Lenovo’s Increasingly International Smartphone Business

Note: For two previous posts on Lenovo on this blog, see here and here. See also this post I wrote for Techpinions a while back. The charts in this post are based on the slide deck on Lenovo’s results available as part of the Jackdaw Research Quarterly Decks Service, which also provides decks for other major consumer technology companies each quarter. Note also that in this and other posts on this blog, I use calendar quarters rather than companies’ fiscal quarters in my discussion and in charts, for ease of comparisons and ease of comprehension for readers not familiar with the quirks of companies’ fiscal calendars.

Lenovo reported its results for the December quarter (its fiscal third quarter) this week, and these results came a year after Lenovo’s strongest quarter by far, in 2014. By comparison to those, this quarter’s results were poor, but they’re actually quite encouraging in the context of the first three quarters of 2015, which showed worsening trends in several areas. Today, though, I wanted to focus specifically on Lenovo’s smartphone business, and its increasingly international character.

The impact of Motorola

First up, it’s important to note the significant impact of Motorola here, something I wrote about a year ago today. The acquisition closed in October 2014, and so the addition of Motorola’s results had a noticeable effect on the company’s overall performance, especially in smartphones. Prior to the Motorola acquisition, Lenovo was selling 2-3 million smartphones outside of China, but afterwards, it was suddenly selling 10-15 million, which obviously had a huge impact.

The rapid decline of Lenovo’s Chinese smartphone business

The subject of another post I wrote a few months ago was the rapid decline of Lenovo’s smartphone business in China, and the way in which the Motorola acquisition was helping to prop up overall sales. Two reported quarters later, and the trend is all the more dramatic. Here’s Lenovo’s smartphone sales in China over the past couple of years:Lenovo China smartphone shipmentsAs you can see, smartphone shipments in China peaked right before the Motorola acquisition closed, and have declined steadily since. I discussed the reasons why in that earlier post, so I won’t rehash them here.

Growth elsewhere, especially in emerging markets

At the same time, however, both the Motorola and Lenovo brands have begun selling much better in certain other regions. Lenovo doesn’t provide a consistent or full breakout of smartphone sales by country or region, but it has provided some breakouts for the last three quarters in its earnings slides, and that gives us enough data to interpolate other numbers. On that basis, then, here are some numbers for smartphone shipments in other countries and regions (note that these are not necessarily mutually exclusive, as Brazil is included in Latin America and Russia is included in Eastern Europe):Lenovo country and regional smartphone shipmentsThere are a couple of things worth noting here:

  • Smartphone sales in Brazil (light gray) were very healthy early in the period, thanks largely to the success of Motorola’s lower-cost smartphones in that market. However, that seems to have faded significantly over the past year or so, with sales in Brazil falling over that time. Latin America is still a significant region, but its numbers dropped along with Brazil’s over the past year.
  • Russia has become increasingly important to Lenovo, and it’s the Lenovo brand that’s used there. It sold over a million smartphones in the December quarter in Russia alone. The Lenovo brand has also done well in Indonesia over recent months, though we don’t have the same amount of historical data for that country, so it’s not included in the chart. But it sold 764,000 smartphones there in Q4 2015, compared with just 183,000 in Q4 2014.
  • India has arguably been the star of the past year or so, rising from under a million sales in Q4 2014 to almost three million in Q4 2015. Lenovo now claims 9.6% market share in India, and interestingly this growth has come through both the Motorola and Lenovo brands.

Perhaps the most significant thing to note is that both Latin America and EMEA passed China in terms of smartphone sales in Q4 2015 for the first time. And India, at just shy of 3 million sales, was only about 10% behind China, meaning that if current trends continue (rapid decline in China, rapid growth in India), India could well become Lenovo’s single largest country for smartphone sales in 2016. Lenovo’s smartphone business has been radically transformed over the last year or so, from one dominated by China to one where China accounts for less than 20% of sales.

The big question now is whether these other new markets will experience sustained growth for Lenovo, or whether they’ll be flashes in the pan as Brazil appears to have been. In Brazil, local economic conditions have likely had an impact, but economic instability is a feature of many of the markets where Lenovo is doing well now, so it will have to demonstrate consistent improvements over time if it’s to continue to grow as it has in these markets.

Better margins

In that earlier post on the impact of Motorola, I pointed out that for all that Motorola was benefiting Lenovo’s smartphone growth, it was also dragging down margins. Lenovo has long promised to turn that trend around, and this quarter it came very close to breakeven in its mobile group for the first time in two years.Lenovo margins by businessThat’s an impressive turnaround, and a sign that – for all Lenovo’s challenges in China – it’s able to exercise enough financial discipline and generate enough scale to build a successful and eventually profitable smartphone business. Given the state of Android smartphone vendors at the moment, that’s quite an achievement.

Breaking down Alphabet’s Other Bets

Alphabet (formerly Google) just reported its first results under its new operating structure, which means that it separated out its “Other Bets” from core Google results, at least for the last five quarters and the last three full years (I wish the company had provided more quarterly results – year on year growth and similar trends are hard to divine with so little data). I’ve just finished putting together my quarterly deck on Alphabet for subscribers (sign up here), and I thought I’d break out some of the charts on the Other Bets specifically for blog readers. Most of these charts (and many others on the rest of Alphabet’s business) are in the deck.

