Beyond Devices

Amazon filed its 10-K report for 2016 late last week, and it adds a few bits of additional information which haven’t been in previous versions. Most notably, it provides a breakdown of revenue by similar product, which is the first real visibility we’ve had into Prime and certain other categories. It doesn’t report Prime directly, but there’s enough data here to provide some really interesting insights into the Prime program, how many members it has, how much revenue it generates, and how revenue is split between shipping and other services.

Amazon’s new revenue breakdown

First up, here’s the new breakdown. Revenue is split into five categories which, other than AWS, we haven’t seen broken out before:

Retail Products – this is basically all e-commerce plus most one-off sales of digital goods except those which are sold on a net basis (likely mostly apps); plus any direct shipping revenue associated with e-commerce purchases

Retail third-party seller services – this is all the revenue Amazon generates from its third party sellers including commissions, related fulfillment and shipping fees

Retail subscription services – Prime is the biggest component here, but it also includes Audible, Amazon Music, Kindle Unlimited, and other non-Prime subscriptions

AWS – Amazon Web Services, as reported in its segment reporting

Other – all the stuff that doesn’t fit in any other bucket, with co-branded credit cards and advertising the only two components called out specifically.

Here’s what that revenue breakdown looks like in percentage terms over the last three years:

As you can see, Product Sales are by far the largest component, but they’re falling rapidly as a percentage of the total, from 77% in 2014 to 67% in 2016, while the other categories are coming up fast. Here are the growth rates for the last two years for these various components:

As you can see, the growth rates are all over the map, with the fastest-growing that mysterious Other section, which I suspect is largely driven by Amazon’s small but flourishing ad business. eMarketer estimates that this is already a roughly billion-dollar business for Amazon, so that would make sense, though the growth rate here is much higher than eMarketer projects. Those credit cards must be doing well too.

But outside that, it’s worth noting that third party services are growing much faster than product sales, with retail products (i.e. Amazon’s own direct sales) the slowest growing of any of these categories. Both retail subscriptions and AWS are coming down somewhat in percentage growth terms, but largely as a factor of becoming quite big numbers – in both cases, the dollar growth year on year actually increased. That third party sellers are growing faster than first party is actually a good thing – Amazon’s margins on those services are much higher, because it only reports its cut rather than the gross take as revenue. This growth has been a major driver, alongside AWS, of Amazon’s increasing margins lately.

Deducing Prime subscribers

Let’s focus, though, on that retail subscriptions business, because that’s where Prime revenue sits. We need to make some assumptions about how much of that revenue is actually Prime to start. Morgan Stanley reckons it’s about 90%, and though I was originally tempted to say it was more than that, checking into the size of Audible made me think it’s probably about right. So I’m going to stick with that.

If we want to know subscriber numbers, though, we need to figure out what the average subscriber pays, and that’s a complex proposition because the price of Prime increased by $20 in 2014 in the US, and costs different amounts in each market. If we make reasonable assumptions about the mix of where those Prime subscribers are located (e.g. by using Amazon’s revenue split by country) and then apply the going rates at various times for a Prime subscription, we can arrive at a reasonable average. Mine starts at $76 in 2014 and rises to $81 in 2015 and $82 in 2016, whereas Morgan Stanley’s is at $88 for both 2015 and 2016.

On that basis, then, here’s a reasonable estimate for Prime’s subscriber numbers over the last four years, together with a sanity check in the form of the minimum possible number Amazon might have based on various public statements it’s made:

The numbers you end up with are just barely above those minimum numbers provided by Amazon. There’s no way to be 100% sure about my numbers, but they certainly imply that Amazon has been making the biggest possible deal out of its total number ever since that “tens of millions” comment at the end of 2013 (which referred to 21 million subscribers according to my estimate). These numbers would also help explain why Amazon didn’t provide a percentage growth number at the end of 2016 as it did in the previous two years: the percentage likely went down, again as a result of an increasingly large base, not lower subscriber growth – it added 20 million subs in 2016 versus 17 million in 2015.

Prime revenue allocation

One other interesting wrinkle which I’ve wondered about for a long time is the way Amazon allocates revenue between the components of its Prime service, which after all combines free two day shipping with a Netflix-like video subscription and various other benefits. Its financial reporting has always made clear that it allocates these portions of revenue to different buckets – specifically, its Net Product Sales and Net Service Sales categories – even though they all come from the same Prime subscriptions. Understanding this split may seem of purely academic interest, but in fact it’s key to divining the economics of Amazon’s Prime video business.

One interesting thing about the new grouping of revenues Amazon provided in its 10-K is that there is just one portion of revenue allocated differently here from in Amazon’s other reporting, and that’s the shipping component of Prime revenues. In the Net Product/Service Sales split, shipping goes into Product, whereas in the Similar Products split it goes into retail subscriptions. Therefore, if we look at the differences between the amounts reported in the various segments, we can deduce the Prime shipping component, and by implication the portion allocated to everything else (mostly video).

What you can see is that the revenue allocation is shifting quite significantly over time from shipping towards the rest – shipping was 63% or almost two thirds of the total in 2014, but only 56% of the total in 2016, and the actual numbers have both risen considerably. For comparison’s sake, the Prime shipping allocation is around a third of Amazon’s total shipping revenue.

Competing with Netflix on content will be tough at these levels

We can then compare Amazon’s non-shipping revenue (the vast majority of which should probably be seen as video revenue) against Netflix’s global streaming revenue:

What you see here is that Netflix’s revenue from its streaming business is massively larger, not least because it allocates the full $8-10 per month it collects from its nearly 100 million subscribers  to streaming, whereas even with 70 million subscribers, Amazon only allocates just under half to streaming.

This has significant implications for the viability of the two companies’ investments in original content. Netflix has committed to spending $6 billion in total on content in 2017, which is more than twice Amazon’s entire revenue from streaming video in 2016. To the extent that Amazon wants to be competitive in content, it either needs to lose money on the whole thing as a subsidy for its e-commerce business, or charge (or allocate) a lot more of its total take to streaming video. Interestingly, the standalone monthly Prime Video service Amazon offers comes in at $9, suggesting that without the flywheel benefits of free shipping, it needs to recoup far more like the total real cost of providing the streaming service.

Here we are, almost eleven years into Twitter’s history and a little over 18 months into Jack Dorsey’s second term at the company, and Twitter is heading for yet another reset. The company says it’s already been through a reset on its consumer-facing product, and that the changes it’s made are delivering results: positive year on year growth in daily active users, though Twitter still refuses to provide the underlying metric. It now says ad products need to go through a similar reset and re-focusing process. As a result of all this, the company isn’t even providing revenue guidance for Q1.

Here’s a quote from Twitter’s earnings call:

we remain focused on providing improved targeting, measurement and creative for direct response advertisers

Specifically, that’s from Twitter’s Q1 2015 earnings call, almost two years ago. But on today’s call, Anthony Noto said almost exactly the same thing again – some of this stuff has been in the works for over two years, and Twitter still doesn’t seem to be making meaningful progress. Rather, it’s now evaluating its direct response ad products to figure out which are delivering an appropriate return on the resources invested in them, with a view to killing some off.

Why is this all taking so long? It seems Twitter has been unable to focus on more than one big project at once, despite its arguably bloated workforce, and it’s hard to avoid the sense that this is mostly about management. It starts with Jack Dorsey, who is trying to run two public companies at once, but it continues with the next layer of management, where there’s been huge turnover in recent years and where product management seems to have been a particular challenge. It feels as though Dorsey at once wants to own product, because he has the authority of a founder in this area, but doesn’t really have the time to do it properly, which means both that things don’t get done and nominal heads of product get fed up.

The other big problem is that Twitter’s big competitors for direct response advertising – notably Facebook and Google – are just way better at this stuff than they are, and Twitter simply hasn’t made anywhere near enough progress here over the last few years. As a result, Twitter is enormously susceptible to competitive threats – its guidance for Q1 is so broad because there was a meaningful difference in competitive intensity between the beginning and end of January alone. Any company that can’t predict its revenue a quarter out with reasonable confidence because of the competitive environment is really struggling.

In the meantime, ad revenue is actually falling year on year, despite the modest MAU growth and apparent growth in DAUs. US ad ARPUs dropped 8% year on year in Q4, and total US revenue was down 5.3% despite flat MAUs. The supposed increased engagement simply isn’t translating into revenue growth. The revenue growth trend for Twitter as a whole is pretty awful:

In percentage terms, the growth rate has been falling since Q2 2014, but even in pure dollar terms, growth has been slowing for a year. The EBITDA guidance for Q1 suggests a pretty big drop in revenue in the quarter, extending the streak here.

What Twitter’s management said today in their shareholder letter and on the earnings call is that it will simply take time for the increased user growth and engagement to flow through, and that Twitter essentially has to convince advertisers that it’s making progress in getting users engaged. But advertisers don’t spend money because of user growth trends – they spend money because it’s effective, and stop spending where it isn’t. Twitter seems to have a fundamental issue convincing advertisers that money spent on the platform will actually pay off, and I don’t see that changing just because it tweaks some ad formats.

Snap Inc (maker of Snapchat) finally made its long-awaited S-1 filing public on Thursday evening. I’ve been dying to get my hands on this filing for months, and spent some time diving into it last night and digesting some of the numbers and other information in it. Here’s a quick summary of what I’ve found and some of my conclusions about Snap’s prospects going forward. Below, I’ve embedded a slide deck which shares many of the individual charts in this post and several more – it’s part of the Jackdaw Research Quarterly Decks Service, which offers similar decks on the most important consumer tech companies each quarter to subscribers.

Snapchat IPO Filing Chart Deck from Jan Dawson

Massive revenue growth

The first thing to note is that Snap is growing extremely fast from a revenue perspective. It showed its first ad in late 2014, and had its first meaningful revenue in 2015 (totaling $59 million), and then passed $400 million in revenue in 2016. The quarterly revenue picture is shown in the chart below.

That’s a very fast ramp, enabled by the fact that Snap held back on monetizing its base for several years following its founding in 2011. Facebook, by contrast, started to monetize the year it launched, and generated $382,000 in revenue in 2004. Its revenue ramp was slower ($9 million in 2005, $48 million in 2006, $153 million in 2007, $272 million in 2008, and $777 million in 2009), but it didn’t hit Snap’s current user scale until 2009. When Facebook turned on revenue generation, it had under 1 million MAUs, whereas when Snap showed its first ad it had 71 million daily active users.

ARPU growth a major enabler

The major driver of this ramp in revenues is rapid growth in average revenue per user (ARPU), as shown in the next chart:

Global ARPU has risen from 5 cents in Q1 2015 to $1.05 in Q4 2016, but the main driver has been revenue from North America, where ARPU was already $2.15 last quarter. The ARPU ramp in other regions has been much slower, with Europe generating just 28 cents per user per quarter in Q4, and the rest of world region just 15 cents. The one dollar ARPU isn’t far off Facebook’s global ARPU in Q1 2012, the last quarter it reported before its IPO, which was $1.21 globally. But its US & Canada ARPU was already up to $2.90 and its European ARPU at $1.40.

Still a very US-centric financial picture

The reality is that Snap’s business is still very US-centric when it comes to generating revenue. North America had 43% of its users, but generated 88% of its revenues in Q4 2016 (over 98% of that coming from the US). That could be seen as an opportunity for Snap to broaden its horizons and put more effort into monetizing Snapchat in other regions, driving up ARPU, but this may also be a sign that Snap simply hasn’t gained the same traction in other regions yet. It increased its sales and marketing headcount by 340% in 2016, so there’s a good chance it’s hiring in these other markets to drive higher ad sales there.

