How Apple has changed the Smart Watch market

A few months ago I wrote a report about the wearables market. At the time I was sceptical about the future of the smart watch. That was before the Apple Watch announcement. I didn’t think I’d find it very interesting. Now I’ve seen it, I’ve changed my mind – I think they’ve  redefined the market by turning the concept of the smart watch on its head.

The prospect of Apple owning the wrist galvanised many other manufacturers into pre-empting them, of which the most notable contenders were Pebble, Motorola, Asus and Samsung. All want to seize the wrist, in what might be described as a case of carpus diem. Many in the industry want to believe in these products, predicting massive sales volumes and revenue. Few have bothered to ask customers what they want. Two who did were Kantor and Apple Insider. Kantor’s panel suggested up to 60% of iPhone owners would buy one, Apple Insider found “as many as 4%” of iPhone users would be early adopters, translating that finding into an estimate of sales between 5 and 10 million units in the first twelve months”. So what’s the truth?

When the Apple Watch announcement came, it only generated a muted whimper of excitement. It wasn’t what most commentators had expected. That was hardly surprising given the level of hysteria which had been whipped up prior to its unveiling. Whilst a lot of subsequent reviews have complained about its lack of functionality I found that I warmed to it, or at least its potential. It’s not just clever packaging of technology, which is what exemplifies the Asus, Motorola and Samsung watches – it’s a redefinition of the purpose of the wrist. I think it may be more of a game-changer than has been reported, but not necessarily in a positive way for the rest of the smart watch industry.

One thing the Apple announcement is likely to have done is to decimate the market for competing smart watches in 2014. Showing their creation off just before the Christmas period, but not shipping until early 2015 (which may well slip) will leave many of their competitors facing Christmas feeling a bit like the turkeys that will grace the dining tables – they’ve been well and truly stuffed. Many would-be purchasers will now wait for the Apple Watch, which will leave distributors desperate to offload stock before next year’s new model arrives. For many manufacturers, that next model is already on the brink of production, giving them the problem of delaying or killing it, or building up an inventory which may end up being given away as a free accessory for a phone. Even worse, the Apple Watch won’t be available in time for them to analyse it before they embark on their next product design cycle. They’ve effectively had the carpet taken out from under their feet (or wrists) for the next eighteen months, leaving them out of the running until Christmas 2016.

The basic problem with all of the other smart watches is they only do the things that your smartphone already does. They don’t provide users with any new applications. Given the fact one needs a smartphone to make the smart watch work in the first place, it’s difficult to see why many will find it compelling. There will naturally be people who buy one for the novelty value and because it’s new. But that’s just a fad. Fads only turn into a market when the product impresses their friends enough for them to buy one and everyone then starts replacing them with newer models to stay ahead and access the extra functionality. Buying one and putting it in a drawer after the first few months doesn’t count. The back of the drawer is not a compelling market segment for growth.

The problem for smart watches is that they are trying to reverse a longstanding trend of not wearing watches. My ad-hoc research suggests that in London watch wearing has fallen below 20% for the target demographic. But manufacturers of smart watches have another problem. These are devices which impose an additional task of charging and it is questionable what the return is for users? Unless the equation can move from merely new and useful to exciting, the smart watch market will struggle.

Another issue is their size. Almost all smart watches seem to be designed for West Coast consumers. Specifically people who only ever wear T-shirts, because the majority of smart watches are too big to fit under the cuff of a long-sleeved shirt. Which is a major sales barrier for anyone living in cooler climates, or who’s not male. I’ve yet to see a mainstream smart watch designed for the female wrist.

