Some recent media has come out stating we need to acknowledge Apple knows what it’s doing as a company and with their strategy. I don’t know any analysts worth their reputation, either on the financial or industry side, who ever doubted Apple knew what it was doing. Part of the quibble with Apple from said media is the belief Apple was leaving money on the table by not changing their established and successful business model of focusing on the high end, more profitable segment of the market. Many called for Apple to make a lower cost iPhone in order to capture more “hardware” sales. But what many of us knew is just selling a lower cost phone doesn’t necessarily mean more money. And, in fact, it could have consequences on the higher margin products. Luckily, Benedict Evans shared a post recently that broke down exactly what I and many others have been saying around the implications of a lower cost iPhone.
What Benedict wrote is something he and I have spoken about on past episodes of our podcast. The thesis was always that a lower cost iPhone would certainly help raise sales of iPhones but would not raise revenues. Selling a lower cost and lower margin product means you need to sell substantially more product to equal similar revenues to selling less of a higher margin good. But as Benedict points out, this does not necessarily mean Apple should not release a lower cost phone — only that it would not necessarily be for the hardware revenue but for the potential value to the ecosystem, in terms of revenue capture beyond hardware, like apps, subscription services, etc. Benedict rightly points out Apple has more options than ever and I would add few companies are in full control of their destiny than Apple.
Back to Apple knowing what it’s doing. This relates entirely to a margins discussion. Several days ago Jan Dawson posted on his blog some thoughts on Samsung. I asked Jan to add Apple and Samsung to a particular chart on margins and it is below.
If any chart shows Apple knows exactly what it is doing, it should be the chart above. Apple remains the anomaly of all consumer electronics companies when it comes to operating margins. Apple has not and does not have to chase the lower margin commodity products thanks to their vertically integrated advantage. Granted, no one is arguing Apple chase the uber-low end. That’s unwise for any branded OEM. But rather, there is a healthy and growing middle of the market. What we are discovering in many markets like China and even pockets of India and Brazil, are more mature customers who started off buying lower cost entry level smartphones are moving upstream and being willing to spend more on their next smartphone. I believe this trend will continue as a large percentage of smartphone users move off basic devices and become willing to spend more on devices in mid-range price tiers.
Whatever strategy Apple decides, given their approach, they have a limit on their total potential customer base. We simply have no idea what the size of that number is. Employing this strategy means Apple will need to foster opportunities for their customer base to spend more in their ecosystem thus incrusting their average revenue per customer beyond the hardware. The point remains — Apple is in control of their destiny.
Samsung, on the other hand, is a giant question mark. What does Samsung do? They have built a business that requires scale. Their strategy has been to fast follow companies and products which have scale then leverage their vertical components businesses to sell products to each other as they scale. Each group benefits, revenues rise, and they are able to slightly buck the low margin fate that faces so many companies. Samsung has always been Samsung’s best customer in components. But the main point is their business requires scale. So what does Samsung do to maintain scale? They are losing in premium to Apple, and they are losing in the lower and mid-tiers regional players in the regionalization of the smartphone market.
What is even more interesting about Samsung’s struggles is they are actually price competitive with some products in many of these markets with the same vendors they are losing out to. So the question is why? Why not Samsung in these markets where they are price competitive? I do believe it has something to do with the fact they are a foreign brand in markets increasingly favoring brands from their home country. Therefore, to assume Samsung should just compete on the low end to get scale back does not necessarily solve the problem. Nor does doing so help their margins, or the inter-departmental sales approach their components business sell within the country. Samsung, like Jan’s chart shows, is stuck in the middle. Their margin line is unlikely to go up toward Apple’s and unfortunately if it is to go down toward the others, it’s a huge, company wide issue for a vertical component company who requires scale.
What I keep landing on is increasingly hardware, for all vendors including Apple and Samsung, is going to have to play a role as a mechanism to other revenue. Xiaomi is a great example of this, using hardware as an entry point to increased revenue of proprietary services. Amazon also, to a degree, employs this model. However, it is foolish for many to believe Apple can’t do this and that their future depends only on hardware sales. The challenge for others, like Samsung, will be to differentiate on more than hardware. The role of the OEM is changing, and will continue to change.