Profits are another story entirely

While Snap’s revenue picture is fairly clear, the bottom line is a lot less healthy – Snap is losing money by the truckload. This may be one of the first companies I’ve seen file for an IPO whose cost of revenue alone outweighs its revenue in the most recent financial year.

Most margins are literally off the charts

It literally makes no sense to include here one of my customary charts showing various margins over time, because both of the biggest ones – operating and net margins – have been at -100% or multiples of it throughout Snap’s reported history (the only time I’ve seen anything like it is when looking at Alphabet’s Other Bets segment). Gross margin is the only one which is anywhere near positive, and was positive in the second half of 2016:

Snap’s cost of revenue is made up of two larger buckets and some smaller ones – hosting costs are by far the largest, and those scale fairly directly with user growth. Snap doesn’t break these hosting costs out in detail, but they grew by $192 million in 2016, and total cost of revenue in 2016 was $452 million, so my guess is that hosting costs were around $300-350 million in 2016. Snap signed a deal in January with Google to extend its use of Google’s cloud infrastructure, which has a minimum revenue commitment of $400m for each of the next five years, so it’s a good bet Snap is expecting to spend at least that much in 2017.

The second largest, albeit much smaller, contributor to cost of revenues is Snap’s revenue share with its publisher partners. When Snap sells ads (which it did for 91% of its ad revenue in 2016), it gives publishers a cut, and this revenue share amounted to $58m in 2016, up from just under $10m in 2015. When partners sell the ads, they give Snap a cut, and it records only this net amount as revenue, so there’s no reported cost of revenue associated with that smaller chunk. The only other notable contributors to cost of revenue are content creation, where expenses rose $13m in 2016, and inventory for Spectacles, which only hit the books in late 2016.

I usually like to include a chart on cost components as a percentage of revenue, but in Snap’s case it makes more sense to show them as a multiple of revenues, as for most of the company’s history that’s what they’ve been. The two charts below show first a zoomed out view over the whole of the reported period and then a slightly shorter-term view excluding total costs and expenses, to make it easier to see what’s happening in detail with some of these expense lines.

Because Snap is so early in its monetization effort, some of its cost components were multiple times its revenues even in late 2015, and its cost of revenue was still almost twice its revenue in Q1 2016. But as the charts above show, there’s been some real progress here, and R&D, Sales & Marketing, and General & Administrative costs are all under half of revenues now and falling. Snap still has a long way to go, though, before it can be profitable: cost of revenue needs to come down considerably as a percentage of revenue, and that means ramping up ARPU to better cover those massive hosting costs. The rest of the costs will continue to come down as a percentage of revenue as Snap scales, so profitability should improve steadily on that front assuming Snap can get back to strong growth (more on this below).

It’s worth remembering that, when Facebook IPO’d in May 2012, it had been net profitable for three years. Meanwhile, Snap’s prospectus says matter of factly, “We have incurred operating losses in the past, expect to incur operating losses in the future, and may never achieve or maintain profitability.” Though that profitability should come in time with scale and rising ARPU, it’s not a certainty. Twitter is another company which had its IPO at a time when it wasn’t profitable but it seemed a continuation of past rapid growth would carry it over the line soon, and yet it still isn’t in the black now (and in fairness, Twitter had a similar though slightly less bleak warning about its own profit prospects in its S-1).

User growth is a mixed bag

Snapchat reports only daily active users, and not monthly active users. That’s actually very sensible, and I always take it as a knock on Twitter that it refuses to give DAU figures – for an app that’s supposed to be a regular daily habit, monthly user numbers are a bit meaningless.

Linear annual growth

Daily active users have grown strongly over Snapchat’s history, as shown in the chart below, which shows the longer-term end of year picture, including some estimates based on milestones Snap provides in the S-1.

The annual picture is incredible – I don’t know when I’ve seen such a straight line for user growth from a base of almost zero (it was roughly a million at the end of 2012, and only a few thousand at the end of Snap’s first year, 2011). The chart below compares this growth to Facebook’s growth over a similar period. It’s worth noting that the Facebook number here is MAUs, whereas Snap’s is DAUs, but the comparison is striking:

I’ve aligned the timescales so that the years when the companies had 1 million users by their respective measures (2012 for Snapchat, and 2004 for Facebook) line up. As you can see, the start and end points are not far off from each other – 1m in the first year, and 161 versus 145 million in the fifth year, but the trajectory in-between is very different. Facebook saw the classic s-curve adoption, while Snap’s has been almost linear.

A much less straight line for quarterly growth

Things get a loss less linear when you look at quarterly growth numbers, as shown below.

There’s something of the s-curve in the first two thirds or so of the chart above, where growth appears to accelerate through late 2015 and early 2016, but it tapers off significantly in late 2016. What happened there depends on who you believe, as there are two possible explanations:

Snap’s own explanation is that a number of product improvements in late 2015 and early 2016 accelerated growth and brought forward some of the growth it would have seen later anyway, while in late 2016 it launched a version of its Android app which had some bugs and caused slower growth

Third party data suggests that Snapchat began to slow down after Instagram launched its Stories feature, a clone of Snapchat’s own, which drove faster growth at Instagram and sucked usage and growth from Snapchat.

In fairness, Snap does acknowledge strong competition in the second half of 2016, but not Instagram specifically. Which explanation you believe is critically important for your view of Snap’s future prospects: if user growth really did slow down because of the competitive threat from Instagram, that isn’t going away, and in fact will only strengthen as Facebook brings Stories to the News Feed. If Snap can’t defend itself against such competitive threats, and if those threats cause an ongoing stagnation in user growth, it becomes a lot less appealing as an investment. On the other hand, if the issues really were a temporary combination of lumpy growth across the year and some Android glitches, that’s a much less gloomy statement about Snap’s future.

Differences by region

Where things get interesting is when you look at the regional breakdown of DAUs which Snap provides in the S-1 – the first of the charts below shows actual DAUs, while the second shows sequential growth in DAUs, both by region.

As you can see, there was an acceleration in late 2015 and early 2016 as Snap says, but there was also a slowdown in late 2016, though to very different extents in the regions. In North America and Europe, sequential growth in Q3 and Q4 was similar to its growth in the early part of the chart, but in the Rest of World region it dropped down to zero in Q4. Now, these figures are inherently lumpy – though they’re stated in whole millions of DAUs, the underlying numbers could be moving more subtly than these zigzag lines suggest, but there does seem to have been a meaningful slowing in Q3 and Q4, and that is worrying.

Terrible timing for the IPO

We won’t really know whether Snap’s explanation or the external explanation (or some combination of the two) is correct until we see another quarter or two of data from Snap on its user base. If it returns to strong growth in Q1 and Q2 of this year, investors can breathe a sigh of relief, but if it doesn’t, then the worries will continue, If I were a potential investor, I’d be very wary of making big commitments to Snap in a March IPO, before any of those figures are known.

The broader worry with Snap’s data here is that it really only provides DAU numbers as a measure of engagement. That’s better than MAUs, as I said above, but it still doesn’t tell you how engaged users are. This recent article in Bloomberg talks about the ways in which Snapchat fosters “streaks” by users, which drive them to open the app at least once a day, but which don’t necessarily drive meaningful engagement. The only deeper engagement stats Snap does provide relate to time spent and the number of times the app is opened – time spent across its base is 25-30 minutes on average, while the app is opened 18 times on average, with younger users skewing higher and older users skewing lower. But as Snap provides no longitudinal reporting on these data points, we have no idea how they’re trending over time and what that might tell us about real engagement.

For both investors and advertisers, knowing what engagement really looks like is critical, but that data is missing here. Snap badly needs user growth along with rising ARPU if it’s to make progress towards profitability, and at this point the user growth side of the equation is uncertain, though ARPU looks to be on a healthier trajectory. Put another way, the timing of this IPO couldn’t be worse – rather than coming at a time of strong, consistent growth, it comes at the first time in Snap’s history when it’s showing signs of significant weakness.

I do a piece most quarters after the major cable, satellite, and telecoms operators have reported their TV subscriber numbers, providing an update on what is at this point a very clear cord-cutting trend. Here is this quarter’s update.

As a brief reminder, the correct way to look at cord cutting is to focus on three things:

Year on year subscriber growth, to eliminate the cyclical factors in the market

A totality of providers of different kinds – i.e. cable, satellite, and telco – not any one or two groups

A totality of providers of different sizes, because smaller providers are doing worse than larger ones.

Here, then, on that basis, are this quarter’s numbers. First, here’s the view of year on year pay TV subscriber changes – a reported – for the seventeen players I track:

As you can see, there’s a very clear trend here – with one exception in Q4 2015, each quarter’s year on year decline has been worse than the previous one since Q2 2014. That’s over two years now of worsening declines. As I’ve done in previous quarters, I’m also providing a view below of what the trend looks like if you extract my estimate for DISH’s Sling subscribers, which are not classic pay TV subs but are included in its pay TV subscriber reporting:

On that basis, the trend is that much worse – hitting around 1.5 million lost subscribers year on year in Q3 2016.

It’s also worth noting that once again these trends differ greatly by type and size of player. The chart below shows net adds by player type:

The trend here has been apparent for some time – telco subs have taken a complete nosedive since Verizon ceased expanding Fios meaningfully and since AT&T shifted all its focus to DirecTV following the announcement of the merger. Indeed, that shift in focus is extremely transparent when you look at U-verse and DirecTV subs separately:

The two combined are still negative year on year, but turned a corner three quarters ago and are steadily approaching year on year parity, though not yet growth:

Cable, on the other hand, has been recovering somewhat, likely benefiting from the reduced focus by Verizon and AT&T on the space with their telco offerings. The cable operators I track collectively lost only 81k subscribers year on year, compared with well over a million subscribers annually throughout 2013 and 2014. Once again, that cable line masks differences between the larger and smaller operators, which saw distinct trends:

The larger cable operators have been faring better, with positive net adds collectively for the last two quarters, while smaller cable operators like Cable ONE, Mediacom, Suddenlink, and WideOpenWest collectively saw declines, which have been fairly consistent for some time now.

The improvement in the satellite line, meanwhile, is entirely due to the much healthier net adds at DirecTV, offset somewhat by DISH’s accelerating declines. Those declines would, of course, be significantly worse if we again stripped out Sling subscriber growth, which is likely at at around 600-700k annually, compared with a loss of a little over 400k subs reported by DISH in total.

A quick word on Nielsen and ESPN

Before I close, just a quick word on the Nielsen-ESPN situation that’s emerged in the last few weeks. Nielsen reported an unusually dramatic drop in subscribers for ESPN in the month of October, ESPN pushed back, Nielsen temporarily pulled the numbers while it completed a double check of the figures, and then announced it was standing by them. The total subscriber loss at ESPN was 621,000, and although this was the one that got all the attention, other major networks like CNN and Fox News lost almost as many.

In the context of the analysis above, 500-600k subs gone in a single month seems vastly disproportionate to the overall trend, which is at around 1-1.5 million per year depending on how you break down the numbers. Additionally, Q4 is traditionally one of the stronger quarters – the players I track combined actually had positive net adds in the last three fourth quarters, and I suspect for every fourth quarter before that too. That’s what makes this loss so unexpected, and why the various networks have pushed back.

