On Bubbles

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There has been a a lot of bubble talk lately. Many startups companies have become “unicorns”, which is a status given to a company that is valued at over $1B but hasn’t yet gone public. Just to give you some examples, these companies include Uber, Dropbox, and AirBnB, among many others. What I hope to achieve in this post is to give you a perspective that you may not have seen, regarding this bubble fiasco. I find myself in this explanatory position for a few reasons. 

First, I follow many venture capitalists on Twitter, and have been watching the VC industry for a few years. I’ve seen great acquisitions (Instagram), and terrible ones (Mailbox). You won’t have to go far to read about VC news, as many VC firms write blog posts disclosing their view on the state of the industry, as well as investments and exits (sales) they’ve made. Personally, I read every VC blog post with a grain of salt, as interests are inherently biased when money is involved (especially if it is your money!) 

Second, I follow the world of finance, which is not as popular among venture capitalists and the tech media. If you should know one thing about the accounting/finance world, it is its undying conservatism. The stock market has been around for a long time, and investors have witness and learned about dozens of depressions and bubbles throughout history. Most recently, two bubbles have scarred investors - the Dot-com bubble, and the housing bubble. As a result, the world of finance is, on average, extremely skeptical of every new IPO, sexy startup, or revolutionary technology, as they have been burned before. 

I live in both of these bubbles every day, and read both sides of the story. Unlike VC’s or financiers, however, I have no monetary interests involved in either bubble - I act merely a spectator and a student. I am not a VC, and have not invested a dime in any startup, nor do I hold investments in any companies. 

We all live in bubbles of influence: you may be interested in programming and follow developers, or perhaps a designer following designers. Consequently, your view can often be fogged by the film of the bubble of your interests. My bubbles are technology (predominantly Apple), VC, and finance. 

Back to the question of bubbles. Are we in one? 

The VC Perspective

Generally, most VC’s will say no. Interest rates are falling, and cash is plentiful. This results in huge funds. Unlike Index Funds, a venture capitalist doesn’t make money by diversification. They make money by going all-on on one or two unicorn companies, which will hopefully get acquired or IPO and provide extraordinary returns to investors - think Twitter and Facebook. 

Another common defense raised by VC’s is the relatively tiny size of venture capital. In 2014, VC funding amounted to $50B, versus $1T that resulted from the buybacks and dividends of publicly traded companies. If you asked me, I would say this is a partially valid defense against evidence of a bubble, but not a full defense. All it tells me is that there might be a smaller bubble than the dot-com bubble. It isn’t evidence of a lack of bubble-mania. 

The Conservatists Perspective

As previously mentioned, many long-term investors today practice conservatism in their investing habits. They are avid students of history and don’t want to make the same mistakes as their elders, even if it means potentially lower returns. These type of investors invest when a company has a future of growth, dividends, or some other type of expansion. Most importantly, however, these investors (who are inspired by Benjamin Graham, Warren Buffet, Jack Bogle, and the like) are judicious when it comes to avoiding overvalued companies. There is a general rule of investing that goes something like this: even the best business in the world can be overpriced. 

To illustrate an example of this principle, let’s take the stock of the most valuable company in the world, Apple. At the time of this writing, one share of Apple is worth $124. A conservative investor might look at this price, and say, “Hey, Apple just released the Watch, and it looks like the next iPhone will be a big hit. According to my estimates, their stock is worth $140!” This investor would then proceed to buy Apple stock at $124, and continue buying Apple stock until it reaches $140. Anything past $140 is too expensive, in this type of investors eyes, and results in overvaluation. Thus, he sells at $140. Perhaps he is wrong, and the actual value of Apple stock is around $150 - but he still made a profit of $16 ($140 - $124 = $16) per share! 

