Apple Pay, partnerships and software as disruption

With Apple Pay just launched and some sort of TV product floating on the horizon, it strikes me that there are three ways to think about how Apple changes industries. 

The first and obvious one is that Apple builds very tightly integrated products. It always tries to controls all the parts of the experience that matter, and over time it tends to bring more and more in house. Hence, it now designs the CPU in the iPhone and iPad and is rumoured to be planning to design the baseband chip too.

This degree of integration gives performance and power management advantages but more importantly makes tightly controlled hardware-software user experiences much easier than for a disaggregated platform like Android. This is particularly important for Apple Pay because the unique thing about it is the experience, not the principle of using NFC for card payments, which has been around for years, both at Nokia and in Google Wallet. Moving from three or four steps to one wave of the phone is only the last 10% of the problem, but of course it’s the 10% that takes 90% of the effort and makes all the difference in consumer adoption, and it’s vastly easier because of the tight integration that Apple gets from controlling the entire platform. 

The interesting part of this integration is that it tends to appear in stages. That is, Apple often builds 'Minimum Viable Products' by releasing discrete components one by one, making sure that each works well on its own and has a sensible stand-alone use case, and ties them together into a larger whole later. Hence Apple Pay needed the fingerprint scanner for Pay, but shipped it a year earlier with other use cases. These building blocks need to have both a specific and a more general purpose: unlock your phone now, payment platform later when other pieces are in place. Equally, I would expect things like loyalty cards to be integrated with Apple Pay in due course, as well as developer access to the NFC chip (just as the fingerprint scanner got an API a year on). 

Second, Apple is distinguished as much by what it doesn't integrate as by what it does. It didn't buy or build a record label and it didn't hire A&R guys. It didn't buy a mobile operator or create an MVNO. It never bought movie or TV rights, and it hasn't created a new payment platform. It is partnering with Chase and Visa, not competing with them. 

This tends to confuse people who hate their phone company/cable company/bank: they wish Apple would get into that business. But this is to misunderstand what those businesses are. My archetypal 'silly Apple rumour' is that Apple will buy Boeing to replace the inflight entertainment systems with iPads because inflight entertainment systems are bad: that may well be true, but that's not what Boeing's business IS. It makes, and sells, very big, complex machines, and the screens are totally peripheral to that business. Record labels and film companies know about finding talent and making great entertainment, mobile operators know how to run vast, complex networks of physical infrastructure and so on.  Apple (or for that matter Google or Facebook) has no skills and no advantage here. So why build when you can partner? Leave it all on their balance sheet. Leave subsidies, credit risk and talent scouting to other people. This brings to mind an ATD interview with Steve Jobs and Bill Gates, when they were each asked what they admired about the other: Bill Gates said taste (in the broadest sense) and Steve Jobs said he envied Microsoft’s ability to partner. Apple's learned something of that. 

This drive to partner means that though Apple may have a fractious relationship with mobile operators or movie studios, it does not tend to mount existential threats to them. This can contrast with Google, which with projects like Google Fibre tends to retain the grad-student idea that it can do anything at all better than anyone else. Apple looks more like a challenging partner than a challenger. Apple Pay is perhaps the best example of this: it allows banks a far greater role in the transaction (and data) than Google Wallet did, and Apple did not build a payments platform - it is not competing with Visa or Chase Manhattan. 

Third, though, for all that Apple may look like a partner, there is something inherently destabilizing in moving an industry into software. Apple didn’t build a record label itself, and gave the labels a great way to compete with piracy, but it also accelerated the unbundling of the album, which has been a huge part of the collapse in recorded music revenue in the last decade. Equally, Apple has not built a global payments platform, but it is moving the end-point of the payment system into software, and that itself is destabilizing. Passbook, after all, is a platform. What happens when any payment ‘card’ can be provisioned instantly in software? When Apple allows third party apps to use the NFC at a point of sales as well as the fingerprint scanner? What does that do to Bitcoin adoption? When you shift the entire route to market of an industry into a new platform with new dynamics, you can cause a lot of pain to incumbents even without doing anything to take them on directly. Much the same applies to TV. 

Finally, I suspect that for Apple the most important part of Apple Pay may be its use in apps, not at physical retail. If you can acquire a credit card and address with just one tap then a major cause of drop-off and cart abandonment goes away, and that in turn alters the calculus around whether you make an app or a website: you have to get people to install the app (which is a cause of drop-off), but after that everything is seamless, whereas on a mobile website you don't need to drive an install but do need to get people to type in their card (though with keychain Apple has a solution here as well). The immediate effect of this is to reinforce the position of iOS as the platform where most merchants see the majority of their value, and hence of course drive them to continue to make iOS apps and make them first, which in turn drives iOS device sales, especially to people who buy things, a virtuous circle that Apple is already benefiting from at the expense of Android. The interesting question here, of course, is what Apple's next step is. Does it try to enable Apple Pay for website accessed on iOS devices (which would be very challenging)? Add it to Macs (though this is a much smaller market)? And, of course, what if it gives third party apps access to payment data in the same way (controlled, permission-based) it does for health?