Revenues

The first thing to talk about is revenues – Other Bets revenue is tiny in the context of Alphabet’s overall results. I had to adjust the scale of the chart below to start at 90% just so it would be visible (and it’s still just a tiny stripe at the top of each bar):Alphabet revenue breakdownOther Bets revenue is under 1% each quarter and each year so far, and it was well under 0.1% of revenues for the year 2013. It’s growing, albeit unpredictably – as CFO Ruth Porat mentioned on the earnings call, these Other Bets are inherently volatile, and so revenues are best looked at on a twelve-month basis. Revenue for 2015 as a whole was just $448 million.

To put that in context, the three biggest revenue generating businesses in the Other Bets segment are Nest, Google Fiber, and Verily (the life sciences business). That likely puts Nest revenues at under $300 million for the year, Google Fiber at $100-150 million, and Verily at some smaller amount still. Given that these are only three of the businesses under Other Bets, that means everything else generates minimal or no revenue. Interestingly, these likely aren’t the three businesses with the biggest expenses, but we’ll come to that in a minute.

Profitability

Next, let’s look at profitability. Whereas Other Bets revenue basically doesn’t show up on a to-scale chart of Alphabet revenues, its operating losses certainly do:Alphabet segment incomeAs you can see, operating losses were very significant in the Other Bets segment. The segment lost $1.2 billion in Q4 2015 alone, and three times that much in 2015 as a whole. For context, sometime in 2005 or 2006, that was about as much operating income as the whole of Google was throwing off over a comparable period. It’s about 15% the scale of the core Google segment’s operating profit today, but negative. And it appears to be growing fairly rapidly, since this loss almost doubled year on year while revenues only grew by 37%.

To compare Google’s segment margin with the margin for Other Bets, I had to use a two-axis chart, because the contrast is pretty stark (Google’s operating margin is shown in blue against the left axis, while Other Bets is dark gray and on the right axis).
Alphabet segment margin

Expenses

What, then, is driving these huge losses? Sadly, Google doesn’t break out R&D spending by segment, but I would assume a great deal of the costs in this part of the business would be accounted for under that line in the income statement. The chart below shows Other Bets segment losses and total expenses (i.e. losses plus revenues) as a percentage of Alphabet’s total R&D, as an interesting exercise:Other Bets as percent of RandDDepending on which measure you use, Other Bets expenses were equivalent to between a quarter and 40% of Alphabet’s total R&D spend in 2015. That’s not to say that they actually accounted for that much of R&D spend – given that Nest and Fiber likely have substantial costs in non-R&D buckets, it’s likely less than that. But given how much of Other Bets’ total expense is likely in non-revenue-generating efforts like self-driving cars, I’d bet a lot of that expense is R&D.

Capital spending

Another interesting way to look at all this is capital spending, which Alphabet does break out for the new segments. On the earnings call, Ruth Porat said the majority of Other Bets capex goes to Google Fiber. How much does Other Bets spend on capex?Alphabet segment capital spendingAs you can see, unlike revenue, capital spending by Other Bets is visible in the context of overall company spending – again, Other Bets punches above its weight in this category. For further context, look at capital intensity (capex/revenues) below: Alphabet segment capital intensityGoogle’s capital intensity is shown on the left in this chart, and as you can see it’s been falling steadily over the last year or so, landing at under 10% in Q4. By contrast, Other Bets’ capital spending has been over 100% (i.e. it spends more on capital expenses than it generates in revenue) for all five reported quarters. If we take the bare minimum estimate of capex spent on Google Fiber (i.e. 50% of total capex), that still means that it spent $435 million on capex in 2015 while generating $100-150 million in revenue.

Trajectory

We’ve taken a look at several aspects of Alphabet’s Other Bets segment, but we’ve only touched on perhaps the most important element: trajectory. In other words, which direction are these numbers heading in? In brief, using Ruth Porat’s suggestion to look at annual results:

  • Revenue is growing, at about 37% year on year from 2014 to 2015
  • Operating losses are growing faster, from $1.9 billion in 2014 to $3.6 billion in 2015
  • Margins are worsening too, from (and these numbers are a bit ridiculous) -488% in 2014 to -685% in 2015
  • Capex is growing faster than revenues on an annual basis, and capital intensity rose from 150% in 2014 to almost 200% in 2015.

None of those is moving in a happy direction as far as the future financial performance of Alphabet is concerned. There is some evidence that Porat’s arrival precipitated some tougher decision making regarding the Other Bets and that some of these numbers began to improve in late 2015, but it’s too early to tell how much of the apparent improvement is real and how much is the volatility she talked about. What is clear is that Google is spending massive amounts on these efforts, and generating very little revenue today. The prospects for Nest and Fiber as revenue generators and profitable businesses are not great, especially given that massive capital expenditure, so it will be the other businesses that will need to justify this investment. My bet (no pun intended) is that we’ll see increasing pressure for Google to provide more detail on what’s going on behind these numbers, and to have more to show for this massive investment, over the coming year.

The iPhone Paradox

For reference, this page lists all prior Apple posts, with a little context. Subscribers to the Jackdaw Research Quarterly Decks Service will be getting a preliminary Apple deck tomorrow, with a final deck to follow once Apple files its 10-Q. 

