“All Advantage is Temporary” – Charles H. Fine
I haven’t written much about Apple on this blog — the notable exception was when I discussed iPod’s long goodbye, in the context of Snap’s move into hardware operations — because there are many smart observers who cover Apple in detail.
When Tim Cook made the announcement revising sales expectations downwards, I felt that the kerfuffle was very much along the expected lines: discussions and opinions about the macroeconomic conditions, the US trade war with China, and the slump in China. All of these conditions are true, but they are not firm-specific to Apple’s fundamental supply chain operations.
So, in this post, I wanted to touch upon an operations issue that has gotten relatively low coverage compared to the trade war. John Gruber at Daring Fireball, who covers Apple with astuteness and passion, got it right (as I expected, I should add).
It’s easy to say “OK, it’s just China”, except that China is Apple’s only hope for iPhone sales growth. The truth seems obvious: Apple reached peak iPhone unit sales a few years ago, and now that they’ve peaked, when something goes wrong in a major market like China, it’s going to result in an overall decline in sales.
The observation is correct. I’ll add some more color through recent data and operations theory to this observation.
Increased Competition in China & iOS Lockout
Surely, competition in China has intensified. The chart from WSJ (subscription required) shows that every other competitor has increased
its market share while Apple has flattened out. So, Apple’s growth stagnation story is true, regardless of the overall market stagnation in China.
The second point is that iOS is not necessarily an advantage in Asia, where Apple has a low smartphone market share. The flip side of the iOS “lock-in” of loyal customers in the US, where Apple’s smartphone market share is sizable, is the “lockout” of new users that Apple needs to grow its market share in China.
Smartphone users in China, a majority of whom use the WeChat ecosystem on android devices, currently have multiple excellent alternatives to choose from. They would see no reason, other than signaling wealth, to switch to the Apple eco-system. If a user in China already owned a good android smartphone, switching to Apple makes any future switching back to the many choices of smartphones within the Android ecosystem very costly.
Nowhere to Go Up: Global and US iPhone Sales have Flattened
It is evident from the data on unit sales, from 2007 through 2018 (below), that the iPhone sales growth has flattened in the last four years. The quarterly sales data adds a few minor seasonality wrinkles but supplements the conclusion.
To be clear, this is not dire straits for Apple. It is a testament to Apple’s strength that the sales have remarkably remained flat, even as the average selling price of an iPhone increased from $618 a year ago to $793 in 2018. Nevertheless, the difference between pre-2015 and post-2015 unit sales growths is substantial.
In fact, one could argue that peak iPhone is well behind us.
Coincidentally, last quarter, Apple stopped releasing its unit sales numbers. The tapering growth in sales is a resultant of the product maturing: newer iPhone innovations have been diminishing in marginal net-value, and customers holding on to their phones longer. The data checks out. In 2018, iPhone users replaced their smartphones after 2.8 years of use on average, compared to 2.4 years of use in 2016. As Horace Dediu at Asymco pointed out, in September 2018, Apple emphasized on the fact that their hardware and software last longer (while focusing on environmental benefits).
I have been perplexed by the speedy rate at which some users replace their iPhones to upgrade to significantly more expensive new versions (that are now north of $1000). I always wondered about how many such users exist, and whether there are limits on their expenditure.
We are hitting the ceiling on those numbers.
When I last upgraded my phone, from iPhone 4(!) to 6S, an Apple store employee whimsically remarked that he hadn’t seen any 4s phones in a long time. Such times are behind us. Now, more people would be more likely to hold on to their old iPhones, as discussed in Kevin Roose’s NYT article “Apple’s Biggest Problem? My Mom”.
“The phone I have does just about everything I need,” she said when I called her to ask why she hadn’t upgraded to one of the newer models. “Why pay $800 for a new one just to be up to date? My needs aren’t that complicated.”
Going forward, many iPhone users are increasingly going to be people who love Apple products — like Kevin Roose’s mom and me — but who also see no need to replace their smartphones at every new release.
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All Technology Advantages are Temporary (Fast Clockspeed)1
In the Wharton Operations Strategy class, I discuss how long technology takes to mature in different industries using Charles Fine’s excellent notion of Clockspeed.
Each industry evolved at a different rate, depending in some way on its product clockspeed, process clockspeed, and organization clockspeed.
In fact, a big influencing factor of clockspeed for hardware products is the inventory obsolescence cost. As products mature older versions don’t lose value quickly. There is a big difference between first-generation and second devices, and but not between the sixth and seventh generations.
Apple iPhone obsolescence costs are dropping.
If at all, iPhones took awhile, taking full 10 years before sales began to flatten out. For iPods, the sales peaked sooner, i.e., within 6 six years. The bottom line, as Charles Fine puts it, is as follows:
[…] All advantage is temporary. No capability is unassailable, no lead is uncatch-able, no kingdom is unbreachable. Indeed, the faster the clockspeed, the shorter the reign. Sustainable advantage is a slow-clockspeed concept; temporary advantage is a fast-clockspeed concept.
I would argue that despite the enormous excitement in Tech Media about the new features — camera portrait modes, adjustable depth of field, Face ID, AirPods instead of earphones, higher-resolution OLED display, many of which come at a hefty price tag — the sales data is a proof that added marginal value for the improved attributes are diminishing.
Indeed, I think XS Max is the best iPhone that Apple has designed and manufactured so far. However, for most users, it is also increasingly evident that newer phones are not substantially better than the iPhones they already hold in their hands. We will see this play out in the sales data in how XR vs. XS Max models grow.
Prices Will Drop and Upgrades will become Cheaper.
We will see that prices will begin to taper, and new “XR” style “medium-premium” (sub $1000 for Apple) versions of the iPhones will begin selling comparatively better than before. We see the evidence already: Suning dropped the price of 128GB version of the iPhone XR from 6,999 yuan ($1,036) to 5,799 yuan ($858) — a 17% discount. (The prices are still higher than the corresponding US prices).
In India, where Apple has begun manufacturing iPhones, Apple’s smartphone market share is less than 1%. Indeed, there is a great demand for a lower-priced entry model despite recent price cuts. In fact, the cheaper iPhone 6E is the leading iPhone model in India, With the sales units in China and the US flattening out, and since there is so much room to grow in India, I cannot see Apple holding off without a low-price model in India.
What should consumers expect?
1. Therefore, as theory predicts, in the short run, the prices for new versions will comparatively drop (i.e., upgrades for existing Apple users will relatively cheaper), and/or costs of maintaining the old versions will increase. Apple has already increased battery replacement prices from $29 to $49 (or $69 depending on the model). As Fishman and Rob (2000) argued, it is necessary for a durable goods “monopolist” to either exercise faster-planned obsolescence of old versions of the products or price the new versions judiciously.2
2. In the medium-to-long run, Apple will increasingly move its business from the maturing smartphone market to the nascent services market. The accessories (particularly, watches and its health and fitness apps) are already showing high-margin benefits.
3. The engineer/Imagineer in me hopes that some modularization in hardware to emerge. Time to re-awaken the ARA project, maybe?
References:
Data from Statista.
- Charles H. Fine. 1999. Clockspeed: Winning Industry Control in the Age of Temporary Advantage. Basic Books.
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Fishman, Arthur, and Rafael Rob. “Product Innovation by a Durable-Good Monopoly.” The RAND Journal of Economics, vol. 31, no. 2, 2000, pp. 237–252. www.jstor.org/stable/2601039.