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Dissecting Google’s Apple Relationship

Bloomberg reported this past week that, based on a court transcript from the Oracle-Google lawsuit, Google paid Apple $1 billion in 2014 to be the default search engine in Safari on iOS. The transcript has since disappeared and neither Google nor Apple have commented on this figure (now or at any previous time). I thought it would be worth dissecting this figure, putting it in context, and discussing what – if anything – it means for the future of the Google-Apple relationship.

Financial context

The financial context for the $1 billion figure is that it sits within broader reporting categories at both Google and Apple. For Google, this payment likely sits within the “Traffic acquisition costs (TAC) to distribution partners” category. This category reflects the payments Google makes to various third parties for sending traffic to Google’s search engine and its other websites. The trend for these payments is shown in the chart below:

Of the various parties Google pays for sending traffic its way, Apple is almost certainly the largest. A smaller player in this category is the Mozilla Foundation, maker of the Firefox browser, which received around $300 million from Google in 2014. The Firefox browser obviously has a much lower share of the search market than iOS does, so it makes sense Apple’s cut would have been much higher. Google paid out a total of around $3.6 billion in this category in 2014, so even $1 billion is only a third of the total. To my mind, it’s quite possible the payments to Apple were actually larger, with the $1 billion number representing some sort of floor for payments rather than the total amount.

The other way to look at the financial context is by way of Apple’s segment reporting. Unfortunately, these payments from Google are in a fairly opaque and crowded segment at Apple, namely Services. As a reminder, Services includes iTunes and App Store revenues, AppleCare revenues, licensing revenue from the Made For iPhone program, Apple Pay revenue, and revenues from the sale of software, among other items. As such, you have to make a lot of assumptions about the size of those other buckets to even get close to an estimate for Apple’s revenue from Google. For reference, though, here’s revenue for that segment at Apple:

Whereas at Google the reported $1 billion payment is equivalent to about 25% of total annual payments in the category, at Apple it’s well under 10%. I’m inclined to believe the payments are actually a little higher, perhaps as much as $500 million per quarter at this point, but even then it’s just 10% of the total revenue in this category.

Broader significance

The reaction from several quarters has been to ask why, if Google was paying “so little” to be the default search provider, someone else hasn’t come in and trumped it. But even aside from the fact the actual payments may be higher, there are several other reasons why this isn’t so straightforward. To start with, there are only a couple of real alternatives to Google in most major western markets: Microsoft and Yahoo. To further complicate matters, Yahoo still uses Microsoft for a lot of its search results, so we’re really talking about Bing as the underlying search engine for both of these options, at least today (Yahoo is working on building its own search capabilities back up). There are other search engines, but they’re so small they’re unrealistic as potential providers of this default position. DuckDuckGo in particular is very interesting in that its privacy stance is well aligned with Apple’s, but unless Apple acquires it (itself an interesting prospect), it’s very unlikely to become the default search provider in iOS.

At Microsoft, search advertising has grown nicely, but it’s still under $1 billion per quarter in revenue (including its cut from Yahoo), which means making such a significant financial commitment would be a huge jump in its costs. To be sure, it could come with significant rewards, but it would entail significant risk for Microsoft. Search revenue at Yahoo, meanwhile, is less than half a billion a quarter, meaning the $1 billion commitment alone would be half a year’s revenue from search. With all the uncertainty around Yahoo’s core business at the moment, this would be a really tough time to make such a big bet there, too.

But even aside from the financial considerations, I’ve written here previously that Apple is likely to be very cautious about switching the default search provider in Safari, especially after its experience with replacing Google Maps with Apple Maps a few years back. For all Apple’s qualms about Google as a competitor/partner and about Google’s privacy issues, Apple wants to provide the best possible experience out of the box for iPhone and iPad users. And the reality is that, while all the alternatives to Google search are decent, they are not truly competitive. There’s something of a 90/10 problem here, where 90% (or more) of searches are likely handled equally well by Bing, Yahoo, or DuckDuckGo, but for the other 10% or so the results on Google continue to be better. I’m doubtful Apple is willing to sacrifice that part of the user experience at this point. Rather, I suspect it will keep Google as the default option in Safari for now, while continuing to build up its own search operation in the form of Siri/Spotlight, with help from its Topsy acquisition and search results from Bing where necessary.

The iPhone Post

There has been a great deal of noise around Apple and the iPhone. If you believe many of the sell-side analysts, the iPhone has peaked. Many of you have written in asking me my thoughts on what is going on. I’ll address them in this post with data.

Shift in Mix of Sales

What many are missing, at least in their public commentary, is the new dynamics of the mix of old and new iPhones sold. What we see happening in December is very strong continued momentum of the iPhone 6 and 6 Plus in all major markets. Last year’s iPhones held their competitive strength in the marketplace and, at discounted prices, enticed not only more of the iPhone user base to upgrade but a high percentages of Android switchers as well.

Looking at supply chain cuts, for whatever quarter they are related to, makes sense in this light as Apple would have cut back build orders of the new line of iPhones if the mix of older phones was higher than they anticipated. This would have also been very hard for most the financial analysts to estimate. Most of them do no primary research and base their models on static templates, not dynamic ones. They would be using a historical model for the mix of new vs. old sales and, even if they erred conservative sensing the iPhone 6 and 6 Plus would have a higher mix, I’m certain even their most conventional models were off base.

While we look at many markets to gather this data, one market I constantly look at is China. With sources there, I can track active devices thanks to popular developer APIs which identify smartphone model numbers. What I’m showing you related to China is a similar picture in many of the markets we track which also happen to be the all Apple’s major markets among others. Notice the strength of the 6 and 6 Plus relative to the 5s in the second half of 2014 and the first half of 2015. The 6 and 6 Plus are doing far better than any n-1 SKU Apple has kept in market according to our data.

Thanks to the extremely strong lineup of 6, 6 Plus, 6s, and 6s Plus, Apple is poised to have its biggest quarter in China, likely shipping 24-25m iPhones to the mainland and surpassing the US market in sales for the first time in a Q4 timeframe. Last year, China outsold the US during the first quarter and, this time around, it looks like China will be their largest market for iPhones sales in Q4 and Q1. The strength of this lineup also caused China Mobile, the nation’s largest carrier, to have its largest net 4G user add in the month of December. Adding 24.59m new 4G customers in a single month and 64 million for the quarter are both new highs.

Growth Dependencies

There are three areas which will impact Apple’s growth of iPhones. The first is the massive base still needing to upgrade.

Here are two charts from our quarterly survey data, looking at the mix of devices owned (at the time of the survey) of both China and the US.

Again, the data tells the story of the strength of the iPhone 6 and 6 Plus, but also a large percentage of the base slow to upgrade. With Apple announcing only 31% of the iPhone base had upgraded to the 6 line of iPhones as of the end of the third quarter, our data tells us 50% of iPhone owners are still on the 5s or below and 47% of iPhone owners in China are on the 5s or older. With the holiday quarter generating healthy sales, it is likely Apple will report high 30s to low 40s percent of the total iPhone base has upgraded even though more than half in the US and China already have. The rest of the markets may just move a little slower and that is a key point to watch as it relates to the iPhone growth narrative.

The next area is Android switching. It bears reiterating that all developed markets and developed parts of emerging markets are replacement markets–China included. Meaning, consumers are on their second, third, fourth, etc., smartphone. Part of Apple’s growth story for iPhones is new users and what we look for are things in the Apple ecosystem that continue to attract first-time iPhone owners switching from another platform. China is a part of this growth story of switching and I stress the iPhones ceiling there is nowhere near reached. Even if Apple took a measly 5% more share from high-end Android sales and 5% from mid-tier priced Android phones, they could add 20m units in new customers. From primary research we ran in early December, 26% of respondents said they had switched to the iPhone from another platform. Interestingly, 7% said they became iPhone owners from a non-smart phone. Keep that in mind for developed markets where 20%, and sometimes more, consumers are still on feature phones.

Lastly, a key factor for Apple’s iPhone growth is replacement cycles. A major question for 2016 I hope to answer is whether replacement cycles are likely to shorten or lengthen. One of the things Apple does is make extremely reliable hardware. The lifespan of an iPhone is longer than any other smartphone by any other manufacturer. This is one reason the resale value is so high but it also allows consumers to hold onto their iPhones longer. As I pointed out yesterday in my post about the billionth iPhone, the fact the iPhone appeals to every spectrum of the adoption curve is unique. But, late adopters and the late market majority don’t tend to buy new things very frequently. My father-in-law is the blueprint of a technological laggard. He still owns an iPhone 5c and is entirely content with no immediate plans to upgrade. While the long-lasting quality of iPhones is one of the major reasons consumers on the later stages of the adoption curve buy iPhones, it will also impact how frequently they upgrade.

Just focusing on the early adopter and early majority, I have some data on their mindset for upgrading.

– 49% of iPhone owners said they were on a carrier plan like AT&T Next or Verizon Edge which allows them to upgrade annually or every other year
– 41% plan to upgrade every two years
– 21% plan to pay their phone off over the plan’s time frame and use it longer than two years
– 20% plan to upgrade yearly
– 18% pay full price up front for their smartphone

Building in relatively predictable upgrade cycles will be helpful for Apple. We anticipate Apple’s own iPhone upgrade program to be popular in markets where Apple has a strong retail presence and in the US in particular. By early December, our surveys were revealing 10% of iPhone customers had already moved to Apple’s own upgrade plan. I anticipate this to grow over 2016 and 2017. However, I do have a sense the late majority and tech laggard parts of the adoption curve will hold onto their devices for longer than two years. As of now, we are not fully clear on how many people that translates to. This will be important to get a sense of in 2016 as we see how much of the 5s and later base upgrades. Hopefully, those metrics will help us understand the life cycle of iPhones with those consumer profiles.

Changing the Narrative

In this post, I articulated how the narrative around the iPhone needs to change. While Apple will still generate large portions of its revenue from the iPhone, I encourage folks to focus more on total revenue growth, not just iPhone shipments. I expect other products in Apple’s portfolio to continue to grow and add to their bottom line. Even if Apple has a YoY decline in iPhone sales in a quarter or two this year, I still expect them to have YoY revenue growth.

Lastly, consider what Apple is doing overall for computing. If we count smartphones, tablets, PCs, and smartwatches as personal computers, you can argue Apple is doing more to advance personal computing than anyone. Apple likely shipped almost as many 64-bit processors as Intel did to PCs (consumer and enterprise, excluding servers) in 2015. And, while Samsung still sells more smartphones each year than Apple, the vast majority of smartphones they sell are under $300. Apple ships more hardware with 64-bit desktop class performance than any other personal computer maker. I stress this point. Who is doing more to advance personal computing for the masses?

GoPro Floundering, Apple’s iAD Strategy, The Great PC Rebalancing

The last few quarters, investors have been quite cautious around GoPro as the bear thesis rang loudly in their heads. Yesterday, it seems the bear thesis played out as they missed revenue estimates by nearly $100m and shares dropped 25% and were halted. The company also announced they would cut seven percent of their workforce.

The fundamental issue here is GoPro reached their max TAM. Wall St. doesn’t love hardware companies and it is for this reason. Once they sell a product to everyone who wants one, growth slows and consumer replacement cycles become unpredictable. For GoPro to be valuable in the eyes of investors, they needed to be doing things to grow their addressable market. GoPro has likely sold in the range of ~20 million units in total to date. The true question surrounding this category is, how big is it? An average of 6 million units a year is not that interesting even if ASPs are high. GoPro has to expand the TAM and that is what they are not doing. The Session was an epic failure and largely overpriced. I believe they should have been more aggressive with the price and perhaps made it less feature rich. For example, maybe 720p instead of 1080p, no wifi, etc, and used this product as their entry level action cam to entice new customers. Instead, they priced it too high and it did not sell.

While I fully understand all areas of the debate around this, I still feel the market is larger than what has been sold to date. GoPro is the dominant vendor with the majority share in this category and I do believe brand matters here. Which means GoPro is not immediately vulnerable to low-end disruption. That may happen someday, but not today. The real question here is if GoPro is indeed a one trick pony. In this dissection of GoPro’s financial Jan Dawson makes the following point:

All of this serves to reinforce the problem I outlined in last week’s column: companies highly dependent on sales of a single product – in GoPro’s case, “capture devices” – may do very well for a period of time but, unless they are able successfully to parlay that success into a broader-based strategy that goes beyond a single category, they often begin to struggle. This is particularly the case when the company fails to build a meaningful ecosystem around its products. GoPro’s financial filings suggest it believes its partnerships with retailers, celebrities, and others will provide differentiation but, given its latest product has essentially flopped, there are now legitimate questions about whether its single trick is enough.

Perhaps the most fascinating part of this discussion is whether or not GoPro should have gone public to begin with. This would make for a fun discussion and is a fantastic case study on many levels.

