Four Quick Thoughts on Snap’s Spectacles

Over the weekend, Snapchat (now Snap, Inc.) announced its video-recording glasses, Spectacles. In talking to reporters on Saturday and spending some time pondering the move, four main thoughts have been running through my brain. I think we’ll almost certainly spend a good amount of time on this week’s Beyond Devices Podcast discussing this, so look out for that episode on Thursday morning.

Two takes on hardware for immersive video

Firstly, it’s interesting to see Snap and Facebook both investing in more immersive video, while also making hardware investments in this space. However, they’ve chosen different focal points for their hardware:

  • Facebook is encouraging people to use their smartphones to capture 360° photo and video, but has chosen to make its hardware investment on the consumption side (Oculus)
  • Snapchat has made a hardware investment in a capture device for 115° video, but the consumption will happen on smartphones.

That reflects a broader strategic focus for each company, with Facebook focused not just on video but on owning the next big platform after missing out on owning smartphone hardware and operating systems, while Snapchat is redefining its identity (see below). Neither company, obviously, is precluded from eventually moving into the other hardware space over time either.

Snap Inc, the camera company

While speaking at a Columbia University startup event in April, Evan Spiegel first began referring to Snapchat as a camera company, and that was now obviously a setup for the Spectacles launch, which has been in the works for at least two and a half years, and Snap Inc has embraced this tagline as its official self-description now too. This redefinition makes sense – there have always been several ways to look at Snapchat: a content company, a social company, an app company, or a camera company. Of those, three still make sense as descriptors after the Spectacles announcement, but what Snap clearly doesn’t want to be seen as anymore is just an app company. But the camera identity makes in some ways the most sense – it’s the first thing users see when they open the app, and snapping and sharing pictures and video is clearly the central purpose of the company.

One of the things Snapchat has done amazingly well since its founding is evolving out of its original narrow pigeonhole into something much broader. Though known in its early years mostly for the ephemeral nature of the content shared through the platform, and thereby gaining a reputation as being somewhat shady, its identity is now very different. The additions of Stories, Discover, Lenses, and a variety of other features has turned it into something much broader, which consequently captures much more of its’ users time. Spectacles, though, are arguably the first addition to the portfolio that isn’t in and of itself about getting users to spend more time in the app, and that’s interesting.

Inevitable comparisons to Google Glass

You can’t launch a video-recording pair of glasses in today’s world without drawing comparisons with Google Glass. But the target demographic, the price point, the design, and the intent are all very different for Spectacles compared with Glass. In addition, the Snap team had the benefit of learning from what went wrong with Glass.

It’s also interesting to think about where the Spectacles technology came from – thanks to the Sony email hack, we know that Snapchat acquired Vergence Labs in March 2014 for around $15 million. Vergence sold video-recording eyeglasses under the Epiphany Eyewear brand, and actually launched before Google Glass. But there were some important differences between EE’s glasses and what Snap has now launched:

  • The price ranged from $300-500 based on storage, versus Spectacles at $130
  • The glasses required a USB connection to plug into a computer for uploading videos to a proprietary hub, from which content could be shared to various social networks, versus sharing over Bluetooth or WiFi direct to a phone running the Snapchat app
  • The glasses had a subtler design, with just one camera discreetly tucked in the corner, versus Spectacles’ yellow-rimmed cameras in both corners.

Interestingly, though, Vergence had this quote on its website when asked about the differences versus Google Glass: “Glass appears to have a few more “electronics features” and we have more “eyewear features”.” This is a great summary of the difference between Snap’s Spectacles and Glass too – the former is a pair of sunglasses that records video, while the latter was technology strapped to your face.   There’s definitely much less of a cyborg vibe to Spectacles. The Spectacles do own their role as cameras – those yellow rims are clearly intended to highlight the presence of the cameras, and lights will further highlight when you’re actually recording. Snap has obviously learned from the privacy concerns around Glass.

Why hardware?

The biggest question in mind throughout all this has been why Snapchat would undergo this transformation from an app company to an app plus hardware company, because that’s a tough transition to make. Consumer electronics involves industrial design, manufacturing, shipping and retail, break-fix capabilities, and much else besides, which an app company never needs to worry about. The business model is very different too – the incremental cost of serving an additional user with an app is close to zero, whereas the incremental cost of selling another unit of hardware is significant. Moreover, the vast majority of Snapchat’s end users have never paid it any money for anything in the past, and will now be asked to stump up $130. Given that for many of Snapchat’s users, their disposable income is probably best described as pocket money rather than a salary or even wages, that’s probably a tough sell.

Two obvious reasons present themselves: business model and differentiation. On the former front, Snapchat’s main business model has been advertising, so hardware revenue can provide a useful additional revenue stream while also hedging against any future challenges in driving ad revenue. But a proprietary camera also allows Snapchat to differentiate itself in much the same way its software Lenses already do. The Spectacles have a unique field of vision and video format, which in turn will be uniquely available in the Snapchat app, and that’s not to be underestimated.

Having said all that, we’re likely talking about a small production run here, which means the risks involved will be limited. If the product takes off, Snapchat can presumably churn out tens of thousands and make lots of money. If it doesn’t, it won’t hurt its financial performance too much (though the big bet on changing the name and identity of the company may look a little hubristic later if that’s the case). The big question is whether Snapchat can actually make money selling these glasses at $130 a pop, when Vergence Labs was selling their predecessors for more than twice that, and Snap’s version has two cameras and two wireless chips.

It’s also interesting to consider what else Vergence Labs was working on at the time of the acquisition – there were three future projects listed on the website at the time: smarter transition sunglasses, a HUD for heart-rate tracking during exercise, and an AR application. Those and others (especially given the dual cameras) are possible future directions for Snap’s glasses efforts too.

The Problem With a Twitter Acquisition

As I’ve said before, I’m both a heavy user of Twitter and a critic of the way it’s currently being run. The lack of growth and the slow pace of change to the product are closely intertwined, and neither is good for Twitter in the long run. (See here for all my past writing on Twitter.)

Because of the slow growth and diminishing expectations of Twitter’s eventual size as a business, the share price is tanking, and that’s raising the prospect of an acquisition (recently, of course, the very prospect of an acquisition has been fueling a rise in the stock price).

Recode had a nice piece a while back breaking down the potential acquirers and arguing for and against each of them, with Kara Swisher and Kurt Wagner taking it in turns to present the pros and cons of each. My summary of that piece was as follows:

There’s a fundamental problem with all the potential acquirers, and that’s that none of them seem likely to do anything meaningful to solve the product problem. Among the potential acquirers are several companies who could create substantial synergies with their own existing ad businesses, including Google and Verizon. Others could do interesting things with the data. But none of them have the kind of track record in consumer social products that gives me any kind of reassurance that they would do better in evolving Twitter as a product than the current management. Let’s review:

  • Google – famously inept at creating successful social products, more likely to acquire Twitter with the intent of finally fixing its own social challenges than to add meaningfully to Twitter’s abilities in this area. Decent ad synergies though.
  • Salesforce – literally no experience in consumer-facing products. Yes, it recently acquired Quip and with it founder Bret Taylor, but one executive isn’t enough. Again, some interesting synergies in other areas, but zero on the end user product side.
  • Verizon – another play for ad synergies, when taken together with AOL and Yahoo (assuming the latter goes through now that the hack has been exposed). But Verizon has no history with successful web or social products (and see Go90 for a recent example of a non-telecom product…).
  • Facebook is probably the only example among those frequently cited that obviously does get social, but it seems so much more likely to be successful in aping Twitter’s features than as an acquirer, not least because of possible regulatory barriers, that this just seems plain unlikely.
  • Microsoft and Apple also seem unlikely. The former has done some interesting things with small app acquisitions lately in the productivity space, but not in true consumer apps, and again has no social chops at all. The argument for an Apple acquisition also seems thin, while it vies with Google for the title of least socially adept consumer technology company.
  • Private equity buyers would have the advantage of doing the turnaround work in private without having to report to public shareholders quarterly. But that only makes me worry that there would be even less urgency about the product changes that need to take place.

