Friday’s news of Apple’s permit to test self-driving cars in California should not have come as much of a surprise given the poorly kept secret of Project Titan. But the permit begs the question of whether Apple is building a car or just building software for a car.
Apple’s overarching philosophy has been to own both the hardware and software to create superior product experiences. Typically, this means owning the technology stack from end to end for a given product; for example, Mac + macOS, iPod + iTunes, and iPhone + iOS; however, sometimes the company stops short of owning the entire experience. The Apple TV requires a third-party television panel, although we would argue that is the equivalent of plugging your Mac into a third-party monitor. Once the Apple TV is engaged, the experience is all Apple. Unlike a television, a car is not just a dumb panel. Modern vehicles require a tremendous amount of sensors and other electronics that monitor the exterior and interior. In an ideal world, Apple’s car project would involve the company building the actual automobile, combining hardware and software. In reality, the complexity of designing and manufacturing a vehicle may push the company to integrate deeply with an automotive partner or partners in an effort more similar to the Apple TV — plugging Apple’s technology into an existing product.
From a software standpoint, building an automotive product beyond CarPlay is a no-brainer. Apple has one of the better stacks of necessary components to build a great car OS:
Entertainment: iTunes/Apple Music
Navigation/Local: Apple Maps
Image Processing/Recognition (Autonomous Driving): iPhone Camera
Security: Touch ID
Third-party Software: App Store (potential for OTA software updates)
Despite the obvious software advantages, the auto market poses challenges that Apple may not be able to overcome on the hardware side, i.e. building the car end-to-end. First and foremost, Apple would likely need to find a manufacturing partner because it is not a manufacturing company, but a design company. Foxconn and other manufacturing partners build iPhones, iPads, and Macs to Apple’s specs. A company like Magna Steyr may be a capable of building a car to Apple’s design specs. Aside from finding a partner, we note that the typical automotive design process takes 5-7 years. Even on an accelerated time table, Apple is likely multiple years away from a completed hardware design for a car. Finally, Tesla and Google have a multi-year lead on Apple in developing autonomous vehicle capabilities, including the associated testing mileage. We see autonomous driving capabilities as a key factor in auto desirability over the next five years.
Apple is almost certainly exploring how it could build an entire car, but as we learned the hard way with an Apple television, exploration does not mean a product comes to market. Apple is the best connected device maker in the world and the car is the biggest connected device in the world. There is a natural fit in the self-driving car market if Apple can figure out how to get past the challenges of making the hardware.
Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.
Yesterday Apple released Clips, a new app for iPhone users. Apple describes Clips as, “A new iOS app for making and sharing fun videos with text, effects, graphics, and more.” And Clips is fun, but it doesn’t show us the kind of augmented reality lenses and layers that we were hoping to see from Apple.
We’ve written a lot about how AR will change the way we interact with computers. Over the next several years, the smartphone will increasingly become a window through which users can see an augmented world. Players like Apple and Google are well-positioned to win the jump ball to own the dominant operating systems in that new paradigm. Google’s leadership in core disciplines like maps, data, and content make it an important incumbent. Apple’s leadership among app developers and payments will be important, but we think design is Apple’s trump card in AR. But Clips is more filters and effects than lenses and layers. There is an interesting real-time transcription capability, but unfortunately Clips is short on true AR.
In about 5 min. I was able to put together a short video with text, effects, filters, and music. Clips uses fairly rudimentary real-time computer imaging, but this could be the beginning of the underlying technology that will one day direct you to your seat in a stadium, overlay talking points during a presentation, or provide instructions as you assemble new furniture.
Apple Services Through 2022. We have written about the need for Apple to reinvent itself in the next decade through services and AR. The Services reinvention is already underway, accounting for 11.6% of revenue in 2016, and closer to 18% of profits. Today we are rolling out our 2022 Services model, and estimate services revenue will account for 20% of Apple’s sales in five years, 30% of profits and growing at 15% annually. For comparison, we estimate Apple’s hardware sales will be growing at about 5% in 2022. This translates to $60B in 2022 Services revenue up from our estimate of $30B in 2017. This growth will in part be maintained by App Store revenue from Apple’s advancement of augmented reality (AR) that will be the company’s next major development platform. We expect AR will be a key feature in the upcoming iPhone X release (more on that here), which will slowly build developer enthusiasm for AR apps.
Beyond 2022. Apple should easily hit its stated goal that its Services business will become a Fortune 100 company sometime in 2017. Thinking about Services beyond 2022, we believe Services will have a steady 10% growth, and account for three quarters of Apple’s overall growth. This will be driven primarily by the App Store, Apple Music + Content, with all three areas strongly benefitting from the addition of AR.
App Store. By 2022, we expect App Store revenue to account for 44% of Services revenue and be growing at 14% annually, due to Apple’s continued leverage of revenue share with developers. Apple will continue to see App Store revenue account for a major portion of total Services revenue. The emphasis on AR capabilities in the iPhone X will be the next foundation for developers, creating an even playing field for creation and distribution of AR content. It’s worth noting that we don’t expect an acceleration of App Store growth from AR; rather, developers will view adoption of AR as fundamental to a mobile experience, and a necessity to maintain existing users and compete for new ones. Our App Store growth goes from 29% in 2017 to 14% in 2022.
