones) shipped so far surprised everyone, Apple first. Games aren’t a side show on the platform, they’ve become a big money maker for developers and a threat to the likes of Nintendo’s DS and Sony’s PSP. Commenting this graph, from Apple’s presentation, Business Insider says ‘the iPhone platform has almost five times the number of game and entertainment titles that Sony and Nintendo’s portable systems have combined.’
Removing the camera to get to a price point? Not convincing, camera modules cost very little, they’re everywhere on cheap cell phones. More