However, cord cutting isn’t the only driver of subscriber losses – cord shaving is the other major driver, and that makes for a more feasible explanation here. Several major TV providers now have skinny bundles or basic packages which exclude one or more of the major networks that saw big losses. So some of the losses could have come from subscribers moving to these bundles, or switching from a big traditional package at one operator to a skinnier one elsewhere.

And of course the third possible explanation is a shift from traditional pay TV to one of the new online providers like Sling TV or Sony Vue. Nielsen’s numbers don’t capture these subscribers, and so a bigger than usual shift in that direction would cause a loss in subs for those networks even if they were part of the new packages the subscribers moved to on the digital side. The reality, of course, is that many of these digital packages are also considerably skinnier than those offered by the old school pay TV providers – DirecTV Now, which is due to launch shortly, has 100 channels, compared with 145+ on DirecTV’s base satellite package, for example.

This is the new reality for TV networks – a combination of cord cutting at 1.5 million subscribers per year combined with cord shaving that will eliminate some of their networks from some subscribers’ packages are going to lead to a massive decline in subscribership over the coming years. Significant and accelerating declines in subscribers are also in store for the pay TV providers, unless they participate in the digital alternatives as both DISH and AT&T/DirecTV are already.

One of the markets I follow most closely is the US wireless market. Every quarter, I collect dozens of metrics for the five largest operators, churn out well over a hundred charts, and provide analysis and insight to my clients on this topic. Today, I’m going to share just a few highlights from my US wireless deck, which is available on a standalone basis or as part of the Jackdaw Research Quarterly Decks Service, along with some additional analysis. If you’d like more information about any of this, please visit the Jackdaw Research website or contact me directly.

Postpaid phones – little growth, with T-Mobile gobbling up most of it

The mainstay of the US wireless industry has always been postpaid phones, and it continues to account for over half the connections and far more than half the revenues and profits. But at this stage, there’s relatively little growth left in the market – the four main carriers added fewer than two million new postpaid phone customers in the past year, a rate that has been slowing fairly steadily:

This was always inevitable as phone penetration began to reach saturation, and as the portion of the US population with good credit became particularly saturated. But that reality means that future growth either can’t come from postpaid phones, or has to come through market share gains almost exclusively.

In that context, then, T-Mobile has very successfully pursued the latter strategy, winning a disproportionate share of phone customers from its major competitors over the last several years. The chart below shows postpaid phone net adds by carrier:

As you can see, T-Mobile is way out in front for every quarter but Q2 2014, when AT&T preemptively moved many of its customers onto new cheaper pricing plans. AT&T has been negative for much of the last two years at this point, while Sprint has finally returned to growth during the same period, and Verizon has seen lower adds than historically. What’s striking is that T-Mobile and Sprint have achieved their relatively strong performances in quite different ways. Whereas Sprint’s improved performance over the past two years has been almost entirely about reducing churn – holding onto its existing customers better – T-Mobile has combined reduced churn with dramatically better customer acquisition.

The carriers don’t report postpaid phone gross adds directly, but we can derive total postpaid gross adds from net adds and churn, and I find the chart below particularly striking:

What that chart shows is that T-Mobile is adding far more new customers in proportion to its existing base than any of the other carriers. Sprint is somewhat close, but AT&T and Verizon are far behind. But the chart also shows that this source of growth for T-Mobile has slowed down in recent quarters, likely as a direct effect of the slowing growth in the market overall. And that slowing gross adds number has translated into lower postpaid phone net adds over the past couple of years too:

That’s a bit of an unconventional chart, but is shows T-Mobile’s postpaid phone net adds on an annual basis, so you can see how each year’s numbers compare to previous years’. As you can see, for most of 2015 and 2016, these net adds were down year on year. The exceptions were again around Q2 2014, and then the quarter that’s just ended – Q3 2016, when T-Mobile pipped its Q3 2015 number ever so slightly. The reason? Likely the launch of T-Mobile One, which I wrote about previously. The big question is whether T-Mobile will return to the declining pattern we saw previously when the short-term effects of the launch of T-Mobile One wear off.

Smartphone sales – slowing on postpaid, holding up in prepaid

All of this naturally has a knock-on effect on sales of smartphones, along with the adoption of the new installment plans and leasing, which are breaking the traditional two-year upgrade cycle. The number of new smartphones in the postpaid base has been slowing dramatically over the last couple of years too:

But the other thing that’s been happening is that upgrade rates have been slowing down significantly too. From a carrier reporting perspective, the number that matters here is the percentage of postpaid devices being upgraded in the quarter. This number has declined quite a bit in the last couple of years too, across all the carriers, as shown in the cluster of charts below:

The net result of this is fewer smartphones being sold, and the number of postpaid smartphones sold has fallen year on year for each of the last four quarters. Interestingly, the prepaid sales rate is holding up a little better, likely because smartphone penetration is lower in the prepaid market. There were also signs in Q3 that the new iPhones might be driving a slightly stronger upgrade cycle than last year, which could be good for iPhone sales in Q4 if that trend holds up through the first full quarter of sales.

What’s interesting is that the upgrade rates are very different between carriers, and T-Mobile in particular captures far more than its fair share of total sales, while AT&T captures far less than it ought to. The chart below compares the share of the smartphone base across the four major carriers with the share of smartphone sales:

As you can see, T-Mobile’s share of sales is far higher than its share of the base, while AT&T’s (and to a lesser extent Verizon’s) is far lower.

Growth beyond phones

So, if postpaid phone growth is slowing, growth has to come from somewhere else, and that’s very much been the case. Tablets had been an important source of growth for some of the carriers for a few years, but their aggressive pursuit has begun to cost them dearly now, at least in the case of Sprint and Verizon. Both carriers had promotions on low-cost tablets two years ago and are now finding that buyers don’t feel the need to keep the relationship going now their contracts are up. Both are seeing substantial tablet churn as a result, and overall tablet net adds are down by a huge amount over the past year:

There may be some recovery in tablet growth as Verizon and Sprint work their way through their churn issues, but I suspect this slowing growth is also reflective of broader industry trends for tablets, which appear to be stalling. Still in postpaid, there’s been a little growth in the “other” category, too, but that’s mostly wireless-based home phone services, and it’s not going to drive much growth overall. So, the industry likely needs to look beyond traditional postpaid services entirely.

Prepaid isn’t growing much faster

The next big category for the major operators is prepaid, which has gone through an interesting evolution over the last few years. It began as the option for people who couldn’t qualify for postpaid service because of poor credit scores, and was very much the red-headed stepchild of the US wireless industry, in contrast to many other markets where it came to dominate. But there was a period a few years back where it began to attract customers who could have bought postpaid services but preferred the flexibility of prepaid, especially when prepaid began to achieve feature parity with postpaid. However, that ebbed again as installment plans took off on the postpaid side and made those services more flexible. Now, we’re going through yet another change as a couple of the big carriers use their prepaid brands as fighter brands, going after their competitors’ postpaid customers. The result is that those two carriers are seeing very healthy growth in prepaid, while the other operators are struggling.  In the chart below, I’ve added in TracFone, which is the largest prepaid operator in the US, but not a carrier (it uses the other operators’ networks on a wholesale basis):

As you can see, AT&T (mostly through its Cricket brand) and T-Mobile (mostly through its MetroPCS brand) have risen to the top, even as Sprint has gone rapidly downhill and Verizon and TracFone have mostly bounced around roughly at or below zero. There is some growth here, but it’s all being captured by the two operators, while the others are treading water or slowly going under.

Connected devices – the fastest-growing category

The fastest-growing category in the US wireless market today is what are called connected devices. For the uninitiated, that probably requires something of an explanation, since you might think of all wireless connections as being connected devices. The best way to think about the connected devices category is that these are connections sold for non-traditional things, so not phones and mostly not tablets either, but rather connected cars, smart water meters, fleet tracking, and all kinds of other connections which are more about objects than people. The one exception is the wireless connections that get bundled into some Amazon Kindle devices as part of the single upfront purchase, where the monthly bill goes to Amazon and not the customer.

This category has been growing faster than all the others – the chart below shows net adds for the four major categories we’ve discussed so far across the five largest operators, and you can see that connected devices are well out in front over the past year or so:

Growth in this category, in turn, is dominated by two operators – AT&T and Sprint, as shown in the chart below (note that Verizon doesn’t report net adds in this category publicly):

At AT&T, many of these net adds are in the connected car space, where it has signed many of the major car manufacturers as customers. The rest of AT&T’s and most of Sprint’s are a mix of enterprise and industrial applications, along with the Kindle business at AT&T. T-Mobile also has a much smaller presence here, and Verizon has a legacy business as the provider of GM’s OnStar services as well as a newer IoT-focused practice.

Though the connection growth here is healthier than the other segments, the revenue per user is much lower, in some cases only single digit dollars a month. However, this part of the market is likely to continue to grow very rapidly in the coming years even as growth in the core postpaid and prepaid markets evaporates, so it’s an important place for the major carriers to invest for future growth.

Note: this blog is published by Jan Dawson, Founder and Chief Analyst at Jackdaw Research. Jackdaw Research provides research, analysis, and consulting on the consumer technology market, and works with some of the largest consumer technology companies in the world. We offer data sets on the US wireless and pay TV markets, analysis of major players in the industry, and custom consulting work ranging from hour-long phone calls to weeks-long projects. For more on Jackdaw Research and its services, please visit our website. If you want to contact me directly, you’ll find various ways to do so here.

Facebook and ad load have been in the news a bit the past few days, since CFO David Wehner said on Facebook’s earnings call that ad load would be a less significant driver of revenue growth going forward. I was listening to the call and watching the share price, and it was resolutely flat after hours until the moment he made those remarks, and then it dropped several percent. So it’s worth unpacking the statement and the actual impact ad load has as a driver of ad growth a bit.

A changing story on ad loads

First, let’s put the comments on ad load in perspective a bit. It’s worth looking at what’s been said about ad loads on earlier earnings calls to see how those comments compare. Here’s some commentary from the Q4 2015 call:

So, ad load is definitely up significantly from where we were a couple of years ago. And as I mentioned, it’s one of the factors driving an increasing inventory. Really one thing to kind of think about here is that improving the quality and the relevance of the ads has enabled us to show more of them and without harming the experience, and our focus really remains on the experience. So, we’ll continue to monitor engagement and sentiment very carefully. I mentioned that we expect the factors that drove the performance in 2015 to continue to drive the performance in 2016. So, I think that’s the color I can give on ad loads.

Here’s commentary from a quarter later, on the Q1 2016 call:

So on ad load, it’s definitely up from where we were couple of years ago. I think it’s really worth emphasizing that what has enabled us to do that is just improving the quality and the relevance of the ads that we have, and that’s enabled us to show more of them without harming the user experience at all. So that’s been really key. Over time, we would expect that ad load growth will be a less significant factor driving overall revenue growth, but we remain confident that we’ve got opportunities to continue to grow supply through the continued growth in people and engagement on Facebook as well as on our other apps such as Instagram.