This is a post I’ve been meaning to write for a while now, but it seems particularly apt given Apple’s results announced today. My key point is this: even as Apple continues to diversify its revenue streams beyond the iPhone, the size of the installed base of iPhones becomes ever more important to its revenue growth.

The context here is that I’ve been talking to lots of reporters over recent weeks in the run-up to Apple’s earnings, and I’ve heard this question (or variations on the theme) a lot: “is Apple’s increasing dependence on the iPhone a problem?” The reason for the question is twofold: on the one hand, Apple’s revenues and margins have been increasingly dominated by the iPhone, and on the other it’s become increasingly clear that iPhone growth would slow following its stellar year off the back of the iPhone 6.

My answer usually goes something like this, and this gets to the heart of the paradox here. On the one hand, yes, Apple has been increasingly dependent on the iPhone for revenue and margin growth, but it’s been working hard to introduce new products and services to the market which can help to contribute meaningfully to growth and profitability. The Apple Watch, Apple TV, Apple Music, and iPad Pro were all introduced in 2015, and could over time provide significant additional revenue and margin. So Apple has the potential to lessen its dependence on the iPhone over time in this way.

However, the other side of the paradox is that almost all of these new products and services are tied to the iPhone in some way, and benefit greatly from the installed base of a half billion iPhone users. The iPad Pro has the weakest tie here, but obviously benefits from its use of iOS and the App Store, and with features like Handoff and iCloud works better with the iPhone than it does independently. The rest have much closer ties to the iPhone: the Apple Watch is (for today at least) strictly an iPhone accessory, the new Apple TV runs apps, most of which were originally developed for the iPhone, Apple Music will be used on iPhones far more than on any other devices, and so on. Even if iPhone growth slows or goes negative (as it will now certainly do in the March quarter), that massive base of iPhone users will keep many other contributors to Apple’s financial success ticking over nicely.

Interestingly, Apple seems to have latched on to this idea as a key talking point for its earnings today, with an emphasis on Services revenue tied to the overall installed base of devices, which it pegs at 1 billion users. (My estimate for the end of December for iOS devices plus Macs was 996 million, so adding in Apple Watch and Apple TV should certainly push it over that billion user threshold). This base of devices, and the rather smaller number of unique users it represents, is Apple’s single greatest asset, and one it will increasingly leverage both as it continues to grow the product and service lines it announced in 2015 and as it adds to them going forward. As such, even as the iPhone itself as a product contributes less to Apple’s overall performance, it’s going to become ever more central to Apple’s future growth.

Quick thoughts on Netflix Everywhere

Note: you can see all my previous posts on Netflix here. The analysis here draws on financial and operating data I collect on Netflix, along with around a dozen other big tech companies. Subscribers to the Jackdaw Research Quarterly Decks Service get quarterly charts based on this data, and data sets are also available to purchase on a one-off or subscription basis. Please contact me if you would like more information about any of this.

Netflix just announced that it’s expanding to around 130 new countries including many of the largest countries it wasn’t in yet. This was a huge and unexpected move, at least so early in 2016, since Netflix had previously indicated that it would make this move more gradually during the year, with just a handful of markets pre-announced for early 2016. I want to focus on the possible financial impact of this expansion, because it seems to me that it could be significant.

First off, Netflix’s International business is significantly less profitable than its US business:Netflix contribution marginsI’ve written in the past (somewhat jokingly) that every time its international business threatens to turn a profit, Netflix expands into a few more countries. As you can see, though, its International segment continues to be unprofitable at this point, and has much lower margins than its increasingly profitable US streaming business. Why is this? There are several reasons, but they’re all applicable to this new expansion and the likely financial impact.

Free trials

Firstly, Netflix offers one-month free trials to customers. Naturally, the impact of these free trials is heaviest in new markets, and you can see this when you look at the percentage of Netflix customers in various markets who are included in its membership count but not in its “paid members” count:
Free trial subscribersIn the past, as Netflix has expanded into new markets, this percentage has been in the 30% range, though it’s recently dropped down to around 10% or just below. However, with 130 new countries going live simultaneously today, it’s likely that this number will skyrocket. With 25 million members in its existing markets, it’s easy to imagine that Netflix might garner comparable numbers of free trial subscribers in the coming months in 130 countries. As such, a huge percentage of its subscribers overseas will be incurring costs but not generating revenue.

Marketing costs and scale

Another major reason why new markets are less profitable is that Netflix has to do far more to promote itself in these markets where customers aren’t yet familiar with its brand. This chart shows marketing spend as a percentage of revenues for the US and International streaming businesses:Marketing costsAs you can see, marketing spend is a much higher percentage of revenue in the overseas business than domestically, where Netflix has actually been reducing its marketing spend other than in its big new content launch quarters.

As Netflix scales in a given market, this impact is reduced, as the base of revenues from existing customers allows the company to spread that high marketing cost over a larger base, and as awareness and therefore word of mouth marketing grows. However, with 130 new countries, Netflix will have to spend heavily on marketing in the coming months to promote its services. Another huge scale effect is the shared costs of doing business in a new country – converting content to new languages, hosting the content locally, and so on all adds up, and in these countries those costs will be shared by a very small number of subscribers in the short term.