In short, the prospects for an acquisition that would actually help solve the fundamental product problems seem very poor indeed. Add to that the inevitable turmoil and further delays in execution caused by the acquisition process itself, and I’m still more hopeful that Twitter will finally get its act together as an independent entity rather than be acquired. It’s just too hard to see things getting better rather than worse under an acquisition scenario.

Refocusing the Apple Watch

As part of my media comment on the Apple event, I talked a little about how Apple has rethought the Watch since its initial introduction two years ago. That thought deserves a deeper dive, and although we did discuss it a little on the Beyond Devices Podcast this week, I wanted to elaborate here. The word that I keep using in talking about what has changed is that Apple has refocused the Apple Watch, and it’s done that in two ways:

  • It’s refocused the feature set of the Watch
  • It’s refocused the Watch portfolio.

Refocusing the feature set

When it comes to the feature set, Apple famously introduced the Watch with an echo of the original iPhone announcement, with a tripartite identity:

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

Though the health and fitness companion came last on that list of three, it’s rapidly risen to the top in terms of how Apple talks about the device today. Tim Cook referred to it this week as “the ultimate device for a healthy life.” Meanwhile, the communication aspects (represented in that second bullet point above) have faded into the background, barely mentioned in this week’s keynote.

But the other thing that’s been de-emphasized in the refocusing of the Apple Watch is apps, and that’s because apps just haven’t worked on the Watch. In September 2015, Tim Cook described what I refer to as Apple’s playbook for hardware devices in the iPhone era, with a set of bullet points:

  • Powerful Hardware
  • Modern OS
  • New User Experience
  • Developer Tools
  • App Store.

It’s clear that, both at its initial unveiling and a year later, Apple saw the Apple Watch as another product that fit this model, under which developer tools and the App Store would be critical to its success. I argued at the time that it would have been impossible for Apple to introduce a new piece of hardware in 2015 which didn’t tap into the App Store model, and yet I’m no longer sure of that view. Apps have largely flopped on the Watch. The reasons are simple – the hardware has been underpowered, and under watchOS 1 in particular apps were too dependent on the phone. But even in watchOS 2, Watch apps were too slow to load, because they didn’t maintain state and didn’t update in the background.

WatchOS 3 is intended to fix at least some of these issues, and the CPU and GPU upgrades in Series 2 of the Watch are aimed to improve app performance too. But Apple still didn’t make apps much of a focus at this week’s event. In other words, even with these potential enhancements to app performance, Apple is still focusing most of its messaging around the Watch on fitness features. I suspect that, instead of saying “this time we really got it right” after versions 1 and 2 fell short, Apple is going to quietly give developers time to figure this out, and then perhaps next time around we’ll see a renewed emphasis on how apps are adding value to the Watch. Pokemon Go and other high-profile apps may well help with this effort, but Apple is trying very hard not to oversell it this time around, and I think that’s smart. This particular form of crying “Wolf!” is running dangerously close to falling on deaf ears at this point.

The Apple Watch Hourglass

What I think we may see as a result is a sort of hourglass on its side, as in the diagram below:

apple-watch-hourglass

The Apple Watch started out trying to be another micro computer. But Apple has now narrowed the focus to mostly being a great timepiece and an increasingly capable fitness device. In time, though, as the apps enhancements kick in and Apple works on other areas like Health in more depth, we may well see the purpose and positioning of the Watch become more expansive again.

The near-term implications of that are important to note: this means the addressable market for the Watch for the time being is mostly about a combination high-end fitness tracker and digital watch, rather than the broader “small computer” market which the iPhone and iPad arguably inhabit, and which is enormously larger. This, in turn, means that the Watch is likely destined for modest, incremental growth over time, rather than the sort of explosive growth that characterized both the iPhone and iPad in their early years. But as Apple begins to think about the Watch more expansively again, so the addressable market will begin to expand, and the sales potential of the Watch will grow with it.

Refocusing the portfolio

The original Apple Watch portfolio had three distinct tiers, with the Watch the core tier, the Sport the less expensive aluminum version, and the Edition the high-end luxury version, with prices to match. The price ranges for this original portfolio are shown in the chart below:

Apple Watch Pricing April 2015

Two important things to note: the enormous separation between the Sport and Watch versions on the one hand and the Edition on the other, and the sheer height of the Edition portfolio’s pricing, topping out at $17,000. That’s a 48:1 ratio between the most expensive and least expensive Watches.

Fast forward a little over a year and you have the new portfolio announced this week, with a slimmed-down Apple portfolio and two partner versions of the Watch as well. For comparability with the chart above, here’s a view of the new pricing to the same scale:

apple-watch-pricing-september-2016-scale-20k

And here’s a version with a scale that makes more sense for today’s Watch pricing (note that the axis tops out at exactly a tenth the price of the axes above):

apple-watch-pricing-september-2016-scale-2k

First things first: Apple has basically eliminated its ultra-luxury Watch Edition models. The only model that has this designation now is the white ceramic Watch, but that’s priced at roughly a tenth of the original Editions. The new price ratio, including the Hermès Watches which actually top out slightly higher than the new Edition watch, is roughly 5.5:1 from most to least expensive. It’s also worth noting that the three Apple ranges are still mutually exclusive but now more or less touch each other — there are no more big gaps in the portfolio, even at the high end. The Series 2 aluminum Watches, starting at $369, pick up just above where the Series 1 Watches leave off at $299, while the Edition hits at $1,249, again just a little above where the Watches peak, at $1,099. The Edition branding still connotes exclusivity and premium materials and therefore satisfy the conspicuous consumption angle, but Apple is now targeting the low end of high-end watches rather than true luxury watches.

Apple now also has its two key Watch partners, Hermès and Nike, to fill in gaps in the portfolio. It’s interesting that we’re seeing these partnerships so early, but I suspect this is another sign that Apple recognizes the nature of this market and its growth prospects. What Apple is doing here is diversifying the portfolio by feature and function early in order to better saturate the smaller addressable market.

Beyond Devices Podcast

If you enjoy these posts, you’ll probably enjoy the Beyond Devices Podcast, in which Aaron Miller and I discuss events like this week’s Apple announcements, as well as other topical issues, and also answer questions about trends in technology.

Our most recent episode is embedded below, and you can find all past episodes on our website, on iTunes, on Overcast, and in other podcasting apps.