How many ecosystems?

We now have over 2bn iOS and Android devices on earth, and this will grow in the next few years to well over 3bn. This kind of scale is unprecedented in the computing industry (there are only 1.6bn PCs even now), and it tends to break prior assumptions in lots of interesting ways. One of the most interesting stress points for me is in the way that we think about ecosystems. It's not clear how 'winner-takes-all' dynamics work, and it's not clear how far ecosystems are global.

The common narrative around ecosystems, as we have seen played out in the past, is that there is a very strong winner-takes-all dynamic - the larger ecosystem draws in developer activity because it offers the single best opportunity and the presence of developers in turn draws in users in a virtuous circle, with minority ecosystems squeezed out. This is what happen to the Mac, and it's what we can see happening to Blackberry and perhaps Windows Phone, and so, perhaps, it will happen to iOS, which is now being outsold by Android 4:1 or 5:1 in unit volumes. 

This is an easy and well-understood narrative, but it seems to me to fail to account for some basic changes.

First, it is not really clear what it means for iOS to be a minority ecosystem when it has 650m active devices even today, and will probably rise to, say, 7-800m, given current dynamics. In 1995, when Windows 95 sealed Microsoft's victory over Apple, there were only 250m PCs on Earth (and Macs were in the low tens of millions). There are twice as many iOS devices now as Windows PCs then. We know that Blackberry is sub-scale in this environment, but are we sure that there is no room for a second ecosystem with over half a billion users?

Second, it's now very clear that in mobile, the scale of the developer opportunity does not map well to install base or sales volumes. We know from data given by Google and Apple at their developer conferences this summer that Apple paid out roughly $10bn to developers in the previous 12 months where Google paid out $5bn, despite having close to twice as many active devices. In other words, the average Android device generates between a quarter and a third as much spending as the average iOS device.

Of course, app store revenue is only one metric, and comes with caveats, such as that the Google number excludes China and the iOS one does not, but pretty much all of the available usage data points to a similar disparity. This chart from Akamai for mobile browser share gives another view of the same gap, and one could multiply charts like this almost indefintely. For a variety of pretty widely discussed reasons, iPhones and iPads get a disproportionately large share of value, engagement and usage. 

Meanwhile, at least in developed markets, the dynamics of early-stage startups strongly favour an 'iOS-first' approach, as Steve Cheney laid out here. Their objective is normally to achieve traction in a fairly defined period with limited resources, and iOS offers lower development costs and a higher concentration of early-adopter users with a higher propensity to spend money, making it much easier to prove that your idea works on iOS than on Android. This in turn means that the 'cool new apps' tend to come to iOS first regardless of the broader unit share picture, and this again is self-sustaining - users who value this tend to choose iOS, reinforcing the effect. 

So, what will happen when the minority ecosystem has 650m users, half or more of actual use and engagement and the majority of developer activity, and this seems to be self-sustaining? How do the winner-takes-all dynamics work here? We have no precedents. 

Third, we don't really know how far we should be thinking about a global ecosystem at all. With numbers this large, we may start to have very different ecosystem dynamics in different places. Development has become much cheaper and many countries will have tens of millions of smartphone users - there will be a range of places where the local market is large enough to sustain local apps developed in defiance of norms elsewhere. 

After all, a large proportion of the apps that matter are fundamentally local. To say that Citibank in the USA, Tesco in the UK or Carrefour in France will pull their iOS apps because it's the 'minority ecosystem' is actually to say that they'll abandon the best half or best third of their users because there are lots of Android users in Indonesia. Equally, the hot new startup in India or Indonesia may well go Android first, and not care how many iPhones there are in San Francisco. The size of the broader global ecosystem is not necessarily that relevant if the target market is local and the local market is large enough to sustain development by itself. So some of these will go global (or try to) but many may not need to.

This in turn means that the question of what platforms are sub-scale or minority is different in different places and so you will get different levels of support for these platforms in different places:

  • In very big markets such as the USA (over 200m smartphones) China (at least 400m already) and India (perhaps 100m) you can build big businesses without worrying much what's used in other places.
  • Small, low income markets may be dominated by Android but also not be able to sustain local developers, and so float on the global services alone.
  • In markets like Spain one can clearly see signs that Android has 'won' and that local brands are slow to support iOS. 
  • In some middle income markets, iOS may have a small relative share but (due to income inequality) a wildly disproportionate share of the most valuable customers. 

