Apple announced a torrent of new software features at last week’s Worldwide Developers Conference, strongly hinting at the upcoming launch of an Apple “iWatch” with frameworks for health tracking and home automation.

But as the buzz and speculation around what this iWatch will deliver continue to ramp up, there is one critical factor that has been largely ignored by the pundits, tech blogs, and rumor sites: business fundamentals.

Much has been made of Apple’s focus on design and the user experience, but the company is equally skilled at creating solid business cases for every product it launches. For this reason, the best way to understand Apple’s thinking on the iWatch is not through slick mockups or leaks from deep inside the mothership, but instead by putting on our Product Manager hats and looking at the facts.

We can learn a great deal about what their next move will likely be simply by looking at market indicators and the company’s public financial reporting.

We’ll be exploring the increasing importance of wearables in the mobile industry at MobileBeat 2014.

Join us in San Francisco on July 8-9!


What We Know

 1. The iPhone product line is experiencing margin compression

Despite its role as the main driver of Apple’s growth and profitability in recent years, the iPhone is under intense scrutiny by investors and industry pundits. The smartphone market is already showing signs of saturation, and will soon be largely commoditized. Competitors at home and abroad are making larger devices with more features, quickly catching up on the low-end.

Apple’s only way forward is to continually play the product leadership game, adding increasingly advanced features while simultaneously increasing the quality of the materials and user experience. Fortunately, this game is exactly what Apple does best, but in the near-term it will inevitably increase the Cost of Goods of future iPhone models.

On the sales side of the equation, Apple is feeling pressure from channel partners (including carriers and resellers) that care very much about the money they make from device sales. The iPhone’s competitors offer selling programs — the terms that govern how much the channel partner earns from each sale — that often give them more profit dollars per device sale than Apple offers. Apple might soon need to adjust its selling programs to keep their channel partners happy.

The bottom line is that both of these factors will shrink Apple’s iPhone margins over time, if they are not doing so already. This threat is the key to understanding the importance of the iWatch

2. Smart watches so far have been disappointing

Samsung’s Galaxy Gear smart watch failure has been quite public, with unprecedented 30% return rates. The Pebble is a decent, but very limited product. Most of the other potential players are still in development, waiting to see how the field takes shape.

Now why would Apple want to enter such a small, fragmented market currently geared to the earliest of early adopters? Because Apple will take a completely different approach, as they do every time they enter a new market.

3. People don’t buy watches to tell the time

Business is good these days for jewelry and watch manufacturers. Gross margins are very healthy, and product life-cycles are long. I have no doubt Apple has noticed that as we argue over $50 price differences for smartphones, every day all over the world people purchase luxury watches that cost many thousands of dollars.

Do these prices have anything to do with the need to have the time on your wrist? Obviously not. Watches are status symbols at their core, which the luxury goods industry has known for a hundred years and nearly all smart watch endeavors thus far have failed to take into account. Apple has taken note, and as I explain below, they are perfectly positioned to take advantage of this oversight.

4. Apple is one of the world’s most admired brands with storefronts in the best retail locations alongside top luxury brands

I was at IFC Mall in Hong Kong recently and, as a life-long Apple fan, was impressed at their massive two-story store taking up an entire corner of the mall. But what struck me the most was the observation that most of the stores surrounding the Apple store belonged to luxury watch, jewelry and handbag brands. Could Apple borrow some of the strategies used by the world’s top luxury brands? Hiring one of the industry’s top-performing stars would be a good start…

5.  Apple has hired the former CEO of Burberry to head its retail stores

In the words of Steve Jobs at the 2007 iPhone launch, “Are you getting it yet?”

What We Can Guess

The launch of an Apple iWatch will solve several problems at once. Here’s what we can guess based on what we know:

1. The iWatch will solve the iPhone margin compression problem

The iWatch will be part smart watch, part luxury good. There will eventually be a slew of models at varying price points, but the top-of-the-line models might be sold at upwards of $2000. More affordable models could be priced in the $200 range. These products will stand out even more than the original iPhone did as public status symbols, with Ive’s famous attention to detail reaching its pinnacle in the product that most symbolizes craftsmanship and refinement.

The iWatch’s significantly higher margins will not only compensate for the iPhone’s margin compression, but actually expand blended margins when considering the impact of iWatch-attached iPhone sales.

2. iWatch will allow Apple to penetrate the upper end of emerging markets, where the company’s greatest growth potential lies

Apple’s financials show us that its greatest growth potential lies in emerging markets. But this doesn’t mean that they will create a product for the masses. The iWatch will resonate strongly with the upper-middle class and upper class of emerging economies like Brazil, China, India, Russia, and others.

Apple doesn’t need to make a “cheap” iPhone when there are already over a million millionaires in China that would love to buy a luxury iWatch with their iPhone. The iPhone will never be the phone for everyone and that is perfectly fine in the company’s eyes. Apple is famous for growing responsibly by choosing who NOT to do business with, and they have plenty of room to grow without trying to be everything to everyone.

3. The iWatch will leverage Apple’s existing tremendous brand equity and retail investment

The iWatch will have some great features, but it could literally just tell time and it would still sell well. Apple will sell the new product via its retail stores, under the lead of a luxury goods wizard, leveraging its perfectly placed retail real estate and attracting customers who are already shopping for luxury goods. Apple store employees are already comfortable selling devices that cost many thousands of dollars today.

The iWatch is today the focal point of many of our hopes for a digital experience that is more engaging, natural, and nuanced. But as others in the smart watch race have focused thus far on the technical aspects of a smart watch, Apple will enter the market in style, literally and figuratively, and this will make all the difference.

Derick Dahl is the Product Manager at iPort, a mobile device accessories company in San Clemente, California, and inventor of LaunchPort, an inductive charging and magnetic mounting system for iPad. Dahl specializes in the design and development of mobile technologies.