Macro, macro, macro, Bento, that’s all we get nowadays on these blog things. We can read about how we are screwed in some new and interesting way, or stuff about that guy Geithner/Paulson/Bernanke, what an idiot he is, or this is what I, the blogger, think is wrong with the latest bailout plan and we should do with the global economy (pick from a selection of half-baked hare brained memes). Isn’t that the econo-bloggy biosphere in a nutshell over the past couple of months, in fact all of 2008 with some notable exceptions?
I, Baruch, would like to pretend that some sort of sophisticated blogging ennui is why I’ve been largely radio silent since 2008. In fact I’ve been working my arse off in the office and playing Civilisation IV in my spare time. I did try and write a couple of posts, one of which was about how much I disliked the Mohammed El Erian book, but none of them panned out. Now I think I’ve got an econo-bloggy post I might actually finish, because it is on something I care about: kicking Apple fanboys in the goolies.
So here’s a post about something micro: I think Apple has blown it in the handset market, and the collapse is coming soon. You will recall my (rather insane and obsessed) contention that the iPhone may well blow Apple up, but was and is the only way they have to play a weak hand. Also, subsequently, my admiration of the actual phone, their amazing initial sales and my guess that Apple had a window to build scale in handset markets. Well, they did precisely nothing with their window and now, I suspect, it has closed. They may be toast. Except they and their fanboy analysts don’t know it yet.
Why do I think this? With a new handset there is a well-trod path to maximising profit over its lifetime, which Apple has not followed. Imagine if you will you are an established smartphone vendor, with a super new handset to sell.
In the first phase from its launch the you graciously permit a loyal fanbase and early adopters, goosed by hot reviews in Engadget and Boy Genius, to buy the new device at a high initial price and a yummy gross margin, say 40%-50%. Because the retail channel has to build inventory you sell them much more than actual sell through into the end market. Sell side analysts are amazed, your stock soars. In terms of volumes, buzz and brand this is the sweet spot, as good as it gets. You are a genius. Well done!
Problem: 4 to 6 months after release, you have run out of early adopters, and now you need to penetrate the more price sensitive punter. Volume starts falling. No matter, you cut the price 10% to 20%. This would be bad for gross margins but for the natural tendency for material costs to come down. “Price down” is like a law of the tech supply chain. Memory prices have been coming down for years, for instance, passive and mechanical bits like the keypad and casing become cheaper to make as they scale up, and one’s engineers are always coming up (or should be) with new ways of making the industrial design more efficient. So gross margins drop only a bit, to 35% to 40%, but your volume goes up again so your operating margin can even increase.
Then, 9 to 12 months from launch, volume drops off again, as the unit gets a bit old. So you come up with “variants”. The cheapest one is simply changing the colour of the casing (Motorola squeezed out an extra 12 months of RAZR sales that way, no kidding). You refresh the model as much as you can, upping the specs or revamping the style, and hold the price of these new machines steady, at the same price point, while cutting the price of the original model. The gross margin of these old clunkers is maybe 25% after this. But by now you and your supply chain can make these old units while asleep, and you can drop boatloads in selected markets to blitz your competitors, dumping them at cheap prices where you worry rivals may be making progress. Eventually, even this no longer works, no-one wants to buy it an at any price, and the product and its variants dies of old age.
So goodbye, and thanks for all the fish. But having an eye to your franchise, you ploughed a good chunk of the profits of your mildly successful smartphone into R&D, to fund many new products. At any given time you should be having a bunch of these products on the go, all at different stages of this same lifecycle, to smooth out your revenues and keep the analysts and shareholders happy.
It’s now almost 9 months after the launch of the 3G iPhone, and Apple has done precisely none of these things. No price cut. No variants. Not even a colour change. A complete buzzkill. Meantime, 3GSM, a big phonemaker get-together, starts in Barcelona on Monday, and everyone is going to have their new touchscreen smartphone on show. As I predicted (and frankly I don’t expect you to be impressed by this, it wasn’t hard) just about every handset maker has done a Manhattan Project rush R&D job to get their own touchscreen iPhone knockoffs out as fast as possible.
Palm has a good one, apparently, the Pre, with a CDMA version out in May, or rather June, and HSDPA (3.5G) god knows when. I don’t expect too much of it, though, it’s been delayed like 2 years and is sold exclusively through Sprint to start off with. Nokia may have something, and meantime has tried to take touch and smartphones low end, with its 5800 “Tube” music device, which may do quite well.
But I’m much more interested in the Android phones I hope HTC will be releasing. The first Android phone, more or less a nasty looking prototype, sold 1m units in Q4, despite being a T-Mobile (not the world’s greatest telco powerhouse) exclusive at a time when the world fell off a cliff. What happens when 2-3 tastier-looking models get released at 30 operators all at the same time? Arithmetically 90m or 1/3rd of the handset market, but OK probably not. The Pre and the Androids should all have lovely touch screens, “blazing fast” browsers, 3.5G radios, cameras and GPS. They’ll all have apps to download, and legions of loyal developers writing versions of Donkey Kong. They will have darling UIs and apparently the Pre will even email people to postpone your early morning meetings for you if you wake up late with a hangover.
Meantime, Research in Motion just told us all it had unprecedentedly huge numbers of new subs in its last quarter, and took back number one in smartphone share from Apple in Q4 after having had their butts kicked in Q3. They did this with the apparently godawful Storm, an iPhone knockoff which buzzes at you every time you press (twice) a virtual key, and the less appalling Bold, a classic Blackberry form factor but one with 3G, a first for the radio-interface-challenged Canadians, fully 10 years after 3G spectrum was awarded in Europe.