All of this means that it isn't so much that 'market share doesn't matter' (the mantra of Apple fans for decades) as that you need to think about what kind of market share, where, and whether that matters. Or as Groucho Marx almost said, "this is my market share and if you don't like it I've got others".

Ways to think about watches

Standing in Cupertino last week, holding an Apple watch in my hand, I was reminded very much of the original iPad launch. Here is an idea for a new thing, and the idea has been implemented very well, but it’s not quite clear if it’s a good idea. 

If you wanted a nine inch touch-screen tablet, the iPad executed that idea pretty well, but did you want one? Was it a good idea? If you want a very small computer on your wrist, both Apple and Motorola (and perhaps Samsung, if that’s your taste) have each made one that’s pretty good, but do you want one? 

This question is actually harder for a smart watch (a term I use only for want of a better one) than it was for the iPad, since the iPad did fundamentally sit within existing behavior - it was a large computer screen that did well-established computer things, but in a different way. You can argue about how it relates to a laptop or desktop and what the trade-offs and limitations are, but owning a computer screen roughly that size, running programs and showing the web, is an old behaviour. You might wonder whether you want a tablet instead of a laptop, but not whether there is a use for that screen. 

We got slightly closer to the same sense of puzzlement with smartphones. I spent much of 2000 and 2001 being asked ‘what’s the killer app for 3G?” by investors trying to work out if the European mobile operators would make any return on the €110bn that they'd spent on 3G spectrum in early 2000. In the end it turned out that the killer app for the mobile internet was having the internet, mobile, though the operators didn’t make much of a return. But it also took 7 years to close the gap between concept videos and the first device that made this real, and for a long time it was not obvious that having the internet on your phone had much value to many people outside Japan. 

In fact, one could argue that the closest precedent for puzzlement is the mobile phone itself. If you tell the young people of today this they won’t believe you, but in the mid 1990s most people thought that mobile phones were an expensive niche product without mass-market potential. We already had phones, and pay phones, so why would you need this other thing? Mobile operators around the world (the disruptive innovators of the day) had to run advertising campaigns suggesting reasons why having a mobile phone might be useful. Price was obviously one reason this was hard to imagine, but there were more basic factors. Simple behaviors we take for granted today were different. People made plans to to meet their friends before going out in the evening, for example. We managed without mobile phones, and had to be persuaded into them. 

It seems to me that there are two kinds of puzzle around a new... thing. One is that you already have a thing that does this. For tablets this was the PC (and the smartphone) and for the iPod it was the Walkman - for the iPod the advantage of the new thing seems obvious now, but people took some persuading even at the time, and for tablets the scope of replacement remains unclear. But for another kind of new product, you don’t already have a thing that does this because there is no ’this’, and it’s not clear what ’this’ might be. A mobile phone is not a landline that doesn’t have a wire - it changes large parts of how you can live your life, so much so that it was not obvious in 1995 what would change. So too a smart watch. Yes, it tells the time, but what else?

So how do we puzzle this out? There are three strands, I think - three pieces of string to pull at:

  • How does a watch complement the smartphone you already take everywhere?
  • What does a watch do of itself that’s different?
  • What is different about something that you wear on your wrist, next to your skin, on display, all the time - what are the self expressive and emotional characteristics of this? 

First, the complement. A watch does not yet have room for a battery that can supply a cellular radio that will last all day, and the screen seems too small to be the only portable screen you have, pending projectors, folding screens or retinal implants. If you must have a smartphone, why the watch as well?

We know that a large proportion of smartphone use is actually at home, when there’s a laptop or tablet in easy reach. Where is your smartphone when you’re at home? In your pocket, in case it rings or bleeps and you miss it? Or if you want to check something? Are you uncomfortable leaving it another room of the house? What if, via the watch, it could come with you, if you want? Are you in that (say) half of the population that keeps your phone in your bag, rather than your pocket? Does that change the value of having a slice of your smartphone on your wrist? What did you think about cordless phones when you first heard about them? Remote controls? The best camera is the one you always have with you - what is the best screen - the one you can see by flexing your am, or the one that takes a few seconds longer? What is there in the convenience of the thing on your wrist? The answer is not nothing at all, but it is hard to know quite what. 