Ten years ago, all I wished was that Apple would survive well enough to keep developing OSX. Back then, there was talk it couldn’t afford to do so, at a billion bucks per version. Today Apple needs to build a reason, other than simple quanty growth, to keep its base, which will soon number a billion credit card carrying adults globally. And to keep its reputation as a workplace where the best can do their best. These best are the disruptors, the next batters up. If Apple loses them, it loses the game.
Apple sees these needs limits clearly. How do we know? It’s hiring folks who can fashion its brand to thrive within lowered growth. Think Mercedes. Even Cadillac.
There seems to be this notion held by analysts that Apple’s high end approach will just not sell well in the third world. That iPhones are just too expensive and so they should either sell a low price line or abandon their efforts. Well, people in the third world are just as vain and status conscious as people everywhere else. And maybe they can’t afford to indulge in ‘overpriced’, indulge-myself-and-feel-great products like a Mercedes Benz. But an iPhone is a much easier reach.
For people in the third world buying an iPhone is not the same as you and me buying an iPhone, it’s more like you and me buying a Merceds Benz. That’s why Apple is quite wary about any moves in the third world that might tarnish its aspirational brand image.
“Apple has not and does not have to chase the lower margin commodity products thanks to their vertically integrated advantage.”
This is a key insight that should be obvious but I see a lot of analysis that a) argues Apple’s vertical integration is a disadvantage, or b) the advantage doesn’t really exist.
“I don’t know any analysts worth their reputation, either on the financial or industry side, who ever doubted Apple knew what it was doing.”
Really? A whole bunch of analysts were big on Apple ten years ago? Really?
When people talk about Apple releasing a low cost IPhone (250-350), it already exists. A used IPhone 4 or 3GS would likely sell at those prices. But, the problem is the older devices were not made at the same scale. In a country like India used IPhones are in short supply which drives up prices and helps maintain the premium image of the device.
Apple has a low cost device strategy and it involves selling used devices in emerging markets. With the scale of the IPhone 5 and 5S, there could be a big business for Apple in used devices and no real need to flood the market with another low cost option.
Ben,
So many times we look at these companies and question or endorse the idea of owning the stack, either hardware and software, or even just software. The idea of being an Android OEM means you are dependent Google. I used to think that Samsung, HTC, LG, Moto etc… were slaves to Google.
But then Xiaomi came along…
Like Amazon understands, Xiaomi does too.
You need to own the customer experience ( like Apple retail stores ) not the software or hardware stack.
Samsung, LG etc…. Still suck at software….
The peculiar thing about computing devices is that the primary differentiating feature is the OS. (Though I would admit this seems to be expanding to “OS and Ecosystem”.) It is far and away the most critical feature that distinguishes one device from another. What this means is that if you want to sell a high end, high margin computing device by differentiating on a feature other than the OS, you will not be very successful. It just isn’t that important to most customers. Fancy materials and snazzy bells and whistles are nice, but if it’s going to cost me significantly more, then I’ll just go with the cheaper model that runs the same OS. That’s why there is no significant high end market for Windows PCs (anybody remember Northgate computers?) and as is becoming readily apparent, for Android phones as well.
Bottomline: the introduction of a lower priced model that runs the same OS as the high end model will eat into the high end, high margin market. If you price it low enough, it will kill the high end market. Apple knows this. And they, better than any analyst out there, know the cross price elasticities for iPhones and for Macs. Any analyst who says Apple should sell a lower priced line of iPhones does not have enough information to make a better call on that than Apple.
Now, even if proprietary services (ie. ecosystem) is fast becoming a critical and profitable differentiating feature, mfrs that are able to differentiate through the OS (and thus sustain a viable high end market) are still at an advantage because presumably the customers who are willing to spend more for hardware will also be willing to spend more on the ecosystem.
It’s just really very hard to make money if you’re smack in the middle of a race to the bottom.