Alternatively, let’s say a more bullish investor thinks the stock has no limit, and growth will continue indefinitely into the future. This investor buys Apple stock a little after the conservatist investor sold his shares, at $150. Fueled by excellent news, a strong economy, and weak competition, Apple’s stock price rises all the way to $215 - far beyond what the business is actually worth. Upon reaching this peak, however, things stop being so rosy. A recently released unemployment report, mixed with less than stellar financial performance, makes the stock fall from $215 to $200 in one day. The plummet continues over the next few months, finally settling on $142 per share, which if you recall, is somewhere around what the company is actually worth ($140). Unfortunately for this more bullish investor, he never sold his stock at $215 since he expected the price to eventually rise higher. Thus, he lost a total of $8 ($150 - $142 = $8) per share, which is $24 (16 + [–8] = 24) less than what the conservative investor earned. 

So you see, even the best company in the world can be overvalued by the speculative and often illogical movements of the stock market. You can earn a lot of money if you time the market right, but very few people can do it more than once. 

This very same type of logical applies to how conservative investors view the most recent tech “bubble”. Sure, Snapchat, Palantir, Square, Pinterest, and Spotify are great companies worth billions of dollars. But there is a limit to how many billions they are worth. Five billion might sound plausible, seven billion is slightly overpriced, but still realistic. 15 billion is a bubble that will at some point burst. 

Bathing in bubbles

What I hope you took away from this post is that there are always two sides to the same story. Both sides make great points arguing against and for bubbles. Ultimately, however, everybody is simply speculating, spreading a psychological contagion from investor to investor. There is one other rule of the market that I haven’t shared yet - a bubble can last for a very long time, and bursts suddenly and by its own accord. I encourage you to branch out of your bubble of influence and into an opposing one, if only to see another viewpoint. It can only help.

Apple Watch and the Hierarchy of Needs

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You will agree, my voracious reader, I am not a product reviewer. For this very reason, I mostly refrain from publishing any reviews of products I have purchased. That isn’t to say I don’t have strong opinions about those products (ask my friends, they will attest), but simply that I do not publish them on this site. Let us leave the reviews to our more adventurous writers. Instead, we aim here to understand the hidden complexities that are not often talked about in the contemporary technology and business press. On today’s agenda - the Apple Watch. 

As you so astutely recall, I have written about a few scenarios the Apple Watch can take upon its entering the market. For your convenience, I have summarized those scenario below:

1) It can flop, and Apple will abandon efforts.
2) It can be a semi-successful product like the iPad.
3) It can be extremely successful like the iPhone. 

Well, as of last week, the Watch became available for preorder, as well as up for display at your nearest Apple Retail locations. Of course it is still too early to tell which scenario the Watch will take, but as of most recently, I have thought of some additional complexities that will undoubtedly affect the success of the Apple Watch. 

The Watch, and the Hierarchy of Needs 

In a 1943 paper titled A Theory of Human Motivation, Abraham Maslow proposed a psychological theory called the Hierarchy of Needs (HoN), which aimed to describe the patterns of motivation us humans go through. Like any psychological theory, the HoN is imperfect and met with heavy criticism. Despite this, it is still commonly taught in most psychology classes and remains as well regarded as a theory may be. For your double-fold convenience, I have reproduced Maslow’s hierarchy below.

With this hierarchy in our retinas, let us begin to answer some questions. First, where do we think smartphones belong (note: there is no wrong answer, only more correct answers). If you asked your writer, he would answer that smartphones started at the peak of the pyramid (“Self-Actualization”), but have descended one level down to “Esteem”. As you descend down the pyramid, the importance of each step grows until you reach “Physiological” needs such as food and water. We cannot live without those items, making them of the utmost importance. Smartphones started at the top of the hierarchy because their utility went from little to great; their impact on our lives followed the same trajectory. 

It is still possible to live without a smartphone, but increasingly, that life is not worth living. I jest, of course, but the importance and value of the smartphone in the life of the average human continues to grow with each new iteration. Deviation from the “Esteem” step, on which I currently place smartphones, leads to helplessness, a lack of respect, and to weakness. Imagine traveling to a new country without a smartphone. Most likely, you would get lost - Helplessness. Alternatively, what if someone told you they don’t have or cannot afford a smartphone? Would that person be given the same respect as a smartphone owner? Lack of respect. Finally, picture yourself doing a group project for which you need to Google something. Without a smartphone, you are helpless. Weakness. 