Outgrowing the DVD business

One interesting aspect of Netflix’s business which I’ve covered in the past is the fact that the US DVD business continues to throw off very nice profits, which in turn has largely funded Netflix’s overseas expansion:International vs DVD contributionsThe problem is that this new expansion will be so significant that it seems very unlikely Netflix will be able to offset the losses with its cash cow anymore. As such, overall margins will likely suffer significantly.

The financial impact could be considerable in the short term

For all these reasons, I believe the financial impact of Netflix Everywhere could be very significant in the short term. I’ve been pretty bullish on Netflix overall, and I’ve felt that its slow and steady international expansion coupled with its gradual improvement in US streaming margins was a fantastic combination. This big-bang approach threatens to derail that strategy, albeit only temporarily, bringing what might have been a longer-term dampener on margins forward into a much more compressed space of time, but opening up a far bigger opportunity longer term. I’m very curious to see how Netflix talks about the financial impact here – its press release on the news was conspicuously devoid of any talk of the financial side. But the market certainly seems to like the news so far.

Digesting Apple’s new App Store numbers

Note: Following something of a hiatus in late 2015 after the birth of our fourth child, I’m hoping to get back to a more regular publishing schedule here as we kick off 2016. Here’s my first post for the new year, which will hopefully be the first of many. You can see all previous posts on Apple from this site listed here.

Apple today released its customary end of year / holiday period App Store numbers in a press release. By themselves, these numbers are impressive, but it’s important to put them in context to really understand their significance. Today, I’ll share a few charts and other related numbers to evaluate the new numbers and their real meaning.

A quick word on sources

It’s important to note briefly before we start that App Store numbers are one of many data points Apple reports selectively and indirectly. We get these occasional milestone announcements at year end and in keynotes, but between those we’re left to extrapolate and interpolate based on other sources, including Apple’s financial reporting, which has historically provided some direct and indirect guidance on App Store sales. So please bear in mind that while some of the numbers below are based on announcements like today’s, many of them are based on these estimates, extrapolations, and interpolations. I believe they’re accurate, but I want readers to understand they’re not direct from the source.

Today’s numbers

Today’s numbers, in brief, were as follows:

  • “In the two weeks ending January 3, customers spent over $1.1 billion on apps and in-app purchases”
  • “January 1, 2016 marked the biggest day in App Store history with customers spending over $144 million. It broke the previous single-day record set just a week earlier on Christmas Day.”
  • Customers spent “over $20 billion” on the App Store in 2015
  • The App Store has now paid out “nearly $40 billion” to developers since it launched in 2008, and over a third of that was paid out in the past year.

There were also some numbers about jobs and job creation, but those won’t be the focus of this post.

Putting the numbers in context

So let’s put those in context. Focusing just on the numbers Apple has reported directly, here’s the picture on the cumulative payments to developers, ending with today’s “nearly $40 billion” (which I’ve pegged at $39 billion):Cumulative payments to devs as reportedUsing my estimates for the periods not directly reported, we get this smoother and less patchy version, which also goes back to the inception of the App Store in 2008:Cumulative dev payments estimatedAs you can see, it’s a lovely curve, with what appears to be accelerating growth. In fact, we can look at that growth more easily by charting trailing four-quarter payments instead, as follows:Four quarter dev payments estimatedWhat you see here is that the growth has been fairly steady for the last few years, since about 2013, with the occasional bump here and there. Apple’s annual run-rate for payments to developers is now around $14 billion, which translates into the “over $20 billion” customer spend number in today’s press release. That’s an enormous revenue number for something which is effectively a feature in Apple’s platform.

Longer-term patterns

If you look again at that last chart, though, you’ll see that the early history is less consistent. There are some ups and downs in the early years, though they’re a little hard to make out in that chart because of the sheer scale of payments in the later years. One way to dive deeper into this and to look at the longer-term trends is to use another set of numbers – the base of iOS devices in use – to put these figures in context. Here, again, we have to make certain assumptions about the size of that base, but we have enough data points to be reasonably confident there too.

The chart below shows the average annual revenue per iOS device in use since the inception of the App Store:Four quarter revenue per iOS device estimatedWhat you see in the chart is a series of different eras in the history of the App Store in which the trends were quite distinctive. In the early going, spend quickly leveled off at around $15 per year per iOS device, and it then began to falter a little. Apple introduced in-app purchases as a new feature in late 2009, and that seems to have sparked a slight renaissance in 2010, along with the launch of the iPad and some higher-priced apps which launched for that platform. However, by 2012, this number was back in decline, likely as the base of iOS devices diversified beyond early adopters and into new markets with lower spending power. In fact, that is the trend you’d expect to see over time, as existing users make do largely with apps they already own, and as new users in new geographies join the base.

However, what you actually see is that, starting around late 2012, the number starts rising significantly, eventually leveling off again at around $25, significantly higher than in the early years of the App Store. What drove this growth? I mentioned already that in-app purchases launched in late 2009, but it wasn’t until late 2012 that Candy Crush Saga launched. Of course, one app didn’t change the trajectory of the whole App Store, but this app exemplifies a new business model that’s become increasing prevalent – even dominant – in the App Store, and in App Store revenues. Many others have followed a similar path to monetization since then, and I suspect it’s the rise of in-app purchases in games that’s driven that growth since late 2012. I’ve written about the rise of these games, and some of the unpleasant economics associated with them, elsewhere, but there’s no doubt they’ve had a significant impact on the App Store and its revenue composition.