Prior to the Apple Watch, I had thought the market would split into two distinct segments. The first would be expensive watches – ones which believe they can play in the “haute horologie” market of Rolex and Breitling, or at least who aspire to. Samsung, Acer, Motorola et al fit there. The second category was cheap watches that are little more than wrist worn ringtones. The Apple Watch has made me think again. I now believe it will form its own category, which it will dominate for at least the next five years until it is either forced to let others join its game, or disappears because consumers aren’t interested. The reason is a subtle but important one. Until the other week everybody believed that a smart watch complemented a smartphone. What Apple demonstrated, and was castigated for by many who didn’t appreciate the difference, is that they’ve turned the tables. In their case, the iPhone complements the Apple Watch. It’s a very neat trick, for which they deserve credit.

Why is it different? It can interact with other Apple watches. That may be twee at the moment, but it has the potential for innovative apps that have noting to do with phones. It can pay for things, which we’ll come back to. It also makes extremely clever use of wireless technology, which should help its battery life. Here, as elsewhere, Apple has been thinking very differently from most of the rest of the industry.

In a very readable article, written from the viewpoint of a watch collector, Benjamin Clymer observes that “If you wear an Apple Watch without your phone, what can it do? If it’s only a watch it has a problem.” He goes on to admit that “in its own way, Apple really pays great homage to traditional watch making. It is still not as cool as a mechanical watch, to real people. I don’t see people that love beautiful things wearing this with any great regularity. It is ultimately a Market Leader in a Category No One Really Asked For”.

That is a profound point and the beauty of the concept – it has generated a category that no-one asked for – it’s not the smart watch that anyone expected. Apple’s task is now to persuade the world that it is a product which they want to wear.

Looking again at the market categories, cheap watches have only one way to go. Bluetooth chip vendors are already pushing reference designs into Far Eastern manufacturers and the only direction these products will go is By 2018 the average price for these will have fallen below $20, tens of millions of them being sold. How they will differ from fitness wristbands is debatable. At the lowest price point, a fair percentage of low cost smart watches may be bundled with handsets.

The branded / expensive (non-Apple) segment will have a hard time. If my guess about the superior user experience of the Apple Watch is correct, competitors may be frozen out of the market for at least two years before they have a chance to catch up. That will lead to a lot of remaindered products left in warehouses, which will put pressure on price. The most likely effect is for the price to plummet from the current $300 mark to an average price below $100 by 2018, as the only way to tempt customers away from the Apple Watch user experience will be price. They’ll sell, but mainly to people who don’t have a iPhone and who worry about having a naked wrist.

It looks as if Apple, whether through chance or design have managed to give themselves a clear run at the market with a product that may well keep its premium $349 price point for the next five or six years. However, they have challenges which could still trip them up. The first is to ensure that the watch does enough to justify its price. Many of those who own an iPhone have never experienced the full price – they were bought with a mobile contract. We don’t yet know how the Apple Watch will be sold, but as it won’t generate more revenue for operators it probably won’t be subsidised. That’s where the different survey results from Apple Insider and Kantor come into play – will it be 5% of users or 60% who stump up to buy it? Although the design is beautiful, it is probably still considered too large by many, limiting its sales. Moreover, where an iPhone may be passed down the family with each upgrade, I’m not sure we’ll see the same effect with watches. If users like them, they could have a significantly longer life cycle – possibly up to three years.

There is a further interesting facet of this story. Whereas the Pebble – the first successful smart watch, was designed to work with any smartphone which had Bluetooth low energy, the Apple Watch will only work with an iPhone. More specifically a recent iPhone. As smartphones become more homogeneous the smart watch allows the phone to stay hidden in your pocket or bag, taking upon itself the role of the conspicuous brand. Apple’s approach of the phone complementing the watch reinforces this change. It’s a double edged strategy which acknowledges that the form factor of a smartphone is reaching a plateau beyond which differentiation is tricky. But it could segment the market more than ever before, inadvertently extending the time at which users upgrade handsets. If that’s the case, success in a smart watch may correlate with lower churn in smartphones, putting further pressure on Apple’s competitors. The Sword of Cupertino is a dangerous threat. Alternatively we may see a thriving market in Android compatible fake Apple Watches, mimicking the established business for fake Rolexes.