If you are thinking these examples are cruel and not perfectly symmetrical to the real world, you would make a solid argument. But it is impossible to deny the rise of the smartphone in our daily lives, and its downward descent on the hierarchy of needs. 

Are you hungry on the day the Dow Jones Industrial Average hits its peak for the year? Probably. What about on the day it falls eight percentage points? Still, you’re probably hungry. And if the market totally plummets, leading to a full-fledged depression. Still, you have to eat. Maslow’s HoN shows that the physiological and safety needs must always be met; the alternative is death. For this reason, companies in the business of selling food, water, and shelter are not as hard hit by the impacts of the economy. This is in stark contrast to companies in the business of selling luxury items such as cars, clothing, and perfume. The hierarchy of needs allows us to gauge the relative importance of these products in our lives, and how the economy and human tastes will affect them. The lower the product is on the hierarchy, the less affected it will be. 

Let us circle back to the iPhone for a minute, which sits on the second to last step. In the case of a market downturn, do you think consumers would still purchase smartphones? Well, you might say, it depends who the consumer is and how bad is the market crash. Your answer would be precisely right. The rich and less affected would still upgrade their phones every year, as would the working middle class, since they would probably require the smartphone for work. It is entirely plausible, however, that the less fortunate, poorer demographic would eschew upgrading their phone this year. If things get really bad, they might even cancel their contract and go without a smartphone. And since the smartphone is on the second step, esteem, it would be hit less hard than the products at the top of the pyramid, self actualization. It isn’t too hard to imagine a future where smartphones will descend further down the pyramid, into love and belonging, and thus be further insulated from any market movements. 

Finally, we have arrived to the point of discussing the Apple Watch, and where we think it fits within this hierarchy. We can quickly dismiss the Apple Watch from the physiological, safety, and love/belonging steps, since it is not necessary for survival, safety, or belonging. That leaves us with esteem, and self-actualization - the least fundamental needs a human being requires. As you recall, I placed the iPhone on “Esteem”, which is the second to last step. I now ask you to pause and think for your own, omnivorous reader: where do you think the Apple Watch belongs? Once you’re done, return your gaze here and let us continue.

If you placed the Watch in the “Esteem” tier, you expect to be provided with the same value, utility, and prestige as the iPhone. Otherwise, you chose “Self-Actualization”, placing the Watch on the top tier of the hierarchy - a tier which supposedly results in the realization of a person’s full potential (who knows what that means, exactly?).

Despite the cryptic definition of “Self-Actualization”, your dear writer believes the Watch fits in this tier. The utility and cultural value of the smartphone reaches far wider than the smartwatch (at this time); in most developed nations, you will not find many people without a smartphone. The Watch, as it exists today, is a luxury item assembled for prestigious wrists. It is a fashion statement just as much as it is a fashion accessory. The value it provides is ancillary to the value of the iPhone. Alone it does little. If you’ve got food in your fridge, a house and a spouse, respectful co-workers, and a smartphone, the Watch is the last remaining step to your actualization. It does not come before those items, however.

If you feel philosophically enlightened from our discussion of the hierarchy, I hope too you will also feel logically and realistically liberated soon. Given our placement of the Watch in “Self-Actualization”, it is the least critical element to our existence. As such, it is a product that is least insulated from market movements. If an economic disaster were to strike, the Watch would be the first product to have its sales hurt. Therefore, the future success of the Watch is heavily correlated with the movements of the economy; when the economy slows, Watch sales will slow. When the economy speeds up, Watch sales will follow. 

The Watch, more than any other product in Apple’s portfolio, sits highest on the hierarchy of needs. It is simultaneously the least fundamental and the most desirable product a person can dream of. Consequently, Apple Watch sales will be predicated upon the buying power of consumers - which itself is derived from the economy - more than any other product Apple has recently released. And that, my friends, is as close to a product review as I will come to.

What is Happening at Tesla?

