YouTube and its alternatives

Eric Blattberg at Digiday has been doing some great work reporting on both some of the newer video initiatives at Facebook and Vessel as well as developments at the current industry powerhouse, YouTube. Eric’s latest piece today is about YouTube’s new effort to clamp down on sponsorships and advertising which bypasses its official ad products, and it’s this that I wanted to cover briefly today. I have two things I want to talk about: firstly, the potential of the newer video platforms; secondly, what Google’s YouTube moves suggest about the company as a whole.

Potential for newer platforms

I’ve been broadly skeptical of some of the newer video initiatives out there – YouTube’s lead has seemed so enormous, its position as the de facto standard for online video so entrenched, that it was hard to see how others could make a dent. Several things are starting to change my mind about this.

Firstly, Facebook’s embrace of video, and especially auto-playing video, has leveraged its massive audience into a very strong position as a video player. I’ve written elsewhere recently about the fact that every major sharing platform slowly migrates from text-based to photo-based to video sharing, but none has pursued this transformation quite as effectively as Facebook. From last month’s earnings call:

Five years ago, most of the content shared on Facebook was text and some photos. Today, it’s primarily photos with some text and video. Over the next five years, we want to keep developing new products and features to help people share the way they want.

Two things have allowed Facebook to make this leap to prominence as a video provider: the massive base of users, an the fact that Facebook is a destination, somewhere users go to spend time, rather than get something specific done. In the process, Facebook has become a massive destination for video, but almost all the video is actually hosted on other platforms. That obviously has cost advantages for Facebook, but it means that it doesn’t own the content, and therefore can’t monetize it effectively. It also means that engagement around videos on Facebook is fragmented, with popular YouTube videos attracting millions of comments scattered across hundreds of thousands of different user shares of the same video. This is starting to change, with ABC News, The Young Turks and others launching videos directly to Facebook rather than exlusively through YouTube. I think Facebook is finally in a position to be the first really large-scale platform to seriously challenge YouTube for dominance in video. The biggest challenge will be how to incorporate advertising into videos when they auto-play – pre-roll clearly isn’t the answer, but what is?

The other thing is that YouTube, with moves such as those Digiday covered today, is actually making it tougher for content creators to monetize on YouTube in the way they see fit. Videos on YouTube generate tiny amounts of money per view for content creators, and one of the ways they’ve overcome this challenge is through sponsorships. That’ll now be banned under YouTube’s new terms of service regarding advertising. At the same time, Vessel, AOL and others are targeting YouTube content creators with an emphasis on better monetization of their viewership. I’ve been skeptical of these efforts, but YouTube is playing right into their hands with some of these moves, which makes me more open to the idea that it might actually start to suffer as a result of competitive inroads from Facebook but also these smaller platforms.

What all this says about Google

Which brings us on to what this all says about Google. YouTube’s management must understand the risks associated with these moves, so why are they doing this? The only thing I can think of is that YouTube’s revenue growth has become so critical to Google’s overall performance that they have to keep squeezing harder and harder to get more money out, despite the longer-term strategic costs. Because Google doesn’t break out performance by business, we have essentially zero visibility into YouTube’s performance, but it’s been one of the strongest growth drivers for the company for years, and as the other parts of the business face increasing headwinds, it’s all the more important that YouTube continue to deliver strong growth.

On the positive side, YouTube’s management under Susan Wojicki is clearly thinking about how best to monetize much of the usage on the site that currently goes unmonetized or under-monetized. That includes YouTube Music Key and the work YouTube is apparently doing on building subscription models for content creators. The challenge is that almost all the moves YouTube is making are either content-creator-friendly at the cost of being user friendly (charging for content users have been receiving for free) or hostile to content creators. There’s very little that YouTube is doing which seems likely to please both users and content creators. I’m curious to see what else we see from YouTube in the coming months, but my worry is that Wojicki has been sent in to crank the handle on revenue in the short term and that this will have long-term strategic costs as other video platforms snatch away both viewership and content creators.

Samsung’s Microsoft deal and Cyanogen

SamMobile reported last night that Samsung was planning to pre-install a number of Microsoft applications on the Galaxy S6, which is to be announced in a few weeks at Mobile World Congress. I think this is a huge boost for Microsoft’s Android apps and for the services behind them – far bigger than the applications that come pre-installed with Microsoft’s own devices, obviously. To get on Samsung’s flagship device (presumably others will follow) is a huge coup for Microsoft. But it’s also a big deal for Samsung, which has until now been pre-installing ersatz versions of Microsoft apps on its devices for productivity.

