Category Archives: Smartphones

Earnings, Microsoft, Q3 2016, Smartphones, Surface

Microsoft’s Evolving Hardware Business

October 21, 2016 Jan Dawson

Note: this blog is published by Jan Dawson, Founder and Chief Analyst at Jackdaw Research. Jackdaw Research provides research, analysis, and consulting on the consumer technology market, and works with some of the largest consumer technology companies in the world. We offer data sets on the US wireless and pay TV markets, analysis of major players in the industry, and custom consulting work ranging from hour-long phone calls to weeks-long projects. For more on Jackdaw Research and its services, please visit our website.

Microsoft reported earnings yesterday, and the highlights were all about the cloud business (Alex Wilhelm has a good summary of some of the key numbers there in this post on Mattermark). Given that I cover the consumer business, however, I’m more focused on the parts of Microsoft that target end users, which are mostly found in its More Personal Computing segment (the one exception is Office Consumer, which sits in the Productivity & Business Processes segment).

The More Personal Computing segment is made up of:

Windows – licensing of all versions of Windows other than Windows server
Devices – including Surface, phones, and accessories
Gaming – including Xbox hardware, Xbox Live services, and game revenue
Search advertising – essentially Bing.

Microsoft doesn’t report revenues for these various components explicitly, but often provides enough data points in its various SEC filings to be able to draw reasonably good conclusions about the makeup of the business. As a starting point, Microsoft does report revenue from external customers by major product line as part of its annual 10-K filing – revenue from the major product lines in the More Personal Computing Group are shown below:

Windows declining for two reasons

It’s worth noting that it appears Windows revenue has fallen off a cliff during this period. However, a big chunk of the apparent decline is due to the deferral of Windows 10 revenue, which has to be recognized over a longer period of time than revenue from earlier versions of Windows, which carried less expectation of free future updates. At the same time, the fact that Windows 10 was a free upgrade for the first year also depressed revenues. As I’ve been saying for some time now, going forward it’s going to be much tougher for Microsoft to drive meaningful revenue from Windows in the consumer market in particular, in a world where every other vendor gives their OS away for free. That means Microsoft has to find new sources of revenue in consumer: enter hardware.

Phones – dwindling to nothing

First up, phones, which appear to be rapidly dwindling to nothing. It’s become harder to find Lumia smartphone sales in Microsoft’s reporting recently, and this quarter (as far as I can tell) the company finally stopped reporting phone sales entirely. That makes sense, given that Lumia sales were likely under a million in the quarter and Microsoft is about to offload the feature phone business. The chart below shows Lumia sales up to the previous quarter, and my estimate for phone revenues for the past two years, which hit around $300 million this quarter:

Surface grows year on year but heading for a dip

Surface has been one of the bright spots of Microsoft’s hardware business over the last two years. Indeed – this home-grown hardware line has compared very favorably to that acquired phones business we were just discussing:

As you can see, Surface has now outsold phones for four straight quarters, and that’s not going to change any time soon. Overall, Surface revenues are growing year on year, which is easier to see if you annualize them:

However, what you can also see from that first Surface chart is that revenues for this product line are starting to settle into a pattern: big Q4 sales, followed by a steady decline through the next three quarters. That’s fine as long as there is new hardware each year to restart the cycle, but from all the reporting I’ve seen it seems the Surface Pro and Surface Book will get only spec bumps and very minor cosmetic changes, which leaves open the possibility of a year on year decline. Indeed, this is exactly what Microsoft’s guidance says will happen:

We expect surface revenue to decline as we anniversary the product launch from a year ago.

I suspect the minor refresh on the existing hardware combined with the push into a new, somewhat marginal, product category (all-in-ones) won’t be enough to drive growth. The question is whether the revenue line recovers in the New Year or whether we’ll see a whole year of declines here – that, in turn, would depress overall hardware sales already shrinking from the phone collapse.

It’s also interesting to put Surface revenues in context – they’ve grown very strongly and are now a useful contributor to Microsoft’s overall business, but they pale in comparison to both iPad and Mac sales, neither of which have been growing much recently:

Ahead of next week’s Microsoft and Apple events, that context is worth remembering – for all the fanfare around Surface, Microsoft’s computing hardware business is still a fraction of the size of Apple’s.

