Is Apple’s gadget dominance ending?

Apple - Dominant player

It seems that there have been so many ups and downs at Apple since the departure of Steve Jobs.  The latest of which hit hard today—a 12% drop in the stock price to a 4-month low.  Some proclaim that Apple has lost its edge since Jobs departure.  I, however, appreciate Tim Cook’s management style—at least as an outsider looking in.  And, I think it will be quite some time before Apple loses it’s dominates in the MP3 player, tablet or smartphone market.

Nearly 70% market share in the declining MP3 player market

Now, most would agree that the MP3 player is now a rather mature market.  At this point, the late majority have made at least their first MP3 player purchase.  With nearly 70% market share, Apple dominates this market and will continue to do so (albeit, a shrinking market).

More than 50% market share in the tablet market

By comparison, early adopters are taking the tablet market by storm.  And, many are going for the cheaper, smaller version of the tablet.  This explains why Apple allowed the iPad mini to cannibalize iPad sales.  iPad unit sales were up 48% in Q1 2013 but revenue was only up 22%.  A good guesstimate is that iPads are outselling iPad mini’s by 2:1.  (You can play with the math a bit to see if you come up with something similar.  I assumed the average iPad sale was $450, average iPad mini at $329.)  But even with this cannibalization, Apple continues to dominate the tablet market with over 50% market share.

More than 50% market share in the smartphone market

What about the smartphone market?  iPhones make up 56% of Apple’s revenue and they maintain more than 50% of the smartphone market.  Android devices (and, specifically, Samsung devices) are making a dent.  However, according to the IDC’s forecast of smartphones through 2016, Apple is expected to grow at 18.8%, while the overall smartphone market grows at 18.3%.  This suggests that Apple will maintain its dominance in this category.

Challenges ahead in the sale of songs and videos

Where Apple is probably most threatened is with iTunes.  Amazon recently opened an MP3 store for iPhones and iPods.  Amazon is a data beast.  They will continue to learn quickly from the transactions of the iOS users and there are many, many more songs on Amazon at 99 cents v. 1.29 on iTunes.  Amazon means to squeeze margins and this will put significant pressure on iTunes margins and/or sales.

That said, iTunes is 7% of Apple’s Q4 2013 revenue.  iPhones, iPads and iPods make up 80%.  Apple isn’t likely to lose their lead as #1 in any of these categories in the near future.

Online Wars: Best Buy v. Amazon

Best Buy - electronics in the home office

Hubert Joly, the new CEO at Best Buy, recently said that the retailer’s new strategy is to focus on online buying and loyalty incentives.  In other words, the company intends to take on Amazon and other online retailers head-on.

Let’’s see, with my Amazon Prime membership I get free shipping (on a boatload of items), instant streaming of TV shows and movies, and library book “rentals” on my Kindle.  The latter two benefits were added recently with no increase in the annual membership fee of $79.  Oh, and with my Chase/Amazon credit card, I earn 3% on my Amazon purchases.  The seamless integration of purchases (books and media) to my tablet is, …well, seamless.  No matter if I purchase items on my phone or my laptop, I turn on my Kindle and there they are:  my latest digital purchases.

Both companies are about $50 billion in annual revenue, but less than 5% of Best Buy’s revenue comes from online sales.  So, yes, they have room to grow the online sector.  They also have much ground to cover to compete with Amazon online.

The company must zig where Amazon (and other online retailers) zag.  Five things the management should consider:

  • Consumers still like to make big ticket electronic and appliance purchases in-person.
  • Price matching will further deteriorate margins.
  • Differentiation makes head-to-head “showrooming”” more difficult.
  • Employees who are trained can compare merchandise to competitor’s online merchandise and “defend” differentiated products.
  • Selling the heck out of warranty and on-site replacement services adds value

Maybe the new strategy ought not be to focus on loyalty.  Not because it’s not important but because it’s a given.  Best Buy has a head start on Amazon on physical locations.  Taking advantage of that and focusing on services (repairs and such) might be a better way to zip when Amazon zags.

Google’s Growth Disappoints

Google's growth

I saw a headline recently that said that Google’s earnings disappointed shareholders.  Now, I get that the company gives some guidance that creates some expectation but here’s the problem:  this $38 billion company only grew 25% in Q4 2011.  Let me say that again,this $38 billion company ONLY grew 25%.  This compares to 33% growth in Q3.  I get that in a relatively short period of time that is a substantial drop, but I also get that our expectations are really getting out-of-line with reality.

In a different heading, I recently saw that the S&P 500 is down 13% since 2006.  We know that the markets have struggled mightily in the last decade yet we continue to have visions of the glory days of old.  We put our hopes (and money) in the high-tech growth companies.  Certainly, it makes sense that those with nascent and expanding technologies will drive market growth.  But, we have to expect that the law of diminishing returns will kick in for, yes, even the high-tech companies.

Now is a good time for a good dose of reality.  We expect the engineering wizards at Google to continue to produce search algorithms that will keep advertisers and consumers coming back for more.  But, with 2 in every 3 web searches worldwide going to Google, we have to ask, how much more can they get?  In fact, how much more do they want?  I suspect not much given the investment in Chrome, Android, YouTube, Gmail and Google+.  But these are much smaller businesses than Search and Google’s best monetization to-date of most of these has been, well, …with search.  So, we’ll have to get used to diminishing returns on the growth of search (and Google) unless or until one of the new investment areas really catches fire.