Some of that is almost a carbon copy of the Q4 commentary, but note the second half of the paragraph, where Wehner goes from saying 2016 would be like 2015 to saying that over time ad load would be a less significant driver. This is something of a turning point. Now, here’s Q2’s commentary:

Additionally, we anticipate ad load on Facebook will continue to grow modestly over the next 12 months, and then will be a less significant factor driving revenue growth after mid-2017. Since ad load has been one of the important factors in our recent strong period of revenue growth, we expect the rate at which we are able to grow revenue will be impacted accordingly…

These remarks turn “over time” into the more specific “after mid-2017”. Now here’s the Q3 commentary that caused the stock drop:

I also wanted to provide some brief comments on 2017. First on revenue, as I mentioned last quarter, we continue to expect that ad load will play a less significant factor driving revenue growth after mid-2017. Over the past few years, we have averaged about 50% revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth. With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully….

Again, it feels like there’s an evolution here, even though Wehner starts out by saying he’s repeating what he said last quarter. What’s different now is the replacement of “less significant factor driving revenue” with “much smaller contribution from this important factor”, and “the rate at which we are able to grow revenue will be impacted accordingly” to “ad revenue growth rates come down meaningfully“. Those changes are both a matter of degree, and they feel like they’re intended to suggest a stronger reduction in growth rates going forward.

Drivers of growth

However, as Wehner has consistently reminded analysts on earnings calls, ad load is only one of several drivers of growth for Facebook’s ad revenue. The formula for ad revenue at Facebook is essentially:

Users x time spent x ad load x price per ad

To the extent that there’s growth in any of those four components, that drives growth in ad revenue, and to the extent that there’s growth in several of them, there’s a multiplier effect for that growth. To understand the impact of slowing growth from ad load, it’s worth considering the contribution each of these elements makes to overall ad revenue growth at the moment:

User growth – year on year growth in MAUs has been running in the mid teens, with a rate between 14 and 16% in the last year, while year on year growth in DAUs has been slightly higher, at around 16-17% fairly consistently

Time spent – Facebook doesn’t regularly disclose actual time spent, but has said recently that this metric is also up by double digits, so at least 10% year on year and perhaps more

Ad load – we have no metric or growth rate to look at here at all, except directionally: it rose significantly from 2013 to 2015, and continues to rise, but will largely cease to do so from mid-2017 onwards.

Price per ad – Facebook has regularly provided directional data on this over the last few years, but it’s been a highly volatile metric unless recently, with growth spiking as mobile took off, and then settling into the single digits year on year in the last three quarters.

So, to summarize, using our formula above, we have growth rates as follows: 16-17% user growth plus 10%+ growth in time spent plus an unknown growth in ad load, plus 5-6% growth in price per ad.

The ad load effect

Facebook suggests that ad load is reaching saturation point, so just how loaded is Facebook with ads today? I did a quick check of my personal Facebook account on four platforms – desktop web, iOS and Android mobile apps, and mobile web on iOS. I also checked the ad load on my Instagram account. This is what I found:

Desktop web: an ad roughly every 7 posts in the News Feed, plus two ads in the right side bar. The first ad was the first post on the page

iOS app: an ad roughly every 12 posts, with the first ad being the second post in the News Feed

iOS web: An ad roughly every 10 posts, with the first ad being the fourth post in the News Feed

Android app: an add roughly every 10-12 posts, with the first ad being the second post in the News Feed

Instagram on iOS: the fourth post and roughly every 10th post after that were ads.

That’s pretty saturated. You might argue that Facebook could raise the density of ads on mobile to match desktop density (every 7 rather than every 10-12), but of course on mobile the ad takes up the full width of the screen (and often much of the height too), which means the ceiling is likely lower on mobile. I’m sure Facebook has done a lot of testing of the tipping point at which additional ads deter usage, and I would imagine we’re getting close to that point now. So this is a real issue Facebook is going to be dealing with. I did wonder to what extent this is a US issue – in other words, whether ad loads might be lower elsewhere in the world due to lower demand. But on the Q2 earnings call, Facebook said that there aren’t meaningful differences in ad load by geography, so this is essentially a global issue.

So, then, if this ad load issue is real, what are the implications for Facebook’s ad revenue growth? Well, Facebook’s ad revenue has grown by 57-63% year on year over the past four quarters, and increasing ad load is clearly accounting for some of the growth, but much of it is accounted for by the other factors in our equation. Strip that ad load effect out and growth rates could drop quite a bit, by anywhere from 10-30 percentage points. Facebook could then be left with 30-50% year on year growth without a contribution from ad load. Even at the lower end of that range, that’s still great growth, while at the higher end it’s amazing growth. But either would be lower than it has been recently.

Of course, it’s also arguable that capping ad load would constrain supply of ad space, which could actually drive up prices if demand remains steady or grows (which Facebook is certainly forecasting). Facebook has dismissed suggestions in the past that it would artificially limit ad load to drive up prices, but this is a different question. Supply constraints could offset some of the slowing contribution from ad load itself, though how much is hard to say.

Ad revenue growth from outside the News Feed

Of course, Facebook isn’t limited to simply showing more ads in the Facebook News Feed. While overall impressions actually fell from Q4 2013 to Q3 2015 as usage shifted dramatically from desktop to mobile, where there are fewer ads, total ad impressions have been up by around 50% year on year in the last three quarters. Much of that growth has been driven by Instagram, which of course has ramped from zero to the significant ad load I just described over the course of the last three years. Multiplied by Instagram user growth (which isn’t included in Facebook’s MAU and DAU figures) and that’s a significant contribution to overall ad growth too. As I understand it, the ad load comments apply to Instagram too, but there will still be a significant contribution to overall ad revenue growth from user growth.

And then there are Facebook’s other properties which until today haven’t shown ads at all: Messenger and WhatsApp. As of today, Facebook Messenger is going to start showing some ads, and that will be another potential source of growth going forward. WhatsApp may well do something similar in future, too, although Zuckerberg will have to overcome Jan Koum’s well-known objections first.

Growth beyond ad revenue

And then we have growth from revenue sources other than ads. What’s been striking about Facebook over the last few years – even more than Google – is how dominated its revenues have been by advertising. The proportion has actually risen from a low of 82% of revenue in Q1 2012 all the way back up to 97.2% in Q3 2016. It turns out that the increasing contribution from other sources was essentially down to the FarmVille era, with Zynga and other game companies generating revenues through Facebook’s game platform. What’s even more remarkable here is that these payments are still the bulk of Facebook’s “Payments and other fees” revenues today, as per the 10-Q:

…fees related to Payments are generated almost exclusively from games. Our other fees revenue, which has not been significant in recent periods, consists primarily of revenue from the delivery of virtual reality platform devices and related platform sales, and our ad serving and measurement products. 

As you can see in the second half of that paragraph, Facebook anticipates generates some revenue from Oculus sales going forward, though it hasn’t been material yet, and later in the 10-Q the company suggests this new revenue will only be enough to (maybe) offset the ongoing decline in payments revenue as usage continues to shift from desktop to mobile.

Of course, Facebook now has its Workplace product for businesses too, which doesn’t even merit a mention in this section of the SEC filing. Why not? Well, it would take 33 million active users to generate as much revenue from Workplace in a quarter as Facebook currently generates from Payments and other fees. It would take 12 million active users just to generate 1% of Facebook’s overall revenues today. And that’s because Facebook’s ad ARPU is almost $4 globally per quarter, and $15 in the US and Canada. Multiplied by 1.8 billion users, it’s easy to see why Workplace at $1-3 per month won’t make a meaningful contribution anytime soon.

Conclusion: a fairly rosy future nonetheless

In short, then, Facebook is likely going to have to make do with ad revenue for the vast majority of its future growth. That’s not such a bad thing, though – as we’ve already seen, the other drivers of ad revenue growth from user growth to price per ad to time spent by users are all still significant drivers of growth in the core Facebook product, and new revenue opportunities across Instagram, Messenger and possibly WhatsApp should contribute meaningfully as well. That’s not to say that growth might not be slower, and possibly quite a bit slower, than in the recent past. But at 30% plus, Facebook will still be growing faster than any other big consumer technology company.

Note: this blog is published by Jan Dawson, Founder and Chief Analyst at Jackdaw Research. Jackdaw Research provides research, analysis, and consulting on the consumer technology market, and works with some of the largest consumer technology companies in the world. We offer data sets on the US wireless and pay TV markets, analysis of major players in the industry, and custom consulting work ranging from hour-long phone calls to weeks-long projects. For more on Jackdaw Research and its services, please visit our website. If you want to contact me directly, you’ll find various ways to do so here.

This is one of those rare weeks when two of the tech industry’s major players have back to back events and in the process illustrate their different takes on an important product category, in this case the PC. I’ve already written quite a bit about all this this week:

My Techpinions Insiders piece on Monday was a scene setter for this week’s events

A media comment on Microsoft’s event

My weekly public Techpinions column gave a longer take on Microsoft’s event

A media comment on Apple’s event.

Now that it’s all done, though, I wanted to pull some of these themes and threads together. I attended today’s Apple event in person and so I’ve spent time with the new MacBooks, though not with Microsoft’s new hardware or software.

Differentiation: from hardware advantages to philosophical approaches

The biggest thing to come out of this week, which I previewed in my Techpinions piece on Monday, was a shift from hardware advantages to philosophical differences as the nexus of competition between Microsoft and Apple in PCs. MacBooks once enjoyed significant hardware advantages over all competing laptops in terms of battery life, portability, and features such as trackpads, but in recent years those advantages have all but disappeared. Instead, what we’re left with is increasingly stark philosophical differences in how these companies approach the market, and this week the focus was on touch.

Microsoft’s computing devices all run some flavor of Windows 10 and feature touch. Apple, on the other hand, continues to draw a distinction between two sets of products by both operating system and interactivity. On the one hand, you have iOS devices with touch interfaces, and on the other macOS devices with more indirect forms of interactivity. Today’s event saw Apple introduce an interesting new wrinkle to touch on the MacBook with the Touch Bar, but it’s clearer than ever that Apple refuses to put touch screens on the Mac and that won’t change soon.

Microsoft’s approach makes touch available everywhere, even when in many cases it doesn’t make sense. It’s optional, though, and Microsoft has pulled back from some of the earlier erroneous over-reliance on touch that characterized Windows 8. Apple, on the other hand, wants to largely preserve existing workflows based on mouse and keyboard interactivity while adding subtle new forms of interaction. It keeps all the interaction on the horizontal plane, while Microsoft has users switching back and forth between the tabletop and display planes. There isn’t necessarily a right and wrong here – both approaches are interesting and reflect each company’s different starting points and perspectives. But it’s differences like this that will characterize the next phase of competition between them.

In some ways, this new phase of competition is analogous to the competition between Apple and Google in the smartphone market. In both cases, there are now devices made by companies other than Apple which match Apple’s core hardware performance. That’s not to say that all devices now come up to Apple’s standards – it continues to compete only at the high end, while both Google and Microsoft’s ecosystems serve the full gamut of needs from cheap and cheerful to high-priced premium. But in smartphones as in PCs, the focus of competition at the high end is now moving to different approaches rather than hardware performance. It’s intriguing, then, that it’s during this era that both Google and Microsoft are finally getting serious about making their own hardware.

The Touch Bar itself is very clever. Apple made the decision to spend a lot of time in today’s event on demos, and I think that was a good use of the time (especially in an event with less ground to cover than most). The demos really showed the utility that the Touch Bar can provide in a variety of Apple and third party apps. What Apple has done here is in essence to take a slice of the screen and put it down within reach to allow you to interact with it. There will definitely be a learning curve involved here – I can see users forgetting that it’s there unless they make an effort to use it, but I can also see it prompting users to try to touch the screen (this happened to me in the demo area). “Touch here but not there” will be an interesting mental model to adapt to, but once users get the hang of it (and developers support it in their apps) I believe it will add real value.

