Apple Is Not an iPhone Company Anymore – Then Again, It Never Was

Bottom Line

Apple’s 2Q19 earnings suggest that Apple is becoming a services company as iPhone sales decline, but this is really just an extension of Apple’s long-term strategy of creating software platforms monetized by hardware.

Analysis

What Happened

iPhone sales are falling rapidly – down 17% from this period last year – and while Tim Cook says that things are improving, nobody should expect iPhone sales to suddenly start rapidly expanding again. The smartphone market is mature, the replacement cycle is lengthening, and while it has done some discounting, Apple is not willing to chase sales down to entry level price points, not even in emerging markets like India. But Apple does have large pockets of growth outside of iPhone. Apple is not growing Services fast enough to offset declining iPhone sales in the near term, but Services have hit 20% of Apple’s total revenue, and the growth trajectory looks good. Apple is also seeing strong results in Wearables - AirPods and Watch alone exceed many company's revenues. iPad sales are another positive; Apple broadened its price points, continues to sell well in education, and is benefiting from reduced competition for premium tablets. Apple explains the drop in Mac sales as due to processor supply constraints, but its repeated keyboard woes are damaging its reputation. It is time to kill the butterfly.

Services are Bigger, but Apple’s Strategy Hasn’t Really Changed

The iPhone alone can no longer drive Apple forward, but in three crucial ways, Apple is really not changing at all:

1. The iPhone isn't going anywhere - people still need pocketable mobile computing devices, and even if they upgrade less frequently, they will upgrade.

2. Apple has other hardware, including relatively new products like Apple Watch and AirPods that are growing rapidly. They cannot grow to the size of the iPhone, but even aside from Mac and iPad, Apple is not a one-product company. Apple Watch also serves as a long-term anchor for iPhone sales; Apple has an enormous lead in smartwatches, and the Apple Watch requires an iPhone to function.

3. Most crucially, Apple was never an iPhone company, it was always a software platforms company that monetized the platform with hardware. While iPhone hardware sales are lower than they were, the iOS user base continues to grow, and Apple is now monetizing more of the software portion of the platform. Apple's "Services" comprise a wide range of offerings, including a cut of every app sale, payments, advertising, online storage, movie rentals and sales, TV, book, and music purchases, Apple Music, and a percentage of every subscription to content and services from other companies that are made via iTunes, the App Store, or Apple TV. In fact, Apple says its users have 390 million subscriptions (of all kinds) within iOS. Services make up 20% of Apple's revenues, the margins on these services are above 60%, and Apple is rolling out new services later this year.

What’s Next for iPhone?

Global smartphone sales are down, and given the outsized role the iPhone still plays in Apple revenues, Apple's sales are holding up fine in the U.S. and Japan, and are not slipping too badly in Europe. However, China is another story. There, Apple revenues fell over 20% while Huawei's device sales have exploded. This is especially problematic because Apple’s ecosystem lock-in is not as strong in a market where many consumers live inside WeChat, regardless of what OS and app store they use. The next iPhone needs to catch up on still and low light image quality - Huawei has been relentlessly improving its phones in this respect – and Apple needs to visually differentiate new iPhones from older ones. If Apple is not able to significantly alter the form factor this fall, it should aggressively play with colors and finishes. To increase ecosystem stickiness, Apple should heavily promote Apple Watch in China. Price discounts on Apple Watch should be used liberally, but Apple should also prioritize creating new health and app features for Apple Watch that are aimed at the Chinese market.

Anything Apple can do at retail to goose iPhone sales will have an enormous impact on its bottom line. Apple can lower iPhone prices, as it is doing in China and India, though there is a limit to how low Apple can go – it does want to retain its premium brand status over time. One sure tactic we are likely to see are higher values for iPhone trade-ins; this effectively serves as a subsidy and rewards loyalty without devaluing new phone prices.

In the near term, Apple’s deal with Qualcomm removes a major distraction for Apple and validates Qualcomm’s business model. It also ensures that Apple can ship 5G iPhones in 2020 using Qualcomm modems. 5G network deployments will not be meaningful to consumers until then, but Samsung and LG should still try to position themselves as innovators – though they may have to pitch 5G as a way of future-proofing a purchase rather than promising specific speeds or use cases. In China, Apple may need to accelerate 5G iPhone development, as the market conditions there dictate a competitive response as large cities are covered en masse. Longer term, Apple’s license agreement with Qualcomm gives it flexibility to build its own modems, which could open interesting opportunities in mobility, automotive, wearables, and AR.

Report Contact

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Press Release

https://www.apple.com/newsroom/2019/04/apple-reports-second-quarter-results/