I have been thinking quite a bit about Apple’s hardware business. As many readers know, I believe Apple is equally a hardware and software company. I also believe they will naturally evolve into a services company wherein they will become equally a hardware, software, and services company in the future. All three of these segments will play a unique role in differentiating their ecosystem and deeply integrating their assets to form a consistent whole. I do not believe any other company on the planet can do what Apple can do to benefit from such an integrated strategy. This is what sets them apart and is why I am in the camp of those who take a long view of Apple. That being said, most people, when they analyze Apple, have them tipping the hardware side of the scale more than they should. This is why I propose a new way of thinking about Apple’s hardware strategy. Let me start by laying some foundation.
When we think about Apple’s core hardware products today, we observe their primary business is making computers small, medium, and large. ((Thanks to Jean-Louis Gassee for giving me this core observation)) The computers that fit in your pocket, your hands, and your lap/desk are the center of their hardware strategy. These will always be the products Apple can use to maintain their margins and continue relatively steady ASPs. This is because these hardware products are personal computers. The intimate nature of personal computing devices by default will keep them from becoming commodities in most cases. In particular, Apple’s small, medium, and large computers will never be commodity products because they run a computing operating system unique to their hardware. This is where the equal parts hardware/software company come into play. Because of this differentiation, these are the products Apple can sell at higher prices. These are the products where independent value will lie. These three products also cover the spectrum of Total Addressable Markets. The iPhone has the single largest possible TAM, followed by the iPad, then the Mac. But the key foundation we need to lay with regard to Apple’s hardware strategy is the volume and price combination.
Selling a higher priced product, that can also sell in high volumes, is the ideal revenue growth driver. Right now this product is the iPhone, which sells in higher volume than any other single smartphone on the market and at a higher ASP. For this reason, the iPhone is more than half of Apple’s revenue and will be for the foreseeable future. As they offer lower priced options, they need to sell dramatically more to maintain a steady line. For example, a company like Nokia can sell magnitudes more phones than Apple but not make nearly as much money. As the price of a particular piece of hardware goes down, regardless of margins, significant volume is necessary for it to make a blip on the revenue radar. This is the key reason why any new hardware from Apple that is not a core computing product and can’t sell at premium costs and/or in large numbers needs to be viewed more as a software and services story than a hardware story. This applies to both new “categories” being spoken about today such as wearables/smartwatches and TV.
I want to restate it is my conviction computing products are the ones Apple can sell at high ASPs, margins, and in significant volume. This is why it is hard for me to believe the hardware element alone for any wearable, smartwatch, or TV is the upside for Apple. Even if they sell a large piece of glass for $1500 or more, they will not sell it in large volumes even though the ASP could be high. The same is true with a wearable or smartwatch. Even though volumes could be higher, the ASP will not be. Meaning volume is key for the revenue on the hardware to be significant. How many $199 wearables would they need to sell for it to register on the revenue radar? If they keep their traditional margin strategy, the cost would be quite higher than $199. Knowing the build of material costs of these devices — the screen, the sensors, etc. — if Apple does keep margins on one of these products it would be quite costly. As the cost goes up, the TAM goes down. This is why I propose the new way to view Apple’s hardware strategy — outside of computers small, medium, and large — is to not view the iPhone, iPad or Mac at the center but to view iOS at the center.
Putting that statement a little more clearly, a TV, smartwatch, health and fitness wearable, car, etc., are all accessories to iOS. The hardware itself is simply a feature of iOS. This strategy deepens the ecosystem and lock-in for Apple but also highlights the benefit of the software and services upside. For example, a health and fitness wearble could tie deeply into iOS and open the door to subscription services, payments or authentication for example. For other companies looking to compete in the health and fitness wearable space, Apple can uniquely offer them tie ins to iOS that ensure their iOS accessory works best with iOS. As these companies build in services like subscriptions or coaching or nutrition advising for example, Apple can sit in the middle of those as well. Accessory hardware simply becomes a feature of the iOS ecosystem. Given the centrality of the iPhone, one could even state it by saying accessory hardware becomes a feature of the iPhone.
If we view lower cost hardware as a feature of iOS, it serves as a gateway to other services and types of transactions where money changes hands. We can then see how Apple benefits from the upside of what this hardware will enable. This is exactly how I feel we have to view any hardware Apple will release that is not a computer small, medium, or large.
Of course these hardware products from Apple may run a proprietary OS, and even iOS in the case of Apple TV, but we can’t let the reality slip that those products are not computers the same way the iPhone, iPad, or Mac are. Outside of that core, iOS is the center, not the hardware endpoint.
One last point. Apple being fully integrated across hardware, software, and increasingly services puts them into a position to benefit financially from all three — in some ways more than any competitor. For example, even though a health and fitness wearable, or even Apple TV, is a gateway to software and services upside, with iOS at the center, Apple can still get margins on hardware in ways others can’t. While the margins may not be as great as their computing products, they can still make some money on the hardware. My point, however, is it won’t be enough to make a blip on the revenue radar without that hardware also leading to revenue upside on software and services. Thus the margins and revenue upside is diversified across all three vectors — hardware, software, and services.
Going forward, we are dealing with new economies of scale in terms of growth. Selling high margin, high ASP products will simply hit a wall at some point in time as it saturates and you run out of customers. Relying on the hope new customers will emerge in the high end is too unpredictable of a variable to count on. Lower cost products is the surest way to grow into the mass market. Tablets, Macs, TVs, health and fitness wearables, and even a smartwatch are not subsidized products. Selling them at extremely high cost, like the iPhone, is simply not an option in many markets. ((Of course, there are options in some markets where retailers will offer payment plans thus bringing tablets, and wearables, into the subsidy ecosystem. But this again is a variable and brings with it competitive complications as well.)) Lower cost products require significantly higher volumes. No product Apple can launch will be like the iPhone. That is why what I lay out is the key to thinking about Apple’s hardware going forward. It’s more about iOS at the center than hardware endpoints at the center. This is the fundamental building block to a an ecosystem that can deliver growth and revenue across the hardware, software, and services spectrum.