No predictions, just a few things to watch and possibly interpret in the numbers. And, at the end, a question: Will the iPhone gain market share in a saturated market – just like the Mac stubbornly does?
No predictions, just a few things to watch and possibly interpret in the numbers. And, at the end, a question: Will the iPhone gain market share in a saturated market – just like the Mac stubbornly does?
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:
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.
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%.”
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.
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:
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:
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”.
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. —
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).
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.
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.
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.
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.
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Contrary to what I expected, the dust hasn’t settled yet. A week later, people still queue, 2h30 Friday morning before being admitted to the sanctum sanctorum in San Francisco. Besides the long lines, there were glitches: activation problems, trouble with the new MobileMe service, with getting access to software updates for the “old” iPhones. Apple claims 1 million phones sold worldwide for the first weekend, probably 400,000 in the US alone. The latter number could explain the activation servers overload: in more normal times, AT&T must activate “only” 25,000 phones a day. Apple apologized for MobileMe problems and even conceded they should suspend some of the verbiage used to promote the service. Calling “Push” the way email and other information is coordinated between computers and the iPhone was found a little “anticipatory”, meaning promises made couldn’t yet be fulfilled. [“Push” means your phone or your computer will receive information without asking for it, without “Pulling”. The Blackberry is still the king of “Push”.]
But this is mostly folklore, fun but transitory. Something more important is taking place: the advent of the App Store. On iTunes, the App Store is a section where you find new applications for the iPhone. On the iPhone, the App Store is an icon that enables the one-click purchase and wireless download of new applications, just like a song and often costing the same, 99 cents, or less. In about the same time it took Apple to sell 1 million phones, users (this includes the updated first generation iPhones) downloaded 10 million applications. Half of these were free. For the paid for ones, about half were games, the rest range from software for general aviation pilots, medical students, bloggers, to light sabers, yes, you read it right, translation with voicing of phrases, nice when you go to China, subway maps, newsreaders, CRM, social networking, instant messaging and music streaming. Apple signed in with a nice, free, flourish: a program transforms your iPhone into a remote control for iTunes or AppleTV, works anywhere in the house through your WiFi network. And on and on… I was going to forget the Chanel Haute Couture Show. Free. Highest Karl Lagerfeld quality. How did this get in? Let me guess, friends in a common advertising agency? Is this one the new business models discussed below?
When the App Store opened a week ago, the catalog featured 27 pages, we’re now at 42. It’s fair to say some applications are silly, useless or unstable. The user review system in the App Store is merciless and deals harshly with stupidity, bad code or dysfunctional UI (User Interface). Also, there is an automatic update mechanism and applications such as Facebook have already been improved. The bad ones will die quickly.
The BFD, as in Big Fundable (or other F words) Deal here is the Great American Instant Gratification. The mental transaction cost of getting an application is very low: lots of choices, small price, one-click transaction. This is the magic of using the existing iTunes infrastructure and exisiting customer behavior. I can’t help but wonder whem Apple (or its competitors) will also use the model for desktop applications, Cloud Computing notwithstanding. I buy iTunes music for my personal computer, why not buy applications for my Mac or my PC from the same store?
Wait, as we say in America, there is more: business models. We’re beginning to see ads on the iPhone, with photos, music or the New York Times. We, VC, will be watching carefully as we wonder if advertising on such small screens will work, will generate real money. Another form of advertising looks more promising: free music channels on the Pandora application. You first set “channels” on Pandora.com from your PC, say Mozart, Bach, Miles Davis and Dave Brubeck. On your iPhone, you click Miles Davis and you either get Miles Davis works or music deemed to belong to the same genre, with a nice note explaining why the piece was put on this channel. And…, if you like it, one click buys it form iTunes. Clever and clever a second time because not convoluted.
Lastly, content presented as, wrapped in applications. For 99 cents you buy and load an application called The Art of War. You’ve recognized Sun Tzu’s book. But, instead of having a separate book reader and content purchased for it, with the risk of “unwanted duplication”, content and reader are now budled as one application for each book. When I pitch my next book to the publisher, I’ll make sur to mention the 45 million iPhones to be sold next year. This number is an admittedly wildly optimistic (and widely criticized) forecast by Gene Munster from Piper Jaffray. Unless RIM (Blackberry), Nokia and Google fight back, which is very likely, they don’t like Steve Jobs wiping his Birkenstocks on their back. —JLG
No, no, not Steve Jobs but an even higher entity smiling upon the company. As I hope to show, Apple’s hard work years ago is now about to pay huge unexpected dividends on the iPhone. When the iPhone first came out of Steve Jobs’ quasi-divine hands in January 2007, it was a hack, the result of clever handcrafting by Apple engineers, a crazed last-minute rush to the show deadline. As such, it lacked the basics of what we call a platform, an industry term of art – or BS. Here, a platform means a combination software, or hardware, or both on which software developers build applications. A platform requires documentation, where the building blocks are, what they do, how to use them. The platform also comes with tools, software to build and test the applications. Last but not least, a platform implies some stability, meaning it works often enough, and it’s predictable, it doesn’t take brutal turns that undo the work of developers.
Early 2007, the iPhone had none of these attributes. So, Steve resorted to proven industry maneuver: If you can’t fix it, feature it. No need for “native” (meaning running on the iPhone itself) applications. This is the New World of Web 2.0, bleated the propagandastaffel. Use the iPhone’s browser (the best in the business, it helped immensely) to run server-based applications. No need to download anything, centralized maintenance, easy updates… The faithful heretics would have none of that and a new game started. One week the hackers managed to break Apple’s barriers preventing the installation of native applications. A few days later Apple issued an update to the iPhone firmware that broke the hacks.