Gaming – an oldie but kind of a goodie

Gaming, of course, is the oldest of Microsoft’s consumer hardware businesses, but its gaming revenue is actually about more than just selling consoles – it also includes Xbox Live service revenues and revenues from selling its own games (now including Minecraft) and royalties from third party games. However, it’s likely that console sales still dominate this segment. Below is my estimate for Gaming revenue:

In fact, Microsoft actually began reporting this revenue line this quarter, though unaccountably only for this quarter, and not for past quarters. Still, it’s obvious from my estimates that this, too, is an enormously cyclical business, with a big spike in Q4 driven by console sales and to a lesser extent game purchases, followed by a much smaller revenue number in Q1 and a steady build through Q3 before repeating. Microsoft no longer reports console sales either, sadly, likely because it was coming second to Sony much of the time before it stopped reporting. Still, gaming makes up almost a third of MPC segment revenues in Q4, and anything from 8-20% of the total in other quarters. In total, hardware likely now accounts for 30-50% of total revenue from the segment quarterly.

Search advertising – Microsoft’s quiet success story

With all the attention on cloud, and the hardware and Windows businesses going through a bit of a tough patch, it’d be easy to assume there were no other bright spots. And yet search advertising continues to be the undersold success story at Microsoft over the last couple of years. I’ve previously pointed out the very different trajectories of the display and search ad businesses at Microsoft, which ultimately resulted in the separation of the display business, but the upward trajectory of search advertising has accelerated since that decision was made.

Again, Microsoft doesn’t report this revenue line directly, but we can do a decent job of estimating it, as shown in the chart below:

There are actually two different revenue lines associated with search advertising – what I’ve shown here is total actual revenue including traffic acquisition costs, but Microsoft tends to focus at least some of its commentary on earnings calls on a different number – search revenue ex-TAC. As you can see, the total number has plateaued over the last three quarters according to my estimates, though the year on year growth numbers are still strong. However, the ex-TAC number is growing more slowly. In other words, this growth is coming at the expense of higher traffic acquisition costs, which seems to be the result of the deal Microsoft signed with Yahoo a few quarters ago and an associated change in revenue recognition. Still, it’s a useful business now in its own right, with advertising generating 7% of Microsoft’s revenues in the most recent fiscal year.

Alphabet, Google, Hardware, Pixel, Smartphones

Google’s Schizophrenic Pixel Positioning

October 5, 2016 Jan Dawson

This is my second post about Google’s event this week, and there will likely be more. The first tackled Google’s big strategy shift: moving from a strategy of gaining the broadest possible distribution for its services to preferring its own hardware in a narrower rollout. Today, I’m going to focus on the Pixel phones.

Positioning Pixel as a peer to the iPhone…

The Pixel phones are the most interesting and risky piece of this week’s announcements, because they go head to head against Google’s most important partners. One of my big questions ahead of time was how Google would address this tension, and in the end it simply didn’t, at least not during the event. The way it addressed it indirectly was to aim its presentation and the phones at the iPhone instead of at other Android phones. There were quite a few references to the iPhone during the event, and they’re worth pulling out:

A presenter said as an aside, “no unsightly camera bump” when describing the back of the Pixel phones
The unlimited photo and video storage was positioned against the iPhone, explicitly so when an image of iOS’s “Storage Full” error message was shown on screen (as it was in a recent Google Photos ad campaign)
The colors of the Pixel phones have names which appear to mock Apple’s color names
The pricing of the Pixel phones is identical to the pricing for the iPhone 7, right down to the first-time $20 increase to $769 for the iPhone 7 Plus from the earlier $749 price point for the larger phones, despite the fact that the larger Pixel has no additional components
A reference to the 3.5mm headphone jack in the Pixel commercial.

