Apple's Tough Choice – Customers For Life Or High Margins
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Apple (AAPL) stock has been hammered as the technology giant has lost smartphone market share to companies like Samsung 
(SSNGY.OB), Lenovo, ZTE, Huawei and others. Apple is not losing market share because it has an inferior product or its competitors have better technology. The reason that Apple’s stock is going down is that it has more or less saturated the global demand for premium smartphones. Apple continues to grow market share in the world’s richest countries like Japan and the USA. But it is losing share in developing, low income countries where citizens simply cannot afford the pricey iPhones. For example the iPhone 5 retails for around ~$775 in India, where the per capital income is just ~$2000. Even the cheapest iPhone 4 retails for ~$500. Only 16.7 million smartphones were sold in India which made up less than 10% of the total mobile phone market. China which is another huge market for Apple has got similar issues.
A big reason why Apple’s margins fell in Q113 was the higher sales of lower priced products. iPhone 4 remains a top seller despite being two generations behind Apple’s latest iPhone version. iPad mini is also selling in huge quantities cannibalizing iPad sales and even Apple’s Mac line of premium PCs. Though cheaper products are lowering Apple’s margins, they are helping Apple gain new customers. It is a known fact that Apple’s customers display very high brand loyalty and stick with Apple products when they go for a repeat buy. I think that Apple will have to make a tough choice to sell lower priced iPhones as it cannot afford to give the massive lower and middle smartphone segments a miss.
Read on GWI Apple – Why The Market Is Being Stupid And 13 Reasons To Buy The Stock.
Why Apple should introduce lower priced iPhones
1. Retain market share – Apple is losing market share as Samsung and LG capture customers in the fast growing emerging markets. Apple does not have products in the lower and mid segments which can compete with the Android players. Even Nokia (NOK) has refreshed its Lumia phones lineup to target almost all segments of the smartphone market. The Lumia 520 is an excellent smartphone which is available at less than ~$200. The developed markets are more or less saturated and future growth will come from this segment. Apple will continue losing market share unless it comes out with a cheaper smartphone product.
Top Five Smartphone Vendors, Shipments, and Market Share, 2013 Q1 (Units in Millions)
| Vendor | 1Q13 Unit Shipments | 1Q13 Market Share | 1Q12 Unit Shipments | 1Q12 Market Share | Year-over-year Change |
| Samsung | 70.7 | 32.7% | 44.0 | 28.8% | 60.7% |
| Apple | 37.4 | 17.3% | 35.1 | 23.0% | 6.6% |
| LG | 10.3 | 4.8% | 4.9 | 3.2% | 110.2% |
| Huawei | 9.9 | 4.6% | 5.1 | 3.3% | 94.1% |
| ZTE | 9.1 | 4.2% | 6.1 | 4.0% | 49.2% |
| Others | 78.8 | 36.4% | 57.5 | 37.7% | 37.0% |
| Total | 216.2 | 100.0% | 152.7 | 100.0% | 41.6% |
Source: IDC Worldwide Mobile Phone Tracker, April 25, 2013
2. Apple has introduced lower priced music players and tablets in the past – Apple will not introduce a cheaper product for the first time. History shows that Apple has launched cheaper versions of the iPod and the iPad to compete better with low priced competitors. There is no reason to think that Apple will dilute its brand by selling a cheaper iPhone.
3. Customers for Life – Customers show high brand loyalty towards Apple products and a number of customers buy only Apple products. Apple needs to sell its products to emerging market customers so that they can experience the Apple ecosystem too. The iOS operating system is one of the best operating systems and customers show a high stickiness to the Apple ecosystem. Nokia managed to sell smartphones at all price points and still retain its brand appeal. Nokia also remained highly profitable till Apple’s iPhone transformed the mobile phone market. I am not advocating that Apple sell $20 feature phones like Nokia, however Apple desperately needs to broaden its smartphone portfolio.
A recent study by Kantar measured 95% loyalty rate among iPhone owners, substantially higher than the competition, and iPhone remains top in customer experience. Last month, we were very pleased to receive the number one ranking in smartphone customer satisfaction from J.D. Power and Associates for the ninth consecutive time. The most recent survey published by Change Wave indicated a 96% satisfaction rate among iPad customers.
4. Higher sales of software and services – Apple has shown a tremendous growth in its iTunes store revenues which have crossed the $4 billion mark for the first time in the last quarter. Apple garners almost ~75% of the global app revenues, despite having a smaller number of devices running iOS as compared to Android. With more hardware running the iOS, iTunes sales and profits will increase.
Today, our iTunes store offer the broadest combination of geographic reach in content depth in the industry, and they surpassed quarterly billings of $4 billion for the first time ever in the March quarter, that’s a $16 billion annual run rate making our digital content stores the largest in the world.
5. Samsung is becoming a big threat – Apple is allowing Samsung to become a bigger and stronger company by not competing in a large segment of the global smartphone market. Samsung has managed to grow profits and sales much faster than Apple. By introducing a cheaper iPhone, Apple will slow if not decrease Samsung’s furious growth in the smartphone market.
Why Apple should not introduce lower priced iPhones
- Will dilute its brand appeal – Apple’s iPhone is a “status symbol” in many parts of the world due to its premium products. It gives a snob value to iPhone owners for which they are willing to pay a huge premium. Cheaper iPhones will lead to millions of new customers. This will lead to a dilution in the “status symbol” appeal of Apple products and the company might lose a section of the high income customers.
- Lower its overall margin – Apple sports one of the highest margins in the electronics industry as it is able to charge a significant premium for its products. The margin is coming down as the company’s product mix changes in favor of lower priced products such as iPhone 4 and mini iPads. The introduction of a cheap iPhone will mean a further lowering of the company’s gross margin as they will eat into the sales of higher priced and higher margin iPhones. This is the biggest risk for the company which is already facing pressures on the margin front.
- Cannibalize its higher priced products – Apple’s iPad mini has cannibalized the sales of the higher priced iPads. Lower priced products will eat into the sales of the higher priced products. But if the overall sales and profits are higher, then a company should launch the lower priced product.
Valuation and Stock Performance
Apple’s stock has not gone anywhere in the last 4-5 months, as the stock has disappointed investors who were looking for new product launches. The declining margins have also scared investors who think that Apple may become the new Microsoft (MSFT). The company is trading at an amazing valuation as the sentiment remains heavily bearish towards the stock. The company is trading at a P/E of less than 10x and is giving a very handsome dividend yield of ~2.75%. I remain positive about Apple’s stock at the current time and would look to build a small position.
Summary
A company should not make decisions based on its margin percentage but should look at overall profits. If a company can make a $100 profit with 50% margin but can make a higher $110 profit with a 40% margin, then it should look to adopt the second business model. I think that Apple has no choice but to introduce cheaper iPhones as the company will lose significant market share. The company’s main competitors are growing bigger and stronger as Apple is not competing in the mid range of the smartphone market. The company has already been forced to discount its products in order to grow in the lower income countries like India. The management realizes that it is nearing saturation for its premium iPhone products. The company’s main focus should be on increasing the reach of its terrific ecosystem. The iOS operating system handily beats other popular operating systems in the ease of use and security. However, millions of users are not able to experience the advantages of the iOS as they cannot afford Apple products. I think that Apple needs to really accelerate its cheap iPhone program as the benefits of a cheaper iPhone far outweigh the costs.