Second, what is it of itself? Apple has announced its watch well before it ships in part to give developers time to make things for it (any Osborning of Android watches over Christmas is entirely coincidental). Apple’s approach is very focused on the watch as a platform in its own right, with the iPhone needed but as a partner. Google’s Android Wear was first shown this spring purely as a remote screen for your Android phone, showing notifications and Google Now, but an API has been added there too. But what can a developer do that’s better on the watch than the phone? This feels much like 2008, when it was clear you could do… something with the iPhone, but no-one imagined Uber: the early apps were Tetris clones and task managers and of course newspaper apps. Hence Apple’s social messaging app, that lets you send sketches or buzzes or just your heart beat to someone, is intriguing as a way to tap into the immediacy of the platform and the sensors and outputs that it offers. Just as no-one predicted Uber from GPS, no-one predicted Instagram or Tinder from the camera. Mobile social apps have become a playground for experimentation in UX - something always on your wrist seems like fertile ground. But the truth is we don’t really know - the watch, like the smartphone or tablet, is a piece of glass - it can be anything. 

Third, it seems to me that the key part of ‘anything’ is not, fundamentally, about computing, but delight, amusement, self-expression and emotion. This is a $400 (or more) thing that you don’t fundamentally need, that you wear on your wrist. That’s why  Hodinkee's review touched such an important point - you wear this. Google  Glass is failing because it doesn’t matter what you see when you turn it on - you’re wearing a ‘thing' on your face. Put the same output into an existing pair of glasses or contact lenses, say, and that would go away, and one could at least talk about whether it’s useful. But 'normal’ people care about stitching and weave and weight and texture and colour. This matters much more for phones than PCs, and much more for a watch than for a phone. It’s just a piece of glass until you turn it on, but it needs to be a pleasing piece of glass before you turn it on. 

Hence, though I’m not a big fan of assessing future markets in the light of past ones, it’s worth considering the existing watch market. Around 1.2bn watches are made each year, of which about 650m are made in China and exported for an average price of $3. At the other extreme, a few tens of millions of watches are sold each year for over (mostly well over) $1000, and these are essentially jewelry, in which you pay for complex manually-assembled machinery and the brand and associated aura instead of very small pieces of uncommon rocks and their aura. But in the middle, several hundred million watches are sold every year for prices between $100 and $1000, made by companies like Swatch and Fossil (which might be called the Luxottica of watches) in which you are sold not the time but an attractive object, much like a handbag or pair of shoes or pair of glasses. And as Hodinkee says, Apple has an offer that is as good or better here at the same price before you even turn it on. Design, fit & finish and user experience are not the paint on the box - they're an integral part of what such a product is, and if you get them wrong, you've screwed up just as much as if the battery only lasts the morning or the Bluetooth drops out. That, amongst other things, is why removable straps are a core part of the technical specifications. 

After you turn it on, well, what does software as part of the experience of a luxury product look like? Nokia’s venture Vertu had a go at this, though I always struggled with the concept of an old low-end Nokia in a platinum box as a luxury good, but Apple is trying to do this for far more people. Apple always talks about delighting users, but for a 'watch', it seems to me that delight is central, and it needs to be the delight of the ‘normal’ person, not the delight of the technical user seeing a cool piece of engineering. That’s the delight that comes from milanese loops, sending your heartbeat to your friend, or a butterfly flapping its wings on your wrist, AND knowing that your team scored or your bus is here.

iPhone 6 and Android value

The new iPhones were much the most predictable part of Apple's event - widely leaked and impelled by an irresistible logic - the customer is always right. For all that Apple thought and argued that you should optimize for the thumb size, it turns out optimizing for the pocket size is a better metric. *

(Of course, this isn't the first time - Steve Jobs famously said that no-one would watch video on an iPod, and that small tablets should come with sandpaper for your fingers).

Meanwhile, Apple did not, as I and others have argued it now could, make any real change to its pricing strategy. We still have a new model at $600 or so (plus another that's even more expensive) and older models at $100 and $200 cheaper, together with a (very) large secondary market act to address some of the top of the mid-range, but no more. 

Instead, these phones are a direct move against premium Android. 

Apple currently has about 10% of global handset unit sales, at an ASP of $550-600, and Android has another 50% at an ASP of $250-300 (almost all the rest are feature phones, now also converting fast to Android at well under $100). But within that Android there is a lucrative segment of high-end phones that sells at roughly the same price and in roughly the same numbers as the iPhone. To put this another way, Apple has 10% of the handset market but half of the high-end, and Android has the other half of the high end. 

That Android high-end is dominated by Samsung, and by screens with larger screens than previous iPhones. Until now.