Apple’s iAd Strategy

Buzzfeed’s John Paczkowski reported Apple is stepping back from its iAd platform. The most pertinent part to understand from the report:

While iAd itself isn’t going anywhere, Apple’s direct involvement in the selling and creation of iAd units is ending. “It’s just not something we’re good at,” one source told BuzzFeed News. And so Apple is leaving the creation, selling, and management of iAds to the folks who do it best: the publishers.

Apple will step back from selling and let publishers sell through it. The report goes on to state Apple will give 100% of the revenues said publisher generates through their platform.

iAd always felt like a play outside of Apple’s core strengths. By essentially opening it up for publishers to use the platform and sell ads, they potentially make it more interesting for advertisers to take seriously. The question I’ve always had regarding iAd is how far Apple allows it to reach. How far beyond mobile ads does it go? Can it go to voice search for example, or can it get to Apple TV in some way? Is their broader strategic benefit having iAd be the main platform for publishers to monetize on Apple’s platform? Perhaps there are more questions than answers here. However, the clear next step in advertising is around video and mobile video. What Apple will allow publishers to do around video will be key. The latest estimates I’ve seen for online video advertising is forecasted to be an all-time high as 40% of US ad spend will be on video in 2016. This number will only grow significantly.

The Great PC Rebalance

We are on the cusp of simply not talking about the PC hardware landscape much longer. It is relevant for many people, but not all people, like the smartphone is. But there are a few interesting things to watch.

Both IDC and Gartner are reporting preliminary PC declines of ~10%. My estimates were -8% and I can see -10% from what I heard from retailers around Q4. We measure PC sales compared to last year and, in reality, yearly PC sales are declining. The market for annual sales is simply getting smaller. While it is still in the 280-290m range (down from 320m three years ago), the bottom has not yet been reached. We may ultimately end up having the PC bottom be in the low 200m per year range. Which carries with it some important implications.

The first is broad industry consolidation. Acer, Asus, Toshiba have already exited, Samsung is trying their hand again but likely to exit eventually–again. Which means the market is left to Lenovo, Dell, HP, and Apple. With very real caution surrounding HP with the hardware split, we may see their exit someday as well. While I’m not officially making a declaration here, it is certainly a scenario I have worked out. If the market is left to just these three or perhaps four players, then share gains will lead to healthy sales for whoever is left standing.

I’ve seen the lineups from all the PC vendors for 2016 and can state confidently this is the strongest lineup of PC hardware we have ever seen. If Apple comes in strong, then the PC market may not be as bad in 2016 as it was in 2015. I still have upside share gains in my model for Apple, but the Windows vendor lineup is strong with Lenovo and HP showing very slick OLED laptops that I expect to get attention.

Also, to the point about GoPro above. I believe it would make sense for Microsoft to buy them. Microsoft has made it no secret they want to be more aggressive with first party consumer hardware. This is the plan with Surface. Microsoft can not lose the consumers and they are at risk of doing so. If they acquired GoPro they could do some tight PC integration, thus again making the case for the PC, and solve some major experience problems with the company. Namely, that you record 30-40 minutes of video and no one wants to sift through all that to find the 10 seconds you want to keep. GoPro has done some things in software to try to help this but it remains a burden.

What is happening in the PC market I call “The Great Rebalancing.” We are seeing stability among the primary vendors and, once it all shakes out, while smaller, it can be a healthy segment of computing.

One thing to watch is the noise Xiaomi and Huawei are likely to make as they enter the PC space. This could shake things up a bit if true and, in particular, Lenovo’s share in China (40%) and how PC TAM could expand in emerging markets.

Here is a look at our PC model as it stands.

The Killer App for My Apple Watch

Now that I’ve had an Apple Watch for some time, I am beginning to garner some important personal perspectives on how I use it and the one app that is the most valuable to me. At the recent CES, wearables and smartwatches were still big news with Huawei introducing new models and Samsung raising the stakes on their watch line with a big push for Samsung Pay. There is no question there is still a lot of interest in this type of wearable.

In fact, we believe Apple will sell around 22 million Apple Watches in its first year on the market and believe Apple had a big holiday season of selling Apple Watches around the world.

That said, I realize there are a lot of people who will never buy an Apple Watch or any type of smartwatch for various reasons. And even some who have bought an Apple Watch have given up on them already. However, for those who have bought one and continue to use it, I keep hearing they really like it and, interestingly, what they consider to be their killer app varies greatly. For instance, my wife’s killer app is “Find My iPhone” since she is always misplacing it. She also loves using it to communicate with our granddaughter who is in Junior High and has an Apple Watch too. For others, it is the activity tracker and step counter. And, as more and more apps become available for the Apple Watch, a range of potential killer apps will emerge. I am sure it will give others even more apps that make the Watch indispensable for them.

But, for a specific group of users known as knowledge workers, the killer app seems to be notifications. I am one of those users. I admit I am a bit anal about the info and data I want and the fact I really like to notified with information or requests that are timely. I got hooked on notifications when I started using the original Samsung Gear watch and then the first gen Motorola watch. Both were connected to an Android smartphone I also carried with me and it gave me a taste of how valuable notifications are in this type of wearable.

So, when the Apple Watch came out, I already knew it would become important. However, since Apple launched other apps as well, I expected to find at least a few that would fit my needs. But during the time I have used the Apple Watch, notifications continue to be the #1 reason I would feel lost if I ever forgot to wear it. In my case, I have tailored the notifications for my particular needs. Besides notifications of calls and text messages, I get news alerts from CNN, AP and ESPN. I recently also added notifications from Twitter but they are tied to key people I follow and not every tweet that gets posted. There are now thousands of apps that add a notification connection but I find the one’s mentioned above to be the most important to me.

I knew notifications were important to me but during CES I talked to dozens of Apple Watch users and they told me the same thing. In fact, on a couple wearable panels, speakers mentioned this as well-notifications have become their most important app on their Apple Watch besides telling the time.

What I think appeals to them is based on two key things a smartwatch does for them. First, since it is connected to their iPhone, it sends them pertinent info or data on the wrist so they are not always taking the phone out of their pocket. It is much easier to glance at a call coming in and act on it once you know who is calling. I only take calls from family, friends and my staff. All others go to voice mail.

And for us knowledge workers who are infomaniacs, getting news blurbs or key info pushed to us saves us from checking our phone often to get that information. It could also save or make us money. I had a friend of mine tell me he tracks three of his key investments via the Apple Watch and was once notified of a major swing in one of his stocks he immediately acted on it and, by doing so quickly, made a major profit on this stock.

Although my comments are anecdotal, I recently saw a report on smartwatches that looked at the top apps people use and notifications are in the top 3 of most used on a smartphone. I suspect by the end of this year it will become clearer that notifications are a big part of why people buy an Apple Watch or similar smartwatch as it really has an impact on how they use their smartphones. It changes the convenience level of mobile technology when data is pushed to us in this manner and does not force us to take out our smartphones.

Of course, the big question is, would people spend $350 or more for an Apple Watch or smartwatch if notifications are the only important app they use?

As of now, the early adopters seem to be saying yes. But, since killer apps are very personal and subjective, Apple will need to work harder with their developers to create even more innovative apps that deliver a whole host of other options that make an Apple Watch indispensable to potential buyers. The good news is we are finally seeing more native Apple Watch apps come out and those should help get more people interested in the Apple Watch.

However, after talking to many Apple Watch users and, given my experience with the watch so far, I suspect even if they find some other apps that are important to them, notifications will be the one they find makes their Apple Watch indispensable.

Fairly Confident Predictions for 2016

A couple of other Tech.pinions contributors have already outlined some predictions for 2016 but, in my first Insiders post of the year, I thought I’d chime in too. The predictions below are mostly ones I’m fairly confident about, but I’ll sprinkle in a couple that are a little more “out there” and identify those clearly.

Amazon: Both AWS and E-Commerce Driving Growth

The big success story for Amazon over the last several years has been AWS, even as its e-commerce business seemed to lose some steam and margins evaporated. But, in late 2015, it became clear Amazon still had a lot of headroom left for its e-commerce business, as that business regained momentum and the combination of AWS and better-performing sales in e-commerce helped boost margins. I still believe Amazon faces some major obstacles in replicating its US model (which relies heavily on infrastructure density) in some overseas markets like India and China, but it’s likely to have success in 2016 in expanding in the UK and other markets where its infrastructure is already strong and the geography and population density are more favorable.

Apple: Continued Growth, Including iPhone

The biggest single question about Apple in 2016 has to be whether it will grow revenues significantly, which in turn is heavily dependent on its ability to grow its iPhone business. I wrote a piece a while back in which I did something of a deep dive into the various factors driving (or holding back) Apple’s growth in 2016, so I’ll refer you to that for the details. But I believe the iPhone will grow for Apple in 2016, albeit at a significantly slower rate than in late 2014 and 2015. However, I don’t think the iPad will return to growth just yet, even with the launch of the iPad Pro. I also think we’ll see significant investment from Apple around iMessage in its 2016 software releases, including peer-to-peer payments and other advances. My long-shot prediction for Apple is it will launch its own smart home hardware in 2016. Its HomeKit strategy just doesn’t seem to be delivering results, and I think the only way to fix that is for Apple to get into the business itself.

Facebook: Another Acquisition, Possibly an Asian Messaging App

Facebook has made several high-profile (and high-value) acquisitions in recent years, including Oculus, Instagram and WhatsApp. I suspect it’s not done yet and one big gap in its strategy continues to be messaging in Asia. As I and others have written about here, Asia continues to be a fragmented market when it comes to messaging and Facebook’s presence in Asia in general continues to be weaker than elsewhere. Acquiring one of the major Asian messaging apps might be one way to help address this weakness, with LINE and Daum Kakao being the obvious candidates.

Google: Alphabet Split Reveals Dichotomy in Businesses

One of the biggest things that will happen in Google’s world this coming year is the first reporting under the new structure created by the new Alphabet entity. What we know is this reporting will come when the company reports its results for Q4. What we don’t know is what those financials will look like and financial analysts have widely divergent views on the performance of the “other bets” business in particular. My prediction is the core Google business will emerge from this new reporting structure looking better than ever but, conversely, the other businesses will look pretty awful from a financial perspective. That increased transparency will, in turn, lead to more pressure and scrutiny for those “other bets”, and my out-there prediction is one of these businesses will be shut down, spun off, or otherwise scaled back as a result in 2016.

Microsoft: Surface Phones Launch, With as Little Success as Lumia

With the launch of Windows 10 and new devices optimized to work with it in 2015, Microsoft has got some of its biggest news out of the way already. But there are signs and reports Microsoft still intends to launch a revamped line of Windows Phones, possibly under the Surface brand, and it’s possible this will happen in late 2016. However, I predict these phones will ultimately suffer from the same fundamental challenges as Windows Phone in general and Nokia/Microsoft’s Lumia line in particular. As such, Windows Phone will continue to struggle, though it will likely limp on in some form indefinitely, especially if it gains any sort of meaningful traction in the enterprise, which is clearly a major focus now.

Samsung: Smartphone Business Fades, Chips Ascendant

Samsung spent 2015 stabilizing its smartphone business, at least in terms of revenue and shipments, but at the expense of margins. 2016 will likely see more of the same, even under new leadership, with an inevitable tradeoff between driving shipment growth and falling selling prices further pressuring margins. It’s going to become clearer than ever in 2016 that Samsung’s heyday as a consumer electronics powerhouse is behind it and that its future lies at least as much in providing components to other manufacturers as in making its own consumer-facing goods. Its chip business should continue to flourish, driving more and more of its revenue and profits and helping to offset the poorer performance in smartphones and elsewhere.

Twitter: Still no Core User Growth, Slowing Revenue Growth

As a heavy Twitter user, I’m invested in its future and its success, but it’s becoming increasingly difficult to believe Twitter will get user growth going again. Jack Dorsey’s leadership seems to have breathed some new energy into the company and he’s outlined a plan for returning user numbers to growth, but I suspect we’ll see very little of it in the core, monetizable, user base (i.e. excluding “SMS Fast Followers” and “Logged-out Users”). As user growth continues to stall, it will be harder and harder for the company to grow revenues as it has to date and revenue growth will slow.

Revenue Streams Automakers Reap from Smarter Cars

At CES in 2013, I had lunch with Glen Lurie, then the GM of ATT’s mobile business. At the time, he told me of his vision of equipping all cars with a cellular wireless radio and using this to deliver more intelligence to a car. Part of the vision was to use the cellular radio as a mobile Wifi hot spot but he saw the time when the car’s entertainment system and its diagnostics would need to be tied to wireless communication so it could help carmakers deliver smarter and more intelligent cars. This meeting took place before Apple introduced their Auto Play or Google rolled out Android Auto.

Two years later, his vision is becoming more of a reality with just about every carmaker adding a cellular radio as an option and integrating Apple and Google’s systems or their own to make cars smarter and safer.

I recently saw a Business Insider report on Connected Car Revenue streams and was intrigued by their forecasts. Here are the highlights of the report:

• Connected-safety features bring in the most revenue of all of today’s connected-car services, at $13 billion. These features alert customers of road conditions, such as severe weather or an approaching hazard, as well as collision avoidance.

