Fast Company says the Apple Watch is a flop. I think Tim Cook disagrees.

Apple watch flop

Most people in the media are focused on calling the Apple Watch a success or failure based on units sales or market share. Those are great numbers for driving readership, but they miss an important truth: companies like Apple care much less about those metrics, and much more about whether the new product makes back the money invested in it, and goes on to make even more money. For long term shareholder value enhancement, that return on investment (ROI) is the only metric that really matters.

First we need to know cost: how much money did Apple spend on developing the watch and marketing it? Apple spends over $6 billion a year on R&D, so it is impossible to figure out what portion of that was for the watch. I just can’t see it being more than $400-500 million. Add another $50 million for marketing (Apple spent $38 million TV ads for the Watch alone) and we are at a $500 million investment.

We don’t know for sure how many watches Apple has sold, or the sales mix, so we don’t know average selling price (ASP) and therefore revenues. We also have only some guesses about how much the watch really costs to make (less than $100,) as teardown pricing is an inexact science at best. A reasonable guess would be that they have sold somewhere around 5 million units worldwide in the three months following the launch, at an ASP of $500, and an operating profit of $2 billion. Even if demand dries up entirely, and they sell ZERO watches for the next 9 month, the first year of sales would see Apple recoup its entire $500 million product development and marketing cost, and have an incremental gain of 300%.

Most companies that develop new products have various ROI hurdles. The lowest is “I hope we get our money back!” More common is “let’s get our money back, and then another 100% return over the product lifecycle.” That is considered a basic success, so 300% return in the first year would fall into the home run category.

Before I go any further, I need to be clear that this is all guesswork on my part. Next, many (many many) people care about this stuff primarily in terms of what it means for the share price, which I have no opinions on. Next, Apple makes about $75 billion per year in operating profit already, so while $1.5B from the watch sounds like a big deal; it may not move the needle much for a company as large and profitable as Apple. My comments ONLY apply to the question of “from Apple’s product development perspective, is the watch a success?”

And here is where it gets really interesting to me. Because the success or failure of the watch is likely not measured by Apple management purely in terms of watch units sold, watch revenues made, or even watch operating profits earned.

First, the media treatment of the launch has been both massive and largely favourable. At $1 per thousand impressions, the brand marketing value is likely in the hundreds of millions of dollars worldwide. I am not referring to Apple ads for the watch; I am talking about “free” media coverage.

Next, the watch is likely to be a useful part of the contactless payment business and Apple Pay. The company has high hopes that smartphone and watch “tap and go” NFC payments are about to be a big thing and if watch sales of 5 million (or whatever) help encourage mobile payment adoption, then that has another big boost for the ROI calculation.

But both of those are minor points compared to phones. Although Apple makes a wide variety of products, many of which would be the main deal at other tech companies, they are all dwarfed by the iPhone in terms of primacy for Apple. The iPhone is over 70% of Apple revenues in 2015 and likely over 75% in terms of profits. To put it bluntly – anything that drives more iPhone sales will be considered a success at Apple!

The Apple Watch only works with the iPhone 5 or later, and really only works best with the iPhone 6. Further, the watch only works with an Apple phone, it won’t work if you have a Samsung. If we keep using my nominal 5 million watches sold, then the math gets very good very fast. What if a million of those purchases were from Android users who were just dying to try the watch? What if another million were folks who bought a newer iPhone at the same time, just to catch all the benefits? And what if another million were thinking about switching to Android, but are sticking with Apple because their watch locks them into that ecosystem?

That last million has its benefits: sticky users, all buying stuff on iTunes and apps and so on. But the real ROI comes from the first two million, which are outright wins: a couple of million “bonus” high end iPhone sales at >$600 ASP is another $1.2 billion in revenues, and $400-$500 million in operating profits.

In other words, even ignoring the revenues from the watch itself, the “drag along” effects of tethering the watch so tightly to the latest iPhone may pay for the entire watch development and marketing costs.

Once again, that is probably irrelevant from a share price perspective. The media loves a horse race, and conversations around whether the watch is meeting, beating, or failing to meet Wall Street forecasts or live up to the hype are dominating the conversation.

But from the perspective of the Apple product innovation folks, they are almost certainly looking at the kinds of indicators of success above. I don’t know if the watch is a success or not, but I hope looking at it from this angle helps.

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