Do Androids Dream of Apple-Blackberry Crumble?

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 :

  1. 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.
  2. 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.
  3. 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?

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27 thoughts on “Do Androids Dream of Apple-Blackberry Crumble?”

  1. I love your comment: “If it looks the same as the 2008 iPhone resting on a cafe table I wouldn’t see any pressing need to upgrade.” As a cog in the cell phone R&D supply chain, I broadly agree with your thesis that Apple will have a challenge growing their 2% market share. It remains a brutal market for everyone with some consolidation likely to happen among suppliers. G’luck with everything.

  2. Actually I think Motorola is has almost always been a basket case. No cause for hilarity, I am afraid. I am on the record on MOTO here:

    https://ultimibarbarorum.com/2007/05/01/vote-icahn/#more-35

    and here:

    https://ultimibarbarorum.com/2008/04/07/i-cahnt-turn-motorola-around/

    So there. But credit where it is due, I do think changing the casing on the RAZR to from metally-ish to pink really worked. What that says about the intelligence of the cell-phone buying public I leave to you.

  3. Good post, enjoyed it.

    Come on, slate the El-Erian book, you know it makes sense. I got as far as the first gushing comment on the back, saw it was by Greenspan and thought this book belongs in the fairytale section of my library. Well, got to page 14/15, then knew it belongs in the section, ‘Books written by the insanely deluded’.

  4. If it wasn’t for the hackers and Jailbraking, Apple would have sold way less. I am writing this right now on a hacked Iphone 2g and I can’t wait until I can switch to Android or WebOS. The iPhone OS is the biggest POS outside of WinMo. It is buggy as s..t. Even when it’s hacked. F’k Steve Jobs…

  5. Apple doesn’t want to be a mobile phone company. The iphone ultimately was defensive: to provide sales as ipods peaked and declined. Apple can settle for a 5% marketshare in phone (with high margins) because it is scaling R&D costs across 3 platforms (ipod, iphones and computers).

    After 2010 (and the exclusive contracts end) they can sell 2-3 unlocked iphone models (probably for between $200 – $500), keep that market for 5-6 years, and move on the next thing in consumer electronics.

  6. Except that Google can’t find the the sack to put multitouch in the core, and every update it has rolled out has taken way too long and has failed to address core usability issues customers crave. 4 months later we still have no multitouch, no horz/virt flipping unless the keyboard is open, no soft keyboard, no good music player, horrible zoom ui, and email app which is completely disfunctional – notifications still only happen when you wake up the phone. Meanwhile iPhone continues to receive awesome software updates. Who needs a new color when the software continues to pioneer the market. I would easily trade in my G1 for an iphone, if only there were people who wanted to be on Android I could sell it to.

  7. Richard — yes, they really thought it through, is completely old school, but everything is updated to work better than civ 1. Civ 3 was total rubbish, you are right.

    Will — I am sorry you don’t like your G1. Maybe the G2 will be better.

    Charlie — problem is that keeping 5% of the handset market (if that is the market you are referring to; and did you mean revenues or units? There is a difference) and high margins doesn’t work.

    Mocha — if you are devil-may-care enough curse a man at death’s door why do you scruple at spelling out the word “shit”?

    Andrew — oh all right.

  8. I think, you are discounting the power of i-tunes store & the ease all of the media + application content could be transferred on i-phone. You also discount a behavior bias that transfers into the desire of people to fit in. That bias often lasts at least couple of years.
    I think apple is preserving cash, waiting for its competitors to ship products, so apple could cut prices and stage huge M&A campaign.
    Besides, right now it is all about survival and cash position, which does make all of the players risk averse. Whoever has the best strategy and cash position rather than the best product will probably win. And while i-phone might fall behind in tech spect’s, i doubt it will kill them. Apple was selling Macs for years with inferior specifications but surviving by making them very user friendly, etc.
    p.s. Also, you are the most intelligent blogger out there, please overcome your apple addiction.