• Entertainment is one of the most popular features available for the connected car, but it is not a major revenue driver. The category will account for only $13 billion in revenue in 2020. Entertainment features include integrations with apps such as Pandora, Yelp, and Facebook.

• People who actually use connected car services are satisfied with them. About half of those who have a connected car actually use the car’s connected features and those who do use many of these features show high levels of satisfaction with them.

• Consumers are pretty split on how they want to pay for these services. 25% of global consumers would be willing to receive in-car advertising if it meant they got free basic services in exchange. This means marketers are likely to have a big opportunity to tap into the connected-car market.

You will notice in the chart below that driver’s assistance and connected safety features are projected to bring in the most revenue, followed by entertainment.

The fact safety is at the top of the revenue list should not be too much a surprise as drivers have always considered safety a key priority when they buy cars. But, as I listen to the various automakers outline their short term ideas about increasing driver safety, I am coming to understand that, if this is where the money is, then creating a self-driving car needs to be their biggest priority for the future.

Indeed, if these forecasts are right, people who buy cars are willing to pay extra for safety. If you follow the whole autonomous car concept and study Google’s experience with their driverless car, you can see how these types of vehicles have the potential of being the safest cars on the road in the future.

But I have to admit smart entertainment system revenues in this forecast seem low to me. If a car has Google or Apple’s auto systems and they are tapped into apps and services, it would seem the revenue potential should be more. Also, since most cars on the market today do not have a smart entertainment system built in, the new retrofit kits coming from many of the top line audio companies should surely bump these revenues up.

In fact, I think millions of car owners who have cars without these new connected entertainment systems will want to buy these retrofit systems and/or kits in the next few years. I see those who own iPhones and Android phones wanting to extend these smartphones features to their cars to give them the special apps and services Google and Apple and their app providers will deliver for Apple’s CarPlay or Android Auto. In fact, this may be one of the most untapped and more important market opportunities for auto makers, Apple, and Google when it comes to these special extensions of smartphones.

Although Business Insider estimates that “of the 220 million total connected cars on the road globally in 2020, we estimate consumers will activate connected services in 88 million of these vehicles.” The report also states, “By 2020, nearly 40 million cars will be using Android Auto and 37.1 million will be using CarPlay, according to IHS, and that will cover nearly all cars launching connected car services”, according to BI Intelligence estimates.

But this is just in new cars that have these services built in. If the industry is not looking at the retrofit market in a similar way, they will be missing a big opportunity. I know most retrofit systems today are expensive. But we should see some moderately priced models as CES. I happened to lease my last car before newer cars came out with Apple’s CarPlay in them and I am one of their target customers, along with millions of others that would like to extend their iPhone or Android phone with their car apps to their existing cars. This could be a very large market opportunity that to date I just don’t see the car makers or even the top line audio suppliers pushing to their current customers but I sure hope they get behind this and make it possible for millions of smartphone users to take advantage of these new auto services by Google and Apple.

Apple Pay in China a New Catalyst

China is quickly becoming Apple’s largest market and, in many respects, one of the most important to the Apple growth story in the next five years. This is why Apple Pay starting to roll out in China with Union Pay and a number of major banks is potentially a huge catalyst for mobile contactless payments in general in China.

Similarly in the US, Apple owns the largest share of NFC capable devices in active use than any other vendor. Which means there is no single brand better positioned to drive secure mobile payments than Apple. In China as of the end of Q3 2015, our primary research indicates over 40% of active iPhones in China are comprised of iPhone 6, 6s, 6 Plus and 6s Plus models. By Q2 2016, well over 50% of iPhones in China will be NFC/Apple Pay capable. No other single OEM is anywhere close to this number of active devices in use being NFC capable. Couple that with a growing installed base of NFC capable Apple Watches and a culture in China that has increasingly become tech savvy, and the stage is set for mobile contactless payments to thrive. In fact, as optimistic I am about Apple Pay and mobile contactless payments in the US, I believe China will quickly surpass the US in percentage of mobile retail transactions from mobile devices at point of sale.

I say this with confidence because, when Chinese consumers are asked if they believe their smartphone will become their primary tool for transactions, they have the largest number of respondents who strongly agree with this statement than in any other market. 35% of consumers in China believe their smartphone will become their primary tool for commerce compared to 8% of Americans. China is ripe for Apple Pay.

While no other vendor has more active devices in use in China, the ecosystem for mobile payments is being laid beyond just iPhones. NFC will be rolled out in POS terminals across the country and quickly in major retailers in top cities like Beijing, Shanghai, Shenzen, etc. While iPhones are extremely popular in those top tier markets, Android at large is still the dominant operating system. Local leaders like Huawei and Xiaomi will adopt NFC and likely their own mobile wallets throughout 2016 as well. While Apple has the more elegant solution, there will be competition from Android OEMs as well looking to appeal to this new consumer behavior. Fragmentation may slow down the adoption of Android-based mobile wallets and contactless payments, but it will get fleshed out over time.

The dynamic to watch is how companies like Alibaba respond with AliPay. While mobile contactless payments, meaning using your phone to tap or authenticate a payment at retail, remains low in China, now over 50% of smartphone owners in China engage in mobile commerce each month. Meaning, use their phone to make a purchase over the internet. When it comes to mobile e-commerce, AliPay is the dominant transaction method. You have to imagine Alibaba will want to maintain this position and not let Apple take control of their customers. One thing to watch will be more retailers accepting AliPay at retail. This will be interesting to see if, when given a choice, consumers stay loyal to AliPay or start to alter their behavior in light of the benefits of Apple Pay as it gets more widely accepted.

While it is interesting to talk about Apple Pay, NFC, mobile commerce, AliPay, etc., the real winners in all of this are the components companies providing the solutions to roll out tens of millions of new payment terminals necessary to make this transition. From the companies providing NFC technology like NXP or those providing touch-screens for the terminals or those providing the terminals themselves, all are poised for explosive growth as many markets support NFC transactions at retail.

While markets like the UK have embraced NFC for some time, that market alone never acted as the catalyst to drive this adoption. Both China and US, but perhaps more quickly in China, will be the catalyst that moves this forward. And I believe faster than many are anticipating.

Apple and Emerging Markets

One of the misconceptions about Apple’s iPhone run was that China was an emerging market. If anyone had been to China in the last four or five years, you would realize there are two China markets. There are parts of China which are under developed but there are also very large parts of the country which are extremely developed and actually quite rich. I’d argue China was ready for Apple before Apple was ready for China. This became clear to me when I started studying the grey market for iPhones many years ago before Apple’s presence was strong there. Every year there are questions about how Apple can grow iPhone sales. But growing revenue is actually a better metric. People fail to see that point so iPhone growth remains a key story.

Wall St. analysts’ opinions are mixed. No one doubts growth will slow for Apple, but whether 2016 sales will be up or down slightly is a key debate. I still maintain China remains a massive growth opportunity but how Apple plans for other emerging markets is perhaps a similarly interesting conversation.

It is no secret Android is hands down the dominant operating system in emerging markets. Using India as an example, Apple’s share of smartphones is less than 5%. In markets where cost is central, iPhones don’t sell well. This is not a surprise. Which is why, in this vein, the lower-cost iPhone keeps entering the conversation. As I explained in this analysis, there is smoke around a lower-cost product but it’s centered around a smaller form factor. Which I personally believe doesn’t line up with emerging market trends in hardware form factors.

When I think about Apple’s strategy for emerging markets, I believe India is the market to watch. The point I made about China being ready for Apple before Apple was ready for China is not true of India. India is thoroughly dominated by Android and my study of the market suggests Indian consumers are quite happy with it and, more specifically, Google’s services. India is also a market very focused on price and value. Apple has a bit of an uphill climb if they want to grow in India and some moves they’ve made, I believe, are focused on learning about the market and their consumers.

Namely, this move to lower the cost of the iPhone 5s in India is quite interesting to me. To some degree, I feel Apple is trying to understand their magic price point in the India market. Via our data, the 5s has seen the most success in terms of consumer interest in India. Colleagues of mine in the analyst community have been tracking Apple to pass 2m iPhones sold in India in 2015 and, with this lower price move, I could actually see them get near 1m in India this quarter alone. Apple is trending up in India — just not nearly sharp enough to make a massive difference.

Apple also has no official store presence in India. They sell through retailers but my sense is Indian consumers, with an emphasis on value and trust, would support an official presence by Apple retail. I could see this as the beginning of a catalyst for Apple in the market.

India could be the market Apple uses as their template for other regions. Brazil is another market Apple has been tentative in and I expect Latin America at large to become a continued focus. Apple has not needed to be in a rush but rather let markets develop and, when the timing is right, start to build their presence. This is likely the strategy of the next five years, the timeline in which many of these emerging markets will develop.

Apple is playing a long game with emerging markets and, hopefully, the street takes this view as well and does not judge them too harshly on some of the short-term market slowdown trends in smartphones.

There are a great many different strategies Apple can take in emerging markets but, in many of them, their presence will add another element of competition which will ultimately benefit consumers in these regions as well.

Apple and a New, Smaller, Potentially Less Expensive iPhone

Recent rumors suggest Apple may be planning to release a new iPhone in 2016 with a return to the smaller 4″ form factor. Some reports suggest this iPhone may target the lower-end of the market, like the iPhone 5c in a way. Other reports indicate it will still have relatively premium pricing — not as premium as the 6s or 6s Plus but also not $300. I imagine this will be an evolving story, but I want to share my thinking about this at a high-level.

Let me be honest, I struggle with this rumor. I’ll also be the first to admit I struggled with the need for Apple to launch a larger screen iPhone, even though I knew the market was trending in that direction. But my struggle is rooted in the basis that the market is trending and moving to larger screen smartphones. I’ve seen a number of research reports suggesting roughly 20-30% of the market is currently interested in a smaller 4″ iPhone. Of course, we know consumers don’t always know what they want until they see it. However, it seems all the data suggests larger screen phones is what the entire smartphone market is shifting to.

There is an argument to be made about price. This I interpret in the same vein of theory which led many to believe Apple needed a less expensive iPhone to get the growth they needed for their stock to remain valuable. But it turns out, what they needed to reset the growth button was a larger screen and a more expensive price point.

My concern with the lower-cost argument is that it targets a demographic that is unquestionably buying larger screens. For example, we may rationalize that Apple could take a lower-cost iPhone and bring it to markets like India. The challenge with this is consumers in India can already purchase very well made, high-spec, 5″ or larger Android smartphones for less than $200. So, can a brand new, smaller screened, slightly more expensive iPhone compete with a $150 well spec’d, 5″ smartphone in India? Maybe, maybe not.

Another market this product could be targeting (if it comes to market) is the pure post-paid segment in western markets. These are customers where price really is the most important factor. They pay their phones off up front, are often using pre-paid SIM cards, and/or simply can not afford a >$600 device or a $25 dollar a month payment plan. While I concede this is an interesting play, here again is a space where we see consumers purchase larger screen phones because, in many cases, it is their only computer. Therefore, the largest screen real estate they can afford is often the most desirable. This mindset is very similar to those of emerging markets consumers as well. Big screens are valued most and they need them to be affordable.

While I can’t yet rule out this potential move by Apple, I’m still skeptical. Most of the arguments presented to me for the need for a smaller iPhone don’t seem to hold water with the market insights we are seeing at the moment. Again, consumers rarely know what they want until they see it. However, the evidence presented for Apple’s need to address this price point to get new customers, if lined up with the data, would suggest they need to launch a lower cost, large screen phone. Essentially, a lower cost version of the 6s or 6s Plus. This seems highly unlikely. But again, we can’t rule anything out yet.

The Wearable Market Duopoly

The last few quarters, I’ve been talking about how the vast majority of quarterly wearable sales have been made up by two players–Apple and Fitbit. This was entirely predictable given the immaturity of the wearable market. The early players tend to dominate. In terms of health and fitness bands, Fitbit’s market share is 36%, the highest of any brand. Apple’s share of the smartwatch segment is 82%. Here is the wearable market breakdown by vendor to date.

From my own primary research, both these brands also have over 80% of the mindshare and purchase consideration over the next six months of all brands currently in the market, either a fitness tracker or a smartwatch. The duopoly between Apple and Fitbit does not appear to be ending anytime soon.

My recent retail checks from the Black Friday weekend and Cyber Monday sales revealed similar trends with these two brands making up most of the volume. The market data confirms it’s a duopoly — so where do we go from here?

The big question in my mind is the sustainability of Fitbit. In fact, it is the key question I get from many big investment firms with a bet on Fitbit. As you can see from the chart above, Fitbit could be under pressure from the low-end by Xiaomi and the high-end by Apple. Fitbit likely knows there is an upside to their ASP. While they will do everything they can to raise it slightly, they are ultimately a company with an ASP between $90-$120 and will strive to maintain that against competitive threats from the low-end.