Let’s pause for a lemma, a building block in the story: from day one, the iPhone had something no competitor had: iTunes. Apple made having an iTunes account a sine qua non requirement for using an iPhone. For downloading songs and movies, just like its younger brother the iPod? That and more. With iTunes you backup your iPhone, you bring it back to “factory settings”, helpful if a hack “bricked” it, meaning if it became as lively of a brick, you install software updates, most of which defeated the impudent hacks.
Moving forward, the pressure was building: Apple made a very smart move by using a trimmed down version of OS X (the Mac’s software… platform) as the software engine for the iPhone. We know and love OS X, said the developers. Mr. Jobs, tear down that wall! It now looks like Google’s Android helped Dear Leader make up his mind. Rumors were mounting: RSN (Real Soon, Now), Google would announce a free, open-source platform for smartphones. Just as Steve smartly turned around and touted Intel processors after years of expounding the superior PowerPC architecture, on October 17th, 2007, he stood up and announced the SDK (Software Development Kit) for the iPhone. Availability by the end of February 2008.
The belief in Providence benignly smiling on Apple now comes in. In 2001, Apple sweated the servers, the legal agreements with publishers, the one-click payment system, the client software on PC and Mac. All this to create the still-unequaled iTunes experience. Now, one bright 2007 morning, they have an epiphany: Songs are zeroes and ones. One click and they land in a bin, a directory in the iPhone. But applications are also strings of zeroes and ones. If we put up iPhone applications in the iTunes store, they land in a different bin inside the iPhone but the one-click purchase and download is the same. Halleluiah! All the work to build the iTunes business now pays off for the applications. We must be The Chosen Ones. This is no small detail. Today, if you’re an independent software developer, writing good code is the easy part. The Evil S&M, Sales and Marketing, await you. Shelf space, physical or on the Web, is very expensive. Setting up download and payment systems isn’t for the faint of wallet either. With the iPhone, Apple removes (most of) these hurdles. All you have to do is write good code.
Picture the young developer still living in his mother’s basement, he sells 50,000 copies of his work for $10, the price of an iTunes album. Apple keeps $3, he gets $7. Times 50,000, he makes $350,000 and can now pay rent to his mother and buy her a car. (For perspective, the current forecast is for between 30 and 45 million iPhones sold by the end of 2009.) Picture also the competition. No one else has such a well-oiled, widely known system to add applications to a smartphone as Itunes. (Google says they will eventually offer one for Android.) This is a billion dollars business. Actually, $1.2 billion in 2009, according to Gene Munster a Piper Jaffray analyst. (For a healthy counterpoint, see the snarky comments on TechCrunch.) Regardless, the arrival of native applications on the iPhone is a big event, one made possible by an unintended – and rather amusing – consequence of the iTunes music distribution system. How will this be written up in books and Harvard Business School case studies? –JLG
News publishers remain obsessed with the question: what will be the main distribution platform for their contents, and what will be the subsequent business models? For clues, let’s zoom in the iPhone’s recent performances as well as its immediate prospects.
The smartphone introduced a year ago by Apple has become the tool of choice for news-hungry Internet mobile users. According to M:Metrics, a survey company that tracks the use of mobile devices, a stunning 85% of iPhone owners report using it to access news and information contents. That compares to 58% of the overall smartphones users and only 13% of basic mobile phone owners. By the same token, iSuppli, another research firm, found out that iPhone users spent 12% of their time surfing the web versus 2.5% for the regular cellphone users. On the top of this, data shows that iPhone users spent more time, by a factor of 12 accessing a social network (another future important delivery platform for news content).
What does that means for the publishing sector? First : interface is key. Try accessing a newspaper (or even the Monday Note) on a Blackberry : it’s 1985’s teletext! Do it on an iPhone, it works fine. The added development is negligible compared to the costs of the average Content Management System (CMS) and can be accomplished internally as shown by many sites (The New York Times, Condé Nast’s Portfolio magazine).
Second, we see applications beyond the made-for-iPhone sites that could benefit the publishing industry. In the coming months, we’ll see a first batch of true applications created for the iPhone. For example, how about a powerful caching system for publishers? With it, the user stores dozens of pages of favorite sites — or hundreds of book pages — on an iPhone or iPod Touch for a quiet reading off-line. (I still wonder why a publishing company isnt developing such an application itself and giving it away with pre-loaded content. Small development cost — count less than $100k for a first version — add a nice viral demo on You Tube and you get significant PR impact).
What about the business model? Well, the most obvious one is advertising. On the Internet, scarcity of pixels doesn’t imply little revenue. Quite the contrary, actually. For most sites, the bulk of their revenue comes from very few top slots on their homepage, the remaining inventory being sold at bargain basement prices. (On the French market, discounts between rate cards and net prices average 80%). Translating: a single banner ad on an iPhone-optimized minisite can be sold at a high premium CPM. Plus there are other revenue sharing systems to explore: the monthly bill of iPhone users is 24% higher than the average mobile user’s. That’s $228 extra per year.
News providers should devote small, highly focused set of resources (a developer + a couple of junior editors would be fine) to develop content optimized for the iPhone and related micro applications. This applies also to advertising agencies and media buyers who should get into this emerging piece of digital real estate.
Can such a move prevent the possible extinction (as the Economist puts it) of parts of traditional media? Certainly not. But it is better to be in the race than on the bench.