How much of an impact will these new iPhones have on that segment? There are a bunch of reasons why someone would buy a high-end Android rather than an iPhone:

  1. Their operator subsidies an Android but not an iPhone - this has now ended, with Apple adding distribution with all the last significant hold-outs (Sprint, DoCoMo, China Mobile)
  2. They don't particularly care what phone they get and the salesman was on more commission to sell Androids or, more probably, Samsungs that day (and iPhones the next, of course)
  3. They have a dislike of Apple per se - this is hard to quantify but probably pretty small, and balanced by people with a dislike of Google
  4. They are heavily bought into the Google ecosystem
  5. They like the customizations that are possible with Android and that have not been possible with iOS until (to a much increased extent) iOS8 (more broadly, once could characterize this as 'personal taste')
  6. They want a larger screen. 

Splitting these out, the first has largely gone, the second is of little value to an ecosystem player and nets out at zero (i.e. Apple gains as many indifferent users as it loses) and the third is small. Apple has now addressed the fifth and sixth, and the massive increase in third-party attach points means that Google's ecosystem (and Facebook's incidentally) can now push deep into iOS - if Google chooses to do so. 

That is, with the iPhone 6 and iOS8, Apple has done its best to close off all the reasons to buy high-end Android beyond simple personal preference. You can get a bigger screen, you can change the keyboard, you can put widgets on the notification panel (if you insist) and so on. Pretty much all the external reasons to choose Android are addressed - what remains is personal taste.

Amongst other things, this is a major cull of Steve Jobs' sacred cows - lots of these are decisions he was deeply involved in. No-one was quicker than Steve Jobs himself to change his mind, but it's refreshing to see so many outdated assumptions being thrown out. 

Meanwhile, with the iPhone 6 Plus (a very Microsofty name, it must be said) Apple is also tackling the phablet market head on. The available data suggests this is mostly important in East Asia but not actually dominant even there - perhaps 10-20% of units except in South Korea, where it is much larger.  Samsung has tried hard to make the pen (or rather stylus) a key selling point for these devices, but without widespread developer support (there is nothing as magical as Paper for the Note) it is not clear that these devices have actually sold on anything beyond screen size and inverse price sensitivity (that is, people buy it because it's the 'best' and most expensive one). That in turn means the 6 Plus could be a straight substitute. 

Finally, not unlike Nokia for much of its history, Apple remains the only handset maker of scale making phones with a premium hardware design. Both Nokia and HTC also made equally desirable hardware but for different reasons have faded from the scene, while Samsung appears unable to make the shift in approach that this would necessitate. Several Chinese OEMs are making significant progress here (most obviously Xiaomi), but are not yet in a position to challenge Apple directly, and indeed are much more of a problem for Samsung, which finds itself squeezed in the middle. 

Setting aside the OEM horse-race commentary, the important thing about this move is how much it tends to reinforce the dominant dynamic of the two ecosystems - that Apple has a quarter of the users but three quarters of the value.  

We know from data given at WWDC and Google IO that Apple paid out ~$10bn to iOS developers in the previous 12 months and Google paid out ~$5bn. Yet, Google reported "1bn" Android users (outside China). Apple, depending on your assumptions about replacement rates, has between 550m and 650m active devices (though fewer total human users). That is, Apple brought in twice the app revenue on a little over half the users. (I wrote a detailed analysis of this here.)

We used to say that of course the average spend for Android users was lower, because the devices were available at any price for $80 to $800 where iPhones average $600, and sold well in poorer countries, but the premium Android users were bound to be worth much the same as iPhone users. This new data showed that this was not true. 

If premium Android users were worth the same as iPhone users, but the mid-range and low-end Android users were (naturally) worth less, then the Android number should have been (say) $11bn versus Apple's $10bn. But it's $5bn. So, even the premium Android users, the very best ones - even the people buying phablets - are worth much less to the ecosystem than an iPhone user. And now Apple is now going after them too. 

This takes us to a final question - is it the users or is it the ecosystem? If Apple converts a big chunk of premium Android users to the iPhone 6 when they come to refresh their phones (and note that since they won't all have bought their phones in September 2012, they won't all be up for upgrade as soon as the new iPhones come out), will their behavior change? Are we seeing less ecosystem value for these users because of differences in the platform they're on, or is there something different about those users' attitudes?

And, of course, if those users do leave, what will the Android metrics look like then?

* Just as for multitasking, and the new extensions in iOS8, Apple had to work hard to make this possible - in this case it had to move away from pixel-perfect layouts to something more responsive. This of course is where Android started - since it was predicated on a wide range of devices it had to allow for different layouts, where Apple started from one screen size. This, I think, reflects a broader trend - that Android and iPhone started in quite different places and have converged over the past 5 years.