Apple’s Headphone Transition Marries Pragmatism and Vision

Today’s Apple event was notable for the fact that so much of what was to be announced had leaked ahead of time. On paper, that left very few surprises for the event itself, but of course what the supply chain leaks can never supply are the reasoning and narrative around new product announcements. And so during today’s event in San Francisco, it’s the storytelling around the changes that I was most curious about, and nowhere more so than around the death of the 3.5mm audio jack.

In the end, the way Apple is handling this transition is a mixture of pragmatism and vision. Normally, you’d want the vision first and the details second, but I think Apple made the right call here in getting the practicalities out of the way first.

Pragmatism first

The biggest risk with the elimination of the headphone jack was that for the first time a new iPhone would feel like a downgrade rather than an upgrade. The minimum bar Apple therefore had to clear here was to achieve feature parity between previous iPhones and the iPhone 7. As a practical matter, that meant giving people an option in the box that matched the functionality of what had previously come in the box, and that meant providing both Lightning EarPods and a Lightning-to-3.5mm adapter.

Jason Snell joked recently that…

it’ll cost $19 if Apple’s sort of sorry, $29 if it’s not sorry, and if it’s free in the box then Apple’s really afraid of consumer backlash.

Of course, in the end, the adapter is free in the box, but that’s a sign of how much Apple wants (needs) this transition to go smoothly. It’s a transition driven by a vision, but it’s a long-term vision and in the short term Apple doesn’t want to lose any customers over it.

Vision second

So what is the vision here? Both Phil Schiller (in person) and Jony Ive (in disembodied voiceover) helped articulate it at the event. Here’s Schiller:

When you have a vision of how the audio experience can be, you want to get there as fast as you can and make it as great as it can be. And we do have a vision for how audio should work on mobile devices. And that takes us to our next feature: Wireless… it makes no sense to tether ourselves with cables to our mobile devices. But until someone takes on these challenges, that’s what we do. Our team at Apple has worked so hard to create something new that delivers on the opportunity of how good a wireless experience can be. That is why today we are so excited to show you a new product from Apple called Apple AirPods.

Ive encapsulates it even more succinctly:

We believe in a wireless future. A future where all of your devices intuitively connect.

If the iPad Pro is “the clearest expression of [Apple’s] vision of the future of personal computing”, then AirPods are the clearest expression of Apple’s vision of the future of audio on mobile devices. And the way AirPods pair to an iPhone is the best illustration of this future — here’s a tweet I posted with a short demo video from the hands-on area at the Apple event:

As you can see from the number of retweets and likes, that tweet struck a nerve. The pairing UX here is so much better than any Bluetooth pairing experience any of us have ever had before, and is the perfect instantiation of Ive’s comment about a future where all of your devices intuitively connect. It’s also a uniquely Apple experience, marrying hardware and software (and a proprietary wireless protocol) seamlessly in a way that creates a tightly integrated experience. Yes, it breaks the link with standards, but that’s classic Apple too, and it still leaves the door open to standard Bluetooth accessories connecting to the iPhone.

The vision is expensive — for now

The big problem with the vision? The $159 price tag. I’ve said all along that I was hugely skeptical that Apple would ship wireless EarPods in the box, and the biggest reason was that doing wireless right is enormously more expensive than doing wired right. Moreover, if Apple were trying to push a vision of wireless, they’d want to create something that wasn’t just good enough but truly outstanding, and that was never going to be possible at anything like the same margins as bundling EarPods that retail for $29.

In the end, of course, that’s turned out to be right — $29 Lightning EarPods are in the box along with an adapter that costs $9 when purchased separately, but the AirPods are $120 more than their Lightning predecessors. AirPods and wireless may be a vision of the future, but in the here and now they’re a little on the pricey side. This is where the pragmatism comes in — Apple had to use Lightning as a stopgap until such a time as the wireless future comes down significantly in price.

For those that want the future today (or in October, at any rate), there are AirPods and a range of W1-compatible Beats accessories ranging from $149 to $299. For the rest of us there are third party standard Bluetooth options and the Lightning EarPods. But I’m happy to bet that a couple of years down the line the price of headphones and earbuds using the W1 chip comes down signficantly to the point where the Lightning option is no longer necessary.

The Death of Project Ara Signals a Return to Adult Supervision at Google under Ruth Porat

Julia Love at Reuters reported Thursday night that Google has suspended Project Ara, which was its modular phone initiative, as part of a broader tightening of the belt across Google’s hardware business.

On the face of it, the failure of Ara isn’t surprising at all — along with many others, I’ve expressed skepticism throughout its life that it would ever come to anything. All that’s really surprising is the timing of its end of life, coming as it does just a few months after a big push around Google’s I/O developer conference.

To my mind, though, this is the latest in a series of moves that suggests some measure of “adult supervision” is returning to Alphabet and Google through CFO Ruth Porat. I’ve written a bit about this previously, but it’s come into a new focus for me over the last week or two.

By way of context, it’s worth going back and remembering where that “adult supervision” phrase came from. As Steven Levy and others have recounted, at pre-IPO Google, there was a sense among investors that Larry and Sergey weren’t the best fit for running a public company — they were too zany and undisciplined. As far as I can tell, Kevin Gray was the first to quote the adult supervision line in a February 2012 piece for Details called The Little Engine that Could:

LAST AUGUST, IN A SIGN THAT GOOGLE WAS APPROACHING MATURITY, Page and Brin relinquished management to famed Silicon Valley suit Eric Schmidt. “We were looking to not screw this up,” says Brin as we dig into smoked salmon and pepper-crusted top sirloin on a sun-filled porch outside the company cafeteria. The noodling strains of Jerry Garcia play in the background. “Basically, we needed adult supervision.” Brin adds that the board of directors, two of whom belong to their VC team, “feels more comfortable with us now. What do they think two hooligans are going to do with their millions?”

In a 2014 piece about the launch of Eric Schmidt’s book about running Google, he was quoted on what this adult supervision looked like:

“My instincts were always to manage to what we have; theirs was always to what is possible,” Schmidt said of the founders. “The latter is a better way to lead.”

Of course, Schmidt had given up this leadership in 2011, and famously re-used the adult supervision line in announcing the change:

What’s interesting about Ruth Porat’s arrival is that she seems to have brought some of this adult supervision back, but with a different flavor. The focus of her efforts — as befits someone who came from the investment banking world — is financial discipline. In some ways, it hearkens back directly to that quote from Sergey Brin above — she’s there to ensure that the “hooligans” don’t screw up with other people’s millions.

And there’s the rub: Larry Page and Sergey Brin have always been defined by their vast ambition and their desires to defy the odds and shoot for the moon (to the extent that Alphabet has a whole division devoted to “moonshots”). Schmidt’s natural tendency was to temper that magical thinking and bring it back down to earth. Though with rose-tinted hindsight in 2014 he praised their approach over his own, I suspect his approach won out a lot.

Under Ruth Porat, however, it seems the adult supervision has been more rigorous, especially when it comes to financial excess. Schmidt’s approach seems to have been about letting Page and Brin get away with as much as possible without really screwing up the company, while Porat’s approach seems to leave far less latitude. In that earlier piece I cited the sale of Boston Dynamics and the belt-tightening at Nest as evidence of a financial clampdown, but in the past two weeks we have the cuts at Google Fiber and now the death of Project Ara as further data points.