The concern about Xiaomi is valid, but only in some markets. To be frank, a company that sells in wealthy regions in China where a sub-$20 wearable is pocket change yet, they are only selling 2-3 million a quarter is very telling about both the broader wearable category in China and the perception of the Xiaomi brand. In fact, I find it incredibly interesting that the best selling phone, in the one of the largest and wealthiest cities in China, is Xiaomi’s cheapest Android smartphone, the Redmi 1S.

Attentive eyes will be watching Fitbit closely over the next year as they balance the growth of their ecosystem and try to make sure they are the best fitness tracker on the market and the first one people buy to enter the market. Their ecosystem is sticky and engaging, and they are the only brand their customers stick with over time.

Again referencing my quarterly wearable vendor chart, the rapid rise of Apple sales as a percentage should be a focus. It is both a testament to the Apple brand, the quality of the product for a version 1, and the total Apple ecosystem. At the pace we are seeing both interest and adoption, Apple may likely displace Fitbit in quarterly volume (obviously they do already in revenue) by Q2 2016.

Our conviction remains that the Apple Watch has potential to penetrate more of the iPhone base than the iPad and potentially cross the 50% penetration rate of the iPhone base. By our current estimates, we believe the Apple Watch installed base could be well over 100m sometime in or by the end of 2017.

One of the most interesting things we saw over the Black Friday weekend was discounts being given on the Apple Watch and Best Buy. This had a huge impact on sales and a Target promo was sold out quickly. Most people in our Apple Watch surveys who don’t own one yet refer to the price as still being too expensive. These deals seem to indicate $249 was a price that moved significant volume. While I don’t see Apple lowering the price quite yet, it is interesting to see how this will impact the competitive landscape. Even though we are not all the way through the holidays, this is shaping up to be a big quarter for the Apple Watch and early indication is its success has impacted Fitbit sales to a degree.

Thinking about price, one thing I am watching closely is the continued roll out of corporate wellness plans where companies will buy a product like Fitbit to give to their employees as a part of a health and wellness plan. Or they will be giving a credit for employees to purchase the product of their choice to help them be more healthy. All indications are the duopoly continues here with Apple and Fitbit benefiting. One can argue a Fitbit being free is better than a $100 subsidy and still paying over $200 for an Apple Watch. But here I refer to the point of $249 being a price that moves in volume. I can see the Apple Watch benefiting quite a bit here with a ~$100 corporate subsidy.

The real question is whether there is much space for other competitors. To have two companies controlling more than half a market leaving other competitors small slices makes for a tough environment to justify investment in the category. There may be an opportunity once the market matures for competitors to start picking off segments but we are quite a few years away from that level of maturity.

Comparing the “Big 6” Consumer Tech Companies

After earnings season ends, I always like doing some comparisons between some of the largest and most important consumer technology companies to see how they measure up on key financial and operating metrics. I’ve shared some of this data with Tech.pinions Insiders once before, and I thought I’d do so again now we’re through the Q3 2015 earnings season. The charts here come from the Jackdaw Research Quarterly Decks Service. You can sign up for them here. The full deck, with about 15 charts, has gone out to subscribers today. The companies included in this comparison are Amazon, Apple, Facebook, Google, Microsoft, and Samsung. I used to include Sony, but it seems to be exiting more and more aspects of the consumer technology business so I’ve dropped them this time around. It’s also worth noting that capex figures for this quarter and employee figures for all periods aren’t available for Samsung.

Revenues – Apple is now the biggest of the big 6

The last time I did this analysis, Apple had just barely passed Samsung as the company with the highest trailing 4-quarter revenue of any of these companies and, since then, its lead has only expanded. As Samsung has suffered revenue declines due to its struggling mobile business, Apple has gone from strength to strength with its strongest period of revenue growth in years, thanks to the new iPhones. Further down the pecking order, Amazon has also now passed Microsoft, which benefited from the acquisition of Nokia’s devices business for a time but is now seeing revenue declines year on year as that business shrinks and currency effects detract from overseas performance in general:

As you can see, Facebook is by far the smallest of this “big 6” and is included for its outsized influence in the market and its margin performance, not for its modest financial scale.

Margins – Facebook is taking a dive

From a margin perspective, Facebook has been the leader for quite some time, but was pipped by Apple and Microsoft over the past four quarters on operating margin:

What’s behind the decline in Facebook’s margin? Acquisitions of new businesses such as Oculus and WhatsApp, which incur substantial costs but no revenues. At the same time, you’ll also note Google’s margins have been steadily improving, while Samsung has begun to turn its performance around in the last couple of quarters, largely thanks to its semiconductor business. And of course, Amazon comes in last place, even with its recent uptick in profitability thanks to AWS. In dollar terms, Amazon’s operating profits over four quarters continue to lag even those of Facebook, which has revenues around one sixth those of Amazon:

Amazon is out-hiring everyone else

As I’ve written elsewhere, Amazon is on a hiring spree at the moment, adding 72,900 employees in the past 12 months alone, significantly more employees than Google has in total:

At this point, Amazon employees around 225,000, or twice as many as either Apple or Microsoft. Apple, Google, and Facebook have been hiring significantly too, but at nothing like the rate of Amazon, while Microsoft has been laying off workers following the Nokia acquisition. Because many of Amazon’s new employees are warehouse workers, and because its revenues are growing at a much slower rate, its annual revenue per employee has been steadily falling and now sits at under $500,000, at the bottom of the pile. Meanwhile, Apple has crossed $2 million per employee in annual revenue, and Facebook passed Google sometime last year.

Very different business models drive these financials

The last thing I’ll mention here is these companies have fundamentally different business models behind their financial performance. Facebook and Google share ad-based business models, with around 90% of their revenues coming from that single source, while Apple and Samsung are most similar in that they derive the bulk of their revenue from hardware, though their execution and strategy are quite different. Amazon and Microsoft each derive the bulk of their revenues from other categories – e-commerce in the case of Amazon and software in the case of Microsoft, though both also have growing cloud businesses. The chart below shows the composition of their revenues by business:

All of this is a useful reminder there’s no single recipe for success in consumer technology and that each of these companies has achieved impressive metrics by ploughing its own unique furrow, rather than by following a single formula.

Is Apple Positioning the iPad Incorrectly?

Over the last few weeks, since the iPad Pro came out, Apple CEO Tim Cook has often stated the iPad Pro could replace a laptop. While I believe there is some truth to this, after using an iPad Pro for some time now, I am starting to wonder if this positioning is completely accurate. When the original iPad came out, I bought a third party keyboard and used it as a laptop for short trips and in meetings to take notes. I even wrote a few columns on it and, over all, liked using it is as a pseudo-laptop. However, when I needed to do “real work” and was dealing with large documents, extensive spreadsheets and managing my media and images, I always went back to a Mac or a Dell XPS laptop for these heavy lifting tasks.

One of the more proactive and important bloggers is Jean-Louis Gasse, a former Apple exec and one of the most insightful people writing about the industry. Early this week, he posted an important perspective on the iPad Pro in his Monday Note where he questions Tim Cook’s positioning and suggests the iPad Pro is better suited for specific tasks instead of an “all things for all people” laptop.

Here is a short excerpt on his view but I highly suggest you read the entire piece since it is excellent. As an aside, it is worth subscribing to his blog since he always has an important perspective on our tech world:

Cook’s insistence that his iPad Pro is a replacement for his laptop is presumably sincere, but it’s misguided and unnecessary. The equivocations, justifications, and vague statements about the iPad Pro are easily resolved by a For What/For Whom question, by investigating the Job To Be Done

You work with architects, civil engineers, materials, fixture and appliances suppliers, kitchen and bathroom installers. Your iPad Pro is flat on a table while you sketch a design for the architect to flesh out, you scribble annotations on drawings and budgets, you redraw a layout by superimposing a layer on the original. The iPad Pro does more than replace your laptop.

You work for a wallpaper manufacturer and design pattern after pattern; you browse vintage nature photography for old hunting scenes, extract images that can be stylized as part of a new collection, add color swatches, overlay line drawings. The iPad Pro and its Pencil are your friends.

Before: a horizontal tablet and stylus for input, a PC with a vertical display.

Now: the computer, the display and the tablet are one – and you take it with you.

Horace Dediu put together a neat video in which he explains “The new iPad is like nothing we’ve ever seen before” and, a bit cheekily, makes the case that it truly is a desktop computer, as in a device that’s best used when laid flat on the desktop, as in the examples above.

Why, then, do so many of us — and I have been in this camp — insist on seeing tablets through PC goggles? We can meditate on the dangers of knowing too much, too deeply; we become prisoners of our deep-rooted beliefs. In a recent Monday Note on Killer Cultures, I referred to the revered founder of Digital Equipment, Ken Olsen, who said he knew people bought PCs, but sincerely didn’t understand why. His company’s All-In-1 productivity software running on a large remote machine covered all his needs. Looking at the iPad Pro, how many of us fail to see outside of our world?

In a recent piece, Living In Different Worlds, Benedict Evans concurs and concludes [edits and emphasis mine]:

“We’re all prone to apply old mental models to new things when they look like the old things. […]The challenge for a new thing is that you can fall into one of two traps – either you try to map it to the old mental model, or you decide that, since it has no existing mental model, it’s useless. So, the automobile is compared to the carriage, Uber is compared to taxis, digital cameras to film cameras, and smart watches to Rolexes. But sometimes there is no model. […] all of us have that same disconnect whenever we try to understand something new.”

Fortunately, we have children. In a Tech.pinion post titled The iPad Pro: The Start of Something New, Ben Bajarin tells us how his 12-year old daughter took over his iPad Pro [edits and emphasis mine]:

“So I should not have been surprised when my daughter started playing with the iPad Pro for a few hours and came back and showed me all the things she had done: movies she made, photos she took outside (which she edited/mashed up using the different apps she also uses in creative projects at school) and taking advantage of the unique benefits of the Apple Pencil. With nearly everything she showed me, I had to ask her how she did it. I had no idea some of the apps on iPad were as powerful as they were, enabling her do things I didn’t think were possible […]”

Presenting the iPad Pro as a laptop replacement for “many, many people”, or asking “why would you buy a PC anymore?” doesn’t shed much light. If you prepare complicated documents, proposals, financial filings, you should stick with a Mac or a PC.

Apple execs are fond of metrics such as the number of new iPhone buyers coming from the Android world (30%). Why not say that the iPad Pro will helpfully replace a laptop for 60%, or 25% of conventional personal computer users? In keeping with Steve Jobs’ Far Better At Some Key Things formula, why not say that the iPad Pro is a great laptop replacement for graphic designers, architects, mechanical engineers, musicians, videographers…and that the audience will grow even larger as new and updated apps take advantage of the iPad Pro’s screen size, speed, and very likable Pencil.”

Gasee is right on the money with this analysis. While I am not an artist, architect or civil engineer, I can see how the iPad Pro would be a godsend for use in their daily work and its potential impact on other major vertical markets could be significant. I understand why Apple would not want to create a marketing campaign for the iPad Pro with such a narrow focus but I suspect these will be the top buyers of the iPad Pro at first.

But there is another market Gasse does not reference directly I also see having some legs when it comes to adoption of the iPad Pro — the broader enterprise market. Apple clearly began their work with IBM to port 100 of their top mobile apps and management tools over to iOS long before the iPad Pro came out. This is clearly the device these apps work best on. The IBM tools are very rich and can be used across many IT apps to handle all types of mobile management and app integration issues. More importantly, IBM has become an important sales force for Apple and brings a direct sales team who will sell Macs, iPads, and iPad Pros to IT customers around the world. Yes, some of these IT situations will be for vertical applications, but it is my understanding that IBM plans, with Apple’s help, to take these to the heart of IT to provide advanced mobile solutions.

The iPad Pro has only been out a short time and availability of the Pencil and Keyboard is still limited. Which means it may take some time for it to find an audience sweet spot. I do sense its impact first will be on many vertical markets and eventually gain strength in IT and Higher Ed where a 13-inch tablet meets specific needs. I am just not sure it can really replace a laptop in its current form but am open to being surprised with its overall market appeal eventually.

Understanding Apple’s Hardware Universe

I often feel public commentary on Apple’s hardware makes some flawed assumptions. The general one being that Apple creates hardware products and their goal is every one of their customers should own one. Case in point, the Apple Watch. While an important new category, most of the commentary around the watch makes the assumption it will penetrate deep into the iPhone installed base — now approaching or just recently passed 500m. I like the universe example because the iPhone is Apple’s sun, meaning it is the product, for now, which all other products revolve around.

The iPhone is, for the most part, Apple’s gateway to their ecosystem. It used to be the iPod. It was the halo product that introduced tens of millions of people to the Apple experience. For hundreds of millions of people today, that product is the iPhone. We know from research and data that, once a consumer lets a brand into their life, they are more willing to consider that brand for future purchases. This is why an Apple hardware universe is central. The direction a consumer goes to purchase other tech products as a part of their individual solution is entirely up to them. The key here for Apple is to cover the spectrum of options for that consumer now that they are in their ecosystem. I recently did a study with iPhone owners and asked them what other Apple products they currently own and use. This research was on a global set of consumers, but most were in the US and Europe. Here are the results.

