The Apple Watch Will Change the Wearables Landscape

JANUARY 1, 2015

The Apple Watch will Change the Wearables Landscape

DEBORAH WEINSWIG Executive Director–Head Global Retail & technology Fung Business Intelligence Centre [email protected] New York: 646.839.7017

JANUARY 1, 2015

The Apple Watch will Change the Wearables Landscape

Executive Summary Apple was not first to enter the smartwatch game. The Samsung Galaxy Gear, Sony SmartWatch, Pebble, Motorola and LG G Watch R, to name a few, all beat Apple to market by a long shot. But in technology, and notably in wearables, it’s not always the first to market who rules the perch. The winner is the one who offers a differentiated product and can effectively inform the consumer. The success of the iPad is a great example of how unique packaging reawakened the market for tablets, a product that had already been around for over twenty years. The user experience changed because the interface had changed. We believe that the Apple Watch could cause the same type of disruption in the smartwatch market and by extension, to the wearables landscape.

SMARTWATCHES CURRENTLY ON THE MARKET There are many smartwatches currently on the market from vendors including LG, Motorola, Pebble, Samsung, and Sony. The graphic below contains a collage of smartwatches.

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The table below contains a list of the top-10 smartwatch companies, their most popular models, along with units shipped, sales, and market share.

Figure 1. Top 10 Smartwatch Companies

Units Name of Sales Market Shipped Company Country Smartwatch ($ Mil.) Share (%) (000) Samsung South Korea Galaxy Gear 800 $240 33.8%

Nike USA Fuelband (incl. SE) 400 60 8.4 Forerunner 220/620, D2, Garmin Switzerland 200 60 8.4 S4 Fitbit USA Fitbit Force 450 59 8.2

Sony Japan SmartWatch 250 50 7.0

Pebble USA Pebble Watch 300 45 6.3

Shanda/Geak China Geak Watch 100 30 4.2

Mio Alpha Canada Heart Rate Sport Watch 100 20 2.8 Yingqu China InWatch One 50 13 1.8 Technology Casio Japan G-Shock Bluetooth 50 10 1.4

Other 30 Companies 450 125 17.6

TOTAL 40 Companies 3,150 711 100

Source: Smartwatchgroup.com

MARKET SIZE

The smartwatch market is poised to take off. Estimates by NextMarket Insights show annual smartwatch sales growing from 15 million units in 2015 to 373 million units by 2020. A recent UBS survey found that 10% of consumers polled want a smartwatch, and concludes that the Apple Watch will have a strong showing in its first year, pulling ahead of most other smartwatches on the global market.

Figure 3. Worldwide Annual Shipments of Smartwatches 2012-2020 (Millions)

400

320

240

160

0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: NextMarket Insights

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A November 2014 Morgan Stanley report estimates that between 30-60 million Apple Watches could be sold in the first 12 months of availability, representing between 1.5 and 3.1 times the total market in 2014. According to Morgan Stanley’s November Blue Paper on Wearables, 19% of consumers will be “probably buying” and 30% “maybe buying” the Apple Watch, similar to purchase intentions for all existing devices combined.

Figure 4. Purchase Intentions for the Apple Watch

30%

25%

19% 19%

Deﬁnitely Probably Maybe Probably Deﬁnitely would buy would buy would buy would not buy

Source: AlphaWise Survey August 2014, Morgan Stanley Research

Piper Jaffray anticipates that the watch will be released later than the currently anticipated Spring 2015 launch and estimates that at least 10 million units will be sold in the first year on the market. Piper’s recent survey shows that only 7% of current iPhone users intend to buy an Apple Watch when it becomes available. Wall Street consensus estimates call for around 15 million units to be sold in the first year. Apple’s primary competitor in the wearables market is Fitbit, which controlled nearly 50% of the 2.7 million unit wearables market during Q1 2014. Business Insider’s BI Intelligence projects that the wearables market will reach $12.6 million by 2018, led by “wrist-born gadgets”. If Apple’s 12% global smartphone market share in this last quarter (IDC) is an indication of how strong the company’s loyalty base will be for the “add on” device of the Apple Watch, the company has a huge potential to disrupt consumer’s buying patterns in this market.

Figure 5. Overview of Brokerage Apple Watch Estimates

Piper Jaffray Morgan Stanley UBS Smartwatch 7% of consumers 10% of iPhone users, 10% of consumers purchase intentions Est. unit sales of 10M in first year on 30-60M first year 24M units FY2015 Apple Watch first market (Sept.) year/2015

Sources: Piper Jaffray, Morgan Stanley, and UBS

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REVENUE SCENARIOS If we conservatively estimate that 11 million units could be sold at a price of $349, the Apple Watch’s least expensive option, we would be adding $3.8 billion to Apple’s top line in the first year the Apple Watch is available on the market. Alternately, if we assume 60% of the market will buy at the lowest price point of $349, 30% at the low end of the $749 mid-price category, and 10% at the bottom end of the luxury category, and also assuming 11 million units sold would generate $6.1 billion in revenue the first year the Apple Watch is on the market.

