Trends in Social Commerce

“Social commerce” is one of the biggest buzzwords in conversations I have with startups and investors in Silicon Valley. The reason is simple. Peer group influence on product decision making is one of, if not the single largest factor in driving purchases. Social networks become the glue to see what our friends are buying and to be able to purchase directly things they recommend. This can be a song, album, movie, clothing, gadgets, appliances, and more. Our social networks become a quick and easy way for peer influence to impact our buying habits. However, we are still many important steps away from achieving this reality.

But it seems Twitter has simply given up on the idea entirely. Yesterday, a story broke that Twitter had disbanded their commerce team and ceased work on their Buy button. It is possible Twitter realized their platform (if it is just a news platform) is not the place social commerce will take place. This is probably correct, but the broader idea has potential.

Let’s start with this data point. Globally, 48% of consumers said an easier/quicker checkout process would encourage them to buy online more. When we filter that answer just by active social networkers it goes up to 60%. Now comes Apple Pay. What Amazon showed us was a stored credit card and one click checkout could stimulate online buying. Other features like free shipping and easy online returns rank high among motivation for consumers as well, but easy checkout is prime among them. Something like Apple Pay or Android Pay could dramatically accelerate online shopping across a plethora of categories.

WeChat may also be setting the prime example with 47% of consumers saying they have made a purchase through WeChat using a mobile wallet in the last month. This is the highest monthly mobile wallet transactions of any market we study. WeChat has many of the foundations in place that are still void in major commerce markets like US and UK. Which is why I have hope that, once this foundation is laid, we will see a dramatic acceleration of online transactions.

Mobile wallets are the first step to driving not just more online transactions, but enabling these to easily happen on social networks. Apple Pay and Android Pay are the two most widespread wallet solutions I can see developing this. I certainly won’t give my credit card to Facebook but I’ll trust Apple Pay. If Facebook has a quick way for me to buy a product I’m interested in or a friend promotes by using Apple Pay to make it quick and seamless then I can see social commerce taking off.

Luckily, Facebook seems to acknowledge this and has stated they will support Apple Pay but this will also be up to the merchant to support it on Facebook as well. Perhaps this is an area where Google’s Android Instant Apps come into play.

While Google showed this idea first, I fully anticipate Apple will have something similar. The idea is, you get an app-like experience without having to download the app. For example, a friend posts a link to BuzzFeed on Facebook. You click the link and see the Buzzfeed mobile app UI but you haven’t installed the Buzzfeed app. Similarly, this works for commerce. Below is the screen shot examples Google highlighted to give us an idea of the use cases:

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It is by no accident two of those three use cases are commerce experiences. The parking meter one highlights the pain point that many parking meters require you to download their own proprietary app in order to pay remotely. I’ve done this before where you download the app to pay then promptly delete it since you will likely never use it again.

This extends to many areas of the app/web experience and makes a lot of sense both for things like commerce, entertainment, and even app discovery. Given how many app or app commerce ads we see on Facebook, I can see an implementation of Android Instant Apps that is very good for something like Facebook when it comes to social commerce. Google is hoping these will play a role in their mobile search results but my hunch is Facebook, and other social platforms, will be the big winners here.

If at WWDC Apple does show how developers can implement Apple Pay into websites, I think we will start to see momentum pick up here. Like so many other pockets of the industry, Apple’s ecosystem will likely adopt this first and Apple customers will be the primary drivers of social commerce in markets like the US and the UK at the start.

Mobile wallets, and the ubiquity and comfort of using them, is step one to many growth drivers of online commerce. If my timeline is correct, 2017 should see many of these trends start to gain momentum.

The Real Threat to Apple: The Invisible Device


The Amazon Echo: what happens if this is all there is to a device? CC-licensed photo by Cryptik Merlin on Flickr

For years, Apple has made a name for itself through the design of its products – their combination of appearance, materials, and software functionality (which is part of the “design”, aka “how it works”). It has been able to command premium prices for desktops, laptops, phones, tablets, even routers by making things that not only work well, but look good.

What happens to that advantage and ability to command a premium, though, when there isn’t a product to hold? What happens if you don’t have a phone to pull out, a tablet to press, or a router to put in the corner of your room?

This thought struck me while listening to John Gruber and Ben Thompson discussing Amazon’s Echo, which we could roughly call a home automation device, and considering Google Home, which is going to be approximately the same thing. Both de-emphasise the physical product (there isn’t even a screen) in favour of an unobtrusive always-listening device which doesn’t need to be pressed or waved at; it just responds when spoken to.

It’s not hard to imagine future versions of Google Home or the Amazon Echo would have less and less physical hardware; essentially, they only need to power a microphone, a speaker and an internet connection. In which case, what would Apple’s version look like? It might look – might even be – the Apple TV. It’s nice, but many people would struggle to pick it out of a lineup. And once it’s underneath or behind your TV, you could forget it’s there.

Razing the playing field

But when you reach that point, the ground on which Apple used to fight – appearance, materials, “look and feel” – has suddenly vanished. The shift to systems which don’t need us to look at them directly and which feed information back to us by means other than an integrated item with a screen, doesn’t so much move the goalposts as set fire to them and terraform the field where they were standing.

In the same vein, I was asked a few years ago – when Siri had newly been announced, but Samsung was already making inroads to the premium market with the Galaxy Note – what I thought the phone of the future would look like. I suggested you wouldn’t actually look at it much. It would probably be Galaxy Note-sized but it would sit in your pocket and feed information to your headphones in response to questions you asked into the mic on the headset. Less need for the screen, less need for typing on the physical object.

Our obsession with photographs and cameras has forestalled that shift; Instagram and Snapchat demonstrate that, when it comes to social interaction, we love the visual. That suggests screens and devices – in other words, things we actually hold and carry around – remain important.

Even so, the invisible device does seem to me the biggest risk Apple faces. The advantage it has is Amazon’s Echo and Google Home are devices for, well, the home and, although we might talk a lot about it, the extent of our desire to have computing interaction with our home is surprisingly limited. Jan Dawson made this point well recently. The current “smart home” market is composed of early adopters because your fridge can’t ever be that smart and you’ll still have to load and unload your washing and put coffee into the coffee machine.

What’s more, most of us spend most of our time outside the home. And that’s where we need our devices. So far, we haven’t quite taken up the idea of chatting away to our headsets in the manner of Joaquin Phoenix in Her. But, bear in mind, social norms can shift; our parents’ generation would have been (and still are) appalled by the way teenagers today will ignore each other while across a table, or their elders, in favor of the glowing screen. And 30 years ago, walking along the street talking aloud to nobody was a sign of insanity. Now it just means you’re on a call. (Spot the difference: if you’re wearing earphones, nobody will turn a hair.) If intelligent assistants really take off, devices might shrink away too. Though every time I follow that reasoning, I arrive back at the need to digest visual information. We’ll still need screens, and hence housings for screens, and hence design.

These answers brought to you by…

That this potentially poses a threat to Apple doesn’t mean that everyone’s safe. Amazon’s pretty safe; if people order things via the Echo, it benefits. But Google relies on people looking at ads for 90% of its revenues and rather more of its profits. If we don’t look at a screen, how do we get the ads? Perhaps it will adopt the solution chosen in the UK by the “Speaking Clock”, a phone service you called to get the precise time read out to you. In 1986, the newly privatised British Telecom put it out to sponsorship, which was eagerly snapped up by Accurist – and so for 22 years, you would be told, “the time sponsored by Accurist is…”

Maybe that’s how Google will adapt if voice is the new interface. Equally, maybe that will open the door for companies like Apple to charge extra so we don’t hear the ads. The invisible device might still yield a premium. It’s just a question of what you’re paying for.

The Big iPhone Debate

In many discussions I’ve had about Apple and their future, the question of the iPhone is always at the heart. Although, as I listen to the tone and specifics of the questions that come my way, I realize this discussion is also about Apple itself.

Can the iPhone grow again? The answer is undoubtedly yes. Will the iPhone see similar growth rates to the initial ramp? Obviously, it will not. I find this visualization helpful.

Screen Shot 2016-05-16 at 5.56.36 PM

There is quite an increase from 2014 to 2015 thanks to the larger iPhones. As you can see, I have added consensus estimates for iPhone sales in 2016. What we have to realize is, in 2012-2014, Apple was seeing 12-20% annual growth rates. Then, with the large screen phones, it jumped to 37% in 2015. Just to illustrate the point, I calculated the average growth rates Apple had seen the two years prior and put them into the same chart to show you what 2015 and then 2016 growth estimates would look like if they followed the same averages.

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Had Apple simply continued the normal growth rates, we would not be talking about a YoY iPhone decline. And honestly, the hypothetical chart I posted is closer to what I think Apple thought was going to happen. It seems Apple management was surprised at both how big the iPhone cycle was with the 6/6 Plus and the rate of slowdown with the 6s/6s Plus. Nothing wrong with either surprise as both were hard to see coming.

The growth rate of the 6/6Plus was a bit of an anomaly. It was hard to predict and was bigger than many thought. The 6s/6s Plus cycle is also showing to be weaker than original estimates. This is proving to be one of the weaker S cycle launches and the maturity of the market, saturation of the high-end smartphone segment, and global economic issues are all playing a role. Looking at the US installed base data we have by model, you can see the 6s is a bit lower in terms of base ownership than the 6 during the same period last year.

Screen Shot 2016-05-16 at 6.09.40 PM

This weaker cycle has a lot to do with the diversity of Apple’s base. They have acquired many new customers but many of those customers don’t need or crave the shiny new gadget. They have grown into the part of the market that does not replace electronics until necessary. They aren’t swayed by a new camera or an OLED screen or wireless charging, etc. This is a new dynamic for Apple. For much of the iPhone’s growth run, they could count on early adopters and the early tech majority to help keep the train going. Couple their regularity of acquiring new devices with the brand new customers coming to the iPhone every year and you have the charts at the beginning of this post.

Yet, I remain convinced that not every person on the planet who wants, or will someday want an iPhone, has one yet. The issue is the growth won’t be at the same high double digits it was before. This was predictable and Apple has been preparing for this very thing. So where do they go from here?

My first thought is the impact on payment/financing plans has not yet been fully observed. Take, for example, this promotion in China brought to my attention.

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This page is translated from the Apple China site and it shows a financing plan for Apple products, not just iPhones, up to 150,000 RMB or $23,000 USD. Several banks are involved and handle the financing. Now, while it is only interest-free for 12 months, I’m intrigued by this move and, in some ways, I liken these banks willing to engage in financing plans for iPhones to carriers willing to subsidize iPhones to acquire high-value Apple customers. With China’s middle class rising and millions of new credit opportunities, it seems likely these banks want to find a way to acquire those Apple customers. This is the start of something interesting at a global level where financing Apple products does the job of acquiring high-value customers for financial institutions.

Another scenario talked about is to stagger the iPhone innovation cycle and move off of a S year lineup. By having one new flagship every other year, it gives consumers something new every year to choose from. This could help smooth the line but may already stress what is the highest scale manufacturing line in the world in Apple’s iPhone.

However, Apple is a consumer products company, not an iPhone company. As I pointed out here, Apple is in uncharted territory never having this many customers in the company’s history. Ultimately, any category where customer experience is terrible is ripe for Apple to enter. There are numerous growth upsides from healthcare services, enterprise services, VR/AR, autos, wearables, etc. As the world goes digital, Apple has a role to play in every area it decides it can better the customer experience.

The Big Six in Q1 2016

Every quarter, once earnings season is over, I put together a set of comparisons for the “big six” consumer technology companies: Alphabet, Amazon, Apple, Facebook, Microsoft, and Samsung. The full analysis goes into a deck which is part of the Jackdaw Research Quarterly Decks Service, which you can read more about and sign up for here. This post summarizes some of the key findings from that analysis in the form of four charts, representing four of the key metrics I look at. As I’ve said in past quarters, Facebook isn’t in the same league as the others in terms of scale – it’s significantly smaller. But it’s one of the most profitable mid-to-large-sized tech companies out there and also one of the fastest growing, so that’s why I include it in this analysis.

Revenue growth – Apple falls to last place

This quarter was notable, among other things, for the fact that Apple, which was briefly one of the fastest growing of these companies, dropped to last place as its revenue growth was negative for the first time in a long time. Even Microsoft, which has struggled with growth since the anniversary of its acquisition of Nokia’s devices business, grew slightly faster in Q1 2016:

Screenshot 2016-05-13 15.33.31

It’s notable Facebook continues to be far and away the fastest growing of this group and has been for the last three years. Apple came closest to matching its growth rate in the throes of its iPhone 6 year but even then was several percentage points behind. Meanwhile, Microsoft continues to ride the doldrums of the maturity of its business, while Samsung is beginning to recover in earnest from its own crisis and was back in positive territory in Q1. Amazon and Alphabet, on the other hand, have been duking it out for second place since Apple’s growth stalled, with Amazon consistently slightly ahead.

Margins – Facebook back on top

The chart below shows margins on a trailing four quarter basis, which helps to eliminate some of the cyclicality in each of these companies’ margins. As you can see on that basis, Facebook came out on top this quarter, having dipped below Apple and Microsoft last quarter:

Screenshot 2016-05-13 15.31.28

Despite Amazon’s recent progress in generating more operating profit, this chart also puts into stark perspective just how little margin it still generates compared with its peers. Even Samsung, whose margins were squeezed by its shrinking mobile business from 2013 through 2015, is now back well into the mid-teens. Alphabet, meanwhile, has had the most consistent growth trajectory over this period, with modest increases over time.

Capital investment spikes at Facebook, falls at Alphabet

Facebook has always been one of the heavier spenders among this set of companies on capital expenditures, but this quarter its capex spiked to over 20% of revenues, a milestone it hasn’t hit for three years and hasn’t exceeded regularly for even longer. On the other hand, Alphabet’s spending has been trending downwards for the better part of a year, though it saw a brief blip this quarter:

Screenshot 2016-05-13 15.32.04

It appears Apple curtailed capital spending fairly significantly this quarter, perhaps in response to its lower revenues and a broader attempt at greater fiscal discipline to try to keep margins on track. It’s often been the lowest spender in this group in percentage terms and occupied that position again for the last two quarters, but this quarter was also the lowest in dollar terms for the first time. Meanwhile, Facebook’s spending, in dollar terms, eclipsed Amazon’s for the first time this quarter as well.

Revenues per employee – Apple and Facebook closer than usual

For the most part, Apple is miles ahead on the metric of revenues per employee, generating almost half a million dollars per quarter on average. This quarter though, with the overall drop in revenue, revenue per employee dropped as well to just over $400,000, a level it’s only hit once before in recent memory, in Q2 2014. Meanwhile, Facebook’s revenue per employee keeps rising and this quarter was just barely behind Apple:

Screenshot 2016-05-13 15.32.16

Amazon continues to be the laggard on this list, with declining revenue per employee as it continues to hire ten thousand or more new employees each quarter. In the past year, Amazon added 80,000 new employees, which is more than Alphabet employs in total and over five times as many as Facebook employs. Microsoft continues to widen the gap with Amazon on this metric, thanks largely to its workforce reductions over recent quarters, though its numbers are still declining, as are Alphabet’s.

Unpacked: Apple Invests in China Ride Sharing Platform Didi

News broke late last night that Apple is investing in Chinese ride-hailing service Didi Chuxing to the tune of one billion dollars. I’m sure this investment will be over analyzed but there are a few high level points I think are worth making. First, it is important to note there is a fierce battle between Uber and Didi in China. As of now, Didi is beating Uber in terms of rideshare. Looking at data we have on apps, in this case, ridesharing apps used by Chinese consumers in the last month, we can see Didi has more regular users than Uber. I took the liberty to chart the latest results from Q1 2016 but also filtered the answers by iPhone users and Android users.

Screen Shot 2016-05-12 at 9.25.33 PM

Statistically, Didi has the lead. From a Chinese consumer perspective, having the backing of Apple (along with Alibaba and Tencent who are also investors) can only help strengthen Didi’s position. Apple can more tightly integrate services like maps, Apple Pay, maybe even have Apple Music playing in the background (once they get the service restored) and expose 11m riders a day to more of an Apple experience. Given the Chinese consumer affinity toward Apple, I think this will only further give consumers a reason to choose Didi over Uber.

Some folks on Twitter last night were remarking this could be a competitive move against Uber — if we believe Uber will someday be an Apple competitor in autonomous cars. Fun speculation and game theory if true but the deeper thing I see happening is Apple making a statement about their investment in the Chinese economy and the continued relationship building Apple is doing with Chinese regulators and consumers. This move will be perceived very well within China and will continue to enhance Apple’s position in the country. They have the benefit of playing locally and feeling like a local vendor to Chinese consumers, even if they are a US company.

I thought it would be great, given the timeliness of this and the smart analysts we have on our team, to also have them chime in with a few thoughts on the deal.

Carolina Milanesi
Cook mentioned on the last earnings call that Apple was ready to make large investments and this is certainly substantial. It shows Apple’s commitment to the Chinese markets both to the consumers and the government. It is well known that China wants foreign vendors to spend money in China, not just make money. This is an excellent way for Apple to do exactly that. The ROI on the investment has a different form from a pure source of insight into Chinese consumers to a platform for Apple Pay to, further down the line, a testing ground for autonomous cars.