Google is attempting to position the Pixel as a true peer to the iPhone, unlike Nexus devices, which have usually been priced at a discount with feature disparities (notably in the cameras) to match. The pricing is easily the most telling element here, because there’s literally no other reason to match the pricing so precisely, and Google could arguably have benefited from undercutting the iPhone on price instead. Rather, Google wants us to see the Pixel as playing on a level playing field with the iPhone. This is very much a premium device, something that Chrome and Android exec Hiroshi Lockheimer explicitly addressed in an interview with Bloomberg published this week:

Premium is a very important category. Having a healthy premium device ecosystem is an important element in an overall healthy ecosystem. For app developers and others. It’s where certain OEMs have been successful, like Samsung. It’s where Apple is also very strong. Is there room for another player there? We think so. Do we think it’s an important aspect of Android? Yeah, absolutely.

What’s most interesting to me is the question and answer near the end there: “Is there room for another player there? We think so.” Given that the premium smartphone market is basically saturated at this point, that’s an interesting statement to make. Unlike, say, in the low end of the smartphone market, where there’s still quite a bit of growth, the only sense in which there’s “room” for another player at the premium end is by squeezing someone else out. Google clearly wants that to be Apple, but it’s arguably more likely to be Samsung if it’s anyone.

We’ve seen from long experience that switching from iOS to Android is much rarer than the other way, and so Google is far more likely to take share from Samsung than Apple, even with its overt focus on competing against the iPhone. In addition, this is fundamentally an Android phone with a few customizations, and will be seen as such, and therefore in competition with other Android devices, rather than the iPhone, for all Google’s focus on the iPhone in its messaging.

…while also mocking the iPhone (and iPhone owners)

But perhaps the biggest misfire here is the schizoid positioning versus the iPhone – on the one hand, the Pixel borrows very heavily from the iPhone – the look, especially from the front; the two sizes; the pricing, the focus on the camera; the integrated approach to hardware and software (of which more below); and so on. And yet at the same time Google seems determined to mock the iPhone, as evident in the color naming and in other ways throughout the presentation. If you want to go head to head against the iPhone, you do it in one of two ways: you show how you’re different (as Samsung has arguably done successfully), or you show how you’re the same but better. You don’t do it by aping lots of features and then mocking the very thing you’re aping at the same time (and by implication its customers, the very customers you’re going after).

True integration, or just a smokescreen?

The other major element of this strategy, of course, is that Google is now capitulating to the Apple strategy of many years and more recently Microsoft’s Surface strategy: the company that makes the best hardware is the company that makes the OS. Again, the approach is best encapsulated in an interview, this time with Rick Osterloh, head of Google’s new consolidated hardware division:

Fundamentally, we believe that a lot of the innovation that we want to do now ends up requiring controlling the end-to-end user experience.

What’s odd is that there seems to be relatively little evidence of this approach in what was announced on Tuesday. Is there really anything in the Pixel phones that couldn’t have been achieved by another OEM working at arm’s length from Google? One of the biggest benefits of taking this integrated approach is deep ties between the OS and the hardware, but from that perspective, Google isn’t actually allowing its Android division to get any closer to its own hardware team than other OEMs. It’s only integration with other Google services (outside of Android) where the Pixel team got special access, and even then only because they’re the only ones who have asked to do so.

All of this undermines Google’s argument that the Pixel is somehow in a different category because it’s “made by Google” (even leaving aside the fact-checking on that particular claim from a hardware perspective). This phone could easily have been made by an OEM with the same motivations – the big difference is that no OEM has precisely those motivations, not that the Pixel team was somehow given special access.

In fact, this gets at the heart of one of the main drivers behind the Pixel – Google reasserting control over Android and putting Google services front and center again. I’ve written about this previously in the context of Google’s attempts to do this through software, as exemplified by its I/O 2014 announcements. But those efforts largely failed to reclaim both control over Android and a more prominent role for Google services on Android phones. As a result, Google’s relationship with Android releases has continued to be analogous to that of a parent sending a child off to college – both have done all they can to set their creation on the right path, but have little control over what happens next.

If, though, this is the real motivation behind Pixel (and I strongly suspect it is), then all this stuff about targeting the iPhone and tightly integrated hardware and software is really something of a smokescreen. I would bet Google’s OEM partners can see that pretty clearly too, and for all Google executives’ reassurances that the OEMs are fine with it, I very much doubt it.

