On the replicability of the iPhone

A couple of my tweets from a few days ago were retweeted first by Ben Thompson and then by John Gruber, and as a result I got a slew of replies on Twitter from people, many of whom misunderstood the fundamental point I was making, and the context in which I was making it. In the interest of making my intentions clearer than 140 (or even 280) characters allowed me to be, I thought I’d write a quick post on my reasoning.

First, the context for my tweets, which were arguably subtweets directed at this paragraph from a recent post by Jean-Louis Gassée:

The most ambitious rumors project 50 million iWatches sold in the first 12 months. I think that’s an unrealistic estimate, but if a $300 iWatch can sell at these numbers, that’s $15B for the year. This seems like a huge number until you compare it to a conservative estimate for the iPhone: 50 million iPhones at $650 generates $32B per quarter.

Here are the original two tweets:

The fundamental point I was making is this: as long as our bar for whether Apple should do something, or whether that thing should be considered a success for Apple, is how it compares to the success of the iPhone, everything will come up short. The iPhone has been such an enormous success for Apple that it is arguably unparalleled in the history both of Apple and of the industry as a whole. If that’s our bar for success now, we’re fooling ourselves, and if Apple were to take that approach, it would likely never launch another product again. This post explores that central context in more detail.

Measuring the iPhone’s success

The iPhone was an enormous success in three key ways:

  • Revenue growth – from $5 million in its first quarter to $419 million a year later to almost $9 billion in a quarter three years later, and to over $30 billion in the last quarter of 2013.
  • Total size in shipments and revenue – Apple shipped over 50 million of these things in the fourth quarter of 2013 alone, and almost 160 million in the last four quarters, generating annual revenue of almost $100 billion.
  • Profitability – Apple doesn’t break out its profits by product line, but firms like Morgan Stanley regularly make good estimates, and the iPhone has hit gross margins of almost 50% in recent years, and past estimates have been even higher. This compares to overall gross margins at Apple of under 40%, and gross margins for other device makers of 10-25%.

Understanding the iPhone’s success

What allowed the iPhone to hit these sorts of numbers? Several factors, notably these:

  • The iPhone has had an average selling price of around $600 or more from the beginning, a number that has held up remarkably well over the years, though it’s recently dipped a little below $600.
  • The actual price paid by many purchasers of the iPhone is far lower, starting at zero in markets with very heavy subsidies, and hitting $200-300 in many other markets. The carrier subsidy model has allowed consumers to feel as if the amount they were paying was half or less of the true cost of the phone. That, in turn, allowed Apple to charge a significant premium and generate unusually high margins.
  • The iPhone entered a mature category which had reached critical mass, though not mainstream adoption, and that category has since started on a trajectory to become effectively ubiquitous in the coming years. Though Apple’s addressable market within smartphones is a subset of the total, the ceiling for the market is extremely high.
  • The iPhone reinvented the category by making it accessible for everyday users and not just for businesspeople needing constant access to their email. It turned it into a pocket computer, much more than a phone, and as such dramatically increased the size of the addressable market (much as it did with personal computers and music players previously, and tablet computers subsequently).

The iPad as a model for repeating iPhone success

The big question now becomes whether any other product Apple might launch can ever match the success of the iPhone in terms of the three metrics I described: growth, absolute size, and importantly profitability. Of course, Apple has launched another product since the iPhone, the iPad. How has that product done? By the standards by which we might judge any other product, remarkably well:

  • Its growth was faster than the iPhone’s growth, by some way: the iPhone sold 5.4 million units in its first four quarters, while the iPad sold more than that in its first two quarters, and sold over 19 million units in its first four quarters, almost quadruple the units of the iPhone.
  • The iPad recreated the category in a way even the iPhone didn’t – tablet computers existed before the iPad, but were essentially a non-event. the iPad changed that, and as such it dominated the market for several years. The iPhone has never dominated the smartphone market.

Despite all this, though, when you compare the iPad against the success of the iPhone, as described above, it falls short:

  • Shipments are around half of those of the iPhone, and revenues are around a third of iPhone revenues
  • Growth has slowed to almost zero year on year despite the much lower penetration of the overall population. Though the early growth was faster, the iPad seems as a result to have hit a ceiling much sooner.
  • Profitability of the iPad is lower than the iPhone. Again, we don’t have exact numbers, but Morgan Stanley estimates gross margins to be around 25-26%, so just over half the margins of the iPhone.

Why is all this? Well, you only have to look at the reasons for the iPhone’s success to see why the iPad hasn’t been equally successful:

  • ASPs are lower – around $450 for the iPad
  • Consumers are paying the full price for the vast majority of iPads, with only a tiny percentage subsidized in any degree by carriers (though many competitors’ tablets are sold at substantially below full price through bundling with smartphones and the like)
  • The total addressable market for tablets is much lower than for smartphones – every person in a mature market is likely not going to end up buying a tablet, at least not in the foreseeable future.

The potential for other future Apple products

The point here is that the iPhone has been unusually successful, and even a product like the iPad, which is equally disruptive and compelling and has sold even more quickly can’t make it on total shipments, revenue and margins. So, could any other product ever achieve such results again? As we saw with the iPad, other products Apple is likely to launch suffer from one of three major disadvantages: they have lower ASPs, consumers pay full price, and the addressable market is smaller.

Take the iWatch as an example. An iWatch will almost certainly have a lower ASP than the iPhone, likely half or less. It will almost certainly be sold at full price, rather than being subsidized. And it will almost certainly be tied to the iPhone in such a way that makes the iPhone base at any given time the absolute ceiling for the addressable market. As such, it is essentially an impossibility for a theoretical iWatch to match the success of the iPhone.

