iPad Revival?

Apple reported its 2017Q2 (Q3 by Apple's calendar) results yesterday, and many analysts were surprised by the very strong iPad sales which were 14% YoY by shipments.

However, this was pretty close to a prediction that I had made in December last year, even before the new, cheaper iPad and the 10.5 inch iPad Pro had been announced. I had said

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.

This is very much in line with the results that were announced, although the positive results came in a quarter early, most likely due to the cheaper iPad which I did not know of when I made the prediction.

As for reasons behind the sales increase, Apple put enterprise sales first and education sales second. Although they did not give any quantitative contribution data from each market segment, this aligns with my prediction that the revival of sales will be "productivity" driven.

With this successful prediction under my belt, I am quite confident giving predictions for the next two quarters. 2017Q3 will also be very strong YoY with growth possibly in the 20% range. Again, "productivity" will be what drives the growth. As for 2017Q4, there will still likely be good growth but not as significant as the preceding two quarters. I expect single digit or low double digit growth for this quarter. This is driven by the large "entertainment" iPad sales during the holidays, which I expect are still decreasing YoY and which will dampen the growth from the "productivity" sector.

Overall, my thesis that we are witnessing a long term revival of the iPad has been strongly enforced. Some analysts seem to think that the strong sales for this quarter are a one-time effect due to the introduction of the lower cost iPad. However, I expect strong growth to continue, proving these explanations to be false.

Do Targeted Digital Ads Work Better?

In a previous post, I predicted that Google's double digit growth will come to an end most likely before 2020. I argued that this was due to the fact that advertising spend has been pegged at about 1% of GDP for a century, and that this hard ceiling would make it challenging for Google to continue fast growth amidst increasing competition from Facebook and other social networks.

Recently it was reported that P&G slashed 140 million USD from its digital ad spending, but saw sales rise for 2017Q2. The article also mentions that

Over five years, P&G is aiming for $2 billion in marketing cuts, including media, with a heavy emphasis on cleaning up the digital supply chain.

Despite high double digit growth for the current quarter, it is clear that there are clouds in the horizon for Google.

The ceiling for ad spending

The Bloomberg article mentioned in my previous post presented the following chart showing just how constant ad spending has been as a percentage of GDP. The earliest data point in this chart goes back to 1926, which is very much the beginning of advertising as we know it today. This is when corporations started to take advantage of the government propaganda techniques that had been employed during World War I, in a massive effort to get young men to enlist in the military forces.

We can see that even as the advertising media shifted from street posters to radio to television and finally the mobile Internet, nothing has significantly grown the advertising market relative to GDP. The fact that ad spending has not significantly grown since the era when all we had were street posters is remarkable when you think about it. Ads used to only be on the streets but radio allowed private time with families to be targeted as well. Even then, ad spending remained constant. Importantly in the context of digital advertising, the advent of highly targeted digital ads which collect all sorts of private information about virtually person on the Internet have not detectably increased total ad spending.

The ceiling for ad spending is very robust indeed.

Sophisticated analytics in digital ads

A lot has been made about the highly sophisticated analytics that digital advertising makes possible (often at the expense of privacy, of course). By use of tracking across multiple websites, it is possible to see whether customers who saw banner ads actually came to an e-commence site to make the purchase. All sorts of techniques have been devised to even connect online behaviour to purchases at physical stores. All this should make it possible for the advertisers to see whether their online ads were useful or not. At the very least, there should be an improvement compared to the classical dilemma; "Half the money I spend on advertising is wasted; the trouble is I don't know which half."

The P&G example above suggests however that the improvement may have been illusional. Despite all the analytics that suggested otherwise, 140 million USD of their digital advertising budget apparently belonged to the wasted half. Maybe all the analytics that sacrifices user privacy does not provide any value after all.

The truth of targeting

Targeting means showing your ads to the people who are most likely to respond positively. Targeting is also purportedly beneficial to the end-user who will end up seeing more "useful" advertisements. Because of these benefits, argue the ad companies, collecting all your personal information is a reasonable compromise. However, despite their best efforts, P&G's CFO Jon Moeller did not have kind words to say.

Clearly we don't need to be spending money that is seen by a bot and not a person. Clearly we don't need to be spending money on ads that are placed in inappropriate places, and that's why you see a significant reduction.

The targeting capabilities that we have today apparently are not very good at distinguishing between a bot and a real human being with a profile that matches what P&G desired. From this, it is reasonable to assume that our current targeting algorithms are even worse at spotting the difference between two humans with different profiles.

