The Law of Conservation of Attractive Profits and Samsung’s Record Quarter

It is being reported that Samsung will soon report a record quarter for its semiconductor business, taking it past even Intel for the first time ever. This is not totally unexpected and is an continuation of a upward trend that started back in 2014. It is also an expected consequence of the modularisation of the smartphone hardware industry as a whole, following a theory that Clayton Christensen originally coined “The Law of Conservation of Attractive Profits”. I have mentioned this quite a few times on this blog as well.

  1. Will Attractive Profits in the Android Ecosystem Move to Component Makers?
  2. More on Attractive Profits in the Cloud
  3. Android OEMs and The Law Of Conservation Of Attractive Profits
  4. The Law of Conservation of Attractive Profits And Personal Computing
  5. Google and the Law of Conservation of Attractive Profits

In a nutshell, the component manufacturers that can produce differentiated products will earn very good profits as the smartphone market becomes more modularised. This is similar to how Intel dominated CPUs during the PC era. 

This does not require near-monopoly power, and so this is what we are also seeing component manufacturers like MediaTek, Qualcomm and even Sony’s semiconductor business showing strong earnings, whereas on the other hand, almost all handset makers are struggling.

Going forward, I expect that the component industry as a whole will show strong profits and earnings. However the market is very competitive, and only those with competitive offerings will reap the benefits. This shifts the balance heavily towards already established incumbents, namely Samsung. Similar to how Intel successfully fended off the threat from AMD using Celerons, I doubt that cheap Chinese semiconductor players will ever unseat them, unless we again see an innovation like the smartphone which will disrupt the whole ecosystem.

How The HomePod Is A Very Typical Apple Innovation

Although I do not have a source handy, I recall that Steve Jobs mentioned in an interview long ago that back during the Apple II days, he had figured out that there were many more would-be software enthusiasts (programmers) than hardware geeks (those that could build and program one-board computers like the Apple I). This philosophy was reiterated in many Apple commercials, for example the Macintosh tag-line, “The computer for the rest of us.”

This, I believe, is the philosophy behind the HomePod. 

  1. Audiophiles today spend a lot of money on buying high-end equipment, contemplating the acoustics of their living room and where to place their speakers. It is reasonable to assume that there are vastly more people who would simply appreciate great music, compared to the number of us who are eager to learn and implement acoustic theory.
  2. Like the Apple II, the Mac and the iPhone, the HomePod is a vastly more integrated system compared to the mainstream alternatives at the time. It is part of Apple’s ecosystem for a great music experience. This has the effect of making the “Chasm” easier to cross, accelerating widespread adoption beyond early adopters. 
  3. It addresses an existing and proven market. We know that there is a market for good sound. We know that people still enjoy entertainment in the living room. Unlike the “smart speaker” market which is undeveloped and still highly speculative, we know the consumer profile to target with the HomePod.

With the HomePod, Apple is taking a proven strategy that has worked for them many times. In my opinion, there is very little doubt that it will easily surpass other “smart speaker” sales, simply by virtue of targeting a proven and vastly larger market.

Corporate Culture

Steve’s DNA will always be the base for Apple. It’s the case now. I want it to be the case in 50 years, whoever’s the CEO. I want it to be the case in 100 years, whoever’s CEO. Because that is what this company is about. His ethos should drive that—the attention to detail, the care, the ­simplicity, the focus on the user and the user experience, the focus on building the best, the focus that good isn’t good enough, that it has to be great, or in his words, “insanely great,” that we should own the proprietary technology that we work with because that’s the only way you can control your future and control your quality and user experience. And you should have the courage to walk away and be honest with yourself when you do something wrong, that you shouldn’t be so married to your position and your pride that you can’t say, “I’m changing directions.” These kind of things, these guardrails, should be the basis for Apple a century from now. It’s like the Constitution, which is the guide for the United States. It should not change. We should revere it.

In an interview with Bloomberg’s Megan Murphy, Tim Cook describes the DNA, the Constituion of Apple. There are some things to note here.