Apple’s price coverage

Of course, MacBooks aren’t the only portable computers Apple makes, and it’s been increasingly making the case that the iPad Pro lineup should be considered computers too. These are Apple’s touch-screen computers, but in most consumers minds they don’t yet belong in the same category as Windows laptops. However, when you put the new MacBooks, older MacBooks, and iPad Pros together, you get an interesting picture in terms of price and performance coverage. The chart below shows base pricing for each of these products:

As you can see, there’s pretty good coverage from $599 all the way through $2399 with just the base prices. If you were to add storage and spec options (and Smart Keyboards in the case of the iPad Pros) the in between price points would be covered pretty well too. But Apple now offers a portable computer at almost any price point in this range, and that’s interesting. The newest MacBooks alone do a nice job of covering the spread from $1199 to $2399 with increasing power and capability, while the older MacBooks fill in some gaps. There’s no denying that these products are premium, but they extend down into price points that many people will be able to reach, while providing really top notch products for those that can afford or justify them. If you focus on those newer devices, I think this is the most coherent and logical MacBook portfolio Apple has had for years.

The next big question is what happens with desktops, because those are now from one to three years old, with no sign of an update. The one that’s had the most focus from Apple in recent years is the iMac, which is both the most mass market and the flashiest – it’s the only one that is highly visible, while both the Mac Pro and Mini could feasibly sit hidden under a desk. I don’t think Apple’s going to discontinue these anytime soon, but the timing of its lack of focus on these devices is providing an interesting window for Microsoft.

A few words on creativity

I won’t repeat everything I said in my earlier stuff on Microsoft’s event here, but suffice it to say that this creativity push is certainly interesting given that timing I just mentioned. However, it’s totally overblown to be talking about Microsoft somehow stealing away Apple’s creative customer base, for several reasons:

First, Apple has long since expanded beyond that base, especially if you look at the full set of devices including iPhones. Apple clearly isn’t selling hundreds of millions of iPhones solely to people that use Photoshop for a living. Even if you look at Mac buyers, they’re much broader than the cliche of ad agency creatives and video editors.

Secondly, all Microsoft has done so far is put a stake in the ground. The Surface Studio is a beautiful device and a well thought out machine for a subset of creative professionals. But workflows don’t change overnight just because a new computer comes along, especially if there’s an existing commitment to another ecosystem. The role of this device is to signal to creatives that Microsoft is serious about serving them, which is notable in its own right, but won’t sell millions of devices by itself.

Thirdly, Microsoft’s bigger creativity push is around software, with 400m plus Windows 10 users getting a bunch of new creativity software in the Creators Update in the spring. This will be much more meaningful in terms of spreading that creativity message far and wide than the new hardware.

Lastly, even with all this, Microsoft’s efforts to associate its brand with creativity and not just productivity will take years to take hold. Perceptions don’t change overnight either.

Apple’s event today was a nice reminder that it still takes these creative professionals very seriously – both the Adobe and DJ Pro demos were creativity-centric, and these new machines are clearly intended for creative professionals among others (the RAID arrays would be an obvious fit for people editing high-bandwidth video, for example). Apple isn’t going to cede this ground easily, but it will be very interesting to watch over the next few years how this aspect of the competition plays out.

Note: this blog is published by Jan Dawson, Founder and Chief Analyst at Jackdaw Research. Jackdaw Research provides research, analysis, and consulting on the consumer technology market, and works with some of the largest consumer technology companies in the world. We offer data sets on the US wireless and pay TV markets, analysis of major players in the industry, and custom consulting work ranging from hour-long phone calls to weeks-long projects. For more on Jackdaw Research and its services, please visit our website. If you want to contact me directly, you’ll find various ways to do so here.

In the shareholder letter that accompanied Twitter’s Q3 earnings today, the company said:

consider that each day there are millions of people that come to Twitter to sign up for a new account or reactivate an existing account that has not been active in the last 30 days.

That sounds great, right? Progress! And yet this very metric is the perfect illustration of why Twitter hasn’t actually been growing quickly at all. Let’s break it down:

Starting point: “each day there are millions of people” – so that’s at least 2 million per day every day

There are ~90 days in a quarter, so 2 million times 90 is 180 million, all of whom count as MAUs in the respective months when they engage in this behavior, and could be potential MAUs for the quarter if they stick around for a couple of months

Over the course of this past quarter, Twitter only added 4 million new MAUs

That implies one of two things: either 2.2% or less (4/180) of that 180 million actually stuck around long enough to be an MAU at the end of the quarter, or a very large proportion of those who had been active users at the end of last quarter left

In fact, it might even get worse. Based on the same 2m/day logic, 60 million plus people become MAUs every month on this basis, meaning this behavior contributes at least 60 million of Twitter’s MAUs each quarter (quarterly MAUs are an average of the three monthly MAU figures) even if all 60 million never log in again. On a base of just over 300 million, that means around a fifth of Twitter’s MAUs each month are in this category

Bear in mind throughout all this that I’m taking the bear minimum meaning of “millions” here – 2 million. The real numbers could be higher.

In other words, this metric – which is intended to highlight Twitter’s growth opportunity – actually highlights just how bad Twitter is at retaining users. Because Twitter doesn’t report daily active users or churn numbers, we have to engage in exercises like this to try to get a sense of what the true picture looks like. But it isn’t pretty.

Why is retention so bad? Well, Twitter talked up a new topic-based onboarding process in its shareholder letter too. In theory, this should be helping – I’ve argued that topic-based rather than account-based follows are actually the way to go. But I signed up for a new test account this morning to see what this new onboarding process looks like, and the end results weren’t good.

Here’s what the topic based onboarding process looks like:

So far, so good – I picked a combination of things I’m really interested in and a few others just to make sure there were a decent number of topics selected. I was also asked to upload contacts from Gmail or Outlook, which I declined to do because this was just a test account. I was then presented with a set of “local” accounts (I’m currently in the Bay Area on a business trip so got offered lots of San Francisco-based accounts including the MTA, SFGate, and Karl the Fog – fair enough). I opted to follow these 21 accounts as well, and finished the signup process. Here’s what my timeline looked like when I was done:

It’s literally empty – there is no content there. And bizarrely, even though I opted to follow 21 local accounts, I’m only shown as following 20 here. As I’m writing now, it’s roughly an hour later and there are now 9 tweets in that timeline, three each from TechCrunch and the Chronicle, and several others. This is a terrible onboarding experience for new users – it suggests that there’s basically no content, even though I followed all the suggested accounts and picked a bunch of topics. Bear in mind that I’m an avid Twitter user and a huge fan of the service – it provides enormous value to me. But based on this experience I’d never come away with that impression. No wonder those millions of new users every day don’t stick around. Why would you?

In that screenshot above, the recommendation is to “Follow people and topics you find interesting to see their Tweets in your timeline”. But isn’t that what I just did? As a new user, how do I feel at this point? And how do I even follow additional topics from here (and when am I going to see anything relating to the topics I already said I was interested in)? Twitter is suggesting even more SF-centric accounts top right, along with Ellen, who seems to be the vanilla ice cream of Twitter, but that’s it. If I want to use Twitter to follow news rather than people I know, which is how Twitter is increasingly talking about itself, where do I go from here?

I hate beating up on the companies I follow – I generally try to be more constructive than this, because I think that’s more helpful and frankly kinder. But I and countless others have been saying for years now that Twitter is broken in fundamental ways, and there are obvious solutions for fixing it. Yet Twitter keeps going with this same old terrible brokenness for new users, despite repeated promises to fix things. This, fundamentally, is why Twitter isn’t growing as it should be, and why people are losing faith that it will ever turn things around.

Note: this blog is published by Jan Dawson, Founder and Chief Analyst at Jackdaw Research. Jackdaw Research provides research, analysis, and consulting on the consumer technology market, and works with some of the largest consumer technology companies in the world. We offer data sets on the US wireless and pay TV markets, analysis of major players in the industry, and custom consulting work ranging from hour-long phone calls to weeks-long projects. For more on Jackdaw Research and its services, please visit our website.

I recently spent a couple of days with AT&T as part of an industry analyst event the company holds each year. It’s usually a good mix of presentations and more interactive sessions which generally leave me with a pretty good sense of how the company is thinking about the world. Today, I’m going to share some thoughts about where the consumer parts of AT&T sit in late 2016, but I’m going to do so with the shadow of a possible Time Warner merger looming over all of this – something I’ll address at the end. From a consumer perspective the two major themes that emerged from the event for me were:

AT&T now sees itself as an entertainment company

AT&T is doubling down on the ampersand (&).

Let me explain what I mean by both of those.

AT&T as an entertainment company

The word “entertainment” showed up all over the place at the event, and it’s fair to say it’s becoming AT&T’s new consumer identity. From a reporting perspective, the part of AT&T which serves the home is now called the Entertainment Group, for example, and CEO Randall Stephenson said that was no coincidence – it’s the core of the value proposition in the home now. But this doesn’t just apply to the home side of the business – John Stankey, who runs the Entertainment Group, said at one point that “what people do on their mobile devices will be more and more attached to the emotional dynamics of entertainment” too.

That actually jibes pretty closely with something I wrote in my first post on this blog:

There are essentially five pieces to the consumer digital lifestyle, and they’re shown in the diagram below. Two of these are paramount – communications and content. These are the two elements that create emotional experiences for consumers, and around which all their purchases in this space are driven, whether consciously or unconsciously.

What’s fascinating about AT&T and other telecoms companies is that the two things that have defined them throughout most of their histories – connectivity and communications – are taking a back seat to content. People for the most part don’t have emotional connections with their connectivity or their devices – they have them with the other people and with the content their devices and connectivity enable them to engage with. AT&T seems to be betting that being in the position of providing content will create stickier and more meaningful relationships which will be less susceptible to substitution by those offering a better deal. And of course video is at the core of that entertainment experience.

The big question here, of course, is whether this is how consumers want to buy their entertainment – from the same company that provides their connectivity. AT&T is big on the idea that people should be able to consume the content of their choice on the device of their choice wherever they choose. On the face of it, that seems to work against the idea that one company will provide much of that experience, and I honestly think this is the single biggest challenge to AT&T’s vision of the future and of itself as an entertainment company. But this is where the ampersand comes in.

Doubling down on the ampersand

One of the other consistent themes throughout the analyst event was what AT&T describes as “the power of &”. AT&T has actually been running a campaign on the business side around this theme, but it showed up on the consumer side of the house too at the event. Incidentally, I recalled that I’d seen a similar campaign from AT&T before, and eventually dug up this slide from a 2004 presentation given by an earlier incarnation of AT&T.

But even beyond this ad campaign, AT&T is talking up the value of getting this and that, and on the consumer side this has its most concrete instantiation in  what AT&T has done with DirecTV since the merger. This isn’t just about traditional bundling and the discounts that come with it, but about additional benefits you get when you bundle. The two main examples are the availability of unlimited data to those who bundle AT&T and DirecTV, and the zero-rating of data for DirecTV content on AT&T wireless networks. Yes, AT&T argues, you can watch DirecTV content on any device on any network, but when you watch it on the AT&T network it’s free. The specific slogan here was “All your channels on all your devices, data free when you have AT&T”.

