As China crisis bites, Apple may have to eat humble pie
Tim Cook’s bet on the country helped make the tech giant the first $1 trillion business but price rises may have pushed customers too far. James Titcomb reports
Apple is famous for surprises. Under Steve Jobs, its mercurial founder and former chief, the company became known for theatrical product unveilings that astonished and delighted fans in equal measure. But last week, it had a different sort of surprise up its sleeve, and not one it had planned. In a letter to investors, Tim Cook admitted that the company had fallen short of revenue expectations by billions of dollars.
Blaming a weak Chinese economy, Cook said that iphone sales had disappointed, sending shock waves through the rest of the tech industry.
The announcement sent shares in Apple plunging 10pc, the biggest one-day fall in more than five years, rattling already volatile global financial markets.
Having lost its crown as the world’s most valuable company little more than a month earlier, Apple’s market value proceeded to slip into fourth place, below Google’s parent company Alphabet as well as Amazon and Microsoft.
To many, the response seemed like an overreaction. Cook said that Apple had made around $84bn (£66bn) in the final three months of 2018, against a prior prediction of between $89bn and $91bn. That is still an astonishing amount of money.
“Apple is far from the only company in the history of the stock market that has had to pre-announce in a negative fashion. No management team is perfect,” says Brian Baker, of Baker Ellis, an Apple investor. “This time they were a little bit off. Everybody makes a mistake.”
Maybe so. But in Apple’s case, such mistakes are exceedingly rare, prompting questions over whether its stumble last week represents the end of the era of seemingly endless growth in smartphone sales that propelled Apple to a valuation of over $1 trillion. If it is, can Apple really reinvent itself – and how?
As a company, Apple is notoriously prudent about the financial guidance it gives investors.
The last time it was forced to cut its forecasts was in 2002, when Jobs admitted that sales of its Mac computers were slower than expected. There was no iphone back then, and the ipod was brand new. The company’s revenues in that quarter were $1.4bn, less than 2pc of the “disappointing” sales figure Cook revealed on Wednesday. The fact that such unhappy surprises are so rare makes them all the more shocking. Under Cook, Apple has shed much of its old bravado and swagger. Investors have still done exceedingly well, however, as it has produced something else: reliability, growth, and a capacity to generate astonishing amounts of money.
Now, the first two no longer seem true. Apple may still be making giant profits, but last week’s unscheduled announcement was a big blow to Cook’s reputation as a safe pair of hands.
Just two months earlier, Apple’s chief had assured investors that its business in China was “very strong”, at a time when many believed warning signs such as escalating trade tensions justified a more pessimistic outlook.
Last week also revealed Apple as a shrinking company: its $84bn revenue prediction was not only below its own financial forecasts, but $4bn below what the company reported a year ago.
A bad quarter is one thing, but the news also shook two of Cook’s key strategic pillars. The first was his full-blooded bet on China, now its biggest smartphone market, but one that Silicon Valley has found difficult to crack. The second was Apple’s strategy of consistently raising iphone prices, and relying on consumers to keep on stumping up more.
Cook established China as a priority almost immediately after taking charge of Apple. In 2012 he became the company’s first chief executive to visit the country, as sales of smartphones boomed.
Unlike its Silicon Valley peers Facebook, Google and Twitter, whose services are banned by internet censors, Apple has prospered in China, and bowed to Beijing’s controls. Apps such as The New York Times have been removed from the iphone’s App Store, and users’ data is stored on Chinese servers.
Cook’s focus on China paid off and by 2015 it was selling more iphones there than in the
US. But since then, it has not grown as quickly as it would have liked.
Since 2015, Apple’s revenues outside of China have increased from $176bn to $214bn, a 20pc rise. In China, however, they have stagnated. In the company’s fiscal 2018, sales in the country were $51.9bn, against $53.4bn in 2015.
According to data from IDC, Apple’s market share in China has now contracted for six
Apple may still be making giant profits, but last week’s announcement was a big blow to Cook’s reputation
straight quarters. “It’s a saturated market and the economy is essentially in recession,” says Ryan Reith, an analyst at the firm.
While the company accounts for almost half of phones sold in the US, and a similar proportion in Britain, in China it has just 9pc, according to Counterpoint Research.
This puts it in fifth place behind domestic manufacturers Huawei, Vivo, Oppo and Xiaomi, which have moved on to Apple’s turf by introducing handsets with high-end specifications – often at a significant discount.
Despite this, Cook has remained bullish on China until recently. “We could not be more pleased with how we’re doing … everywhere I look, I feel really good about how we’re doing in China,” he told investors less than a year ago.
