Apple must learn that it’s not in California any more

Developing markets offer growth: but the firm’s phones must become cheaper and its services must compete with local rivals

After years of boom, Apple looks set for a rockier road in 2019 – partly through faults of its own and partly through social and economic factors that are affecting all the big smartphone manufacturers.

The company’s chief executive, Tim Cook, laid the blame for a shock cut in sales forecasts – and the subsequent share price tumble – on the economic downturn in China. A convenient excuse, but far from the whole picture.

The root of Apple’s troubles is that its key developed markets, including the US, EU and South Korea, have all hit smartphone saturation point. With few first-time buyers left, sales rely on persuading those with often perfectly usable phones to upgrade, which is a much harder task.
Users are now holding on to their phones for as long as three or four years, meaning something has to change. While maintaining competitive products to keep rivals at bay, you either have to launch something radically different (an incredibly hard task), push the price of your phones up, seek out still-growing markets or shift to a services-based revenue stream to wring more money out of existing users (think the App Store, Apple Pay, iCloud storage, Apple Music and the like).

Apple is doing all of the above. The trouble is that two of these strategies clash. By jacking up the cost of its best handsets to £1,000 or more, it has effectively priced itself out of the mass market in India, leaving China as its only hope of significant growth in sales volume and users. But China is different from Apple’s tried-and-tested markets.

When your lives are run through an app that is device- and platform-agnostic, then the brand and operating system of the phone does not matter. The playing field is levelled, and there is no customer lock-in provided by exclusive services such as iMessage or Apple Pay. That is Apple’s problem in China, where WeChat serves as the app not only for chat, but also for access to the government and news, conducting business, hiring cabs and purchasing goods.

When rivals are releasing phones of similar quality and at significantly cheaper prices, then Apple asking as much as £1,000 or more for its top products is hard to swallow in the west, let alone in China.

Furthermore, Apple is doing the right thing by its customers by offering cost-effective battery replacements and software support that lasts up to five years. That, combined with high prices, risks encouraging buyers to hang on to their old handsets for longer.
That’s not to say Apple isn’t in a good position. Its services push is providing meaningful revenue that almost matched that from Mac desktop and iPad sales combined in 2018. However, services revenue does need to become a priority sooner than the company might have anticipated: it faces stiff competition from Google, Spotify and others even on its own phones. Selling accessories such as the Apple Watch, Beats headphones and AirPods – meaning it can earn money outside the iPhone upgrade cycle – is also a smart move.
The trouble is that the recorded 59% of Apple revenue driven directly by iPhone sales hides the fact that its services revenue also overwhelmingly relies on the iPhone as the conduit. So while Apple must seek to extend sales as much as possible, it’s critical for it to maintain its current 1.3-billion-plus user base if services are to become the main driver of revenue.

The road will certainly be rocky for Apple over the next few years, with choices to be made over strategy and pricing for developing markets that seem to be at odds with its approach in developed markets. And all bets are off if we sink into a US-China trade war.

But away from direct sales, it stands in a stronger position than its rivals, including Samsung and Huawei. None of the major manufacturers have as many lines of service revenue as Apple; the lion’s share of the money from digital goods on Android smartphones outside of China goes to Google, not the phone makers.

 

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