Alphabet, Artificial intelligence, Google, Pixel, Smartphones

Google’s Big Strategy Shift

October 4, 2016 Jan Dawson

There’s so much to say about today’s Google hardware event, and it’s tempting to pour it all into this one post. Instead, though, I’m going to be focused here and probably write several separate posts on announcements from today during the rest of this week. It’ll also be the main topic of conversation on the Beyond Devices Podcast this week, so be sure to check that out later in the week.

My focus here is what I’m terming Google’s big strategy shift, but it may not be the shift you’re thinking of. Yes, it’s notable that Google is making its own hardware, but it’s been doing that for years. The big shift therefore isn’t so much that Google is making its own hardware, as that it’s preferring that hardware when it comes to Google services, notably the Google Assistant.

Previously, Google services have been launched on either the web or through the major app stores, typically Play and iOS simultaneously or one shortly after the other. But with the new devices announced today, Google appears to be using the Google Assistant as a way to advantage its own hardware rather than going broad. That’s a massive strategic shift, and has much broader implications than simply making a phone, a speaker, or a WiFi router.

Think about what this means: Google is choosing to favor a few million hardware sales over usage of these services by billions of people, at least in the short term. Its old approach was to pursue the broadest possible distribution for its services by making them available in almost all the places people might expect to find them. But its new approach is much more reminiscent of Apple’s, which of course is designed to differentiate hardware and not drive maximum usage.

Why, then, would Google do this? The most obvious reason is that Google couldn’t find enough other ways to make its new devices stand out in the market, and so chose to use the Assistant as a differentiator. That’s understandable, but it’s a pretty significant strategic sacrifice to make. Another possible explanation is that it didn’t want to overload the Google Assistant with too many users at once, and so it’s put it in places where usage will be limited at first – Allo (currently 75 in the Play store and 691 in the App Store), Google Home, and the Pixel phones. That’s a bit odd given how broadly used all the services behind the Google Assistant already are – it’s not like Google can’t handle the server load – but it might make sense to work out some kinks before making the Assistant more broadly available.

The next question then becomes how soon the Google Assistant becomes available elsewhere – on the web, as part of Android, or as an iOS app. The sooner it becomes available, the more easily Google will achieve its usual goal of broad distribution, but the more quickly it erodes one of the big differentiators of Pixel. The longer it holds it back, the less relevant it becomes (and the harder it becomes to tell Google’s AI story), but the longer Pixel stands out in the market. I’d argue that how Google answers this question will be one of the strongest indicators we’ll have of how it really feels about its big increase in hardware investment.

Apple, iPhone, iPhone 7, Smartphones, Upgrades

A Different Way to Think about iPhone Upgrade Cycles

September 1, 2016 Jan Dawson 2 Comments

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):

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:

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:

China, Earnings, Emerging markets, India, Lenovo, Motorola, Q4 2015, Smartphones

Lenovo’s Increasingly International Smartphone Business

February 3, 2016 Jan Dawson

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

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

The impact of Motorola

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

The rapid decline of Lenovo’s Chinese smartphone business

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

Growth elsewhere, especially in emerging markets

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

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

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

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

Better margins

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

Android, Earnings, Lenovo, Motorola, Q2 2015, Smartphones

Lenovo’s tough quarter

August 13, 2015 Jan Dawson

Lenovo reported this week that it had just concluded a tough quarter, and was going to be taking actions to streamline its business and operations, including laying off a significant number of employees and cutting costs in the mobile business in particular. This post runs through some of the components of Lenovo’s tough quarter and examines where the business is likely to go from here.

Note: this is my second post on Lenovo – the first was on its Q4 2014 results, the first it reported after acquiring Motorola. Please note also that in this post as elsewhere on this blog I use calendar quarters for ease of comprehension and comparison, even when companies’ fiscal years are different.