Podcast: Apple day

NFC (near field communication) technology has been around for about a decade, and with the exception of transit cards mostly outside the United States it’s gone nowhere. Now Apple has debuted Apple Pay. Has Apple filled in the gaps in terms of user experience, sheer number of devices, and retail footprint to finally make NFC work? In six months will we all be swiping our phones at every coffee joint and grocery store? Once Apple has virtualized your credit cards, what comes next? Benedict Evans is joined by a16z’s Frank Chen and Zal Bilimoria to discuss the latest from Cupertino’s finest around payments, the long-awaited Apple Watch, and a bigger (and biggest) iPhone.

Note on cheap iPhones

Ever since the iPhone launched, people have been pointing out that it is very expensive, relative to the rest of the market, and wondering when, and how, and if Apple might go cheaper. Much like the 'Apple television', this is a story that's so old people have got very bored with it, but that doesn't mean we should forget it. 

First, a recap.

Apple's phones start at $400 and average $550-$600 where the average for phones globally is about $180 and the average for Android is $250-300. Apple's sales are entirely high-end. This has taken it to around 10% of all the phones sold on earth each quarter - it appears to have about half to two thirds of the high-end segment, with Android (mostly Samsung) having the rest. However, the bulk of Android's sales are actually at lower prices: hence Apple has 10% of sales and Android has another 10% selling at the high end but a further 40% selling at lower prices. Windows Phone and Blackberry have 2-3% and the rest is feature phones, which are converting to smartphones at prices under $100, which means Android. 

This difference between market share and pricing is, incidentally, the reason why the iPhone has 10% of handset unit sales but a third of revenue, and why the iOS app store has two thirds of app store revenues.  

So, maybe 20% of the phone market is premium, of which Apple has half, and 40% (say) is at $100 or lower and still mostly featurephones (though within that there's a lot of people trading up from lower prices). But there is a lot of debate within the industry about how the space in between plays out. The narrative generally splits the market into four rough segments: 

  • $50-100 smartphones: currently these are dominated by companies you've never heard of using off-the-shelf chips from Mediatek, Spreadtrum and others, and though they run Android and have 3G they often have only 256 meg of RAM, which makes for a pretty poor experience. And the build quality and screens are not great. 
  • $100 to (say) $200 - this is where the branded companies start playing. At this price devices like the Lumia 520, the Xiaomi Hongmi and the Motorola X provide an experience that you would not, actually, be unhappy with. I describe these phones as like driving a Toyota or a VW: you know you're not in a BMW (or a Bentley), but there's nothing wrong with them at all and some of them are pretty cool. 
  • Then, $200-450 (or thereabouts) counts as mid-range, and 
  • $450-500 and up counts as premium. Arguably there's a super-premium segment further up. 

One can debate where I've drawn the price bands, but the point is that there are different tiers of experience. One of the big debates in the industry is how viable the third category is. Do people who bought a $400 phone two years ago decide they can get something better for $200 now? Or do they decide to upgrade to $600? Do people move up into this segment from below? Do people who bought a $500 phone two yeas ago move down into this category? (Since these people are by definition less price-sensitive this seems less likely). 


When people talk about whether Apple should do a 'cheap phone', it's important to be clear about which of these segments you're really talking about. When people say 'Apple is missing out on the next x billion people' - that is, the portion of the market that's still on feature phones - they're actually talking about the first category. Even Samsung doesn't really play here, nor Xiaomi. This is is the land of the $200 PC - very low margin commodities with a poor user experience. 

However, the second and third categories are rather more interesting. Apple says, over and over, that the objective is not to sell the most phones, but to make phones that it can be proud of. In 2007 the iPhone was an MVP lacking industry standards like 3G and a decent camera, yet it still needed to be $600 or more to deliver the vision. Today Apple could perfectly well make a phone it could be proud of at $300. Indeed, there's nothing that it would be ashamed of in the Lumia or Xiaomi at $150 and below.  

Meanwhile, if you look at the history of Apple's pricing, it has always made products at the high end but also in the mid-range. It has pushed to find the 'lowest viable price' for an 'Apple-quality experience' (and then added 10% or 20%, perhaps). In 2007 that price for a smartphone was $6-700, but now it is $200 or $300. That is, there is absolutely no technical reason why Apple could not make a great iPhone and sell it for $300 or so today. It wouldn't be the same as the premium product, but then the iMac was not the PowerMac. 

