Notes of interest from Apple's 3Q14 earnings: iPad sales down, Mac sales up, and China

Apple released their third quarter earnings yesterday.  Revenues and profits were up over last year, mostly driven by iPhone sales and 28% overall growth in China.  However, iPad unit sales were down 9% compared to the same quarter last year.  At the same time, Mac unit sales were up 18% in a computer market that is declining slightly overall. So iPad sales are down and Mac sales are up, isn't this the opposite of what should be happening in the post-PC era?  In the earnings call Tim Cook gave some additional insight into the situation.  Although iPad sales were down, he said in developing markets sales were up overall and mentioned a few with rapid growth:  Middle East (64%), China (51%), and India (45%).  He also mentioned that Mac's were stronger in developed markets and rattled off a number of countries including the US and Canada where Mac sales were up at least 10%.  He also mentioned that Mac sales in China were up 39%.

The first takeaway for me is that China continues to be Apple's biggest opportunity by far, both in terms of growth and absolute size.  With iPhone sales up 55% in BRIC countries (Brazil, Russia, India, China), it seems China has a large appetite for all of Apple's main product lines and that will make up a huge portion of the company's growth going forward.

The second takeaway is that iPads aren't replacing the PC.  I continue to think it makes the most sense to look at tablets and PCs together as part of one large-screen device category.  We'll all have smartphones, and most of us will have a large-screen device also.  For some people that will be a computer, for some it will be a tablet.  Apple's numbers point to how that trend may be playing out.  Macs seem to be doing better in countries like the US and Western Europe and iPads are doing much better in developing markets.  As a whole, people in developed markets may want to use more productivity apps (whether for doing work at home or personal use) and prefer to buy a computer.  Whereas, people in developing markets (who are also more likely to own a smaller and less capable smartphone) prefer a tablet as their large screen device.

It's also the case that people in developed markets where among the first to buy iPads and aren't in a rush to upgrade them, whereas people in developing markets are really just starting to get in on the tablet craze.

It will be interesting to see how this trend plays out over the next few quarters, especially as Apple releases larger iPhones.  I don't think we've seen peak-iPad yet, but it's clear that current tablets aren't yet capable of replacing the PC market.  If iPad sales are going to return to growth Apple will need to focus on making them more capable for basic productivity tasks and getting them into the enterprise.

Apple + IBM + iWatch. Huge opportunity?

Last month I read a very interesting article on Techpinions by Tim Bajarin.  Tim recounted his recent family trip to Disney World and explained how they use RFID wristbands to manage access to the park and hotel rooms and even pay for meals once linked with a credit card.  Tim thought this type of functionality could be one of the pillars of Apple's upcoming iWatch.  I was reminded of the article this week when Apple and IBM announced their enterprise partnership. I can imagine a world where enterprises deploy thousands of wristbands to employees instead of RFID employee badges.  IBM would write enterprise or even company-specific applications and Apple would supply the hardware.  Maybe they wouldn't even be wristbands at all, they could be a little dongle worn around the neck or clipped to a pocket.  This could enable all sorts of other features:

• automatic locking and unlocking of laptops and tablets based on proximity (or a factory worker's machinery or UPS driver's truck ignition)
• step tracking to determine efficiency of building/warehouse/factory layout
• step tracking could also be used to give a high-level view of employee activity while in the office

Apple and IBM have a huge opportunity in the enterprise outside of just iPhones, iPads, and productivity applications.  I don't know the enterprise software and services industry well enough to determine if IBM was the best partner, but they're clearly a capable one with sufficient scale to make a meaningful push into the enterprise.

The unintended consequences of the FCC's open internet proposal: Will content companies buy up internet providers?

A lot of public debate has been going on about 'net neutrality' and the FCC recently voted on a set of proposals.  The proposal doesn't outlaw so-called internet 'fast lanes', which has many people worried.  In theory, an internet service provider could charge a Netflix or YouTube fees to access their 'fast lane' and ensure their content is delivered to customers more quickly than other internet traffic.  It doesn't have to be streaming video, fast lanes could apply to getting quicker search results or a better Instagram experience.  If this does become a legal and common practice, I think there could be a lot of unintended consequences.

Will fast lanes make internet providers acquisition targets?

Imagine if you're a huge tech company that drives a lot of traffic (Netflix, Google, Facebook, etc).  Your content is delivered to millions of people through a series of different internet service providers.  Then one day you suddenly had to cut deals and pay tolls to ensure your customers continue to get the same high quality service they've come to expect.  You might use that as a differentiator over your smaller competitors that couldn't afford to cut the same deals.  If you were especially ruthless, you might even drive up the price of those fees so that only the largest and most profitable companies could afford them.

Another strategy may be to go a step further and buy companies that provider internet service so that you'd have more control over how your content is delivered to consumers.  Google already does this in a small way with Google Fiber.  It isn't big enough to have much sway in the market, but they are able to keep competitive services 'honest' in the markets where Google Fiber is available.

Comcast already did something similar in the TV industry when they bought NBC Universal in 2009 after failing in their $41 billion takeover attempt of The Walt Disney Company.  At the time, NBC Universal was valued at $30 billion and Comcast was valued at about $50 billion.  That was a huge transaction, but how would it look today?

