Ben Thompson had a great column this week, in the wake of Apple’s quarterly results and Microsoft’s announcement of the Surface Laptop:
Did you hear about the new Microsoft Surface Laptop? The usual suspects are claiming it’s a MacBook competitor, which is true insomuch as it is a laptop. In truth, though, the Surface Laptop isn’t a MacBook competitor at all for the rather obvious reason that it runs Windows, while the MacBook runs MacOS. This has always been the foundation of Apple’s business model: hardware differentiated by software such that said hardware can be sold with a margin much greater than nominal competitors running a commodity operating system.
Hardware differentiated by superior, exclusive software is the key to understanding Apple. It’s the reason the company was founded. Apple II’s were the best personal computer hardware and had the best software. Part of why Woz is so venerated is that he was unimaginably gifted at both hardware and software. Hardware differentiated by software is how Apple survived in the late ’90s, when the company was struggling. It explains all the company’s success after that: the iPod, the resurgence of the Mac, iPhone, iPad, and Apple Watch. Any comparison between Microsoft’s Surface Laptop and Apple’s MacBooks that doesn’t place heavy emphasis on the value of MacOS is vapid.
Thompson then turns to Apple’s languishing iPhone sales in China:
But that is not what is going on in most of the world: plenty of folks — more than last year — are happy to buy the iPhone 7, even though it doesn’t look much different than the iPhone 6. After all, if you need a new phone, and you want iOS, you don’t have much choice! Except, again, for China: that is the country where the appearance of the iPhone matters most; Apple’s problem, though, is that in China that is the only thing that matters at all.
The fundamental issue is this: unlike the rest of the world, in China the most important layer of the smartphone stack is not the phone’s operating system. Rather, it is WeChat. Connie Chan of Andreessen Horowitz tried to explain in 2015 just how integrated WeChat is into the daily lives of nearly 900 million Chinese, and that integration has only grown since then: every aspect of a typical Chinese person’s life, not just online but also off is conducted through a single app (and, to the extent other apps are used, they are often games promoted through WeChat).
There is nothing in any other country that is comparable: not LINE, not WhatsApp, not Facebook. All of those are about communication or wasting time: WeChat is that, but it is also for reading news, for hailing taxis, for paying for lunch (try and pay with cash for lunch, and you’ll look like a luddite), for accessing government resources, for business. For all intents and purposes WeChat is your phone, and to a far greater extent in China than anywhere else, your phone is everything.
As Thompson adds in a footnote, “Or, to put it another way, the operating system of China is WeChat, not iOS/Android.”
Thompson cites a staggering statistic: among existing iPhone users in China who bought a new phone in 2016, only 50 percent of them bought another iPhone. That is an incredible statistical outlier compared to iPhone users in the rest of the world, where Apple’s retention rates hover around the mid-80s.
Here’s a Business Insider report from November of last year, with retention statistics from 2014 through 2016 from UBS analysts Steven Milunovich and Benjamin Wilson. Business Insider leads with the iPhone’s slowly declining retention rate globally, but the real story is halfway down the page, in this chart.
According to that research from UBS, iPhone retention rates hover in the mid-to-high 80s in the U.S., U.K., and Germany. In Japan they’re in the mid-70s, but holding roughly steady. China’s numbers have plummeted — and these numbers from UBS (in the mid-50s for Q4 2016) are in line with the 50 percent number in the Chinese survey Thompson cited.
So here’s Apple’s China problem: Chinese iPhone users aren’t nearly as loyal to the iPhone platform as iPhone users elsewhere are. This is already hurting Apple financially. Apple’s Q2 2017 financial results (announced this week) were, overall, OK. But other than China, they were actually good. The drop in iPhone sales in China was so severe, and China is so big, that it singlehandedly turned a good quarter into a so-so quarter.