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If we want to reduce poverty and misery, if we want to give to every deserving individual what is needed for a safe existence of an intelligent being, we want to provide more machinery, more power. Power is our mainstay, the primary source of our many-sided energies. - Nikola Tesla 

I thought long and hard about the perspective from which I would be writing this post. On the one hand, Tesla is the underdog car manufacturer, in combat with gas-guzzling titans. On the other, it is a company that creates batteries that just happen to have four wheels attached to them and get you from point A to point Z. After several hours of deep-thinking and consternation, I settled on an answer. The answer came from Tesla’s 2014 Annual Report, after reading what Tesla identifies itself as (emphasis mine):

“We design, develop, manufacture and sell high-performance fully electric vehicles, advanced electric vehicle powertrain components and stationary energy storage systems. We have established our own network of sales and service centers and Supercharger stations globally to accelerate the widespread adoption of electric vehicles. We believe our vehicles, electric vehicle engineering expertise, and business model differentiates us from incumbent automobile manufacturers.”

As analysts, we are often quick to jump to conclusions, but let’s repress that instinct for this post. Personally, I’ve always viewed the word “vehicles” to represent cars, trucks, and motorcycles. But vehicles are actually much more than that - they're a mechanism for transportation. I bet the same objects come to your mind when you hear the word vehicle, in part because traditionally, that is what vehicles were, and still are to this day. Tesla isn’t a battery company, as many are led to believe. It’s a transportation and energy company based on electric technology. 

Today, that technology finds its habitat in the Model S, which is Tesla’s premium four door sedan. Later this year, that electric technology will be crammed into the Model X, a crossover between a SUV and a minivan. In 2017, we will have the Model 3, a lower-priced sedan, as electric technology becomes cheaper to manufacture and consequently moves downmarket. It isn’t too hard to see a future where this electric tech will be found in bikes, trains, helicopters, airplanes, and other vehicles of transportation. In short, Tesla is in the business of providing energy. 

That’s the future of Tesla, but the present is the presence for this post. Let’s take off our rose-colored glasses for a second, and view Tesla with more conservatism (as accountants such as myself are classically trained to do). What is currently going on in Elon Musk’s lair? 

Revenues have been growing rapidly at Tesla $386M in 2012, $2B in 2013, and $3.2B in 2014. By my calculations, Tesla will generate $5.6B in revenues in 2015, mostly due to production improvements and the introduction of the Model X in 3Q15. Tesla’s revenues could actually be much higher - they’re held back by supply. The faster Tesla is able to manufacture more cars, the faster revenues will grow. 

As we’ve discussed before, automotive industry profit margins are nothing to be jealous of. Traditional car company gross margins range from 11% (GM) to 26% (Honda). Tesla beats them all, with 28% margins. Unless you work as an accountant for Tesla (if so, please do not hesitate to contact me), it’s difficult to say with certainty why Tesla commands the highest margins. That said, I can offer a few pontifications. 

Tesla is a premium car brand and charges premium car prices. The starting price for a Model S is $70K, but the average revenue Tesla makes per car is approximately $97K (not a perfect comparison, but a Honda Civic starts at $18K). Obviously the margins will be much higher for expensive vehicles, which Tesla is in the market of producing. It will be interesting to see if margins will remain high once Tesla releases the Model 3, which is supposed to start at a much lower price-point. 

Tesla margins may also be high because of lower cost of revenues, which in English means cheaper parts (in relation to the selling price of the car). Most gas-powered cars use an internal combustion engine (ICE), which has many moving parts that need to be purchased from individual suppliers. Prices for these parts tend to fluctuate - in some periods prices may go up, and in others prices may go down. As a result, the cost of manufacturing a car with an ICE can be a volatile and expensive proposition. Tesla doesn’t use an ICE in any of its vehicles. Instead, the cars are powered by an electric motor which in turn is powered by a muscular battery. Tesla’s electric motor has many fewer parts than the ICE, which I suspect is another critical reason for the higher margins. 