Jan Dawson

  1. It’s a great way to use some of that offshore cash that’s sitting around.
  2. There’s obviously a car connection, but it’s pretty tenuous. It’s not like whatever car Apple is working on could be used by Didi in China. There’s likely to be a fairly significant mismatch cost wise there.
  3. Apple doesn’t do corporate VC or anything like that. So this is a huge departure from their past pattern. It isn’t an acquisition – the valuation is around $25 billion at this point so this is a very small share. So they don’t benefit directly from the technology or revenue. On the other hand, if they did acquire Didi, it would be a fascinating extension of the services strategy. But again, a huge departure from Apple’s history.
  4. Car wise, this does give Apple new insights into driving in China, which could be useful for other things – maps, self-driving cars, etc.
  5. This also gets Apple deeper into China in ways that could be beneficial for leverage, for other services in China, and so on.

Tim Bajarin
This clearly gives Apple deeper roots into the Chinese market and is a strategic move to expand their presence. It also helps them flesh out a more precise auto-related strategy to fine tune their own approach to enhancing Apple’s connections to cars.

Unpacked: The Tablet is more Social Than Personal

The tablet category remains a central part of our analysis amidst the personal computing hardware landscape. I’ve been bullish on this form factor, despite the market issues, and still believe it represents the most approachable and easy to use larger screen computer on the market. We have been digging into consumer behavior around the tablet category for several years and the one trend that always stood out to me was how the tablet was more of a social device than a personal one for a good chunk of the market. I charted specific devices and what percent of consumers indicate if the product is shared or not.

Screen Shot 2016-05-05 at 9.31.27 PM

I’ve intentionally grouped these devices in their order. From upper left to lower right, the ranking of shared vs. personal is displayed. The smartphone is the least shared and most personal device consumers own. The PC is not far behind. When we look at the tablet, we see it is closer to less personal and less individually owned consumer electronics. I picked both game consoles and TVs as a comparison as they are both much more communal devices in the home.

I sense this observation has a role to play in how consumers view their tablets and their ownership of it and is one of a few reasons I believe most consumers have yet to replace their tablet as frequently as their phone and have not considered replacing their PC/Mac with a tablet. It all comes down to how the device is used and viewed by its owner. If the product is not used that much individually, but perhaps more so socially, then the burden to have the latest and greatest is not high. The main point here is devices which are viewed as more personal, and arguably more essential, will be viewed differently than ones considered less essential.

Perhaps nowhere is that more clear than when we asked consumers to rank their most personal device. In several different phrasings of the question, in every result, the tablet ranked the lowest in device importance and most personal device. That, I believe, is very telling about how it is viewed by the mainstream and a key reason why the market is struggling as it is.

Note how big the tablet market could have been if no one shared it and it was more like the smartphone as a primarily personal device. This sharing dynamic has certainly made it so not everyone in the household needs one, even if they all want one. Perhaps down the road this is a good thing and may help spur more individual ownership. Time will tell.

Lastly, it should come as no surprise that tablet sharing ranked highest among parents and age groups between 24-44. Tablet sharing was the lowest among the 55+ demographic. A group which also ranked tablets much higher as the most personal and important computer they own.

Similarly, countries which have much larger households filled with many families living together and a strong cross-generational mix also ranked quite high with tablet sharing. Notably, the Latin America region and Asia Pacific.

There is a clear pattern here with regard to tablets but the narrative is likely to start to change over the next few years. At least, the story needs to if companies with a vested interested in this category hope to inject some needed life into it.

India Bans Second Hand iPhones, the Services Narrative, Hardware Maturity

India will remain a key area of interest in the iPhone narrative. While we can chime in on the big debate of whether the iPhone will see growth again in 2017, we can’t ignore the reality that, even if it does grow, only single digit growth is to be expected. I say that with one massive and largely unpredictable caveat. Apple’s customer base fueled the anomaly we saw in Q1/Q2 2015 with the release of the iPhone 6/6 Plus and we can’t discount the possibility of some new innovation to get them to move in massive quantities again at some point in time. That being said, that is largely unpredictable and, even if it happens, it will be a one off instead of the norm. Which is exactly how we should view the growth engined fueled by the 6 and 6 Plus.

Long time subscribers and readers will know we have been talking about India for a while. Sales in 2015 crossed 2m in India and we believe there is growth to be had with Apple in India as the country continues to develop. I remain skeptical we will see anywhere near the same kind of rapid growth we saw in China, but growth will come in India for sure. It is interesting news that the country is not going to let Apple sell refurbished iPhones (or certified pre-owned iPhones) in the country. The main speculation is this could be a move to protect local brands. It’s not a secret that India wants to see their own homegrown brands succeed and grow, along with devices made in India. Those two variables continue to fuel some of the political moves made by local administrations. It is also no secret India is looking to get Apple into the country both with retail stores and to entice them to make phones there as well, in a hope to create more jobs and spur the economy. I read partially into this move the fact Apple does not have any local retail stores. iPhones are sold through “official resellers”, not by Apple directly in the country. Often times, these retailers may also dabble in grey market goods or fakes even if they are an official retailer. Arguments have been made by other analysts that India is concerned about the quality and trust of these devices, given some vendors may be shady. I doubt whether that is fully the case and have strong reason to believe, if Apple had retail stores in India, they would be able to sell refurbished (certified pre-owned) iPhones through their own official channel. So, as of now, my read of this is India regulators have done this specifically to get Apple to make strides in doing the things Indian officials prefer they do to compete in India.

The Services Narrative

At some point, I need to write out my full thesis on the Apple services narrative. But here are some things to chew on.

First, I’d like to submit this chart of total revenues by a number of key companies driving the industry today:

Screen Shot 2016-05-04 at 8.49.53 AM

I show this to highlight the outlier Apple is, thanks to their being a consumer-focused vertically integrated company from a hardware and software standpoint. It is the monopoly they have with iOS that is the sole driver of the position they are in to drive significant hardware revenues. Apple’s monopoly on iOS is a primary driver of why hardware margins are not at risk. Sales may be slowing and the category is maturing for smartphones, PCs, and tablets. Apple TV, Apple Watch, any VR play from Apple, and any other hardware endpoint will doubtfully ever see the scale of the iPhone. Hardware revenue is not as large a concern for Apple, just the rate in which it increases. This is why the services narrative starts to get interesting. I’m not going to chime in on if we are at peak iPhone yet but I will say, I do not believe Apple is at peak revenue. Besides new hardware categories, I think services is the big upside here.

Apple is making the case their customers are loyal. True. They spend money regularly thanks to the fact Apple sold them the hardware. My data confirms Apple customers, even if they convert from Android, spend more money the longer they are in the ecosystem. Many consumers don’t just own one Apple product — the average is between 2-3, with an intent to add more over time. I’d propose we view services in a similar light. As Apple acquires customers, these customers often become prime candidates for new hardware. I’d argue the same is true with services. As Apple adds new services these customers become prime candidates to buy them. $3.99 for cloud storage per month. $10 for Music per month. $25 for a TV subscription per month (speculation on my part). $30 a month for your iPhone. Maybe $60 per month for an iPhone, iPad, and Apple Watch. You get the picture. Note that’s per individual user. With over 600m people, this opportunity compounds.

For fun, I charted just services revenue for a few key companies we all agree fall into the services category against Apple’s services business:

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Looking at this chart, we need to make a few points. First, I looked at Comcast’s breakdowns of just TV subscription services revenue and estimated their quarterly revenue. I did this to make a point about the potential for TV subscription revenue. Comcast makes just over $5 billion a quarter from their TV subscription services and they do so with only 18-19% of the US market as their customers. We believe Apple will launch a subscription TV service at some point and ~50% of US customers are Apple customers. I broke out Amazon Web services just for comparison and scale, then Facebook and Google for your advertising/free services comparisons.

Services alone is a decent business but, by itself, it’s not really a gigantic business. Now, looking at the services revenue at scale and seeing what upside Apple can add to their hardware business starts to get to the root of how Apple can integrate services into their hardware and build a stable and growing business on top of an already massively profitable hardware business. My hunch is these two realities will be deeply intertwined.

Hardware Maturity

PC, tablets, and now smartphones are mature markets. Which means these three segments will begin to face dynamics of mature categories where growth is typically slower and the slowing pace of innovation also slows the growth cycle as existing customers hold onto devices longer due to a lack of need to get the shiny new object that won’t change their life as much as previous ones did. That is the reality and there is no escaping it. Growth can be had, for sure, it just won’t come at the same rate as before.

If you have not read this excellent post by Benedict Evans, I encourage you to do so. His observation is relevant in the categories I mentioned and it seems like we are certainly seeing this dynamic play out as innovation has slowed. There are new hardware categories, like wearables and VR, but again we question if they have the scale of the smartphone or even the iPhone. Looking back over the past 10 years, something unique happened. We saw the dawn of a purely global market for consumer technology and innovation happened at a pace not seen before. That was simply not sustainable and now we are seeing the pause as we wait for a new cycle. All of this is relevant to keep in mind as we think about the next few years in consumer technology.

Apple’s Emerging Market Challenge

Last week, Apple reported that sales of iPhones were down in the last quarter vs a year ago and, from the numbers, it was clear Apple’s iPhone growth has peaked. Apple’s forward-looking predictions for the next quarter show iPhone sales will also be down over the same quarter last year. As a result, their stock took a significant hit, although most of the financial analysts saw these numbers as the new normal and almost all put out a buy recommendation suggesting the worse is behind us.

The one bright spot was the news their services business was stellar and, in fact, is now bringing in more revenue than the Mac business does. Finally, the financial analysts see Apple’s services business as a big deal and are factoring that into Apple’s long-term growth.

However, the big question seems to be, could Apple ever really grow the iPhone market again? It is clear now the introduction of the iPhone 6 was an anomaly in that the larger screen met with huge demand as a large pent-up audience wanted a bigger screen. In that sense, this giant bump in sales was a one-off event and, as we now see, it would have been almost impossible for Apple to repeat that type of sales bump with the iPhone 6+ series. It appears the 4 inch iPhone SE will meet the needs of quite a few buyers who felt the 5 and 5.5 inch screens of the iPhone 6 series were just too big but even this demand is not enough to get them back to the huge growth numbers of the past.

There are two technology boosts I see coming that include dual cameras and their entry into VR with a VR-dedicated iPhone that could revitalize iPhone demand. A VR iPhone could actually be the one that forces a huge upgrade at some point. I will address these opportunities in a separate piece in the near future.

However, there is one specific area Apple could target that could cause a bump larger than the one they got with the iPhone 6 series — going after the market in India. Today, Apple has about 1% of that market. At the same time, only about 25% of the Indian population (1,276,267,000 people) has smartphones. That leaves a market of just under 1 billion who could buy a smartphone. Today, most of them sell for under $200 with some selling for around $100 or lower. Only the wealthier folks in India can even afford an iPhone.

We have been doing a lot of research in India these days and see that, while Apple is a known brand in India, there is not the same interest or demand outside of the upper crust audience. This is in huge contrast with China. Apple is considered a luxury brand in China and even those just entering what we call the middle-class lust after an iPhone. In fact, owning an iPhone changes a person’s status within their peer group.

But in India, it is price that matters. Indians are much less focused on status and brands as they are focused on getting the most bang for the buck. Tim Cook said in the earnings call that Apple has their eyes on India and “India is today what China was 10 years ago.” That is true in two key areas. First, India is rapidly changing and tech has had a big influence on these changes. Access to the internet is getting better and being used for new levels of communication and commerce. This has influenced the second key — it is helping people get better jobs, a better education and to raise their earning potential. This is being done on a small level today and why it is similar to China 10 years ago.

However, economists who follow India suggest the impact of a potential rising middle class in India could be huge for its people and its economy. But they also peg this rise to people who have access to the internet and can use it to get a better education, manage their farms and markets, get better jobs, and potentially make more money.

Although Apple could wait another four or five years to jump into India big time and hope a rising middle class could afford an iPhone, I would think they would want to be a part of helping this market grow and make a major contribution to the overall economic development. But to do so, Apple would have to create an iPhone just for the Indian market at a price that would be acceptable to this very cost conscience audience.

Given Apple’s current iPhone premium pricing, this presents quite a conundrum for them. That pricing will continue to only attract the rich in India. On the other hand, if they were able to create an iPhone with more flexible pricing, they might be able to get the mid to upper end of this emerging middle class and, over time as more join this range of consumers, they could grow that market substantially.

From our research in India, pricing needs to be in the $239-$279 USD range. This is the price point the mid to upper middle class seem to be able to tolerate. Of course, the problem is that there are a lot of smartphones in the $149-$229 range that are actually very full-featured and even this group buys the “more bang for the buck” smartphones when it makes sense.

This is the challenge Apple faces if they really want to grow their iPhone market substantially in India. Whether they do it now or later, this is the pricing challenge they will face. They could hold off and let others take a stronger aim at this group of users and hope to jump in later. They could also start a major branding campaign in India and make this market more receptive to an Apple product within a year or two and hope to make it into some type of status device.

It is not clear how Apple will attack this market but, from the research we are getting from India, it seems getting a bigger start now would really help them gain momentum as this market develops through better wireless networks and an audience of users who are starting to move up in society and will want a top notch, high-powered smartphone.

China, Apple’s iOS source code and the pursuit of unfounded speculation

iPhone and code on screen
Source code isn’t trivial – and that for the iPhone is closely guarded. Photo by Jason Swaby on Flickr.

Let’s begin at the end – because news stories generally should start off with the most recent information. Speaking under oath to the US Congress, Apple’s general counsel Bruce Sewell said: “I want to be very clear on this. We have not provided source code to the Chinese government.”

It’s a strange thing to have to say. But the rumours have been swirling for a while. So I tried to track them down to their source. It turns out to be much stranger than you’d think.

Beginning with the briefs

A month ago, when Apple was fighting off the FBI’s demand that it unlock an iPhone 5C used by one of the San Bernadino killers, the US government seemed to suggest that Apple had already helped out the Chinese government.

In a sworn affidavit, Craig Federighi, Apple’s SVP of software engineering, flat-out denied it: “Apple uses the same security protocols everywhere in the world. Apple has never made user data, whether stored on the iPhone or in iCloud, more technologically accessible to any country’s government. We believe any such access is too dangerous to allow. Apple has also not provided any government with its proprietary iOS source code.”

In its “Reply Brief in Support of Apple’s Motion to Vacate” (relating to Apple’s legal tussle with the FBI over the creation of ‘GovtOS’ to hack into the iPhone 5C used by one of the San Bernadino shooters), on pages 20 and 21 Apple says:

“Finally, the government attempts to disclaim the obvious international implications of its demand, asserting that any pressure to hand over the same software to foreign agents ‘flows from [Apple’s] decision to do business in foreign countries…’. Contrary to the government’s misleading statistics, which had to do with lawful process and did not compel the creation of software that undermines the security of its users, Apple has never built a back door of any kind into iOS, or otherwise made data stored on the iPhone or in iCloud more technically accessible to any country’s government.

The government is wrong in asserting that Apple made ‘special accommodations’ for China, as Apple uses the same security protocols everyone in the world and follows the same standards for responding to law enforcement requests.”

At that point Apple’s brief cross-refers to Federighi’s sworn statement – which means if it’s untrue then he’s perjuring himself, and liable to imprisonment.

Why does this matter? Because there are quite a few people who are completely convinced that Apple has given the Chinese government access – at least for code review, perhaps for more – to the iOS source code. And the US government repeated that claim in its docket, apparently leaning on various claims about Apple made in the media, rather than supplying something a bit more, well, robust.

I think I’ve tracked down the basis for this meme. As with a lot of modern journalism, it starts with a pretty wild claim, and then it gets repeated – but nobody bothers to actually check the original.

Cutting into Quartz

As far as I can ascertain, the first time an English-language site (or indeed any site) suggested that Apple had provided source code to China’s government was in a January 23, 2015 article in Quartz, headlined “Apple is reportedly giving the Chinese government access to devices for ‘security checks’“.

That’s a pretty straightforward headline on an article which Quartz’s Asia correspondent Heather Timmons, an experienced journalist, wrote, following up on a tweet the day before from the state-run People’s Daily in China:

OK, but what are “security checks”? Tim Cook was quoted in the story with a preemptive denial:

“There were rumors that Apple built back doors in its devices, and let third parties have data and access those devices, but that was never true and that we would never do that in the future either,” Cook reportedly said.”

Why “reportedly” said? Because the quote is a translation from a story in the Chinese-language Beijing News, which said that Lu Wei, the director of the National Internet Information Office, met in early December (2014) with Cook, who “said China will cooperate with network security assessment of Apple products”.

The article continues (via Google Translate): “China is also willing to open to Apple and other technology giants, but only if the iPhone, iPad and Mac products must ensure information security and privacy of users, while maintaining national security.”

It then has the Cook quote about back doors, to which Lu Wei responded [in translation] “You said not, your new products to make our network security officer for evaluation. We need to draw conclusions, so that consumers must be assured.” Cook said Apple will fully cooperate with the Network Security Assessment China [of] Apple products, to ensure that the user can feel safe and secure during use of the product… which means that Apple is willing to accept China became the first official review of network security company.”

The Bing translation is pretty much identical, except that it uses “reliable” rather than secure. The tone is the same: no mention of source code. (Better translations welcomed.)