Grand ambition is admirable, as is attempting to defy the odds and prove the naysayers wrong. But such a mindset still has to be grounded in reality, and those who think this way still need to know when to give up. In the past, Project Ara might have run for much longer before being killed off, but it seems the new era of adult supervision at Alphabet will give such projects a much shorter leash. On balance, that’s probably a good thing.

A Different Way to Think about iPhone Upgrade Cycles

The context for next week’s Apple event is one of a maturing smartphone market, in two key ways: the devices themselves are becoming more polished, more reliable, and in many ways “good enough” even several years after purchase; and the market in developed economies is becoming saturated. This double-faceted maturity is causing smartphone sales – and especially premium smartphone sales – to slow and even to drop in markets like the US.

As such, it’s interesting that the three major threads in reporting about the new iPhones Apple will announce next week are:

  • Keeping the same general design as the iPhone 6 and 6s
  • Eliminating the 3.5mm headphone jack
  • Introducing new cameras, with the best only available on the larger device.

Of these three threads, two may be considered inhibitors to upgrades – however it’s positioned, the removal of the audio jack is likely to give some people pause, and the lack of a new design is also likely to make some people want to wait until the form factor changes next year. Among these three, only the camera improvements are a clear potential driver of upgrades, but the impact may be muted when it comes to the smaller device, and again those preferring that size may decide to pass this time around.

That seems like the obvious conclusion to draw from the reporting so far about next week’s event, if you focus on the likely hardware changes this time around. For context, here’s a table showing past annual iPhone hardware and software upgrades (you might need to click to enlarge it):

Annual hardware and software upgrades

Note that I’ve necessarily simplified the lists of upgrades to focus on a few – the actual laundry list of big and small features would be much longer for each year. The point is, though, that each new iPhone comes out of the box with both new hardware features and new software features relative to the previous version. The software features are, of course, also available to those who keep their devices of recent vintage through iOS updates.

What Apple observers – especially in the press – tend to focus on is the annual hardware upgrade. That makes perfect sense – it’s what’s new, and it’s also what’s unique to the experience of buying that device over keeping last year’s. But of course the default upgrade cycle isn’t annual but biannual – the most common timeframe for upgrading an iPhone in the US and many other markets is every two years, not every year. Certainly there are those who upgrade every year, and those who upgrade on a longer cycle, but in terms of averages the mode duration is two years, and the mean is in that ballpark too.

That rather changes the picture in terms of thinking about the hardware upgrade cycle, so let me introduce a second chart that illustrates how this makes a difference:

Two year upgrade cycles

Apple doesn’t generally talk about specs like processor speed or RAM, but I’ve included them because they’re the simplest illustration of the behind the scenes improvements made in each new iPhone. The key column in that table is the last one, because it is a much better indication of the hardware upgrades iPhone users upgrading every two years will see when the buy a new phone. This column combines the hardware improvements made in both the subsequent devices, all of which are present in the new phone.

Let’s go back to next week’s event. Apple will introduce what we presume will be the iPhone 7 and 7 Plus, with camera improvements, behind the scenes speed upgrades, and possibly some surprise features that simply haven’t leaked. But even excluding all of that, anyone upgrading from an iPhone 6 from two years ago will get:

  • 3D Touch
  • Live Photos
  • 4K video recording
  • Faster Touch ID
  • Noticeable speed improvements.

That’s already quite a bit – now add in camera improvements and whatever else is new in the iPhone 7, and it suddenly becomes a pretty compelling upgrade. This is the way to think about the iPhone upgrade cycle and what Apple announces next week. Apple tends not to talk about this, and it doesn’t tend to recap all the new features that were already in last year’s phones, but all that absolutely matters to the typical customer upgrading on a two-year cycle. And that’s why I suspect Apple may be able to get away with this departure from its normal upgrade cycle and the risks it’s taking with keeping the form factor from the iPhone 6 and 6s and ditching the headphone jack.

For more on all this, and a general preview of the Apple event next week, you might want to listen to this week’s episode of the Beyond Devices Podcast, which is also embedded below:

EU Apple image

Apple and the EU

Apple and the EU

This morning’s EU action against Apple wasn’t a complete shock — the Financial Times previewed the substance yesterday, though not the amount. Regardless, just as they have in the past claimed expertise of patent law, encryption, automotive manufacturing, or the jewelry market, today everyone who covers tech is suddenly an EU tax expert.

In talking to the reporters who’ve approached me to talk about this today, I’ve tried to avoid diving into that fray. The complexities of the tax arrangements described in the EU press release are dizzying, but represent just a summary of what’s an intricate set of financial arrangements intended to allow Apple to carry out its European tax strategy. None of us not trained in EU tax law should attempt to draw conclusions about the specifics of the accounting structures here. We’re simply not qualified. Apple and the Irish authorities – both of whom obviously have very competent people on staff – have apparently reached different conclusions here from the EU’s staff, and they’re all experts.

But it is possible for non-experts to have an opinion on the reasonableness of the approach the EU is taking here. Apple has acted in good faith throughout, working with the Irish authorities to secure “comfort letters” assuring the company that its behavior was appropriate and conformed to applicable laws regulations in place at the time. The EU now wants to come in after the fact and change the basis on which Apple should be taxed in a key European jurisdiction.

The period in question is 2003 to 2014, meaning that the EU wants to reverse the basis on which Apple paid taxes in Ireland up to thirteen years ago, under agreements that were first made in 1991. If the EU objected to these arrangements then, it should have investigated them then, and not have waited until so long after the fact to look into them. But of course Apple wasn’t nearly as big a target then (or even in 2003) as it is now, and this is where the politics come in.

Apple has, of course, long communicated its approach to this issue. Since its products are conceived and designed in the US, and its software built here, it should pay the bulk of its taxes in the US. It doesn’t consider the current US tax regime favorable, and so has chosen to maintain much of its cash and other liquid assets overseas until such a time as it makes financial sense to repatriate it. But as its investor FAQ on the topic makes clear, it has “previously accrued U.S. taxes related to the income in question.”

This is the key point here — I’ve seen Apple’s European tax strategy described as one for tax avoidance, but this isn’t actually about avoiding paying tax (though it — like all responsible companies — pays the minimum amount possible under applicable laws). It’s about Apple choosing to pay taxes (the full amount due) in the appropriate jurisdiction. Apple will eventually have to pay taxes on the full amount earned in Europe and elsewhere in the world, but it believes that the US is the proper jurisdiction in which to do so. There’s currently a lot of that money overseas on which it hasn’t yet paid taxes, but it won’t escape taxation entirely or indefinitely.

Ultimately, this case — like so many others – comes down to your perspective and preexisting notions. If you’re inclined to believe that big US tech companies don’t pay enough taxes in Europe, this likely confirms that view and makes it official. On the other hand, if you’re more inclined to believe that the EU uses its various investigations as a way to handicap big US tech companies who are more successful than European equivalents, there’s more evidence here for you too. None of this is settled yet, and we’ll have years of court cases before this is decided, but even in the short term I suspect we’ll see lots of non-European companies rethinking their investment strategies for the EU in light of the ruling.

Five Years of Tim Cook’s Apple in Charts

This week marks the fifth anniversary of Tim Cook’s appointment as permanent CEO at Apple – he was appointed CEO on August 24th, 2011. As a result, we’ll no doubt see quite a few retrospectives this week looking back over his time at Apple, and evaluating his tenure. As context for that analysis, I wanted to share some numbers about Apple in the quarter and year before he took over, and compare it with numbers for the quarter and year ending in June of this year. Not all the applicable data sets go back that far – Apple has changed its reporting segments in at least a couple of ways during this five year period, but we’ll mostly try to compare before and after as closely as possible.