Currently, Comcast is worth about $137 billion.  Their biggest competitors are Verizon ($204B), AT&T ($182B),Time Warner Cable ($40B), CenturyLink ($21B), and Charter ($16B).  A big portion of Verizon's and AT&T's value comes from their mobile phone businesses, so their fixed broadband/cable/telephone businesses alone are worth much less.  These are huge companies, but there are lots of tech/media companies that are even bigger: Google ($381B), Facebook ($162B), Amazon ($149B), Walt Disney ($147), Time Warner Inc ($63B), CBS ($34B), Netflix ($26B), and on.

My point is, there are plenty of tech and media companies that are large enough to go out and buy one of the five biggest internet service providers in the US.  Some are even big enough to build their own.  If the FCC gives internet providers the ability to build toll bridges into their networks then some of these tech companies may just decide to vertically integrate in order to have more control over their own destiny and stamp out competition.  Some companies that are more mobile focused such as Google or Facebook may decide they're better off buying or building a cellular broadband network.  Is this good for American consumers, and is this really what the FCC wants?

Thoughts and questions about Apple reportedly buying Beats for $3.2B

Last night The Financial Times reported that Apple was in the final stages of talks to acquire Beats for $3.2B with the deal being announced as soon as next week.  Acquisitions of this size are completely out of character for Apple.  Like many journalists and bloggers, the more I think about this the less sense it makes.  Assuming the report is accurate and a deal is inevitable, I've got a ton of questions without any obvious answers...

Is Apple interested in the headphones, streaming music, or both?

My gut reaction is that they're really interested in the streaming music service.  The Apple engineers don't need help tuning speakers and device EQ to make things sound better.  If they wanted to they could design a pair of headphones or a docking station to compete with Beats.  Apple already tried speakers with the iPod HiFi, which was quickly discontinued.  Music has always been important to Apple, from iTunes to iPods to GarageBand.  There have been a number of rumors about the future of iTunes lately, and perhaps this is part of Apple's answer to Spotify and Pandora.

Why not just buy Pandora or Spotify or Jawbone?

The Beats streaming service is not that successful yet.  Assuming the $3.2B price is accurate, they could spend another few billion to acquire Pandora (current market capitalization of $4.65B), which is the leading music streaming service in the US.  They could buy Spotify too, although that would probably be much more expensive.

If they're interested in the Beats hardware, a company like Jawbone seems like a more natural fit.  They make nice bluetooth speaker systems and headsets, and of course the UP wristbands.  All of those would fit into Apple's product lineup more naturally than Beats would in my mind.

Will they keep the Beats brand?

I can't imagine Apple doing any co-branded products with the Beats logo on an iPhone, iPad, or Mac.  They could continue to sell the headphones and speakers under the Beats brand though.  Most consumers probably wouldn't realize that Beats was owned by Apple anyway.

It's got to be about the people

I think the acquisition has got to be about the people, not the products themselves.  Apple is hellbent on staying cool and fashionable.  They want those creative marketing minds that turned big plastic headphones into a fashion accessory.  Another possibility is they want access to Jimmy Iovine's music industry contacts and expertise to build out the next generation of iTunes and iTunes Radio.

They're still focused on music

Whatever their motivation, as a music lover and Apple fan I'm happy to see they're still focused on music.  I'm more hopeful of unique Apple hardware and software that makes the experience of discovering and listening to music more effortless and enjoyable.

The great mobile irony: What Google and Apple do well and how they make money

Google's Android operating system had a phenomenal year of growth in 2013.  In the third quarter Android accounted for about 81% of smartphones and 67% of tablets shipped worldwide.  The press seems to concentrate on these Android and iPhone unit sales and market share, but there's another report that I find equally interesting:  Android vs iOS usage statistics.  A recent report analyzed the hourly usage and data consumption of various handsets in the US and Europe.  Unsurprisingly, the iPhone dominated.  I say unsurprisingly because every time one of these reports is released Apple comes out on top, and usually by a wide margin.  Another analysis shows how iPhone users shop more and spend more than Android users.  Obviously, there are plenty of tech-savvy Android users, but they make up a small portion of all Android users.

The great mobile irony

Apple makes most of its money, and I'd guess virtually all of its profits, off of device sales.  That is, they make money when we buy iPhones and iPads.  Google, however, gives away Android for free in the hopes that it will increase the number of mobile internet users and people using Google's services like search, Gmail, Maps, etc.  Google makes money when we click on ads in Google search results, or on websites that feature Google ads (like this one.)

The irony is that Google makes its money off of usage, which Apple dominates, and Apple makes its money off of device sales, which Google's Android partners dominate.

What does that mean for the mobile industry?

I believe Apple is trying hard to monetize all of that usage.  They not only want to make money off of device sales, but throughout their life as we use them every day.  Apple created its own mobile advertising network, and then diverted a lot of those resources to selling ads for the iTunes Radio music streaming service.  I'd expect more initiatives like that in the future.  I wouldn't be shocked if we saw Apple build or acquire a movie streaming service or try to monetize Podcasts.

Meanwhile, Google will continue making Android more intuitive and easy to use and working with its hardware partners on premium Android devices.  Part of the reason Android dominates market share figures is due to the low cost of Android handsets.

Another interesting note from the hourly usage figures was that after the three most recent iPhones and Samsung Galaxy phones, the next most used device was a Blackberry.  Maybe there's hope for them yet if they can make software apps for iPhone and Android and monetize their usage.