  1. There is no mention at all that relates to WHAT Apple will do or create. There is no mention of computers, silicon, software, artificial intelligence, art, luxury or anything to do with the final product, other than a focus on customer experience and building the best.
  2. It is all about the HOW. The attention to detail and the aspiration to be “insanely great”. Controlling core parts to make sure that Apple can do this.

One day, smartphones will cease to be as important as they are today. In fact, it’s even probable that computers, software and even artificial intelligence will become commodities within the current century. Companies that are predicated on indexing all of the world’s information or AI or robots, may find themselves clinging on to a commoditised utility.

Apple’s DNA transcend this. Apple has a value system that is future proof in the span of centuries. Even if Apple decides one day to exit the smartphone market, the DNA can live on and Apple will likely continue to prosper (although maybe at a smaller scale).

There are not too many companies that last even for a few decades. The average life expectancy of an S&P 500 company is now a mere 15 years. Probabilisticly, only a few of the tech bemoths of today will make it to 2040. When the babies born today enter the workforce, out of Apple, Google, Microsoft, Amazon, Facebook, and Samsung, they will most likely only encounter a couple.

When we look at the dominant companies of today, we should keep in mind that we are looking at what IBM, Sun Microsystems, HP, Xerox, Sears, Nokia looked like in their respective heydays. The formulae for companies that continue to prosper for decades and even centuries is still not well understood by the business academia, but I think that it is noteable that Apple’s DNA is future proof.

Quick Thoughts on the 2017 WWDC Keynote

  1. HomePod illustrates very clearly how Apple thinks differently from the rest of Silicon Valley. Here, Apple is going after a market that exists and a need that has been explicitly sought after by consumers. Apple is simply providing a significantly better solution to this market. This is similar to how the iPod entered a market already built and served by the Sony Walkman, and is similar to how the iPhone entered one already built by Nokia and Blackberry. This is in contrast to Amazon and Google who are trying to create a new market. The market adoption dynamics will be very different.
  2. Safari’s tracker blocking solution is interesting and will protect users privacy. Importantly, customers have noticed and have been worried about the spooky retargeting ads, and by providing a remedy for this, Apple will position itself well. Equally important however is that this will not significantly change the dynamics of the advertising market. My position is that targeting itself has not significantly contributed to the shift to digital marketing, and only to the relative market share among the digital advertising networks and Google/Facebook. The real driver of ad spend is still eyeballs and has been this way for decades. Neither ad blocking nor tracker blocking will change this. My prediction remains unchanged that Google will continue strong growth for the next few years, but will drop to single digit growth around 2020 due to saturation of the digital advertising market as a whole and competition from Facebook.
  3. The iOS 11 improvements for the iPad are hugely significant, especially in combination with the work that Apple has been doing with IBM and other corporate IT vendors/consultants. Although there still likely remain obstacles that will not make the iPad a true replacement for laptops, the improvements are large enough to encourage many people to give the iPad a second look as a work machine. We can safely predict an uptick of iPad revenue going into the later half of 2017.

State Of Online Advertising And Google’s Growth Prospects

In a previous post I discussed how Google’s growth was upper bound by total ad spending budget which has remained almost constant for a century, and that this suggested that double digit revenue growth at Google would probably end before 2020.

In simple terms, there is no longer room in the advertising industry for both Google and Facebook. Since Facebook has more momentum, it is likely that we will see Google being increasingly squeezed. Although the total digital ad spending will likely still see mid double digit growth, Facebook will take the majority of this growth and Google will probably drop to single digit growth before 2020.

The graph below is from a Morgan Stanley report and provides a forecast of the internet advertising landscape.

We can see that the combined revenue of YouTube and Google Search is projected to decline from 42% market share to 41%. This is a bit more optimistic than my prediction that Googles revenues will be squeezed, but nonetheless, it forecasts that Google will only be able to grow at the digital advertising average. (This year, this was mid double digits but according to eMarketer, this will drop to about 3% + total ad industry growth in 2020.)

