Defending iOS With Cheap iPhones

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Over the last 12 months, Google ( GOOG ) Android devices have outsold Apple's ( AAPL ) iOS by about 3 to 1. There are now perhaps 775m-800m 'official' Android devices in use, versus perhaps 415m iOS devices. This is without counting sales of the Amazon Kindle Fire or the (very) many Android devices sold in China that are not connected to Google services - these may be a further 150-200m active devices now (or more). So, the Android install base is more than double the size of iOS. If you look just at phones, there are maybe 250m iPhones in use and perhaps 700m 'official' Android phones alone.

Of course, Android has had a larger installed base than iOS since mid 2011, but engagement remained far behind. Until well into 2012 publishers and developers tended to see app download rates on Android of a half to a quarter of what they experienced on iOS, in absolute terms, while payment and purchase rates were a quarter or lower of iOS rates. This was due partly to weak execution by Google and partly to a vicious circle of self-selection: Android phones were cheaper (averaging $250-300 globally versus $600 for the iPhone) and had a poorer choice of apps, so they attracted people with less money and less interest in apps. The small and very vocal number of people who really want an Android are far outnumbered by people who don't particularly care.

This engagement gap is now starting to close:

  • Google has significantly improved the execution of the 'Google Play' app store, and has made a strong effort to extend operator billing
  • The sheer size of the Android base, at close to 800m active devices (outside China), versus around 400m for iOS (and around 250m iPhones), means that even with lower proportionate engagement rates the absolute numbers are starting to catch up

Hence, by the first half of 2013 Android cumulative downloads caught up with iOS (both at around 50bn), and both now see a run-rate of something around five apps downloaded per active device per month.

(click to enlarge)

Google does not give any data on payment trends, but Apple gives enough to estimate that iOS users spend about a dollar a month on apps and in-app purchases. Android payment levels (both on Google play and with other methods) are significantly lower (perhaps half the value of iOS in total, despite having double the users, but there's very little data to go on), but again are rising (this Distimo report is one illustration).

Hence:

  • There are 2-3x more Android users than iOS users
  • The average Android user, for a range of reasons, downloads fewer apps and spends less on the app store than does an iOS user
  • However, there are so many more Android users that the total rate of app downloads has caught up with iOS and the total value of payments rate may also be starting to catch up

In other words, the average Android smartphone user is worth much less than the average iPhone user, but there are lots more of them.

Does install base matter? It may start to.

It is possible to argue that this does not matter much: if Apple's ecosystem of 400m active devices is big enough to sustain developers already, does it matter that the Android opportunity may become even bigger?

When Apple launched the app store, a year after launching the original iPhone, it had sold just 6.1m iPhones (as well as a significant number of iPod Touches), yet this was enough to attract a flood of developers - even a year later it had only sold 26.1m, which is roughly the same as the 27m Microsoft ( MSFT ) Windows Phone Lumias that Nokia ( NOK ) has sold to date. Yet Windows Phone is an afterthought at best for developers. Though some independent developers may see an opportunity in an empty Windows Phone app store, for most the question is where best to allocate limited resources. Where is the opportunity cost, and where is the best return? The size of an ecosystem per se is not important - what matters is which should be the first priority.

Hence, developers are starting to move from creating new products on the basis 'iPhone, then maybe Android' to 'iPhone and then Android' or even 'iPhone and Android at the same time'. Cool little apps from seed-funded companies are still iPhone-only, but most big well-funded businesses are doing both. Android is no longer optional for any publisher seeking real reach. This applies even more if your app is free, since Android download rates are much closer to iOS than are Android payment rates (and of course 'free' doesn't mean no revenue).

Of course, this comes with problems. It's pretty clear that for many developers supporting Android costs 2-3x what iOS costs (the BBC made this explicit , for example), which pushes it further down as a priority. In addition, lower individual engagement means lower CLV, and so the dynamics look different on (for example) customer acquisition. But the greater absolute numbers all act to push the other way.

If total Android engagement moves decisively above iOS, the fact that iOS will remain big will be beside the point - it will move from first to first-equal and then perhaps second place on the roadmap. And given the sales trajectories, that could start to happen in 2014. If you have 5-6x the users and a quarter of the engagement, you're still a more attractive market.

This is a major strategic threat for Apple. A key selling point for the iPhone (though not the only one) is that the best apps are on iPhone and are on iPhone first. If that does change then the virtuous circle of 'best apps therefore best users therefore best apps' will start to unwind and the wide array of Android devices at every price point will be much more likely to erode the iPhone base. Part of the reason for spending $600 on an iPhone instead of $300 on an Android is the apps - that cannot be allowed to change.

A new, cheaper, high-volume iPhone would have the potential to mitigate or even reverse this trend. Clearly, like current low-end Android, it would sell to a demographic with a lower average engagement and purchase rate and so the average iOS rates would drop. However, it would mean that iOS's reach would expand significantly at the expense of Android. How would a $200 or $300 iPhone sell? Easily double digit millions, possibly up to 50m units a quarter.

This means that the financial value of a cheaper iPhone cannot be considered in isolation. A large part of its purpose is to defend sales of the high-end model.

Note: This is an excerpt from a longer report on the outlook for a cheap iPhone that I published for Enders Analysis.

See also Procter & Gamble: Bulls Won't Regret It, And Neither Will You on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Technology

Referenced Stocks: AAPL , GOOG , MSFT , NOK

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