What was supposed to be a slow return to work after the holidays, mostly prepping for CES, got much more exciting thanks to a letter to Investors that Apple’s CEO Tim Cook wrote on January 2 warning investors about the performance in the December ’18 quarter.
You can find the full letter here, but in essence, Tim Cook points to weaker iPhone sales in Greater China due to a more fragile economic environment, longer replacement cycles due to more carriers moving away from subsidies, the battery replacement program and higher prices driven by a weak Dollar.
After reading the letter in its entirety and listening to Cook’s NBC interview, there are a few points that I think are worth highlighting.
The data shared on Greater China points to a mixed-bag performance for Apple rather than overall doom and gloom. iPhone sales were so weak in Greater China that they negatively impacted overall revenue. Yet the fact that other products and services performed well would indicate that the concern some expressed of a possible Apple boycott on the back of the US sanctions as yet to materialize. Growth in services revenue also suggests that the current user base in China remains engaged in the ecosystem, a behavior that we know drives loyalty.
What is happening is that a weaker economy now impacted by the sanctions is lowering consumer confidence. Many are jumping to the conclusion that Apple’s loss in China is a win for the Android ecosystem players as consumers churn. There is no question that Huawei, OnePlus, Oppo, Vivo, and Xiaomi have grown in China offering an alternative to non-local brands but this has been true for quite some time, and most of their growth has been coming from within the Android ecosystem. While current economic conditions might drive some iPhone owners to look at switching camps looking for cheaper devices, it is more likely they will delay their purchase especially if they do not “need to upgrade.”
We will know more next quarter when buying behavior during Chinese New Year will bring some clarity on whether the slow down Apple is experiencing in iPhone sales will continue and whether other brands will be impacted by the weaker consumer confidence.
Installed Base Outside of Early-Tech
Many industry commentators are blaming the current iPhone performance on Apple’s decision to increase prices of the new iPhone Xs and Xs Max compared to last year’s iPhone X. I think this might be a little too simplistic an explanation of the current environment Apple is facing.
Apple proved with the iPhone X that a high price did not deter consumers. In markets such as the US where most consumers are on installment plans the difference between the iPhone X and the iPhone Xs is a few Dollars a month. What might have played more of a role is that some iPhone X owners might not have seen the need to upgrade to the iPhone Xs especially if they were not on an annual upgrade program or the bigger size of the iPhone Xs Max was not of interest. While this is not changing the fact that replacement sales are impacted it does paint a different story for the future.
Cook’s specific mention of widening the annual upgrade program to more markets, offering installment plans options with more trade-ins and making it easier for people to transfer their data on new devices are all steps that point to wanting to nudge mainstream users to move to newer models. This is where the problem lies — those more pragmatic buyers who are satisfied with the features their current model offers. From Apple’s comments it seems that this is now a larger group than it used to be in previous years and the part that Apple underestimated. This is likely to be an industry-wide problem and Apple’s retail strength will make tackling it much easier than for any other vendors.
Considering other devices sales remained strong this quarter despite availability constraints on Apple Watch, AirPods and MacBook Air, we should also consider that some of the disposable income that in previous years might have been put towards a new iPhone might instead have been diverted towards another Apple product. Not a bad thing for Apple!
I do also wonder if the current iPhone lineup might have played a role in the lower upgrade sales as mainstream consumers are resisting some of the changes such as larger form factors, Face ID and the lack of a headphone jack. This is the first time Apple has a full portfolio of products that are two years old or less. Uncertainty around these new features coupled with the battery replacement program might have pushed potential buyers to keep their older iPhone with a new battery and renewed life. I see these as deferred sales rather than lost sales. When the time comes, it will be interesting to see if these pragmatic buyers will spend more money upgrading to the latest model and seeing it as a multi-year investment or whether they will choose an older product at a reduced price.
Hardware and Services: An Intertwined Opportunity
Don’t be too quick to criticize Apple on the new portfolio and consider how hardware and services are intertwined in Apple’s future. For Apple, it is paramount to drive users to newer models and not just because of the hardware revenue those sales generate. Newer products with the latest features make sure users can engage in new services and use features that increase stickiness to the ecosystem. This engagement is what Apple must continue to foster to be able to benefit long-term from the user base they have built.
It is very telling that at a time when Apple decided to no longer disclose iPhone sale volumes, they also decided to start sharing services gross margins. Apple made it clear they want investors to focus more on the opportunity services offer to the company long term. If you think about this opportunity, there are no other smartphone vendors other than Google that can say their users are generating revenue for them even when they are not buying new products. So, while lower iPhone sales are certainly something to be concerned about Apple continues to show there is an upside in other product categories and services.
Apple vs. Other Smartphone Vendors
This final point is possibly the most important one to keep in mind when we compare Apple to other smartphone vendors. Apple’s revenue while highly dependent on iPhone over the years does not end with the iPhone. While it is true that no other single product has done for Apple as much as the iPhone, the product offering as an aggregate still puts Apple ahead of all other vendors who might be selling higher volumes but have no direct way to monetize from their users once the sale has occurred. The only exception being Xiaomi, but with the caveat that its monetization helps recuperate the initial loss on hardware. All other Android vendors are mostly working to drive value to Google rather than themselves.
Even Samsung, a brand that offers a much broader range of products, even broader than Apple, is still struggling to benefit from the user base to drive not just services revenue but also cross-device stickiness.
Apple’s strong reliance on iPhone revenue makes it hard to not see Apple as a smartphone vendor but measuring its future opportunity only on iPhone sales is shortsighted.