While the iphone has a cachet that its Eastern rivals do not, a swell of patriotism amid mounting trade tensions is seen as pushing Chinese consumers to Huawei and others. Last month, a Huawei executive was arrested in Canada after being charged by the US government with breaking sanctions. Washington is seeking extradition, and Apple has been seen as one potential victim of an anti-us backlash in China.
Several of the Apple services that give it a key advantage in Western markets, such as its imessage app, Apple Pay system, and App Store, do not play quite the same role in China.
Reith says that this is down to Wechat, China’s dominant messaging app, which is also a portal for finances, games and music. Wechat works just as well on rival phones as on the iphone, which means customers are less inclined to pay the significant premium to buy an Apple phone that they do in the US or Europe.
“[Apple’s advantage] certainly doesn’t exist to the extent that it does in the West,” Reith says. “In China, anybody using a high-end device or a low-end device, they all spend most of their time in Wechat.”
Smartphone users may be willing to pay more for an Apple device when times are good, but as the economic picture in China worsens, the price difference between an iphone and a local rival starts to matter a lot more. And Apple has made that difference only more apparent in recent years, raising fears the brand may have reached a tipping point.
One of Cook’s great successes has been in increasing revenues from iphone sales, even as the number it sells has flatlined.
Apple has never been a budget brand, but as of late it has become super-premium. The most expensive iphone XS Max costs up to £1,449, almost double what the dearest iphone 6S Plus cost three years ago.
Until now, Apple had seemed to defy gravity: in its most recent quarter, the average selling price of an iphone was $793, up from $671 three years ago.
Apple managed to push through price rises even as critics said that the newer versions of its phones had fewer of the major technological leaps that previous models did.
But last week’s sales warning showed that, perhaps, consumers have been pushed beyond what they are willing to pay for a phone.
While Apple blamed the Chinese economy and the prospect of a trade war with the US, a situation out of its control, for its struggles in the country, it also admitted that China was far from the only factor at play. “In some developed markets, iphone upgrades also were not as strong as we thought they would be,” Cook said. He said that the stronger dollar had meant higher-than-normal price increases in some countries, and that cutting the price of replacement batteries had also been a factor.
James Abate, a managing director at Centre Asset Management, sold his shares in Apple shortly before last week’s announcement. “The excuse of China is not really the right cause … some people have an aversion to spending over $1,000 on a new phone,” he says. “The reason why we sold Apple was that for the first time consumers were reluctant to upgrade.”
Now, Apple is left with the nightmare that investors have feared for years: a saturated smartphone market, with little room to raise prices. Daniel Ives, an analyst at Wedbush Securities, said last week’s announcement will be a “defining moment for Cook”, but one that leaves him with an unpalatable choice. Either he chooses to ride out a period of weak sales and hope future iphones are good enough to encourage upgrades, or cut prices now and take the hit to Apple’s fat profit margins.
The latter would be an unusual move for a company unused to admitting to mistakes, but analysts believe it is the most likely course. Cook pointed to “a number of steps we are taking to respond” to the disappointing sales figures, including making it easier for users to trade in their older iphones for new ones.
“We can’t change macroeconomic conditions, but we are undertaking and accelerating other initiatives to improve our results,” Cook said.
All of this, however, could be seen as just tinkering around the edges.
The best-case scenario for Apple investors would be a magical new product that replaces the iphone. Apple has poured billions into research and development in recent years. But this seems unlikely.
Cook has said that Apple is working on driverless car systems, but progress is unclear, while other companies such as Alphabet’s Waymo appear more advanced. The company is also investing in augmented reality (AR), a new form of computing that implants digital objects into the real world. So far, however, there appear to be few immediate uses beyond gaming. The alternative, smart glasses that put virtual objects directly in a user’s vision, are years away from being good enough for everyday products.
Last week, Cook pointed to the progress it has made in some more realistic new areas. Sales of the Apple Watch and Airpod headphones, the two most successful products launched since Jobs’ death in 2011, have risen by 50pc in the last year.
Sales of Mac computers and ipads are rising after a tough few years. And its services division, which includes apps and music streaming, reached a new record. But nothing comes close to the iphone, which still makes up two thirds of Apple’s revenues and remains one of the most profitable products on earth. Few items are relied upon as much as our smartphones, and it is hard to imagine that changing any time soon. Navigating the end of its growth story will be Cook’s biggest test yet.
‘China is not really the right cause … some people have an aversion to spending $1,000 on a phone’