At a high level, this is an insightful look into the specific penetration of the iPhone base. What is interesting about this data is how it confirms my suspicion of multiple product overlap among a good portion of Apple’s customers. Meaning, one customer does not own just one or two products but generally multiple examples. I know this because this question was a multiple choice question. For example, if we add the total of iPad versions, it comes to over 100%. We know the installed base of iPads only equates to around 35-40% of the total iPhones in use. Which means there is a portion of the iPad user base which owns more than one iPad and there is a portion of consumers who own an iPad and not an iPhone. The former is larger than the latter.

To follow up my suspicion, I also asked respondents to estimate how many Apple products are in active use in their household. While no single number dominated, household ownership of Apple products is fairly spread out.

When I analyze Apple’s hardware approach, what seems like an expanding product line, which many view as them moving away from their simple set of options, is expanding to cover the diverse needs of a growing user base. Things like the iPad Pro or the Apple Watch are designed to cater to pockets of Apple’s customers. The question we are faced with is, how big the segments are within their base Apple is creating products for. This is a better way to look at their hardware strategy than simply thinking everything they build is intended for every one of their customers. Some categories, like the Watch, may appeal to more people than something like the iPad Pro, but Apple’s goal is to make sure their first party hardware covers the range and evolving needs of their customer base. Essentially, Apple wants their customers to continue to be their customers even as they start looking at other categories.

If Apple can appeal to their own customers for health and fitness rather than lose that customer to Fitbit, then it makes sense for them to offer a product. Or, if Apple wants to make sure they have a product like the iPad Pro to keep those customers from going after products like the Surface, it is wise for them to do so. Similarly with Apple TV, why should Apple let customers go to Chromecast or Amazon Fire TV or Roku if this is a mainstream use case of their customer base? It makes more sense for Apple to offer first-party hardware to cover as many bases as possible. So long as they believe the base is big enough, it is worth covering.

From my math, Apple’s hardware installed base is nearing or over 800m at this point. Keep in mind, this is not a unique user number, as the 500m or so iPhone users is essentially the Apple installed base. The iPhone is Apple’s sun and each of the other hardware categories revolves around it. Even if other products like the Mac or the iPad act as feeders, it is ultimately the iPhone that is the strongest product to bring new customers deep into their ecosystem.

The iPhone and Growth at Apple

Apple reported its results for the third calendar quarter of 2015 last week and, as is often the case, the performance of the iPhone was the biggest specific thing investors were looking at. The good news for Apple and its investors was iPhone growth was indeed strong year on year and this in turn drove strong growth in overall revenues. The big question is whether this strong connection between iPhone growth and overall revenue growth is a good thing or not.

Note: in the analysis below and in the charts, I’ll use calendar quarters rather than Apple’s fiscal quarters, which I find easier to grasp.

Apple without the iPhone isn’t growing

The key thing to understand here is the rest of Apple isn’t really growing:

As you can see, total revenues for the rest of Apple have been stagnant on a trailing 4-quarter basis for about the last two years, at right around $80 billion.

iPad is primarily to blame

What’s the reason for this? Well, it’s quite simple: it’s largely about the iPad, which has been shrinking faster than all the other product lines combined are growing. Until the June quarter this year, the Other Products category was also declining, but the launch of the Apple Watch has now begun to offset the decline of iPods and Beats accessories and grow that category over the last two quarters:

However, the annual shrinkage in the iPad revenue line is leaving Apple with anything from $4-7 billion in revenue it has to make up elsewhere just to stay flat year on year. Even with the Mac continuing to buck the downward trend in the overall PC market and App Store-driven growth in Services, Apple hasn’t been able to offset this decline entirely.

Two very different revenue growth rates

As a result, year on year growth for Apple with and without the iPhone looks very different:

Over the eight year history of the iPhone, Apple has had only three quarters when the growth rate of the rest of the company eclipsed the growth rate including the iPhone:

Q3 2011
Q2 2012
Q1 2013

Interestingly, the iPad had just eight consecutive quarters posting year on year growth (with one additional isolated quarter of growth later), and all three of those quarters I just listed happened during this period, which lasted from Q2 2011 to Q1 2013.

Looking forward

So far, this analysis has been entirely backwards-looking. But let’s look forward to the next few quarters and ask what might happen to Apple’s overall growth. The company’s official guidance for the next quarter is for 1-4% growth in reported terms, which is significantly down on growth over the past four quarters (30%, 27%, 33%, and 22%). As we pass the one-year anniversary of the launch of the iPhone 6 line, the “comps” (year on year comparisons) become that much more challenging for Apple to beat. The outsized growth that came from outsized iPhones is going to slow again as the biggest one-time iPhone conversion cycle in several years comes to an end and Apple’s guidance reflects that. However, it also reflects the ongoing currency headwinds Apple faces – the underlying growth in constant currency will be more like 8-11%, still slower than the last four quarters, but not by as much.

However, I think there’s even upside beyond this number, especially in Q4 2015, for several reasons:

Apple has been conservative in its guidance before, especially in quarters with huge upside and may turn out to be so again.
With regard to the iPhone, it’s entirely possible year on year growth may turn out to be stronger than expected. The 30% Android switcher rate combined with the relatively low number of upgraders so far from within the iPhone base suggests a huge combined upgrade-and-switching cycle lies ahead. iPhone growth could therefore be well above what the company is suggesting it will be.
In addition, iPad shrinkage (which as we saw above is by far the biggest driver of shrinkage in the rest of Apple’s business) could well slow considerably in Q4 as the iPad Pro launches. Even a couple of million sales of an iPad that starts at $800 would make a huge positive difference to the hole the iPad has been leaving in Apple’s year on year revenue growth. Anything more would be icing on the cake.
As we saw above, the Apple Watch has already turned around the Other Products line, which had been shrinking by around 10% year on year but is now growing nicely. A big Q4 – especially with lots of Watch gifting – could grow that line significantly. Add in the impact of sales of the new Apple TV, now with a higher ASP, and Other Products could grow even faster.
If Services and Mac continue to grow at the solid rates they’ve shown over the last few quarters, the combined impact of all of this could be decent growth in the rest of Apple’s business. Add that to the potential for stronger-than-expected iPhone growth, and suddenly overall growth could be significantly above the 1-4% suggested by guidance.

None of this is guaranteed, of course. That’s precisely why Apple’s guidance is fairly conservative. I’m not sure there have ever been as many unknowns in one quarter of Apple reporting as there are this time around:

The year following an unprecedented iPhone upgrade cycle
The first holiday quarter for the Apple Watch
The launch of an entirely new iPad form factor
The launch of an entirely new Apple TV and associated App Store

The important thing to note, though, is all these unknowns are on the upside, not the downside – if these things broadly perform relatively poorly, then Apple will still hit its guidance. But if any of them does well – and especially if several of them do – there could be a pretty significant beat to guidance for Apple next quarter.

Microsoft’s Surface Book and its Impact on Apple and PC Vendors

I have been intrigued by various reviewers who have suggested Microsoft’s Surface Book is the best laptop on the market today. If I were one of Microsoft’s PC partners, this very thought would offend me. PC makers have bent over backwards recently to try and create slick, well designed laptops, taking their cue from Apple and trying to make them thin, sleek and light, yet highly functional. Dell’s XPS 13 and Lenovo’s new YogaPro comes to mind as good examples.

When Microsoft introduced the Surface Book in NYC earlier this month, I had to miss the event due to a schedule conflict so I had not seen it in person to judge myself. But now that it’s on shelves, I went over to the Microsoft Store and got a chance to check it out. I have to admit, the reviewers who praised it as the best laptop on the market have a point. Its design is somewhat close to a MacBook Air and, in that sense, it’s relatively equal to a 13 inch MacBook Air. But it of course differentiates from the Apple laptop significantly since it has a detachable screen that can be used as a tablet.

Perhaps a more accurate way to describe the Surface Book is it is the best “convertible” PC on the market. At the very least, it should give the traditional PC vendors a new target to go after from a design perspective and force them to try and create something even better for a cheaper price. Actually, I think that is part of Microsoft’s strategy — to push PC vendors to be more innovative. But I also believe Microsoft is in the hardware business to stay and will be a competitor to their customers from now on, too.

For Apple, I see the Surface Book putting pressure on them to possibly create their first true convertible in the future. I spent some serious time with the Surface Book and loved it in the tablet mode. It is thin, light and, with their new Pen, works really well since the version of Windows 10 on it is customized for this design. When I used it in the laptop mode, I was really surprised how well it worked as a Windows 10 laptop and loved the idea I had both a laptop and a tablet in a solid package that used a very powerful desktop class OS.

Of course, Apple does have a product in this category, although it is more like a 2-in-1. The real virtue is its tablet role and a keyboard is kind of an input addition close to Microsoft’s Surface Pro designs. Their new iPad Pro comes out in November and will play a similar role in the Mac community, albeit with iOS as its anchor instead of Mac OS X. The Surface Book is such a stellar design, I think it will become the poster child for most Windows PCs someday and be the catalyst to make convertibles the standard laptop over $500 in the future. If that happens, it could push Apple in this direction too.

At the launch of the iPad Pro, Tim Cook said the iPad does 80% of what people need to do when they compute and this new tablet/keyboard combo will be sufficient for most people’s needs, whether for business or consumer users. This is important since Apple pretty much defined the touch UI through the iPad and has continued to make touch with iOS the best touch-based OS on the market. To them, iOS seems to be the OS they will champion to business and consumers in any 2-in-1 or maybe even someday a convertible design.

Microsoft has a different view that says a desktop class OS with touch is the best way to go. The touch UI on Windows 8 and 8.1 were weak but the touch UI on windows 10 is much improved and works well with their desktop class OS. It is here where Apple and Microsoft have a deep divide.

Apple clearly wants iOS to be the heart of their broader reach into the market and make it the cornerstone of their business and consumer strategy. Mac’s will always have a place, especially with power users, but Apple seems to see power users who need a Mac as a much narrower audience. There is a larger audience that could benefit from iOS and its ecosystem of 1.5 million apps, which makes it much more versatile for most users.

This leads to two big questions for Apple in light of Microsoft’s Surface Book. First, if Microsoft and their partners are successful in making “convertibles” the standard laptop configuration over time, will Apple be forced to follow suit? How long can they stick with their laptop is a laptop and a tablet is a tablet focus if a convertible becomes something business and consumers really want?

And secondly, if they do a convertible, which OS will they use? At the moment Mac OS X is not touch based and Apple would have to put a lot of engineering dollars into it to make it competitive. It is more likely a convertible would have iOS but Surface Book and likely competitors who create similar versions could prove, in this form factor, a desktop class OS is what people really want.

At the moment, my best guess is Apple uses iOS on any device that needs a touch interface. Which means, if they do a convertible, it would be iOS based. And they would keep the Mac and OS X focused on the trackpad and very keyboard-centric. It is also too early in the convertible cycle within the Windows world to conclusively proclaim this is the future of laptops. But from what I saw in the Surface book, I believe it will have a significant impact on future PC OEM designs and perhaps, at some point, it could force Apple in a similar direction.

Underestimating the iPhone

As a whole, Apple is generally regularly underestimated as a company. However, with the iPhone making up such a large percentage of Apple’s revenue and many calling Apple an iPhone company, that underestimating extends to the iPhone. Apple’s and the iPhone’s growth significantly has to end, is the common narrative. Apparently, it is not sustainable in the minds of many.

The smartphone market is a big one. The biggest market of any consumer tech product. It’s the only product almost every adult will own some day. Apple’s share of smartphone sales for the calendar Q3 2015 quarter was 14.5%. The dynamics of the global smartphone market are hard to read for many but have been clear to me for some time. As markets mature, consumers start becoming more refined in their needs, wants, and desires with a smartphone. This simple dynamic is what led Apple to have the highest number of consumers upgrade their smartphone to an iPhone from an Android phone. This dynamic, which is a result of both the maturing of markets like greater China and Eastern Europe, is an underappreciated one in terms of the iPhone’s upside. Another statistic I’ll share from our primary research is, while our data returned a 28% switching from Android to iPhone number, 26% of Samsung owners in our panel indicated intent to make the iPhone their next smartphone.

During yesterday’s earnings call, Tim Cook shed some interesting light on this new user question. The Android switching dynamic is certainly a new user addition to the Apple ecosystem. However, some interesting stats were shared about China as well.

– 50% of iPhone buyers in China buying a iPhone 6 and up are buying their first iPhones
– The number of first-time buyers was even higher than 50% for those who purchased an iPhone 5s

The key takeaway is that the new iPhones are driving new users to the customer base, especially in China, and the legacy models are playing a significant role as well in driving new customers. This later point on the 5s gives me an indication the iPhone 6 and 6 Plus, at now discounted rates, will continue to drive this dynamic of adding customers. Cementing again the theme of last year that the year before models are drivers for Apple in the lower-tier price points. Take this point and apply it to the iPhone 6 and 6 Plus. These phones are so well built and the SoC so well made, they can last quite a long time in the market. Next year at this time, the iPhone 6 and 6 Plus will still be in the market and discounted even more than they are right now. They will still be competitive in the overall market and even more attractive to first-time buyers/switchers by hitting lower price points. Meaning, Apple’s lineup is strengthened each year with last year’s and the year before model at addressing many different price points and, remarkably, still competing at those price points several years later with newer Android phones.

