05 Feb WILL THE CHINA CONUNDRUM BE APPLE’S UNDOING?
Who Doesn’t Love a good troll? Especially if there is someone else at the receiving end!
When Apple’s (NASDAQ: AAPL) iPhone XS and XS Max went on sale in Sept 2018, what caught everyone’s attention were these Huawei Vans that were driving past Apple Stores dispensing juice to passersby.
See the tagline? “”Get juice that lasts,” followed by “No traces of Apple.”
It is not the only company that took a sly dig at Apple’s battery life, the least of its worries.
Is China – The proverbial bad Apple?
In its quarterly earnings release for Q1 2019, Apple reported quarterly revenue of $84.3 billion, a decline of 5 percent from the year-ago quarter with revenues from iPhone® declining by 15 percent from the prior year. The company squarely lays part of the blame on China’s economic deceleration.
Tim Cook apportioned the reasons for decline to broadly five factors, namely the different timings of iPhone launch that created a difficult compare for Q1, 2019 as per the company. Secondly, a strong dollar made a dent in the company’s revenue growth by about 200 basis points as compared to the previous year. Thirdly, the company faced supply constraints owing to an unprecedented number of new products. Fourthly, the most significant impact was made by fewer iPhone upgrades than anticipated by the company, which the CEO Tim Cook attributes to the customer adapting to fewer carrier subsidies, US dollar strength-related price increases, and reduced pricing for iPhone battery replacements.
“While macroeconomic challenges in some markets were a key contributor to this trend, we believe there are other factors broadly impacting our iPhone performance, including consumers adapting to a world with fewer carrier subsidies, US dollar strength-related price increases, and some customers taking advantage of significantly reduced pricing for iPhone battery replacements,” according to Apple’s CEO Tim Cook.
Fifth and the major reason is the economic deceleration in countries like Greater China coupled with rising trade tensions between China and U.S, which are adversely affecting the market sentiment.
Tolling of the bells?
China, Apple’s second largest market, is where the two companies are locking horns over market domination. Huawei (Including Honor) is the leader in Chinese Smartphone market with 22% share and Apple is a distant fourth with 13% share. However, Huawei seeks to extend its supremacy to the premium (Handsets priced > $400) Smartphone segment where it is still behind Apple’s 43 percent market share with just 9% according to a report by counterpoint research.
“Apple used to be the must-have, aspirational brand for all wealthy and middle-class Chinese consumers,” said Shaun Rein, managing director of the China Market Research Group and the author of “The End of Cheap China.” “But over the last year, there has been a real deterioration of the Apple brand.”
The Chinese market saw a launch of top-notch display and camera models by the top four players in 2018, an area that is Apple’s Achilles’ heel. Apple which is still trying to leverage on its premium branding and high price might be using an incorrect strategy for making inroads into a conventionally price sensitive market. In a market that is nearly saturated there is very little brand loyalty and an increasing demand for feature laden phones that are easy on the pocket. The rise in prices is having a prohibitive effect with fewer customers opting for upgradations and replacements.
Apples and Oranges – are the oranges finally catching up?
The company has no plans to lower its prices to entice new customer or existing customers to upgrade. Instead it is mulling over other alternatives to make sure that the customer stays with the company.
In the words of the CEO, “We can’t change macroeconomic conditions, but we are undertaking and accelerating other initiatives to improve our results,” said Cook. “One such initiative is making it simple to trade in a phone in our stores, finance the purchase over time, and get help transferring data from the current to the new phone”.
The players in the Chinese mobile market are quickly adapting to changing customer demands by including higher-end chips offered by companies like Qualcomm and features like under-the-glass fingerprint sensors. They are slowly making inroads into the U.S market which is traditionally considered Apple’s strong hold, with models such as OnePlus previously only available online are now being carried by T-Mobile US Inc stores and slowly becoming a techie favorite.
The Forbidden Apple
China is the largest mobile market in the world as nearly all of the country’s 750 million internet users own a smartphone making it an integral part of any global player’s growth strategy.