The inefficiencies of Tesla begin to appear a bit lower in the income statement, namely with Research and Development (R&D) and Sales, General, and Administrative (SG&A) expenses, which account for 15% and 19% of revenue, respectively. In other words, $34 out of every $100 Tesla makes in car sales goes to keeping the lights on for the business! I’ve made a handy chart to see a simplified version of Tesla’s income statement, just in case the accounting minutiae goes over your head:

As Tesla grows, it should scale its operating expenditures (which include R&D and SG&A) to be more in line with the growth of revenues. In 2014, revenues grew 58% while operating expenses grow 106% - nearly twice as much as revenues! This isn’t a huge cause for concern yet, but it is something worth keeping in mind.

Tesla posted net losses of $396M in 2012, $74M in 2013, and $294M in 2014. From an investors point of view, Tesla is an extremely young company, and an insanely risky investment (Tesla paid a lot of money in interest, over $100M, to compensate creditors for this risk). That said, many great companies have initially started as unprofitable enterprises, later to become billion dollar printing machines. 

What is Tesla, really?

Tesla is currently manufacturing electric cars, and viewed in that light, it’s a decent business. Tesla sold 32K cars in 2014, and plans to sell 55K in 2015. Global car sales in 2014 were 71M, so there is plenty of room for growth. But as I’ve mentioned at the outset of this post, I wouldn’t view Tesla solely as a car company, because based on that alone, the future isn’t bright. I don’t see Tesla succeeding in the car market if they continue making expensive, electric cars. Unless they get the Model 3 to very low price point (<$30K), there is a natural limit to their growth. Only so many people can afford $100K cars, and out of those, even fewer want an electric car. 

When viewed as a transportation company and an energy provider, however, the future of Tesla looks much better. They would be in the business of providing energy solutions, be it vehicles or stationary power sources, which would be both a lucrative and fascinating market to enter. Cars would be just one product offering (“look how powerful our electric energy solution is in our car; would you like to purchase the same solution to power your house?”). Tesla never got the recognition he deserved during his lifetime, but the Tesla of our generation is determined to change that.

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Strategies for Spotify

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Just recently we’ve taken a look at some strategies Beats could take to steal the throne from Spotify, and to a lesser extent, the other music streaming services (Rdio, Deezer, Rhapsody, etc). Since we don’t discriminate on music services here, we will be doing the same strategy recommendation piece for Spotify. Spotify will not just sit idle when the Beats redesign goes live, and it will presumably retaliate through its own strategies. I don’t know, of course, but I would speculate that Beats is one of the major topics that gets discussed during management meetings at Spotify HQ. If it isn’t, Spotify is doing themselves a huge disservice, by shutting their eyes from impending competitive pressures. 

Before we get into the strategies section, let’s take a brief glimpse at the data. Currently, Spotify is the largest on-demand streaming service, with 60M users, of which 15M are paying subscribers (20% pay-to-free ratio). By my calculations, Spotify has been growing users at a rate of 3.75% per month. This percentage was calculated by taking the user-growth numbers Spotify has provided every few months. It is impossible to say with certainty if this is a high or low rate of growth, since none of the competing music services provide enough data to compare them to each other. If you want to read the technical details of my calculations, this post from November is your destination. Otherwise, we can continue to the meat and potatoes of this analysis. 

Strategies for Spotify

#1 Partnerships with music social networks

In my strategies for Beats piece, one of the strategies I recommended was exclusives. Beats could pay labels $X amount in royalties in exchange for being the exclusive streaming provider for an artists newest album (I advised the period to be a month to lock users into Beats). Spotify doesn’t have billions in cash like Apple does, which is why the exclusives strategy is not feasible. Instead, Spotify should partner with music social networks, specifically The Hype Machine and SoundCloud. 