The other aspect here is what I call content mobility. What I mean by that is being able to consume the content you have access to anywhere you want. That’s a given at this point for things like Netflix, but still a pretty patchy situation when it comes to pay TV, where rights often vary considerably between your set top box, home viewing on other devices, and out-of-home viewing. The first attempts to solve this problem involved boxes – VCRs and then DVRs for time shifting, and then the Slingbox for place shifting. But the long term solution will be rooted in service structure and business models, not boxes. For example, this content mobility has been a key feature of the negotiations AT&T has been undertaking both as a result of the DirecTV merger and in preparation for its forthcoming DirecTV Now service. It still uses a box – the DirecTV DVR – where necessary as a conduit for out-of-home viewing where it lacks the rights to do so from the cloud, but that’s likely temporary.

AT&T’s acquisition of DirecTV was an enabler of both of these things – offering zero rating as a benefit of a national wireless-TV bundle, and the negotiating leverage that comes from scale. It also, of course, gained access to significantly lower TV delivery costs relative to U-verse.

Now, the big question is whether consumers will find any of this compelling enough to make a big difference. I’m inherently skeptical of zero rating content as a differentiator for a wireless operator – even if you leave aside the net neutrality concerns some people have about it, it feels a bit thin. What actually becomes interesting, though, is how this allows DirecTV to compete against other video providers – in a scenario where every pay TV provider basically offers all the same channels, this kind of differentiation could be more meaningful on that side of the equation. If all the services offer basically the same content, but DirecTV’s service allows you to watch that content without incurring data charges on your mobile device, that could make a difference.

Context for AT&T&TW

So let’s now look at all of this as context for a possible AT&T-Time Warner merger (which as I’m finishing this on Saturday afternoon is looking like a done deal that will be announced within hours). One of the slides used at the event is illustrative here – this is AT&T’s take on industry dynamics in the TV space:

Now focus in on the right side of the slide, which talks about the TV value chain compressing:

The point of this illustration was to say that the TV value chain is compressing, with distributors and content owners each moving into each other’s territory. (Ignore the logos at the top, at least two of which seem oddly out of place). The discussion around this slide went as follows (I’m paraphrasing based on my notes):

Earlier, there were discrete players in different parts of the value chain. That game has changed dramatically now – those heavy in production are thinking about their long-term play in distribution. Those who distribute are thinking about going back up the value chain and securing ownership rights. Premium content continues to play a role in how people consume network capacity. Scale and a buying position in premium content is therefore essential.

In addition, AT&T executives at the event talked about the fact that the margins available on both the content and distribution side would begin to collapse for those only participating on one side as players increasingly play across both.

The rationale for a merger

I think a merger with Time Warner would be driven by three things:

A desire to avoid being squeezed in the way just described as other players increasingly try to own a position in both content ownership and distribution – in other words, be one of those players, not one of their victims

A furthering of the & strategy – by owning content, AT&T can offer unique access to at least some of that content through its owned channels, including DirecTV and on the AT&T networks. This is analogous to the existing DirecTV AT&T integration strategy described above

Negotiating leverage with other content providers and service providers.

Both the second and third of these points would also support the content mobility strategy I described earlier, providing both leverage with content owners and potentially unique rights to owned content.

How would AT&T offer unique content? I don’t think it would shut off access to competitors, but I could see several possible alternatives:

Preserving true content mobility for owned channels – only owned channels get all rights for viewing Time Warner content on any device anywhere. Everyone else gets secondary rights

Exclusive windows for content – owned channels like DirecTV and potentially AT&T wireless would get early VOD or other access to content, for example immediate VOD viewing for shows which don’t show up for 24 hours, 7 days etc on other services

Exclusive content – whole existing shows and TV channels wouldn’t go exclusive, but I could see exclusive clips and potentially new shows go exclusive to DirecTV and AT&T.

The big downside with all this is that whatever benefits AT&T offers to its own customers, by definition it would be denying those benefits to non-customers. That might be a selling point for DirecTV and AT&T services, but wouldn’t do much for Time Warner’s content. The trends here are inevitable, with true content mobility the obvious end goal for all content services – it’s really just a matter of time. To the extent that AT&T is seen to be standing in the way of that for non-customers, that could backfire in a big way.

On balance, I’m not a fan of the deal – I’ve outlined what I see as the potential rationale here, but I think the downsides far outweigh the upsides. Not least because the flaws in Time Warner’s earlier mega-merger apply here too – since you can never own all content, but just a small slice, your leverage is always limited. What people want is all the relevant content, not just what you’re incentivized to offer on special terms because of your ownership structure. I’ll wait and see how AT&T explains the deal to see if the official rationale makes any more sense, but I suspect it won’t change much.

Note: this blog is published by Jan Dawson, Founder and Chief Analyst at Jackdaw Research. Jackdaw Research provides research, analysis, and consulting on the consumer technology market, and works with some of the largest consumer technology companies in the world. We offer data sets on the US wireless and pay TV markets, analysis of major players in the industry, and custom consulting work ranging from hour-long phone calls to weeks-long projects. For more on Jackdaw Research and its services, please visit our website.

Microsoft reported earnings yesterday, and the highlights were all about the cloud business (Alex Wilhelm has a good summary of some of the key numbers there in this post on Mattermark).  Given that I cover the consumer business, however, I’m more focused on the parts of Microsoft that target end users, which are mostly found in its More Personal Computing segment (the one exception is Office Consumer, which sits in the Productivity & Business Processes segment).

The More Personal Computing segment is made up of:

Windows – licensing of all versions of Windows other than Windows server

Devices – including Surface, phones, and accessories

Gaming – including Xbox hardware, Xbox Live services, and game revenue

Search advertising – essentially Bing.

Microsoft doesn’t report revenues for these various components explicitly, but often provides enough data points in its various SEC filings to be able to draw reasonably good conclusions about the makeup of the business. As a starting point, Microsoft does report revenue from external customers by major product line as part of its annual 10-K filing – revenue from the major product lines in the More Personal Computing Group are shown below:

Windows declining for two reasons

It’s worth noting that it appears Windows revenue has fallen off a cliff during this period. However, a big chunk of the apparent decline is due to the deferral of Windows 10 revenue, which has to be recognized over a longer period of time than revenue from earlier versions of Windows, which carried less expectation of free future updates. At the same time, the fact that Windows 10 was a free upgrade for the first year also depressed revenues. As I’ve been saying for some time now, going forward it’s going to be much tougher for Microsoft to drive meaningful revenue from Windows in the consumer market in particular, in a world where every other vendor gives their OS away for free. That means Microsoft has to find new sources of revenue in consumer: enter hardware.

Phones – dwindling to nothing

First up, phones, which appear to be rapidly dwindling to nothing. It’s become harder to find Lumia smartphone sales in Microsoft’s reporting recently, and this quarter (as far as I can tell) the company finally stopped reporting phone sales entirely. That makes sense, given that Lumia sales were likely under a million in the quarter and Microsoft is about to offload the feature phone business. The chart below shows Lumia sales up to the previous quarter, and my estimate for phone revenues for the past two years, which hit around $300 million this quarter:

Surface grows year on year but heading for a dip

Surface has been one of the bright spots of Microsoft’s hardware business over the last two years. Indeed – this home-grown hardware line has compared very favorably to that acquired phones business we were just discussing:

As you can see, Surface has now outsold phones for four straight quarters, and that’s not going to change any time soon. Overall, Surface revenues are growing year on year, which is easier to see if you annualize them:

However, what you can also see from that first Surface chart is that revenues for this product line are starting to settle into a pattern: big Q4 sales, followed by a steady decline through the next three quarters. That’s fine as long as there is new hardware each year to restart the cycle, but from all the reporting I’ve seen it seems the Surface Pro and Surface Book will get only spec bumps and very minor cosmetic changes, which leaves open the possibility of a year on year decline. Indeed, this is exactly what Microsoft’s guidance says will happen:

We expect surface revenue to decline as we anniversary the product launch from a year ago.

I suspect the minor refresh on the existing hardware combined with the push into a new, somewhat marginal, product category (all-in-ones) won’t be enough to drive growth. The question is whether the revenue line recovers in the New Year or whether we’ll see a whole year of declines here – that, in turn, would depress overall hardware sales already shrinking from the phone collapse.

It’s also interesting to put Surface revenues in context – they’ve grown very strongly and are now a useful contributor to Microsoft’s overall business, but they pale in comparison to both iPad and Mac sales, neither of which have been growing much recently:

Ahead of next week’s Microsoft and Apple events, that context is worth remembering – for all the fanfare around Surface, Microsoft’s computing hardware business is still a fraction of the size of Apple’s.

Gaming – an oldie but kind of a goodie

Gaming, of course, is the oldest of Microsoft’s consumer hardware businesses, but its gaming revenue is actually about more than just selling consoles – it also includes Xbox Live service revenues and revenues from selling its own games (now including Minecraft) and royalties from third party games. However, it’s likely that console sales still dominate this segment. Below is my estimate for Gaming revenue:

In fact, Microsoft actually began reporting this revenue line this quarter, though unaccountably only for this quarter, and not for past quarters. Still, it’s obvious from my estimates that this, too, is an enormously cyclical business, with a big spike in Q4 driven by console sales and to a lesser extent game purchases, followed by a much smaller revenue number in Q1 and a steady build through Q3 before repeating. Microsoft no longer reports console sales either, sadly, likely because it was coming second to Sony much of the time before it stopped reporting. Still, gaming makes up almost a third of MPC segment revenues in Q4, and anything from 8-20% of the total in other quarters. In total, hardware likely now accounts for 30-50% of total revenue from the segment quarterly.

Search advertising – Microsoft’s quiet success story

With all the attention on cloud, and the hardware and Windows businesses going through a bit of a tough patch, it’d be easy to assume there were no other bright spots. And yet search advertising continues to be the undersold success story at Microsoft over the last couple of years. I’ve previously pointed out the very different trajectories of the display and search ad businesses at Microsoft, which ultimately resulted in the separation of the display business, but the upward trajectory of search advertising has accelerated since that decision was made.

Again, Microsoft doesn’t report this revenue line directly, but we can do a decent job of estimating it, as shown in the chart below:

There are actually two different revenue lines associated with search advertising – what I’ve shown here is total actual revenue including traffic acquisition costs, but Microsoft tends to focus at least some of its commentary on earnings calls on a different number – search revenue ex-TAC. As you can see, the total number has plateaued over the last three quarters according to my estimates, though the year on year growth numbers are still strong. However, the ex-TAC number is growing more slowly. In other words, this growth is coming at the expense of higher traffic acquisition costs, which seems to be the result of the deal Microsoft signed with Yahoo a few quarters ago and an associated change in revenue recognition. Still, it’s a useful business now in its own right, with advertising generating 7% of Microsoft’s revenues in the most recent fiscal year.

Note: this blog is published by Jan Dawson, Founder and Chief Analyst at Jackdaw Research. Jackdaw Research provides research, analysis, and consulting on the consumer technology market, and works with some of the largest consumer technology companies in the world. We offer data sets on the US wireless and pay TV markets, analysis of major players in the industry, and custom consulting work ranging from hour-long phone calls to weeks-long projects. For more on Jackdaw Research and its services, please visit our website.