The vast majority of Android vendors are fighting the trends of the race to the bottom. Android is suffering from the “good enough” problem in many markets. This makes it hard for vendors to have cutting edge specs or genuine innovation, which is helping tip the market in Apple’s favor as global markets mature. A truly fascinating dynamic to understand.

With only 31% of the base upgraded, 69% of Apple’s global installed base is still ripe to upgrade. Based on my estimates, that breaks down to roughly 320-330 million consumers still needing to upgrading. How long this transition of the base will take is unclear but roughly 330 million consumers are ready for an upgrade.

Lastly about iPhones. China seems to keep stumping many Apple watchers. Interestingly, we are now starting to see seasonality for Apple in China in ways we did not before. Note my chart of Apple shipments in US and China.

(Forgive me for not revealing the Y-Axis as the hard data is for our institutional clients)

As you can see, Apple’s shipment line in China was steadily going up. Now, it has seasonal variance just like the US market has for some time. These dynamics are new, with no historical comparables to lean on. Even other Chinese OEMs who sell in China don’t have this same degree of seasonality. This means the two biggest quarters for iPhone growth will come from the Dec holiday quarter for many markets and the March Chinese New Year holiday quarter. These two quarters alone made up 42% of Apple’s fiscal year shipments of iPhones. I expect that percentage to rise as a part of Fiscal 2016 iPhone shipments.

China seasonality is helpful for the overall model and looking at similar big shopping quarters in other markets for Apple could help understand the growth signals as well.

A few other highlights:

Mac: 5.7 million Macs is incredibly strong, given the PC environment we are witnessing. This is fueled both by enterprise sales as well as the back to school segment. Feedback we got from IT managers and CIOs was the Macbook was gaining traction in their workforce and we heard similar with students. I’m looking for a 6m+ Mac shipment quarter in Dec.
Apple Watch: Based on math I feel is reasonable and logical and given several assumptions of products in the “other” category, I’m fairly confident Apple Watch sales were in the 3.5-4m range for the quarter. Up sequentially is a postive sign and feedback I’m getting from many retailers is positive for the direction of Apple Watch sales next quarter. Most importantly, though, Apple Watch owners love it.
iPad: I’m not as worried about this category as others may be. Its decline is not concerning. I do believe iPad Pro will help but this product is not on as predictable of a refresh cycle as other products. I’m willing to bet we will have some surprise iPad sales quarters, but working these into forecasts will be very tough. So consider the iPad a sleeper with some surprising quarters ahead likely.
Services: Perhaps one of the least appreciated parts of Apple’s model is the services business. This business had a record $5.1 billion quarter, up 10% YoY. This is positive because it means Apple is continuing to get their customers involved in their ecosystem. Upside here can continue to come from Apple Music, iCloud storage, an Apple TV subscription service (if it happens) and, of course, continued growth in App Store revenue. All of this points to stickiness and loyalty in the Apple ecosystem.

Things are looking positive for Dec for Apple in many vectors. The market dynamics we are seeing change in real-time in categories like PCs, and smartphones, are truly fascinating and again teach us new things about consumers in these segments. All of this makes historical comparables and “conventional wisdom” hard to base a complete model on. Luckily, we have our quarterly market research across 30 global markets and 25,000 consumers to lean on.

The Future of Consumer Hardware Belongs to the Chinese

I’m sharing a scenario, one I’m not certain will play out, but an interesting one to propose and think about nonetheless. What if the vast majority of global market share of computing devices belongs to Chinese OEMs? Huawei, Xiaomi, Oppo/Vivo are making global moves and continue to take share from Samsung. It is like we are watching a saga unfold before our eyes where a host of Chinese OEMs are chipping away at Samsung’s quarterly smartphone sales each passing quarter.

Samsung is very likely on its way to losing the crown of #1 smartphone vendor by sales annually to Apple in 2016. I don’t see their downward spiral recovering. Their unit sales of between 70-80m units will be chipped away at by a number of Chinese OEMs in the low and mid-tier and Apple on the high end. To paint the picture as of today, here is my modeling for Q3 2013 of the top smartphone vendors by volume.

For the past few quarters, Chinese OEMs have made up over 40% of the total smartphone volume and I expect this to rise. Huawei is on pace to be the first Chinese OEM to pass 100m unit sales annually and only the third smartphone vendor to ever do it. Huawei is inserting itself as a global player. They rank highly in several markets besides China and are rising in many of the segments they compete. What intrigues me about this dynamic is it seems the model proving successful for scale in smartphones is tonscale in China then go global. Huawei did this and Xiaomi is attempting it. Oppo/Vivo grew in China and is now going global. With the size of the China smartphone market (between 90-100m smartphones per quarter at present), brands that grow and scale there are well positioned to go global. We can argue whether Huawei or Xiaomi are the Chinese OEMs of the future but I have a growing conviction whoever it is, they will come from China.

The follow-up question to this is, can this same dynamic play out in other categories? Several of the names mentioned above intend to bring PCs and more capable computing tablets in the shape of 2-in-1 PCs to market over the next year. These devices are not designed to compete with Dell or Lenovo in more commercial markets but are squarely going after consumer markets in China, India, Indonesia, and others where we see some signs of life for PC growth. Whether successful or not, they are clearly going after PC hardware designs and I bet it doesn’t stop there. What about large panel TVs (after all, a tablet is a small panel TV)? I’ve seen some pretty amazing TVs from China OEMs and it seems just a matter of time before they expand globally and take out Sony and Samsung.

Add all this together and I can make a strong case that Chinese brands will gain significant market share in smartphones, PCs/tablets, and TVs. All devices people spend a great deal of time with. While they likely won’t own the software, they will make a run at the services layer. To penetrate global markets, these brands may also integrate tightly with local players. For example, TCL has partnered with Roku as a part of their US strategy. Expect to see more of this when the Chinese manufacturers make a push in TVs.

China is good at putting together quality components, they are getting better at design and, while marketing is still a challenge, I bet they get better at that as well. The US may be a tougher time for many of them but it’s a big world out there and globally they can own significant share in all these categories. Given their ability of massive scale, quality goods, and low-price, you can argue they are as well positioned as anyone to compete for the 3-4 billion consumers who will purchase these products and for whom price is a factor due to their lower annual income.

One question I’ll also throw in (if I don’t, it will come up in the comments) is, where does Apple fit in this? I personally don’t see the Chinese OEMs impacting Apple in any real way due to the emotional element of the Apple brand and products. In markets where that doesn’t exist, like India, or in categories with less emotional attachment because they are appliances, like large glass TV screens, are where I expect the Chinese to succeed. Specifically in markets where price is an issue due to lower-income customers. In fact, I can build a strong argument that, once Apple takes the #1 spot in annual smartphones sales from Samsung, they hold on to that crown for quite some time. There may not be one Chinese OEM who sells 200-300m smartphones each year but instead many smaller ones doing anywhere from 50-150 per year. Similarly in other categories, there may not be just a few dominant OEMs but market share divided up among many.

I’d love to see more companies compete in consumer hardware but, as I pointed out here, it is tough, risky, and most VCs I work with aren’t much interested in hardware companies. China OEMs have a lot of advantages, ones I’m convinced set them up for scale, quality, and low prices in nearly every category they decide to go after. Essentially, I’m laying out a future where it’s pretty much just Apple and Chinese manufacturers in consumer hardware. I’m becoming more convinced that it’s likely this is how the consumer tech hardware market plays out.

Changing the iPhone Narrative

I’ve been picking up an interesting trend in several Wall St. hedge fund research notes. While not my only evidence, the following articles on Barron’s are two accessible ones many can read:

–Apple: iPhone Demand Upside, Says Morgan Stanley
–Apple: Piper Pounds the Table; Time to Get Ready for an ‘iPhone 7′

For many close watchers of the Apple stock, and any Wall St. stock for that matter, you know Wall St plays a 90-day game. They are making bets on or against the stock that either the company will beat estimates and their willingness to invest or sell depends on, to a degree, their confidence of the amount of a beat or a miss. I play this game with investor clients regularly and continually witness it play out in real time. For Apple, the stock largely moves now on the quarterly opinion of iPhone sales. The grand institutional investor narrative centers on the question of how Apple can keep growing iPhone sales on a YoY basis, with a particular emphasis now on the holiday quarter. It is as though the holiday quarter iPhone sales figure is the barometer for how the YoY growth will fair. Right or wrong, this seems to be a key part of the conversation.

What intrigues me about what I’m reading in a few narratives like the ones linked above is the perceived (by me) attempt to make the narrative less about the holiday quarter and more about the full year. I can’t help but wholly endorse this change, but I hope a number of institutional investors take note. An area of concern is this change by the Apple bulls is because of fears the December quarter shipments may not be what everyone hopes. Currently, Wall St. consensus sits between slightly lower than last year at 73m units all the way up to 78m units. That is the range for the quarter but, to be honest, there will be serious concerns over iPhone growth even if Apple sells 75-76m iPhones. This is where the unnaturally inflated expectations of many investors come into play. You’ll hear me emphasize, just price to iPhone guidance and you won’t get burned. What Apple guides to is my most intriguing number that will be revealed during next week Apple’s earnings call..

Another Big Year
There are several things at play I think make looking at Apple’s YoY growth for iPhones as the correct metric vs. just looking at 90-day cycles.

China: With the US and China markets being Apple’s largest, the US upside is not as high as China’s from a pure growth standpoint. While China is a significant quarterly contributor to iPhone sales, the region’s largest contribution will come in the first calendar quarter due to the Chinese New Year. My estimates for launch weekend contributions from China were in the 3-4 million range and we continue to hear they are on a similar pace as last year. China does have a significant shopping day on Nov 11th called Singles Day, where Chinese consumers who are single treat themselves to a gift. I’d imagine the iPhone will have a great sales day. But even with that, I think China’s largest contribution will come over the Chinese New Year, as the iPhone ranks at the top of gifted items in China. With as big of a market as China, I’d argue if we were going to look at quarters that signal iPhone momentum we need to look at both the calendar Q4 and subsequent Q1 quarter together as a measurement.

Upgrade Plans May Be Out of Whack: The other reason I caution away from focusing on calendar Q4 too heavily, particularly this year, is Apple’s new Upgrade Plan has introduced and interesting wrinkle. In Katy Huberty’s latest note (not public) their in-house research revealed 45% of US consumers across the big four networks responded they would definitely/probably purchase their next iPhone through Apple’s Upgrade Plan. This is very significant if it holds up. I’ve seen two other primary research points on this, both in the 40%-60% range, revealing the same interest level toward Apple’s upgrade plan. To put this into perspective, currently the average percentage of customers who buy from non-carrier stores, including Apple stores, is less than 15%. The wrinkle this provides is the percentage of customers who want to and plan to upgrade their iPhones but are not eligible currently or this quarter is not known. If a consumer is set on waiting until they are eligible so they can purchase through Apple rather than their carrier, then this sale may not happen until after Q4. Even though, under normal circumstances (if Apple’s payment plan didn’t exist), that customer may have upgraded early or, at least, in the December quarter rather than waiting. If a healthy percentage of consumers desiring to upgrade hold-off until they are eligible to buy through Apple, it could very well disrupt this quarter’s iPhone sales number. Should Apple come in closer to or under 74m units in the Dec Q, my theory would be this dynamic played a big role. Which means a few super quarters could be coming in 2016 and it may be hard to know which ones it will be.

Apple will likely report somewhere between 34-40% of their installed base has upgraded during the earnings call next week. With third party research suggesting iPhone loyalty is over 90%, we fully expect the base to upgrade over the course of the next year. I’d bet 80% or more by this time next year.

Ultimately, between the installed base upgrade transition and the high levels of switching from Android to iOS in many primary markets we study, I’m not concerned for the annual growth cycle of Apple. Look at the smartphone industry transition to Apple in my chart with historical smartphone sales and my current (always subject to change) estimates for calendar 2015.

I’m modeling:

– Samsung will post its first ever YoY decline in smartphone shipments
– In 2016 Apple will sell more smartphones annually than Samsung, placing Apple squarely as the number one smartphone vendor by sales.

The fundamentals of Apple’s business and the market are making a 90-day game a little more difficult. Savvy investors understand this and be looking for the larger annual narratives to shape their outlook. New market growth, conversions to the upgrade plan, growth in new categories and services revenue, and more leave me confident the revenue growth trends will continue and new hardware and market dynamics will challenge old school templates used to frame Apple’s overall model.

The Unsung Hero in Apple’s Strategy

TL;DR version: It’s their A-series processors. However, I’ll lay out many of the reasons why this single component may be the source of Apple’s most significant competitive advantage.