But what I really wanted to talk about here was what this says about Microsoft’s broader strategy, and what it might mean for the rumored investment Microsoft is making in Cyanogen. Nokia, of course, forked Android itself using AOSP when it created the Nokia X line of smartphones shortly before the Microsoft acquisition was announced, but it was killed off right after Microsoft took control. So rumors of an investment in yet another Android fork seem funny – was Microsoft hedging its bets on Windows Phone and preparing another Android-based device line?

I think the much more likely explanation is that Cyanogen and Microsoft are planning something rather different, something much more along the lines of that Samsung deal. Cyanogen’s biggest weakness is that it’s missing all the Google apps and services that you sacrifice when you use AOSP. The challenge for any company doing this outside of China has always been what to replace them with. Inside China, it’s simple, because Google’s own services are largely irrelevant and local alternatives are actually better. But outside China, Amazon and others have struggled to provide really compelling replacements. The two companies that have comprehensive sets of services and applications that can replace Google’s today are, of course, Apple and Microsoft. Apple’s are (today) unique to its own products and platforms, but Microsoft is increasingly pursuing a cross-device strategy. Hence its investment in Cyanogen.

I wouldn’t be at all surprised if at least some flavor of Cyanogen devices in future come with Microsoft apps and services where the Google ones would normally be. We won’t see Microsoft launching another Android-based line of devices, but rather an Android-based line of devices that puts Microsoft’s services and apps front and center. That, after all, is the real goal here: getting Microsoft’s services in front of as many customers as possible, integrated into the platform in a way that makes them the default options for key tasks, and which provides benefits across the platform. Windows Phone has been the only platform where that’s been true, but Cyanogen could easily become a second. Quite what Cyanogen’s current customer base would make of that is unclear, but then Cyanogen’s future depends on broadening its appeal way beyond the hackers and tinkerers who flash alternative ROMs on their Android devices, and Microsoft could be a great fit there.

Both these deals – Samsung and Cyanogen – are good for both parties. Samsung and Cyanogen both need compelling apps to set their platforms apart, while Microsoft badly needs the broader exposure it will get from being pre-installed on these devices.

Thoughts on Twitter’s Q4 2014 earnings

I’ve just sent my Twitter deck to subscribers (screenshot at the bottom of this post). This analysis picks a few of the key charts from that deck. As always, you may want to read my previous posts on Twitter, as a lot of the themes here are ones I’ve touched on before.

As I’ve talked about before in relation to both Twitter and Facebook, there are three main growth drivers for these companies: user growth, increased engagement, and better monetization of that engagement. Twitter’s problem continues to be that only one of these three is going in the right direction:

Twitter growth driversUser growth has been slowing significantly over the past two years, and especially over the last few quarters. This quarter the company added just 4 million MAUs (or 8 if you’re charitable and give them back the 4 million additional MAUs they claim they lost to an iOS 8 bug). Even at 8 million, that’s by far the slowest growth in several years. Engagement, meanwhile, as measured by timeline views per MAU, has also been stagnant or falling for several quarters. The only metric moving in the right direction is monetization, and boy is it moving in the right direction! Here’s that chart broken out by itself, with the numbers:

Twitter monetizationAs you can see, the number has risen from 60 cents to almost $2.40 in the last three years, and it’s rising rapidly. In the US, this number is now almost $6 on a quarterly basis. The challenge with this number, though is that it’s unique to Twitter and therefore not comparable to anyone else’s metrics. However, since we know total ad revenue and we also know the number of MAUs, we can do a rough calculation for ad revenue per MAU for Twitter, and then compare it with the equivalent figure for Facebook:Facebook and Twitter ARPUWhat you can see is that the two lines are following a very similar trajectory, with Facebook quite a bit ahead of Twitter. I think what investors were so heartened about today was that Twitter demonstrated this ability to grow revenues significantly without growing users much at all, which suggests there’s still significant headroom on this ARPU measure. That means that, even if the other two growth drivers are underperforming, Twitter can still get good growth through the one lever that’s performing well. If it can get MAU growth going again as it promised to on today’s call, that will simply have a multiplier effect on that ARPU number, which will be so much the better.