The same goes for almost any other product Apple might announce – it would likely either have a lower ASP, be sold at full price, and/or have a smaller addressable market. A product with half the ASP of the iPhone would have to not only sell twice as many units as the iPhone but do so at the same or higher margins, either of which seems extremely unlikely. The subsidy model in particular enabled for the iPhone something neither Apple nor any other consumer electronics is likely to see again.

With the exception of monopolies, only two-sided business models, where two separate parties pay for a product, ever achieve such margins – the iPhone is one such, and cable networks in the US (which make money from adverting and subscriptions) is another. An intriguing possibility for a health-focused iWatch or similar device is that insurance providers, healthcare providers or others might somehow subsidize the device as carriers did the iPhone, which might create such a two-sided business model. That might theoretically lead over time to a business with the same margins as the iPhone, even if not the same size addressable market.

Apple’s future lies in several products, not one

So what does all this mean? Does it mean Apple is doomed? Of course not. But it does mean that Apple shouldn’t use the iPhone’s success as the bar against which all possible future products should be measured against. Indeed, since the iPhone both acts as the likely ceiling for what future products can achieve, and will likely itself be boosted by other products which add value to the Apple ecosystem, the iPhone will likely only get stronger.

This isn’t to say that other Apple products will fail, as it’s already proven with the iPad that it’s capable of producing products that are enormously successful if judged by any other standard. But it is to say that Apple’s future growth won’t be driven by any single product to the extent that it was from 2003 to 2007 (with the iPod) and from 2007 to 2013 (with the iPhone). Apple’s future lies in a wider range of products than it has today, with quite a number of them contributing to both overall revenues and overall revenue growth.

Further reading

This analysis is part of a much longer analysis I’m doing for my subscription clients in the form of an in-depth Apple profile, which will be available in the next couple of weeks. Please contact me directly if you’re interested in that report or a research subscription.

Other recent posts on Apple include:

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  • jwan584

    Couldn’t be more clear or less controversial.

  • This is fascinating. I can’t think of another product in any category that products $5 million in revenue its first quarter and then $30 billion in its last quarter, nearly 7 years later. The only possibility I could come up with was maybe a prescription drug like Lipitor.

  • Mark Jones

    I agree with your almost all of your points but have a few additions/quibbles:
    – iPhone’s success also included the fact that one US carrier broke ranks with the others in order to gain prestige, gain subscribers to reverse the growing gap with no 1 Verizon, and gain data use and revenue from its large and sunk investment in a 3G network. Some posit it had to do with the RDF of a Mr. Jobs instead of AT&T self-interest.
    – iPhone success might not have to do with subsidy as much as with having a low, manageable upfront payment and monthly installments. As with relatively expensive products sold in other industries, consumers are unable or unwilling to make large cash payments (even if it will be to their advantage over the long run).
    – A future Apple product could outdo iPhone – it would be a wearable that doesn’t need a separate iPhone but does as much or more (this is not yet possible today). It would have an equally large total addressable market (6-7 billion). Through key Apple-patented hardware technology advances (i.e., optimized low-power processor tech, liquidmetal, sapphire, batteries, etc), it would gain a larger market share than iPhone has (vs. Android-based vendors). It presupposes that the current hardware vendor competitors fail to adequately invest in R&D given the tiny profits from Android sales (in the same way that Intel and MS starved PC vendors), while Apple continues to do so. (Google and Qualcomm invest but Google is distracted by satellites and cars, a shrinking ad/search market due to the shift from PCs/web to mobile apps, and increasing privacy concerns.) Apple also establishes the lowest cost supply chain for these high end technologies (both for internal and external sourced components) as a result of dominating the high-end smartphone market today, thus giving it a 12 to 24 month head-start on wearable. Yes, lots of things need to happen just right but it’s possible.

    I especially agree that in the mean time, Apple’s growth will need to come from increasing iPhone/iPad sales (neither has peaked), and selling accessories like wearables and home hubs. Apple has sold profitable accessories in the past.

    • I see what you’re saying here, but you don’t really address the margin issue – that’s the part that’s hardest to replicate without a two-sided business model. I think a wearable that doesn’t rely on a smartphone for heavy lifting on connectivity, processing etc. is a number of years out still. And I suspect since the vast majority of us will still carry smartphones, it will likely remain tied to the iPhone base for some time to come too.

      And I believe subsidy was absolutely critical – most consumers never knew they were paying for it in installments – the perception was they were paying simply the upfront cost (a perception that is now starting to change as the subsidy model evolves towards true, transparent installment plans)

      • Mark Jones

        Agree, it’s definitely a number of years out, but when it occurs, people will switch from smartphones to wearable phones/computers, just as they did from featurephones to smartphones. Apple has learned software patents are useless, and instead will develop and defend performance/cost advantages in hardware, components, and materials. As for margin, the carriers will still need subscribers to pay for their continuing infrastructure investments (i.e., 5G, 6G). Wearable phones will increase data usage (always-seen/heard intelligent assistant vs. out-of-mind in pocket/purse). We’ll have more data soon about whether the false subsidy was more attractive than installments, given the Edge, Next, Jump, and Framily plans in the US.

        Again, I agree with just about everything you wrote. People who invest in Apple thinking the next product will drive 30-100% growth are foolish. So thanks for the being a voice of reason.

        I just wouldn’t say “everything will come up short.” Whatever replaces the smartphone in a few years from now is the most likely single product that might not. And we are already beginning to see clues as to how Apple can get there, and do an even better job than the first time around.

        • I agree – but in some ways it’s what replaces the iPhone, or put another way the continuation of the iPhone – i.e. whatever exhibits essentially the same characteristics.