Timmons clearly wondered what a security check entails, and noted that Apple didn’t provide any information when contacted, and sought some outside opinions. But then things go a bit askew. Timmons continues:

“But analysts said the most likely interpretation is that the company is giving Beijing access to its operating system source code in return for being able to continue to do business in China”

Now that’s a pretty big claim to anyone who knows what source code is. So, which analysts? The first seems to be ‘Percy Alpha’, “a pseudonymous founder of the anti-censorship group Greatfire.org”, which monitors connectivity and censorship topics around China’s “Great Firewall”.

‘Percy Alpha’ is quoted as saying:

“Handing over source code [would] mean that the Chinese government would know exactly how an Apple software works.”

Well, yes, it would. But there’s no evidence provided that “Percy Alpha” knows that is what happened. However, the story mentions “analysts”. Who else says Apple handed over the source code? The next quoted is Ben Cavender or China Market Research Group in Shanghai, saying that

if that is in fact what has been agreed, it’s a landmark deal, and Apple has not generally provided such information to other governments.

Clearly, Cavender doesn’t know if it has or not; my reading of the structure of the story is that Cavender was presented with the ‘Percy Alpha’ quote and asked to comment on it. Which leaves us with “Percy Alpha”. What, exactly, did he know?

Meme, aloft

Bear that question in mind, but put it to one side for a moment while we watch this “source code” story spread. (This isn’t, by the way, a criticism of Timmons; she asked people questions, and reported what they said. It’s notable too that the person who wrote the headline on the piece didn’t go with the “source code” element; instead, they went for the “access to devices” angle.)

On the same day, an article in iDigitalTimes on the same day references the first Quartz article – though it talks to someone different, at Quarks Labs [unrelated to Quartz, the news outlet] who says “Apple giving access to the source code of their product? Never!” (The quotes from the person at Quarks Labs are actually worth reading. One wonders what might have happened if they’d been in Timmons’s contacts book.)

Even so, the idea had begun running.

Next up, in terms of size, was Engadget, also on the same day, with an article saying “Apple lets China examine iOS code to assuage spying fears”. The basis for the claim? “According to the Beijing News, Chinese officials met with the [Apple] CEO in December to reach a deal which will allow the State Council Information Office to check for backdoors.” It’s the same Beijing News link, but there’s absolutely no supporting evidence – either in the story or the translation – to support the “source code” claim. And yet there it was.

The San Bernadino shootings in December, and the subsequent resistance by Apple to the FBI’s demands to hack into one of the shooters’ phones, brought this claim back to life again.

Among those who revived it was one of Quartz’s own writers in a February 17, 2016 piece headlined “Apple is openly defying US security orders, but in China it takes a very different approach”. “If Apple had indeed agreed to a Beijing security audit, it could have shared vital information with the Chinese government, such as its operating system’s source code, that could indirectly help government agents discover vulnerabilities on their own,” the writer observed.

The basis of the “source code” claim? The original Quartz story, the writer told me.

Not all outlets regurgitated the claim. A New York Times story on February 21 this year noted that “Apple sees value in its stand to protect security” and pointed out that

In China, for example, Apple — like any other foreign company selling smartphones — hands over devices for import checks by Chinese regulators. Apple also maintains server computers in China, but Apple has previously said that Beijing cannot view the data and that the keys to the servers are not stored in China. In practice and according to Chinese law, Beijing typically has access to any data stored in China.

No mention of source code. But Lawfare, a legal blog founded by a team including former advisers to Barack Obama, thought there should have been – so they created it. “Some reports have speculated that while Apple defies the US government it has no problem acquiescing to Beijing’s security demands”, including backdoors, said a piece on February 22. Which “reports”? That Quartz piece. In fact Lawfare, and others, have leant on that original article so many times it seemed worth swimming back upriver to the source.

No firewall, no smoke?

So we return to that earlier question: what exactly did ‘Percy Alpha’ know about Apple’s negotiation with China? I got in touch with Greatfire.org. ‘Percy’ has left, I was told by ‘Charlie Smith’ (another pseudonymous staffer, I’m guessing). Did he know where the “source code” suggestion had come from?

“Are we really the source of this Apple speculation on China?” he answered. “I know that we give Apple a hard time, but are we the only voices who are doing so? I have been looking over the Justice Department filings and have seen Apple’s response saying that there are three sources of information coming from three different newspapers – in your opinion, are we the source for that information in all three publications?”

Yes, I responded, ‘Percy Alpha’ at Greatfire really does seem to be the source.

“I don’t have the smoking gun, and Percy did not either when he gave that quote to Quartz,” said Charlie. The source code quote was “guesswork/speculation”, he said.

OK, but was it informed speculation based on contacts inside the “security review” teams, or people or companies that had gone through it, I asked?

“I would imagine that only a small number of people know exactly what the security review entails – the folks at CAC [Cyberspace Administration of China] and the reps from the companies that have gone through the process,” replied Charlie. “But, yes, I guess I have to agree that this is pure speculation on our part.”

Pure speculation. This didn’t stop Charlie making exactly the same “source code handover” claim in February 2015 to the Washington Post.

That’s because he thinks he’s right. “I believe that they would have had to do that [share the source code] because the authorities had concerns about certain things which would require that they look at the code. If you review the legislation (unofficial translation) it is also clear that an audit would not just be a rudimentary check.”

The translation doesn’t mention an audit, and it’s not obvious where Apple’s phones and the iOS source code would fit into the “Network Information Security” clauses there. More to the point: it’s a big allegation to make based on no direct evidence.

Source code reality

To be clear: source code audits do happen, in China and elsewhere. Notably, in 2012 the Chinese telecoms company Huawei submitted its router source code for review by the UK’s security agencies and the Australian government. (The US’s National Security Agency also targeted that source code for hacking, according to documents released by Edward Snowden.) The topic of Huawei and source code turns out to be a sensitive one, at least for Cisco, which accused Huawei of stealing code back in a lawsuit in 2003-4.

IBM is also reported to have let the Chinese government review “some product source code” in a secure room “without the ability to remove it from a room”, according to the Wall Street Journal in October 2015 – which quoted, at second hand, one of IBM’s own senior vice-presidents speaking in China. The WSJ noted that Microsoft said it had shared some Windows source code with the Chinese government. But Apple’s name is notably absent, either there or in a February 2015 story in the WSJ about US companies’ reluctance to share source code with China.

And of course the Chinese government can easily review the Android source code – famously, it’s open to anyone.

Even the US tries it. In March, Zack Whittaker at ZDNet reported that the US government has attempted to use the Foreign Intelligence Surveillance Act (FISA) to obtain source code from tech companies in numerous lawsuits. (It’s notable that IBM’s statement to Whittaker leaves lots of wiggle room: “the company does not provide ‘software source code or encryption keys to the NSA or any other government agency for the purpose of accessing client data.'” Which leaves other purposes open.) Many of the companies contacted didn’t comment. We have Federighi’s response for Apple from the court docket.

And how do you get at Apple’s source code? It’s very tightly locked away, according to evidence provided at the Apple-Samsung trial in 2012:

Apple source code is provided the highest level of protection and security within Apple. Physical access to the iOS source code is limited to select groups of authorized Apple employees, with access being provided only to portions of cod on a need-to-know basis. Acess is limited to employees directly involved in software development, management, and security. The employees with such access must be approved by management as authorized employees, their accounts must be specifically granted access.

Finally

So what access does Apple give in China? There’s a clue in Federighi’s affidavit: right after the part about not allowing access to source code, Federighi states: “While governmental agencies in various countries, including the United States, perform regulatory reviews of new iPhone releases, all that Apple provides in those circumstances is an unmodified iPhone device.” (Emphasis added.)

So in the end, it might come down to simply that: an iPhone for testing.

Critics of Apple – who are plentiful, and include Charlie at Greatfire – say that there’s wiggle room in Federighi’s statement. Regulatory agencies aren’t security agencies, points out Greatfire’s Charlie. To say “Apple has also not provided any government with its proprietary iOS source code” doesn’t rule out showing a government some part of its source code.

In that, he’s right: if you want, you can always find some formula of words that hasn’t been ruled out which might cover some way of interpreting a situation where someone sees some source code. It’s an endless corridor where every door just leads to another. All we have is Apple’s, and Federighi’s, and Sewell’s, denial. Those will satisfy some. They won’t satisfy others.

But it would be good if those claiming Apple has shown – or otherwise shared – its source code with foreign governments could put up some proof of it happening. The reality is that, despite my best efforts, I’ve found nothing solidly founded in anything published; only two denials, by two senior Apple people, on the record, under oath. Ranged against them: one pseudonymous staffer at a Chinese monitoring site.

At a time when the issue of access to Apple’s source code is one of the hottest topics in the technology/legal world, solid proof rather than unfounded speculation seems like the least we should demand from our discourse on the subject.

Apple Earnings Fact and Fiction

Anyone who follows Apple commentary closely, either by what Apple has said on previous calls, or by the Wall St. analysis, knows this quarter’s YoY decline in revenue was not a surprise. A key point to make, right off the bat, is Apple met their own guidance for this quarter. Apple guided between $50 and $53 billion in revenue for Q2 2016 and they came in at the low-end of $50.6. Gross margin guidance was 39%-39.5% and they came in at 39.4%. Basically, Apple knew this was coming and prepared investors for it. The fiction is that they missed expectations. What they missed was beefed up Wall St. expectations. If they miss their own guidance then we have a story. If they miss expectations by the street, then all is still right in the Apple world.

As I reflected on the past few years, an interesting observation must be made. It appears what happened in the December quarter of 2014 and the March quarter of 2015 with the iPhone 6/6 Plus was an anomaly and could not be counted on to be repeated. This was actually a point made by many at the time, calling the 6/6 Plus a super cycle and questioning whether it should be used as a comparable for the following years’ same quarters. While Apple narrowly beat YoY Dec quarter revenue, the inflated March quarter in 2015 due to China hyper growth of iPhone sales proved to be the harder compare. Bottom line, the iPhone 6/6Plus created a perfect storm of a super cycle in both the US, getting a large number of consumers to upgrade early, and creating massive demand in China. It is unlikely we’ll see a scenario like this again for some time. The kind of quarterly numbers Apple will put up in terms of iPhone sales and revenue in calendar 2016 are likely to be the true baseline quarterly numbers to compare here on out. I’m not going to be surprised if YoY revenue declines are still in the coming quarters. Apple is guiding lower for the upcoming Q3 2016 quarter over last year’s Q3 2015 quarter. So again, they see it coming and my advice is to abide by Apple’s guidance and their guidance only.

The real question I’ve been asked by the media yesterday is, where do we go from here? Well, it’s going to get worse before it gets better. But we can’t ignore the larger global smartphone market favors Apple the more mature it gets. What we have observed in non-US markets like China, parts of Europe, and pockets of emerging areas like Brazil/Mexico and India, is those consumers who have owned multiple generations of smartphones begin to realize how important the device is to them and they look to spend more on their next one. This is a key market dynamic fueling the switch to iPhone narrative and our research with consumers confirms that the longer an Android smartphone owner has one, the more likely they are to consider Apple over time. Which means Apple still has many customers in waiting. They just have to be patient.

On the iPad front, I don’t see things getting better at all. As Carolina Milanesi articulates in this post, tablets are still viewed as a luxury, not a necessity, and are ranked lowest in “most important device”. Will some consumers swap out their current PC with an iPad Pro? Yes. Will it be enough to change the iPad trajectory? Probably not. I’m intrigued by Tim Cook’s statements of positivity around next quarter’s iPad numbers. Our research still shows high levels of contentment with consumers and their current iPads but perhaps they have some kind of promotion coming they believe will help push volume.

I’m still bullish on Macs and the PC/Mac vs. Tablet research we have suggests to me the Mac may see more upside short term than the iPad, unless Apple can dramatically change the narrative around driving consumers to replace their PC/Macs with iPads. The PC is still viewed as a necessity in many consumer markets and, with some level of consumer refresh likely coming, I’d wager Macs benefit from this in the second half of 2016.

Services are the buzzword around Apple lately. On this point, Tim Cook said:

Services revenue jumped 20% to 6 billion dollars. App Store revenue was up 35% to beat last quarter’s all-time record, and Apple Music continues to grow in popularity with over 13 million paying customers today.

We feel really great about the early success of Apple’s first subscription business and our music revenue has now hit an inflection point after many quarters of decline.

The services business is powered by our huge install base of active devices which crossed 1 billion units earlier this year. As we discussed on this call in January, those 1 billion plus active devices are a source of recurring revenue that is growing independent of the unit shipments that we report every three months.

Let’s pull out a few statements. Interestingly, he calls Apple Music their first subscription business when .Mac and MobileMe were technically subscription businesses. As is iCloud photo storage and sync, but perhaps media subscription business is more apt. And yes, there will be more media subscription businesses from Apple than just Music.

This line is also quite telling. “…recurring revenue that is growing independent of the unit shipments..” Cook and Apple are telling us this is a growing business and is expanding whether hardware shipments are or are not. “Look past hardware sales” is the main point Tim Cook is trying to make here and I agree. I’ve been saying the same thing for some time. Apple has a large installed based that has a propensity to spend in the Apple ecosystem over others. Even our data confirms Android switchers to iPhone almost instantly begin spending more once they are on iOS than they did on Android. Our data also confirms this golden point. Apple customers, on average, spend more in Apple’s ecosystem the longer they are in it. Meaning they spend more in year three than they did in year one. This is all upside on the services front from Apple and I’m bullish they continue to make strides integrating services into their hardware and software strategy.

Lastly, on the iPhone. We are in a lull in the global smartphone market at large. Growth is happening in pockets, like India, but only in pockets, not at large. For the developed world like China and the US, Apple is going to need to ignite a new cycle and my gut tells me it the dual-camera feature will do it. Unfortunately, it doesn’t seem like dual-cameras will be on the mainstream iPhone lineup until 2017 at the earliest. So, with iPhone sales, I expect calm waters to continue and Apple needs to navigate with very little to no wind at their back.

Apple Watch at One: What Next?

This week, the Apple Watch will celebrate its first anniversary. If the rumors are correct, we should expect a new Apple Watch this fall, most likely in September. Given this, it’s worth thinking about the Apple Watch as it is today and what should happen when Apple updates the device in a few months.

Vision versus Reality

Apple’s vision for the Apple Watch was a little like the original iPhone strategy, in that it had three parts. The Apple Watch was to be:

  • the most advanced timepiece ever created
  • a revolutionary way to connect to others
  • a comprehensive health and fitness companion

In addition, Apple made much of the apps that would be available for the device and showed several on stage.

In reality, while the Apple Watch turns out to be very good as a fitness device, the rest of the vision articulated a year ago has turned out to be a little off the mark. From my personal use and from survey data from Wristly and others, it would appear people do indeed use the Apple Watch as a fitness companion but the main value comes from notifications and the watch face complications. Apps have largely been a disappointment, even since watchOS 2 launched last fall, because they simply load too slowly and inconsistently to be useful. In my experience, the communication aspects – notably Digital Touch – have been a novelty that quickly wore off. I do use the Apple Watch for communication but I don’t use any of the Watch-specific features – Messages is one of several apps where I use actionable notifications (also available on iOS) rather than the app itself to communicate.

I use the fitness features regularly – I wasn’t in the market for a fitness tracker as such, but having a regular reminder of my progress against goals right on my wrist, which I now consult dozens of times a day, has been very motivating. I don’t use any third party apps for fitness tracking most of the time, but I find the three rings plenty to keep track of how I’m doing, try a little harder if I need to, and so on. I find the Modular watch face with its many complications invaluable at this point for getting a quick sense of what’s going on in my life. I’ve worn watches all day every day since I was about six, so it is natural to look at my wrist regularly throughout the day to check the time. Now I get more value out of that glance because I also see what’s next on my calendar, what the weather is, how I’m doing with my fitness goals, and so on. The watch face provides the true “Glance” functionality for me, rather than the feature actually called that, which I never use. Notifications – which I carefully tuned when I first got the Watch – are the other essential part of its functionality for me. I get a lot of notifications, and it’s great to be able to see these on my wrist, dismiss some, respond to others, make a mental note to deal with others later, and switch to another device to deal with the rest. I love that my notifications no longer have to beep or vibrate in a way that’s noticeable to others, and are much more personal than in the past.

All of this means the Apple Watch for me largely fills the same functions as most other early smartwatches, though it does them considerably better. This takes me back to a report I wrote in the months before the Apple Watch launched which said that as long as smartwatches mostly focused on notifications and fitness they’d find a limited market, since most people don’t care about those things. It’s better than other smartwatches, but it’s not as different in the jobs it does as Apple’s vision for it would have suggested.

Apple Watch 2

All this raises the question of what Apple might do with the second version of the Watch to address these issues and expand the addressable market for the Watch. The most obvious thing would be boosting the performance of the Watch significantly, allowing apps to perform more effectively. That means boosting the processor on the Watch such that it can handle these tasks natively with a much quicker response time. It likely also means giving the Watch more network autonomy. Apple likely isn’t ready to add an LTE chip to the Watch, but having its own connectivity would make a big difference in the responsiveness. At least being able to connect to WiFi when available independent of the iPhone would help here, though it wouldn’t help when out and about. I suspect if Apple gave the Watch a big enough spec bump, apps would become truly useful and it, in turn, would spark innovation in that area. The initial batch of Watch apps were largely ineffective because of a combination of lack of vision and poor performance. Apple needs to fix both problems and that likely starts with the hardware.

