As I have reflected on Apple’s earnings the past few days I kept coming back to what I am observing with the premium smartphone market. What I think is interesting about what we learned with the 5c is that Apple customers prefer them to be in the premium segment. Brian Hall wrote a column last November that Apple couldn’t go downstream and he anticipated the 5c struggling in the market.
I was skeptical of his remarks but now I am wondering how much truth there is to it. There is absolutely nothing wrong with a premium strategy. It is an excellent business that is healthy and can stand the test of time. However, I’ve never been convinced Apple only wants to focus on the top 20% of any market they enter with personal computing products. In Walter Isaacson’s biography of Steve Jobs, he writes about an interview where Steve was talking about why the Mac lost to Windows. In summary Steve Jobs admitted the Mac was priced too high. In fact, at the 30th anniversary of the Mac John Markoff mentioned that Jef Raskin, the original creator of the Mac wanted to make the Mac a very approachable $500 highly portable computer. All the Mac team wanted to do ended costing a bit more than that. But then in September, in Tim Cook’s interview with Businessweek, something he said stood out to me.
We never had an objective to sell a low-cost phone. Our primary objective is to sell a great phone and provide a great experience, and we figured out a way to do it at a lower cost. – Tim Cook
The last line, “we figured out a way to do it at a lower cost” is the one that intrigues me. I believe Apple is committed to this line. Creating the best, not the most, but figuring out a way to make the best and offer it at a lower cost.
This brings us back to the 5c. The statement above from Tim Cook is referring to the iPhone 5c. The 5c was ultimately challenged in the market because it was too close in price to the iPhone 5s in subsidy markets. More consumers seemed to spring for the extra $100 to get the iPhone 5s than did for the 5c perhaps hinting that if Apple is to have two different current generation and differently priced iPhones in the market that they need to be priced further apart.
Perhaps an option is to focus on making the best product they make at lower cost. If Apple’s manufacturing can support them offering their flagship premium phone but doing so at lower costs, and maintaining margins, they could in theory bring the premium fight to the middle tiers of the market. Which would open up their total addressable market pretty quickly in markets like China and India. It could also bring the cost of the subsidized flagship product as well which could increase quickly the number of iPhone users to switch from Android in key western markets.
Ultimately, the current carrier subsidy model is a challenge to Apple in lower price tiers. If they release a phone that is in the most popular price tiers in China and India ($115-246 USD), it would be practically free in subsidy markets. Apple could of course release phones that are only available in certain markets as well to deal with this but one has to question what Apple could release in one market that would not be desired in others as well.
Apple’s dependence on the iPhone is growing. In 2013 the iPhone made up 53.4% of their total fiscal year revenue which was an increase from 2012 where the iPhone was 50.3% of fiscal year revenue. Of course, new revenue streams (categories) are ways to increase revenue growth in new ways and perhaps lesson the dependence of Apple on iPhone revenue. But it needs to remain firmly planted in everyone’s heads that as much as new categories or new revenue streams are good additional sources of revenue there is no market in annual units sold as large as the smartphone market. We estimate that in 2018 we will sell 1.9 billion smartphones every year.
The key thing to understand about the smartphone segment is that growth has slowed across the board. We added approximately 450-500 million new smartphone owners in 2013 and that number will drop to around 300-350 million in 2013 and stay somewhat flat. The vast majority of those new owners will be in the sub $200 (wholesale) price category. Likely not customers for Apple. So who is Apple competing for? They are competing for owners whose interests are maturing and who may value their ecosystem. Interestingly, among current smartphone owners worldwide we are seeing 25% begin to move upstream from the low-end to the mid-market. The question, should Apple continue to focus on the high-end price tiers, is if/when will more mature consumers move from the mid to the higher end of the market. This may be only a matter of time, but it will require time to manifest.
We do anticipate some growth still to be had in the higher tiers as markets mature and more importantly as the rapid development happens in developing countries. I firmly believe Apple is employing the correct strategy by focusing on making the best products not the most. But if we read between the lines from Apple’s executives speaking, making the best does not necessarily mean charging the most.