The problem is, of course, that there is a ceiling here at some point – we just don’t know how high it is yet. Google generates between $30 and $50 per user annually in ad revenue from its own properties, so that could be a ceiling. But that’s based largely on one very effective form of advertising: search. There’s no guarantee that Twitter will ever be able to achieve that level of spend. Which brings us back to the question of the logged-out user. What was heartening both on today’s earnings call and in the last couple of weeks of news is that Twitter is finally really making some progress in telling the story of how it will grow this number. Though it refused to spell out the details of the Google agreement, it’s clear that Twitter hopes to drive significantly more traffic to Twitter.com in this way, for example. And then there’s the logged-out homepage it demoed this past week.

Despite all this, my two big questions for Twitter remain the same:

  • How will it monetize all this activity from logged-out users? It’s said very little about this, even on today’s call, and all this usage has to be monetized for it ultimately to do Twitter any good.
  • What are the new metrics by which we should measure Twitter’s progress on its new goals? It hasn’t established a consistent metric for measuring logged-out user activity (the 500m visitor number mentioned on today’s call was unchanged from three months ago). It’s abandoning its timeline views metric for engagement but won’t give us a different one. And ad revenue per 1000 timeline views only measures monetization of logged-in users, so how should we measure progress on monetizing the logged-out user? Twitter continues to try to steer everyone away from the metrics it does provide, but won’t supply metrics that support the new story it’s trying to tell.

Here’s a screenshot of the Twitter deck that went to subscribers earlier this evening:

Twitter deck screenshot

Motorola’s impact on Lenovo

Note: this is part of a series on major tech companies’ earnings in Q4 2014 (click here for previous posts). In this post as elsewhere, I’m using calendar quarters (e.g. Q4 2014) to designate reporting periods, even though Lenovo and certain other companies have fiscal years which use different designations. Q4 2014 in this post and elsewhere refers to the quarter ending December 2014.

Lenovo reported its results yesterday, and although I have not traditionally covered Lenovo in depth here, I wanted to examine something specific: that is, the impact of the Motorola acquisition on Lenovo’s reported numbers. As such, I’m going to highlight a handful of charts here, but I’m also sending a deck on Lenovo with quite a few more charts to subscribers (if you’d like more information or to sign up, click here).

One quick note: the acquisition of Motorola closed in October, but Lenovo also acquired IBM’s server business around the same time. As such, not all the impacts described below are entirely due to the Motorola acquisition, though several are, and I’d estimate the Motorola acquisition had a significantly greater impact than the server business did. Lenovo reported a full quarter of System X (server) results in its reporting, and two months of Motorola results.

Smartphone shipments

The most obvious impact of the Motorola acquisition was a dramatic rise in smartphone shipments reported by Motorola. The chart below shows the trend line, with a very clear bump in Q4:

Lenovo smartphone shipmentsIt’s worth noting, however, that shipments have been growing at Lenovo even before the Motorola acquisition. In my mind, the company has been one of the more successful and stable players in this space over recent years. However, that success has come largely in China, which has dominated shipments in the past. So another impact from the Motorola acquisition is the change in that mix:

Lenovo smartphone shipments China and RoWHopefully you’ll notice two things here. First, and perhaps most obvious, is the spike in rest-of-world shipments in Q4, which rose from under 4 million a quarter to over 14 million. Motorola shipped 10.6 million devices in Q4 alone, so it accounts for the majority of those rest of world shipments. Secondly, you may notice that China shipments actually fell year on year and quarter on quarter. Shipments rose from Q3 to Q4 in 2013, and this dip is fairly significant. It’s quite likely that Lenovo, like Xiaomi, suffered from the impact of Apple’s new iPhones in China in Q4. What’s worth watching is whether this recovers in Q1.

Mobile as a contribution to revenues

Until Q3 2014, Lenovo’s business was dominated by revenues from PCs. PCs contributed nearly 90% of Lenovo’s revenues two years ago, and it’s always stayed above 75%. That business, too, has performed well over recent years, despite the difficulties in the overall market, and so this dominance happened despite the growth in Lenovo’s smartphone and tablet businesses. But with the acquisition of Motorola, Mobile Devices suddenly went from around 15% of its revenues to almost a quarter:Lenovo mobile as percent of revenueThis is helpful for Lenovo particularly because of the overall headwinds in the PC space. PCs have continued to grow for Lenovo, but lessening its dependence on this business while exposing itself to the upside in smartphones is critical for Lenovo’s future growth, and the Motorola acquisition helps significantly with the balance of these two businesses.

