Good News: Apple No Longer Is The iPhone Company
by Jean-Louis Gassée
When the iPhone grew to represent more than 50% of Apple’s revenue, critics worried that the company was overly dependent on the device. Now, critics fret because the percentage fell to 48% in the quarter ending in June. The decline isn’t bad news; it’s the mark of a neatly maturing business that benefits from its ecosystem’s network effects.
Oh my god! iPhone sales keep plummeting, minus 12% compared to the same quarter last year. And we now have the horrible spectacle of Steve Jobs’ Jesus Phone being desecrated, demoted to just a bit below 50% (48.3% exactly) of Apple’s revenue.
Within hours of Apple’s numbers release, the noble and worthy scriveners at two national newspapers (I’ll provide no links to the myopic scribbles) stuck to the facile story line. Our critics’ obsession with iPhone market share is what psychoanalysts call “regressive fixations on partial objects”, the comfortable but erroneous thumbsucking attachment to something that’s easily embraced without concern for the broader war that’s being waged.
They’re missing the Apple ecosystem forest for the iPhone market share tree.
Still, there is a problem to be solved: What do you do when your leading product finds itself in a saturated and stagnating market? A strong temptation is to wage a price war. When the race to the bottom ends, the last man standing is supposed to be able to raise prices back to profit-making levels.
We saw this in the PC business around 2007 when the netbook genre launched such a conflagration. At the time, in the uncertain terms we’ve become familiar with, the kommentariat ordered Apple to introduce a netbook, or else!
Netbooks were cheap, in both senses of the word (I can attest to that having bought two). Nobody won that war.
Today, with only 6% in units market share, the Macintosh line is a healthy $24B/year business with gross margins in the 25% — 30% range.
(According to its latest SEC Filing, Apple’s overall hardware margins stand at about 30%, with 64% for services. By comparison, HP Inc. will generate about $38B in revenue this year and score a less than 10% gross margin for the laptops and PCs in its “Personal Systems Group”. The PSG is substantially less profitable than HP’s Printing unit with its lovely recurring supplies revenue.)
With this in mind, one can’t see Apple waging an iPhone price war, even as the smartphone market shrinks: — 2.5% this year says Gartner. The company isn’t going to try to do battle with Samsung, Huawei, Oppo, Xiaomi, OnePlus — and countless others — by lowering its iPhone prices.
Apple’s iPhone Game Plan is in plain view, repeatedly explained by its executives to Wall Street analyst in Earnings Release conference calls and other public pronouncements: Let the iPhone stay in its natural element: the Affordable Luxury segment, analogous to Audi for cars or Burberry for clothing. And, from there, play the ecosystem game.
Today, iOS worldwide market share stands above 16%, while Android is close to 80%, with a smattering of “others” rounding out the total. Even if iPhone market share continues to decline, Apple won’t engage in the race to the bottom embraced by many Android OEMs. The iPhone will prosper by sacrificing volume to profitability, just as Macintosh prospers with a minority market share.
Easier said than done, you might rightly say. And that’s where one needs to step back and consider Apple’s overall money-making strategy in a broader context: The Ecosystem Game.
It’s a game where every member of Apple’s ecosystem — hardware, services, content — is in the business of helping other members of the tribe generate higher margins. The iPhone sells Watches, Watches sell iPhones and AirPods, which sell Music, which sells HomePods. tv+ and Arcade sell Apple TV4Ks that, in turn, make Macs and iPads more helpful in offices and homes, and so on. It’s not a network effect in the academic sense, but I’ll still use the term for my lack of a better economics vocabulary.
There was no Apple ecosystem when Macs fought netbooks, but now there’s this special kind of network effect that should help us rethink and understand Apple’s business. It sheds a better light on the company’s chance to continue prospering in the smartphone segment, even when compared to muscular competitors such as Samsung and Huawei. Certainly, Apple’s ecosystem isn’t as strong outside of the US as it is in its US home market, but, still, Watches, iPhones, and AirPods work well together everywhere.
Before we go, two more things from the latest earnings release.
One: Apple’s R&D spending grew by $1.6B (+15.5%) for the first nine months of this fiscal year. This remarkable increase is explained with a smile by referring to “interesting future products”. For reference, I looked at Apple’s R&D spending 10 years ago. In 2009, Apple spent about 4% of revenue ($341M) in R&D. In 2019, that number is 8%, $4.26B, more than 12 times the 2009 figure.
Two: Manufacturing Purchase Obligations (MPO) increased 10% compared to last year. The MPO represents the money Apple has committed to pay its manufacturing partners for products that are in gestation. As Horace Dediu has pointed out, Apple’s MPO is (usually) a good predictor of changes in revenue for the upcoming Xmas quarter and its big product introductions (see the May 6, 2018 Monday Note titled Apple Numbers: Q1 2018 “Surprise” for more).
Admittedly, the predictor number has been known to fail. The 90% increase last year promised a grand 2018 Xmas quarter. Instead, we got a January 2nd “Profit Warning” and the Q1 FY 2019 “China Problem”: revenue down by 26.7%. Caveat haruspex.
(For the geeks among us: You’ll find the MPO number in the Management Discussion and Analysis [MD&A] section of last quarter’s 10-Q SEC Filing. Mysteriously, the PDF version disappeared from Apple’s site after I downloaded it.)
Last, last thing: By a tiny percentage (+ 1%), the just reported 3rd quarter of Apple’s Fiscal Year 2019 is the highest 3rd quarter ever in company history. But let’s not make too much of the achievement. As Tim Cook likes to say, the company doesn’t play by a 90 day clock.
— JLG@mondaynote.com
