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Apple had another great quarter, but much of the response wasn’t exactly glowing. From the New York Times:

Apple on Tuesday turned in another quarter of enviable revenue and profit growth, fueled by sales of the iPhone. But the results raised a perennial question for the world’s most valuable company: How can it keep its growth streak alive?…Over all, Apple posted a profit of $11.1 billion for its fiscal fourth quarter, up 31 percent from a year ago. Revenue was $51.5 billion, up 22 percent from last year. The results exceeded Wall Street estimates. The growth question is a quandary created by Apple’s own success. The company has gotten investors accustomed to double-digit growth rates and enormous profit. That sets a high bar for Apple to clear each time and creates tough comparisons to beat later. Apple’s holiday quarter last year was enormous, driven by the unveiling of the larger-screen iPhone 6 Plus, analysts said, making it difficult to compare to this time around. To keep up this kind of growth, analysts said Apple had only a few levers to pull: Attract more first-time customers, get more people to switch from rival Android-based phones and continue to grow in China. “We didn’t get great visibility into the central question that we have about Apple,” said Toni Sacconaghi, an analyst at Sanford C. Bernstein. “Can the iPhone grow in fiscal 2016?”

Forgive me in advance for this rant.

Look, as I noted last quarter, I appreciate that stock analysts — and the reporters who quote them — are approaching iPhone sales from a different place than I am, specifically, one focused on what will affect the movement of the stock over the next six months or so. I’m quite happy to not be in that game and instead spend my time looking at broader trends in the market and making more long-term predictions.

That said, I am increasingly finding most commentary around the iPhone to be just a bit maddening: the iPhone — and, by extension, Apple — is in the strongest position it has ever been in, and I feel like far too many folks are being obtuse about that reality.

Step back five years or so, and there were legitimate strategic questions about the iPhone: probably the two most popular were whether or not the iPhone could maintain its average selling price (ASP) or if it needed to go down-market, and whether or not Android would overwhelm the iPhone from a marketshare perspective and thus, over time, win over the complementary parts of the iPhone’s ecosystem (especially developers). As long-time readers know, I consistently argued that neither would happen — iOS and its ecosystem would continue to provide significant differentiation that maintained ASP, there were far more wealthy customers in large developing countries like China than average income numbers would suggest, and that these two factors would perpetuate the ecosystem’s allegiance to iOS — but I could at least respect that the thinking behind these objections was grounded in a cogent analytical framework (that just happened to be wrong).

On the other hand, I have a much more difficult time being respectful about today’s bear arguments that basically boil down “the iPhone was too successful previously” or, perhaps more accurately, “just because.” If you want to argue that the iPhone will be less successful than it has been previously, ground it in something other than your vague intuition!

Enough ranting, though, because reality is enough, and it is very kind to the iPhone’s prospects:

Reality #1: Smartphones are the most important products in people’s lives, which means that the willingness to pay for the “best” is higher than it is for just about anything else; relatedly, the smartphone budget is likely the last to be cut in any sort of economic tightening

Smartphones are the most important products in people’s lives, which means that the willingness to pay for the “best” is higher than it is for just about anything else; relatedly, the smartphone budget is likely the last to be cut in any sort of economic tightening Reality #2: Nearly all iPhone users upgrade to new iPhones, while a significant number of Android users switch. Ergo, the more saturated the smartphone market becomes (and the more people appreciate just how important a smartphone is to their lives, per Reality #1) the better Apple does

Reality #3: Apple’s increasing monopoly on the high-end of the market is creating a virtuous cycle that ensures they will own the high-end indefinitely. From an app perspective, new and updated apps launch first on iOS, which means people who care buy iPhones, which means future new and updated apps launch first on iOS. From a component perspective, Apple is increasingly the only manufacturer that can even afford to buy the best components, and they have massive scale which ensures they get first dibs on what is new. This, of course, further solidifies Apple’s hold on the high end, which only strengthens their position with component manufacturers further. From a broader hardware perspective, Apple’s scale means their costs are lower than any potential competitors, which means their investment in new technology like 3D Touch can be commensurately higher, which again, solidifies their hold on the high end, which increases their scale even more. On the flipside, Android competitors are still behind on apps (they get them, but later and often of lower quality), have inferior (or at least more expensive) components, and less and less money to spend on building premium products, which only adds fuel to point number one: it’s hard to see why anyone would switch from iOS to Android, but very easy to understand why folks would move in the opposite direction.