There’s no doubt that games in general, and those featuring in-app purchases in particular, are a major driver for the App Store growth Apple trumpets on a regular basis. The two big questions that arise out of all of this are whether Apple wants to continue to rely so heavily on a model that has unsavory characteristics, and whether in focusing on this dominant category it’s neglecting other business models in the App Store. That latter topic is something we’ve discussed a couple of times recently on the Beyond Devices podcast, most notably in Episode 24.

Diving into AT&T’s Consumer and Business Mobility businesses

AT&T recently restructured its reporting segments to reflect the fact that it now has all its business-focused activities in a single division – AT&T Business Solutions. This division includes its business-focused mobile activities, while a separate division – Consumer Mobility – houses its consumer-focused (and wholesale) mobile activities. In an admirable bit of transparency, AT&T is actually providing both overall results for the same combined AT&T Mobility business that used to exist, but also some breakdowns for both Business Mobility and Consumer Mobility separately. This provides some interesting opportunities to see the differences between these two businesses, and I’ve spent some time over the last couple of days dissecting these two segments.

A business in two halves

First of all, let’s look at how the business splits between Business and Consumer Mobility. The first chart below shows the revenue split between the two, while the second shows the subscriber base split:

Business Consumer revenue splitBusiness Consumer base splitAs you can see from that revenue chart, this is a business split almost exactly in two, with the division between the two right around 50/50 depending on the quarter. However, as the subscriber base chart shows, the balance in subscriber numbers is shifting rapidly towards the Business side, which had 57% of AT&T Mobility subscribers in Q3, up from just 51% in Q1 2014. We can also logically conclude – and I’ll expand on this below – that Business Mobility has lower revenue per user than Consumer Mobility.

ARPUs are very different by business

Sadly, AT&T doesn’t give us a detailed split of average revenue per user by segment, but it does give us some numbers directly, and also gives us enough other information to derive others. The chart below shows average revenue per user for a variety of the sub-segments in the new reporting structure:
Churn for various businessesAs you can see, the highest ARPU is that associated with postpaid subscribers on the Consumer Mobility side, at a little over $60 per month per subscriber, while the lowest ARPU belongs to the “Other Service” line on the Consumer Mobility side. That Other Services line is mostly made up of wholesale subscribers, such as those belonging to MVNOs using the AT&T network, so it’s not surprising that they should be low, since AT&T just gets a small percentage of retail revenues.

However, there are also some other interesting things to note:

  • These numbers give us our first real insight into prepaid ARPU at AT&T in several years. AT&T has been referring to prepaid ARPUs here and there in investor briefings recently, but hasn’t given a regular figure. But it’s now clear that prepaid ARPU is around $37, and jumped quite significantly when Cricket came on board, something that only fully hit results in Q2 2014.
  • Business Mobility ARPU is lower than total Consumer Mobility ARPU, by a few dollars, and Consumer Mobility postpaid ARPU is higher than total postpaid ARPU for AT&T, both of which suggest that Business Mobility generates lower ARPUs for the same services than Consumer Mobility. That is, in fact, the case, since business customers often get discounts not available to consumers. Overall Business Mobility ARPU is also lower because of the large number of Connected Devices subs in the Business base, which tend to have much lower ARPUs, as you can see in the chart below:

Business Mobility base composition

Churn rates are lower in business than consumer

Another big difference between the two segments is churn rates. Here are the overall churn rates for Business Mobility and Consumer Mobility: Churn for business and consumerThis shouldn’t surprise us, since:

  • Business Mobility includes Connected Devices, which often have very long lifecycles and therefore very low churn on a monthly basis
  • Consumer Mobility includes prepaid, which has always had higher churn than postpaid.

However, even when you compare Consumer Mobility postpaid churn alone to total postpaid churn for AT&T, you can see a difference of around 15 basis points: 
Postpaid churn consumer and totalThis also isn’t that surprising – the more lines associated with an account (whether as part of family plans or business contracts), the lower churn tends to be, because it’s more of an upheaval to move several lines (which may have different contract end dates) than to move one. 

Business Mobility is one of Consumer Mobility’s largest sources of churn

One of the most interesting things about the two subscriber bases is that Business Mobility is actually taking over quite a few subscribers from Consumer Mobility each quarter. The chart below shows postpaid subscribers for both segments:Postpaid subs by segmentThis, along with the rapid growth in Connected Devices, helps to explain why Business Mobility is growing as a proportion of the total, but why is Consumer Mobility’s postpaid base shrinking so rapidly, while Business Mobility is growing quickly? At first, I wondered if this was a sign of some underlying problem in the consumer business, but it turns out it’s something rather different. This quote comes from an additional 8-K filing AT&T filed this quarter alongside its results announcement:

Our business wireless offerings allow for individual subscribers to purchase wireless services through employer-sponsored plans for a reduced price. The migration of these subscribers to the ABS segment negatively impacted consumer postpaid subscriber and service revenues growth.

Now, I don’t believe AT&T actually counts these subscribers as either churn or net adds on either side, when they’re merely transitioned from one segment to the other. But in addition to this internal churn, there is still a fairly stark difference in the postpaid net adds between the two segments:Postpaid net adds business and consumerAs you can see, Business Mobility seems to have far higher net adds than Consumer Mobility, which shrank to almost zero in Q3 2015. That’s a bit of a worrying sign for AT&T, and something we’ll want to keep an eye on going forward.