  9. I decided about five years ago that what happened to PCs when the IBM-PC came out would happen to cells. Anyone remember trash-80s? The CP/M operating system? Altair? Imsai?
    If ATT hadn’t retarded the spread of Unix by ten years or so by dog-in-the-mangering it via their license, MSFT would either be nothing or much less than they are. I was using an X-windows precursor and Unix on a machine with 512K of ram clocking at about 1MHz back in the early 1980s. I figured that what with Stallman’s GNU and Linux finally having freed Unix, the commoditized standard-architecture cells would be running some Unix variant (that’s what OSX is: BSD Unix on top of the Mach Microkernel with a nice GUI on, the latter being Apple’s claim to fame, aside from basically hijacking some open source [which the GPL license GNU and Linux have should prevent].
    I’ve got a G1. It is basically an ugly prototype. Who cares. The software is what counts. I put the 1.1 upgrade on it and the progress is impressive, and I expect that to accelerate as interest grows.
    Symbian, one of the ugliest messes I’ve run across, is dead dead dead. Palm has seen the writing and is apparently switching to some kind of Linux. MSFT being basically like a cockroach, their crap will be hard to eliminate, but I think in five or so years cells running anything other than a Unix variant (or maybe Haiku or some other upcoming free software OS) will be have already been history for a year or so.

  10. As a starter, Apple could just come up with a decent email client (even half as good as RIMM’s) and I would gladly pay for an upgrade. Ah, and the possibility to snooze reminders would be appreciated as well. iPhone, the dorkiest smartphone in the world.
    Anyway, I truly look forward to a serious kick in the goolies of all those hysterical fanboys that talked me into buying this brick. I kicked mines already.

  11. I decided about five years ago that what happened to PCs when the IBM-PC came out would happen to cells. Anyone remember trash-80s? The CP/M operating system? Altair? Imsai?
    If ATT hadn’t retarded the spread of Unix by ten years or so by dog-in-the-mangering it via their license, MSFT would either be nothing or much less than they are. I was using an X-windows precursor and Unix on a machine with 512K of ram clocking at about 1MHz back in the early 1980s. I figured that what with Stallman’s GNU and Linux finally having freed Unix, the commoditized standard-architecture cells would be running some Unix variant (that’s what OSX is: BSD Unix on top of the Mach Microkernel with a nice GUI on top, the latter being Apple’s claim to fame, aside from basically hijacking some open source [which the GPL license GNU and Linux have should prevent]).
    I’ve got a G1. It is basically an ugly prototype. The software is what counts. I put the 1.1 upgrade on it (easy: see my blog for HOWTO) and the progress is impressive, and I expect that to accelerate as interest grows.
    Symbian, one of the ugliest messes I’ve run across, is dead dead dead. Palm has seen the writing and is apparently switching to some kind of Linux. MSFT being basically like a cockroach, their crap will be hard to eliminate, but I think in five or so years cells running anything other than a Unix variant (or maybe Haiku or some other upcoming free software OS) will be have already been history for a year or so.

  12. I have to disagree.

    The last thing the iPhone needs to do is follow the standard phone model of releasing model after model of slightly different phones to push up sales.

    There is no brand loyalty because the experience and features are so fragmented. Your user experience was wasted once you picked up a new model.

    The reason the iPhone works is that the 3G isn’t much different from the 1st Generation iPhone, and that is where it’s strength is.

    You are missing the most important part of the iPhone, which isn’t Gross Margins or cool case colors or anything else.

    Like the iPod, it isn’t about the device, it’s all about the library. iPhone (or iPod) isn’t about getting someone to upgrade their old phone for a new one, but getting them to buy application after application and song after song.

    If your device is well made, you don’t need to produce one radical design or gimmick after another. Your radical design and gimmick are in the applications store or the content library.

    At one time there we dozens of different computer platforms, and they shook down to 2-3 major platforms and hundreds of makers. That shake-out is now happening in the phone space as well.

    The era of the handset is dead. Now its all about the applications those handsets run.

    If you disagree, look at the average iPhone users applications sitting on their phone. The iPhone is where programmers know they can make a million dollars in a month if their app is good enough. No other phone product has that ability. When all the best are producing apps for one platform, they sell your platform for you.