There are, obviously, a bunch of execution questions around this, such as how to avoid fragmenting the platform too much and how to segment the different product lines to avoid cannibalising the high-end too. What would the product matrix look like? Would Apple stop selling older models entirely? What happens to the gross margin with a wide range of entire new phones and no older ones? What happens to the resale value of the new flagships, and how does that affect sales? But then, Apple didn't worry about cannibalising Mac sales with the iPad. This might be, in a sense, a test for Tim Cook - whether he can do the right thing (assuming that's what it is) even if it erodes other businesses or pushes the stock price down, the way Steve Jobs could (or Larry Page, or Mark Zuckerberg) - can he behave like a founder?

There are two interesting sets of consequences from any such phone: the impact on Apple and the impact on Android. 

First, Apple. I've embedded a simple spreadsheet below calculating the financial impact on the company from a blockbuster 'cheap iPhone'. One can argue about the detail, but the key point is that if you sell 40m 'iPhone Nanos' (and presume for the moment that you actually can) at $250 at a 20% gross margin, that generates $2bn a quarter in gross profit for a company that reported almost $15bn gross profit last quarter. That is, a blockbuster iPhone that doubles Apple's market share adds just 15% to gross profit, before allowing for the inevitable cannibalisation of the high-end product. Factor that in and you probably only add 5-10% So, this does not really address the 'growth question' - it doesn't double Apple's business again. 

Screen Shot 2014-08-06 at 2.07.20 PM.png

That does not mean it is not worth doing, of course. Even apart from the financials, the broader value is the impact on the ecosystem landscape. I am not convinced that iOS, with perhaps 500m-600m active devices already compared to Google Android's 1bn or so, can really be described as sub-scale, especially given it has two thirds of app store revenue. However, adding a 'gateway' device in the mid-range with significantly more unit sales would build a much deeper moat around that ecosystem. (Though it would also dilute that high-level customer base.)

The other side of this coin is of course the impact on Android. The two markets where iPhone sales are effectively at parity with Android are the USA and Japan, and those are also the two markets where the subsidy structure means that the iPhones is not at a big price premium to Android. This is probably not a co-incidence. Meanwhile, we also see strong indications that the second-hand market for iPhones, mostly in the $2-300 range, is also extremely strong. It doesn't seem unreasonable to suppose that a new, attractive iPhone in this segment would be highly competitive. So, such a phone would sell, and sell well, and take a big chunk of the most valuable Android customers. Not, of course, the ones who value 'open' and the Google ecosystem above everything else, but true enthusiasts are a minority on both Android and iOS. 

It is also worth noting that in the high-end, where Android is roughly equal in sales to the iPhone, two major competitive drivers for an Android purchase are a larger screen and more customization options: Apple addresses many of the second with iOS8 and is strongly rumored to be planning a large-screen phone, addressing the first.  Hence, in six months, we could see both a stronger Apple proposition at the high end and also a new and pretty compelling offer in the mid range. 

Finally, the interesting thing about all of these questions is that they are largely under Apple's control. Apple chooses not to do a large screen phone, and it chooses not to go into the mid range, and it chose not to allow, say, third-party keyboards. There were strong technical challenges for all of these, but those have probably now been removed (certainly for the third point, given the extensibility of iOS8). This means Apple has more cards to play than we've yet seen. 

App store revenue

App store revenue is not an ideal way to scope the value of an ecosystem to developers. The majority of the revenue comes from games, mostly freemium using IAP, while a large proportion of the most valuable apps are offered for free and generate revenue through other means (Facebook or Amazon, for example).

However, it does give a pretty good proxy for the broader behavior of the users, and it also of course is very relevant for developers who do want to to charge. 

For the first time, Google gave numbers for app store developer revenue at IO this year, and in the latest quarterly results Apple gave (almost) like-for-like numbers: 

  • Google said it paid out $5bn to developers from Google IO in 2013 to Google IO in 2014 (a little over 13 months)
  • Apple said it has paid out $20bn to developers in total by the end of the June 2014 quarter, and at WWDC June 2013 it gave a figure of $10bn paid to developers (at the June 2013 earnings call a month later it then said it had paid out $11bn). So in the last 12 months, it paid out roughly $10bn. 
  • Google also said at IO that it has 1bn 30-day active Android users - the degree of precision is not clear. The iOS number is fuzzier: trailing 24 months' sales would be a little under 500m, but extending that to a three year lifespan would take it to over 600m. 

Obviously all of these numbers are rounded and were given at scheduled events, so need to be taken as imprecise. The fact that four different growth rates are involved also makes calculating ARPUs a little tricky.

That said:

  • In the last 12 months, on public numbers, Google has paid out roughly half of Apple - $5bn versus $10bn, on roughly double the number of devices. 
  • On a run-rate basis, annual gross app store revenue across iOS and Android is now $21bn. 