One further strand in the evolution of the smart watch market is the ability of the Apple Watch to make payments using Apple Pay. This is not the first time that secure, contactless payments have been tried in a phone, but the market conditions have changed. Credit card fraud is increasing and the payments industry is privately concerned that they’re beginning to lose the cat and mouse struggle with the fraudsters. The problem is that rolling out a new, more secure payment scheme is immensely expensive. Europe addressed that back in the late 1990s with the introduction of Chip and Pin, but it has never taken off in the US. Phone vendors have been playing with NFC for the last ten years, but have never shipped enough compliant phones to make it worthwhile for retailers to upgrade their Point of Sale equipment. That’s the chicken and egg dilemma which has stymied any progress in the market. Apple has upped the bar by including this payment capability in the iPhone6. Although these will only be bought by a small portion of the market, they will probably sell around 150 million units in 2015, growing to over 200 million in subsequent years as older non Apple Pay compliant handsets become obsolete. That is a critical mass which can persuade retailers to start upgrading their ePOS systems, beginning with high end stores frequented by the iPhone owning demographic before moving down into general retail.

There’s been a long debate about whether it’s easier to get a phone out to pay as opposed to getting a credit card out. That debate may now be irrelevant, because it doesn’t get much easier than paying with your wrist. If Apple Pay compliant terminals become widespread across the world, it turn out to be a compelling new user experience. The challenge for Apple will be to keep it to themselves. High end retailers may initially embrace it, but the wider retail market will not want to limit it to iPhone owners. Nor, if it decreases fraud, will the financial sector. They will put pressure on Apple to make it a more open standard, which will eventually remove it as lock-in benefit for the Apple Watch. I don’t see that happening until around 2018, as banks don’t move quickly. Until then, nothing is likely to put much pressure on Apple to reduce the price of their watch. As they lose that exclusivity, the price of the Apple Watch may finally start to fall. Whether competitors can then increase their pricing remains to be seen. It is a great opportunity for Apple, but by no means certain. However, if Apple stumbles along the way the whole smart watch sector may fall with it.

This year has been the foundational year for smart watches, with Pebble growing and the big players pushing a surprising array of what I term branded smart watches. A fair amount of the revenue had already been collected before the Apple Watch announcement, which should push the market to around $1 billion. In 2015 the Apple effect will push down price for its competitors as they try to clear stock, leaving Apple to take the lion’s share of revenue. Although cheap watches will dominate overall sales numbers sales from the second half of 2018, selling more than all of the other watches put together, it will be a segment that runs on thin margins, putting something on the wrists of those who want a replacement for a cheap watch, not a mark of status.

I don’t expect more than about 16% of iPhone users to wear an Apple Watch, but they will be paying full price for them. After owning almost 50% of the market in 2015, it will slip to just over 20% by 2018, but it should remain steady. However, they will take around 70% of the overall revenue for the sector. Could someone else challenge them? It’s possible, but Apple has a key advantage of a single phone platform and updateable operating system which makes it easy to promote a watch experience that works for all of its customers. Every other handset vendor has a fragmented platform across many phone models making it far more difficult to reach critical mass. Nor do I see any competitor understanding user experience anything like as well.

If this scenario plays out, other vendors may attempt to differentiate their products by moving away from calling them smart watches. They will incorporate other sensors so there will be increasingly blurred boundaries between wristbands, gesture recognition bracelets, smart watches and child trackers. By 2018 the watch element will probably not drive the sale – it will simply be the standby state of the wrist worn device. That’s another reason I like the Apple Watch – it really isn’t trying to be a watch or a receptacle for technology. It’s trying to be a new experience. For more dystopian readers, Ira Levin’s 1970 novel “The Perfect Day” provides a chilling view of where the technology could end up. It’s probably no more fictional than any other prediction. Alternatively you can download the updated Smart Wearable report to see where the market is going.