Another area where Apple could extend the functionality of the Watch is by adding more sensors. Independent GPS is an obvious one, and it would fix one of the few big holes from a fitness tracking perspective. But it could also be extended with a variety of body sensors, which could provide additional information for health and fitness apps. This could be done in the Watch itself (that’s certainly where the GPS needs to reside), but it could also be done through either Apple-made or third-party Watch bands which could be specialized for particular needs. This could be one way to address the regulatory challenges associated with moving deeper into the healthcare sphere, which I alluded to last week. Opening up a Band connector to third parties could enable this innovation without Apple having to deal with the FDA and equivalent bodies itself.

From the reporting I’ve seen, it seems more likely Apple will address the latter of these two needs than the former, and I think that’s a shame. The market for the Watch can only really expand beyond its current scope if the Watch does meaningfully more. That means unleashing the thousands of apps that could come to the device if the hardware really supported them. I love my Apple Watch but it still feels like I’m using a subset of what could be a much fuller set of features if Apple were to really move its performance forward in the fall.

Apple Security, Smartphones are More Fun Than Driving

I want to share a few more thoughts for subscribers about the briefing I was at on Friday with Apple executives where they gave more depth on their security strategy and philosophy. As I sat through the list of things Apple outlined and diagrammed of the inner workings of iOS security, it hit me that security and privacy are now being “baked in” at every level of Apple’s future products. As we understand how Apple is making long-term decisions at the chipset design level, an operating system design level, and even at a manufacturing level, we see Apple is now making long-term security decisions deeply embedded into their chipsets, hardware, and software.

Prior to this meeting, I would not have included security as a part of the Apple ecosystem with the same depth I now feel it must be included. One thing Apple outlined was how they had thought through support for third-party keyboards as an example for why they sandbox apps. Sandboxing was designed to keep apps from becoming malicious but was also designed with some flexibility included. This makes it so you can have a third party keyboard but that keyboard can not go fetch your home address, personal emails, banking information, or even collect or track your use of it without your express permission. I don’t know about you but I get constant phishing emails from friends’ email addresses who own Android smartphones. Some third party app got their email, spoofed it, and sent it to their contact list. Apple’s design of sandboxing prevents this and a whole lot more from happening. Apple is integrating security built from the ground up and extending it to the every area of their ecosystem.

Even with the impressive deep dive on how Apple’s security solutions are architected, executives were still keen to point out that security is a moving target. As good as Apple’s security solutions are, Apple is clear they can not and will not stand still. Hackers get better and smarter every day. Apple is going to have to go beyond custom SoCs, security built software in iOS, and go even deeper into cloud security to truly bring their entire security philosophy to every area of their ecosystem. There are many parts of Apple’s products they don’t control as much as in the iPhone and iPad. Their cloud solution is one, but so are Macs. Apple made an effort to go in-depth on how secure the iPhone and iPad are because they design the silicon. However, they don’t have this luxury yet with the Macintosh. This has convinced me even more that, if Apple truly wants to bring their security philosophy to their products in every part of the ecosystem, they must also do what many predict and make A-series processors for Macs. Let’s just say, this briefing has convinced me even more A-series processors for Macs are inevitable.

Smartphones are More Fun Than Driving

I hope an anecdote will lead to an insight. I am the twice a week carpool for my Jr. High daughter’s track team. We take a group of kids home twice a week and during this journey I get to hear all that is trendy in the world of Jr. High Schoolers. Much of the conversation is about technology. During this trip, I’d estimate they spend 90% sending messages to friends and looking at Instagram. The experience has made it clear to me why this generation will so easily embrace self-driving vehicles. While I’m not going to suggest everyone hates driving, I certainly do and I’m sure many others do as well. But there has not been a generation that has entirely grown up with a smartphone to use while they are being chauffeured around at the same time. Sure, generations grew up with GameBoys or, in my case, a Game Gear, but in this generation, every single one of them has a smartphone. And smartphones are more fun than driving.

Ultimately at a holistic level, I think this generation’s relationship with cars (and driving) is dramatically different than generations prior. For every previous generation, cars were mainstream. But no generation had access to a pocket computer at all times. Some part of me believes this is part of the formula which changed the younger demographics’ view of driving.

Intel’s Executive Shake Up, Apple’s Challenge in India, Twitter to Stream NFL

Anytime a big iconic company has executive turnover or reshuffling, people take note. Yesterday, Intel did just that with some very senior executive movements at the company.

There are many ways to interpret this, from doom to gloom to appropriate restructure and build. But the commonality of the news is a result of Intel’s struggle at finding any bright spots beyond the data center. The PC category continues to be a mess and our consumer studies on the segment do not suggest it is getting better.

Intel needs to position itself to ride the next waves of computing but, even here, their continual struggles on the graphics side of things remain an issue. Having just attended NVIDIA’s keynote, where founder Jen-Hsun Huang painted a picture of all things AI, VR, and cars, NVIDIA’s approach to high-performance computing has been paying off as the elements of computer graphics remain a critical component for next generation computing. I’ve long said Intel made a mistake not acquiring NVIDIA many years ago and I still believe that’s true.

I remain bullish on Intel’s process technology and their upside in manufacturing. The problem is, part of Intel is still stuck in the past and, hopefully, the churn will be good and fresh blood and fresh thinking emerge and start pushing a new culture at Intel.

Apple’s Challenge in India

For everyone who is keeping a close eye on India, Apple’s road here will be long and challenging. Unlike China, where we knew the pieces would fall together and Chinese consumers would fuel a big cycle for iPhones, India is a very different market.

While a key part of Apple’s strategy in India likely starts with approved Apple retail stores, iPhones are currently sold through approved distributors. These distributors can be flexible with the price they sell iPhones based on what margin they are willing to take. If they are willing to take less margin to sell more, they have some flexibility to do that or they can price high and keep margins. When I was discussing the state of iPhone sales in India with a few tech journalists based there who were attending the last Apple event, they explained they saw the price of the iPhone 6s drop relatively quickly as these resellers were looking to be aggressive. This fluctuating pricing can both help and hurt since it is essentially fluctuating with demand. This is not terribly unlike the China grey market, which I have studied in depth, where merchants move the price of a used iPhone based on what is hot at the time. For example, if on any particular day white iPhone 5s are popular, vendors will hike the prices of just that SKU. Grey markets are a wild west and the Indian market, while regulated with approved iPhone vendors, has some similarities as pricing can vary.

While the iPhone SE is a major part of emerging market discussions, I think too much emphasis has been put on the 4″ form factor and not enough on pricing as of late. When Apple states 30m iPhones sold were 4″ or that many first time iPhone owners are buying the 4″ device, the reality is it is the price of those phones, not the size, that is drawing many of those consumers. I’d wager if a 4.7″ iPhone was priced at or near the price of the 5s, the 4.7″ would outsell the 4″ dramatically. The iPhone SE is a tremendous device at $399 but it is the price that is attractive, not the size for a large chunk of the market.

Apple’s story in India needs to be a value-centric message. Apple has not really had to market to a pragmatic buyer and this is the mindset they face in India. Spec-wise, with all but the screen size, the iPhone SE is attractive and competitive. But we do have to take the screen size into consideration in a value-centric market. To an Indian buyer who has already established a 5″ screen or so is a good value device (more screen, more value), what are the tradeoffs they are willing to make to go smaller? Meaning, by sacrificing screen size, what other benefits will they get beyond what any other competitive device offers? This is where Apple will have to spend their time marketing the total value to Indian consumers if they hope to gain more share in India.

Twitter to Stream the NFL

An interesting bit of news about Twitter hit yesterday morning. They have acquired the rights to stream Thursday Night Football.

This is an intriguing move but it carries with it both a question of the agenda and the monetization. Twitter paid less than $10 million for the rights and it likely includes rights to both desktop and mobile streaming, although this has not been confirmed. It appears Twitter can add some production of their own to this stream including live periscope streams, proprietary highlights (perhaps for Moments), and other associated video. However, they can’t place national ads as those are retained by the main networks. So Twitter’s monetization is limited to local ads which are not paid at a premium.

The agenda question remains. Is this to drive ad revenue or increase user growth? The monetization angle seems a larger uphill climb so I’m guessing this is an attempt to convert new users to Twitter. I don’t expect people to all of a sudden stop watching this game on their big screen TVs. But, if Twitter can more tightly integrate the second screen experience around the game on smartphones, tablets, or PCs, then they may give people reasons to try Twitter or, at least, check out the non-logged in experience in a browser. Again, a major factor for this to work is Twitter layering on production value on top of the broadcast. If this is done right, I can see it being quite interesting and perhaps successful in driving users. At the very least, at $10m, this is a fairly low-risk proposition which Twitter may learn some very valuable things from and use to grow in the future.

FBI v. Apple: “Unduly Burdensome”

You might well be asking yourself, if the FBI withdrew its challenge against Apple, then why are we still talking about FBI v. Apple? Well, the San Bernadino case is over, but there are many, many more cases still pending. The ACLU published an interactive map of locations where the FBI is currently using the All Writs Act to demand assistance from Tech companies. You can view it HERE. So yeah, this matter is far from over.

Author’s Note: For an outline of how I think FBI v. Apple will play out, please see HERE.

As I’ve written before, there are two big issues that the FBI must overcome before it can get a court to order Apple to undo its own encryption. The first issue is CALEA — a statute that appears, on its face, to prohibit the FBI from asking for the very thing they’re currently asking for. I discussed CALEA HERE.

Today I focus on the second big stumbling block facing the FBI. If the FBI is going to use the All Writs Act to order Apple to assist them in breaking their own encryption, the FBI must first demonstrate that the requested assistance is not “unduly burdensome”.

One Phone, One Time

The FBI has steadfastly insisted that this case is just about one phone, and that the action they are requesting of Apple would occur only once. That is a crock of manure.

So important is this issue, that I was going to devote an entire article to it. However, since the current case is over, let me just point out that the director of the FBI — during testimony — under oath — before Congress — said:

“(O)f course” the FBI would use the ruling from this case to “return to the courts in future cases to demand that Apple and other private companies assist . . . in unlocking secure devices.”

So much for ‘one phone, one time’.

But is it really all that important? Is the claim that this is just about ‘one phone, one time’ really that big of a deal?

Oh yeah.

In their pleadings, the FBI said that Apple “desperately needs” this case to be about more than just one phone.

Apple desperately wants—desperately needs—this case not to be “about one isolated iPhone.” ~ FBI Pleadings

Someone was desperate, all right, but it wasn’t Apple. The FBI knows that if they are forced to acknowledge that Apple is going to have to comply with similar requests over and over again, then they will also be forced to acknowledge that the burdens that Apple could be expected to endure will expand exponentially.

It was the FBI who desperately wanted — desperately needed — this case to be about one isolated iPhone. That is why they continue to defend their position even when the facts, logic, common sense and the testimony of their own director make their position indefensible. Zealous advocacy is to be commended. Purposefully misstating a material fact is to be condemned.

In just one week, the FBI’s gone from “just one phone” to sharing with the entire law enforcement community. Remember this for the next one. ~ Jonathan Ździarski (@JZdziarski)

Precedent

This case was never about getting information from the phone. It was always about setting a legal precedent that would allow the FBI to force tech companies to build back doors to the FBI’s specifications.

“Ah,” you say, “you can’t prove that. You’re starting to sound like a conspiracy nut.”

Oh yeah? You know who else sounds like a conspiracy nut? Richard Clarke, former national security advisor and head of counter terrorism.

[The FBI] is not as interested in solving the problem as they are in getting a legal precedent,” Clarke said. “Every expert I know believes the NSA could crack this phone. They want the precedent that government could compel a device manufacturer to let the government in.

The FBI director is exaggerating the need for this, trying to build it up as an emotional case … It’s Jim Comey. And the Attorney General is letting him get away with it. ~ Richard Clarke

All the evidence is consistent with the “crackpot conspiracy theory” that the FBI has been systematically trying to compel firms to backdoor their own encryption. At this point, I would venture to say that you have to be a crackpot NOT to believe these theories.

Unduly Burdensome

Duty To Assist Law Enforcement

Even now, I don’t think people realize what this case is all about. Apple did nothing wrong here. They were just being asked to help law enforcement out. Our legal system allows that, but only to a very limited degree.

[pullquote]The government does not hold the general power to enlist private third parties as investigative agents[/pullquote]

While the government can, in some circumstances, require third parties to support law enforcement investigations — for example, by requiring them to produce relevant evidence or give truthful testimony — the government does not hold the general power to enlist private third parties as investigative agents.

Some typical examples of what citizens can be asked to do:

— Produce existing business records;
— Freeze assets and accounts;
— Turn over security footage.

Let’s examine that last example. The FBI can go to a store and ask them for their security footage, but that’s about it. They can’t ask the store owner to stay up all night filming a suspect, and they can’t ask the store owner to install additional cameras in his lunch room, bathroom and boardroom. All of that is way, way, way beyond the call of duty.

What the FBI is asking of Apple is way beyond the call of duty too.

Legal Buzzwords

The Courts have placed severe limitations on what law enforcement can and cannot ask third parties to do. Here are the kind of buzzwords that are seen when reading through the applicable case law:

Must not be “in any way burdensome”; “meager assistance”; “minimal effort”; “no costs will be incurred”; “require minimal uses of company resources”; “no disruption to its operations”; the absence of any conceivable “adverse effect”; “normal course of their business”; “must not adversely affect the basic interests of the third party or impose an undue burden”.

Perhaps now you begin to see how little law enforcement can demand of us, and how free we are to refuse those demands.

Public Utilities vs. Private Entities

Most of the cases cited by the FBI in support of their position concerned highly regulated public utilities, not private companies. And the Courts have gone out of their way to note that much more can be demanded of public utilities — such as phone companies — than of private parties.

Even in those cases where public utilities were required to assist law enforcement, the types of burdens the Courts imposed were not at all as onerous as the one being requested of Apple.

For example, the FBI claimed that the Courts compelled the Mountain Bell telephone company to do programming, so it would certainly be nothing new for the Courts to compel Apple to do the same.

But in 1979, when the Mountain Bell case occurred, “programming consisted of a technician — a single technician mind you — using a ‘teltypewriter’ and the entire process “t[ook] less than one minute” ~ Apple Pleadings

Here is an image of the type of device that law enforcement asked Mountain Bell to “program” in 1979:

Pasted Graphic 2

So yeah, not the same as asking a company to create a tailored operating system.

Proprietary

In the current case, we’re talking about messing around with someone’s proprietary intellectual property. To my knowledge that has never occurred under the All Writs Act before. Ever.

Let me repeat that: The Courts have never required a third-party to alter — more less degrade — their proprietary property in order to aid law enforcement.

Screwing around with someone’s proprietary property is not like asking them for security footage. It’s more akin to asking an author to rewrite portions of their book and then put that book up for sale under the author’s name. Similarly, what the FBI wants Apple to do is to rewrite portions of their security software and then put it up for sale under Apple’s imprimatur.

Unprecedented

In fact, the requested action by the FBI is unprecedented at every level. Never before has law enforcement asked that such a burden be imposed under the All Writs Act.

For A Living

Proprietary? Unprecedented? The FBI shrugs these off, blithely responding ‘fiddily dee dee, writing a little software is not a burden for Apple. After all, they write software for a living.’

(I)t is not an unreasonable burden for a company that writes software code as part of its regular business.

(T)his case requires Apple to provide modified software, modifying an operating system—writing software code—is not an unreasonable burden for a company that writes software code as part of its regular business.

Oh yeah? As Apple pointed out in their pleadings, following the government’s thinking to its logical conclusion leads to absurd results.

(I)t would not be unreasonably burdensome to demand that Boeing build a custom jet for the government because Boeing builds planes as part of its regular business or to demand that a pharmaceutical company make drugs for executions after it has made the intentional decision not to. ~ Apple Pleadings

Just because Apple is in the business of building encryption software does not mean Apple is in the business of tearing down their encryption software any more than Boeing is in the business of building planes that are specially designed to crash.

Costs

The compromised operating system that the government demands would require significant resources and effort to develop. Although it is difficult to estimate, because it has never been done before, the design, creation, validation, and deployment of the software likely would necessitate six to ten Apple engineers and employees dedicating a very substantial portion of their time for a minimum of two weeks, and likely as many as four weeks. Members of the team would include engineers from Apple’s core operating system group, a quality assurance engineer, a project manager, and either a document writer or a tool writer. ~ Apple Pleadings

The costs for Apple to accede to the government’s request are extraordinary and unprecedented…

…but no one cares. Apple makes billions of dollars, so no one has any sympathy for them.

There are, of course, other, more long term, and more damaging, costs such as forcing Apple to violate their existing representations, and the harm that would be caused to Apple’s reputation, their global brand and their bottom line.

Again, hardly anyone outside of Apple cares about those costs either. “Whoop de doo,” they say. “Price of doing business.”

Except, of course, that’s dead wrong. Hurting your brand and your reputation and your product are NOT the price of doing business. On the contrary, they’re the penalty paid for doing your business very, very badly. And Law enforcement simply does not — at least not without statutory authority — have the power to command you to run your business badly.

It’s important to understand that the costs described above are just the beginning, not the end, of the burdens that the FBI’s request would place upon Apple. The truly oppressive costs would come in forms that few have adequately considered.

Forensic

Standard forensic practice would require the code of any forensic tool Apple produces to be preserved for at least as long as it might be needed as evidence in court. We’re talking about years, and, with appeals, perhaps decades. So just forget about the idea of creating, then destroying, a software skeleton key as quickly as you made it. That’s out.

