Toni Sacconaghi Alert: Excessive iPhone Demand Reason to Panic
February 26th, 2008
Daniel Eran Dilger
Based on a handwringing report issued by Toni Sacconaghi of Bernstein Research, Barron blogger Eric Savitz and Rex Crumb, a colleague of John Dvorak at MarketWatch, are both worried that Apple won’t be able to sell enough iPhones this year, and doubly concerned that a significant chunk of what the company does sell will be used unlocked. In other words, the iPhone faces a possible demand shortage problem that is complicated by excessive worldwide demand in markets where Apple hasn’t yet established an exclusive partner. Oh the humanity.
Crumb seemed oblivious to the contradictions in his punditry as he segued from worrying about “whether demand for the iconic device is sufficient to support that [10 million] target” and “another issue” of widespread unlocked iPhone use worldwide. He also had no problem reporting on Friday that “[the iPhone] could be responsible for as much as 80% of Apple’s future earnings growth” only to write on Monday that the iPhone is ‘no longer a growth driver’ for Apple. Which is it?
Perhaps Crumb doesn’t give the consistency of his repetitive, negative Apple spin much thought, as he was largely just uncritically regurgitating analysts’ reports. Monday’s analyst was Keith Bachman of BMO, who contradicted Sacconaghi’s outlook on the iPhone to the extent that Crumb was forced to only allude to Sacconaghi’s fears in general terms to avoid highlighting the fact that the two analysts’ opinions don’t align, meaning at least one of them has to be wrong.
The Hunt for the Missing iPhones.
And yes, that’s the same Sacconaghi who a month ago invented the idea that around 1.4 million of the iPhones sold were probably sitting in inventory somewhere, or were perhaps being used unlocked. His report set off a gaggle of wags desperate to express their concerns about the “missing iPhones” caught in a Purgatory somewhere between their retail sale and a verifiable service provider activation.
Never before in the history of consumer electronics have analysts worked so hard to contort reality in order to find potential problems with the sales, inventory, and consumer usage patterns of a device, and then extrapolate these into scary reports that suggest the imminent collapse of a highly successful company at the hands of its incompetent rivals.
More recently, Sacconaghi has been warning that Apple is being “optimistic” to think it can sell 10 million iPhones in 2008, and he fears that the company may lose as much as $1.3 billion in revenue on unlocked phones this year. Both ideas skip across the lake of reality like smooth stone projectiles that only occasionally touch the surface, and at every contact risk being overwhelmed by the surface tension of logic and pulled down from their skittering slaps into the placid fluid and quietly dropped to its muddy bottom, only to be certainly followed by another volley of pebbles.
Is Ten Million iPhones a Stretch?
Sacconaghi based his iPhone sales worries on the idea that Apple sold around 180,000 iPhones per week in the winter quarter. Multiply that by 52 weeks and you only get 9.3 million, just short of Apple’s 10 million goal. But it gets worse.
The winter quarter is the busiest quarter of the year for consumer electronics sales, and clearly is the most blockbuster quarter for iPod sales. Apple has consistently sold roughly three times as many iPods in the winter quarter than in the first three calendar quarters of the year. That suggests that the “run rate” during the winter quarter wouldn’t necessarily be replicated throughout the rest of 2008, falling even further short of the 10 million goal.
Of course, in reality, iPhones and other electronics devices don’t have a fixed “run rate.” The iPod didn’t being selling at a somewhat regular pace until it was eight years old. The RIM BlackBerry has been growing at an irregular but rapid pace for years. The Xbox 360 hit up and down cycles its first year and then shipments dramatically fell in 2007. None of the other game consoles follow a regular run rate either. There really aren’t any consumer electronics products that sell at a specific “run rate” over a year long period, so analysts need to stop bringing up this farcical metric to make wild long term predictions.
The Seasonal Cycle.
Additionally, the iPhone isn’t an iPod. Apple blows out a spectacular winter quarter in iPod sales because of gift giving, but iPod sales are unique for the company. Apple does not sell three times as many Macs in the winter quarter; in fact, Apple typically sells more Macs in the quarter ending in September due to education sales.
The iPhone doesn’t have the back to school rush of the Mac line, but also doesn’t have as large of a boost from holiday sales as the iPod. It if did, we’d have seen sales go up three fold quarter over quarter in the holiday season.
After iPhone sales ramped up in September, they hit a high point through the winter quarter and appear to have returned to only slightly lower levels month over month in January and February; the iPhone is still selling at rates well above the numbers sold in September following the price cut incentive. This curve matches the increasing demand for Mac desktops, but looks flat when compared to the blowout quarterly iPod sales peak.
Non Seasonal Sales Factors.