Stages Of Innovation And When To Wage Wars

Benedict Evans wrote, as always, an excellent and thought provoking piece on the state of smartphone innovation. In this piece he mentions the following;

slowing innovation in the iPhone and in Android doesn’t mean weakness (“Apple doomed!” “Android falling behind!”) but strength: it reflects the fact that we are in a phase in which they’re unassailable. The fact that almost all of the white space has been filled in – the big problems solved – also means that we have left the part of the S Curve in which a new idea or execution could overturn the incumbent. They’re too feature-rich and, of course, have too much scale in units and ecosystem.

The main point here is that slowing innovation does not signal a weakness. Benedict attributes this to being at a phase where the incumbents are too entrenched that nothing could overturn them. I agree that this is certainly one aspect, but I wish to add one more thing. That is a portfolio management perspective. The growth-share matrix tells us that new companies will tend to enter businesses from the “Question mark” quadrant, high-growth markets with the potential to become lucrative. Conversely, companies will not invest in slow-growth markets but instead try to milk them. Therefore, from both a business incentive perspective (the growth-share matrix) and from a capability perspective (Benedict’s point), innovation will slow down in maturing markets and the threat of new entrants will also decrease.

Of course, that is only true until the next S curve comes along and resets the score, just as the iPhone did to both Microsoft and Nokia.

I also agree to this point, and would like to provide a different perspective. Assume you are a company like Microsoft or Samsung, a company that valiantly tried to create a mobile operating system that would challenge iOS and Android. Now what should your strategy be? Being held hostage to Google’s Android is obviously no fun, and your hope is that you will somehow control the ecosystem. We have seen how developing a smartphone OS did not work, most likely due to the reasons above. Instead, your strategy should be doing your best to capture the next S curve.

The work Samsung has been doing for its Tizen OS-based wearables is therefore a very sensible strategy. They have positioned themselves well in preparation for growth in this market. This is a war that Samsung has been wise to fight.

One final point that I would like to note is that although we are seeing slower innovation in smartphone features, this is not necessarily the case for the business models around low-cost hardware. We are seeing many low-end entrants in the handset market, and this is proof that there are many companies seeing growth opportunities. There will continue to be significant business model and manufacturing innovations in the low-end, and smartphones will continue to be exciting, especially in developing markets.

How Can Android Wear Succeed?

I know I’m very late to the party, but I recently noticed this post via a comment on “The Overspill” newsletter by Charles Arthur.

“Until we have an Apple Watch of our own, no one is going to take Android Wear seriously (opinion)” link

Essentially, this article calls on Google to create their own Android Wear watch instead of leaving this to their partners.

If Google is serious about Android Wear, it should be serious about building Android Wear watches – full stop. Only Google has the long-term motivation to keep the platform alive, and only Google can afford for its hardware business to be a zero-sum game in the name of building up an ecosystem. Without our own “Apple Watch” to act as a guidepost, as proof that a better smartwatch can be made, Android Wear seems doomed to continue on in stagnation and obscurity.

Of course, the problem with this argument is that it does not align with how Android nor Windows became popular. Google did not have to build its own phone for Android to gain steam. Similarly, Microsoft did not have to make its own PC to make Windows popular. In both cases, the respective companies followed a strict OEM partnership strategy. Essentially, this argument suggests a lack of understanding on why Android and Windows became popular in the first place.

  1. Both Windows and Android gained popularity on the back of the success of the Macintosh and iPhone respectively.
  2. Both Windows and Android were low-end alternatives to the Macintosh and iPhone. They did not necessarily bring something new, and in fact they started out being downright inferior. They were however cheaper.
  3. Due to the success of the Macintosh and the iPhone, customers were already aware that a GUI and a touch-based smartphone were very good ideas and that they would be useful. Apple had already educated customers to the benefits, and had primed the market. All that Google and Microsoft had to do was to make the same benefits accessible to the rest of the market.

So applying this to the state of smartwatches, we can foresee the following scenario that would take us to the success of Android Wear.