Motorola has been a great defense against shrinking sales in China

I believe the Motorola acquisition was originally contemplated as a way for Lenovo to build scale and especially to break into some new markets. However, it’s turned out to be a phenomenal defensive strategy against some significantly worsening trends in Lenovo’s largest smartphone market, China. As part of Lenovo’s quarterly results presentation, it shared these numbers – sourced to SINO – on smartphone sales in China, and they provide a great context for Lenovo’s problems domestically (this is my chart, based on the same numbers):

There are two important trends to note here: firstly, total sales (shown in red) have declined in the past year; secondly, subsidized sales (shown in blue) have declined even more strongly, and are shrinking as a share of total sales. The fact that the Chinese smartphone market is shrinking is bad enough, but Lenovo is particularly exposed to that carrier-subsidized segment, which is rapidly going away as carriers discontinue subsidies under pressure from the government. The result is that Lenovo’s Chinese smartphone sales are shrinking rapidly:Lenovo’s smartphone shipments in China peaked at almost 14 million in Q3 2014, and have fallen steadily since, to just under 5 million in Q2 2015. Were it not for the addition of Motorola’s smartphone sales, Lenovo would have seen a serious dent put in its overall sales. As it is, things don’t look quite so bad overall from a shipment perspective, though sales have still declined over the past two quarters:Without the Motorola business, Lenovo’s smartphone shipments overall would have fallen from 15.8 million in Q2 2014 to just 10.3 million a year later.

But Motorola is also dragging down profits

The problem is that, while Motorola’s shipment numbers have been a great benefit to overall shipments, its financials continue to be a drag on the business. It’s hard to isolate Motorola’s performance within the overall numbers reported by Lenovo, but there are hints when you look at Lenovo’s operating margins by geography and by segment, where Motorola’s results disproportionately affect the Americas and Mobile respectively:Note: Lenovo changed its reporting segments in Q4 2014, and as such we’re missing operating income by segment for Q3 2014 until it reports them with Q3 2015 figures next quarter.

As you can see, both the Americas and the Mobile segment saw significant declines over the last few quarters as Motorola joined the company. Economic conditions in Brazil particularly impacted the Motorola business but also affected other parts of the business, so that’s part of the reason for the sudden drop in Americas margins. However, Motorola was unprofitable when it joined, and it continues to be so. In fact, Lenovo just subtly changed its profitability target from having the Motorola business be profitable in 4-6 quarters after acquisition to having the total Mobile segment of which Motorola is a part be profitable, a recognition that it’s going to take longer to turn the Motorola business around.

In PCs and tablets, growing share in shrinking markets

I’m not going to spend as much time on PCs and tablets as on smartphones, but I did want to note that in these two categories Lenovo’s challenge is a bit different. The markets themselves are shrinking, so even though Lenovo’s share of both markets is growing, that’s not delivering strong growth overall. In fact, PC shipments dropped several percentage points year on year, while tablet shipments only grew modestly. If growth trends in the PC market continue to worsen, even Lenovo’s significant outperformance of the market won’t help it, while its tablet sales are too small to help offset the challenging conditions in smartphones and PCs.

Lenovo’s proposed solution is familiar

We’ve heard it so many times over the last several years from different Android vendors that Lenovo’s proposed solution to what ails it in in the smartphone market is very familiar: streamlining and simplifying the product portfolio, while making the smaller number of models more compelling and better differentiated. Samsung, HTC, LG, Sony and others have all embraced this strategy over the last few years, and while it’s likely a good idea, none of those companies have seen significant turnarounds as a result, and all continue to struggle to a greater or lesser extent in selling smartphones.

However, Lenovo is also taking some other steps to turn its performance around, cutting its workforce, and moving to what sounds like single sales and product organizations. Interestingly, it’s largely focused on the Lenovo sales organization (though it’ll presumably keep some Motorola staff on in key markets like North America where Lenovo has never had a presence), and the Motorola product design, development, and manufacturing organization. Earlier, it was cautious about consolidating the two manufacturing organizations in particular, and it’s intriguing to see the company consolidating around the Motorola function rather than the Lenovo equivalent. It will be interesting to see to what extent the Lenovo and Motorola brands continue to be marketed distinctly if both sets of devices are coming from the same team.