And, of course, the Apple engineers would have to testify at trial about the back door that they had created, otherwise, under the fourth amendment, the evidence would be inadmissible.

Essentially, the encryption breaking portion of Apple would become a permanent arm of the government’s forensic team.

This, of course, is materially different from merely asking a store owner to provide law enforcement with a copy of their security footage.

Pariahs

Apple would have to maintain an in-house team of engineers dedicated to hacking its own users and affirmatively undermining the company’s promised security measures. The engineers involved in this effort might be some of the very same engineers responsible for designing and building the security features in the first place. Can you imagine what an awkward position that would place them in? Everyone else at Apple would view them as the as saboteurs. They would be treated like pariahs and their job would make their lives a living hell.

A House Divided

It is extremely difficult to write bug-free code.

There are two ways to write error-free programs; only the third one works. ~ Alan Perlis

The suggestion that Apple would be able to program a back door without risking a major screwup is laughable. I mean, have you even MET programing?

QUESTION: Joe’s code has 20 bugs. If Joe fixes 2 bugs per hour for 8 hours, how many bugs does Joe’s code have now?

ANSWER: 27.

[pullquote]Improving security would be costly and dangerous[/pullquote]

Software bugs can interact with existing code in complex ways, creating unanticipated new paths for bypassing iPhone security and exploiting the phone. Purposefully creating vulnerabilities likely creates even more vulnerabilities and those can be pretty dangerous. That means every design choice Apple makes to improve device security entails, not only the foreseeable front-end costs of implementing it, but the unpredictable back-end costs of degrading that improved security. And that’s especially true in this situation, where Apple would have to create the code entirely by itself, and without the possibility of any outside security audit.

[pullquote]The smart thing would be to stop improving your encryption[/pullquote]

Have you considered the contradictory incentives that would create? What is the point of making your encryption better if you know that you are simultaneously required to break that encryption? You’re just making your life — and life of your co-workers — harder. Instead of simply asking whether new security measures are cost-effective to implement from a user’s perspective, engineers would need to evaluate whether they could justify the additional cost of being required to attack those measures too.

The only way to avoid unnecessary costs, unnecessary work, unnecessary danger, and unnecessary conflicts with co-workers would be to stop improving the encryption.

Morale

The effect on morale, for both the engineers and the company overall, would be devastating.

What Apple engineer is going to want to destroy the company’s encryption and make things worse for their customers? Is that even ethical? There’s already been talk of Apple engineers refusing to comply with such an order or resigning their positions.

And how is Apple supposed to keep up overall morale when employees all know that one part of the company is actively sabotaging the other, and all in order to make their product worse and to make their customers less safe?

Safeguarding

As if it’s not enough that the government is forcing Apple to create govtOS, they’re also making Apple responsible for safeguarding it too.

Apple is being forced to make a nuclear weapon, then either take responsibility for guarding that weapon or destroy it and rebuild it later. ~ Jonathan Ździarski on Twitter

The FBI frames this burden as a favor since they’re “allowing” Apple to decide for itself whether they wish to share the requested software skeleton key or keep it in the safety of their own secure headquarters.

The Court’s Order is modest. It applies to a single iPhone, and it allows Apple to decide the least burdensome means of complying. ~ FBI Pleadings

Oh, thanks a bunch, FBI.

When the FBI says that it is “allowing” Apple to decide the least burdensome means of complying with their request, what they’re really saying is that they’re foisting the responsibility of solving this impossible task onto Apple. To paraphrase Pyrrhus (he, of the pyrrhic victory), if the FBI does Apple another such favor, Apple is ruined.

Apple v FBI debate remind anyone of Jurassic Park? “We want you to create mutant dinosaurs, but only for safe captivity on this one island.” ~ Jon Fortt on Twitter

When asked, during a Congressional hearing, about whether it would be difficult to safeguard govtOS, FBI Director Comey testified that he had “a lot of faith” that Apple could protect the code from falling into the wrong hands. How oh so very convenient for Comey and the FBI and how oh so very inconvenient for Apple — who has to do all the work and endure all the risk as well.

Once you’ve created code that’s potentially compromising, it’s like a bacteriological weapon. You’re always afraid of it getting out of the lab. ~ Michael Chertoff, co-author of the Patriot Act, US Secretary for Homeland Security under George W. Bush

The government says, ‘Hey, security is no big deal’.

(T)here is no reason to think that the code Apple writes in compliance with the Order will ever leave Apple’s possession. ~ FBI Pleadings

There is, in fact, EVERY reason to think that the requested code will leave Apple’s possession.

Apple would end up being responsible for the Hope diamond of security keys. ((Now that I think about it, the value of the Hope Diamond pales in comparison to the value of breaching Apple’s encryption.))

Hope_Diamond
The code would be a major prize and actors would go to almost any length — including kidnapping — to obtain it.

It makes Apple employees targets of foreign governments, kidnappings, hacking, surveillance, blackmail, etc. ~ Jonathan Ździarski on Twitter

And who would these attackers be? The baddest of the bad. Hackers, cybercriminals, authoritarian governments such as China and Russia. Some of the best minds — with some of the worst intentions — would bend their efforts toward obtaining this newly created skeleton key.

[I]t may simply be impossible to keep the program from falling into the wrong hands. ~ NSA expert Will Ackerly

And since Apple would have to maintain each key, and since Apple would have to create and re-create the key thousands upon thousands of times a year, Apple’s burden would be constant and never-ending.

We strongly believe the only way to guarantee that such a powerful tool isn’t abused and doesn’t fall into the wrong hands is to never create it. ~ Apple Pleadings

A Skeleton Key

The government is also very mistaken in their claim that the crippled iOS it wants Apple to build can only be used on one iPhone.

The technical experts have warned us that it is impossible to intentionally introduce flaws into secure products—often called backdoors—that only law enforcement can exploit to the exclusion of terrorists and cyber criminals. ~ Congressman John Conyers

Once GovtOS is created, personalizing it to a new device becomes a simple process. If Apple were forced to create GovtOS for installation on the device at issue in this case, it would likely take only minutes for Apple, or a malicious actor with sufficient access, to perform the necessary engineering work to install it on another device of the same model. ~ Apple Pleadings

A signed firmware update that is not truly limited to a single device, even one created for legitimate forensic purposes, becomes like a ‘skeleton key’ for the entire class of devices. Moreover, the more often this tool is used, the greater the risk it will be stolen or otherwise disclosed. ~ Apple Pleadings

Apple wouldn’t be creating a single key to open a single lock. They would be creating a skeleton key that would be capable of opening a billion locks.

Just in case you didn’t get the irony, FBI now has a backdoor that isn’t restricted to a single device, like they insisted Apple could make. ~ Jonathan Ździarski (@JZdziarski)

A Footprint

As if it’s not bad enough that the requested skeleton key is likely to be stolen, security experts say that the mere act of creating the software would put at risk the privacy and integrity of the data stored on millions of iPhones worldwide.

[u]sing the software even once could give authorities or outsiders new clues to how Apple’s security features work, potentially exposing vulnerabilities that could be exploited in the future. ~ Brandon Bailey

[T]here is no way to make a backdoor that works only for this single phone—the process of creating the backdoor establishes a blueprint and workflow for compromising all iPhones. ~ Kalev Leetaru, Forbes Contributor

The danger is not whether the FBI submits one request or a thousand, it’s forcing Apple to create the tool. ~ Bruce Schneier, security technologist at Harvard University’s Berkman Center for Internet and Society

We’re not just talking iPhones here. Security experts fear that if Apple is forced to create a “key” to access one of the San Bernardino terrorists’ iPhones, then that technology will leave a “footprint” that cannot be erased. And that ‘footprint’ could provide a hacker with a path for attacking not just Apple, but the encryption of others as well.

My definition of an expert in any field is a person who knows enough about what’s really going on to be scared. ~ P. J. Plauger

We’ve come a long, long way from law enforcement merely asking a store owner for some security footage, right?

Does Not Exist

Another aspect of this case that hasn’t been receiving enough attention is the fact that the FBI is asking Apple to create something that does not exist. In all the government’s past requests for citizen assistance, never — NEVER — has the government asked someone to create something that didn’t already exist.

[pullquote]How exactly do you compel creativity and ingenuity?[/pullquote]

And we’re not talking about building a new chair or making a new dress either. We’re talking about writing code — something that’s not easy to create. Setting aside the First Amendment issues — which deserve an article of their own — how exactly do you compel creativity and ingenuity?

Apple is being asked to use their very best engineers — you know, the ones who were supposed to be making their encryption harder to break — to use their creative juices in an effort to break and degrade their encryption.

FBI is not only ordering Apple to perform surgery, they’re ordering them to invent a new medical procedure, and with no medical training. ~ Jonathan Ździarski on Twitter

Actually, it’s even more sinister than the above analogy implies. The FBI is ordering Apple to invent a new medical procedure that would undo prior surgical repairs and do their patient harm.

Apple Has A Compelling Interest Not To Comply

JUST MARKETING

“Ah, so what,” says the government, “This is all Apple’s fault anyway. They brought this on themselves.”

This burden, which is not unreasonable, is the direct result of Apple’s deliberate marketing decision to engineer its products so that the government cannot search them, even with a warrant. ~ FBI Pleadings

Let’s just set aside for the moment that what Apple is doing is one hundred percent legal (and, according to CALEA, what the government is attempting to do is one hundred percent illegal). Apple’s refusal to dilute their encryption is a “marketing decision”…

…in roughly the same sense that not serving burgers garnished with sewage is a “marketing decision”. ~ Julian Sanchez on Twitter

KEY EMPLOYEES

Have you given any thought to which engineers Apple would have to use in order to break their own encryption? You should.

Apple has maybe 5 employees capable of writing the software. Doing this means not fixing some other vital bug. ~ Rob Graham ❄️ on Twitter

The FBI’s request would not just turn Apple’s best minds toward the task of breaking Apple’s encryption, it would also divert those self-same minds away from the all important task of making Apple’s encryption better.

DISCOURAGE CUSTOMER UPDATES

If Apple can be forced to use their automatic updates to remove security features, it creates an incentive for customers to not update their devices. It’s in Apple’s best interests that customers update their operating systems as soon as possible and customers also benefit, not just from the features provided in updates but by security enhancements as well. The disincentive created by the FBI’s intrusion into Apple’s software update procedure would make the operating system open to even more security vulnerabilities.

SAFEGUARD CLIENT DATA

Apple is not just petulantly refusing to honor the FBI’s request out of childish spite or due to a lack of patriotic fervor. Apple has a compelling interest in safeguarding the data protection systems that ensure the security of hundreds of millions of customers who depend upon, and store their most confidential data on, their iPhones. An order compelling Apple to create software that defeats those safeguards undeniably threatens those systems and adversely affects both Apple’s interests and the interests of iPhone users around the globe. The protections that the government asks Apple to compromise are the most security-critical software component of the iPhone—any vulnerability or back door, whether introduced intentionally or unintentionally, can represent a risk to all users of Apple devices simultaneously.

Apple is being asked to build a cruise ship that will flood just one customer’s compartment, without making the ship any less seaworthy.

In essence, the FBI is demanding that Apple re-write its own software code, degrade the security of their customers, and create potentially catastrophic risks to the security of users’ Apple devices. How is that not going to be construed as unduly burdensome?

NORMAL COURSE OF BUSINESS

In every other case where the Courts have compelled a company to assist law enforcement, they justified it by pointing out that the request did not require the company to do anything other than what it was already doing in its normal course of business anyway. For example, law enforcement can request security footage from a store because the store, in the normal course of business, installed a security camera and took, and kept, security footage. The burden of providing a copy to law enforcement is minimal.

That is not the case here. Not only is the FBI asking Apple to do something they would not do in the normal course of business, they’re asking Apple undo what they normally do.

ANTITHETICAL

Apple is being asked to take an action that is not only costly, not only NOT in the normal course of business, not only dangerous, but something that is antithetical to their business and something that is plainly “offensive to it.” N.Y. Tel. Co., 434 U.S. at 174.34

Apple is not required to sabotage its own products. On the contrary:

(Apple is) free to choose to promote its customers’ interest in privacy over the competing interest of law enforcement. ~ Magistrate Judge Ornstein

Buzzwords Redux

Let’s look at that list of legal buzzwords again:

Must not be “in any way burdensome”; “meager assistance”; “minimal effort”; “no costs will be incurred”; “require minimal uses of company resources”; “no disruption to its operations”; the absence of any conceivable “adverse effect”; “normal course of their business”; “must not adversely affect the basic interests of the third party or impose an undue burden”.

After re-reading the above, do you really think there is any reasonable way to construe the government’s request of Apple as anything but burdensome?

Third Party

One final time, I feel I need to re-remind everyone that Apple is not the bad guy here. Apple did nothing wrong. They didn’t break any laws. This is about law enforcement asking a third party — who is not engaged in any wrongful conduct — to not just take an action, but to take an action they don’t want to take and one that would be harmful to them.

The government is asking Apple to do them a favor, but what a favor. The FBI asking Apple to trash it’s own encryption is like your neighbor asking you to burn down your house so he can stay warm.

[pullquote]Consider the effect on small businesses[/pullquote]

And have you considered the effect the FBI’s request would have on companies not named Apple?

The government is desperately trying to maintain the ludicrous fiction that this is about one phone, one time, because it doesn’t want the Court to think about the very real world consequences of what would happen when their requests were made to not just Apple, but to all companies, everywhere, all the time. Unlike Apple, few companies have the resources necessary to comply with such requests and even fewer have the resources necessary to resist such requests. ((Two examples are Hush Mail (a Canadian company) and Lavibit. Both companies were devastated, and essentially forced to close their doors, simply because they could not afford to fend off government requests for their client’s data.))

The government’s requests would chill innovation and deter companies from entering the important field of encryption.

Conclusion

An FBI that asks Apple to break their encryption for the greater good is like a cannibal that asks a chef to teach him how to cook so he may better serve mankind. Sounds noble, but it’s just going to get us all in hot water.

The FBI is attempting to compel Apple to reengineer a product design solely to defeat the product’s purpose. Asking Apple to create that which does not already exist and which Apple does not want to create and which will harm the company now, and going forward, is the very definition of burdensome.

What the government is demanding of Apple is simply above and beyond what can be, and should be, demanded of a good citizen.

Intel Retires Tick-Tock, Apple’s Focus on the Cloud, The Fallacy of Apple Revolutionary

Intel Retires Tick-Tock

An entirely predictable news item came out yesterday. Intel plans to shift away from their Tick-Tock method and extend the life of current generation process technology to what is likely to be three generation of cores. I take no issue with this and don’t see it as bad for Intel in the slightest or that it gives their competition any advantage on process technology. What this does showcase, however, is the fascinating dynamic being hit by everyone in the component landscape. Hardware is commoditizing across the board in consumer tech and when that happens, it becomes harder and harder to sell premium and leading edge innovation parts to customers that want to sell devices at scale and rock bottom prices. This dynamic is a factor among the many reasons why Moore’s Law is likely at its end. Not because we can’t get to new process technology nodes, such as 10nm which is next on the list, but because it is harder to do so economically. Which means that for Intel, TSMC, Samsung, and Global Foundries to find the investment worth spending billions of dollars to get to the next node, they need to know they have customers who will pay the premium for it. And that list is now exceptionally short. In fact, it is largely limited to one name–Apple.

Intel, and I expect a great many other foundries to do the same, will need to extend the life of 14nm to three generations of products just so they can recoup the investment it took to get them there. The PC industry decline and the relatively small chipset volume, but high margins on servers, is not enough to fill their fabs and recoup their investment to get to 14nm so they will extend its life to justify their costs. This is the new reality in the world of semiconductors.

Intel will surely get to 10nm as will Samsung, and TSMC in a roundabout way, but they will have to lengthen the life to possibly even four generations to recoup their billions of dollars it cost in CapEx and R&D. All of you have noted we have been writing quite a bit about VR these days and this dynamic I just outlined is a key part of the reason. The component industry has a reason to pursue premium innovation again. There are some significantly difficult technical problems to solve to get VR/AR to go mainstream and we need these companies pushing the envelope in performance, sensors, battery life, and more. Unfortunately, the smartphone, PC, tablet, and even the automotive industry does not have the high-end component scale worth chasing after with new high-end silicon. VR and AR, on the other hand, are worth it and this is why the whole of the component industry is excited about VR.

Apple’s Focus on the Cloud

The Information had an interesting story regarding Apple and Cloud infrastructure. The crux of the article goes into the challenges Apple has had with their cloud solution, essentially the major issue many point out regarding Apple overall as being weak at cloud services, but also the deals and custom designing of server hardware which Apple is exploring to solve this issue. This bit in particular was of interest regarding “Project McQueen”, the code name for this custom hardware project.

Apple is also working on projects to design its own servers. At least part of the driver for this is to ensure that the servers are secure. Apple has long suspected that servers it ordered from the traditional supply chain were intercepted during shipping, with additional chips and firmware added to them by unknown third parties in order to make them vulnerable to infiltration, according to a person familiar with the matter. At one point, Apple even assigned people to take photographs of motherboards and annotate the function of each chip, explaining why it was supposed to be there. Building its own servers with motherboards it designed would be the most surefire way for Apple to prevent unauthorized snooping via extra chips.

