The CD-Smartphone Analogy

on September 1, 2016

Smartphones have reached an interesting point in their history. When I say this is now a mature market, I mean two separate things: first, the technology has matured to the point where devices are “good enough” and second, the market is becoming fairly saturated in developed economies. Though it is clear these two forces will have an impact, it’s not yet clear exactly what that impact will look like. However, it might be useful to look at the adoption curve for another technology which saw a rapid ascent about thirty years earlier – the CD.

CD adoption was rapid but misleading

What’s interesting about CDs is growth in unit sales was very rapid from their arrival on the market but it was also misleading. The chart below shows US unit sales for various music media from 1984 to 2012, based on RIAA data. I’ve included cassette tapes, CDs (both albums and singles), and downloaded albums and singles, but not vinyl (which was in sharp decline by 1984):

CD sales

Cassette sales didn’t peak until around 1990 (years after CDs first came on the market) but they peaked at around 450 million sales per year, compared with around a billion sales per year for CD albums and singles combined. Vinyl sales had earlier peaked at around 500-600 million sales per year for singles and EPs/LPs combined. CD sales were measurably higher at their peak than either of the two predecessor media. Why? I’d argue it was a combination of two things: the music industry saw a resurgence of sorts during the 1980s and 1990s, thanks to the rise of MTV and a variety of other factors, so there was some underlying growth; but secondarily, CDs sales benefited from the large number of people who upgraded their existing music collections to CD in a way they didn’t when migrating from vinyl to cassettes.

This is important because it artificially inflated expectations of how large the music industry would be going forward. I’d argue there was a bulge in sales in the 1990s caused by this media migration and lots of re-buying of the same music on a new format. Of course, the next medium to come along was digital sales and, although total unit sales were actually larger than CDs, the vast majority of those sales were of individual songs at 99 cents rather than albums at $10 or more. Why the dive in album sales? Simple – the new format was compatible in an unprecedented way with the old format – computers with CD drives could “rip” the contents of CDs and create digital files that could be played on those computers, iPods, and MP3 players. And of course, first piracy and then music downloads quickly eroded CD sales too, leaving the music industry at significantly lower revenue levels than in the peak of the CD boom.

The smartphone parallel

So far, so straightforward. But what does this have to do with smartphones? The parallels clearly aren’t perfect, but I believe there are some similarities between the two markets and their behavior which are worth drawing out. Critically, I’d argue the inflated expectations of the size of the music market that were created by the CD boom have a parallel in today’s smartphone market.

The reality is that smartphone sales each year are composed of two components: those buying their first smartphone and those upgrading from an existing device. We’ve seen very healthy smartphone sales globally for many years now and, for much of the last 15 years, we’ve seen very healthy year on year growth as well. In some ways, though, we’ve been in the CD era here and the past may well be a pretty poor predictor of the future.

What’s critical at this point is the maturity I mentioned at the outset is beginning to affect the pace of sales among both groups of smartphone buyers. In the early years of the smartphone market, first-time buyers far outweighed upgraders and were a very healthy source of growth. Lately though, this source of sales has slowed to a trickle as the vast majority of people who will ever buy a smartphone in markets like the US, Western Europe, Japan, and South Korea already have one. However, the second source of sales is also showing signs of slowing, as people hold onto their perfectly adequate phones rather than upgrading them every two years as they once did.

As this happens, we’re entering a period analogous to the early 2000s in the music industry. The major drivers of growth in the smartphone market to date have been essentially temporary in nature, Now we’re in an era characterized by dramatically slower growth, even declines. This will be particularly felt at the high end of the market, where penetration is nearer saturation on a global scale, and where the financial incentives to hold onto phones longer are that much stronger. We may well already have seen the peak for annual smartphone sales and almost certainly have for premium smartphones. That presents interesting challenges for companies like Apple or Samsung, who target the high end of the market either heavily or exclusively. As we approach Apple’s iPhone launch event next week, Apple should be thinking very hard about how to ensure existing iPhone owners see compelling reasons to upgrade and non-iPhone owners are convinced to switch.