Spotify is great for major artists who are signed with music labels. In my experience, it’s very rare that I can’t find an artist I like on Spotify. Kendrick Lamar’s latest album, To Pimp A Butterfly, was ready to stream the day it was released. Barring few exceptions (I’m looking at you, Taylor Swift), popular artists always have their music available on Spotify. The same can’t be said about many indie artists and song remixes, which are often found on sites like Hypem and SoundCloud. Spotify should partner with these indie music social networks, and structure the deal in a mutually beneficial way. Spotify would gain many users who previously listened to indie music on Hypem/SoundCloud. In return, Spotify would pay Hypem/SoundCloud for the access to their data and music. To be fair, this deal would benefit Spotify much more than the indie social networks, but so goes the nature of business. Hypem is run lean, so it’s probably profitable. What it needs is more users, which Spotify can provide. SoundCloud, by all acounts, is losing money, despite have millions of registered users. Getting paid by Spotify could help them become profitable. Ideally, Spotify could purchase either Hypem or SoundCloud, but it is doubtful they have the cash for it.

These partnerships would also be a powerful competitive advantage to retaliate against the personalized playlists Beats offers. Unless Beats makes its own partnership with Hypem/SoundCloud (doubtful), Spotify would be the only streaming service to offer the type of indie music that’s only available on these music aggregators. 

#2 Audiobooks

The music streaming business is a loss-leader. It is an offering that adds value to existing customers in order to keep them attached to your ecosystem. That’s what Google is doing with Google Music, Microsoft with Xbox Music, and now Apple with Beats. I can’t say with certainty since the data is unavailable, but I have strong suspicions that the above companies are actually losing money on operating their music streaming offerings. We know as a fact that Spotify is posting net losses, and will probably continue to do so in the foreseeable future. The tech giants can afford to lose money on streaming in order to strengthen their ecosystem, but Spotify and the other streaming services can’t. Even if Spotify does manage to operate at extreme efficiencies of scale and achieve profitability (big if), that income won’t be enough for a company of that size, especially if Spotify has plans to go public. What then, could Spotify do to become profitable? 

Spotify has an incredible engineering culture, and the service experiences almost no downtime. Compared to competitors, Spotify streams songs the fastest: I’ve been using Spotify for the past two years and I have never experienced any stream-related problems. I can’t say the same for Beats/Rdio (I’ve not used the other streaming services). Spotify also has well designed apps, which are only getter better (early on, Spotify was not well designed, but lately I have been very impressed with the UX). These strengths can be used to enter a new market: audiobooks. 

Essentially, Spotify will be diversifying its income streams by entering into a new market for audiobooks. While we again encounter the problem of a lack of data, this time on audiobook profitability, the nature of the business implies positive profit margins (unlike music streaming, a book won’t be bought twice). Spotify won’t be starting from the ground-up here, as their infrastructure is already set up, so it is likely that they can enter the audiobook business at a lower cost than music streaming through economies of scale and leverage. 

In fact, there are already some audiobooks available on Spotify, but from what I found they mostly include public domain books (Pride and Prejudice, The Art of War, Romeo and Juliet). The Spotify app, however, is currently optimized for music listening rather than audiobooks, so listening to multi-hour audio streams is an obstreperous affair. Similar to how Facebook broke its main app into a web of focused applications (Facebook classic, messenger, groups, etc), Spotify should make a separate app specifically designed for audiobook listening. If that is seen as a big risk, I would advise to start with an app that provides only free, public domain books, since they’re already hosted on Spotify servers. If there is indeed demand for audiobooks, slowly add books from other publishers to eventually compete with Audible and iTunes. 

#3 Podcasts

Podcasts are another vertical Spotify could enter, especially if they partner with SoundCloud. SoundCloud, by the way, already hosts thousands of podcasts, and makes the process easy for both creators and listeners. Despite SoundCloud’s podcast features, there is still no comprehensive platform (monetization, hosting, dedicated apps, portal, listener data) for podcasts, despite many years of existence. What’s more in their favor is that podcast popularity is increasing, as internet connectivity and better apps make them simpler to find and consume. The good news for Spotify is that it doesn’t look like Apple has plans to host the podcasts - instead, iTunes is merely a portal to find them. 