Regional impact

We’ve already looked at the impact of Motorola on smartphone shipments outside the US, but the other big impact from this is the share of revenues from different regions. Motorola’s revenue contribution is essentially recorded in the Americas segment, and you can see the impact in this next chart:

Lenovo revenue by regionNote the dramatic growth in the size of that Americas block in Q4 2014 (again, the Motorola acquisition wasn’t the only contributor, as the IBM server business is also US-based). EMEA also grew a little, while China and AP remained fairly steady.

Margin impact

The impact of the two acquisitions can perhaps be most clearly seen in the regional segment margins Lenovo reports. The chart below shows these:

Lenovo margins by regionMargins in China and AP were essentially unaffected by the acquisitions, with AP rapidly catching up with China’s margin levels. But Americas margins dipped into the red for the first time in a long time in Q4, and EMEA margins also dipped somewhat. This is the downside to adding both the new businesses: neither was profitable under its previous owner. With the significant growth in smartphones year on year at Motorola, and efforts to get the Motorola brand back into China, together with various synergies, Lenovo expects Motorola to become profitable within about 18 months of the close of the deal. But in the meantime, Motorola’s results will be something of a drag on overall results.

I’m generally very bullish on Lenovo and the Motorola acquisition. I wrote more about it on Techpinions recently.

Below, I’ve pasted a screenshot of the Lenovo deck which will be going to subscribers shortly.

Lenovo deck overview

Twitter’s new ad product won’t help

I’m making this part of by earnings series, even though Twitter hasn’t actually reported yet, because it hits one of the key points I expect to come up in Twitter’s earnings this week and gets at one of the fundamental concerns I have about Twitter’s growth going forward.

Today, Twitter announced that it would start offering advertisers the ability to serve their promoted tweets off the Twitter platform itself. This is an important step for Twitter because its key growth challenge has been that the number of monthly active users on the platform itself isn’t growing rapidly, and it sees its biggest opportunity in serving what it terms “logged out users,” or those who see tweets without being explicitly logged in to Twitter or one of its apps. This is something I’ve talked about quite a bit here over the last few months, notably here and here. The challenge as I’ve seen it has been that (a) Twitter hadn’t articulated how exactly it would monetize that usage and (b) Twitter can’t use any of the data it has about its users in these third-party contexts, so the advertising would be only minimally targeted.

Today’s announcement gets at the first of these problems, in that it’s the first meaningful articulation of how Twitter can play outside of the core Twitter experience. But it doesn’t solve the second problem. In fact, the way Twitter has chosen to implement the promoted tweet product is a great illustration of how steep a hill Twitter has to climb here. I’m reposting below a chart I’ve used several times here in relation to the effectiveness of advertising:

Advertising relevance vs timelinessWhat this chart attempts to demonstrate is that there are two characteristics to effective advertising: relevance and timeliness. What makes search advertising so effective is that it hits both of these – i.e. an ad next to search results is relevant now to that user. Most other forms of advertising can at best produce relevance without timeliness, and in some cases neither. The problem with Twitter’s new ad product is that it looks an awful lot like a classic display ad, with little or no connection to the context and with no use of Twitter’s demographic data about the user. It’s likely that these ads will use some targeting from the property on which they appear, assuming those properties have that information, but Twitter itself brings nothing to the table here but the format.

Twitter makes the argument with regard to Flipboard specifically that the app already shows normal (non-promoted) tweets, so these promoted tweets won’t seem too out of place, but it’s a far cry from seeing a promoted tweet in the midst of a stream of regular tweets in the Twitter app or on Twitter.com. This is at best very loosely native advertising. And very few other properties show enough tweets in native format that these ads won’t look just like another sort of banner ad.

It seems investors don’t mind, at least in the early reactions: the stock is up 6% today. But to my mind nothing about today’s announcement really gets at solving the fundamental problems solving Twitter. We’ll see how this is presented on the earnings call this week, but given this and recent comments from Twitter founders Ev Williams and Jack Dorsey (ironically, in a tweet storm I can’t easily link to because he didn’t post it right), I’m wondering whether this is a pre-emptive strike ahead of another set of poor user growth numbers. Both Williams and Dorsey seem to be saying that we need to be looking beyond Twitter’s actual numbers at the societal impact it has, which seems like a strange thing to say if the numbers are actually going to be any good.

Quick thoughts: Another way to think about Nest

A couple of good blog posts from other analysts this morning triggered a thought in my mind about Nest.