Netflix reported its financial results on Monday afternoon, and the market loved what it saw – the share price was up 20% a couple of hours later. The single biggest driver of that positive reaction was subscriber growth, which rebounded a little from last quarter’s pretty meager numbers. Here are a few key charts and figures from this quarter’s results. A much larger set can be found in the Q3 Netflix deck from the Jackdaw Research Quarterly Decks Service, which was sent to subscribers earlier this afternoon. The Q2 version is available for free on Slideshare.

Subscriber growth rebounds

As I mentioned, subscriber growth rebounded at least a little in Q3. However, the rebound was fairly modest, and the longer-term trends are worth looking at too. Here’s quarterly growth:

The numbers were clearly better than Q2 both domestically and internationally, but not enormously so, especially in the US. Here’s the longer-term picture, which shows year on year growth:

As you can see, there’s been a real tapering off in the US over the past two years, while internationally it’s flattened following consistent acceleration through the end of last year. To put this year’s numbers so far in context, here’s a different way of presenting the quarterly domestic data:

That light blue line is the 2016 numbers, and as you can see each of this year’s quarters has been below the last three years’ equivalents, and the last two quarters have been well below. Arguably, Q3 was even further off the pace than Q2, so for all the celebration of a return to slightly stronger growth, this isn’t necessarily such a positive trend when looked at this way.

The cost of growth

Perhaps more importantly, this growth is becoming increasingly expensive in terms of marketing. I’ve mentioned previously that, as Netflix approaches saturation in the US, it will need to work harder and spend more to achieve growth, and we’re still seeing that play out. If the objective of marketing is growth, then one way of thinking about marketing spending is how much growth it achieves.

Ideally, we’d measure this by establishing a cost per gross subscriber addition – i.e. the marketing spend divided by the number of new subscribers enticed to the service as a result of it. However, since Netflix stopped reporting gross adds in 2012, we have to go with the next best thing, which is marketing spend per net subscriber addition, which is shown in the chart below:

As you can see, there was a massive spike in Q2 due to the anemic growth numbers domestically, but even in Q3 the number is around 3 times what it had been in the recent past. Yes, Netflix returned to healthier growth in Q3, but it had to spend a lot to get there. But even in the international line, somewhat dwarfed by US spending the last two quarters, there has been an increase. In its shareholder letter, Netflix wrote this off as increased marketing for new originals, but the reality is that the marketing was still necessary to drive the subscriber growth it saw in the quarter, which in turn was lower than it has been.

The price increase worked – kind of

Of course, one big reason for the slower growth these last two quarters is the price increase Netflix has been introducing in a graduated fashion – or, in its own characterization, “un-grandfathering” of the base which was kept on older pricing for longer than new subscribers. As I wrote in this column for Variety, the price increase was really about keeping the margin growth going in the domestic business as Netflix invests more heavily in content, and I predicted that it would pay off in the long term.

Here’s what’s happened to the average revenue per paying customer as that price increase has kicked in:

There’s an enormous spike domestically in Q3, whereas internationally the increase kicked in a little earlier, despite the fact that it only affected certain markets. Overall, though, the price increase has driven average revenue per subscriber quite a bit higher – around $2 so far – so it’s arguably worked. Of course, it’s come at the cost of increased churn and perhaps slower customer additions, and the longer term effects of that will take a while to play out. We’ll need to watch the Q4 results to see whether growth starts to recover, or whether the results we’ve seen over the last two quarters are a sort of “new normal” we should expect to see more of going forward.

Meanwhile, domestic margins continue to tick up in a very predictable fashion:

The key, though, at this point, is to marry this increasingly profitability with breakeven followed by increasing profitability overseas, something Netflix has been predicting will happen next year. As of right now, the international business as a whole is still unprofitable, but several individual countries outside the US are already profitable for Netflix, and so it has a roadmap for other markets as they grow and hit scale milestones as well. What investors buying the stock today are really betting on is that this scenario plays out as Netflix expects it to, but it’s arguably still too early to tell whether it will.

This is my second post about Google’s event this week, and there will likely be more. The first tackled Google’s big strategy shift: moving from a strategy of gaining the broadest possible distribution for its services to preferring its own hardware in a narrower rollout. Today, I’m going to focus on the Pixel phones.

Positioning Pixel as a peer to the iPhone…

The Pixel phones are the most interesting and risky piece of this week’s announcements, because they go head to head against Google’s most important partners. One of my big questions ahead of time was how Google would address this tension, and in the end it simply didn’t, at least not during the event. The way it addressed it indirectly was to aim its presentation and the phones at the iPhone instead of at other Android phones. There were quite a few references to the iPhone during the event, and they’re worth pulling out:

A presenter said as an aside, “no unsightly camera bump” when describing the back of the Pixel phones

The unlimited photo and video storage was positioned against the iPhone, explicitly so when an image of iOS’s “Storage Full” error message was shown on screen (as it was in a recent Google Photos ad campaign)

The colors of the Pixel phones have names which appear to mock Apple’s color names

The pricing of the Pixel phones is identical to the pricing for the iPhone 7, right down to the first-time $20 increase to $769 for the iPhone 7 Plus from the earlier $749 price point for the larger phones, despite the fact that the larger Pixel has no additional components

A reference to the 3.5mm headphone jack in the Pixel commercial.

Google is attempting to position the Pixel as a true peer to the iPhone, unlike Nexus devices, which have usually been priced at a discount with feature disparities (notably in the cameras) to match. The pricing is easily the most telling element here, because there’s literally no other reason to match the pricing so precisely, and Google could arguably have benefited from undercutting the iPhone on price instead. Rather, Google wants us to see the Pixel as playing on a level playing field with the iPhone. This is very much a premium device, something that Chrome and Android exec Hiroshi Lockheimer explicitly addressed in an interview with Bloomberg published this week:

Premium is a very important category. Having a healthy premium device ecosystem is an important element in an overall healthy ecosystem. For app developers and others. It’s where certain OEMs have been successful, like Samsung. It’s where Apple is also very strong. Is there room for another player there? We think so. Do we think it’s an important aspect of Android? Yeah, absolutely.

What’s most interesting to me is the question and answer near the end there: “Is there room for another player there? We think so.” Given that the premium smartphone market is basically saturated at this point, that’s an interesting statement to make. Unlike, say, in the low end of the smartphone market, where there’s still quite a bit of growth, the only sense in which there’s “room” for another player at the premium end is by squeezing someone else out. Google clearly wants that to be Apple, but it’s arguably more likely to be Samsung if it’s anyone.

We’ve seen from long experience that switching from iOS to Android is much rarer than the other way, and so Google is far more likely to take share from Samsung than Apple, even with its overt focus on competing against the iPhone. In addition, this is fundamentally an Android phone with a few customizations, and will be seen as such, and therefore in competition with other Android devices, rather than the iPhone, for all Google’s focus on the iPhone in its messaging.

…while also mocking the iPhone (and iPhone owners)

But perhaps the biggest misfire here is the schizoid positioning versus the iPhone – on the one hand, the Pixel borrows very heavily from the iPhone – the look, especially from the front; the two sizes; the pricing, the focus on the camera; the integrated approach to hardware and software (of which more below); and so on. And yet at the same time Google seems determined to mock the iPhone, as evident in the color naming and in other ways throughout the presentation. If you want to go head to head against the iPhone, you do it in one of two ways: you show how you’re different (as Samsung has arguably done successfully), or you show how you’re the same but better. You don’t do it by aping lots of features and then mocking the very thing you’re aping at the same time (and by implication its customers, the very customers you’re going after).

True integration, or just a smokescreen?

The other major element of this strategy, of course, is that Google is now capitulating to the Apple strategy of many years and more recently Microsoft’s Surface strategy: the company that makes the best hardware is the company that makes the OS. Again, the approach is best encapsulated in an interview, this time with Rick Osterloh, head of Google’s new consolidated hardware division:

Fundamentally, we believe that a lot of the innovation that we want to do now ends up requiring controlling the end-to-end user experience.

What’s odd is that there seems to be relatively little evidence of this approach in what was announced on Tuesday. Is there really anything in the Pixel phones that couldn’t have been achieved by another OEM working at arm’s length from Google? One of the biggest benefits of taking this integrated approach is deep ties between the OS and the hardware, but from that perspective, Google isn’t actually allowing its Android division to get any closer to its own hardware team than other OEMs. It’s only integration with other Google services (outside of Android) where the Pixel team got special access, and even then only because they’re the only ones who have asked to do so.

All of this undermines Google’s argument that the Pixel is somehow in a different category because it’s “made by Google” (even leaving aside the fact-checking on that particular claim from a hardware perspective). This phone could easily have been made by an OEM with the same motivations – the big difference is that no OEM has precisely those motivations, not that the Pixel team was somehow given special access.

In fact, this gets at the heart of one of the main drivers behind the Pixel – Google reasserting control over Android and putting Google services front and center again. I’ve written about this previously in the context of Google’s attempts to do this through software, as exemplified by its I/O 2014 announcements. But those efforts largely failed to reclaim both control over Android and a more prominent role for Google services on Android phones. As a result, Google’s relationship with Android releases has continued to be analogous to that of a parent sending a child off to college – both have done all they can to set their creation on the right path, but have little control over what happens next.

If, though, this is the real motivation behind Pixel (and I strongly suspect it is), then all this stuff about targeting the iPhone and tightly integrated hardware and software is really something of a smokescreen. I would bet Google’s OEM partners can see that pretty clearly too, and for all Google executives’ reassurances that the OEMs are fine with it, I very much doubt it.

There’s so much to say about today’s Google hardware event, and it’s tempting to pour it all into this one post. Instead, though, I’m going to be focused here and probably write several separate posts on announcements from today during the rest of this week. It’ll also be the main topic of conversation on the Beyond Devices Podcast this week, so be sure to check that out later in the week.

My focus here is what I’m terming Google’s big strategy shift, but it may not be the shift you’re thinking of. Yes, it’s notable that Google is making its own hardware, but it’s been doing that for years. The big shift therefore isn’t so much that Google is making its own hardware, as that it’s preferring that hardware when it comes to Google services, notably the Google Assistant.

Previously, Google services have been launched on either the web or through the major app stores, typically Play and iOS simultaneously or one shortly after the other. But with the new devices announced today, Google appears to be using the Google Assistant as a way to advantage its own hardware rather than going broad. That’s a massive strategic shift, and has much broader implications than simply making a phone, a speaker, or a WiFi router.

Think about what this means: Google is choosing to favor a few million hardware sales over usage of these services by billions of people, at least in the short term. Its old approach was to pursue the broadest possible distribution for its services by making them available in almost all the places people might expect to find them. But its new approach is much more reminiscent of Apple’s, which of course is designed to differentiate hardware and not drive maximum usage.

Why, then, would Google do this? The most obvious reason is that Google couldn’t find enough other ways to make its new devices stand out in the market, and so chose to use the Assistant as a differentiator. That’s understandable, but it’s a pretty significant strategic sacrifice to make. Another possible explanation is that it didn’t want to overload the Google Assistant with too many users at once, and so it’s put it in places where usage will be limited at first – Allo (currently 75 in the Play store and 691 in the App Store), Google Home, and the Pixel phones. That’s a bit odd given how broadly used all the services behind the Google Assistant already are – it’s not like Google can’t handle the server load – but it might make sense to work out some kinks before making the Assistant more broadly available.

The next question then becomes how soon the Google Assistant becomes available elsewhere – on the web, as part of Android, or as an iOS app. The sooner it becomes available, the more easily Google will achieve its usual goal of broad distribution, but the more quickly it erodes one of the big differentiators of Pixel. The longer it holds it back, the less relevant it becomes (and the harder it becomes to tell Google’s AI story), but the longer Pixel stands out in the market. I’d argue that how Google answers this question will be one of the strongest indicators we’ll have of how it really feels about its big increase in hardware investment.