Even if the SoundCloud partnership is not possible, Spotify already has the expertise to host and make them available to listeners. Not a podcast per-say, but spoken-word comedy shows are already available on Spotify. All it needs to add now is a dedicated app, a better way to find podcasts, and most importantly, the ability to host them. Podcast creators (especially indie ones) would be willing to pay for the service, and it would serve as another outlet to help creators find new listeners. 

Coda

Spotify should do its absolute best to become the go-to audio destination on desktop, mobile, and wearable devices. Competition in music streaming is already fierce and will only get more competitive when the rebranded Beats enters the market. Worse, the music streaming business is currently unprofitable. Huge companies can afford to subsidize their music offerings as an additional value-add for their ecosystem, but Spotify can’t. Spotify can try to turn the industry on its head and attempt to become profitable, but it will be swimming upstream against the Niagara Falls. That is why it should be leveraging its existing infrastructure and competitive strengths to enter the other audio markets, audiobooks and podcasts. The partnerships with SoundCloud and Hypem (especially SoundCloud) would not only boost the value of its music streaming service, but also help them enter the market for podcasts. Spotify already has data about its users. Now imagine if they could provide this data to podcast creators, which in turn can sell tailored ad spots to advertisers. Being a music streaming provider is not enough for Spotify to turn into a profitable business. Platforms make profitable businesses, and Spotify should try to become a comprehensive audio platform: music, audiobooks, and podcasts (The Spotify MAP). 

If you have anything to add, or just want to share your meandering thoughts about what we covered, please comment below! I’m also active on Twitter, so don’t hesitate to reach me at @lsukernik.

Automotive Industry Exploration (Part III)

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In Parts I and II of our Automotive Industry Exploration, we took a look at the revenues and costs of some of the largest players in the automotive world. We found that industry profits are quite low compared to those Apple is used to, mainly due to the intense costs of manufacturing a vehicle (materials, labor, equipment, etc). We also noted that if Apple were to enter the business of manufacturing cars, they would need to introduce some new technology into the equation. That new technology could come in the form of production efficiencies, new use cases, or something we cannot currently surmise. If not for this missing piece, Apple would be just like every other car manufacturer - high revenues, high costs, and average margins. If that doesn’t sound enticing to you, you might be right. It probably isn’t (for you and Apple). 

For Part III of our exploration, we will be delving into the unit sales of the car manufacturers we visited previously. If you are like me, your best educated guess about which car brand is the most popular came from what you saw on the streets of your city, which may not be the most accurate data. After comparing the unit sales of the car manufacturers, we will dive into the unit sales of only one company: BMW. This choice was made for a few academically valid reasons. First, BMW is my favorite car manufacturer. Second, they gave the clearest breakdown of unit sales by car model (1 Series, 2 Series…). Third (and perhaps most arguable), out of all the car companies, BMW is most like Apple. They value design, they make premium products that are still affordable by most of the middle-class, and finally, they sweat the details. Part III will be the final post in this three-part series on the automotive industry as a whole. In future posts, we may explore some car companies independently (Tesla, Daimler, Volkswagen) and in greater detail, as well as keep a tab on what is happening with the Apple Car. 

Big Picture: Automotive Industry

The companies in this chart sell roughly 60% of all the cars sold in the world. Estimates of global car unit sales range from 72M - 84M in 2014, and this chart covers 48M of those sales, hence 60%. If we assume the world population is 7 billion, then we can say that around 1 out of every 100 people buy a new car every year. In reality, that statistic is lower, but the thought is nonetheless intriguing. Some other points:

  • Toyota simply dominates the other car manufacturers: it sold 1.2x the cars of Volkswagen, 1.4x Ford, 2.1x Honda, and 4.3x BMW.
  • The German luxury brands (BMW & Daimler) together sold 3.7M vehicles in 2014. In terms of unit sales, they are positively paltry compared to the Japanese (Toyota, Honda, Nissan) and American (Ford, GM, Chrysler) titans. If we add Audi unit sales to 3.7M (since Audi is also a German luxury brand part of the Volkswagen Group), that number will equal roughly 5M. German luxury cars thus account for approximately 6% of global car sales.
  • For such an old industry, there is surprisingly lots of competition in the manufacture of cars. Although it is true that many car companies have over time consolidated (i.e. GM produces Buick, Cadillac, Chevrolet, and GMC), no one brand controls over 20% of the global market share. For consumers, this is great news. But if you’re thinking of getting into the car business, you better step up your game, because there’s plenty of competition. 

