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Why The Apple Watch Will Fail

|Includes: Apple Inc. (AAPL)

Background

Apple Inc. (NASDAQ:AAPL) has recently launched its Apple Watch and forecasts have varied wildly as to exactly how this new Apple product will end up selling. The Apple Watch retails for a higher pricethan its competitors and offers few differences in terms of functionality. The company is essentially relying on brand recognition and customer loyalty in order to sell the watches, which has worked in the past for selling iPhones and Macbooks. However, there is a significant difference between those two products and the Apple Watch, which I will discuss in this article.

AAPL Chart

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Why the Smartwatch Market is Different

Apple has become the biggest name in technology and has developed an instantly recognizable and hugely profitable brand name. This has led to success in, among others, the mobile phone market and the laptop market. The company established this brand through the innovation and design genius of Steve Jobs. But there is a main difference between those two successes and Apple's smartwatch business. The company's success in those markets was mainly due to two main factors: 1) there was an existing market and 2) Apple's sleek and stylish products filled a void for this type of product in the market.

These two conditions were present in Apple's forays into the mobile phone and laptop markets, but the environment in the smartwatch market may not be as ripe for the company's picking. There is an existing market for smartwatches but not nearly to the extent there was for smartphones and laptops when Apple's products entered the market. Smartwatches, and watches in general, are not a staple of society like cellphones or laptops were and are, and many are uninterested in the wearable device concept. This may change in the future, but for now it seems that the general public is somewhat disinterested towards these products. After all, there is a big difference between buying a device that you will use rather than buying a device that you will wear.

Regarding the second condition, I would argue that the smartwatch product concept itself is already a sleek and stylish one and that Apple has no advantage over other smartwatches in the market. In addition to that, the fact that the Apple Watch is one of the moreexpensive products on the market will not hurt sales as well. I believe the Apple Watch's high retail price can be traced back to the company's reliance on brand recognition. But brand recognition can only take you so far. According to Quartz, the Apple Watch initiallysold out and then sales immediately fell off a cliff.

That graph does not look promising at all. The lackluster sales numbers are indicative of the two conditions I mentioned previously. The smartwatch market is not large enough for a Apple to come in and sell a high-priced product that has limited product differentiation and expect to make a splash. Now perhaps Apple is trying to expand the market like it has done so successfully with other products, but initial results don't look good. The previous graph is little misleading because it's meant to show the contrast between the initial number of watches ordered and watches ordered on subsequent days. The following graph is more telling.

Ignoring the spontaneous peaks and troughs, the general trend has been a decline in sales. Different analysts and firms have been raising estimates and decreasing estimates constantly. One Morgan Stanley analyst raised her forecast to 36 million Apple Watch shipments for 2014. I don't know about you, but considering the graph above I would say that forecast is extremely generous at best.

It's my opinion that Apple's main issue is that it can't differentiate its product and therefore can't justify its higher price. Brand recognition works to a certain point, but the more the benefits outweigh the costs, the more likely it will become that consumers will go elsewhere and forsake their loyalty. An indicator that a product is selling mostly on brand loyalty is if the pre-orders for the product are through the roof but then sales drop off a cliff. This could be showing that consumers loyal to Apple all wanted the next new thing from the company, but actual demand from non-loyal or less loyal consumers is very low. It remains to be seen whether there will be some turnaround in consumer demand and interest in smartwatches, but current information indicates that the Apple Watch will not expand the market and will not allow Apple to dominate market share in the existing market.

How Does This Factor Into the Investment Thesis?

The failure of the Apple Watch in itself does not affect the long thesis, and if this is an isolated incident then Apple is still an excellent stock pick. However, it is also possible that this could be the harbinger of more failures for Apple products. Apple built its brand by making fashionable, simple and competitive products that appealed to all consumers. Not by creating an indifferentiable product and relying on brand recognition to make the sales.

It is likely that the failure of the Apple Watch will be a one-time fluke and that all Apple products going forward will garner the same success as their popular predecessors, perhaps learning from the mistakes of the failed smartwatch. On Monday, Apple hired Jony Ive as Chief Design Officer. Mr. Ive had a very significant role in creating the design and user interface of the Apple Watch. I don't doubt that the Apple Watch is a good product, just that it will be a successful product. The failure of the Apple Watch will hopefully spur Apple and Jony Ive to make their next product a true Apple product, and convince them not to rely on brand recognition to makes the sales.

Conclusion

The Apple Watch has stumbled out of the gate and market conditions are contributing less than kindly towards the product's sales numbers. It is my opinion that the Apple Watch will not be nearly as successful as the company's other products were to their respective markets and that sales will be immensely underwhelming. A future one-eighty of consumer sentiment may change the situation, but as of right now things are not looking good for the Apple Watch. This specific instance does not affect the bull thesis for Apple unless it's indicative of more to come. Apple must make products that can stand on their own and that don't rely on brand recognition to generate revenue, or they might find themselves in trouble.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.