The first of the two blog posts is from my fellow Techpinions contributor Ben Bajarin. I recommend reading the whole thing, but here’s the key thought:

Apple’s customers are higher value customers and their growing installed base means they are amassing one of the largest, if not the largest, installed base of premium customers on the planet. This observation has some striking implications…

He goes on to talk about two of the implications, and I think the insight there in  particular is great. One of them is the impact this has on the competition, among which of course we find Google, which owns the mobile operating system that’s mopping up the vast majority of the non-Apple customers.

Something else I read this morning (a post from Benedict Evans that’s really about something completely different) prompted me to think about this in the context of Google’s Nest acquisition. I’ve been thinking about Nest primarily as Google’s strategic play in the smart home space, and as the hub and vehicle for the rest of what Google will do in the home. And I think that may well be in large part what that Nest acquisition is about.

But thinking about Nest in the context of Ben Bajarin’s piece made me see Nest in a different way. Think about Nest for a minute: its characteristics as a product, the people it’s likely to attract, even the people who work there. This is a very Apple-like product, made by a former Apple executive, and I’ve always said that Nest was a much better fit at Apple than at Google. It’s even sold in Apple stores.

What if Nest is at least in part about capturing those very lucrative and attractive Apple customers without having to convert them to Android? What if what Google is building with Nest is at least in part a concession that Android and phones based on Android aren’t likely to attract these customers, but by playing in a completely different space – the smart home – Google can in fact attract those customers? And once it has them there, perhaps convert them to other aspects of the Google ecosystem, which after all is where Google really makes its money? There’s no particular reason why Google needs to have all its customers on Android anymore – it’s served its function of preventing Microsoft and Apple from dominating the mobile world. And of course, there’s been lots of talk about even Google’s services making more money on iPhones than on Android. What if Google could establish a different beachhead in devices that’s not dependent on first converting people to Android? What’s fascinating about Nest is that it’s about the only recent Google initiative that’s not about reinforcing Android as a platform – Android Wear, Android Auto and Android TV are all about extending Android specifically into new domains rather than simply spreading Google services into new domains.

I’ve no idea if this was actually part of the thinking behind the acquisition of Nest – most likely, like other acquisitions, it wasn’t about a single strategic objective but rather several. But it would certainly be an interesting response to the emerging reality that Apple has captured the vast majority of the most valuable customers within its ecosystem, and trying to win them back through phones seems to be a losing strategy.

The big downside to this, of course, is that Google has very deliberately kept Nest somewhat at arm’s length from the rest of the company (a point Benedict raised in his post). But this strategy only works if Google continues to build links between the two, as it’s already begun to do with Google Now integration. With Tony Fadell now overseeing Glass as well, there’s obviously even more linkage between Google proper and the Nest team, and it’s another sign that Fadell might be asked to oversee more Google devices and pursue the same strategy.

Why I’m more bullish on Facebook than Google

This is mostly a Facebook earnings post in disguise – part of my series on major tech companies’ earnings. Google reports this afternoon and it’s my hope to get this out before their results hit the wires. I did a big deck full of charts and comparisons for Facebook for subscribers – sign up or read more about that offering here.

Google and Facebook are the two largest online advertising businesses in the US, and as such face similar market conditions. But they’re coming from very different places, while managing the challenges in very different ways. I maintain that the best way to look at Facebook’s growth potential (and Twitter’s, incidentally) is through three key metrics:

  • User growth: measured in growth in monthly active users (MAUs) year on year
  • Engagement: growth in DAUs as a % of MAUs
  • Monetization: growth in average revenue per user.

The chart below summarizes the state of affairs with regard to Facebook according to these three metrics:

Facebook core growth leversAs you can see, two of the three look very healthy over the longer term, with engagement growing steadily and monetization increasing rapidly. User growth has slowed a little from past rates, but Facebook still adds over 150 million new MAUs every year, and the number’s actually begun to tick up slightly. Engagement stalled a bit this past quarter, as DAUs appeared to plateau at 64%. That was driven by slight declines in Asia and the Rest of World segment, along with flat numbers elsewhere. But it’s a one-quarter phenomenon for now, so we shouldn’t get overly worked up about it. We’ll see what happens next quarter. Engagement is, at any rate, merely a means to an end, as one of two drivers of monetization, which is doing fine. In short, Facebook’s core levers for growth are going well.

