Addressing Concerns over Apple’s iPhone Growth

on August 9, 2015

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There is no single question I get more from contacts on Wall St. than those that center on how long Apple can keep growing. Knowing Apple derives a great deal of its revenue from the health of the iPhone business, the question of, “How much higher can the iPhone grow?” is fundamental.

Interestingly, Apple added a disclosure to their latest 10-Q for the June quarter regarding risks to results:

“Further, the Company generates a majority of its net sales from a single product and a decline in demand for that product could significantly impact quarterly net sales.”

Clearly, Apple understands what is at stake. However, I also believe they understand there is still headroom to grow iPhone unit sales. Here are some of the fundamentals.

Upgrades: Apple is giving us the percentage of the base who upgraded for a reason. Tim Cook also used a third party statistic about iPhone repurchase intention on the latest analysts call saying 86% of iPhone owners plan to purchase another one. He also compared that with a 50% repurchase intention of the next highest brand measure, which would have been Samsung. The point is, iPhone owners buy more iPhones (the number is in reality higher than 86%) and every upgrade cycle for an Android user is an opportunity for another brand.

I believe the iPhone global installed base has passed 450m units now so Apple still has roughly 330 million (or more) iPhones to sell to their existing customers. It is likely that, by the end of 2015, 40-50% of the iPhone base will have upgraded given current trajectory. We have country by country details from our survey work where we ask about specific device ownership. In the survey, we ask very specific smartphone model ownership questions as well. The iPhone 5s remains the largest owned by a significant margin, highlighting the strong opportunity for upgrading.

Android Switching: This is one of the dynamics I don’t believe is fully appreciated or internalized regarding what is happening globally in the smartphone market. Android is sick and has been for quite some time. The extent of this sickness is not understood but it has been obvious for those who can see it. In 2012, I defended Apple rigorously against investors, and some prominent VCs, who felt Samsung was too strong a force to be reckoned with. I explained why Samsung’s dominance was only temporary. A great deal of my logic was centered around the dynamics of Android itself, which I predicted would have broad sweeping ASP impact on the Android vendor landscape. The clear takeaway is not a single Android vendor will ever be safe. I’m fond of saying when you ship someone else’s software, you are only as a good as your competitor’s lowest price. This makes it very difficult for these companies to do primary R&D and innovate.

The dynamics of a mature smartphone market are consumers internalize and self-select what they want and what they don’t want. It takes time for a market to mature and, when it does, you generally see a more refined set of desires and feature sets. Often, this takes experimentation. Lower cost Android smartphones helped get more consumers into the market of smartphones and, with each generation they owned, they began to refine what they wanted and didn’t want based on their unique needs and desires. It turns out that, in many cases, Android isn’t panning out for them. Android forces the hardware landscape down in cost, which has a broad impact on components and features. Apple does not have to play this game and can innovate on feature, function, user experience, etc. This sets them apart once the core needs, wants, and desires of consumers are refined. This is one of the fundamental dynamics driving Android switching and how mature markets work, evolve, and ultimately operate. This must be internalized to understand why it will continue in favor of Apple in many markets. While helpful (but not definitive on consumer decision making), we chart consideration to purchase by smartphone brand. I’ve lumped the broader (over 30) countries we survey into regions. Notice Apple’s lead in purchase consideration in many of them.

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I make this point not to state this high purchase consideration will lead to more iPhone sales. Only that Apple has a captive audience to sell to. This is why we believe they are well positioned as the market continues to mature and consumers refine their interests.

China: Lastly, we have to talk about China. China remains Apple’s single largest region for growth prospects. The ceiling for iPhone sales in the US is close. Apple is creeping toward 50% share of smartphones in use in the US. Yet, I’d argue the sheer desire to own an iPhone is stronger in China than in the US. Apple has, currently, only 13% share of active smartphones in use in China. As middle-class and overall household income in China rises, numbers like 30% of the China smartphone installed base consisting of iPhones aren’t out of the question.

We do primary research in China and one study we run is a quick survey asking respondents what OS they use for their primary smartphone. As you can see from my chart, iOS continues to grow and interestingly for the first time, we saw the percentage of respondents who said Android is their primary smartphone OS decline. This was from our latest Q2 survey of over 2,000 people in China.

Screen Shot 2015-08-09 at 9.03.25 PM

However, there are concerns over the Chinese economy. I personally believe they are over blown, but I understand the concern. But let’s look at a case point for reference.

Luxury brand Louis Vuitton reported strong sales including in China, despite the stock market and economic issues in the region. While some brands are clearly being hurt and the article mentions Burberry, it is not doom and gloom for all. I’d argue smartphones are more central, personal, and needed and Apple remains well positioned in the status and aspiration area for Chinese consumers to have an impact on iPhone sales in China. Alternately, many consumers in the rising middle class are not as impacted by the stock market as many would believe. Those who are have enough money that, while it hurts, they still have plenty of disposable income.

A last point I’ll make is that we continue to see iPhone ownership rise among those in much lower income tiers in China. This is a dynamic many can not fully appreciate. However, it is important to understand pooled household income to acquire things is common in China. With the gifting dynamic so high, we notice even in lower-income households they pool their income to buy an iPhone for a younger upwardly mobile member of the Chinese household.

What’s happening with Apple in China is truly remarkable and hard to internalize for many Western minded thinkers. Apple’s ceiling in China is high and their position in the Chinese market will continue to surprise many. You can’t build these surprises into the stock price, particularly as the Chinese market is so misunderstood by many western minded individuals. We can only hope that, while most large institutional investors can’t understand what is happening with Apple in China, they will learn to not bet against it, or Apple in general for that matter.