  1. Apple will continue to work hard to educate customers on the benefits of a smartwatch. Apple will explore what features resonate, and what a smartwatch would actually be useful for (something that is still quite ambiguous).
  2. Once the Apple Watch starts selling something like 20-30 million units per year, then a) customers will be fully aware of the benefits of a smartwatch and b) Google will know what to make.
  3. Then all that Google needs to do next is to collaborate with their partners to develop such a smartwatch that is half the price of an Apple Watch, and to bring the benefits to Android users. Importantly, it is OK for this smart watch to be downright inferior. Since Android users are currently >80% of the smartphone market, there is a potential for Android Wear watches to exceed Apple Watch sales someday.

My point is, Google does not need to make its own smartwatch. Doing so would not move the needle one bit. Instead, what Google needs to do is to keep their OEMs cosy until Apple Watch goes mainstream, and make sure that their team can pounce then. The risk here is that Samsung is going their own way with Tizen OS, and will not be with Google when the moment arrives. Google has to make sure that Sony, LG and others will not follow suite, and this is indeed the only meaningful thing they can do.

The funny thing is even among the huge tech giants, it is only Apple that can predictably make a new category product go mainstream. All the rest can do is follow.

Uber The Colonist

It seems that Silicon Valley is at last waking up to what Uber really is.

  1. “Monopoly as the Uber Business Model”
  2. “Understanding That Unregulated Monopoly Was Always Uber’s Central Objective”

I am a bit disappointed that it took this long for Silicon Valley to see this, but I suppose better late than never.

Over a year ago, I wrote this;

The question is will Uber be a sustainable business? Will it raise prices after venture capital runs out and there is no competition left? If they are forced to employ their drivers as employees and if they have to also pay for their driver’s cars, which is quite possible long term, can they still maintain current prices? If Uber becomes a monopoly, will they be any better than the regulated monopolies before them for both the drivers and the customers? I have serious doubts on this, and unless Uber discloses the sustainability of its business, commits to future low prices and the welfare of its drivers, I think that strictly regulating Uber makes a lot of sense. The last thing that you want is for Uber to kill your local taxi industry, and replace it with one which is just as expensive (potentially more) and where all the profits are funnelled to a Silicon Valley company far away. This is why we have anti-trust laws, for example, and this is why we regulate industries (like the public transport, mail, health and food industries) that directly affect the welfare of our citizens.

The point that I want to emphasise is that if the US is killing itself as a result of its relaxed views on anti-trust and disdain for regulation, then so be it. I do not mind the world’s largest superpower shooting itself in the foot.

I am however not OK with how the US is exporting this to other countries. If Uber is killing local taxi industries in developing nations, preventing the deployment of public transport by providing an artificially cheap option, and in general making these countries dependent on the US for basic needs, then I see this as a new form of colonialism. This is what Gandhi fought against with the Swadeshi movement.

And we should also note that this is not restricted to Uber. One could argue that the stagnation of tech in developed countries has caused Silicon Valley giants to search for growth in the developing nations, and their huge resources are allowing them to use predatory, money-losing tactics. It’s just that since the US is inherently an inwards-looking country and nowhere near being truly cosmopolitan, they don’t realise how much damage they’re causing.

Just see how much China’s Internet has prospered by shutting out Silicon Valley.

If Silicon Valley wants to earn money in developing nations, I see no problem in doing so. However, they must compete on equal terms. They must earn profits. For example Apple is OK because even in developing countries, they charge the same price (which turns out to be super-premium in these places). Apple does not drive out local competitors, but encourages them to copy and provide the same features at lower prices (again, look at China). Local cheap competitors thrive because of Apple.

Predictions For 2017: iPad Sales Growth

This is the second in my series of posts where I make predictions for 2017. The first one was about Autonomous Driving.

iPad sales growth

2016 was the year when we started to see revenue growth (but not unit growth) in the iPad. Many were quick to say that this was due to the introduction of the iPad Pro, but I think this misses the fundamental dynamic of what is happening in the tablet market. In fact, I have said in this blog multiple times, that most tech pundits have not understood the dynamic of the tablet market from the very beginning. The people who attribute revenue growth squarely on the iPad Pro inevitably expect a very slow growth going forward, since they do not see continuous growth drivers. My prediction is different in that I expect accelerated growth that will be in the high single digits.