Note: here as in all the analysis on this blog, I use calendar quarters rather than companies’ fiscal quarters for analysis for ease of comprehension by those not familiar with companies’ fiscal calendars – hence, Q2 2016 is the June quarter recently ended and reported. Many of the charts shown here are part of the Apple quarterly deck which is available as part of the Jackdaw Research Quarterly Decks Service, which you can read more about here. The underlying data is also available on a custom basis as either a one-off delivery or a quarterly service – please contact me for more information.

P&L measures

Let’s start with the corporate income statement. By any measure, Apple is simply a lot larger than it was five years ago. Here are trailing 4-quarter revenues:

Trailing 4 quarter revenue 560

Revenues in the four quarters before Tim Cook was appointed were $100 billion, whereas in the last four quarters they were over $200 billion. However, as you can see from the chart, it hasn’t been an inexorable rise up and to the right. Revenues grew very strongly in that first period, then began to level off somewhat throughout 2012 and 2013, then spiked following the iPhone 6 launch. And of course over the past year revenue growth has been negative for the first time in many years at Apple. The overall effect is still a more than doubling of total revenue, but the current trajectory is negative. As I’ve written previously, I continue to believe that we’ll see a reversal of this trend in the next few quarters as a combination of factors kicks in, but I’m betting Tim Cook would have rather his 5 year anniversary would have fallen either side of this lull instead of in the middle of it.

Meanwhile, margins have been up and down over time, with a bump in the early part of Tim Cook’s time at the helm, followed by a drop down to slightly lower levels, a steady rise, and then a drop off again:

Trailing 4 quarter margins 560

The ups and downs here largely correlate to overall growth rates for Apple, with higher revenue growth rates driving higher margins for a time as cost expansion takes a while to catch up with revenue growth, only to fall again as growth slows. On operating and net margin, Apple has ended these five years slightly below where it started, whereas on gross margin it’s in more or less the same place. But it’s worth noting that dollar profits are still way up on where they were, and that’s the metric that Apple and its investors are likely more focused on:

Trailing 4 quarter operating income 560

Yes, there’s the same up-and-down pattern, but again operating income on a twelve-month basis is roughly twice what it was five years ago over the past year.

R&D spend has ballooned

The only other line from the income statement I want to zero in on is research and development spending, because there’s been a fairly dramatic change here over the past five years. Here’s total R&D spend in dollars on a twelve-month basis, and spending as a percentage of revenue:

Trailing 4 quarter R and D spend 560 Trailing 4 quarter R and D spend as percent 560

R&D spend was under $2.5 billion the four quarters before Tim Cook took over, but it was almost $10 billion five years later, a roughly fourfold increase. And that’s not just because Apple’s revenue has grown during that time – R&D has actually grown significantly as a percentage of revenue over the same period, going from just over 2% to just over 4%, or almost doubling as a percentage. That’s interesting, because R&D actually fell fairly consistently as a percentage of revenue during most of Steve Jobs’ second stint as Apple CEO, from a peak of 8% in 2001 and 2002 all the way down to 2% just before Cook took over. That’s largely a function of the massive iPod- and iPhone-driven revenue growth during that period – dollar R&D spend rose from around $400 million a year to over $2 billion a year during the same time period – but it’s interesting to note that Cook has reversed the trend and significantly increased R&D spend even above and beyond the rate at which revenue has grown. Interestingly, that 2 percentage point increase in R&D spend is roughly equal to the 2 percentage point drop in margins during the Tim Cook era.

The cash hoard grows

The other major corporate financial metric that’s worth a quick look is cash. Apple’s cash and investment assets have grown enormously over the past five years, as the two charts below show:

Cash metrics 560Cash metrics two quarter only 560

The starting and ending totals are easier to see in the second chart, but the steady growth is perhaps easier to see in the first. Regardless, Apple ended calendar Q2 2011 with a total balance of cash and investments of $76 billion, while it ended Q2 2016 with a balance of $231.5 billion. In other words, it has added over $155 billion to its coffers over this time. Meanwhile, an increasing proportion of this cash and investments has been held overseas – the percentage was 63% five years ago, but was 93% at the end of Q2 2016.

Of course, the other cash-related metric worth noting during the first five years of the Cook era is the way Apple has been using that cash to pay dividends and buy back stock. Steve Jobs famously refused to pay dividends, but around a year into his tenure, Tim Cook instituted both these programs to return cash to shareholders. As of April of this year, Apple said it had “returned over $163 billion to shareholders, including $117 billion in share repurchases.” That makes the increase in its overall pile of cash and investments all the more remarkable.

Unit shipments are up for iPhone, less so for other products

One of the most interesting things to look at in regard to the last five years is what’s happened to unit shipments for Apple’s three major product lines. The long-term trend is shown in this first chart:

Trailing 4 quarter unit shipments 560

Again, we’re all familiar with the trajectory of iPhone sales over recent years, so let’s be brief here. It’s worth noting that Tim Cook’s appointment coincided with the decision to move the launch date for new iPhones from June to the Fall, with the iPhone 4s launching in October of 2011. That explains the flat part at the beginning of the iPhone chart above. Following that shift, though, the iPhone saw strong growth in 2012 and 2013, but began to flatten out, only to spike in late 2014 and into 2015 thanks to the iPhone 6, then slumping a little in late 2015 and the first half of 2016. But again, it’s worth looking at the total numbers here. Apple shipped 69 million iPhones in the four quarters to Q2 2011, and shipped 214 million in the most recent four quarters. That’s a massive expansion of Apple’s business here, despite the recent lull (shipments peaked at 231.5 million on a twelve month basis in Q4 2015).

It’s also interesting to note that Apple has shipped 859 million iPhones during the Tim Cook era, compared with just 130 million in the pre-Cook era. In other words, roughly 87% of the almost one billion iPhones Apple has ever sold have been sold during Tim Cook’s time as permanent CEO.

What’s almost more interesting, though, is what’s happened to Mac and iPad sales, which performed roughly the same in the most recent quarter as they did five years ago:

Unit shipments for two quarters 560

As you can see, both Mac and iPad sales were up just a few hundred thousand on those from five years earlier, despite the doubling of iPhone sales over the same period. As the earlier chart shows, for iPads that’s because sales first grew significantly, peaking at 26 million quarterly and 74 million over twelve months in Q4 2013 and falling since.  Mac sales, too, have had better quarters than the most recent one, though the peak was not  much higher than today. Both products are due for something of a rebound in the coming quarters, as new Mac are (hopefully) finally introduced and the iPad Pro trend continues to help sales. And it’s worth noting that 300 of the roughly 330 million total iPads sold to date have been sold under Tim Cook, along with almost 112 million Macs.

Of course, we don’t have official shipment numbers for the Apple Watch, though there are various estimates out there. But it would be inappropriate to skip over that product entirely – it was the first brand-new product introduced in the Tim Cook era, and likely sold around 15 million units in its first year on the market. That’s a much faster run-rate than the iPhone, but down a little at this point on iPad sales in their first year. But it’s interesting that, as Tim Cook marks his five year anniversary, we’re seeing another product whose launch timeframe is being moved from the first half to the second half of the year, causing something of a lull in sales in the meantime.