I jokingly tweeted a few weeks ago asking how long it would be before Apple started designing its own server chips. While tongue-and-cheek, I had a certain tone of seriousness due to the optimization which could be done if they had custom hardware. The word that kept coming up in the Information’s article was scale. It noted time and time again that Apple is having issues scaling good technology they are licensing, which is fast and efficient, to their massive needs. It got me wondering if one of the reasons Apple has struggled with cloud is because they have larger problems to solve than a Google or Facebook due to the engagement levels of their ecosystem and how much is happening at a core computing level on their platform. It sounds odd to say Apple’s scale problems are harder than Google’s or Facebook’s but what if that is true due to the complexity of the platform and ecosystem? I’m just speculating but the bottom line is if they are truly having issues scaling then custom cloud and custom hardware makes sense. It could be optimized and tuned for their needs, which is certainly in line with how Apple operates.

The Fallacy of Apple Revolution

I came across this article from Walt Mossberg on The Verge and I’m reminded how this sentiment, that Apple needs to be revolutionary every year with every product cycle, is such a tired narrative. The iPhone is a mature product selling into a mature market. Understanding these dynamics are paramount to any company that sells technology to consumers. There comes a point in time where it is right for a company to focus on sustaining innovations and that time is now for the iPhone. The time for Apple to create new things, which may disrupt the iPhone, is also near. We speculate this could be The Apple Watch or maybe future VR or some embedded voice assistant in our ears or whatever. But the iPhone does not need to be reinvented like so many believe. It needs to be iterated with sustaining innovations since that is the stage we are in the cycle. It is really that simple.

Let’s examine this statement for a moment:

But the top-of-the-line iPhones were challenged impressively just two weeks ago by rival Samsung’s beautiful, carefully engineered new Galaxy S7 phones. A Verge test showed the Samsung’s cameras are better. Only the sadly typical software mess on those phones makes them lag behind Apple’s long-superior iPhone.

If the smartphone category is to take a leap forward, and the iPhone is to maintain its ever-thinning lead as the best smartphone you can buy, Apple needs to impress big time in the fall.

Firstly, Samsung is likely to sell 30-40m high-end Galaxies this year. We know this just by looking at historical comparables from the line, Samsung’s typical sales share, and buffer in some upside. Contrast that with 200m iPhones of similar spec and price. Samsung has done some wonderful things with the new S7 line, and I expect will as well with the Note in the fall, but 30-40 million? The market pull in the direction of which strategy is quite clear.

Lastly, the smartphone category does not need to take a leap forward. We are no longer in that cycle of the category. Iteration rules the day and Apple’s base will upgrade when they see fit. Not a single “leap” or massive innovation will move the mass market in any meaningful way until they are good and ready. It is the curse of consumer markets, which I could write a book about because it so misunderstood. Apple doesn’t need to be revolutionary, yet. But I’m certain they will be again in the future with whatever new category is up their sleeve.

The Not-So-Hidden Agenda Behind Apple’s New iPhone and iPad

On Monday, Apple introduced two new products that are quite important to their overall strategy and will have an impact on achieving two key goals in the future.

First up is the iPhone SE. From a design standpoint, it is almost identical to the 5c but with all of the updated technology features in their newer iPhone 6 and 6s line. But this iPhone is important to Apple for two key reasons. First, it comes in at $399, which makes it the lowest cost premium phone they have ever brought to market. Our research shows there is actually pent-up demand for this in China and many countries where a 4 inch model is still prized by many. We estimate this could add another 40 to 50 million per year to their overall iPhone sales.

However, I see this as Apple’s first serious entry into the mid-market for smartphones and, more importantly, this is the smartphone they will use to begin a major initiative to gain market share in India. I realize that, at $399, it is still way overpriced for India and most emerging markets but it delivers a psychology breakthrough in people’s thinking in these markets. This new price brings it into the realm of serious aspirational interest. Apple’s brand is highly prized in emerging markets but the higher priced models made an iPhone a prize they could never have.

Now, with the iPhone SE, it starts them thinking perhaps at some point they could actually own an iPhone. The people in these markets are smart enough to know that while this new iPhone is still priced too high, Apple can ride the supply chain down and within a year perhaps drop it another $100. This would make it even more affordable in emerging markets. I see India as Apple’s new China. Apple’s growth in mature markets is steady. In China there is still room to grow market share, but India is a greenfield for them that was untouchable with current iPhone models at their higher end prices.

Indeed, Apple is about to open a 5th Ave class store in India and will soon have satellite stores throughout the country as it moves to expand its presence in this market. If Apple is going to grow iPhone market share, it will have to come from emerging markets and India will be the next major market they go after.

The second product of note is the 9.7 inch model of the iPad Pro. This too is important for Apple’s future. Although the 13 inch iPad Pro has struck a chord in markets where drawing, graphics and high degrees of mobility are critical to the business process, it was still too large for some people. A 9.7” iPad Pro deliverers the same features of a larger iPad Pro but in a smaller package.

But what is unique with the launch of this product and an emphasis on the larger and smaller iPad Pro is that for the first time Apple has publicly targeted the Windows PC world. More specifically, the folks who have PCs over five years old. Intel and other PC makers have stated there are at least 600 million PCs still in use that are over five years old. To the traditional PC crowd, this has been their target market for some time.

However, it is now also a target market for Apple. When Phil Schiller launched the new, smaller iPad Pro, he made it clear Apple is now going to go after the PC crowd and will use the iPad Pro to target PC replacers in the same way Microsoft and their partners are using similar 2-in-1 models. This is a big shift in Apple’s strategy. For years, they did not embrace the 2-in-1 concept but Microsoft’s Surface and other competitor’s models in which a tablet/keyboard combo has been positioned to compete with traditional laptops has shown there is interest in this form factor.

Now that Apple has declared they too plan to expand their position and marketing clout to potential PC upgraders, they will be a worthy competitor to Microsoft and the other PC players who also covet people who are thinking of upgrading. How successful they will be when competing head on with a Windows solution vs and iOS version will be a big question but the fact Apple has 1 million iPad apps available should help them at least get the attention of the switchers.

These two products are very strategic to Apple’s expansion of their hardware, software and ecosystem. I expect Apple to put serious marketing dollars into them and make these new products an important part of their expansion plans. The iPhone SE allows them to offer a premium smartphone play at a more affordable price and I think starts them down a broader path to going after emerging markets more aggressively in the next three years. The smaller iPad Pro creates another workhorse option in the line that makes it even more attractive to both business and consumer users. Together they are quite important to Apple’s future.

Three Big Questions for Apple’s Event

A week and a half ago, I wrote about where I thought a theoretical iPhone SE would fit within Apple’s lineup and how it might be priced and positioned. As the day of the event finally arrives, I wanted to outline for Insiders three big questions I will be looking to have answered during the event because these will tell us a great deal about why Apple is announcing these particular new products now. The first two deal with some of the same subject matter as my earlier piece, while the third deals with the new iPad and its significance.

Note: all three of these questions make assumptions about products which haven’t been announced, based on credible reporting from sources with good histories. It’s always possible those assumptions turn out to be flawed, in which case the premise for the questions may be too.

Why launch the iPhone SE now?

As I wrote earlier, Apple clearly made a conscious decision to discontinue new 4-inch phones when it launched the iPhone 6 line. And yet, now we’re getting a new phone that shares many of the specs and features of the premium models at a smaller size. I speculated as to why this might be, but it will be very interesting to hear Apple talk through the reasoning. Why is Apple launching this phone now, given this seems to be a reversal of its earlier policy? Will it concede it underestimated how many people would insist on having a smaller device? Or, given the iPhone 5s has remained on sale, will they position this as an update of the iPhone 5s with updated innards?

Who is the iPhone SE for?

The second big question is who the iPhone SE is for. As I also mentioned in my previous piece, I suspect it’s for those in mature markets who want a smaller phone but who don’t need the latest and greatest, and perhaps would like to pay less. But how will Apple describe this target market? Apple has never competed or marketed its devices on price, but given this device will likely be priced $200 lower than its other new iPhones, it will have to explain that price differential somehow. I suspect we’ll see language about this being a great option for those who want new features like always on “Hey Siri”, Apple Pay, and a great camera, but prefer a smaller phone that’s easier to use with one hand. And while I don’t expect Apple to explain the March timing in detail, it may hint this device will be bought by those who don’t have to have the latest phone as soon as it comes out.

What happens to the iPad lineup when the Air goes Pro?

One of the other credible reports about Monday’s event is the iPad Air won’t be upgraded in the traditional fashion but will instead morph into a 9.7-inch iPad Pro. With past product lines, the “Pro” option (or its arguable iPhone equivalent, the Plus) has generally been inserted as an additional option on top of the existing lineup. In other words, it’s generally been an upward expansion of the line rather than a replacement of an existing product. That doesn’t seem likely to be the case here and that says something interesting about the iPad lineup as a whole. The situation before Monday’s announcement is there are three iPads with distinct names, two of which have names that refer largely to their size, and one of which is separated both by its size and functionality. As of Monday, we could have a situation where we have two Pro devices defined foremost by their functionality, plus one Mini of recent vintage, and then a set of older devices.

Remember that the 9.7-inch iPad is the original device in this product line, the one launched in 2010. The Mini was distinguished when it launched by its smaller size (and to some extent its price), but the 10-inch iPad remained the default option. Now, that looks set to change, which raises the broader question of what an iPad is now. With two of the three devices, including the best-selling mid-sized version, now branded as Pro, is that how we should think of the iPad going forward? As a high-powered device for people to do really serious work, one that justifies a price that starts at $600 and goes up significantly from there? In this version of the portfolio, the Mini becomes the low-end exception to the rule, rather than one of two mainstream options. That’s a subtle but important shift and an indicator of how Apple intends to evolve the iPad portfolio, if the reports are correct.

This makes sense in the context of both finding new buyers for the iPad (people looking for laptop replacements) and driving existing owners to buy new ones (because this iPad can do things their old one can’t). Both of these are important strategic objectives, but both also risk turning the iPad into something different and will also have implications for how past buyers think of them and think about replacing them. It’s possible to imagine a future scenario where Apple ends up releasing a sort of iPhone SE equivalent in the iPad line – the device for those who don’t want to move up to an iPad Pro but want a newish 10-inch tablet from Apple.

With all this said, I also think my two iPhone SE questions are interesting applied to the new iPad as well – why now, and for whom? I’ll be watching for answers and clues for those on Monday.

Android N, Samsung’s Last Stand, Rough Q1 for iPhones

Google gave a handful of blogs a preview of their new Android N operating system. Amongst the two best guesses I have seen for what N will stand for is Nutella and Neopolitan. I’m voting for Nutella since I love to the stuff.

We know new Android releases only get used on a small fraction of devices. This is actually one of the things I hope to see Google address at Google IO and it would be validated if the rumors are true they are trying to take back control of Android. With Marshmallow running on less than 3% of devices, for these updates to truly mean anything Google needs to take more control on how they get rolled out.

Some inside baseball nuggets on Android from an OEM standpoint. Android OEMs have multiple choices of apps to use when it comes to things like calendar, mail, contacts, text messenger, etc. This is one of the reasons there is dramatic inconsistency across Android devices. I run into this frequently when I bounce between Android devices — some of them sync with my Microsoft exchange stuff and some don’t. Some handle text and MMS messages differently. All because the OEM can use a range of different core apps. This lack of consistency in these core apps that come with the device is a hot mess. These are the types of things Google needs to clean up. I’ve heard is starting with the messaging app in Android N )which is supposed to be much more like iMessage) and OEMs will only use that one across all devices. This would be a positive step forward.

The other big initial feature I think is interesting is the split screen mode for apps. This is clearly a tablet feature. While our data continually shows the market for Android tablets is mostly sub $100 and shrinking, not growing, I have been optimistic on the idea of an Android-based device in the Surface or iPad Pro form factor for emerging markets. My thesis has been, this $300-$400 Android 2-1 PC makes more sense in markets where PC/Windows penetration is low and Android is the main OS in country. India is a prime example of this and a key market where I can see an Android 2-1 PC doing well. I’m actually doing a study on this very idea in India at the moment to see if I’m right. If this idea has legs, it will need Google’s assistance to embrace it and take it to market. I’m hoping this feature in Android N is a step in that direction.

Samsung’s Last Stand

Samsung’s mobile business is in transition. Their blended ASP (combined feature phones and smartphones) was around $190. Their smartphone ASP is in the $220 range. I believe what we hear from management is they would like this to change. They are reorganizing to attempt to attack the markets where more premium smartphones are sold, particularly in the US and China, with a goal of focusing on selling more premium devices even if it means selling fewer smartphones overall.

Models for this year by buy-side investment firms model Samsung in the low 70m range for Q1 2016 which will be a seasonal decline. However, expectations are that ASP goes up. I am yet to be convinced. The dynamics of the Android user base are so dramatically different than that of iOS I fear this will be the undoing of their new strategy.

When you look at Samsung’s installed base, you realize their mix of devices skews much older in key markets. For example, the Galaxy S6 represented only 9% of the US installed base according to Kantar’s latest data and it shows up as 10% in my data for US mix. The 6S Edge shows up at 2% in Kantar’s data and 4% in my data. So combined Samsung’s S6 flagships represent 12-14% of their US installed base. The vast majority of Samsung’s base is actually on the S5 at 20% of their installed base. So we can certainly gauge this as an upgrade opportunity, possibly. Samsung does have a solid intent to repurchase rate, with 63% of consumers in our most recent study who currently own a Samsung smartphone saying they are very likely to repurchase a Samsung device. Contrast that with 82% of iPhone owners who not just plan to buy another iPhone but have also not even considered switching. 26% of existing Samsung owners have considered or plan to switch to the iPhone compared to 8% of iPhone owners who have considered switching to a Samsung device. The picture for Samsung is even bleaker outside the US where other brands are gaining steam.

The new S7 lineup is a good one and I do think they have a healthy base of S5 and S4 users to pull from. But they’ll stay flat in premium shipments, likely ~40m in total in 2016, which is their normal range. The Galaxy Note lineup in the fall could add another 5-8m in calendar 2016 so ~50m current gen flagships in 2016. Not terrible, but not changing the trend line.

Rough Q1 for iPhones

While it appears the Chinese New Year was good for Apple and Q1 2016 iPhone sales of the 6s and 6s Plus are on a steeper adoption path by several percentage points than this time last year. But it seems other global markets are weaker as many analysts have modeled. We still have one month to go, but it does seem there is reason to worry about total iPhone shipments in Q1, despite China being strong. Closer to the end of March, I’ll have a better read and will send out updates on how Q1 is looking for iPhones.

Despite the rumored launch of a 4 inch iPhone, it is looking like 2016 will be a tough year overall for iPhone shipments. I am, however, optimistic on other Apple products like the Mac, the iPad Pro, and even the Apple Watch which I’m modeling to help balance some of the weaknesses in iPhone sales in 2016.

Is the iPhone Coke, New Coke, Pepsi or Just Sugar Water?

On January 10, 2016, long time subscriber and frequent commentator, Obarthelemy wrote:

User Experience is in the eye of the beholder. Until I see double-blind tests about it, I flatly deny that Apple’s is superior/premium…. ~ Obarthelemy

This really got me thinking. How would the Apple iPhone, Phones that ran Android, Windows Phone, etc. fare against one another in a double-blind test?

Like Carl Sagan, I’m a huge believer in the scientific method:

…the scientific method was the best method ever invented for arriving at the truth of things. ~ Carl Sagan

However, before we discuss whether the iPhone or Android Smartphones ((Smartphones that run the Android operating system.)) or any other smartphone would win in a double-blind test, we should first take a step back and ask ourselves whether a double-blind test is the best way to judge consumer preferences for smartphones — or consumer preferences for ANY product, for that matter.

Fortunately, we don’t have to guess. That question was asked and answered in the 1980s by the marketing campaign known as the Pepsi Challenge.

The Pepsi Challenge

The Pepsi Challenge (see 30 second commercial) marketing campaign of the 1980s was supposed to be a scientific inquiry; a double-blind experiment.

In a world overwhelmed with soda options, how could you really know which soda you liked best? It made sense to put prejudice and branding aside, wear a metaphorical blindfold and focus purely on the flavor of the various options. ~ Pepsi paradox: Why people prefer Coke even though Pepsi wins in taste tests

Here’s the thing: The Pepsi Challenge wasn’t just a marketing gimmick. It really is true that in blind taste tests people preferred the taste of Pepsi over Coke.

In fact, the Pepsi Challenge marketing campaign was so successful that Coke began a series of its own internal taste tests aimed at developing a superior product. The result was New Coke — a sweeter cola reformulated to be better than Pepsi and better than the classic formulation of Coke in blind taste tests.

The reaction to New Coke was not at all what the Coca-Cola company had expected. Regular Pepsi drinkers were underwhelmed. Regular Coke drinkers hated it.

The board of Coca-Cola then reversed itself, re-introduced the old formula under the brand name “Classic Coke”, and sold both New Coke and Classic Coke side-by-side. Over time, New Coke all but disappeared with Classic Coke, once again, taking its place as the company’s flagship product.

Today, despite the double-blind taste tests that showed that Pepsi was preferred over ‘Classic’ Coke, and New Coke was preferred over both Pepsi and Classic Coke, people buy far more Coke than Pepsi, and almost no one at all is interested in buying New Coke. ((According to industry statistics compiled by Beverage Digest, Coke owns 17 percent of the American market for carbonated soft drinks. The next most popular choice is Diet Coke with 9.4 percent. Pepsi languishes in third place at 8.9 percent.))