I subtly disagree with Ben Thompson on one point. Thompson attributes the iPhone’s slide in China to two factors:
Thompson knows Chinese culture well — he lives in Taipei, visits China often, and speaks Mandarin. My grasp of Chinese culture is rudimentary at best, and I’ve never traveled to Asia. So I defer to him on the point that the iPhone as a status symbol is more important in China than it is elsewhere.
Thompson, though, I think places too much weight on the fact that at a glance, some models of the iPhone 7 are indistinguishable from the iPhone 6 and 6S. Thompson argues that this is more of a problem in status-conscious China than it is elsewhere — that in China, there are many people who forego an upgrade to an iPhone 7 because other people won’t be able to tell that it isn’t, say, a boring two-year-old iPhone 6. I just don’t buy that. For one thing, the black and especially jet black iPhone 7 models are instantly recognizable as the latest and greatest.
But more importantly, I just think the whole “if it doesn’t have an altogether new form factor, it’s boring” thing is hogwash. I wrote an entire column about this when the iPhone 7 debuted, and won’t rehash the whole argument here. But I am convinced this viewpoint is mostly that of the tech and gadget obsessed.
Again, I’ll concede that the status symbol aspect of a high-end smartphone may well be more important in China than anywhere else in the world. But even if I also concede that the iPhone 7’s mostly-like-the-iPhone-6 form factor is a problem for the Chinese market, if the iOS platform engendered the loyalty in China that it does elsewhere, the result would be Chinese iPhone owners waiting another year for the next iPhone. Instead, according to the market research cited above, half of the Chinese iPhone owners who bought a new phone in 2016 switched to an Android device. There are some fine looking Android phones at the high end of the market, but there are none that, based on form factor alone, would explain this. And none of them have anything close to the luxury brand prestige that Apple does.
In Apple’s “hardware differentiated by software” formula, the software is more important than the hardware. That’s why gadget writers so often get Apple wrong: they’re focused solely on hardware — the object, not the experience of using the object. That’s also why the financial press so often gets Apple wrong: they focus only on the hardware because that’s where the money comes from.
If forced to choose, I would much rather run iOS on a Google Pixel than Android on an iPhone 7. I would rather run MacOS on a ThinkPad than Windows on a MacBook Pro.1 Whenever I bring up this thought experiment — would you rather run Apple’s software platform on non-Apple hardware or run some other software platform on Apple hardware — I get email from readers who say they actually do choose Apple products, especially MacBooks, for the hardware. I believe them, but those are the sort of customers with the least loyalty to Apple. If all you depend on is, say, Chrome, a text editor, and a terminal, it’s easy to switch to another laptop brand. If you depend on native Mac and iOS apps, iCloud, and iMessage, it’s arduous, at best, to switch.
If it really is true that “the operating system of China is WeChat, not iOS/Android”, that’s the whole ballgame right there. Again, my disagreement with Thompson here is subtle. He even describes WeChat’s centrality to the Chinese smartphone stack as “the fundamental issue”, leaving the supposed boringness of the iPhone 6S and 7 as a secondary issue. My difference with Thompson is that I don’t think the iPhone 6S/7 hardware is a problem at all. Personally, I think the iPhone 7 is such a great phone, and the 7 Plus in particular has such a great camera, that the quality of the latest iPhone hardware, including how it looks, shows just how much of a problem it is that WeChat, not iOS, is central to the iPhone experience in China.
That’s a real problem for Apple, because even if Thompson is right (and I’m wrong) and Apple does have a boring-looking-hardware problem in China, they can (and seem poised to) remedy that by releasing exciting new iPhone hardware this year. But if the problem is that iOS engenders far less platform loyalty in China because of WeChat’s centrality — or even worse, if WeChat is central and better on Android than it is on iOS — there’s no easy fix for Apple.
For those of you like me, who know very little about WeChat, this 2015 piece by Connie Chan (as linked to by Thompson) is a terrific introduction: “When One App Rules Them All: The Case of WeChat and Mobile in China”.
I always use ThinkPads as my go-to example of high-quality PC hardware; perhaps I should start using Microsoft Surfaces? ↩︎