Which business is more favorable for AT&T?

The ultimate question is which of these two roughly equally-sized businesses is better for AT&T. In other words, is it a good thing that AT&T is seeing some subscribers transition over from Consumer to Business? Well, one thing we haven’t looked at yet is margins, which AT&T doesn’t report directly for Business Mobility, but which we can derive based on the figures it does provide for both AT&T Mobility as a whole and the Consumer Mobility segments:

Margins consumer and businessBusiness Mobility margins are actually a little lower than Consumer Mobility margins, by an average of roughly 2-3 percentage points most quarters. That likely reflects the lower ARPUs related to the heavier discounting that takes place on the business side. But of course, offsetting both the lower ARPUs and the slightly lower margins is the benefit of lower churn, which should help AT&T on the business side over time. The good news is that, thanks to cost cuts and efficiency gains AT&T has made recently, both sides of the business are seeing rising margins.

What we’re getting here is a unique insight into a division that’s normally totally opaque – none of the other US carriers provide this kind of split in their reporting. It would be fascinating to see a similar split for the others – T-Mobile has never really gone after the enterprise business until recently, while the other two carriers have definitely pursued it more aggressively. I suspect AT&T has the largest enterprise mobility business of the big four, but I’d love to see these details for the other carriers too.

Cord-cutting Update Q3 2015

I wrote a post last quarter about cord-cutting and the numbers I collect on pay TV subscribers in the US, and with all the major pay TV providers now having reported their results, I thought I’d do a quick update, especially since I’m seeing some misguided and misleading stuff out there based on others’ estimates. To be clear: cord-cutting is now a very real phenomenon, and it appears to be accelerating. A focus on single quarter results, especially on a sequential rather than year-on-year basis, can easily muddy the waters. But looking at the long-term trends makes the underlying pattern very clear.

Note: the charts and analysis here are based on the data I gather for my clients at Jackdaw Research, and a deck with lots more charts based on this data is part of the Jackdaw Research Quarterly Decks Service. You can learn more about that service and sign up here. The Q3 deck is available now to subscribers and can also be purchased on a one-off basis for $10 by clicking here. The deck from a year ago, which is similar in content, is available on Slideshare.

The three mistakes observers make

There are three fundamental mistakes people trying to measure cord-cutting frequently make:

  • They focus solely on quarterly trends, in what’s an extremely cyclical industry. Comparing this quarter’s net adds to last quarter’s tells you nothing about the underlying trends, because every calendar quarter has its own regular pattern. Ignore those patterns, or look at quarter-on-quarter trends rather than year-on-year trends, and you’ll get things totally wrong.
  • They focus only on some categories of players, such as the cable companies alone, or just the cable and satellite companies. There are three major sets of players in the US pay TV industry: cable operators, satellite operators, and telecoms operators. Ignore any one of these, or focus just on one – however large – and you’ll again come away with the wrong picture. For the last few quarters in particular, telecoms TV net adds have fallen quite a bit – leave those out of the picture, and you get a very distorted view.
  • They focus purely on the larger players. It’s very easy to focus on the largest publicly-traded pay TV providers – they’re by far the largest and  most impactful in industry terms. But even if these players serve the majority of the market, they by no means serve all of it, and in the last couple of years many of the losses have come among these smaller players. Ignoring those losses again risks distorting the picture.

A balanced view of cord-cutting

With that out of the way, I present here what’s as balanced a view as is possible to provide of what’s really going on. It’s very hard to build a truly complete picture, but if you want a representative picture, you have to include all three categories of players, and at least the largest of the smaller players too, while focusing on year on year trends. My post last quarter outlined the players I cover and the definitions I use, so I refer to you to that post if you’d like more context.

First, here’s the view of year on year video net adds for all the publicly-traded players whose reported results I track:Year on year video net adds all public playersAs you can see, the trend is consistent over the last five quarters – from almost 400k net adds in Q2 2014, the number has fallen each quarter, dropping into negative territory in Q2 2015 for the first time, and almost doubling in Q3, with almost 500k net losses among this group of pay TV providers.

The two bigger players we’re missing here are Cox and Bright House, neither of which is publicly-traded. Based on past reporting and estimates, I’ve estimated their results for Q3 2015, and adding them into the mix makes the picture look even worse:Year on year video net adds including Cox and Bright HouseLosses are now just above 500k for the quarter, and the first negative quarter (though it’s invisible in the chart) was actually Q1, when these providers lost 2k subs, according to my estimates. However, again, it was Q1 2014 that was the high point.

The dynamics between player groups are changing

Of course, underlying these dynamics is a set of different trends affecting different players. One of the reasons why some of the early commentary this quarter got things so wrong was an undue focus on the good results from some of the big cable companies. In fact, the cable companies have done better this quarter, but only because two of the big telcos – Verizon and AT&T – have dialed back their efforts in selling their TV offerings. The chart below shows year on year video net adds for these different groups of players (with cable excluding Cox and Bright House):Year on year video net adds by groupAs you can see, the cable recovery which began in late 2013 has coincided pretty much exactly with the telco slump that began around the same time. Telco adds year on year have dropped from around 1.5 million to just a couple of hundred thousand. This quarter, AT&T de-emphasized selling U-verse and actually lost subscribers for the second quarter in a row. Verizon is still gaining subscribers, but so slowly that it’s penetration rate in its addressable markets has actually begun to shrink. The satellite providers largely cancel each other out most quarters, such that their performance impacts overall market performance fairly little, but those slowing adds at the telcos are more than offsetting the slightly smaller losses at the cable companies.