At the same time,  this can’t go on forever:

  • Facebook’s user growth can’t keep going at the same rate forever – almost all services eventually start reaching saturation of the addressable market, and with 60% penetration of the total population and 75% penetration of the mobile population in the US and Canada, it’s already bumping up against a ceiling in some regions. Elsewhere, notably in Asia, penetration remains low, but isn’t growing rapidly either.
  • Engagement can’t keep going up forever either – some users will always be occasional rather than regular visitors to Facebook’s properties, and they can only spend so much time on the core Facebook experience in a day.
  • Monetization will start to slow eventually too – both the limits to overall ad spend and increasing competition from other companies in mobile advertising generally and app-install ads specifically will start to eat into Facebook’s growth prospects.

I believe Facebook is aware of all these things, which is why it’s invested in several new businesses, among them WhatsApp and Instagram in the messaging/photo sharing space and Oculus Rift in the interfaces business. It’s also broken Facebook Messenger out as a separate service, which has been controversial but seems to have paid off in spades. Here are the user numbers for the three messaging apps:

Facebook messaging MAUsNone of these is generating significant revenue today, but as Mark Zuckerberg said on yesterday’s earnings call, they all have potential to to do so in future, and Facebook will be very careful about turning the profit spigot on for each of them in the meantime. In other words, Facebook has invested for the future, and has several products waiting in the wings which can start to generate additional revenue (mostly through advertising though potentially through payments or other streams) when they’re needed to shore up overall growth.

Perhaps the most heartening thing about Facebook, though, is that it’s been so clear about two things: the strategy behind these products, and the metrics associated with them. The underlying drivers behind both Facebook’s business today and its business tomorrow are clear for all to see, and we’ve just looked at them. You can draw different conclusions about where those trends might be going longer term, but at least you’re looking at the same data Facebook is looking at as an outsider, and especially as an investor.

This is where Google comes in. I’ve written elsewhere, and especially in a couple of recent pieces on Techpinions, about the fundamental risks to Google’s business in the near term. But I’m more worried than anything else about the fact that Google (a) doesn’t provide good enough transparency into the drivers of its current business, and (b) hasn’t articulated a clear vision for how and when its equivalent investments for the future will pay off. It is neither providing outsiders (including investors) with the understanding they need of how its current business will develop, nor is it telling a compelling story about how its business will evolve over time.

Meanwhile, there are significant headwinds coming up for Google: despite its efforts to shore up its control of Android, it’s arguably in greater danger than ever of losing control over this core platform. Between Chinese OEMs, Amazon and Samsung each customizing the platform to meet their own needs, Cyanogen threatening to take it away, and Microsoft investing in Cyanogen, there are several threats to Google’s ability to continue to control and drive revenue through Android. Internet growth is slowing worldwide, and the new users who come online will have and command far less spending power, while gravitating towards local alternatives and app rather than web models in their usage. Google really doesn’t seem to have an answer for any of these. So far, their earnings are holding up (we’ll see what happens today), but I think it’s only a matter of time before these cracks begin to show.

For those interested, below is a screenshot of the Facebook deck, with some of the metrics described above and many others. Again, click here to find out more or to sign up.Facebook deck overview

Quick thoughts on Microsoft and Amazon in the cloud

At the end of last year, I wrote a piece for Techpinions Insiders about what to expect for Amazon in 2015, as part of a series on major tech companies. As part of that piece, I wrote the following about Amazon’s AWS business:

AWS has been one of Amazon’s big success stories over the last several years, generating higher margins than e-commerce and growing extremely fast. But growth faltered a little in 2014, as competition, from Google and Microsoft in particular, intensified. The basic storage and infrastructure services are becoming rapidly commoditized, with plummeting prices and little real differentiation. As such, both margins and differentiation will move to what these companies build on the basic services; hence Amazon’s launch of Zocalo and other enterprise tools that sit on top of AWS. But here it is going up against Microsoft’s traditional stronghold and Google’s increasingly capable offerings. End user software hasn’t been Amazon’s strong suit, but it’s Microsoft and Google’s bread and butter. I remain skeptical of Amazon’s ability to successfully compete in this area. Meanwhile, others not in the cloud storage business are also building their own competing platforms at this higher layer, including Box, Salesforce and others. If AWS is to become the highly profitable core Amazon has always lacked, it needs to successfully compete at this layer as well as the basic services it has provided historically. It’s not clear to me Amazon will be any more successful at this in 2015 than it was in 2014.