A changing mix of segment revenues

All that movement in unit shipments obviously flows through to product revenues too. The revenue split by segment has changed fairly significantly over Tim Cook’s tenure. Apple’s financial reporting by segment has also changed over the last five years, with the iPod no longer separated out as its own reporting line, the Accessories bucket being merged with iPod, Apple Watch, Apple into “Other Products” and “iTunes, Software, and Services” becoming just “Services”. In the chart below, I’ve collapsed these segments for comparability:Revenue split by segment 560

The iPhone, which was already a very significant portion of Apple’s overall revenue, has only become more dominant over the past five years, rising from 45% of revenue in the twelve months to Q2 2011 to 64% in the year to Q2 2016. But other components have also risen or fallen – iPad has dropped from 16% to 9% and Mac from 20% to 11%, while the combination of iPod, accessories, and various other hardware products has dropped quite a bit too. The only other segment that’s risen as a portion of the total during this time – despite the rapid growth of iPhone revenues – is Services. An increase from 9% to 10% of revenue doesn’t look like much, but it’s much more impressive when you look at the dollar amounts instead:Trailing 4 quarter Services revenue 560

What’s now the Services segment has grown from under $10 billion in the twelve months to Q2 2011 to well over $20 billion in the most recent twelve months, with the trajectory actually steepening in recent quarters. Yes, it’s still just 10% of total revenue over the past year, but it’s actually Apple’s fastest-growing segment at the moment.

The other interesting thing to look at in the context of segment revenue is the difference between unit shipments and revenue performance, which is driven by changing average selling prices (ASPs). You can see it a little in iPhone revenues:

Trailing 4 quarter iPhone revenue 560By now, that iPhone trajectory should be familiar, but it’s worth noting the growth – from just over $40 billion on a twelve-month basis to $140 billion. It’s subtle, but the 3.1x growth in shipments has translated into a 3.5x growth in revenue, and that’s largely down to ASPs. Here are average selling prices on a trailing 4-quarter basis for the three major product lines at the beginning and end of Tim Cook’s first five years – note that because of changes in reporting structures I’ve used Q3 rather than Q2 2011 as the starting point here:Trailing 4 quarter ASP 560

As you can see, iPhone ASPs have risen over the five years despite the increasing maturity of the product and the introduction of two cheaper models (the iPhone 5c and more recently the iPhone SE). Mac ASPs have dropped, but only slightly, while iPad ASPs have dropped fairly significantly, driven by the launch of the iPad Mini in 2012 and the increasing tendency to keep older devices in the lineup for longer at lower prices. But something interesting has been happening to iPad revenues in recent quarters, even as shipments continue to fall year on year:

Trailing 4 quarter iPad revenue 560

This flattening of revenues, and the growth this past quarter, has been driven by the iPad Pro, which has raised ASPs considerably. iPad ASPs bottomed out at around $415 a year ago, but were $490 in Q2 2016, up $60 from Q1, putting them back at late 2012 levels.

 

 

Regional trends and the rise of China

One of the most dramatic changes at Apple in the Tim Cook era has been the rise of China as one of its two major markets. Here, again, unfortunately, we’re thwarted a little by a change in Apple’s reporting a few years back, in which it eliminated Retail as a separate segment and rolled it into the individual regions, so we’re going to use Q4 rather than Q2 2011 as our starting point, and for comparability we’ll use Q4 2015 as the end point. As such, we’re measuring a four-year rather than five-year period, but the changes are still very visible. Here’s the share of Apple’s revenue by region at those two points in time:Apple revenue by region 560

As you can see, Greater China has increased massively as a proportion of revenue over this period, going from 10% to 24% of revenues, while every other region has shrunk in percentage terms. In Q4 2015, Greater China contributed the same percentage of revenue as Europe. Looking at the dollar amounts is again helpful – here’s actual revenue by region for those two quarters:

Apple revenue in dollars by region 560

It’s worth noting first that every region has grown during these four years, but Greater China has clearly grown far faster than any other region, from $4.5 billion to over $18 billion during this time. That’s massive growth, and I’d say it’s one of Tim Cook’s great achievements during his tenure. It’s also clearly something he hasn’t given up on, given his recent frequent visits to China and the investments in Didi and in an R&D center to be built there. It’s also worth looking at operating income by geography, because here too China has made a significant contribution:

Apple operating income by region 560

Retail is far more international

I want to close out with Apple’s retail business, which gets less attention in Apple’s official reporting than it used to, since Retail has been wrapped into the regions, but is as important to Apple’s strategy as ever. And Tim Cook has been instrumental in expanding the Retail footprint, especially overseas, though Retail has also been the focal point of arguably Cook’s biggest blunder as CEO – the appointment of John Browett to run the business. However, Angela Ahrendts’ appointment seems to have more than made up for that mistake.

Here are a couple of charts about Apple’s retail footprint:

Retail stores by geography 560 Split of Apple retail stores by geography 560

At the end of Q2 2011, Apple had a total of 327 retail stores, of which 270 or 72% were in the US. By the end of Q2 2016, Apple had 488 stores globally, of which 218 or 45% were now overseas. Tim Cook’s time as CEO has seen Apple stores opened in seven new countries across four continents:New Apple Retail countries 560But of course it’s also seen a massive expansion in the number of Apple stores in China, which had 36 stores as of the end of July, up from single digits when Tim Cook took over.

Conclusions

I’ve deliberately made this more of a factual post than an evaluation of Tim Cook’s tenure – as I said up front, this week will see lots of this sort of stuff, and I’ve already talked to several reporters doing their best to sum up five years of work in a few hundred words. But I think it’s worth noting several things here, some of which I’ve mentioned in the text:

  • Apple under Tim Cook has sold far more iPhones and iPads than it ever did under Steve Jobs – 87% of total iPhones sold and 90% of iPads ever sold. Though Steve Jobs launched these products, it was always Tim Cook who ensured the supply chain met demand as well as possible, and it’s been Tim Cook who’s overseen the massive expansion in that supply chain over the last five years as the scale has grown to something unprecedented.
  • Tim Cook has made the decision to increase Apple’s spending on research and development not just in dollar terms commensurate with revenue growth but actually doubling it as a percentage of revenue during his tenure despite the massive growth in revenue. That reversed the trend under Steve Jobs, and the increased investment in R&D is roughly equivalent to the drop in margins during this time – Cook has made a massive bet on R&D and by implication on future products.
  • Cook has made China a special focus, and this focus has paid off in a big way, with a roughly fourfold increase in revenue from Greater China and an equivalent increase in operating income. Greater China has grown from 10% of revenues to roughly a quarter, and Apple’s retail footprint there has also grown dramatically. That growth in China has been a major contributor to Apple’s overall growth in the last five years, and Cook clearly remains committed to China as a focus for Apple as evidenced by his recent investments there. He’s begun to talk more about India and its potential, but I remain skeptical that India can be much more than a rounding error for Apple over the next few years.
  • Only one entirely new hardware product has launched under Tim Cook, and yet we have almost no official data to go on to evaluate the performance of the Apple Watch so far. Opinion remains divided about how to evaluate the Watch, but I’m on the side of those who considers it a modest success in Apple terms and a smash hit in the context of the market into which it was launched. Like the iPhone the year Tim Cook took over, it’s going through an interesting transition as its release moves from the first half to the second half of the year, but I suspect that like the iPhone in late 2011, the Watch is due for big growth in late 2016 and beyond.
  • I suspect the transformation we’ve seen in Services, driven largely to date by the App Store and latterly by Apple Music, is just the start of what we’ll see under Tim Cook. He’s already hinted several times at additional services to come, and TV is an obvious focus here. But I also think some of the rhetoric about Services has been overblown – it’s still only 10% of revenue, and unlikely to grow massively past that point unless Apple decouples services from its devices, which I think would be a mistake.