Reality #4: The iPhone’s biggest advantage in China has always been its role as a status symbol, but as the iPhone scales in China that market starts to look a lot like the rest of the world: it’s not only that owning the iPhone says something about you, but that the fact so many (relatively) wealthy people own the iPhone results in the ecosystem increasingly becoming a selling point in its own right. Oh, and China just happens to be the most populous country with the largest emerging middle class in the world

Reality #5: The richer an economy becomes the more products shift away from up-front payments. I first made this observation when explaining why The $550 iPhone 5C Makes Perfect Sense: While any discussion about the iPhone touches on subsidies, the subsidies themselves — and the degree to which the iPhone is accessible — are much more a function of the underlying economy. [Richer countries] are more service-oriented, and have higher purchasing power. There is much higher credit-card penetration, and, generally speaking, greater respect for copyright. All of these factors [mean the richer the country the] more attractive to Apple… While this argument was making the case that the iPhone 5C was about targeting wealthier countries, not developing ones (which was the conventional wisdom), the underlying observation is a critical one: smartphone subsidies in wealthy countries were never going to be replaced by the up-front purchase of smartphones, because the trend in service industries of all types is towards more credit-based offerings, not fewer. Indeed, we’re actually seeing the United States in particular move in the opposite direction: towards straight-up subscription iPhones. And, just as subsidized iPhones naturally sold better than iPhones that required full payment up-front, it seems obvious that subscription iPhones will sell even better, particularly in the long run.

To my mind the only iPhone objections that make sense are that the addressable market will be saturated, that said saturated market will lengthen its replacement cycle since their current phone is “good enough,” and that China will fall off a cliff. My answer to all of these, though, comes back to what I noted in Realty #1: the ever-increasing importance of smartphones in people’s lives means that the market size of people willing to pay a premium for their smartphone is actually growing; even small improvements are valued more than they would be in other, less-critical products; and that the smartphone budget will be the last to be cut. And, of course, the iPhone-as-a-subscription works directly against the “replacement-cycle-will-lengthen” argument.

Again, I get that analysts are coming from a more short-term perspective, and it’s very fair to argue that pent-up demand for a large-screen iPhone makes for a difficult “comp” for the next few quarters specifically. Moreover, Apple’s currency exchange challenges are getting worse as hedges taken out before the U.S. dollar took off have long since expired. But no one should lose sight of the fact that, for the long term, the iPhone’s prospects are better than they have ever been (and I didn’t even mention enterprise sales: the iPhone has less competition than ever, and increasingly an ecosystem around it that reflects that reality).

To be sure, there are reasons to question Apple, both about short-term issues (see my concerns about Apple Pay yesterday, the why of Apple Music, and the un-Apple-like aspects of the Watch launch) and long-term ones (the rise of machine learning, whatever comes after the smartphone, a car?), and I will continue to challenge the company on those points. I just see no compelling argument for why the iPhone’s continued success fits on that list.

The Macintosh Company

There’s a reason most of this update is about the iPhone: when it comes to Apple’s earnings, nothing else really matters. More broadly, smartphones in general have made PCs yesterday’s news. Still, it’s remarkable to think about how far the Mac business has come.

Given that the iPod started shipping in November 2001, Q4 2001 — fourteen years ago — was the last quarter where Apple sold basically Macs and nothing else. The company was proud of its results in a challenging economic environment:

Apple today announced financial results for its fiscal 2001 fourth quarter ended September 29, 2001. For the quarter, the Company posted a net profit of $66 million, or $.19 per diluted share. These results compare to a net profit of $170 million, or $.47 per diluted share, achieved in the year ago quarter. Revenues for the quarter were $1.45 billion, down 22 percent from the year ago quarter, and gross margins were 30.1 percent, compared to 25.0 percent in the year ago quarter. International sales accounted for 41 percent of the quarter’s revenues. Apple shipped 850 thousand Macintosh units during the quarter.

Yesterday Apple announced it had sold 5.7 million Macs in Q4 2015, accounting for $6.8 billion in revenue. Those are increases of 570% and 369% respectively (the Mac accounted for $1.45 billion in revenue in Q4 2001). Certainly Apple’s other products played a role in this increase thanks to the “halo effect,” but it’s fair to argue that while first the iPod and then the iPhone made Apple into a financial juggernaut, they didn’t save the company: the Mac managed to save itself.

Indeed, the Mac remains one of the strongest arguments for the iPhone’s continued success; there is precedent for a higher-priced OS-differentiated product housed in the best hardware outgrowing the competition in a saturated industry for years, and it just so happens to be made by the same company.

This Daily Update was sent to Stratechery subscribers on Wednesday, October 28, 2015. To learn more about the Daily Update or to subscriber please visit this page.

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