At the same time, Lenovo is also embracing new channels domestically, mimicking Xiaomi in its pursuit of the online model with the launch of the ShenQi online store this past quarter and the ZUK Z1 phone in August through that channel. This makes tons of sense given the shift in purchasing from one channel to the other, but it’s not yet clear that Lenovo has the competencies required to pull this model off.

There are also hints in Lenovo’s press release that it might seek to acquire other PC businesses as a way to further grow scale while driving cost efficiencies. The key quote here is:

Accelerating the drive for 30 percent share in PCs by better taking advantage of consolidation, while becoming even more efficient and reducing costs to ensure sustainable, profitable growth.

That may mean something else, but it certainly sounds as if it could be referring to an acquisition strategy in the PC market.

Where does Lenovo go from here?

Given the tough domestic conditions, it’s going to be hard for Lenovo to turn its performance in China around dramatically, which makes its rest-of-world strategy all the more important. But though the addition of Motorola made for favorable year on year comparisons, the Motorola business itself actually shrank year on year in terms of shipments, from 7.7m in Q2 last year to 5.9m this quarter. Motorola has had real success with its low end devices, the Moto E and Moto G, but that success has come to a great extent in certain markets that are now facing challenging conditions too. Brazil is perhaps the best example – Lenovo sold just 167,000 smartphones there in Q2 last year, but the combined company sold around 2.5 million smartphones there in Q2 2015, and yet this turned out to be something of a liability this quarter as conditions worsened. Latin America as a whole accounted for 3.7 million shipments, and if the economies there continue to struggle, that likely doesn’t bode well for Lenovo.

With these headwinds in key markets like China and Latin America, Lenovo needs to do better in other regions, but those regions are relatively small for the company today, with just 1.4m shipments in North America and 2.8m in EMEA in Q2. Lenovo is heavily dependent on the BRIC countries, which account for over 60% of its smartphone shipments today. And yet the Motorola brand has been struggling in the US, its erstwhile stronghold, for several years now. What’s selling is the low-end smartphones, with an average selling price for Lenovo as a whole of a little over $100, and Motorola’s ASP around $200.

I’ve been quite bullish about Lenovo until now, but at the moment I’m less certain on its prospects for the short to medium term, especially if things don’t change domestically. But Lenovo isn’t alone in this – it’s been caught up in the perfect storm that’s affecting many of the major Android vendors, and that’s been causing a number of them to announce significant cuts in their businesses in recent weeks. The good news is that PC margins continue to be relatively healthy (at least in the context of the broader Windows PC market), and PCs represent the majority of Lenovo’s business today. But if Lenovo really wants to follow through on its strategy of becoming a major player across these device categories, it’s going to have to find a way to turn its smartphone performance around.

Earnings, Microsoft, Smartphones, Windows, Windows 10, Windows Phone

Microsoft’s devices restructuring

July 8, 2015 Jan Dawson

Microsoft today announced a restructuring of its devices business which I think most of us have been expecting to land any day since CEO Satya Nadella’s memo to employees a couple of weeks ago indicating tough choices were ahead (and indeed, which the company strongly hinted might be coming back in April). However, even though this was widely anticipated, the exact meaning of it is less obvious. I see many taking it as a capitulation, but Microsoft clearly isn’t getting out of the phone business at this point. Below are my thoughts on what this move means, and what might still come later.

Not a concession of defeat – yet

Though clearly a concession that things haven’t been going well for its devices business, this isn’t a concession of total defeat just yet, and there are two reasons why I say that:

Microsoft accounts for almost all Windows Phone device sales itself, with over 95% of the market according to AdDuplex. As such, killing its own devices business would simultaneously kill Windows Phone as a platform
Microsoft’s positioning around Windows 10 has had a heavy mobile component, with universal apps and various tools for porting apps from other mobile platforms major focus areas in the announcements over the last several months. As such, it seems extremely unlikely that Microsoft would be ready to kill off Windows Phone.

In short, the timing just doesn’t seem right for abandoning either Microsoft’s first party phone business or Windows Phone as a whole. That’s not what’s happening today, though that doesn’t mean it’s not coming somewhere down the line, as I discuss below.

