memorandume

◼ TECHNOLOGY Bloomberg Businessweek October 1, 2018

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THE BOTTOM LINE MACI is probably right only for 10,000 to 15,000 people a year, but it’s a big deal to those people, and it’s driven Vericel’s revenue up an estimated 25 percent this year.

In the latest iPhones that went on sale on Sept. 21, the biggest upsell isn’t the wide-stereo speakers, the dual-lens camera, or the stainless steel accents. It’s the tiny Nand storage chip that lets you save all those photos in Portrait Mode.

The high-end XS and XS Max models unveiled earlier in September come with a 512-gigabyte storage option, twice as much as the previous maximum and enough to hold a couple hundred thousand photos or dozens of high-definition mov- ies. That’s up from a maximum 256GB on last year’s flagship iPhone X, and 64 times as much as what the original iPhone had a decade ago. Apple Inc. charges customers a lot more for this storage than it pays suppliers, and it hasn’t reduced the markups for higher-capacity options or provided a way for customers to add storage later, even though com- ponent prices are falling sharply.

Apple is tackling a global smartphone industry slowdown by raising iPhone prices, offering new dig- ital services, and wringing more profit from parts that are becoming more commoditized. Selling more

● The new 512GB storage chip could make the company $134 more per phone than the 256GB option

You Can’t See Apple’s Most Lucrative iPhone Feature

▲ Apple Senior Vice President Philip Schiller at iPhone XS and XS Max unveiling

The cells grow slowly through the collagen membrane, which dissolves harmlessly, then they migrate through the damaged cartilage to the bone. There they adhere and spur cartilage production, gradually filling in the gaps and resulting in less pain and better knee function. “It’s like filling a pothole in the road,” says Vericel Chief Executive Officer Nick Colangelo.

Complicated as that may sound, it’s a breeze com- pared with traditional operations, which are much more invasive and complex, and for some patients it’s much more effective than the usual cortisone- and-pills approach. MACI, approved by the U.S. Food and Drug Administration in December 2016, is a tantalizing possibility for the growing popula- tion of even weekend athletes wobbling around with damaged cartilage. Vericel says the number of U.S. surgeons trained in the procedure will top 900 by the end of 2018, close to double the 2017 figure. “I think you’ll see wider adoption of this technique, since it’s very straightforward,” says Kristofer Jones, an orthopedic surgeon at the University of California at Los Angeles who’s an expert in cartilage repair.

MACI is part of a broader boom in tissue engi- neering, the use of advanced cell therapies to grow parts of organs and other anatomy. The approach has already been used to rebuild dam- aged trachea and blood vessels, and researchers are developing it to repair chronic wounds and treat spinal cord injuries.

The cartilage scaffold has quickly become the flagship product for Vericel, known until 2014 as Aastrom Biosciences Inc. Since MACI’s FDA approval, Vericel has reported five consecutive quarters of record sales. It expects 2018 revenue of more than $80 million, up from $64 million last year. About 10,000 to 15,000 U.S. patients a year qualify for the procedure, creating a potential market for Vericel of $700 million a year, estimates Danielle Antalffy, an analyst at investment bank Leerink Partners LLC.

As those numbers suggest, MACI isn’t cheap. The scaffold alone costs $40,000, and because the procedure is so new, securing insurance coverage can be difficult. It also doesn’t work for everybody with cartilage damage. The 27 million Americans with the inflammatory condition osteoarthritis need to stick with traditional treatments. But for under-55s who don’t want to think about knee replacements just yet, it’s worth it, Mannino says. “I’m too young,” she says, “to not be able to walk up and down the stairs.” �Michelle Cortez

◼ TECHNOLOGY

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What’s next

PandoraDeal Snapshot

The sale, which values Pandora at about one-quarter of its peak share price in 2014 and 37 percent below its 2011 initial public offering, is a reminder that the company has struggled to improve its finances and keep up with shifting industry trends.

BUYER

Sirius XM Holdings Inc. Satellite radio broadcaster

ANNOUNCED PRICE

$3.5b in stock

The internet radio company announced an agreement on Sept. 24 to sell itself to Sirius, which acquired a stake of less than 20 percent in 2017 and is controlled by billionaire John Malone.

The idea is that Pandora’s 70 million monthly users, including about 6 million paying customers, will help Sirius compete more directly with the likes of Spotify and Apple Music. So far, executives have offered few details.

For almost its entire life, Pandora, unlike Sirius, has spent more money than it’s generated.

Sirius and Pandora are better off together, but the combined company will still face serious challenges adapting to a music business shaped by Spotify, YouTube, and the Amazon Echo. Pandora Media Inc. was a pioneer that wound up as a footnote and has mostly itself to blame. �Shira Ovide, Bloomberg Opinion

$400m

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◼ Sirius XM ◼ Pandora

Sirius XM

33m subscribers

$13.30 revenue per user

Pandora

6m subscribers

$6.52 revenue per user

THE BOTTOM LINE If Apple is able to take advantage of the drop in Nand flash memory prices, it isn’t passing the savings on to consumers of its increased storage options.

storage with iPhones is a powerful example of the latter strategy. “Storage is one of their levers to cre- ate more revenue and is absolutely the most profit- able iPhone feature,” says Wayne Lam, an analyst at researcher IHS Markit. Adding more isn’t much work for Apple, because it just means swapping a chip, he adds, “whereas when you increase the screen size, you have to completely re-engineer the phone.”

Here’s Lam’s rule of thumb: Storage costs Apple about 25¢ per gigabyte, while the company charges customers roughly 78¢. By doubling the maximum available amount, it’s digging deeper into this earn- ings gold mine. Apple charges an extra $350 to jump from the 64GB minimum to the new 512GB option. Data compiled by Bloomberg show that, exclud- ing assembly and related software work, the largest storage option could make the company about $134 more per phone than the storage tier below, up from $107 in last year’s models. The 512GB option could make Apple $241 more per phone than the 64GB model.

The iPhone uses Nand flash memory to store photos, video clips, and most of its software. The market price of this component is about half what it was a year ago, according to InSpectrum Tech data. But Apple isn’t passing the savings on to consum- ers: The 78¢-per-gig charge hasn’t budged since last year. Of course, Apple uses contracts to lock in the price of such components as Nand flash, so it may not be benefiting yet from recent price declines. So far, though, storage costs customers more on an iPhone than on, say, a Samsung Note 9. Samsung charges 65¢ a gig to move from the 128GB Note 9 phone to the 512GB model.

Ponying up for extra storage could lead iPhone users to spend more in other ways, too. People who’ve become used to having what seems like a bottomless pit in their phones are likelier to cram the devices with more music, apps, movies, and sub- scriptions, boosting Apple’s services revenue. And Apple is charging anyone who wants an iCloud plan to back up their entire 512GB phone an extra $9.99 a month for 2 terabytes (2,000GB) of remote storage.

This all starts to add up. A customer who pays $1,449 upfront for a 512GB iPhone XS Max could potentially pay at least $40 a month more to Apple if they subscribe to iCloud and Apple Music and buy one movie on iTunes each month. That’s all before buying or subscribing to any apps. So as long as users are willing to pay a hefty premium for the priv- ilege, Apple seems likely to keep upping its storage options. �Mark Gurman and Ian King

DATA: COMPILED BY BLOOMBERG

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