Netflix: Bruised but not Broken

Netflix - bruised

I love the Netflix distribution model.  They are everywhere you want them to be.  Got a networked gaming console?  They’re there.  How about a new blu-ray player?  There!  A tablet?  There!  You don’t need an installation technician.  You don’t need any new equipment.  Just turn on your devise.  Connect it to your (wireless) home network.  Sign up.  And, you are in!  If you don’t have any of the approved devices, Netflix won’t leave you out!  Get DVDs by-mail.

Stop paying your cable company or satellite provider for VOD when you can just turn on Netflix.  Your cable bill is already sky high.  Yes, Netflix streaming library is a bit limited but you can supplement it with their great DVD-by-mail service.  Oh, the possibilities!…until

The price hike.  Two months ago, you could get a combined streaming and DVD-by-mail subscription for just $10.  Outstanding value—even with Netflix’ streaming content deficiencies.  Then, Netflix decided, if they took a 60% increase on the combined subscription, they could grow revenue and buy more content.  At the same time, they lowered the cost of streaming only and DVD-by mail only to $8.  Did they do this to keep loyal streaming only or loyal DVD-by-mail only customers?  No, they’ve told us in the past that combined service subscribers are the most loyal.  They probably lowered the price to keep an attractive price point for new customers—which most marketers know are more price-sensitive than existing customers.

So, if you take a big percentage increase (and a relatively small dollar increase) on your most loyal customers, will they stay?  To be sure, you will lose customers but the smart folks at Netflix figured out that you can grow revenue and still lose a few of your most loyal customers.  (And, don’t they need the money for more content?)  Here’s the problem:  These loyal customers were also Netflix evangelists. They told everyone in their circle about their Netflix experience.  And, now, they tell everyone how Netflix treats loyal customers.

I know the Netflix guys think the cable and satellite guys are dinosaurs but maybe they ought to hire a few dinosaurs; because the dinosaurs will tell you how important customer satisfaction and retention is as the business matures.  Retention is always the long term play.

So, the Netflix stock was badly bruised today, and, as an investor, I’m disappointed.  As a customer, I like the wake up call.  But, all is not lost.  Now—not 2 years from now—is the time for Netflix to think about improving retention and loyalty.  The plan:

  1. Go ahead and split the services.  Each business unit needs to focus on their unique customer experience and better understand their customer segments.
  2. Stop saying customers are disappointed in the decision to split the services.  They are not and it seems disingenuous.  They are disappointed in the size of the price increase.
  3. Repair the brand damage.  See #2 and hire a brand guru.
  4. Get more content.  It is much of the experience and more content equals more loyalty.  (Isn’t that why combined subscribers are more loyal?)
  5. Anticipate your competitors.  They are not too happy about Netflix’ effect on their ARPU.  Sounds like a pet, but it’s a measure of average revenue.

Netflix took a hit today, but they have time to turn it around.  As an investor and a customer, I am so ready for the turnaround.

I Love to Get My Groupon, but…

Groupon deal

Like most people, I love a good deal.  I tell my mother, my sister, my friends, anyone who will listen about any bargains I find and snag.  So, I signed up for Groupon and I’ve opened nearly every email they’ve sent me.  BUT, I just took a look at the new Groupon IPO filing and I’m not sure it makes sense to add “Groupon” to my Microsoft Word dictionary.

Here’s the problem.  Now that the creative accounting has been adjusted, it’s very clear that the company isn’t making any money and they have much to do to get to profitability.  According the filing, Groupon spent $6.40 to acquire new subscribers in first quarter of 2011.  (That was $208 million in marketing expenses for the incremental 32.5 million customers added in first quarter.)  But, Groupon’s gross profit—the money it gets after paying merchants from gross proceeds—is just $3.25 per subscriber.  (Compare $270 million in gross profit to 83 million total subscribers.)

How will Groupon close the gap?  They have several options:

  • Reduce marketing spend (Highly unlikely.  As Groupon notes in its filing:  “[W]e expect our operating expenses to increase significantly in the foreseeable future.”)
  • Increase the number of subscribers who become actual Groupon purchasers
  • Increase the number of Groupons each customer purchases
  • Increase the average revenue on each Groupon sold
  • Increase the number of relevant deals offered
  • Demand a higher percentage of the merchant deal (though this strategy is fraught with danger, given that the company currently extracts about 50% of revenue on every deal)
  • Focus the marketing spend on prospects that yield the highest conversion (subscriber-to-purchaser) rate
  • Optimize the presentation of deals so that more deals are sought out and “opened”

Here’s the tough part, Groupon purchasers are, by definition, looking for a deal.  They are accustomed to finding good deals and are being conditioned to do seek them out as more online couponers enter the market.  Deal-seekers aren’t usually brand loyalist.  So, when Yelp or OpenTable or Livingsocial or your local direct mail vendor-turned-online couponer presents a deal, the lowest-priced, relevant deal is the winner.  So, competition can and will significantly lower margins in this business.  The question is: Can Groupon get profitable and sustain profitability as more copycats enter the market?  We will soon see.