A trend likely to accelerate

Hidden within these results is the fact that DISH now has its own over-the-top streaming video service, which is a potential substitute for some of these pay TV services. Sling TV subscribers are reported within DISH’s total base of subs, such that we can’t see the dynamics between the two, but others have estimated that without Sling DISH would have seen a significant drop in subscribers over the last couple of quarters. And of course Sling isn’t the only company providing these services – whether it’s indirect substitutes like Netflix and Hulu or direct substitutes like Sling, Sony’s Vue, and whatever Apple might eventually announce, a big part of the reason for the cord-cutting that’s now very evident in the market is the availability of substitutes. To date, DISH is the only one of these companies that has a competing product within its own walls, and that may turn out to be a smart strategy. But whether these companies eat their own lunch or lose share to others, it’s increasingly clear that cord-cutting is real, and accelerating.

Amazon’s exploding workforce

One of the things that struck me the most about Amazon’s earnings last quarter was the rate at which it’s hiring, as that rate has always been high, but accelerated significantly this past quarter. Below, I’m going to share a few key charts to illustrate this trend.

These charts are taken from the slide deck for Amazon I put together each quarter as part of the Jackdaw Research Quarterly Decks Service, a subscription service which provides slides on financial and operating metrics on some major consumer technology companies each quarter. I’ll post a screenshot of the slides in the Amazon deck, which went out to subscribers last night, at the bottom of this post. Any reporters reading this can contact me directly to receive copies of this and other decks from the service.

The first chart is the total number of Amazon employees, which includes both full-time and part-time employees, but excludes contractors and temporary personnel, of which Amazon hires many each holiday season:Amazon employeesYou can see the broad upward trend, but hopefully you can also see the spike this past quarter, which was significantly higher than in previous quarters. To put it in context, let’s look at another couple of charts. The first shows year on year net employee growth and the second shows quarter-on-quarter growth:Year on year net employee growthQuarter on quarter employee growthAs you can see, in both cases the growth this quarter was well above the historical trend. So what happened? Well, Amazon’s management was asked about this on the call and this was the answer, from Brian Olsavsky, the CFO (as reported by Seeking Alpha):

Headcount was up 49% year-over-year, which is higher than Q2 – we saw in Q2. This is going to be primarily in our ops area. If you exclude ops-related employees, our headcount’s growing actually slower than our FX neutral growth rate of 30%. So, what’s going on in ops is we’ve added 14 net fulfillment centers this year, bringing the total to 123 globally. We’ve added four sort centers in the U.S., bringing U.S. footprint to 23. We’re staffing earlier in those locations, we’re in good shape for the holidays and ready to go.

The other issue is there, the other reason is that we are also doing a lot of conversion of temp workers to full-time workers purposefully. There is a metric employment of full-time hires. So it is a little bit higher due to that program.

The bold text there is mine, because it highlights the major drivers here:

  • Amazon is building large numbers of new fulfillment centers
  • It’s getting those fulfillment centers staffed up to full levels earlier, especially in preparation from the holiday season
  • It’s also converting a higher number of the temporary workers it hires to permanent workers.

All this is particularly interesting in light of the recent New York Times story on Amazon’s working conditions (mostly in office jobs), because this is an unprecedented hiring spree at Amazon, but it’s almost all going into “ops” – or fulfillment and other blue-collar jobs. Indeed, this is reflected in Amazon’s rapidly falling revenue per employee:Amazon four quarter rev per employeeWhereas five years ago Amazon generated over a million dollars per employee, today, it generates less than half that, at $555,000 per employee in Q3 2015, and falling fast. Both the sheer number of employees Amazon has, and the nature of those employees, continues to be one of the biggest differences between Amazon and its business model and all the other big consumer technology companies it competes with. Amazon added 72,900 employees over the last 12 months, which is around 80% of Apple’s total workforce, for comparison’s sake.

Here’s that screenshot of the Amazon slide deck from the Jackdaw Research Quarterly Decks service:Amazon deck screenshot

Quick thoughts on Square’s Q3 2015 numbers

Payments company Square filed an amended S1 with the SEC on Monday, with financial and operating metrics for Q3 2015. I previously talked about Square’s original IPO filing on Techpinions a couple of weeks ago, and today I’m just going to focus on a couple of elements of the new numbers. If you’re not familiar with Square, I suggest you take a quick read through that earlier piece as it will be helpful context for what’s below.

The charts here are taken from more in-depth analysis I do as part of the Jackdaw Research Quarterly Decks Service, a subscription service which provides slides on financial and operating metrics on some major consumer technology companies each quarter. I’ll post a screenshot of the slides in the Square deck, which went out to subscribers last night, at the bottom of this post. Any reporters reading this can contact me directly to receive copies of this and other decks from the service.