What’s the heck is going on here? If New Coke beats Pepsi in taste tests, then why is it less popular than Pepsi? If Pepsi wins taste tests against Coke, then why does Coke still dominate the soda market?

Hypothesis #1: Marketing Is All That Matters

Some industry observers contended that Coke’s ultimate success over Pepsi was proof that superior marketing wins out even over a superior product. Marketing, therefore, was all that really mattered and consumer companies should invest lots of money in advertising. But that explanation doesn’t really hold water.

If marketing is all that matters, then why didn’t Pepsi — which supposedly had the superior product — just improve its marketing? For that matter, if marketing is more important than product, why doesn’t every company just improve their marketing?

Half the money I spend on advertising is wasted, and the trouble is I don’t know which half. ~ A maxim of obscure origins, put in famous mouths

And if marketing were all that, then why wasn’t the Coca-Cola company able to sell New Coke? They devoted far more advertising dollars to New Coke than they had ever used to promote the former version of Coke, but New Coke — which was specifically formulated to beat both Coke and Pepsi in taste tests — went exactly nowhere.

When a man says there’s nothing that marketing can’t do, you know that the man has nothing to do with marketing.

Hypothesis #2: Sweet Sips

A second theory was that people preferred Pepsi in bind taste tests because people prefer sweeter tastes when sipping. And there is a factual foundation for this assertion. Even in blind taste tests of wine, people almost invariably preferred sweeter varieties. And no one is seriously contending that sweeter wines are always superior to other varieties of wine.

However, if people prefer sweet tastes when sipping, then why do the taste tests reverse themselves when the sodas being tested are labeled as Coke and Pepsi? If sweetness was what mattered most in taste tests, then Pepsi should win out over Coke. And New Coke — which is even sweeter than Pepsi — should win out over both Pepsi and Coke. But this is not what happens. When taste tests with labeled sodas are conducted, the verdicts are reversed. Coke beats Pepsi and both Coke and Pepsi beat New Coke.

Again, what the heck is going on here?

The Brain Overrules The Taste Buds

When Read Montague of Baylor College Medicine performed a version of the Pepsi Challenge with subjects hooked up to an fMRI machine, he found something interesting. In blind taste tests, most people preferred Pepsi, and Pepsi was associated with a higher level of activity in an area of the brain known as the ventral putamen, which helps us evaluate different flavors. By contrast, in a non-blind test, Coke was more popular and was also associated with increased activity in the medial prefrontal cortex — the part of our brain associated with higher-thinking functions. In other words, the higher-thinking functions of the brain were overruling the decision of the taste buds.

You might be saying, “See! This is exactly why we need double-blind studies. People are letting their irrational feelings for a brand interfere with their taste buds and when it comes to choosing flavors that we like, the taste buds — not our irrational brand preferences — should win out. Double-blind tests are the answer.”

Umm…no.

Double-blind tests are the answer all right, but they’re the answer to the wrong question.

There are no right answers to wrong questions. ~ Ursula K. Le Guin

Let’s re-review Carl Sagan’s quote on the scientific method:

…the scientific method (is) the best method ever invented for arriving at the truth of things. ~ Carl Sagan

The truth of “things”, yes. But people are not “things”. Consumer preferences are not “things”.

Double-blind tests are designed to eliminate pre-existing biases and the power of suggestion. That’s ideal for scientific inquiries, but it’s totally inappropriate for studying consumer preferences. In fact, it’s worse than useless because double-blind tests eliminate the very thing we’re looking for. When determining consumer preferences, biases and the power of suggestion are not noise to be eliminated — they’re the signal we wish to identify. When studying consumer preferences, we don’t eliminate biases to get to reality. Our biases ARE reality.

The Human Rowboat

The philosopher J. S. Mill once observed:

(T)here are two kinds of wisdom in the world:

1) Scientific; and
2) The Wisdom of Ages.

The first kind of wisdom changes every day. The second kind of wisdom changes not at all. The first kind of wisdom consists in what we know about the world and how it works. The second is what we’ve collectively learned about human nature through the experience of individuals across thousands of years of history. The second kind of knowledge is unsystematic, consists in psychological rather than empirical facts, and is present in more or less equal amounts in every historical period. ((As an aside, my style of writing has been deeply influenced by this idea that there are two kinds of wisdom. I write about technology, but I pepper my articles with quotes filled with the wisdom of ages. It’s always surprising to me how relevant the thoughts of Socrates, Nietzsche, Benjamin Franklin, Groucho Marx, and others who lived yesteryear are to the technology problems of today.))

The scientific method is good for discovering facts, but personal preferences are not facts to be discovered, they are feelings to be uncovered. We are creatures of both logic and emotion. To assume that human beings are only logical is — well — it’s illogical. And very, very counterproductive.

The brain and the heart are like the oars of a rowboat. When you use only one to the exclusion of the other, you end up going around in circles. ~ Dr. Mardy

The above is just a simile, but I think it’s a great one. When it comes to understanding consumer preferences in technology, many otherwise very intelligent people go around and around in circles because they put all their weight behind technology, and neglect — or refuse to acknowledge — the human half of the equation.
???

The history of technology is the history of understanding things and misunderstanding people.

The Intersection

The best technology products — and this is important, because it’s so widely misunderstood — do not consist only of the best technology. The technology must also cater to the way human beings think and work.

You’ve got to start with the customer experience and work back toward the technology, not the other way around. ~ Steve Jobs

The broader one’s understanding of the human experience, the better design we will have. ~ Steve Jobs

This is why Apple goes on, and on, and on about standing at the intersection of technology and psychology.

I think really great products come from melding two points of view: the technology point of view and the customer point of view. You need both. ~ Steve Jobs

Dr. Land at Polaroid said, “I want Polaroid to stand at the intersection of art and science,” and I’ve never forgotten that. ~ Steve Jobs

Apple has the opportunity to set a new example of how great an American corporation can be, sort of an intersection between science and aesthetics.

We want to stand at the intersection of computers and humanism. ~ Steve Jobs

The reason Apple resonates with people is that there’s a deep current of humanity in our innovation. ~ Steve Jobs

People Don’t Buy A Product, They Buy An Experience

When we make purchases, we use all of our senses, along with our accumulated memories, feelings, knowledge, etc. We apply the lessons we learned yesterday to the purchases of today. We don’t buy products in a vacuum, we buy them within the context of our lives.

When people drink soda in a blind taste test, they prefer Pepsi. When people drink soda in a cup with the soda’s logo on it, they prefer Coke. Why? Because people don’t buy a product, they buy an experience. And for most, drinking Coke is a better experience than drinking Pepsi.

It was actually Pepsi, not Coke, that tricked us with their marketing by convincing us that a blind taste test represented an accurate way to measure the desirability of a soda. The Pepsi challenge wasn’t scientific at all — it was a gimmick because it measured the wrong thing. Products and services aren’t judged by how good they are, they’re judged by how good they make us feel.

We never desire strongly, what we (only) desire rationally. ~ Francois De La Rochefoucauld

New Coke succeeded in labs and Pepsi succeeded in blind taste tests because they appealed to a single sense. Classic Coke succeeded in the marketplace because it appealed to our overall sense of well being.

People don`t ask for facts in making up their minds. They would rather have one good, soul-satisfying emotion than a dozen facts. ~ Leavitt

The Apple Experience

Coke is not successful because of their ingredients any more than a great Chef is successful because of his or her ingredients. It’s how the ingredients are put together and how they are presented that make a great meal.

— Great Chefs sell an experience.
— Coke sells an experience.
— Apple sells an experience.

You can’t use double-blind tests to determine which is the best soda and you can’t use double-blind tests to determine which is the best smartphone either.

The primary reason why so many industry analysts misunderstand Apple is confusion surrounding what Apple actually sells. Apple doesn’t sell phones, tablets, laptops, and desktops, and… smart watches. Apple sells experiences.

Apple is a counterintuitive company because they are an experienced technology company that tries to arrange technology so we don’t have to experience it.

Apple has always been, and I hope it will always be, one of the premiere bridges between mere mortals and this very difficult technology. We may have the fastest PCs, which we do, we may have the most sophisticated machines, which we do. But the most important thing is that Apple is the bridge. ~ Steve Jobs

Apple is a company of solutions wrapped in experiences. ~ Lou Miranda

The reason why Apple can consistently collect between 90-95% of all the smartphone profits is because, while they’re competitors are selling technology, Apple is selling an experience.

Apple has no competition who sell what their customers are buying. ~ Horace Dediu (@asymco)

Conclusion

User Experience is in the eye of the beholder. Until I see double-blind tests about it, I flatly deny that Apple’s is superior/premium…. ~ Obarthelemy

Dude, that ship has sailed.

Double blind tests are not the standard by which you judge the taste of soda and they’re not the standard by which you judge the user experience of a smartphone either. In the marketplace, profit garnered from sales — not double-blind tests — is the only measure that matters. And Coca-Cola and Apple Co., have most all the profits.

What I love about the consumer market that I always hated about the enterprise market is that we come up with a product, we try to tell everybody about it, and every person votes for themselves. They go “yes” or “no.” And if enough of them say yes, we get to come to work tomorrow. ~ Steve Jobs

In the free market, you get to vote “yes” with your dollars, but you don’t get to veto the votes of others.

Indeed, a major source of objection to a free economy is precisely that it… gives people what they want instead of what a particular group thinks they ought to want. ~ Milton Friedman

The verdict of the market is final and inviolate. ((Absent the use of force, the verdict of the market is final and inviolate))

Facts do not cease to exist because they are ignored. ~ Aldous Huxley

Dual-Lens Cameras and a New High End iPhone

The rumor mill is alive and well discussing some research analyst notes around the alleged dual camera feature for the new iPhone 7 this fall. It appears the rumors are looking at three variants for the iPhone with the 7, 7 Plus, and something above that which will supposedly feature dual-lens cameras. I’ve been tracking the component landscape in optics for some time and dual-lens cameras (I’ve seen demos with a dozen camera arrays) is a question of when not if.

The more demos I’ve had of some of the capabilities of dual-lens cameras on a smartphone, the more excited I get about the possibilities. For example, recording multiple videos at one time, perhaps one in slow motion and the other speed up and then being able to blend or edit them. Taking a large enough picture, megapixel wise, that you get the equivalent of 10x or more optical zoom with no image degradation. All consumers will see the benefit of zoom and not needing to carry a DSLR just so they can get pictures of their kids playing sports because they aren’t close enough. With dual-lens cameras, those days are gone. The ability to take pictures in extremely low-light gets even better with dual-lens cameras. Optical image stabilization sees dramatic performance increases. 3D imaging becomes possible. This could lead the way to VR and more immersive images and video. The benefits of dual-lens cameras are significant and, when consumers see what can be done with imaging with phones that sport dual-lens cameras, there will be a real “wow” factor.

Knowing this gives me confidence the technology is the kind of thing which could drive a new buying cycle and be the “must have” of the high-end devices that support it. Interestingly for Apple, many component analysts point to the LinX acquisition as playing a role with the needed IP to do unique things with optics. There is also clear capacity expansion in many of Apple’s core suppliers around optics. There is enough smoke here to take it seriously. However, the rumors are saying this dual-lens camera tech will only come to the highest end variant of the iPhone 7 Plus due to supply chain constraints. Essentially, there is going to be a very expensive high-end version of the 7 Plus which contains this stuff and it will be in short supply but likely very high demand.

Huawei was actually the first OEM to ship a dual-lens camera smartphone in the fall of 2014. It seems the supply chain is reinforcing that Huawei is also looking to be aggressive with this feature. Right now, these are the only two OEMs being mentioned for 2016. Samsung it appears won’t have anything until 2017 and, hopefully during that time frame, Apple will be able to scale the tech down the line.

From what I’ve seen and heard, it does seem this could be one of those must-have features. More importantly for Apple, the camera capabilities rank quite high among the features Android owners are considering when thinking of switching to an iPhone.

The challenge will come in the form of the rest of the market embracing these features and moving them to lower cost smartphones fairly quickly. I think 2019 is probably the time frame when you see really good dual-lens camera experiences in products under $500 so there will be a time advantage.

However, there is a software and ecosystem element of this which will favor Apple. The software to do this well will be very difficult and, more importantly, the app ecosystem to take advantage of it favors Apple’s developers who move much faster than others. So, while the rest of the market will get these features, the ecosystem may be void or less supportive of the value.

The long and short of it is that I’m bullish on the prospects.

Could the FBI Court Order to Apple be Counter-Productive?

Since the court order came out ordering Apple to assist the FBI in accessing the iPhone of the San Bernadino terrorist, I have been talking to various legal authorities and Washington insiders to try and get a real world sense of how Apple’s strong stand against this could play out. Clearly, Apple is highly committed to their position and, as Tim Cook told ABC recently, they are willing to take this to the Supreme Court if they must.

This is of course a highly emotional issue and, at least in the FBI’s mind, a kind of one-off situation. Since the shooter is dead and the phone itself belongs to the City of San Bernadino, they felt this was the one case they could really challenge Apple on and, using public opinion, force them to find a way to get Apply to comply with this specific order.

But I get a sense that, while the FBI did expect Apple to appeal, they did not anticipate Apple would also use this case to actually champion the importance of personal privacy and security and to challenge it at a level that could ultimately force it to Congress and/or the Supreme Court for resolution.

From Apple’s viewpoint, they appear to have ultimately realized that at some point this larger question of digital security and privacy had to be forced to higher authorities to get a proper ruling. To the FBI’s chagrin, this court order was looked at by Apple as the ideal way to force the national conversation and get the kind of legisltative action needed to determine the digital privacy and security rights of US citizens. But any legislation also needs to balance the real need to protect citizens from terrorism and any other national threats in which data on something like a smartphone would be critical to use for this purpose.

This push towards making this a constitutional issue was reinforced by a NY judge on Monday who agreed this type of case must be looked at from a congressional level since the original founders could not have imagined the concept of digital rights, encryption and its impact on the Constitution. But think of this as the “top of the first” in this battle between the FBI, Apple, and privacy and security advocates.

My Washington contacts feel that, no matter who is elected president, the US Senate and House will still be polarized and will take various positions on this issue and will never get to doing anything constructive about this legal question. Instead, they seem confident it will take the Supreme Court to actually bring a ruling on this important and sensitive topic. With that in mind, Silicon Valley will be probably be more active when it comes to supporting whoever is put forth to replace Justice Scalia, as it is most likely this will not get to the Court until it has all nine judges seated.

But I am getting a sense from people in the know I talk with that the FBI bit off more than they could chew with this legal maneuver.

More importantly, if the eventual outcome is to tighten cyber security and privacy laws, this move by the FBI would have been very counter-productive for them. But, at the same time, they probably did the American people a favor since it will now force our government officials and the higher court to, at the very least, give us more precise rules and laws on this critical issue for America and other democracies and governments around the world.

Why the Apple/IBM partnership is a Bigger Deal than I Imagined

I spent the last few days in Las Vegas at IBM’s annual Interconnect customer conference where they shared with 23,000 attendees the latest and greatest technology coming from Big Blue. It is one of the largest customer events I go to and I always enjoy hearing about things like Watson, BlueMix and all the various products and services they offer their clients.

My own history with IBM dates back to the early 1980s. Right after I joined Creative Strategies, one of my first major consulting projects was with their original PC team and I helped them do the research for what became their original distribution strategy. This project allowed me to work with the father of the IBM PC, Don Estridge, and his team and I got to see the birth of the PC industry up close and personal.

Of course, over the last 30 years IBM has evolved dramatically. They are now almost exclusively a software and services company that provides all types of products for large enterprises around the world. Although I have not dealt with IBM a lot in the last 15 years, given their new focus and our research being more consumer related, I began to take more interest in them again when they developed a major partnership with Apple and decided to support Mac’s and iOS in a big way.

One of IBM’s major initiatives is called Mobile First and it pertains to creating mobile solutions for their customers. As IBM began this journey into mobile, they found many of their customers had iPhones, iPads and Macs. It became clear that, if they really wanted to make headway with a mobile first program, they would need help from Apple. Once they approached Apple and got to see their mobile roadmap and how the iPhone and iPad were getting serious traction in the enterprise, IBM made the big decision to port all of their mobile apps to iOS in order to support their customers at all levels of need.

The result is IBM is now offering over 100 iOS apps for use on iPhones and iPads in the enterprise and giving their customers very powerful mobile solutions that help them integrate mobile apps and solutions into their overall IT programs. I got to see some of the apps and they are amazingly powerful. One interesting one is for aviation pilots. It allows them to manage fuel, does the calculations, and allows them to adjust the plane’s use of it automatically. Another one was focused on how a major European airline uses it to handle priority bookings for their premium customers who miss connections and can be booked on a new or different flights even when they are in the air approaching the first airport to make further connections.

Ultimately, all of these mobile-first apps on iOS gives IBM more latitude for meeting the needs of a huge customer base and endears them as a trusted vendor to a worldwide base of IT professionals. But there is another part of this deal that is equally big and, while it was announced when the partnership was launched, I don’t think most understand why this makes the relationship with IBM so big.