Figure 6. Apple Watch Revenue Estimate (@ 11 Million Units)

Unit Price Assumed Mix (%) Total Sales ($ Bil.) $349 60% $2.3 749 30% 2.5 1249 10% 1.4 TOTAL SALES 100% $6.1

Source: FBIC

Thus far, consumers have shown an intense but passing fascination with gimmicky wearable products. Just tracking the numbers of steps taken, or seeing how well consumers slept has not turned to be endlessly entertaining. One of the big issues at the top of industry conversations is long-term consumer engagement. Designers have discovered that a compelling experience optimized for long-term consumer engagement is a crucial element that products need in order to be integrated full time into a user’s lifestyle.

Designing for the senses and sustainability inside a space must be part of the inception of a new wearable. The Apple Watch’s combination and application of visual, tactile and audio capabilities is unique to the smartwatch and, most importantly, can be individualized to the customer.

APPLE WATCH VS. SONY SMART WATCH: THREE KEY FEATURES

Let’s compare key features of the Apple Watch with the current top smartwatch on the market – the Sony Smart Watch 3. APPLE WATCH SONY SMART WATCH 3 • S2 processor • 1.6 in size • Needs iPhone 5 or higher • TFT LCD “transflective” display • Flexible retina display • 8mm thick • Wi-Fi/Bluetooth 4 connection • 10m Bluetooth range • 38mm or 42mm sizes • 3-4 day battery life • Strengthened Ion-X glass Sapphire • Compatible with Sony products crystal screen • Inductive charging • Built in microphone • Customizable screen design • Full integration with most apps/Apple tools

The slogan for the original iPhone was, “Apple reinvents the phone.” Very quickly the iPhone became a device whose broad range of functionality distinguished it from other smartphone devices and made it a must-have item with many consumers. Apple is

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approaching the smartwatch market in much the same way—reinventing what customers have come to expect from their smartwatches not only through adding functionality and customizing touch and visual components, but also by perfecting and distinguishing existing usage. Apple has won when the consumer begins to view the Apple Watch as both a tech and fashion piece for daily use.

Figure 8. Consumer Interest in Purchasing a Smartwatch, by Country

Total US UK China Italy Base: All likely to purchase a 747 64 48 340 295 smartwatch Samsung Gear 37% 31% 25% 34% 43% Apple Watch 25% 28% 17% 36% 13% Sony SmartWatch 6% 6% 6% 5% 8% Motorola Moto 360 2% 0% 6% 3% 1% Garmin Forerunner 2% 2% 6% 2% 2% Z1 Android Watch-Phone 2% 2% 4% 2% 1% Source: UBS

FUNCTION AND APPLICATION: WHAT’S SPECIAL ABOUT THE APPLE WATCH? The Apple Watch isn’t just built for fashion, mobile optimization or fitness tracking. It is designed to surpass current wearable technology options in all three. Apple Watch Models This table below shows several Apple Watch models, their price range, and their key physical characteristics.

Figure 9. Overview of Apple Watch Models

The Sport The Watch The Edition

Type/Designe

Estimated Price Range $349 $749-999 $1,249-4,999 Distinction Anodized Aluminum Stainless Steel 18k Gold Source: Apple

Key Features • Fashion: It can be personalized and customized. The Apple Watch can be customized and personalized (in the choice of metal, design and color of the band and face, as well as personalized setup and alerts) more than any other smartphone currently on the market. The consumer has made this message clear—whatever item they are wearing on their person needs to create, define and proclaim individual style. Apple describes the Apple Watch as its “most personal device ever,” and it is seen as value added to the consumer’s most important piece of personal technology—their iPhone.

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• Mobile Optimization: New apps for the watch. Apple’s WatchKit software development kit, announced last November, enables developers to start creating new Apple Watch apps. Some of the functional and cutting edge abilities of the Apple Watch include notifications the user can take action on or respond to from a glance, such as turning lights off after leaving the house, assessing flight details, or re-routing a trip to work when a train or bus is late. The American Airlines app, for example, will remind the wearer when to head to the airport, notify them of gate changes and connecting flight information and provide in-flight real-time “where am I” information—that is, of course, if the user is connected to onboard Wi-Fi. • Fitness Tracking: Innovative measurement and calculation. Health and fitness devices are some of the better known and used wearables in the market, but they have also faced challenges of long-term customer engagement. One of the more interesting health functions of the Apple Watch is the accelerometer, which measures total body movement, calculating calories burned. This could be an answer to the issue of health monitoring wearables that currently provide heart rate or other such data without meaningful application, and also an incentive to the consumer to continue using the product over time. Health functions are also interactive. An Apple Watch can suggest fitness goals based on its wearer’s history and continued interaction with the device. It even reminds wearers to get up if they’ve been sitting too long.

