The Apple Problem

on January 28, 2014

Apple’s most recent quarterly earnings, as usual, have generated an enormous amount of press, a staggering amount of pontificating and lots of interesting questions. On the one hand, the initial after hours market reaction has been swift and to the point: pushing the shares down over 8% at one point last evening—the equivalent of a staggering $40 billion in market value. Apple apologists, on the other hand, are equally quick to point out the incredibly important role that the company and its products continue to play by highlighting lifetime sales, device usage, ecosystem health and other interesting, if not always particularly relevant, factoids. The company itself points out that the underlying health of the business is better than the numbers might first suggest.

Of course, the numbers themselves are, by any objective measure, not bad at all. The highest iPhone and iPad sales ever, a 19% increase in both Mac sales and iTunes store revenue is something that most companies would be incredibly happy to have. But, this is Apple and when it comes to Apple, all bets are off—whether you’re on the side trying to push them up or the one trying to bring them down (interestingly, there don’t seem to be a lot of people in the middle on this one…). I’ve argued for a while that, as far as the market goes, Apple got treated unfairly on its wild ride up and equally unfairly on its big slide down a year or so back.

The real issue here—as it often is with Wall Street—is about expectations. Apple was expected to do better on iPhone sales and was certainly expected to give higher guidance for next quarter, especially after the potentially ground-breaking deal with China Mobile. (Remember: with stock prices it’s virtually never about the absolute numbers, it’s about how things do against what “the street” wanted to see.)  [pullquote]From the time I first saw them at the launch event in Cupertino, the Easter Egg-like pastel colors of the 5C struck me as something that would have limited appeal.”[/pullquote]

But beyond these expectations, there clearly were some challenges with Apple’s iPhone numbers—specifically, one problem: the 5C. Though no details were given, it’s clear that the company had more 5Cs than they needed and not enough 5Ss. As I watched my Twitter feed during the earnings call I saw lots of people offering their own views as to why this may be the case—including the lack of new functionality, pricing too close to the 5S and so on—but no one even mentioned what seems to me, at least, to be blatantly obvious: it was the colors of the phones themselves. From the time I first saw them at the launch event in Cupertino, the Easter Egg-like pastel colors of the 5C struck me as something that would have limited appeal. I don’t claim to be a color expert of any sort, but heck, I would’ve even preferred to see a return of Bondi Blue.

But the challenges that Apple faces go well beyond colors. Though Apple loyalists like to point out that market share doesn’t matter or isn’t relevant anymore (I guess it only matters when you’re winning—interesting how things get turned around over time…), the truth is, market share does matter. It may not matter from a global total smartphone or tablet perspective, but it certainly does when you start to break things down by countries by demographics or by other important metrics. In this regards, several critical trends are conspiring to create some strong headwinds for Apple. First, most of the growth in both the tablet and smartphone markets over the next few years is going to be in developing regions where incomes are lower, subsidies from telcos are much less common, smartphone lifetimes are expected to be longer and local domestic brands still have a lot more influence than large multinational brands. (High-end smartphones are saturated here in the US and Western Europe, so it wasn’t terribly surprising to hear Apple say that North American sales were down in the quarter.) The critical test here will be how the iPhone fares with even the upper middle class in Tier 2 and Tier 3 cities in China. Given the strong preference for local brands like Huawei, ZTE, Lenovo and CoolPad, as well as the strong in interest in “phablet”-size phones over there, this could be a serious challenge. Presuming the iPhone 6 will have a larger screen, this challenge could be somewhat offset later in the year, but the company’s limited expectations for their fiscal Q2 could reflect this concern in the short term. Second, the overall tablet market is starting to slow and it’s not inconceivable that within 5 years, tablets will face some of the same sales challenges that PCs have had to deal with over the last few years. The cannibalization of tablets by “phablets” may even exacerbate this problem. After a tough drop over the last several years Apple’s share has begun to stabilize in tablets, but the company can’t count on the high-growth curve for the overall category that it may have in the past.

Of course, most of these challenges are going to also impact Apple’s competitors in the higher-end device space—they aren’t unique to Apple. Plus, Apple has proven over and over again that they’re able to innovate in way that its competitors can only dream about. So, don’t get me wrong, I’m not worried about Apple’s long-term fate in the least. However, that doesn’t mean we won’t see a bumpy road over the next few quarters and that’s an Apple problem that has to be given serious thought.