Perhaps one of the most significant contributions Tim Cook has made at Apple can’t be seen in any of these charts, because it’s about the changes to Apple’s culture that have happened under his leadership. The increased openness, best exemplified by the frequent interviews Cook and other executives now regularly grant to various publications (and even podcasters), is one element of this, though Apple’s secrecy about future products remains as tight as ever. But an increased sense of social responsibility, especially as regards the environment and contributions to social causes is another major change. This doesn’t have a direct financial impact, but it’s made a positive contribution nonetheless, and no evaluation of Cook’s tenure would be complete without a recognition of that fact.

Nougat Launch Highlights Android’s Slow Rollout

Google today released Android 7, codenamed Nougat. What this means in practical terms is that owners of recent Nexus devices can download and install the new version immediately, while the vast majority of Android device owners have to wait patiently for the update to be available for their device. This seems like a good time to revisit some of the stats around Android version adoption to put all this in context, because the reality is that it’ll likely be almost two years before even 50% of the base has access to the features in Nougat, while Nougat itself will likely never get above 40% penetration of the base.

For earlier posts on this topic, see:

Although those past posts have largely focused on the implications for developers, this time around I want to focus a little more on the implications for users.

Overview of Android version adoption

If you’re reading this, you’re likely familiar with how Android rollouts work, but here’s the process in brief:

  • Google finalizes and releases a new version
  • Device makers, who have had access to beta versions, work on customizing that final version to run on their various devices, incorporating their own software customizations, user interface elements, and so on
  • In the vast majority of cases, that updated software is sent to mobile carriers, who also have to spend time testing and approving the update
  • Once the device-specific version is approved by the mobile carrier, it is made available to users of that carrier.

The end result is a very slow rollout of new Android versions, when compared with, for example, Apple software releases, which are instantly available to all users everywhere on day 1, or even Microsoft’s Windows updates, which are available to consumers immediately at launch (although business users likely have to wait for their IT departments to approve and push out updates).

The history of what this process looks like in practice from a user adoption perspective is shown in the chart below:

Android Versions Overview 560px

I’ve grouped released into the major dessert-denominated categories so as to simplify things here. As you can see, there’s a clear pattern early on which morphs over time:

  • Early on (2009-2011), adoption quickly spikes to rates in the 60-70% range, falling gradually over time
  • Over time, the time to hit this milestone lengthens, but peak penetration remains similar (2012-2014)
  • More recently, peak penetration drops significantly, to around 40%, while the drop off happens more gradually too.

Let’s drill into all that a bit more. But first, a quick note on the quirks of how these versions have been released in the past. The chart below shows the gap in months between Android version releases, which has varied greatly over time:

Android Versions Months From Last Release 560pxEarly on, major new (“dessert”) releases showed up  every few months, with the C, D, and E releases following particularly quickly on each others’ heels, while the F-J releases came slightly less quickly, and the most recent releases have occurred a little either side of a year apart. It’s worth noting that the H release, which isn’t in the chart above, was for tablets only, while the I release converged the smartphone and tablet flavors, and also that the K release (KitKat) took a very long time to follow Jelly Bean, which as a result had that much more time to build a substantial base. This will be important context as we look at some of the trends below.

Peak penetration has fallen dramatically

To start with,  peak penetration rates – i.e. the maximum penetration of the Android base – have fallen dramatically with recent releases, as shown in the chart below:

Android Versions Highest Percentage 560pxThere are a couple of anomalies here, which mostly relate to the quirks of release timing and other details I just referred to. But in general it’s very clear that earlier releases hit peak penetration rates in the 60-70% range, while the two most recent releases have hit maximums of 41% and 36% respectively (Marshmallow hasn’t peaked yet).

Time to peak penetration is long

One of the reasons for the lower peak penetration rates is likely that adoption as a percentage of the base has been that much slower. The time taken to reach peak penetration has lengthened since those early days, despite the fact that peak penetration rates are lower. The chart below illustrates this:

Android Versions Months to Peak 560px

The pattern here is marred by a couple of outlier data points – notably the Gingerbread release, which took an unusually long time to reach peak penetration for an early release, and the Lollipop release, which did so quite quickly. But the trend is generally upward – early releases mostly took 10-12 months to hit their peak rates, while later releases have mostly taken 14-18 months to do so. That means releases often don’t peak until after a new version is released.

This is particularly striking right now, when Nougat is being released, but its predecessor Marshmallow is currently only the third most widespread version of Android, behind the two previous versions. The top version is actually the version from two years ago, while the next most popular version is the one from three years ago.Android Versions Ranking August 2016 560px

Put another way, the version of Android Google “released” in October last year is currently outranked by the version released in July 2012, as well as the versions released in October 2013 and November 2014. And of course that will be the case for the Nougat version too for the foreseeable future.

The user perspective – 18 months for the average user

As I mentioned up front, I’ve often focused in these analyses on the developer perspective – after all, targeting a base which is fragmented across so many different versions is tough. But Google has addressed that fragmentation at least in part over the last several years, and that path has been well trodden both by me and by others. Today, I instead want to focus on the user perspective – what does all this mean if you’re an Android user?

I think a useful way to think about this is how quickly a majority of Android users can expect to be able to experience the features and functionality in a new version of Android after it’s launched. The chart below shows how long it takes versions of Android to reach 50% penetration of the base from launch. Because recent versions have peaked before hitting 50%, I’ve included the combined total for that version and the subsequent version (which of course also offers those features):

Android Versions Months to 50pc 560px

As you can see, from the Eclair to Gingerbread releases, it took a year or less for new versions to reach 50% of the base. But the ICS release took 18 months to reach that milestone together with Jelly Bean, which itself took just a little less time to reach 50% on its own. And the KitKat and Lollipop releases took over 18 months to reach 50% of the base.

In other words, the average Android user can expect to wait over a year and a half (and probably six months from the release of the subsequent version) to be able to use the features in a new version of Android. If you factor in the months from when a new version is demoed on stage and announced at I/O or before, it could easily be two years before many users see these features.

No wonder Google appeared to de-emphasize the core features in the N release of Android at I/O this year. The core features of Android N for smartphones got just 14 minutes of stage time in the nearly 2 hour keynote – compare that to an hour for iOS at WWDC. And that makes sense if most users won’t see those features for two years.

But of course from a developer perspective it also applies to things like the VR features in the new version of Android, which also require new devices. The addressable market for Daydream on Android will be tiny for the foreseeable future – if Nougat adoption follows the path of the two previous releases, it can hope for roughly one-third penetration of the base in two years.