Apple has only sold two full quarters of iPhones, so the seasonal factors that will push sales aren’t yet evident. However, Apple’s iPhone sales have been going up due to number of factors that have little to do with seasonality. The price cut at the introduction of the iPod Touch appeared to double sales on a weekly basis. Clearly, price is a major factor in stimulating demand and Apple can use further price cuts to boost sales if it needs to do so. There is no evidence Apple needs to cut its prices to compete, as there is already strong demand.
In addition to price, there are other demand factors related to availability, promotion, and visibiltiy. In the winter quarter, Apple began selling in new markets in Europe. In 2008, Apple will add official markets in Asia and other countries. Within a month, the company is scheduled to release its iPhone SDK, which will greatly expand its utility and features. That SDK also covers the iPod Touch, which is also a hot seller and paving the way toward the iPhone for many users on the fence about changing their mobile service provider.
If Apple had any concerns about meeting its 10 million unit goal for iPhones, it would have to present that in its statements to investors. Instead, the company described confidence in its ability to meet its goal, just as it blew past its original goal of 1 million units several weeks ahead of schedule. Looking at sales in 2007 to predict demand in 2008 simply fails to account for too many factors that will accelerate iPhone sales.
On top of the known factors, there are other unannounced but likely developments that will also affect iPhone sales, including additional price reductions or new feature additions at the same price, such as additional storage or faster mobile network support. Anyone who thinks Apple will have any trouble selling ten million iPhones this year simply hasn’t given the subject much thought.
Is Apple Losing Billions on Unlocked Phones?
The best reason for thinking Apple won’t have too much trouble selling additional iPhones in new markets is the high demand for unlocked phones. If buyers are shelling out a premium for exported, unlocked phones and forgoing the full features of the iPhone in order to use them worldwide–outside of markets Apple has set up in the US, Germany, France, and the UK–that certainly suggests there will be ready demand once the company officially expands.
We know this happening because web traffic statistics indicate iPhones are requesting web pages from nearly every country around the world in volumes that make mobile traffic from other phones look inconsequential. This has been reported everywhere from Net Applications to Google. Worldwide, the iPhone has captured a rapidly increasing percentage of web traffic, doubling over the last three months from .06% to .13% in January. In just the US, the iPhone now requests .20% of all web traffic, even before including traffic from iPod Touch users.
That worldwide demand for Apple’s unique new WiFi mobile platform is creating value in exclusivity for mobile providers, which in turn prompts them to pay Apple a portion of their service fees. Of course, when users unlock the iPhone for use with other carriers, Apple doesn’t get this additional revenue. Sacconaghi worries that the hundreds of thousands of iPhones being sent to China and other markets will “cost” Apple as much as $1.3 billion in unrealized revenue over the next year, based on the idea that 30% of all iPhones are being sold for use unlocked.
This is particularly silly because nearly every other phone headset manufacturer–apart from BlackBerry maker RIM–makes nothing at all from carrier revenue sharing. How much revenue have Nokia, Samsung, Motorola, Sony Ericsson, LG, HTC, Palm, and other phone manufacturers “lost” due to having no way to earn revenue back from the carriers? It must be in the imaginary hundreds of billions!
Conversely, if Apple were set to “lose” $1.3 billion on 30% of the 10 million iPhones it plans to sell in 2008, how much is it uniquely making on the 70% of iPhones that will generate carrier revenue for Apple? According to Sacconaghi’s own math, something like $3 billion. Why is $1.3 billion of fanciful “loss” newsworthy while $3 billion of actual revenues is carefully ignored? How ruthlessly absurd that Sacconaghi blows out this inanity as serious market analysis, and how transparent that so many of these bloggers picked it up and ran with it as if it were non-ridiculous.
Based on unit sales reported by the top five manufacturers in the fourth calendar quarter of 2007, Nokia “lost” $33 billion in carrier revenue shares it never collected, and is set to “lose” another $134 billion next year. Along with Apple, the top five phone hardware makers will “lose” an astounding $304,180,000,000 (below, click graphic to enlarge). Only Apple will actually cover its losses with earned revenue shares of roughly $3,000,000,000.
Sacconaghi’s math might be wrong. Apple could be earning less from carrier revenue shares. That would also mean that it is “losing” less from unlocked use of the iPhone worldwide. However, no matter what Apple makes from its exclusive mobile partners, it’s far more than the big fat nothing that other hardware makers are getting, and any analyst who can find fault with Apple’s business model should be in another line of work.
But Wait, There’s More.
What Sacconaghi didn’t really outline clearly was that Apple enjoys special circumstances that enable it to make money from several other parallel, interconnected businesses related to the iPhone in addition to carrier revenue sharing. Other phone manufacturers either don’t make this money at all, or face various limitations that both prevent them from keeping up now and from ever catching up later.
The next segment will look at five ways Apple’s iPhone engine makes money compared to other hardware makers, why they won’t be able match the company’s revenue engines in the near future, and why this makes any difference to end users.
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