Product Highlights • Functions: Timekeeping, new ways to connect, health and fitness The Apple Watch combines the usages of a watch and smartphone, and offers faster, more tactile ways of keeping in touch via new touch and visual sensors • Versions: Apple Watch, Apple Watch Sport and Apple Watch Edition Design Highlights • Real-time finger sketch messaging • Taptic engine with haptic feedback: You tap it to operate various functions, it taps on your wrist for notifications • Ability to create individualized communication functions (i.e. sending someone your heartbeat) • Force touch: The watch distinguishes between a light tap and a deep press • Cross-platform: You can start a message on the watch and finish it on your iPhone • Custom heart rate monitoring: 4 sensors allowing a comprehensive daily picture • Wi-Fi and GPS enabled to track workout distance • 4 sensors for heart rate monitor allowing a comprehensive daily picture • Accelerometer evaluating body movement, measuring three types of activity (calories burned, for brisk and standing activity) • Water resistant speaker • Custom S1 chip and Inductive charging in a completely sealed unit • Energy efficient • Retina display

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THE iPHONE-APPLE WATCH CONNECTION: A HUGE POTENTIAL CUSTOMER BASE AWAITS The Apple Watch must be connected to an iPhone 5 or newer to function. It is clearly intended to be an accessory to the intensely marketed iPhone 6 and 6 Plus. And similarly, it might just convince some consumers to switch to the iPhone ecosystem from Android so they can have one. Some pundits speculate that Apple could sell 200 million iPhone 6 units in the first fiscal year (Oct 2014-Sep 2015), which makes for a huge potential customer base for the Apple Watch. The growth potential of the smartwatch industry including Android models is enormous, with some analysts predicting sales of 373 million units by 2020. ABI Research predicts that Apple Watch will gain at least half of Android’s share in wearable devices in 2015, with also showed iOS gaining a 35% share in the global smartwatch market, not far from Android’s 42%.

Figure 11. Worldwide Smartphone OS Market Share (Share of Unit Shipments)

Source: IDC, 2014Q3

According to data from market researcher NPD Group, the majority of people use smartwatches for functionality other than calls, music, and fitness—leaving lots of room for e-mail, shopping, games, banking and other usage.

Figure 12. Smartwatch Use Preference in the US

24% Making and Receiving Calls 38% Listening to Music

Fitness Tracking 20% 18% Others

Source: NPD Research, January 2014

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As More Teens Buy iPhones, More Will Pair Their Phone with a Smartwatch With the percentage of teens buying iPhones on the rise, it follows that their smartwatch choice will be the Apple Watch. How will retailers in the teen and early 20s categories be affected? Because technology is increasingly more of an important fashion statement than clothing such as jeans and tops, we believe the following retailers and brands could see a negative impact in 2015 from Apple Watch sales.

Figure 13. US Teen iPhone Ownership, % of Affluent Teens

73% 67% 65% 62% 55%

40%

I Own an iPhone I Expect My Next Phone to Be an iPhone Fall 2012 Fall 2013 Fall 2014 Source: Piper Jaffray

RETAIL COMPANIES COULD BE AFFECTED

For the lowest price point of the Apple Watch, it is likely that 18-25 year olds could purchase an Apple Watch purchase rather than a new piece of clothing or accessory. Retail companies and brands that could be adversely affected by Apple Watch purchases include: American Eagle Outfitters, Abercrombie & Fitch, Hollister, Urban Outfitters, Aéropostale, and PINK-Victoria’s Secret. The Apple Watch Could also Disrupt Mid-Level Luxury Markets With Apple Watch prices ranging in the U.S. from $349 to upwards of $3,000 (based on options and watch finishes range from stainless steel to 18k rose gold), the Apple Watch is a luxury wearable. With overall luxury sales worldwide cooling, we are seeing the mid- level luxury market growing, especially in China. While the Apple Watch is priced in the U.S. to fit directly into this mid-level luxury range, other countries where the iPhone is harder to come by could bring the cost of the Apple Watch up thousands of dollars more, as we saw take place with the iPhone 6 and 6 Plus. We believe this could further disrupt the luxury market, especially the first two quarters of 2015. Luxury brands and companies that could be adversely affected include: Coach, J. Crew, Michael Kors, TAG Heuer, and Tiffany & Co.

A CATALYST FOR A MORE ROBUST WEARABLES ECOSYSTEM We believe that the launch of the Apple Watch will increase consumer awareness of wearable technology and will also serve as catalyst for greater and broader development of the wearables ecosystem. Apple clearly sees the wearables industry as having massive growth potential. We suspect its success in redefining the marketplace will have a massive effect in drawing in other players and expanding this market in the future.

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The Apple Watch has been imagined by designers, metallurgists, algorithm scientists and other specialists, working in tandem to create a market disrupter, fully reaching into hardware, software, design and long-term consumer engagement issues. The goal of creating a product integrating both core technology and fashion drivers, is indicative of how much Apple sees the wearables industry as having massive growth potential.

Deborah Weinswig, CPA Executive Director – Head Global Retail & Technology Fung Business Intelligence Centre Global (FBIC Global) New York: 917.655.6790 Hong Kong: +852 6119 1779 [email protected]

Marie Driscoll, CFA [email protected]

Christine Haggerty [email protected]

John Harmon, CFA [email protected]

Amy Hedrick [email protected]

Fong Lau [email protected]

Lan Rosengard [email protected]

Jing Wang [email protected]