Windows 10 and focus

It’s clear that at least some within the business believe that Windows 10 and some of the related efforts targeted at developers will help to turn the fortunes of Windows Phone around. I’ve shared my skepticism about that hope in several pieces here over the last few months (including the two linked to in that second bullet above), and wrote an in-depth report about Windows Phone and its prospects too (available here). I continue to believe that Windows Phone suffers from several more or less insurmountable challenges, and don’t see any clear way out of this situation even with Windows 10.

At least part of the problem with Windows Phone has been that it was losing money at its current scale and that scale wasn’t growing rapidly enough to make a difference. By scaling down the business still further, Microsoft likely shifts the equation slightly in favor of profitability, though at the rate the feature phone business has been declining, that may not be enough. But the focus Microsoft is planning to bring to its portfolio is a good thing – for such a small devices business, Microsoft (and Nokia before it) has had a bewildering array of devices on sale, and could likely get by with a much smaller number, say one or two in each of its series (500, 600, 700 etc). But amid this “focus” comes this statement reported by Mary-Jo Foley at ZDNet:

Microsoft will focus its phone efforts on three segments: Businesses, value-phone buyers and flagship phone customers, moving forward.

This is a funny kind of focus! As far as the smartphone market is concerned, flagship and value phones are basically all there is at this point in many markets, so that’s no focus at all. And the mention of business users reflects a basic misunderstanding of the phone market which Nokia seemed to have overcome way back, when it abandoned its E-Series devices. The fact is that business users are just the same as anyone else – they want phones they like to use, that allow them to do not just work but personal stuff too. I’m also curious what this all means about the feature phone business and whether Microsoft will now abandon that entirely. There was a theory that being in feature phones would allow Microsoft to provide a migration path to smartphones over time, but I’ve always been skeptical about that, and at the rate of decline this business is seeing, it’s more of a liability than an asset at this point.

Microsoft shrugged

Meanwhile, the impairment charge is so large that it’s hard to imagine that it’s for anything other than the whole value of the business acquired from Nokia. Remember that though the total price paid to Nokia was 5.44 billion euros (reported as $7.2 billion at the time it was announced), only 3.79 billion (or $5 billion) was for the devices business, while the other $2 billion or so was for patents. The $7.6 billion impairment charge is therefore not just more than the original purchase price, but significantly more than the price paid for the devices business specifically. That either means that Microsoft is also writing down some of the value of the patents or accounting for a significant additional investment in the business since the acquisition (or both). However, at the end of the day, the key point is that Microsoft has at this point basically unburdened itself of the value of the acquisition, such that if it does have to wind the business down it likely won’t have to take another significant impairment charge.

By the time it’s done with the layoffs announced today, Microsoft will also have jettisoned around 80% of the employees associated with the Nokia acquisition. It took on around 25,000 (down from the 32,000 originally anticipated) when the acquisition closed, but laid of around half three months later, in July last year. Now, a year later, it’s losing another 7-8,000, taking the remainder down to just 5,000, or 20% of those originally brought on board.

As such, if Microsoft does have to abandon Windows Phone and its own devices business (I simply don’t see how it’s going to get more OEMs on board for Windows Phone, so the two are inextricably linked), at least it’s now written down much of the value of the acquisition, and will have eliminated most of the employees by the end of this year. That will make it much easier financially and operationally (if not emotionally) to pull the plug when the time comes. But it will be a huge sea change for Microsoft to concede defeat in operating systems for mobile devices after 15 years of trying.

Postponing the inevitable

I suspect today’s move is just another step along the road that eventually leads to an abandonment of this business, even if Microsoft isn’t ready to concede defeat today. The good news is that Microsoft has a strong alternative strategy in place with its third party mobile apps business, which has produced some good results recently, so that it’s not putting all its mobile eggs in the Windows Phone basket as in the past. I continue to worry that a third-party apps business may struggle as both Apple and Google increasingly tie their first party services tightly into their operating systems and virtual assistants, but it certainly seems to have a better shot at gaining users than Windows Phone for now.