Uncovering the Reasons for T-Mobile’s One Launch

T-Mobile today announced its latest Un-Carrier move, Un-Carrier 12. The crux of the plan is new unlimited plans under the T-Mobile One brand. The headline from T-Mobile is about simplicity and unlimited for everyone, but the upshot of this new pricing is that the base price for postpaid at T-Mobile just went up quite significantly. And the reason for the move is that Un-Carrier is losing momentum and T-Mobile needs to boost growth again.

The context – slowing growth

I’ve written about this a little bit in the past, but here is the context: T-Mobile is losing momentum with its Un-Carrier moves. Two key metrics – postpaid phone net adds and porting ratios from other carriers – have both been falling.

The chart below shows postpaid phone net adds on a quarterly basis, with one line for each year, so you can see how each quarter compares to the year-ago quarter:

TMO phone net adds 560px

As you can see, the 2016 quarters so far are below Q1 and Q2 in 2015, while Q2 was also below 2013, and Q1 was below 2014. In 2015, every quarter but Q2 was below 2014 net adds. So there’s a very clear trend now that T-Mobile is adding fewer phones each quarter than a year earlier. If you strip out the exceptional Q2 2014, when phone net adds dipped, the trend is now clear for a year and a half.

Moving to porting ratios, which T-Mobile reports on its earnings calls, the trend there is fairly clear too. It reports porting ratios against each of the other three major carriers, as well as an overall porting ratio most quarters. An average of the three individual carriers’ porting ratios tends to track fairly closely against the overall porting ratio, so I’ve included that in the second chart below to fill in some gaps:

TMO porting ratios 560px

TMO porting ratios overall 560pxThat second chart is probably the easiest one to read, because the trend is so clear. The overall rate peaked in Q3 2014 at just under 2.5, and has fallen since to under 1.5. Against individual carriers, the biggest change in the last two years has been Sprint, whose troubles two and three years ago allowed T-Mobile to capture massive numbers of subscribers, but whose recent improvements have made that cherrypicking much harder. I’ll stop here with the context, but it should be clear by now that T-Mobile is having less and less success with adding new customers and winning subscribers from competitors as time goes on, as its various Un-Carrier moves offer diminishing returns.

T-Mobile One – simplicity at a cost

T-Mobile is selling simplicity here – that’s the headline. It will have one plan going forward, and that plan will be unlimited, with a pricing structure that’s extremely easy to understand. In the context of recent pricing moves from competitors, that’s admirable, and attractive to customers. Unlimited is the simplest message of all, and has huge appeal in the peace of mind it provides.

However, this change is coming at a significant price premium. T-Mobile’s current plans start at $50 for a single line, with 2GB of data.  A second line at that price costs $30 additionally, for $80 total. A third line is only $10, so $90 in total, and the same pricing continues for additional lines. Let’s compare this to the new pricing which will be offered from September 6, which will be the only pricing available for new customers:

TMO One Pricing 560px

 

The headline here is that, for the plans at 2GB and 6GB per line, the new pricing is more expensive, while for the plans at 10GB and the Unlimited plans, the new pricing is the same or cheaper. That’s significant, because T-Mobile says their most popular plans are the 6GB and 10GB plans, so a good chunk of their customers would be paying more on this plan, while many others would be paying roughly the same or slightly less. This helps to explain why T-Mobile says it doesn’t expect a meaningful change to its ARPU.

But of course for new customers, the starting point is now $70 rather than $50, meaning that the entry point for new customers has gone up by $20 for a single line. Put another way, competitors who previously matched T-Mobile’s entry pricing now undercut it by $20 (and Sprint has just launched new pricing today). So, even though the headline is all about simplicity and the gift of unlimited, the reality is that customers coming in at the low end will end up paying more than they would have before, and potentially more than they would at competitors.

The reason for the shift to unlimited

Here’s the rub, though, with this whole thing: T-Mobile introduced BingeOn, its video throttling strategy, a year ago. That did two things: it made it much more economical for T-Mobile to offer bigger and unlimited data plans, because it cut bandwidth usage dramatically; but it also meant that many customers who would otherwise have been on the standard trajectory of ever increasing usage pushing them into ever bigger data buckets instead went backwards. The same consumption of video suddenly drove far lower usage. The result is that T-Mobile doesn’t have the same driver of ARPU that almost every other carrier does, because it kneecapped data growth.

There’s an analog here with what happened with all the carriers a few years back when it became clear that voice and text usage were no longer going to grow as they had in the past, while data was going to continue to grow rapidly. At that point, the best move from a financial perspective was to move away from metered voice and text, because there was no longer upside for charging for every bit of usage, and instead only downside as usage dropped. On the other hand, it made sense to begin metering data and move away from unlimited plans, because that’s where the usage growth was, and where the future revenue opportunity would be too.

What T-Mobile is doing here is finding an alternative way to move people to higher tiered data plans even though they no longer need to. The appeal of unlimited is such that people will move to it even if they’re not close to hitting their current data cap, just for peace of mind. It’s even more likely that a T-Mobile customer would actually need to move to a higher plan when you consider that T-Mobile has offered Data Stash, which allows customers to roll over a data allowance over many months.

The cost of unlimited

T-Mobile made much today of the fact that its network was designed for unlimited, and that competitors’ networks were not. But that’s really another way of saying two things: T-Mobile is far smaller than its two major competitors, and so has far fewer customers on an national network, using far less data in aggregate; and with BingeOn, it’s reduced the data usage associated with video consumption by about two thirds.

But it’s not really about the network per se – it’s about the cost. Unlimited customers (for the most part) don’t actually use dramatic amounts of bandwidth in the average month. It’s likely that many of them would fit fine in the 5-20GB buckets offered by the carriers. But suddenly taking the limits off all customers risks significant increases in usage because it changes behavior dramatically, and that could incur significant costs in increased data capacity. So that’s a high-risk move, and it’s why most carriers don’t do this.

But anyone can offer unlimited if they price it right, which is why you see T-Mobile pricing it at roughly the same price as 10GB plans under its previous options. It’s also why streaming video up to 4K costs an additional $25 per line per month. There’s a cost to unlimited, and if it’s truly unlimited rather than being throttled to 480p, it costs more. This is really just a question of pricing, but that’s why T-Mobile’s pricing is going up here – it’s not magic, just economics.

A sign of confidence

The other thing that’s going on here is that T-Mobile is getting more confident in the performance of its network. One of the interesting facets of pricing in the US mobile market is that pricing power largely depends on perceptions of network performance. This is why Sprint can run campaigns offering 1% worse performance than Verizon at half the price and yet doesn’t see a massive influx of customers from its competitor. Network quality, but more importantly perception of network quality, requires certain carriers to charge less for the same services in order to win customers, while other carriers can charge more on the basis of their perceived better network quality.

Both Sprint and T-Mobile (and especially T-Mobile) have been increasing the quality of their networks in recent years, and perception on the T-Mobile side is finally starting to catch up with reality. It’s absolutely a sign of the company’s increased confidence in both its actual network and perceptions of its network that it’s willing to raise prices at this point. It clearly feels like it’s more able to compete with the big guys on network, and so can move its pricing more in line with theirs. That Sprint instead focuses on that 1% difference and 50% lower pricing is a sign that it’s not there yet, by a long stretch (leaving aside the wisdom of highlighting the worse performance of your network in national advertising).