As part of the deal, IBM has become a reseller of all Apple hardware. But not only a reseller-an actual sales arm for Apple that represents their hardware and walks them in to big accounts as part of a full-service solution. I talked with some of the IBM mobile team and it was clear that having this broad relationship with Apple is very strategic to their overall IT solutions since almost all of their customers have some form of mobile solutions in their enterprise mix. While they also support Android mobile devices to a degree, they have not ported their mobile first apps to Android yet and prefer optioning an Apple solution whenever possible. That means Apple is more than just a partner, they are a preferred part of IBM for mobile solutions and this makes this relationship an even bigger deal than many of us thought at the beginning.

One other thing that was really remarkable about Interconnect is in the opening keynote, they had Brian Croll, VP of Worldwide Marketing for Mac and iOS at Apple do a presentation of their SWIFT programming language. It let this audience know this significant programming tool from Apple can be used to create custom software much more easily as part of any solution IBM and an IT shop are working on together. He also explained it has been made an open source project so it could be used for all types of software programming and in any type of project in the future. Apple’s presence in this keynote clearly reinforced their commitment to Apple and in a not-to-subtle way made it clear Apple was a serious partner with IBM.

It was made clear to me IBM has become Apple’s literal salesforce into the enterprise in a highly visible, calculable and strategic way and this partnership is highly profitable to IBM and, in turn, is very profitable for Apple as well. While we may think of Apple more as a consumer company, thanks to this IBM partnership, Apple is just as much an enterprise company and, with IBM’s continued help, this should help Apple grow their enterprise business exponentially in the future.

Four Wild Cards that Could Spur New Apple iPhone Growth

There has been a lot of talk that the iPhone has peaked and that it will not see any significant new growth. Although iPhone growth has slowed, I am not quite ready to say Apple’s iPhone sales have actually peaked and there will not be new users who will be attracted to the iPhone platform.

In fact, as we do more research into the iPhone market and its longer-term growth potential, we see four significant wild cards out there that could help drive iPhones sales exponentially over the next three to four years.

The first one is something Tim Cook mentioned in the earnings call and is related to Apple’s interest in India. Last year, Apple sold about 800K iPhones in India in Q4 2015 but, according to our research partner in India, Apple’s brand is huge in that country and the iPhone is one of the top aspirational smartphones on many people’s wish list. Of course today, the iPhone is priced well out of reach of the broad market and only people in the upper earnings bracket can afford an iPhone. Yet, smartphone growth in India is at an all time high and mobile apps are driving all types of commerce and social connections.

A new study by InMobi and Tune analyzed the biggest mobile usage trends in India for 2015 and found shopping is the most popular type of app in the country.

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The study further showed:

– App installs grew 129% over their level in 2014, signaling strong mobile growth. India currently accounts for 9% of the world’s app downloads.

– Shopping apps were the most popular app category in 2015, accounting for 25% of total installs.

– Entertainment, games, and lifestyle apps captured relatively similar shares of installs, accounting for 16%, 15%, and 12%, respectively.

– Travel and communication/social apps were the fastest-growing app categories in 2015; installs were up 474% and 163%, respectively. Travel apps benefited from heightened competition between app-based cab services while communication and social apps were helped along by strong growth in the mobile messaging app market.

Finally, India actually leads the world in installs driven by app advertising even though mobile app advertising is still relatively new to the country. Almost 25% of all installs within the country were driven by paid ads.

While interest in mobile devices is growing, Apple would likely need to create a dedicated iPhone for this market if they want to see any serious growth. We expect Apple to double their iPhone sales in India in 2016 but even with that, this is a very small number of the smartphones sold into this market.

But Cook’s stated interest in India is pretty high and Apple could surprise us by targeting this specific market differently than others. Possibly by doing a unique, high-quality iPhone just for India but at a mid-range price more acceptable for a larger group of smartphone buyers who would like the cachet of an iPhone but can’t afford the iPhone as it is priced today.

I realize this would be out of Apple’s traditional game plan but that game plan probably will not work in India given the iPhone’s premium pricing. We are watching Apple’s moves towards India closely since this wild card could be quite important to future iPhone growth if Apple can find a way to get a model that is acceptable and at the right price points for this market in the next three years.

The second wild card is Apple’s new program that allows people to upgrade their iPhones yearly. The first cycle of users that can take full advantage of this program will kick in when the new iPhone 7s hit the market later this year. We are projecting as many as 25% of Apple’s current iPhone users could use this program and, if so, it could help them grow the iPhone market substantially in 2017.

The third wild card is a new iPhone 7 itself. Rumors suggest Apple will have a significant new design with much better cameras and audio and, given their iPhone launch cycles, every other year brings a new model that breaks new ground and causes solid upgrades. In the earnings call, Cook said that only 40% of iPhone users have even upgraded to the 6S and 6S+ models and that there is still a lot of room to grow just within this audience. Add more switchers from the Android crowd and 2017 could see more solid growth for the iPhone.

And the fourth wild card may be out there a bit but Apple creating their own VR solution could help them spur new iPhone growth and expand their overall ecosystem of products and services. Apple has been mum on this but rumors say they have hired some top VR talent and VR is said to be getting a high priority inside Apple these days. Apple has to look at this seriously since Samsung is using the Gear VR to help sell more Samsung 6 series smartphones and Google is said to be working on their own similar VR headset for use with all Android phones by this summer. We are also hearing that Google will make creating content for VR on Android a big part of their software developer conference in May. While Apple’s MO is to sit back and let this market develop and then jump in, this time they may need to move faster as using a smartphone to power a VR experience will drive VR into the mainstream sooner than later.

BTW, we can’t discount new growth in China either. The Motley Fool’s Daniel Sparks argues there is still a lot of opportunity for Apple in China.

The significance of Apple’s Greater China market

During Apple’s first fiscal quarter of 2016, one market stood out as the tech giant’s fastest-growing market by far: Greater China. Particularly intriguing about this market is not only is it Apple’s fastest-growing, it’s also now its second largest market.
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Apple CEO Tim Cook shared a few more reasons to be optimistic about this market during the company’s most recent earnings call:

– iPhone sales in Greater China during Q1 were higher than ever

– App Store sales in the market were also at a record high

– iPhone sales in Mainland China were up 18% compared to the year-ago quarter

– Mac sales in Mainland China were up 27%, year over year

– Almost half of iPhones sold in Mainland China during Q1 were to first-time buyers

Going forward, Cook cited low LTE penetration and a growing middle class as potential catalysts for growth over the long haul.

When looking at future iPhone sales and the potential growth of the iPhone, I believe one has to factor in these wild cards and their potential to help Apple continue to grow demand. I just don’t think the market for the iPhone has dried up. There is still room for Apple to grow this market if they continue to innovate and make more targeted bets on countries like India.

What Is Apple Afraid Of?

Apple, the company, just had one of its best quarters ever. AAPL, the stock, just had one of its worst quarters ever. What the hell is going on here?

It’s hard to say who gets criticized the most, the successful person, or the failure but it’s mighty close. ~ Joe Moore

Apple And AAPL

The first thing we have to understand is Apple, the company, is a very different thing from AAPL, the stock. It’s true that severe stock fluctuations can have an ill effect on a company but on balance, the stock follows the company, not the other way around.

Bad Advice

Whenever Apple’s stock (or any company’s stock) suffers a precipitous drop, the know-it-alls ((Bloggers just like me.)) come crawling out of the woodwork with advice on what they should do. As Harry McCracken pointed out in his January 2014 article entitled “Apple Must…”: A Brief History of People Instructing the Company to Do Things, this advice has been uniformly awful.

Most of the “advice” people have been giving Tim Cook today on how to run Apple would eventually bankrupt the company. ~ Neil Cybart on Twitter

Advice to Apple usually falls on one of two sides of the same coin. Apple should:

— Stop doing what made them successful; and
— Start doing what made their competitors unsuccessful.

You guys keep asking Apple to do what everyone else does yet somehow think the result would be different. ~ Ben Thompson (@monkbent)

What Is Apple Afraid Of?

A good way to sharpen our focus on the actual threats to Apple is to ask ourselves: What is Apple afraid of? What is the worst case scenario Apple is trying to avoid? What worries keep Apple’s executives up into the wee hours of the night?

Benedict Evans suggests Apple’s worst fear is developers leave the Apple platforms.

For Apple, I’d suggest the fear is that the developers leave. This is what happened in the 90s and it was a key part of the company’s near-death experience.

Once developers start leaving you’re in a vicious circle that’s very hard to reverse (this is where Windows Phone is now). ~ Benedict Evans

Most industry observers thought the Apple of 2007 was going to suffer the same fate as the Apple of 1984: Introduce a great new product (Macintosh/iPhone), keep prices extraordinarily high, allow a competitor to undercut their price and gain market share, (Microsoft Windows/Google Android), inevitably lose their developers, then their platform, then just plain lose everything.

Apple has done a great job of keeping their developers by attracting the most profitable customers to its platform. The developers go where the money is. So even though Apple only owns about 14% of the smartphone market, they control almost all of the customers developers cherish most.

Out Of The Woods

But that doesn’t mean Apple is out of the woods. They need to find new ways of insuring their current developers stay with their platforms and new developers are attracted to their platforms. I would suggest Apple is currently taking a three-pronged approach to this problem.

Customer Sats
First, Apple needs to maintain its premium customers since they’re the ones most willing to pay for the developer’s wares. This is why Tim Cook absolutely OBSESSES over “Customer Sats” (customer satisfaction).

It’s a virtuous cycle. Apple creates great products that attract great customers that attract great developers. Apple’s customers are happy, which makes Apple’s developers happy, which makes Apple happy, and so on and so forth.

Accelerate Refresh Rates
Second, Apple is attempting to accelerate the iPhone’s refresh cycle. You buy a phone from Apple, you pay it off over two years, but every year you can upgrade it. This will cause a certain segment of iPhone buyers to routinely upgrade their phones every year instead of every two years. And the the incentives for buyers to stick with the iPhone will be enormous.

Growth
Third, Apple needs to find a way to continue to grow its iPhone platform.

Wall Street’s greatest fear is Apple has nowhere to go and nowhere to grow. They have a point. There’s only so many people who are willing to pay $600-$700 for a smartphone. ((Although the number of people willing to buy an iPhone is always greater than the naysayers believe. The cry that Apple was going to soon run out of customers has been made each and every year since the iPhone’s inception.)) At some point, Apple will no longer be able to go up. What then?

When companies run into their market ceiling, the traditional business strategy is to go down. That is, expand their product portfolio, introduce cheaper versions of the existing products, gain more market share. There are two problems with this strategy.

First, lowering prices would hurt Apple’s brand. Apple attracts premium buyers because they sell a premium product. Lowering prices might increase sales, but it would dilute Apple’s cachet among its existing customers.

Second, Apple already controls most of the profits in the smartphone sector. For example, Apple garners between 90 to 95 percent of the profits from smartphone hardware sales. What is the point of lowering prices and lowering margins in order to gain another point of profit share? It’s counterproductive.

Expanding The Platform

Instead of going down, Apple is, instead, spreading their platform out. Apple may be running out of customers willing to spend money on an iPhone but that doesn’t mean iPhone customers are running out of money.

[pullquote]Apple may be running out of customers willing to spend money on an iPhone but that doesn’t mean iPhone customers are running out of money.[/pullquote]

Apple is spreading their platform so those who own and love their iPhone can buy more and more Apple products. That’s why Apple works very, very hard to maintain the quality of their notebook and desktop computers and why Apple is introducing new platform products, such as the Apple Watch and the iPad Pro. These various additions to the overall Apple platform give happy buyers more opportunities to buy, give happy developers more opportunities to sell, and give happy Apple more developers developing.

Is It Enough?

Will this be enough to guarantee Apple’s continued future success? Absolutely not. This is a holding action, but it’s a holding action that’s netting Apple as much as $18 billion a quarter. Someday Apple will have to create new and better products. But is this a surprise to anyone? Every company, everywhere, throughout all time, has had to do the same.

New products cannot be rushed. Microsoft came out with a smartphone in 2001, but Apple — even if they had been the Apple of today and not the nearly bankrupt Apple of yesterday — could not have come out with the iPhone in 2001. The technology was simply not ready yet.

These waves of technology, you can see them way before they happen, and you just have to choose wisely which ones you’re going to surf. If you choose unwisely, then you can waste a lot of energy, but if you choose wisely it actually unfolds fairly slowly. It takes years. ~ Steve Jobs

Nor should Apple rush new products to market. That’s not smart and that’s not their raison d’être.

Our north star is to make the best product. Our objective isn’t to make this design for this kind of price point, or for this arbitrary schedule, or line up other things or have X number of phones, it’s to build the best. ~ Tim Cook

The smartphone market is eight years old. Eight. That’s it. The pace of technology is certainly accelerating, but the smartphone market has hardly seen its best days. It took the desktop/notebook market forty to fifty years to mature. I suspect the smartphone still has a few good years ahead of it too.

Apple: The Growth Thesis

Apple’s management is starting to tell a new type of story. Understanding this story is key to understanding their growth strategy. Listening to management and fitting what I heard into what I’m seeing globally in consumer markets, I believe Apple’s growth thesis is built on the following assumptions.

The Apple Experience as a Service

Apple is trying to paint the picture that they are not just a pure-play hardware company. At first blush, this sounds like a tough argument to make. However, it is essential they make it. Having studied the history of this industry, we can predict time and time again a market shift from value lying in hardware, then shifting to software, then finally moving to services. This is why a company like Google or Amazon, who started off as services companies, are valued the way they are. Wall St. doesn’t love hardware companies (see Fitbit and GoPro) but they do love software and services companies.

Apple makes most of their money in hardware but building the services narrative is central. This is exactly what they are doing by making the following points:

1) Our installed base is large and growing

2) Our customers spend a lot of money in our ecosystem

3) Our customers never (or rarely) leave us

Every one of these themes was part of an overarching story Tim Cook told on the earnings call and they are all true.

The services story compounds. Some time ago, a very smart executive told me the most brilliant thing Apple did was sell you a piece of hardware, the iPhone, and get you to spend $1 a day (on an app). That was early in the adoption cycle of iPhones when apps were all the rage. Now, Apple is looking to get you to spend a predictable monthly amount on everything from cloud services, like iCloud photo sync and storage, Apple music for $10, and eventually a TV service at $X per month, along with anything else.

So, look at the services story this way. Between subscribing to hardware and services, Apple can potentially offer a consumer the full Apple experience for $X per month. Let’s just say, beyond the hardware margin, Apple succeeds in having their base adopt Apple Music for $10, Apple TV for $20 per month or $50 per month for family (I’m just making these numbers up to make a point), and cloud storage and all data in sync for $5 per month. If they get 100m people, or less than 20% of their user base, to buy into this, well, You can do the math but that is significant revenue from services. And it seems modeling that at a family or individual level is not that much of a stretch given what we know about Apple’s customer base spend in the ecosystem.

One other area I have been thinking about is Apple’s services opportunity to enterprises. As iPhones, Macs, and iPads continue to increase in share of enterprise sales, perhaps partnering deeper with IBM or developing new business services can lead to revenue from the enterprise world as well.

Well Positioned as Consumer Mature

Another key thesis I believe Apple has about their products is related to markets as they mature. Apple has seen, as have I with our research, that as consumers become more mature in their technology needs, greater and greater percentages of people not only strongly consider Apple’s products but do in fact buy them. This is why the Mac keeps outperforming the continually negative PC market. As consumers PC needs mature, Apple is attracting more customers looking for greater value, product quality, customer service, longer life, lower total cost of ownership, and more.

This was framed by Tim Cook when he made a point about China LTE device penetration to be about 20%. A buyer of an LTE device is a more “mature” customer who is about to buy their second or likely third smartphone. This buyer will be more aware of what they want and what they don’t want and thus, Apple believes will be more likely to consider an iPhone. At 20% LTE device penetration, his point is there will continue to be a huge opportunity to compete for these customers.

Now China is a unique market. Even with the currency issues and foreign exchange, Apple sold more iPhones in mainland China than in any other December quarter. And even by the end of January, I still see continued momentum on the ground for sales in China. Other markets are much more difficult. While consumers in China are more tolerant of iPhone price increases due to foreign exchange, other markets are not.

Reading between the lines, what I gather is Apple believes they are well-positioned when global markets recover. iPhones and other Apple products will still not be the cheapest but, as India (a market Apple said was up 76% to approximately 800,000 to 900,000 unit sales for the quarter) further develops and their customer base matures and starts upgrading devices, Apple believes they will be competitive.

It is worth pointing out Apple is competing for replacement customers, not first-time smartphone owners. The thesis here is, as the customer matures and looks to upgrade their Android device for the full Apple experience, Apple will be competitive. This is where continued innovation in the ecosystem and hardware, software, and services layer to truly differentiate their experience from anything you get on competing platforms is crucial.

Modeling the growth of net new additions to the Apple ecosystem will be tougher than before. More importantly, predicting when macroeconomic issues resolve will be even more difficult. Even the best economists in the world are continually wrong in their predictions.

At a fundamental level, both these growth points are related. Apple is trying to be the first fully integrated hardware, software, and services player in consumer tech. From a growth standpoint, we and Apple’s investors, need to figure out if we believe the services growth story and that Apple can gain meaningful share from Android.

Lastly, while my main points on hardware are related to the iPhone, since that is the short term emphasis, the rest of Apple’s hardware should be viewed in this light as well. The Apple Watch is not only going to become a serious revenue contributor but also a deeper lock-in, attractive to a switcher, etc. Apple TV, Mac, iPad, and anything else becomes not just a hardware sale but a portal to a rich services ecosystem. All the pieces are there.