Market Insight

Apple takes risks with iPhone 7 & Apple Watch to return to smartphone growth

September 07, 2016


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Apple has unveiled: -

Two new iPhone models, iPhone 7 and iPhone 7+ notable features include:  
- Both models now have optical image stabilization, faster f1.8 lens, 4 LED true tone flash
- Plus offers twin camera modules with 26mm and 56mm lens, for wide & telephoto
- 25% brighter display, wide color gamut, same resolution and 4.7" or 5.5" size.
- Adds stereo speakers, drops 3.5mm headphone socket, and supports new Apple AirPod wireless earphones
- IP67 rating for water and dust resistance.
- New A10 chipset, with the first quad core application processor in an iPhone  

Apple Watch series 2, including a Nike-brand model
- Now "swim proof", water resistant to 50m
- Faster Apple-designed S2 chipset, with dual core application processor, claimed to be 50% faster, with x2 graphics
- Adds built-in GPS, open to app developers
- Same square display as the first generation
- And Apple updated the original Apple Watch with the new chipset, but not the other features, called Apple Watch series 1, price from $269

 

Our Analysis

Apple needs the iPhone 7 to be a major success because it is the main driver of growth for the whole company. Direct revenues for the iPhone represented 57% of total Apple revenue in the second calendar quarter, but the importance of the iPhone for Apple is much greater than direct revenues alone.

The iPhone drives acquisition for Apple's entire ecosystem, supports up-sell of Apple Watch, Macs and iPads. The more iPhones Apple sells, the larger the addressable audience for accessories such as Apple Watch series 2.

IHS expects the new iPhone 7 camera design will successfully convince consumers to upgrade their older iPhones, despite the lack of headphone socket. IHS forecasts Apple will ship 209m iPhones in 2016.

The camera is the most significant iPhone 7 feature 

With the new iPhone 7 range design, Apple is correctly focusing on the defining feature of flagship smartphones, the camera. Apple benefits in several ways from the improved iPhone 7 camera:-

  • Improved cameras drive smartphone upgrades. In a maturing smartphone market, a new camera helps persuade consumers their current smartphone is no longer good enough. IHS expects the iPhone 7 camera to successfully differentiate it from other smartphones. The camera is one of the few smartphone features with vast room for improvement.
  • Highlights Apple's ability to innovate better through hardware and software integration. Apple has demonstrated innovation with Live Photos, "sweep" panorama modes in the past, burst user interface... now its software combines two camera images together for new depth of field effects. 
  • Higher quality cameras support Apple services revenues. The more photos and videos consumers take, the more likely they are to pay a monthly subscription for increased iCloud storage to back up their photos and video. Driving higher services revenues has been a key Apple strategy since late 2015.

Shrewdly, Apple's long term "Shot on iPhone" marketing campaign where billboard adverts show off real iPhone photos has set the stage for Apple to market the latest iPhone 7 camera innovations.

These improvements go far beyond the new camera hardware: iOS 10 includes automatic photo organization, image recognition, and video creation which helps customers enjoy their photos. Unlike Google Photos, which pioneered these techniques, Apple's iPhone hardware is taking on most of the load of the processing rather than the cloud. This supports Apple's positioning on privacy as well as reducing Apple's cloud computing costs.

Apple takes courageous risks with iPhone 7 models

But Apple has seen iPhone shipments fall year on year in 2016 and it needs the iPhone to return to growth, Yet, Apple is taking major risks with the iPhone 7 design, including:

  • Apple is keeping the best iPhone dual camera features limited to the larger iPhone 7 Plus. But IHS data shows in the last year there has been a shift towards sales of smaller screen iPhone models. In the second calendar quarter, just 21% of iPhone shipments were for Plus models (see chart below). Rival Huawei, offers a dual camera design in the compact P9 which is similar in size to the regular iPhone 7.
  • Water resistance is a double edged sword which opens customer support headaches. For many years, Japanese smartphone makers have offered IP rated smartphones. Yet in 2016, Sony has drawn back and no longer offers it on all high end models. Samsung has added IP rating to its S7 and Note 7 flagships, but in the past had issues and support issues with the older Galaxy S5. Apple itself delivers water resistance on the first Apple Watch, but chose not to make strong marketing claims to sidestep potential support issues.
  • Adverse reaction to the decision to drop the headphone jack threatens to drown out communication of iPhone 7 improvements. Apple has to make the case the many enhancements are worth the inconvenience of the lack of a headphone socket, or consumers will hold off upgrading to iPhone 7.
  • The iPhone 7 keeps broadly the same exterior design as the 6 and 6S. This is a risky strategy as normally iPhone models with a big exterior design change trigger a large jump in shipments, while the incremental "S" designs have seen lower year on year growth rates of around 5%. Apple is relying on the camera, IP rating and new colors to drive sales.

Audio innovation should be possible without requiring the end of the headphone socket

Apple also has a long history of dropping support for legacy technologies to make its current products more compelling, by enabling them to be smaller, faster, or lighter. The decision to drop the 3.5mm headphone socket is the latest example. Apple is not the first to drop the socket: The Moto Z and select models from Chinese manufacturer LeEco have launched without the 3.5mm socket in 2016. These manufacturers have had little adverse reaction, in part, because they sell many fewer smartphones than Apple.

Unlike previous moves to cease offering floppy disk drives, the iPod dock connector, CD drives, multiple USB ports and many others, the headphone is a riskier move for Apple because of the numerous number of non-computing devices which use the socket. The result is consumers will have to compromise with adaptors for many many years to come.

Apple Watch Series 2 evolution treads water

Apple addresses some of the rough edges in the first generation smartwatch, including speed, degree of water resistance and ability to accurately track runs when used independently from an iPhone. These are sensible but unexciting enhancements. But battery life performance is as yet unclear, the GPS if used for long period may in effect even worsen performance over the first generation model. This will not become clear until Apple Watch Series 2 ships.

However, while series 2 will appeal to consumers who liked the original design, Apple will attract few new admirers with the similar design. To widen appeal further, IHS recommends Apple should offer models with a round display, offer an always-on display, open watchOS to third party watch faces to re-ignite third party developer support, and lengthen battery life to several days to enable sleep tracking and greater convenience.

For now, the increased fitness capabilities and Nike partnerships will keep the Apple Watch business moving, without creating a break out new product category success for Apple as the original iPhone was nine years ago.

Organization
Apple Inc.
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