In 2008, The year Apple bought P.A. Semiconductor, I was working with a company specializing in semiconductor industry IP licensing. The CEO became a good friend and he was a long-time exec in Motorola’s chipset business back in the day. Suffice to say, our meeting shortly after the news dropped was an interesting one. One of the key parts of this discussion was centered around how the strategy by semiconductor companies is to differentiate their chips by their designs. Meaning, how they put together the entire solution either onto a single chip or with many chips (co-processors) working together. Each vendor selling chips to others, generally, had a custom design and solution. What the smart semiconductor insiders knew with this acquisition of P.A Semiconductor was Apple was going to start designing their own chips. However, unlike others in the competitive chipset design business (Intel, Qualcomm, Nvidia, Broadcom, and a few others), Apple would not be designing these chips to sell to others but exclusively for their own devices and operating systems.

As I’ve studied the semiconductor industry for over 15 years now and the nuances between each chipset designer are fascinating. The way each one designs their chips to solve market problems and compete against other vendors is unique and creative. But all of these vendors have to design into their SoC or entire chipset solution the broadest of solutions in order to capture as many different parts of the market as possible. So a vendor like Qualcomm will design their architecture and then tailor it for different parts of the market. The initial design is broad, yet its applications can be made more specific. The same is true with Intel. They must cover the broad market with their solutions. Apple, on the other hand, does not, meaning every bit of their engineering resources, architecture designs, and nuances in optimization have a single purpose — to make iOS the most sophisticated, capable, and powerful mobile operating system on the market. Apple has been acquiring some of the best chipset designers in the world and they are tasked with making the most powerful and battery-efficient designs in the industry. These designs are exclusive to iOS while, at the same time, being competitive with the broader market chipset vendors as well. Without being a semiconductor industry insider, it is hard to internalize just how big of a deal the A-series processor design is in the grand scheme of things.

Prior to designing their own chips, Apple’s vertical hardware and software intergration stood apart because they could tune the software to the hardware, which contained many parts of the puzzle they did not own, and make specific software optomizations to accompany that hardware. This has only extended to a much deeper level now that they can tune/design the CPU/GPU and many other parts, like display drivers, motion processors, image sensors, and a host of other critical things, into the design and optimizations of other hardware and, most importantly, the software.

The results of Apple owning so many of the key components is not just the visual performance in terms of speed or graphics, but how fast Touch ID is, for example. Or their superior protection by being able to do hardware level security integrated into the chipset via the secure enclave, and locking in safeguards at the SoC level. So overall superior performance, security, and new software capabilities like 3D touch, are just a few of the things Apple can do to integrate and differentiate on their platforms. There are more to list and more will come, but there are two key points I’d like to draw out.

Other companies will be very slow to catch up. No vendor has quite nailed Touch ID the same way Apple has in terms of reliability and accuracy. The new Samsung devices I’ve tried are close, but experts have told me there are security concerns. They got one part close but not the other key ingredient. The real observation to be made here is what Apple has done to the premium hardware sector in smartphones, PCs, tablets, etc., in that it is mostly non-existent. In nearly every computing category Apple competes in — tablets, PCs, and smartphones — they own between 75% and 90% of the premium category. The impact of this reality is other vendors who compete in these spaces will find it more difficult to justify investments in leading edge components (even if they exist) because they won’t sell enough in volume. Samsung as an example, will lead in things like curved glass or other features which they own the supply chain for, but their ROI on those components won’t come from their handset business but from other companies. They key question here is, are there other customers for high end components other than Apple? If there are not, then even Samsung’s latest will be delayed due to lack of customers willing to pay premiums for curved glass or other things they focus on. And with the coming near-impossibility to sell an Android handset for more than $500, I do not forsee any other hardware vendors out there able to buy premium components en mass and commercialize them at the high-end where they must be due to their price.

Apple Suppler Leverage. Once Apple becomes the main customer for all high-end innovations, they acquire the upper hand in supplier and supply chain negotiations. Take this latest move to dual-source the A9 from Samsung and TSMC. Samsung is on 14nm and TSMC was on 16nm. Samsung had the capacity to make all of Apple’s chips but Apple chose to dual-source to not only keep their suppliers honest, but to give business to TSMC so they can use the money to invest in their next process node at 10nm. TSMC has prioritized Apple to the point of aggravating other very well known semiconductor companies, causing delays for others to get their latest chips to market. Should TSMC make the jump to 10nm and the process is mature, Apple would be the only customer for it, as they are the only ones who can afford to pay the premium. This gives Apple a great deal of leverage. This is just one example of many I hear from my contacts in the supply chain where Apple has the upper hand.

When I put all this together, what stands out to me is, in this race, Apple is sprinting and everyone else is walking. Others in the market may get there but Apple will get there first. The markets they compete in really are theirs to lose and owning all the key parts of the hardware and software and increasingly, services chain, means it’s hard to see how they lose it any time soon.

Microsoft and Apple’s Diverging Bets on Their Future

As I watched the live video from the Microsoft device launch event earlier in the week, I could not help but be struck by the incredible divergence of OS strategies Apple and Microsoft have as they try and push their respective platforms into the market. Microsoft has clearly put all bets on Windows and, through Continuum, it now makes it possible for all of their devices to work together better and deliver across-the-board productivity to devices and services for potential users. As we found out multiple times during the Microsoft event, the primary focus of their strategy revolves around productivity.

On the other hand, Apple is always trying to make Mac OS X better and it seems the MacBook Pro, Mac Pro and perhaps even some MacBook Airs continue to gain ground in the enterprise and are moving upstream in terms of a solution for business power users. But if you look closer at recent Apple announcements and product introductions, Apple clearly seems to be placing more and more of their bets on iOS. We already know iOS is a great consumer operating system but, with the introduction of the iPad Pro, Apple is making an important statement about taking iOS well beyond the consumer market and positioning it as the everyday device for mainstream business users. And even though Apple now stresses productivity, it really pushes the “fun” and “creative” aspect of their apps to hook more people to their ecosystem.

At Apple’s recent event, Tim Cook stated an iPad Pro could do about 80% of what a PC could but is much more versatile. Like Microsoft, they have their own cross-device software called Continuity. They take this a bit further by making it work with two different operating systems even if they are based on the same root code. The iPad Pro may be thought of as something targeted at the Surface Pro and in many ways it is. But the use of iOS in the iPad Pro and how Apple will take this more consumer-focused OS into mainstream business is really where Microsoft and Apple diverge. More importantly, Apple appears to be betting the company on iOS being its OS for consumers and business and seems well positioned to take advantage of an iOS ecosystem of 1.5 million apps to support that position.

To date, Microsoft’s revenues for Surface Pro have been about $6.7 billion, which probably translates to about 8-10 million sold since release. It will not surprise me if Apple sells as many or perhaps a bit more iPad Pros during its first 12 months on the market. And the big thing that will help them create strong demand will be the app ecosystem that comes from the App Store. Apple even hedged their bets by working with IBM to port over 100 enterprise class mobile apps for iOS, thus bulking up their overall business app offerings. Even Microsoft has given Apple a boost in their quest to make iOS more attractive to a business and productivity audience by creating a full, and by the way, great version of Microsoft Office for iOS. I am not sure Microsoft would have done this if they had realized Apple would go after their core business customers with iOS. As I have written before, I believe Apple will eventually do an ultra thin laptop powered by iOS that would go after Microsoft’s new Surface Book, although I doubt it will be detachable.

I am very impressed with the new Surface Pro 4 and their stellar new Surface Book but it looks to me like Apple and Microsoft are now going after the same business customer but with very different operating systems. At the moment, Apple probably has the edge because of the iOS app ecosystem although, to be fair, most of the productivity apps needed for use in business already exist. But make no mistake, we have a new battle royale going on. Instead of the Mac vs Windows fight of the past, it is now iOS vs Windows that is becoming the new battlefront.

Why Apple’s $25 Billion Enterprise Business will Double in Five Years

While Speaking at the BOX customer conference this week, Apple CEO Tim Cook said, “If you look at the last 12 months, (enterprise sales were) $25 billion. This is not a hobby. This is a real business.”

Although I was not at this event, I am told by some who were there that the size of Apple’s enterprise business was a huge surprise to them. Their perception had been Apple is really a consumer company, not one focused on IT.

But this is not news to Apple’s competitors in the enterprise. They have been telling me for years Apple has been making serious inroads with IT directors and more and more Macs were being brought in “through the back door”. They have been forced to support Macs now in the same way they support Windows machines. And, for most enterprises, the iPad has become the tablet of choice in this market segment since it was launched in 2010. Apple is selling about 4 million Macs per quarter and we estimate at least 35-40% are going into the enterprise.

But there was another comment Tim Cook made that was perhaps even more interesting. “We’re in the early days of what we can do,” Cook said. “My gosh, we haven’t started yet.” This is a correct assessment by Cook about their enterprise business and one that should scare competitors. Apple does not have a dedicated sales force, support division or even a structured organization focused on the enterprise, yet they had $25 billion in sales to this business audience.

Cook’s comments suggest to me that, besides creating more products for the enterprise, they will hire more sales and support staff and perhaps create an enterprise solutions team to formally go after the enterprise over the next five years. In that sense, Apple has not even started their real enterprise push and yet, they are making billions of dollars in sales to these business customers.

BTW, if this does happen, this would be another break from the Steve Jobs legacy at Apple by Tim Cook. Jobs pretty much pushed back on creating a dedicated effort targeting the enterprise. I suspect he was really put off by the two Apple CEO’s before him that went after the enterprise in various ways and totally failed in their attempts. He was especially appalled at Michael Spindler’s move to make the Mac look like a PC and license the Mac OS so it would become integrated into the business market faster. But I think Jobs was much more interested in capturing consumer audiences and just did not give their teams the support and dollars needed to make the enterprise a major emphasis. But now under Cook, it is clear enterprise is a targeted audience Apple will be more aggressive with in the future.

It also reinforces the role the iPad Pro will play in making a more aggressive move into this lucrative business user base. It is not a coincidence IBM ported their mobile applications to iOS, not Mac OS. And with Microsoft delivering the full Windows Office toolset for the iPad, the same fundamental tools used on PCs is fully available on the Mac OS and the iPad, making Apple’s devices a stronger alternative to Windows machines that have dominated the enterprise for three decades. As I mentioned in other columns, I also think a big part of this enterprise strategy revolves around iOS instead of the Mac. Yes, the Mac will still be an important tool for business users but it could be pushed more towards the power and professional users such as graphics designers, engineers, media creators, etc. But as Cook has said, you can do about 80% of what a person will do on a PC with an iPad Pro and it, along with perhaps iOS-based MacBooks and other hardware, supporting iOS could be where they get the greatest traction in their quest to extend their role in IT.

While Apple has quietly made these inroads into the enterprise, I believe Apple’s build out of an enterprise class sales, support and solutions consulting group, should that happen, would give them the framework to start making a much more formal push for the adoption of Macs, iPads and iPhones into the enterprise. It would also most likely spawn their first serious ad campaigns just targeting the enterprise crowd by 2017. That is why I think they could double their enterprise sales within five years and, if they put the full Apple mindset on creating new products for IT and do a strong marketing push to IT programs, their sales to enterprise customers could be even higher.

Google’s Continued Onslaught of Microsoft with Pixel C

I’d like to dive in a little deeper on Tim’s article of earlier today and address a few points. Over the past few months, we have been having some heart to heart conversations with those in the PC ecosystem — Dell, HP, Lenovo, Intel, Microsoft and so on. The meat of these conversations is what I wrote about a few weeks ago regarding the split in computing operating systems between consumer OS’ and commercial OS’. Suffice it to say, this was a hot and somewhat controversial topic.

While Tim and I had no idea Google was making the Pixel C, we referenced the one made by Jide as an interesting example. My premise is simple. But let me share some statistics first.

There are now globally almost 3 billion active computers in use running a mobile operating system. Contrast with the fact that there are roughly 1.3-1.5 billion devices running a desktop OS in use. Narrow in on the desktop OS number and we observe about 800-900 million are used by pure consumer markets, in a home or a purely personal environment. The rest are used commercially for “work” in a work setting. We note the market for desktop operating systems is not growing and is, in fact, contracting.

What is key is a healthy percentage of those 800-900 million consumer PCs in use are not used every day. It is not a stretch to conclude the desktop operating system in pure consumer environments is not utilized nearly as much as desktop operating systems in enterprise/commercial environments.

I make these points simply to articulate how the desktop OS plays different functions in pure consumer and commercial settings. Within that context, it should come as no surprise when I say the smartphone is the primary computer for several billion people. More time is spent globally per day computing on a mobile operating system than a desktop one and this imbalance will only skew more in favor of mobile operating systems.

This is where I think Google believes the Pixel C is skating to where the puck is going. The Pixel C, like the iPad and iPad Pro, is not directly targeting becoming a desktop OS replacement. The “PC” as a truck and the desktop OS as its engine metaphor holds up. Both these moves by Apple and Google are simply a recognition that the market for desktop operating systems is simply much smaller than the market for mobile operating systems by a factor of 3-4x. They seem to have also concluded a mobile OS can play a role in the broader computing landscape than simply on screens 4-6″ large. I believe they are right.