However, the countries mobile market is flooded with replicas of iPhones in terms of looks, features and software that are available at a far cheaper price, while the government and judicial machinery look the other way. The company’s rigid stand as regards it premium pricing is proving detrimental to its growth in this market.
In a bid to appeal to the mid-price segment, Apple attempted to use its iPhone XR priced at $1,099 as a viable alternative, however the company’s move hasn’t gone according to plan with some still viewing it as too expensive and an inferior product marring the brands image. It could have made use of its cheap, budget-friendly iPhone SE priced at $350 instead, making it a missed opportunity. Another step that backfired was the introduction of installment plans for purchasing the device which led to the customer retaining the devices longer than desired, leading to an inevitable delay in upgradations.
App, App and Away!
China is also the largest market for mobile apps accounting for $1 out of every $4 generated through app stores and mobile commerce, according to a study by nextweb. Apple’s vision for the future is driven by its paid services, and it therefore seeks to increase the base of its device owners by offering apps and games that appeal to the masses.
China’s mobile app market is worth $35 billion, according to a report by Straitstimes. But gaining a foothold here is extremely difficult owing to the country’s stringent regulations that limit the scope for its app development. The company came in for severe criticism in 2017 for its decision to remove VPN applications from its Chinese App Store, some viewing it as appeasement of the government to the detriment of its customers.
Any foray into the Chinese market requires heavy customization to meet regulatory demands as well appeal to customers. The biggest hurdle to customization or app development is that it mandates a local Chinese partner, as licenses in these areas only given to Chinese entities.
Customers tend to gravitate towards apps that accept payments through electronic wallets as compared to a credit card demanding third-party mobile payments systems which is another challenge in itself.
The social media channels used for marketing these apps are completely different in China than the rest of the world which makes customization challenging and entails completely reworking the context to suit the diverse population.
Are Paid Services the Way Forward?
Apple’s revenue from its devices and paid services such as Apple Music and iCloud was US$37.1 billion in the Q4 of 2018, derived from its active installed base of 1.3 billion iPhones, iPads and Macs, a number that the company is seeking to multiply as part of its future growth strategy.
Despite the drop in revenues, it is still upbeat about its long-term prospects owing to its installed base of active devices hitting an all-time-high and the revenue from other sources such as Services, Wearables and Mac growing by 19%.
“While it was disappointing to miss our revenue guidance, we manage Apple for the long term, and this quarter’s results demonstrate that the underlying strength of our business runs deep and wide,” said Tim Cook, Apple’s CEO. “Our active installed base of devices reached an all-time high of 1.4 billion in the first quarter, growing in each of our geographic segments. That’s a great testament to the satisfaction and loyalty of our customers, and it’s driving our Services business to new records thanks to our large and fast-growing ecosystem.”
Everyone is not as optimistic, “There’s no single problem facing Apple, and few of these obstacles are exclusive to the Cupertino-based company,” said Geoff Blaber, an analyst with CCS Insight. “However, the more intensive competition from Chinese phone-makers such as Huawei, coupled with a global political environment that’s fundamentally different, brings a new level of uncertainty. Resolution of the trade conflict could deliver a sudden lift to demand but the headwinds at the start of 2019 are stark compared with the growth-friendly environment of recent years.”
Desperate times call for desperate measures
In December 2018, Apple ran a promotion offering iPhone XR for $449 as against its original price of $749 provided a customer exchanged an iPhone 7 plus, a high-end handset released in 2016.
While some considered it a clever move to increase its active base while getting rid of excess inventory, others saw the move as counter-intuitive and suicidal.
Analysts feel that though the company is trying to increase its customer base to augment paid-service revenues, they can never replicate the profit margins from hardware sales
As per Abhey Lamba, an analyst at Mizuho Securities “while Apple makes about $300 for each iPhone sold, it takes about 60,000 transactions via Apple Pay to make $100.”
If there is one thing about Apple though, it is its ability to rise from the ashes like the proverbial phoenix. Only time will tell if Tim Cook can pull of resurgence similar to the one that Steve Jobs pulled off in 90’s, but analysts and investors will be keenly watching his every move.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.