AAPL: New Products and Innovation.

By: Mike the PhD. http://seekingalpha.com/author/mike-the-phd


One of Apple’s (AAPL) latest patent filings isn’t for a new laptop, cell phone, or tablet. It’s not even for a new kind of TV. Instead, Apple seems to be exploring diving into the computer accessories market with an iPen. This new iPen combined with the recent talk in the press over the last few months about a new iWatch suggest that Apple may be looking to shift its strategy surrounding major products going forward.

Historically, Apple has tended to make major products that represent a significant purchase for an individual. The uniformity across products allowed individuals to link these products together, but creating an ecosystem for each product was by and large left to third parties (think about the App stores, or most of the software for MacBooks, or even most of the accessories available for iPods). For example, Apple produces the accessories that are essential for a given gadget (e.g. chargers), the company does not sell iPod alarm clocks or iPhone cases. This has long been a point of pride for the firm as Tim Cook discussed in an interview with Bloomberg Businessweek last year. However, all of this may be changing if the firm’s new patent filings are any indication.

A smart watch is an idea that has been tried many times before with little success. In the 1970s, Casio made calculator watches, in the 1980s Seiko made mini-keyboard watches, and Microsoft made web enabled watches a decade ago. In each case, the smart watch proved to be a dumb idea for the company involved. Few people bought these products, which have been widely regarded as geeky novelties. Even the most persistent of smart watchmakers to date has had little success – Sony still sells a line of smart watches for $129 apiece. These can be used for emailing, tweeting, or playing music, but they apparently can’t be used by Sony (SNE) to make much money as they are rarely discussed by the company.

According to an engineer friend of mine at Apple though, the company strongly believes it can do better. Apple has a team of a little over 100 people working on a smart watch, which it plans to introduce in the fall of this year. The watch will serve as an iPhone accessory and the company hopes it will help to shore up iPhone sales for the next generation or two.

The iWatch is to be a device similar to the wildly popular Pebble smart-watch, which interfaces wirelessly with a smartphone for messages (i.e. emails, texts, incoming calls, etc.). The iWatch should be able to do at least this, and more. In fact, it is possible the iWatch could become a popular real-life version of the classic Dick Tracy Video Communicator Watch. My contact tells me that the iWatch should actually be able to be used to make and receive phone calls directly, check map coordinates, monitor vitals like heart rate, and keep track of daily exercise. In fact, it is possible the iWatch may not even need a battery since Apple has filed a patent for a “flexible wrist worn device” that is “powered by kinetic energy” – aka walking and moving your arms.

Gross margins on an iWatch could range from 50-60% according to some experts, and if the product gains wide acceptance, Apple might be able to sell 50 million+ units in the first 6-8 months. According to Citi Bank analysts, the iWatch could be a $6 billion product for Apple based on a watch price of roughly $125 (Apple Bill of Material cost of ~$50-60).

Further, Apple appears to be following Detroit’s lead in that the company now makes considerable amounts of money on selling parts and repair services for its products. A MarketWatch article recently discussed the mammoth costs of repairing a broken iPhone screen explaining that new iPhone 5 screen replacements cost upwards of $200 each. Virtually all of the screen repairs are currently done by Apple because of the company’s control over its parts supply chain. In total, iPhone repairs have cost customers more than $6 billion since 2007, according SquareTrade. Future accessories like the iWatch add complexity to the Apple eco-system and should enable the company to increase its revenues from repair bills as customers have ever more devices that need to be replaced or repaired.

But wait you might say, ‘The iWatch is just one data point… it certainly might mean the start of a new product strategy at Apple, but it could just as easily be a one-off idea the firm has that looks to be worth exploring.’ And all of that is true, except that Apple seems to be exploring another similarly significant accessory… the “iPen.” While the iPen is a much newer concept, rumors have been circulating for months about a smart iWatch with varying views on the usefulness of the product.

Most recently, Apple took out a patent on an iPen. Apple filed for patents on the first iPen designs several years ago, but never introduced the product, perhaps because it was more interested in making sure the newest iPhone and the iPad were launched without a hitch, or perhaps because Steve Jobs didn’t see the potential (UK’s Daily Telegraph quoted him as being disparaging towards tablet styli in 2007 ). However, the idea seems to be making new headway at Apple as the firm filed a new patent on an updated device at the end of 2012. Adding credence to the possibility that the iPen is on its way, Apple filed for the patent under the names of two of its engineers, a technique the firm has often used in the past for devices that actually do make it to market. Given that no other popular tablets on the market use a similar stylus, it is highly unlikely that Apple is using this patent filing as a defensive mechanism for the iPad, which likely means the company is at least evaluating the market for the iPen.

Based on the patent filings, the iPen seems to be intended as a smart device that will not write just like a regular pen rather than only on a tablet. The firm’s patent described the pen as “A portable computer arranged to rest comfortably in the hand has a small display screen. Accelerometers capable of detecting movement of the pen with respect to gravity provide input to a microcontroller, which selects a response from a number of viewing modes. The pen may be held in either hand and the output message to the screen will be oriented according to the location of the pen. Full personal digital assistance functionality may be incorporated in a relatively small plastics casing and functions, such as calendar, contracts the like may be incorporated.” Now patent filings are intended by companies to be opaque, yet just clear enough to get the patent, so exactly what Apple’s plans are is still unclear. However, one possibility I think is that Apple is angling to create a pen that will enable a user to write down notes on standard paper (in a meeting, or a class, etc), and then easily transfer those notes to an electronic form without needing to scan or retype the notes. The pen might also be equipped with some sort of software to allow it to record speech and then put the speech into an electronic form later.

Presumably, the electronic device working with the pen would need to be a Mac or an iPad. Therein lies the interesting point I think – for the first time, Apple may be getting ready to release a product that is not particularly useful as a standalone product. An iPen without an iPad or a Mac would be just a pen (with perhaps some ability to receive electronic messages or some other minor features). Now it’s possible that Apple intends to bundle the iPen with the iPad, or that the iPen would be sold on its own. Either way, the device would be much more costly than other accessories like ear buds or a spare charger. As such, if Apple is expanding into the accessories market with high value add-ons like the iPen that would instantly make the firm’s products even more profitable, and frankly it would also give customers an increased incentive to upgrade their old devices.

Regardless of one’s views on the likelihood of success for either an Apple smart watch or a smart pen, Apple has a history of being able to make controversial products a success where others before have not (e.g. the iPad vs. virtually all past tablets). As a result, the products clearly do have some possibility of being big hits for Apple.

What I think is more important though, is that taken together these two products suggest that Apple may be starting to look at how it can develop families of products around its mainstay devices like the iPad and the iPhone. By creating optional add-on products that could significantly increase the “package” price for a device, Apple may be able to begin making its products even more profitable, and potentially give users a reason to upgrade their older devices. In much the same way that Ford started out making cars “in any color as long as it is black,” Apple started out making devices that you could buy any way you wanted as long as it was Apple’s way. Today of course Ford offers a multitude of color and design options with numerous add-ons that make each vehicle sold tremendously more profitable. If Apple’s latest products are any indication, the company may be getting ready to take a page out of the automakers’ book. (For a more extended discussion of the implications of this possible change for Apple’s profitability, see my blog here.)