Apple Music + Content. By 2022, we expect Apple Music + Content revenue to account for 23% of Services revenue, growing at 30% annually. We remain optimistic on the future of Apple Music. Despite a rough start, Apple has steadily built its music subscriber base to roughly 25m (as of Feb. 2017). By the end of 2017/early 2018, we expect Apple to begin offering additional video content as well, including its own original content (more on that here). While this pursuit adds Apple to an already tight freeway of content producers and providers like Netflix and Amazon, Apple’s combination of AR and VR related hardware and content could offer some differentiation.
Growth in this segment is ultimately dependent on Apple’s investment in the quantity and quality of its content, en route to its internal goal of 100 million Apple Music + Content subscribers by 2022. Apple is well on its way to achieving this target with roughly 25m music-only subscribers to date, while the preponderance of future subscriber adds will need to come from a hybrid music/content offering.
Over the next 5-10 years, we believe augmented reality will emerge as the next dominant computing paradigm and that Google and Apple will provide the operating systems that power AR computing. The OS will need to incorporate core technologies including artificial intelligence, maps with points of interest, organized informational data, social data, a developer community, content, and payments. In what follows, we focus specifically on the payments element and report on the state of the union of Apple Pay.
Apple Pay State Of The Union:
2,091 banks accept Apple Pay globally, up from 1,439 in July of 2016.
We estimate about 13% of active iPhones have activated Apple Pay.
We estimate 30% of new iPhones are activating Apple Pay.
53% of retailers listed as “coming soon in browsers” have launched in the first 6 months.
31% of retailers in the Internet Retailer 100 accept Apple Pay, up from 28% in Oct.
44% of retailers in the Internet Retailer 100 have adopted Apple Pay at point of sale.
40% of retailers in the Internet Retailer 100 have adopted Apple Pay in-app.
13% of retailers in the Internet Retailer 100 have adopted Apple Pay in mobile browsers.
9% of retailers in the Internet Retailer 100 have adopted Apple Pay in desktop browsers.
22% of all possible points adoption leverage Apple Pay within the Internet Retailer 100.
Apple Pay adoption trend since Oct, 2016. In March 2017, we counted 31 of the Internet Retail 100 accepted Apple Pay in some form. In October 2016, while at Piper Jaffray, we counted 28 of the Internet Retail 100 accepted Apple Pay in some form, including point of sale, mobile and desktop (excluding in app).
A better way to measure Apple Pay adoption. We looked at the Internet Retailer top 100 online sites to gauge adoption of Apple Pay. Next, we created an Apple Pay adoption score that looks at current retailer adoption as a percentage of potential adoption. There are 4 ways a retailer can adopt Apple Pay, including point of sale, in app, mobile and desktop browsers. This equates to maximum of 316 Apple Pay adoption points within the Internet Retail 100, considering that only 62 offer point of sale and 54 offer an app. We found 22% Apple Pay adoption in March 2017, or 71 of 316 possible points of adoption. Since this is the first time we have measured the adoption score, we don’t have a comparative score.
Point of sale. Apple Pay has 44% adoption at point of sale within the Internet Retailer 100. 62 of the top 100 online retailers offer point of sale; among them, 27 accept Apple Pay in store. Apple Pay launched at retail and in-app in the fall of 2014. Apple added Apple Pay for mobile and desktop browsers in the fall of 2016. In other words, the company has had over 2 years to build adoption at point of sale. Apple Pay at point of sale works with a broader tap and pay network; most locations that accept Apple Pay also accept other tap and pay offerings including Google Wallet and Samsung Pay. Since this our first measurement, we don’t have a comparative number. Bottom line: adoption of Apple Pay at point of sale is growing nicely, in-line with growth among other digital payment players, including Google and Samsung wallet.
At this point, it might not even be that crazy to say it, but we think AirPods are going to be a bigger product for Apple than the Watch. After using AirPods for the past month, the Loup Ventures team is addicted. The seamlessness in connecting and disconnecting with our phones and enabling Siri has meaningfully improved the way we work and consume content. AirPods are a classic example of Apple not doing something first, but doing it better. And they look cool. We think there are three reasons that AirPods are more important than the Apple Watch.
Google has been talking about designing products for an AI-first world for about a year now. In our view, an AI-first world is about more natural interfaces for our screen-less future. Speech is an important component of the next interface. Siri, Alexa, Google Assistant, and Cortana are making rapid improvements in terms of voice commands they understand and what they can help us with.
We view AirPods as a natural extension of Siri that will encourage people to rely more on the voice assistant. As voice assistants become capable of having deeper two-way conversations to convey more information to users, AirPods could replace a meaningful amount of interaction with the phone itself. By contrast, using Siri on the Apple Watch is less natural because it requires you to hold it up to your face. Additionally, the screen is so small that interaction with it and information conveyed by it is not that much richer than an AI voice-based interface.