This week, Microsoft reported its earnings for the December quarter, and among other things Satya Nadella said this about Microsoft’s own cloud business in response to a question about cloud margins:

Overall, the shift to the higher layer services is the real driver here, which is obviously Office 365 and its various levels is one factor. The other one is what I talked about in the Enterprise Mobility Suite, that’s really got fantastic momentum in the marketplace because the solution has really come together and is fairly unique, as well as Dynamic CRM.

So these are all got a different profile in terms of margin and they are all now pretty high growth businesses for us. So when you think about our cloud, you got to think about the low-level infrastructure. Even there we now have premium offerings and then we have higher level services. So that aggregate portfolio is what helps us move up the margin curve.

I juxtapose these two quotes – one about Amazon and one about Microsoft – because I think today’s announcement by Amazon of new enterprise email services plays directly into the challenge I described, and which Microsoft seems to be managing much better. It continues to be critical for both companies (and Google) to migrate their way up the cloud stack to the higher-layer services (as both I and Nadella called them), but Microsoft is already there, while Amazon continues to try to compete in a space I’m really not sure they can. We’ll see what AWS results look like tomorrow, but I expect this to be something that comes up on the call.

Thoughts on Apple’s Q4 2014 earnings

Notes: this is part of a series on major tech companies’ Q4 2014 earnings. All past earnings posts can be seen here, and all earnings posts for Q4 2014 can be seen here. For the sake of easy comparisons and transparency, I always use calendar quarters in my analysis. Hence, Q4 2014 in this and every post on this blog means the quarter ending December 2014, even though some companies (Apple included) have fiscal years that end at other times of the year. 

A blowout quarter

The hardest posts to write are often the ones where it’s utterly uncontroversial that the results were astonishingly good, and that was definitely the case with Apple’s record-breaking earnings today. So instead of hashing over the same stuff as everyone else is, I’m going to try to pull out a few possibly overlooked data points. Apple changed its reporting structure in a couple of ways this past quarter, and that gave us one or two new insights while also sadly burying some data points and obscuring others. I’m going to be working through the revised numbers over the next 24 hours or so, and will be issuing my quarterly deck for subscribers once the 10-Q report is out, as that’ll fill in some gaps in the current data. I may well do another post on the earnings at that point too.

ASPs

I tweeted about the iPhone ASPs as follows shortly after the numbers came out:

In some ways, that about sums it up. But of course that chart shows two sets of ASPs, going in dramatically different directions (as I indicated they would in my Techpinions earnings preview post on Monday):

  • iPhone ASPs rose in Q3, but even more dramatically in Q4, largely thanks to two things: the iPhone 6 Plus, which raised the base price of the top-end iPhone model by $100, and the introduction of a 128GB model, which raised the top-end price as well. The combination of these two conspired to lift ASPs $50 above last year’s number.
  • iPad ASPs continue to fall, on a fairly predictable slope, over the last few quarters, enabled conversely by a lowering of the entry price for iPads.

The two charts below show the pricing moves behind those ASP trends:

iPad retail prices iPhone retail pricesAs you can see, the lowest price for iPhones has remained very stable for four years, while the highest possible price has risen $200 since 2010. But the iPad’s lowest selling price has fallen from $500 to $250 during that same period, while the highest price has barely changed. Given the lack of subsidies on the iPad, lower full retail prices translate directly to what consumers actually pay, whereas higher prices on the iPhone side are masked by carrier subsidies and/or installment plans in many cases. All this helps to explain why the iPhone ASP keeps rising while the iPad ASP keeps falling.

Retail’s varying importance in different geographies

Apple giveth and Apple taketh away when it comes to financial reporting. This quarter, Apple took away all visibility over the current quarter’s retail finances, as it rolled retail reporting into regional reporting. However, in so doing, it provided a wonderful insight into past retail performance on a region-by-region basis, something we’ve never had before. I’m curious to see whether it provides any retail-related financials in its 10-Q, but for now we’ll have to make do with this interesting data set. I’ve taken that historical data and generated the following chart, which shows retail revenues as a percentage of total revenues on a regional basis:

Retail as percent of revenuesThere’s obviously a huge variability by region, and this reflects a factor I’ve documented in the past. Here’s the old-style revenue split by region vs. the number of retail stores by region, which highlights the regions which have fewer retail stores than their revenue contribution would suggest:

Retail stores vs revenueAs you can see, the regions with the smallest percentage of revenue from retail are the same as those with the smallest number of retail stores relative to their overall revenue contribution, so this isn’t a big surprise. Japan comes bottom on both metrics. The next question is which of these two factors is the cause and which is the effect, given that there’s clearly a correlation. I suspect there’s some of each, but it’s also clear why Apple is investing so heavily in retail stores in China. It’s also clear why Apple is adding so many more retail stores outside the US than inside it (though that trend reversed a little in the last two quarters).