Again, collecting all that personal information seems to have been in vain.

Future developments to watch

P&G is not the only company cutting back on digital advertising. Unilever is reportedly doing the same. As a result, in the next few quarters, we should get a better picture as to whether these companies will continue to see strong sales growth despite cutting back, or whether they will see negative impacts and eventually come re-invest in digital. We will also be able to discern whether or not there will be a ripple effect as other companies reconsider their ad portfolios.

If P&G and others do not observe a negative impact despite a continued cut-back on digital spending, then this will significantly blunt the growth of digital advertising. Although I expect this to slow down considerably within the next few years anyway, this may come earlier than I previously though. In the short term however, this will actually benefit Google because they are most likely to be able to maintain advertiser trust by implementing measures to counter the bot issues. In aggregate, I would expect a short term boost followed by an earlier slowdown for Google and Facebook , and an much more imminent downfall for other digital advertising companies.

One possible change that I would very much welcome, is a better understanding of how valuable our personal data really is. Television and magazine advertisements do not collect your personal information, but are nonetheless targeted to a certain degree based on the programme or genre that you are viewing. Targeting itself does not necessarily need personal information as long as the ad placement itself is intelligent, and targeting does not need to stalk your whole Internet browsing habits. Digital advertising might not necessarily need to stalk you. By understanding the true value of these privacy intrusions, our society should be in a much better position to discuss whether we have to make these concessions or not.

Can advertising grow beyond the 1% ceiling?

Given that a large number of Internet companies rely on advertising as their main revenue source, the presence of a hard ceiling should worry venture capitalists who are pouring ever increasing amounts of money into them. If tech is to continue to grow as a whole by high double digits, then tech needs to find a way to either break out of this, or to develop new business models with a more direct revenue.

However, as I have argued, I consider it unlikely that digital advertising is more revolutionary than radio or television advertising, and I strongly doubt that the 1% ceiling will be broken. As digital advertising saturates the ad market as a whole, this market will become a zero-sum game and will not contribute to the growth of overall tech.

Therefore, my belief is that tech needs to stop relying on advertising and that this is starting to be an urgent issue. As the tech advertising space saturates, the current incumbents will become stronger and stronger albeit with slower growth rates. On the flip side, it will be harder and harder for new entrants with an advertising business model to make it. Advertising will quickly cease to be a viable revenue strategy for start ups.

Why Discontinue the iPod Nano and Shuffle

Yesterday, Apple announced that it had discontinued the iPod Nano and Shuffle, and that the new iPod line-up would now simply consist of only two iPod Touch devices.

Back when the iPod was introduced into this world (2001), Steve Jobs unveiled the "Digital Hub" strategy in which the PC would be in the centre of you digital life, connecting and managing all the content that you either acquired through your devices (still cameras or camcorders) or purchased (via iTunes or via physical CDs). This was also an assertion that despite the negativity surrounding the future of PCs at that time, the Mac would actually continue to thrive through successful execution of this strategy. Fast forward to 2011, Steve Jobs announces iCloud, which essentially replaces the central position of the PC in the "Digital Hub" with cloud-based services. PCs, iPhones and iPads will be equal citizens and will sync to the cloud; PCs will no longer be the Hub that connects everything together.

Apple has diligently executed on this strategy. For example, managing your photos no longer requires a PC, and even the ones that you only have on a memory card can be transferred to your iOS device (via a card reader) and synced to the cloud. For your music, you can purchase and listen to it from your iOS devices as well as your PCs.

The only devices that still required a PC, the holdouts from the Digital Hub era, were the iPod Nano and the Shuffle. Therefore, Apple's decision to discontinue these projects is symbolic not only of the decreased role of audio only devices, but also of the diminished role of PCs for consumers.

In fact, when you consider the newly announced HomePod which is very much an audio-only device, the argument that this is just about audio-only devices being obsoleted by smartphones no longer holds water. Apple clearly thinks that audio-only devices even without adequate touch screens have an important role. The difference between the HomePod and the iPod Nano and Shuffle, and the reason why one is being newly introduced while the other is being discontinued, is more about being connected to the Internet and being able to directly download/stream content. It is also about being able to use Siri, which again requires an Internet connection (at least today).

This suggests that maybe in the near future, we might see an iPod Shuffle-like device again. This time however, it will use Siri as its main user interface, and it will connect directly to your iTunes library in the cloud or download songs from Apple Music. It might actually be worn on your wrist.

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.