    As long as iTunes and the Application Store remain THE place to produce mobile apps, Apple doesn’t have to produce endless versions to appeal to the masses.

  13. Ultimi Boredom…this is the longest blog entry I’ve ever read about something completely insignificant…couldn’t even make it through the whole thing. Good work!

    Thanks!

    Spinoza

  14. Getting out of your depth. Maybe that silence of yours was welcome after all!

    While most of what you say is true, it is mostly IRRELEVANT.

    Apple customers do not buy a product, they buy a dream. And “classical” economic thinking falls of the cliff, again, as usual.

    Poor Barruck, please, stick to the companies that you do understand, the like of MFST, INTC and other bores

  15. Crikey, Josh, spot on; you enunciate my concerns precisely. Whenever I write one these things I think “why the hell would anyone be interested in this stuff”. No, I really do. Thanks for taking the time to write in.

    Verec, why do you think I understand INTC and MFST any better? I spend less time thinking about them. Wait, maybe that’s your point.

    Andrew, I agree quite a lot, and yours is similar to the point made by Monsieur de Chaos. But Apple doesn’t make a lot of money from the apps, I fear, just like it doesn’t make much off iTunes. I think they would prefer to sell hardware, and think about GMs and how to make more people buy the phone.

    Cash and Chris, I can only agree with everything you say.

  16. If there is one company who knows how to make boatloads of PROFIT in the single-digit market-share space it is Apple.

    The iPhone makes a lot more sense if you think of it as a small computer which can get data via the cell network, and happens to make calls too. If you’re cellphone-centric it will never make sense. Most analysts focus on volume, Apple focuses on quality. Fewer people care about quality over price, but those that do will pay a premium.

    Which is kind of like their computers. The conventional wisdom has been wrong on Apple for, what, decades now? Somehow they seem to do okay.

  17. Apple does not focus on quality. Apple does not focus on customer service. They focus on user-friendliness. And while it might be true that they don’t make much on their applications & media, those are complimentary goods that turn consumers toward i-phone. The tech savvy people do not buy I-phones. The lazy consumers like myself that don’t give a damn about tech spec’s but care about ease of using Bloomberg LP , Pandora, etc with no brainier updates do.

    Anyway, just heard the rumor that Apple is coming out with a cheap phone by the summer. And it is a smart move for them to delay products right now, and release updates when consumer spending does pick up, while destroying their competition in a price war. Also given Apple has 25 bl cash war-chest and their competitors don’t, the result might be obvious.

  18. Anyway Baruch, the transition from shorting the universe and keeping everything in cash to a new, potential market bullish reality is what concerns most of us the most.
    Any philosophical lessons on how to not get killed while going long/short and than all the way long would be very much appreciated. :)

  19. More doom for AAPL and MSFT. While the Register is telling us the interesting new Nvidia Tegra may be in the next Iphone,

    http://www.reghardware.co.uk/2009/02/16/nvidia_touts_tegra/

    Cnet is telling us Nvidia is aiming for Android also:

    http://news.cnet.com/8301-13924_3-10165037-64.html?tag=mncol;posts

    While I’m sure AAPL would like to have the same lock on their hardware base they kept for so long with their computers (keeping them a boutique-computing item) it looks like Nvidia is aiming for the standard hardware base market.

  20. I don’t think apple has made anything wrong.
    people are bored. people need entertainment. people want to have something better and nicer than others have.

    The early phone catches the worm.

    Apple does not want to compete with global companies like Nokia. Apple produces high end products with high end look and feel and high end marketing for high end people.
    How and why should Apple produce an iPhone NANO? Sorry, this does not work and would be completly nuts because there is no reason for it.
    A phone without webbrowing and so on just for those people who want an apple phone, too?
    Come on…with an iPod this is no problem at all. iPod is just for listening to music. But a brand new APPLE phone which is made for calling someone else??? hmmm… not a really huge inventory.

    sorry for my bad english.

  21. iForgot:

    the next big thing will be a revolutionary CAR built by apple!!!
    something the USA really need!!!

    the

    iCar or iDrive or perhaps iDoNotWalk… ;-)

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