Growth remarkably diversified by region

One last data point: Apple’s growth this past quarter was amazingly widespread by region. Over the last five quarters Apple’s gone from pretty low overall growth back to roaring growth on a year over year basis. In some of those past quarters, one or two regions carried much of the overall growth, whether Japan for a couple of quarters last year, or China during almost all quarters. But this quarter was notable for just how broad-based that growth was by region, with every region but Japan making a pretty meaningful contribution to overall growth (and Japan suffering from tough comparisons with a very strong quarter a year ago rather than any poor underlying performance):

Year on year rev growth by regionApple provided some numbers around this on the earnings call, citing 22% revenue growth in developed countries, 58% revenue growth in emerging markets as a whole, but 70% revenue growth in China year on year. Unit shipments grew by an astonishing amount in the BRIC countries as a while too – I’m not 100% sure of the number but I believe it was 90%.

Divergent fortunes for Apple and other major phone makers

As I said, I hope to have more top-line analysis later on, but for now I’ll end with this thought: the contrast between Apple’s and most other phone makers’ numbers couldn’t be starker, perhaps most dramatically as it relates to Samsung: record-high shipments at record-high prices, generating record-high profits, just as other vendors are seeing ASPs plunge, shipments stall and and margins squeezed. There’s been so much skepticism for so many years about Apple’s ability to continue to make its unique business model work over the long term, and Apple continues to prove them wrong. I believe with the launch of the Apple Watch in April, HomeKit devices finally starting to ship in significant numbers in the coming months, CarPlay, Apple Pay and who knows what else that might arrive in 2015, Apple is simply reinforcing what’s becoming an incredibly strong, sticky, and growing ecosystem.

My thesis on Microsoft

It’s earnings season and I generally post a particular kind of post when that’s the case, including the Microsoft earnings post I did last night. Typically, I highlight a few key data points and analyze those, without stepping back to do a big-picture view on a company. But sometimes I worry that this leaves readers without a good sense of how I see the company in question and its prospects. So I wanted to do a follow-up post to yesterday’s in which I take a broader view and share my overall thoughts on Microsoft and its prospects. I’ll provide a list of links to previous pieces on Microsoft at the end of this post in case you’re interested in exploring any of this in more detail.

Windows PCs are in a long-term decline

A big part of how you see the future of Microsoft depends on what you think the underlying trend is and will be in Windows PCs, so let’s start there. I see two theories in the market at the moment, and which of these theories you subscribe to very much provides the lens through which you see Microsoft’s results each quarter. One theory is that Windows PCs are on either a stable or growing trajectory over time, and that any quarters in which there is negative growth are the exceptions to that rule. The other theory is that Windows PCs are on a downward trajectory over time, and that positive growth quarters are the exceptions rather than the rule.

For the following reasons, I subscribe to the second theory:

  • PCs as a form factor are now one of several that can be used for the purposes that once required a PC, with tablets and smartphones providing adequate computing power and capability for what many people need
  • PC hardware has reached the point where even those who see a need for a PC don’t perhaps see the need to upgrade it as frequently, because a PC from several years ago is still perfectly adequate, especially if relegated only to those tasks other devices can’t perform effectively
  • Competition is gaining ground, with Chromebooks taking significant share in education and Macs gaining share in the broader PC market, especially among college students and other key groups. As such Windows PCs will be an ever smaller share of total PCs
  • People are choosing platforms other than Windows in new device categories such as smartphones, tablets, wearables, smart TV devices, and so on. As these other platforms increase the degree of integration within their ecosystems, it will be harder for Microsoft to sell Windows PCs that don’t integrate as effectively with Android tablets or iPhones.

For all these reasons, I see a downward trajectory over time in sales of Windows in total, even accounting for the many different form factors Windows runs on. As such, last quarter’s poor performance in Windows sales is much more indicative of the longer-term trend than short-term headwinds. I see Windows 10 slowing the decline a little, but I actually think the free upgrades could stall or postpone new device purchases for some users, which may be counterproductive in the short term. I don’t see Windows 10 solving any of the fundamental challenges I just outlined. Continue reading