Next week, Google is expected to unveil a new operating system named Andromeda, which in some ways combines the existing Android and ChromeOS operating systems. The choice of name is interesting – Andromeda is a figure in Greek mythology, and it’s worth briefly recapping her story. Specifics vary depending on the version of the story you consult, but here’s the gist: Andromeda was the daughter of Cepheus and Cassiopeia, king and queen of Aethiopia. Her mother boasted that she was more beautiful than the Nereids, who were the companions of Poseidon. As a punishment for Cassiopeia’s hubris, Poseidon sent a sea monster to ravage Aethiopia, and an oracle recommended to Andromeda’s parents that she be chained to a rock on the shore, where the sea monster would eventually claim her and be pacified. Fortunately for Andromeda, Perseus happened along and saved and subsequently married her. Below is one of many artistic representations of this story. Why do I bring this up? Well, given Andromeda is also the name of the hybrid OS due to be announced next week by Google, there are some interesting parallels. This past weekend Hiroshi Lockheimer, who owns Android and ChromeOS at Google, tweeted as follows:

We announced the 1st version of Android 8 years ago today. I have a feeling 8 years from now we’ll be talking about Oct 4, 2016.

— Hiroshi Lockheimer (@lockheimer) September 24, 2016

Think back to September 2008, and how Android was received then. Although Google had certainly talked up the new operating system plenty, and some of the early coverage was pretty breathless too, the reality is that early Android was pretty disappointing. The hardware was clunky and ugly, and it took several years for Android smartphones to begin to approach parity with the iPhone, both in terms of performance and in terms of sales. Of course, over time Android smartphones became very competitive and eventually began to outsell iPhones significantly, but if you were to plot the trajectory, it would look something like the chart below. My worry with Lockheimer’s remarks is that, in September 2008, Android wasn’t obviously going to be the hit it has since become. In hindsight, the launch of Android was enormously important, and helped create today’s smartphone market, but at the time the G1 launched it was a clunky and marginal bit of hardware. The concern is that whatever Google announces next week will be received – at least initially – in the same way. Perhaps some will see in it the promise of amazing things to come, but I suspect the initial impact will be marginal, and it will take years to see the true impact. And it’s entirely possible that the impact won’t be nearly as impressive as Google clearly thinks it will be. Although Lockheimer is saying that we’ll look back on October 4th as being a milestone event, he’s saying it ahead of time, and that’s where the hubris comes in. Interestingly, the mythological Andromeda’s personal trajectory fits rather nicely onto that curve above too – her mother’s hubris has her flying high, only to be brought low by Poseidon’s wrath and her parents’ intended sacrifice of her, though eventually she’s rescued by Perseus and things start looking up again. Google’s Andromeda might well go through the same curve too – overhyped up front by company executives, only to fail to meet expectations in its early versions, though perhaps redeemed as the vision plays out over time.

Over the weekend, Snapchat (now Snap, Inc.) announced its video-recording glasses, Spectacles. In talking to reporters on Saturday and spending some time pondering the move, four main thoughts have been running through my brain. I think we’ll almost certainly spend a good amount of time on this week’s Beyond Devices Podcast discussing this, so look out for that episode on Thursday morning.

Two takes on hardware for immersive video

Firstly, it’s interesting to see Snap and Facebook both investing in more immersive video, while also making hardware investments in this space. However, they’ve chosen different focal points for their hardware:

Facebook is encouraging people to use their smartphones to capture 360° photo and video, but has chosen to make its hardware investment on the consumption side (Oculus)

Snapchat has made a hardware investment in a capture device for 115° video, but the consumption will happen on smartphones.

That reflects a broader strategic focus for each company, with Facebook focused not just on video but on owning the next big platform after missing out on owning smartphone hardware and operating systems, while Snapchat is redefining its identity (see below). Neither company, obviously, is precluded from eventually moving into the other hardware space over time either.

Snap Inc, the camera company

While speaking at a Columbia University startup event in April, Evan Spiegel first began referring to Snapchat as a camera company, and that was now obviously a setup for the Spectacles launch, which has been in the works for at least two and a half years, and Snap Inc has embraced this tagline as its official self-description now too. This redefinition makes sense – there have always been several ways to look at Snapchat: a content company, a social company, an app company, or a camera company. Of those, three still make sense as descriptors after the Spectacles announcement, but what Snap clearly doesn’t want to be seen as anymore is just an app company. But the camera identity makes in some ways the most sense – it’s the first thing users see when they open the app, and snapping and sharing pictures and video is clearly the central purpose of the company.

One of the things Snapchat has done amazingly well since its founding is evolving out of its original narrow pigeonhole into something much broader. Though known in its early years mostly for the ephemeral nature of the content shared through the platform, and thereby gaining a reputation as being somewhat shady, its identity is now very different. The additions of Stories, Discover, Lenses, and a variety of other features has turned it into something much broader, which consequently captures much more of its’ users time. Spectacles, though, are arguably the first addition to the portfolio that isn’t in and of itself about getting users to spend more time in the app, and that’s interesting.

Inevitable comparisons to Google Glass

You can’t launch a video-recording pair of glasses in today’s world without drawing comparisons with Google Glass. But the target demographic, the price point, the design, and the intent are all very different for Spectacles compared with Glass. In addition, the Snap team had the benefit of learning from what went wrong with Glass.

It’s also interesting to think about where the Spectacles technology came from – thanks to the Sony email hack, we know that Snapchat acquired Vergence Labs in March 2014 for around $15 million. Vergence sold video-recording eyeglasses under the Epiphany Eyewear brand, and actually launched before Google Glass. But there were some important differences between EE’s glasses and what Snap has now launched:

The price ranged from $300-500 based on storage, versus Spectacles at $130

The glasses required a USB connection to plug into a computer for uploading videos to a proprietary hub, from which content could be shared to various social networks, versus sharing over Bluetooth or WiFi direct to a phone running the Snapchat app

The glasses had a subtler design, with just one camera discreetly tucked in the corner, versus Spectacles’ yellow-rimmed cameras in both corners.

Interestingly, though, Vergence had this quote on its website when asked about the differences versus Google Glass: “Glass appears to have a few more “electronics features” and we have more “eyewear features”.” This is a great summary of the difference between Snap’s Spectacles and Glass too – the former is a pair of sunglasses that records video, while the latter was technology strapped to your face.   There’s definitely much less of a cyborg vibe to Spectacles. The Spectacles do own their role as cameras – those yellow rims are clearly intended to highlight the presence of the cameras, and lights will further highlight when you’re actually recording. Snap has obviously learned from the privacy concerns around Glass.

Why hardware?

The biggest question in mind throughout all this has been why Snapchat would undergo this transformation from an app company to an app plus hardware company, because that’s a tough transition to make. Consumer electronics involves industrial design, manufacturing, shipping and retail, break-fix capabilities, and much else besides, which an app company never needs to worry about. The business model is very different too – the incremental cost of serving an additional user with an app is close to zero, whereas the incremental cost of selling another unit of hardware is significant. Moreover, the vast majority of Snapchat’s end users have never paid it any money for anything in the past, and will now be asked to stump up $130. Given that for many of Snapchat’s users, their disposable income is probably best described as pocket money rather than a salary or even wages, that’s probably a tough sell.

Two obvious reasons present themselves: business model and differentiation. On the former front, Snapchat’s main business model has been advertising, so hardware revenue can provide a useful additional revenue stream while also hedging against any future challenges in driving ad revenue. But a proprietary camera also allows Snapchat to differentiate itself in much the same way its software Lenses already do. The Spectacles have a unique field of vision and video format, which in turn will be uniquely available in the Snapchat app, and that’s not to be underestimated.

Having said all that, we’re likely talking about a small production run here, which means the risks involved will be limited. If the product takes off, Snapchat can presumably churn out tens of thousands and make lots of money. If it doesn’t, it won’t hurt its financial performance too much (though the big bet on changing the name and identity of the company may look a little hubristic later if that’s the case). The big question is whether Snapchat can actually make money selling these glasses at $130 a pop, when Vergence Labs was selling their predecessors for more than twice that, and Snap’s version has two cameras and two wireless chips.

It’s also interesting to consider what else Vergence Labs was working on at the time of the acquisition – there were three future projects listed on the website at the time: smarter transition sunglasses, a HUD for heart-rate tracking during exercise, and an AR application. Those and others (especially given the dual cameras) are possible future directions for Snap’s glasses efforts too.

As I’ve said before, I’m both a heavy user of Twitter and a critic of the way it’s currently being run. The lack of growth and the slow pace of change to the product are closely intertwined, and neither is good for Twitter in the long run. (See here for all my past writing on Twitter.)

Because of the slow growth and diminishing expectations of Twitter’s eventual size as a business, the share price is tanking, and that’s raising the prospect of an acquisition (recently, of course, the very prospect of an acquisition has been fueling a rise in the stock price).

Recode had a nice piece a while back breaking down the potential acquirers and arguing for and against each of them, with Kara Swisher and Kurt Wagner taking it in turns to present the pros and cons of each. My summary of that piece was as follows:

None of these really come off as likely buyers. The counterarguments are pretty strong for all, prohibitive for some https://t.co/ZrsYLlzQkV

— Jan Dawson (@jandawson) September 15, 2016

There’s a fundamental problem with all the potential acquirers, and that’s that none of them seem likely to do anything meaningful to solve the product problem. Among the potential acquirers are several companies who could create substantial synergies with their own existing ad businesses, including Google and Verizon. Others could do interesting things with the data. But none of them have the kind of track record in consumer social products that gives me any kind of reassurance that they would do better in evolving Twitter as a product than the current management. Let’s review:

Google – famously inept at creating successful social products, more likely to acquire Twitter with the intent of finally fixing its own social challenges than to add meaningfully to Twitter’s abilities in this area. Decent ad synergies though.

Salesforce – literally no experience in consumer-facing products. Yes, it recently acquired Quip and with it founder Bret Taylor, but one executive isn’t enough. Again, some interesting synergies in other areas, but zero on the end user product side.

Verizon – another play for ad synergies, when taken together with AOL and Yahoo (assuming the latter goes through now that the hack has been exposed). But Verizon has no history with successful web or social products (and see Go90 for a recent example of a non-telecom product…).

Facebook is probably the only example among those frequently cited that obviously does get social, but it seems so much more likely to be successful in aping Twitter’s features than as an acquirer, not least because of possible regulatory barriers, that this just seems plain unlikely.

Microsoft and Apple also seem unlikely. The former has done some interesting things with small app acquisitions lately in the productivity space, but not in true consumer apps, and again has no social chops at all. The argument for an Apple acquisition also seems thin, while it vies with Google for the title of least socially adept consumer technology company.

Private equity buyers would have the advantage of doing the turnaround work in private without having to report to public shareholders quarterly. But that only makes me worry that there would be even less urgency about the product changes that need to take place.

In short, the prospects for an acquisition that would actually help solve the fundamental product problems seem very poor indeed. Add to that the inevitable turmoil and further delays in execution caused by the acquisition process itself, and I’m still more hopeful that Twitter will finally get its act together as an independent entity rather than be acquired. It’s just too hard to see things getting better rather than worse under an acquisition scenario.