Here I will illustrate my thesis and show why we should expect strong growth in 2017.

名称未設定 numbers

The above chart shows my hypothesis for what has been happening in the iPad market from the beginning; why we saw a very strong introduction, followed by a decline, and then a plateau.

  1. First of all, I separate the iPad market into two distinct segments. The first is the “Entertainment” segment which includes gaming, video watching, etc. The second is “Productivity” which includes writing, drawing, video/audio production, etc.
  2. In the initial phase of the market, we saw a huge uptake of usage in the first “Entertainment” segment. Even though the iPad was a new category device, looking at its gaming and video capabilities, it was a clear and obvious replacement for mobile game consoles like the Play Station Portable and the Nintendo 3DS. It was also a simple replacement for secondary TV screens. Since consumers could easily see the benefits and how it would work, the initial adoption was very rapid. That is, there was no need for an early adopter phase where only a fraction of the population would understand the merits of the device.
  3. However, as smartphones gained processing power and larger screens, they also started to satisfy the “Entertainment” segment. Hence the later decline in sales for this segment which started to happen in 2013-14.
  4. All this while, the “Productivity” segment of the market was going through a regular adoption curve of new category products. That is in the first few years, only the brave early adopters used iPads for “Productivity”. However, the number of these users has slowly but steadily been rising. In many cases, this has been happening more in the corporate market than in consumer markets because frankly, “productivity” is more important for our work than for leisure. It is important to note that whereas larger screen smartphones are adequate for playing games and watching videos, it is really torture editing a spreadsheet on smartphones. The benefits of a larger screen tend to be more pronounces in the “productivity” segment.
  5. Therefore, looking at the sum of both segments, we will see something like the yellow curve where a period of decline will be followed by steady growth.

Although I have made the “productivity” segment to show linear growth in the above chart, in reality, it is more likely to be sigmoidal. Therefore, when the “productivity” segment gains steam, we are likely to see quite steeper growth.

From my thesis, I can predict the following;

  1. We will see strong growth of the iPad in 2017 onwards. 2017 will start slow, but growth will accelerate.
  2. Since growth will come from “productivity” segments, the seasonality of iPad sales will become less severe.
  3. We will continue to see strong sales coming from corporations, but sales to consumers may continue to be weak.

Since 2017 is still the early phase of “productivity” segment adoption, it might yet be a bit early to see a strong impact in 2017Q1 and Q2. However, I do expect 2017Q3 to show a significant effect. 2017Q4 will be less impressive due to the “entertainment” segment dominating during the holiday season.

Predictions For 2017: Autonomous Driving Reality Check

I am planning a series of posts where I make predictions for 2017. I will put each prediction out one by one, and I will only pick those that have a strong implication for how we think about tech and innovation in general. I will also try to pick those that are likely to actually happen in 2017, rather than something that will happen eventually. That is to say, I will make it possible to check if the prediction was correct at the end of 2017.

Serious autonomous driving fatalities

In 2016, we saw a Tesla owner killing himself in a self-driving car. We also saw Uber self-driving cars running red lights in San Francisco.

Tesla managed to wiggle out of the problem by putting the blame on the driver, who may have been watching a Harry Potter movie instead of being ready to resume control of the vehicle. Uber managed to put the blame on the driver, by saying that the driver was actually in control of the vehicle at that time (which frankly sounds rather unconvincing).

In 2017, more companies will put their self-driving cars into public roads. Fierce competition and investor pressure will mean that some companies will even do this prematurely, before the technology is truly ready. In effect, it is likely that we see something like the Titanic crashing into an iceberg. That is, we will see companies hastily putting autonomous cars onto roads before they are ready, possibly with more fatal consequences. For the sake of prediction, I would say that we will see at least two fatalities by June.

What will subsequently happen is very politic and depends on the huge lobbying power of the large tech companies. There will no doubt be a move towards regulation, but on the opposing end, we will also see an eagerness from governments to embrace the promise of innovation. It is difficult to predict which way the scales will tip.