Apple’s Tim Cook issued a “letter to investors” last week on Apple’s profit warning and lower than expected performance for the first quarter of fiscal 2019 which normally has been the best quarterly period for Apple every year. Tim Cook blamed the Chinese economy and sudden drop in iPhone demand in mid-quarter as the main reason. However, the issues run deeper than what Mr. Cook has put forth which we aim to analyze here.
- All Apples in One Basket: Apple has too much dependence on firstly iPhones and secondly in terms of markets – USA and Greater China. Since the peak iPhone 6 series Super Cycle in 2015, iPhone base growth has slowed due to almost flat iPhone volume sales. Further, Greater China has been becoming a problem child for Apple which we started highlighting long back in 2016 (here), 2017 (here) and 2017 (here). The Apple iPhone traction has slowed not only in China but in emerging markets (here) as well even though it holds strong in markets such as US, Canada, EU, Australia and Japan. Apple’s iPhone’s attractiveness is on a cliff-edge and tilting downwards especially in China which its second largest iPhone market. This has nothing to do with Chinese economy slowing down but because of the following reasons:
Apple is heavily dependent on its iPhone business (Apple FY2018):
- 63% of its Devices Installed Base
- 63% of its Corporate Revenues
- 64% of its Corporate Profits
Apple is similarly heavily dependent on two geographies (Apple FY2018):
- 43% of its Revenues comes from Americas (USA bigger portion)
- 20% of its Revenues comes from Greater China
- Longer Replacement Cycles: China’s smartphone market demand has been slowing down over past eight quarters (here) especially for premium smartphones which use premium components and design with ability to perform well over years plus they have gotten expensive thus elongating the user replacement cycles.
- Uninspiring Design: New iPhone Xs series from design standpoint has become commonplace as it is the same as last year’s iPhone X vs competition which has moved one or two generation ahead with innovative full-screen (notch and notchless) design
- Insane Pricing: Further, the new iPhone Xs series remain super expensive with base iPhone Xs 64GB starting at ~US$1250 in China with the top version of iPhone XS Max (512GB) as costly as US$1900 which is as costly now as a 13″ 512GB 8GB MacBook Pro. This is now beyond the reach of many and even loyal to Apple Chinese consumers. Apple is charging roughly 25-30% premium over its announced price for the new iPhones in spite of the iPhones being locally manufactured in China. The price sensitivity of Chinese consumers on how much premium they would pay to Apple is nicely stress-tested now. Our China team via channel checks see the slowing iPhone demand a function of exorbitant price & uninspiring design change from iPhone X. The initial launch bump running up to Alibaba 11.11 was healthy with early adopters still ready to pay some premium (this base is getting smaller and smaller) and the large majority upgrades/switchers are not interested in upgrading to expensive Xs series.
- Less Sticky Ecosystem: Apple’s Software and Services revenues globally reaching a run-rate of US$ 10 Billion per quarter. Bulk of its global revenue comes from licensing, search engine giants paying for being prevalent in Apple browser, App Store revenue billings (Apple Tax!), some from Apple Music, video and subscriptions, Apple Care, Apple Pay and so forth. However, in China except for App store, it has been difficult for Apple to monetize services and implement stickiness for the Apple ecosystem. Bulk of the users spend their digital lives using Tencent, Alibaba or Baidu’s apps and services. Tencent’s Wechat itself is the most powerful ecosystem making Apple’s OS redundant (see here).
- Competition Innovating: Adding to this, Chinese brands are out-competing/out-marketing Apple on design, mobile-first innovations & offered value proposition which is being recognized by brand-conscious Chinese consumers. The current iPhones might be great for older gen iPhone users from design upgrade (not price) perspective but not enough to attract mature non-iPhone users to switch camps.
- Competition Profiting: What Apple has done here is to let competition also charge a “comfortable premium” which is relatively lesser than Apple and allowed competition to book some extra profits. The new iPhone pricing has also slightly conditioned Chinese smartphone users on premium pricing (HOV flagship level) but not convinced for the new iPhones.
- Competition Leading: The rise of Chinese brands especially – Huawei, OPPO, vivo (HOV) across mid- to super premium segment is hurting Apple. How these brands softly killed Samsung once a market leader slipping to less than 1% share in just 10-12 quarters. Apple could follow the same trajectory soon. Huawei’s performance (see chart below) out of all the brands has been phenomenal in China. Mate Series is a serious alternative to premium iPhones & a de-facto business phone, especially among males.
- Competition in Control: Chinese market looks like a zero-sum game, but winner is one with prudently priced well balanced portfolio and unique value proposition, enough room to grow with mid to premium portfolio & expand its user base.
- Apple Weakened in 2018: Apple’s China struggle is a function of insane pricing which has backfired (misjudged it), stronger competition & maturing market. Thus, while China smartphone market demand is expected to decline 9-11% but Apple iPhone is poised to decline 15-17% YoY in 2018, hence its market share will slip further in 2018.
- iPhone’s China Ban: From outlook perspective, the current ban of iPhones (infringement of Qualcomm’s IP) in China which Apple has still adhere to would put greater brakes on iPhone’s future in China (& Germany)
- US Trade War & Nationalism: Adding to the above issues, the heated-up USA-China trade war might also have implications on Apple if Chinese consumers reach a point to give up on American products especially from Apple with sense of “nationalism” creeping in. Anecdotal evidence suggests this has already commenced among elderly Chinese population.
Source:: Monthly Market Pulse (here)
- Apple’s China problem has been building up since the peak Super Cycle, not learning from Samsung’s fall and not building any stickiness factors beyond “premiumness” which is diluted.
- Too much dependent on iPhone’s hardware charging exorbitant premium every year till the point the value proposition dint make any sense compared to the innovative competition
- There is no easy fix for Apple as situation is being compounded with IP infringement ban, Trade war invoking a sense of nationalism and hard to correct the pricing mistake immediately – which means accepting the pricing mistake and in turn permanently damaging the brand equity.
- We believe, Apple will have no choice but to let this phase pass and maybe the China growth opportunity for near-to mid-term and focus on other markets. Apple will have to salvage the lost volumes lost in China and protect its global installed base growth via users buying new iPhones (& not hand-me downs, used or refurbished iPhones)
- China has always been a wild card for growth for US companies and thus very few companies have consistently grown and become successful. With local companies innovating faster with astute localization, targeted marketing and greater value proposition its going to be difficult for likes of Apple.
- While China could well be beginning of bigger problems for Apple or could be a wake-up call but still Apple is the most profitable and revenue generating devices vendor globally. At the end of Dec 2018 quarter, Apple generated almost US$ 1 Trillion in cumulative iPhone revenues since the first iPhone launch by cumulatively shipping over 1.5 billion iPhones till date.