Small Picture: BMW

In total, BMW sold 1.8M cars in 2014. The above chart gives us a breakdown of those unit sales, model by model (BMW uses the word “Series” in substitute of model). A few things stand out in particular:

  • The 1, 3, and 5 Series alone account for 33% of BMW’s unit sales. They are by far the most popular cars BMW produces.
  • 70% of BMW’s unit sales are from compact cars (Series 1 - 7). 29% of the unit sales are from SUV’s (X1 - X6, no X2 exists yet). 1% is from the BMW i, which is their electric model.
  • If you wanted to compete with BMW, you could strike from one of three places (or all three, if you’re feeling audacious). You could attempt to steal from their most lucrative business, luxury compact cars, since there’s a huge market for them. Alternatively, you could make luxury SUV’s. Finally, and probably the best choice, you could make electric cars. BMW only sold 18K i cars in 2014. Perhaps there is no demand for them, or, most likely, BMW is underserving the market for electric vehicles. If Apple were to enter the car business, I’d wager they would produce electric vehicles (you will recall I am not a betting man though, so rest assured that your money is safe). 

This chart is the same as the last, but it adds one additional detail - the base MSRP of each BMW model.

  • With few exceptions, it would be fair to say that the cheapest models sell in the largest quantities. Meanwhile, the most expensive models sell in predictably lower quantities. If you asked me, I would venture to say that the supply for low-end luxury cars matches demand. The supply of high-end luxury cars also seems to match the demand for them.
  • BMW covers a wide area of the pricing spectrum: the lowest MSRP is $32,100, while the highest is $76,100 on the opposite side of the spectrum. Of course, these prices are not at all indicative of what you will actually pay for a souped-up BMW - that price will be much higher. Still, I find it interesting how diverse the pricing is for a luxury car. It is much less surprising now to see that Apple Watch pricing is similarly spread out over a large area ($350 - $17,000). 

Coda

Overall, the car market is a competitive and somewhat unfriendly place to do business. If you had billions of dollars lying around and were interested in starting a new business, it is doubtful the automotive industry would be it. The profits are decent, but the costs and barriers to entry are huge (but not insurmountable, as Tesla has proven). Moreover, not that many cars actually get sold every year (around 78M). If you want to compete in this business, you’re not going to make much money using economies of scale, since margins aren’t good. The best way to make money in this industry is to be extremely efficient (Toyota, Honda), or to charge premium prices (BMW, Daimler). Even the efficient brands manufacture premium versions of their vehicles: Toyota makes Lexus, and Honda makes Acura. What you don’t want to be is Ford, GM, or Chrysler, which are neither efficient nor have successful premium brands (Lincoln and Cadillac barely qualify as such). As our previous analysis has shown, the American car companies are some of the least profitable car companies around, so replicating them is a fool’s errand. You can, however, make a healthy profit selling premium cars, as BMW has shown us.

So let’s return to our original question: what would Apple gain from entering the car market? In short, not much. Our three part analysis has shown that the automotive industry isn’t nearly as profitable as consumer technology. Of course, profits aren’t everything, and Apple’s goal when entering into the automotive industry could be a nobler one. But you would be hesitant to spend dozens of billions of dollars on a business that won’t return them to you. For this reason, I have come to the conclusion that Apple will not enter the car business as it exists today. If they do enter, it will have to be with something totally different. We’ve touched on what that difference could be in Part II, so I won’t go into that here, but it cannot simply be a superior version of a gas-powered car. Success might come from a place Apple has been before: Think different.

For next week, we will explore some strategies Spotify can take to combat the impending Beats (by Apple) release.

If you have anything to add, or just want to share your meandering thoughts about what we covered, please comment below! I’m also very active on Twitter, so don’t hesitate to @lsukernik me!