The chart below shows the public data points. 

The problem with this, of course, is that with only two data points from Google, we don't know the trajectory - if this is a steep curve the recent period might be pointing more sharply upwards. 

A further observation: if the current market dynamics remain, Google Android's user base will at least double in the next few years - the iPhone base is still growing, but it will probably not double. However, those users will be gained at progressively lower (much lower) device price points, and with significantly lower spending profiles. 

For more discussion of why the two platforms look different, see this post. 

Finally, just to make life easier, Play is not the only payment system you can use on Android, even Google Android. A material number of apps, mainly games and mainly in emerging markets, use other payment methods. So that number might really be somewhat higher. 

The next phase of smartphones

It’s now 7 years since the iPhone reset the phone business, and indeed the entire computing and internet businesses. But it was pretty clear at the time that the first iPhone was an MVP, and Google’s first Android… homage, the HTC G1, was even more so. It feels rather like the last 7 years have been spent adding all the things that really needed to be there to start with, both in hardware and software. For iOS and Android these have come in different orders, since their opening assumptions were very different, but they’ve ended up at much the same place in terms of the user experience and interaction model. There are small differences in how you interact, and there are always things that are on one platform before the other, but the basic user flows are very similar, and almost all the obvious gaps have been filled. 

Along these lines, my colleague Steven Sinofsky makes the point that for any new ‘thing' in computing, at the beginning everyone is doing roughly the same stuff because the stuff you need to add is pretty obvious and undifferentiated - you might deliver different things in different orders but you’ve got basically the same wish list. It’s once you’ve finished building out that stuff that things start to diverge. 

This, I think, is what we started to see at this year’s WWDC and Google IO - the end of the first 7 years and the start of a new phase, with the fundamental characters of Apple and Google asserting themselves. As Jean-Louis Gassée put it, iOS 8 is really iOS 2.0

Hence, WWDC was all about cloud as an enabler of rich native apps, while the most interesting parts of IO were about eroding the difference between apps and websites. In future versions of Android, Chrome tabs and apps appear together in the task list, search results can link directly to content within apps and Chromebooks can run Android apps - it seems that Google is trying to make ‘app versus web’ an irrelevant discussion - all content will act like part of the web, searchable and linkable by Google. Conversely for Apple, a lot of iOS 8 is about removing reasons to use the web at all, pulling more and more of the cloud into apps, while extensions create a bigger rather than smaller gap between what ‘apps’ and ‘web sites’ are, allowing apps to talk to each other and access each others’ cloud services without ever touching the web. 

Unlike the previous differences in philosophy between the platforms, which were mostly (to generalise massively) about method rather than outcome, these, especially as they evolve further over time, point to basic differences in how you do things on the two platforms, and in what it would even mean to do specific tasks on each.The user flows become different. The interaction models become different. I’ve said before that Apple’s approach is about a dumb cloud enabling rich apps while Google’s is about devices as dumb glass that are endpoints of cloud services. That’s going to lead to rather different experiences, and to ever more complex discussions within companies as to what sort of features they create across the two platforms and where they place their priorities. It also changes somewhat the character of the narrative that the generic shift of computing from local devices to the cloud is a structural problem for Apple, since what we mean, exactly, when we say ‘cloud’ on smartphones needs to be unpicked rather more. That's a subject for my next post. 

Meanwhile, this sort of divergence is why I’m a little skeptical about the other two big reveals in the last couple of months: the Fire Phone and Facebook’s mobile announcements at F8. Facebook is trying to build essential plumbing to connect the web and apps together, in particular with its deep linking project. But this is like building the plumbing for a building that’s still going up, and where you don’t know what it's going to look like. Making tools to connect apps and the web together when Apple and Google are shifting the definitions of those terms is going to be challenging. 

Amazon has a bigger problem. Most obviously, more and more of what it means to be ‘Android’ will come from the closed Google services that aren't part of AOSP and that it doesn’t have access to. If Amazon wants to free-ride on the Android app ecosystem, it will need to spend more and more time replicating the Google Android APIs that the apps it wants are using, or the apps just won’t work - presuming that Amazon even has the sorts of search-led assets to do that. But more fundamentally, AOSP is being pulled along by Google’s aims, and will change in radical and unexpected ways. This isn’t like building on Linux - it could be more like taking a fork of DOS just before Windows 3.1 came out. Are we quite sure (to speculate wildly for rhetorical effect) that we won’t be running Android apps in a sandbox on our ChromeOS phones in 5 years? Where would that leave Amazon’s fork? AOSP is not necessarily a neutral, transparent platform for Amazon to build on.