For nearly two billion people who use a smartphone as their only computer, and many of them Android as their only operating system from a literacy perspective, should they ever want a product that gives them more machine than what they have in their smartphones, are they going to buy a Windows PC? Will they learn a completely foreign OS where many of their apps will likely not exist? My gut tells me that, for many of these consumers who on-boarded to the internet with Android, they would be more willing to stick with Android when it came time to get more machine if they ever need it.

The software angle here is notable as well. All of the exciting global software plays are happening on mobile operating systems, not desktop ones. If you follow the software that gets consumers excited, makes developers money, and marches computing forward, it is all happening on mobile. So are those developers all of a sudden going to start paying attention to desktop operating systems? I think both Google and Apple are betting they don’t. Both these companies are betting on their mobile developer ecosystem to embrace larger screen computing form factors.

This discussion is around the 2-and-1 PC form factor but, in the case of Android, you could even make a case it could work on a notebook or even a desktop form factor. The momentum of software consumers are getting excited about is mobile and, if there is upside at all for larger screen computers, I feel it will be on the back of mobile operating systems, not desktop ones.

You will be tempted to argue with me and say things like, “You can’t do real work on a mobile device or operating system”. However, this statement is not true and has a very limited view of what work is. Microsoft has embraced that even something like spreadsheets and word processing could and should be done on mobile devices by taking Office to mobile operating systems. Slack and Quip are two prime examples of work getting done on mobile. With the cloud, we can now manage our photos, music, and media all on mobile. I can edit two simultaneous 4k video streams on my iPhone — I can’t do that on several older PCs I have. The world skews mobile and, if it can be done on a mobile device, it will be done on a mobile device/operating system.

Google and Apple seem to believe, just about everything can be done with a mobile operating system.

Could the iPad Pro Cannibalize MacBooks?

In my main column on Monday, I talked about how iOS could become the enterprise OS of the millennial generation. I argued that, as Gen Z and Gen Y become millennials who cut their computing teeth on iOS, they would take tools based on this into the business world and, over time, iOS would become defacto for this younger generation in business. But I also mentioned that, if Apple is successful in getting this younger generation to make iOS the standard business operating system, then its impact on Microsoft, Intel and their OEM partners would be impacted by this over time.

If you look at kids in college, high school, and even grammar school, iPad and Android devices dominate their mobile tools and the Mac is their preferred computer for most in college and high school. When I spoke to an MBA class at a major university last year, there were 101 students in the class and all but one had a Mac. Although one could argue that if these kids move into the business world and are forced to adapt to Windows they would. But it is more likely that, because of BYOD, Apple-based products would come into these IT departments in increasing numbers. Also, there have been many stories written in the last three years about companies realizing they need to support Macs and iPads if they want to entice the type of top talent they need to run their businesses in the future.

Apple’s new iPad Pro gives this younger generation a new tool to add to their Apple product mix when going into the business world. Apple could use this to drive iOS into mainstream business and, over time, make iOS the primary business OS. In the article, I talked about its ramifications for vendors in the Windows ecosystem and the challenge this has for Microsoft in trying to keep the Windows franchise the center of the business computing world in the future. Had Steve Ballmer invested in Windows Phone once the iPhone came out and made it a serious competitor, perhaps this younger generation would have this option and, if enough people were Windows Phone users, that could translate into them keeping Windows as their business tool once they went into the workforce. But that ship has sailed and the momentum has swung, particularly to Apple, when it comes to making a mobile OS grow up to become something even business users could embrace.

If this plays out as I suspect it could, it also presents an interesting problem for Apple. Unless the Windows crowd can find a way to convince a younger generation to switch to Windows, iOS seems to be on track to become at least a major enterprise alternative in business settings for this next generation of workers. But the iPad Pro could be problematic for Apple.

Apple seems to have purposely positioned the iPad Pro directly at the business community and if successful, its flexible nature could end up being the preferred business tool of the millennial generation and end up cannibalizing sales of the MacBook and Macbook Air line of Apple laptops.

This is only problematic in that they have spent decades positioning the thinner and lighter MacBooks in this area and it would be a change of direction. From Apple’s standpoint, they would still get the revenue and, as Cook has stated, the iPad Pro is more in line with their purest vision of portable computing in the future.

However, its impact on Intel could be significant. For years, many people have wondered if Apple would use their own chips someday in their MacBook, Mac Pro and iMac line. But I’ve always thought Intel’s processors made more sense for these products and, with Intel constantly upping the power threshold as well as lowering the energy draw, that Apple would use Intel’s chips for a long time. I still think that is the case for the MacBook, MacBook Airs, MacBook Pros, iMacs and Mac Pros. But the MacBook and MacBook Air represent about 50-55% of all personal computers Apple’s ships. If the iPad Pro catches on and can deliver a more flexible MacBook-like experience, then this product could eat into Apple’s MacBook demand and Intel would lose significant business — fewer Intel chips would be shipped to Apple customers.

As I have written a couple of times over the last week or two, I see the iPad Pro as being much more disruptive to the market for laptops. Even Apple’s own laptop business could be affected by this move. The good news for Apple is even if it does affect them, their revenue stream will not be impacted and indeed it will probably grow. But for those in the Windows world this could, over time, impact their current business model and strategy. It will be interesting to see how the iPad Pro influences the overall market in the next three years. I sense that it will present a serious challenge to the Windows crowd.

iOS 9 and Upgrade Rates

With iOS 9 launching this past week, Apple will effectively be resetting the clock on upgrade rates for its biggest and most important operating system. In marked contrast to Android, the latest version of iOS is almost always the most popular version, with the exception of the first month or so after launch. As such, iOS 8 usage has quickly plummeted, iOS 9 has rapidly risen to 50% or so after less than a week, and will continue to rise steadily thereafter. These patterns are fairly well established at this point but it’s worth looking into the details and how iOS 9 might be different.

The established pattern

The chart below shows the established pattern for iOS upgrades, which has a fairly striking shape (as I’ve noted before, somewhat like Half Dome at Yosemite National Park). I’m relying here on Apple’s own numbers, as provided on its Developer Program site. Where I show Android numbers, they’re from Google’s equivalent site.

Note the overall shape of the graph with a very dramatic change in month 12, when a new version of iOS is released and the clock gets reset. But you may also have noticed that the precise upgrade rates have been different for these last three versions of iOS, with each version bringing a slightly lower level of upgrades compared with the previous one. This is perhaps best illustrated by looking at the peak usage for each version, right before the new version is released (I’ve included peak upgrade rates for the last three major versions of Android on the right of the chart, for context):

As you can see, the peak adoption has fallen from 94% for iOS 6 to 87% for iOS 8, though obviously both are still much higher than the major versions of Android achieve.

Prospects for iOS 9

What is driving this falling adoption rate, and what might we expect to see with iOS 9? There are several possible causes of the falling rate:

Older devices are no longer supported by new versions of iOS and, therefore, can’t be upgraded
Recent updates to iOS have been fairly large, requiring significant amounts of free space on devices to install the update over the air and smaller, though still decent sized, free space on devices updated through iTunes. Some users have therefore chosen to forgo updates rather than delete apps, photos, or other content they wanted to keep on their devices
Deliberate choices to stay on older versions – some users may have made the deliberate decision to stay on older versions, perhaps as a reaction to a perceived increase in instability in new versions over the last couple of years
Apathy and/or lack of awareness. Though I regularly update my devices the day updates become available (or even earlier, through the developer and public beta programs), my wife rarely updates any of the software on her devices unless I prompt her. She dislikes technological change and is usually fine with missing out on some features. I suspect there are many like her who don’t update their devices through apathy or simple lack of awareness of new software and its benefits. Of course, one interesting side effect here is that those who didn’t upgrade to iOS 8 for this reason will likely also forgo the iOS 9 upgrade, thereby swelling the total numbers of holdouts.

Let’s now apply these reasons to iOS 9 and see how they might impact upgrade rates:

Unlike iOS 8, iOS 9 doesn’t abandon any older devices supported by the previous version – both iOS 8 and iOS 9 support the iPhone 4S as the oldest iPhone, and iOS 9 also supports all the same iPads as the two previous versions of iOS. As such, there should be no increase in the number of non-upgraders for this reason at least.
iOS 9 comes with a significantly smaller requirement for free space relative to iOS 8, something Apple highlighted at WWDC and has since. This should actually help some users who struggled to update devices with cramped storage to upgrade to iOS 9.
Users making the decision to deliberately stay with older versions are usually weighing the disadvantages against the benefits of upgrading. iOS 9 is intended to be a more stable release, focusing more on polish and bug fixes than dramatic new features, so some users may be more willing to upgrade than they have been. However, other users may not see enough in iOS 9’s new features to drive them to upgrade either, so this may end up being a wash.
Apathy and lack of awareness are likely unaffected by any of the specific details relating to iOS 9 although, if awareness of specific features such as Apple Music or the News app rises, that could drive general interest in upgrading.

All in all, I don’t see a lot of reasons for iOS 9 to see lower upgrade rates than previous versions per se, and there are several reasons to think upgrading might actually be quicker and/or higher for iOS 9. Early signs from Mixpanel data and from an Apple press release out this morning suggest iOS 9 is tracking ahead of the pace of iOS 8 adoption in the first few days, which tends to confirm that. It’s possible this early pace is affected positively by the smaller file size, which does seem to have been a big issue last time around and that, over time, things will settle in at a similar rate to iOS 8. In fact, given that holdouts will tend to forgo multiple upgrades, it’s almost inevitable the upgrade rate declines somewhat over time as these users stick around on top of the single-version holdouts. As the secondary market for iPhones heats up, devices may also stay in market longer and, even though iPhone 4 units likely make up a pretty tiny percentage of total phones in use today, some users of older devices may choose to forgo upgrades for speed rather than pure compatibility reasons. As such, I suspect we’ll see another small reduction in the total percentage of users upgrading to iOS 9 relative to iOS 8 long term, much as we did with the previous two versions. However, iOS continues to post some of the fastest and most complete upgrade rates of any OS we’ve ever seen and that’s unlikely to change.

The Consumer Operating System Schism

In thinking broadly about the consumer market and all that has changed within it, I’ve been struck by an observation. It seems we have a schism in operating systems. It may very well be we are down the path between more consumer-centric operating systems (iOS and Android) and more corporate/business operating systems (Windows and OS X).

This is on the basis of what I’ve been saying about the iPad Pro along with Tim’s point about the potential of an Android PC. If we step back and reflect on the broad landscape, a specific observation stands out. There has been very little real software innovation when it came to things consumers care about in the desktop space. Most of what we have seen interesting and new around desktop software is about utility or productivity (outside of PC gaming, of course). The vast majority of interesting software that gets consumers excited and emotional is happening on mobile operating systems. After all, consumer-centric developers are mostly focused on mobile platforms, not desktop or laptop ones. One platform, the mobile one, has all the developers thinking about pure consumers while one platform has all/most developers thinking about business users. While business developers are certainly, out of necessity, crossing over and thinking about mobile platforms, the plethora of consumer-centric developers do not seem to be and are not spending much, if any, time thinking about desktop operating systems. This, in my mind, has led to the schism.

This hit me while I was discussing the overview of my thinking with a company very much centered on desktop/notebook platforms. The question revolved around invigorating the PC category again. My response was, more consumer-centric developers creating unique and innovative experiences for desktop and notebook platforms won’t happen. The question about reviving the PC is not one that is relevant to enterprise customers. Those customers aren’t going anywhere. It is squarely centered on consumers use/need of a PC in the shape of a desktop or notebook. The issue is the same as it’s always been — there simply isn’t a lot of innovation in consumer software happening on either Windows or OS X. It is all happening on iOS and Android. I don’t see that changing.

Apple taking a mobile OS, along with the developer ecosystem around it, and adding devices with larger screens is my central point. For all intents and purposes, the iPad Pro has a screen size now common among all notebook vendors at nearly 13 inches. What Apple is proposing to their developers, many with consumer-centric mindsets, is to start to think about larger screen computers and go crazy innovating on software. Now, there is no guarantee developers push the needle here any more than they did with the iPad. However, if we had to make a bet on whether innovation in consumer software will come from traditional developers (mostly corporate ones) who have been focused on desktop operating systems, or developers who have been innovating in consumer software for years and are now starting to think about bigger screen computers, which ones would we bet on? I’d bet on the mobile developer community.

This is why I say we may need to accept there is a schism between consumer operating systems and business/corporate operating systems. You’ll use Windows for “work,” if your job requires such a tool, and you’ll use iOS or Android at home and for play.

I suppose the question is whether or not there is hope at all in the consumer space for desktop operating systems. This obviously has huge implications to many on the platform side of PCs, especially those in the Windows camp. However, this schism is inevitable if Microsoft in general and the Windows ecosystem in particular, cannot stimulate a healthy consumer software developer ecosystem for their platform.