None of this is good news for Apple, and you can see the problem in the iPhone production data since launch: 8-9m in Q3, 4m in Q4 (down from a build plan of 8m), and some say only 2m in this current Q1. They are not building scale, they are losing it. To be fair, this coincided with the onset of the worst consumer recession since the 1930s, but, still.
What astonishes is the lack of a price cut, which would have been a natural thing to do in response to falling demand, have created buzz, and would have freaked out its incredibly stressed competitors even more. And where’s the refresh? Why not a de-specced, lower cost iPhone, the “iPhone Nano”? Or maybe make the current one the low cost iPhone and up-spec a new one with a better camera, more memory, video and cut and paste at the $200 subsidised price point of the original? I can see a number of explanations for this dereliction in follow-up :
- An internal decision making problem. Steve Jobs’ being sick, and no-one else having the authority to push these things through. They forgot. This is the least bad explanation, as they can remember to do it again.
- The glamour of a rising gross margin. If it was 40% at launch, it must be 55-60% by now, which might make up for a lot of lost volume at the bottom line. Are they going for a record? Are they trying to win a bet? Someone should tell them that maximising GMs is not always a good idea.
- They can’t follow up. They have run out of ideas.
Actually I fear it is 3. If you look at the specs of the iPhone, someone told me, you can’t cut anything at all. The OS is a stripped down MacOS, ie designed to run on a PC, not a handset. You can’t de-spec the memory, processor, or battery because the thing is running at the limit of efficiency already. It would fall over. If Apple cut the touchscreen or the browser it would no longer be recognisable as an iPhone.
OK, no problem, you would think. Apple can up-spec: it could add a better camera, a better processor, boost memory capacity, or fluff the OS somehow. At the same time it would cut the price of the old model. This is what they will probably do this summer. But, really, would any of these changes be substantive? God knows no-one in retail is buying higher ASP stuff any more unless they see a really good reason to do so, some super feature, some killer app. If it looks the same as the 2008 iPhone resting on a cafe table I wouldn’t see any pressing need to upgrade. One analyst with a buy on Apple extricated himself from this problem by suggesting that Apple could sell what was effectively the old 2.5G iPhone as the low cost iPhone. That’s right, re-release a 2-year old handset and flog it as something new. That’s how Apple re-invents the handset market. Boy Genius would go completely mental; doing that would alienate the blogs for a generation. Buzzkill again.
So you see where I’m going? With the 3G iPhone, Apple not only outdid Nokia and RIMM, they outdid their future selves. They created the acme, the Nazz of the smartphone, and some sort of new undiscovered technological innovation is needed to proceed to the next level. Meantime, we will see next week that most everyone has caught up. There’s a word for what happens next: commoditisation. When no substantive competitive advantage exists, prices contract, margins tank, customers get to boss you around, and no-one is nice to you any more.
But wait, it gets worse. Don’t forget the macro (howevermuch I may want to). So far in 2009, I am told, expensive handsets are not selling. Punters are trading down. RIM told us, after announcing a great bump in net adds in Q4, that we should be prepared for a more “normalised” run rate. Amusingly up until December smartphones and ultra low cost were the only categories in handsets with any volume growth. The latter category is even harder than smartphones, so every struggling handset vendor has pinned its hopes on the ostensibly easier higher end market, and the standard assumption is for 20%-30% unit growth in smartphones in 2009. I suspect it’s going to be more like 10% to 15%; and sometimes I worry that it may not grow at all. I don’t think ASPs will be going up, so actual revenue growth is likely to be difficult. Commoditisation and overcrowding into recession is going to be extremely nasty indeed.
In commodity markets, it remains the lowest cost guys who survive, and the ones with the best distribution. Open source beats closed source. I would bet on the Androids. Apple, remember, remains on exclusives with single operators in all the key markets. Note those are one-way exclusives; those operators can sell whatever other handsets they want. Another big loser would of course be RIM, who are getting killed on margins anyway, who won’t have any substantive product launches until the end of the year, and who have to endure watching the Androids, the Pre, and whatever Apple and Nokia bring out in the middle of the year, before they get to sell in any cool new handsets again. They might have had their moment in the sun already this year, and it’s only february.
So, amazingly, it looks like my original thesis was broadly right. iPhone v.1 flops due to business model. 3G iPhone huge runaway success initially, but succeeds in rousing sleeping giants who do all they can to bring out competing products. I guess you could say I am one quarter out in terms of when these handsets start to sell (Q2 and Q3, mainly, and I said Q1), but that’s no biggie. As I say here, I am surprised Apple hasn’t done anything with its advantages. I also think I am still on course when I wrote this last summer:
what if Apple’s entering the smartphone market turns out to be a disaster for everyone? What if it leads to huge price down, greater competition, and an overall lower margin in the market? Not just long term Schmapple, but Schmokia, Schmimm and Schmamschmung too?
You still own Apple stock don’t you Bento? I would sell some here, but note I don’t know anything about the Mac or iPod franchises. I can’t believe they are great, but you never know. For the rest of you, don’t even think about making any investment decisions based on any of this. Blogging is not a serious medium for investment ideas and anonymous bloggers should be trusted even less. Look at these jokers. What are they like, comedians?