As a quick into, here’s Square’s revenue line by product:Square revenue breakdownAs you can see, revenue growth is pretty healthy, primarily driven by core transaction volumes, but helped also by a newer category called Software and Data Products. This is where Square Capital, Square’s cash advance business, sits, along with a couple of SaaS businesses it’s acquired and launched.

Importantly, Square’s gross margins from these different businesses are very varied, as the chart below shows:Square margins by productSoftware and Data Products have had by far the highest margins of all, although they’ve come down as Square has begun to incur costs of revenue around these businesses, which started out at almost 100% margins, with almost no costs. However, the Hardware business has historically been run at a loss, as Square essentially gave away many of its hardware products for free, although it’s now moving to a sell-at-cost model for some of its newer products. Lastly, you can see the huge discrepancy between the gross margins on Starbucks transactions, which have been consistently negative (around 20-30%), and all other transactions, which are very consistent at 35%.

Where things get really interesting is when you look at Starbucks transactions, which are fairly consistent in both revenue and gross profit dollars for now, in comparison to Software and Data Products. Square small segmentsThe latter is now just large enough to effectively cancel out the Starbucks gross loss, and at the current rate of growth it should fairly quickly outweigh it, which should help substantially with overall margins going forward. The ending of the Starbucks relationship (formalized this week with an announcement that Starbucks will indeed be going with another vendor going forward) combined with the growth of the Software and Data Products business are arguably the two keys to Square’s journey to future profitability.

A screenshot of the full set of slides from the Square quarterly deck I sent to subscribers yesterday is below:Square deck screenshot

Apple Music survey results

Related: Apple topic page, all Apple Music posts.

The three-month anniversary of the launch of Apple Music passed at the end of September, which means many of the early trial users have been faced with the decision of whether to become paying customers or to cancel the service. As such, I though it was a good time to run some surveys to ascertain who’s using Apple Music, why, and how. The full results of the two surveys I ran in early October, along with detailed methodologies, can be found in a new Jackdaw Research report, which you can download for free here.

In this post, I’m going to focus on just one of the two surveys (which was run through the MicroHero survey app), and specifically address several theories I had put forward in an April Techpinions column. Those theories were:

  1. Apple’s service, like all other paid music, would be most popular among older demographic segments
  2. Discovery would be an important element of the service, and as such those who thought discovery was important would likely gravitate toward the service in higher numbers than those who didn’t
  3. The integration of users’ owned music libraries was likely to be a key feature too, and as such Apple Music would do well among people who valued this feature.

The MicroHero survey had 500 respondents, which is good for a margin of error of about 4 percentage points, but I’m not claiming that the specific percentages I’ll share below are necessarily representative of the general population. As such, you should focus on the trends and patterns shown below rather than the specific percentages.

 Age patterns

With regard to the age breakdown, there were two interesting findings: younger users were more likely to have tried Apple Music than older users, but older users were more likely to have become paying customers when their trials ended. The charts below illustrate these two findings:MicroHero trial signup by ageFirst off, as you can see, the older users were, the less likely they were to have tried Apple Music – rates were about twice as high for the youngest age group as for the oldest, with some ups and downs in-between. This shouldn’t be surprising, as younger users are typically more tech-savvy, more aware of new trends, are bigger users of music streaming services in general, and so on.

However, when looking at those who did trial Apple Music, older users were far more likely than younger users to have converted their trials to paid subscriptions:MicroHero sub status by ageAs you can see, the percentages here are virtually reversed, with the under 35 age group canceling at roughly the same rate as the 35+ age group became paying subscribers. Again, this shouldn’t be too surprising, even though it’s a reversal of the age pattern for trials. Older listeners have always spent more on music than younger listeners, who tend to have less disposable income and more time on their hands, often giving them a higher tolerance for the disadvantages associated with free music (whether bootleg concert tapes, recording songs off the radio, or listening to music with frequent ad interruptions, depending on the era).

The importance of discovery

One of the early questions in both surveys asked respondents to rank various features of music streaming services in order of importance. Discovering new music wasn’t the top-rated feature, but for those respondents that did rank discovery as highly important, the rate of conversion to paid Apple Music subscriptions was higher than the average. The chart below shows how this group compared to the overall base of respondents on their conversion to paid subscriptions:MicroHero Discovery conversionAs you can see, the rate of conversion for those who prioritized discovery was similar to the rate of conversion for the 35+ age group we saw above, and significantly higher than the average. This is a great validation of Apple’s strategy to promote discovery as an important feature of Apple Music, which seems to have paid off well.

Owned music integration less important than expected

Conversely, users who said the integration of their own music into a music service was very important didn’t appear to favor paid subscriptions at a different rate from the rest of the respondents, contrary to my theory from April. However, when I asked respondents who had decided to become paid subscribers why they did so, integration of their own music was something over 50% of them said was a significant factor. Below are the results for this question from the second survey, which was run through Qualtrics:Qualtrics features likedAs you can see, two other features actually ranked higher than the integration of owned music – the integration of Apple Music within iOS (through features such as Siri), and discovering new music. As such, my hunch that owned music integration would be important was borne out somewhat, but not as strongly as my theories about age and discovery.

These and quite a few other findings are outlined in more detail in the report, which features 23 charts in total, relating not just to Apple Music in particular but music consumption habits in general. Again, you can download the report for free here.