Apple Q2 Earnings Insights

There were a few key insights that came from Apple’s Q2 earnings. One thing I’ve noticed through the years, and a reason I spend more time writing about Apple’s earnings than any other company, is that in many aspects trends within Apple’s ecosystem and their users, give us insight into other companies challenges and opportunities. In some regards, Apple is a bellwether for consumer market behavior.

iPhone Sales Stabilizing
In general, the smartphone market seems to be stabilizing. There are likely going to be times where Apple’s sales outgrow the smartphone industry, but in general, it seems the worldwide market is stabilizing, and we are getting a handle on what to expect in terms of annual volumes.

I wrote about this extensively after the holiday quarter where it was clear iPhone sales had peaked. It was inevitable and many lessons we learned tracking the PC category once it peaked applied to both Apple and the smartphone market. The biggest question on hardware makers minds when the PC peaked and began to decline was how low the bottom would be in annual sales. That was the question as companies planned roadmaps for hardware, and retailers made plans to carry inventory. For several years the market faced decline then stabilized. The smartphone market appears to be stabilizing a bit more quickly, and that is likely to the shorter life cycle (3-4 years) for smartphones vs. PCs (5-6 years).

In some brief conversations, I had with investors last night the question of whether the worst is behind us for iPhone sales. While it does seem from an iPhone business revenue perspective the worst is behind us, thanks to higher ASP and stable margins (for now), there is still likely to be some unpredictable fluctuation in unit sales as certain markets still stabilize their refresh cycles.

One key strategy for Apple in stabilizing iPhone sales is their trade-in program. This has always been a win-win strategy for carriers and their customers, and it makes a lot of sense for Apple to invest heavily in this program. It was interesting to hear Tim Cook talk about the success of this program. This was the key part of his commentary that stood out to me:

Our retail and online stores continue to be a key point of innovation. As we mentioned in January, we’ve been working on an initiative to make it simple to trade in a phone in our store, finance the purchase over time, and get help transferring data from the old phone to the new phone. As part of this initiative, we rolled out new trade-in and financing programs in the U.S., China, the UK, Spain, Italy, and Australia. The results have been striking. Across our stores, we had an all-time record response to our trade-in programs, and with more than four times the trade-in volume of our March quarter a year ago.

It seems from this quote, Tim Cook is signaling the more regions, and stores, that support these trade-in programs the bigger upside potential to keep predictable patterns of iPhone sales. For Apple, this is crucial and brilliant strategically in helping them assess demand and handle build-inventory. It also puts them one step closer to their consumer controlling more of the phone purchasing experience than when a consumer buys the device through the carriers (which is still a terrible experience).

Apple’s retail remains one of the most under-appreciated assets Apple has at its disposal to better manage the relationship with their customers in a very Apple (good user experience) way.

The other part of these trade-in programs worth mentioning is Apple then has a resale market for trade-in phones. Most people don’t know these programs are a carriers best friend because it allows them to sell a phone twice and the second time often being to enterprises buying in volume. Tim Cook also mentioned on the call the high penetration of iOS in the enterprise and the strong demand of enterprises to buy iPhones. Many businesses purchase refurbished iPhones for their mobile fleets, and it is healthy revenue; Apple can get a slice of when it comes to their trade-in programs.

A Few Points on China
It is worth highlighting a few things related to the China market. Apple’s management indicated the initial concerns they had over China after the December quarter might not be as worrisome as previously thought. There are things like government stimulus plans, pricing changes from Apple, and the success of their trade-in plans which has helped create a more positive outlook from China. A point about the trade-in plans in particular, which was one thing Tim Cook said was doing specifically well in China. Chinese consumers have long sold their devices to the grey market in China and used that money to buy a new smartphone. This is already a normal behavior in China; it is just that most outsiders never saw it because of how hard it is to track the grey market. In fact, it was this grey market that led to a massive installed base of iPhones (>100 million) in China before Apple was ever officially partnered with a carrier there. The point I’m making is China was a market always poised for success for an Apple trade-in program, and I expect that to be overwhelmingly successful in China.

Were Chinese consumers leaving Apple? This is a question I often received as there was a common reception that because of WeChat being a dominant platform, consumers would jump back and forth. This never really happened in mass, however, as most consumers stuck with their platform of choice. That being said, it is noteworthy that both Android (not a single OEM) and Apple have very high loyalty rates in China. It does not appear there is, or ever has been, as many platforms switching in China than we have seen in other markets historically. Looking back, it is clear the economic issues in China paired with rising iPhone costs was the biggest reason for the drastic slowdown.

All of that should be encouraging for Apple since they are manageable problems and they are not losing customers. This also paves the way for more services innovation locally from Apple in China as they start to invest in a more services specific (gaming, video, etc.) strategy for China.

Lastly, Services is Still a Story
I think I’ve written more about Apple’s services as a theme than any other Apple topic this calendar year. But it is for a good reason. Just look at how investors respond to Apple’s services growth. Apple sees declines in iPhone sales and revenue yet continued growth in services and the stock is responding positively largely thanks to the services upside potential.

I jokingly tweeted yesterday that it would be ironic if Apple finally gets the PE they deserve because of their services business. But it would be ironic, yet in a way predictable. Investors seemed to largely subscribe to the idea Apple would always face competitive threats from low-end priced devices. Even when the iPhone continued to prove that theory wrong, it never seemed to change investors views. But, investors love predictable revenue businesses which is exactly what services are. This is why the continued success of Apple’s services revenue, now the second largest business from a revenue contribution standpoint, will continue to drive Apple’s stock up.

But this services strategy has another dynamic I think is interesting. If Apple can get the majority of their customers as a services subscriber in some capacity, it practically guarantees that customer is never leaving the Apple ecosystem. Which, if we carry that logic out, means Apple can almost guarantee hardware sales of not just iPhones, but also whatever comes after iPhones (like AR glasses maybe), and a range of other hardware and accessories. The deeper Apple goes with services and getting their base of customers to buy into their services the near impossibility it will be for competitors to steal their customers with future hardware. Services will be the ultimate lock-in for Apple.

This is why it is imperative Apple succeed with services. If they don’t, it makes them a bit more vulnerable in whatever the next technological phase develops into.