However, the other big challenge is monetizing that usage, which continues to be my biggest concern for Microsoft. Its traditional software licensing model simply isn’t going to cut it in consumer markets, and I suspect the SaaS model will be equally challenging. As such, as I outlined in my “Thesis on Microsoft” piece a while back, Microsoft is going to have to make its money more or less exclusively through enterprise cloud services while using the consumer market to drive continued scale.

Connected car, Devices, Smartphones, Smartwatches, Tablets, Wireless

The changing devices on the US mobile networks

May 4, 2015 Jan Dawson

For much of the last three decades, the terms “wireless carrier” and “cellphone provider” have largely been synonymous. Your wireless carrier was the company that provided the service for your cellphone, and in the vast majority of cases also sold you that cellphone, often at a heavily subsidized rate. However, the reality is that the wireless carriers in the US are becoming much more than just cellphone providers, and in fact cellphones are becoming a smaller percentage of devices on the major US mobile networks over time.

Phones are growing, but not as fast as in the past

The total number of phones on the four major US mobile networks (AT&T, Sprint, T-Mobile, and Verizon Wireless) continues to grow, but the rate of growth has slowed. Whereas in the past phone subscribers grew by double digits every year, now they grow by single digits at best, and the reason is obvious: the vast majority of people who will ever own a phone already have one.

The small amount of growth there is in phones comes in large part from the generational effect of new users emerging at the younger end of the population scale, combined with a few laggards and late adopters among the older generations. Continue reading →

Earnings, Q1 2015, Smartphones, Tablets, Verizon, Wireless

Thoughts on Verizon’s Q1 2015 earnings

April 21, 2015 Jan Dawson 5 Comments

Verizon reported results this morning. In listening to the call and reviewing some of my numbers, I was struck my the fact that Verizon is in the midst of several important transitions. I’ll highlight three here today:

Converting the phone base to smartphones
Converting the phone base to installment billing
Converting broadband subs to FiOS

Each of these three transitions is largely about moving a portion of Verizon’s base from one thing to another, rather than about growth per se, but each has a financial impact, and two of the three are accompanied by new growth opportunities.

Converting the phone base to smartphones

The first transition is converting the phone base to smartphones, and specifically to 4G LTE smartphones. Here’s what that process looks like at Verizon Wireless:

As you can see, the total number of phones isn’t really growing much (in fact, Verizon lost phone customers in Q1). But smartphones within the base, and especially 4G smartphones, are growing very rapidly. The financial impact here is that smartphone owners, and 4G smartphone owners in particular, consume lots more data. In a world where almost every plan includes unlimited text and voice, the path to growth from these customers is increasing data usage, and getting them on a 4G smartphone is the best way to do that. This growth opportunity will last for another couple of years at least – there are still 11 million 3G smartphones and 17 million basic phones in the base to convert. But at some point it will come to an end. Continue reading →

Adoption, Android, Android versions, Apple, Google, iOS, iOS 8, Smartphones

Contrasting iOS and Android adoption patterns

April 10, 2015 Jan Dawson 10 Comments

I’ve done two previous posts (here and here) on Google’s Android developer dashboard stats, and I was surprised to find it’s been just over a year since my last one. I may still do a deeper dive revisiting some of the points from those previous posts, but this time around I wanted to do something different – contrast Android and iOS adoption patterns. Google has published data on Android version adoption for quite some time now, but Apple’s only been doing it for the last couple of years, so we have less data. But we still have enough from both platforms that we can draw some interesting conclusions.

iOS adoption – huge initial ramp plus slow conversion

The pattern for iOS adoption is very clear – a massive initial ramp in adoption in the first few days and weeks, followed by a steady conversion over time. The chart below shows the share of the base on each version in the first 24 months from launch:

As you can see, by the time the first month is over, more than 50% of the base is already on the new version, and it ramps to around 90-95% by a year later, just before the next version launches. At that point, it immediately drops to 25-30% as the new version takes over, and slowly dwindles from there down to under 10% after two years. There are differences in adoption rates for the various versions shown – as has been reported, iOS 8 has seen a slower initial adoption rate than iOS 7, though it’s now over 75%. Correspondingly, the share of iOS 7 has fallen slightly more slowly than iOS 6 did, though the gap in both cases has closed a bit recently. Continue reading →