Apple released earnings this week, and while they out-performed at the top and bottom impressively, the devil is in the details. Clearly the iPhone is doing very well, but Apple’s dependence on one product is becoming increasingly troubling, particularly given that Apple has the least control over that product (even though they are working furiously to address that exposure). iPads and the Apple Watch continue to underperform expectations, and the Mac continues to be less and less relevant to the company.
Let’s walk through some of the concerns.
iPhone 60% and China
The company effectively lives or dies on the iPhone, which now represents around 60% of its revenue and likely an even higher percentage of its profits. A decade ago Apple was far more balanced. The most impressive growth is coming out of China. Apple recently and impressively dodged a bullet when the carriers started to aggressively eliminate subsidies, which would have crippled Apple sales. But they came out with a brilliant financing/buyback program which that appears to have fully mitigated this exposure. However, smartphones continue to be tied very tightly to carrier performance, and the carriers are going through a lot of difficult changes at the moment.
To compound those potential pitfalls for Apple, Google is testing a service that could force Apple to counter if it is successful. (And Google is pretty much giving it away which could do ugly things to Apple’s margins). Google’s service, Called Project-Fi, massively reduces monthly smartphone bills. The only thing keeping it from going vertical is that it initially sucked, but apparently it is getting much better. They should have it sorted within 12 months and the financial benefits to moving to Android to get to this low cost service are compelling.
In addition, China and the US aren’t getting along very well at the moment. It isn’t hard to imagine that a trade war might result, which would hurt all the companies selling into China. Apple would be particularly hard hit given how much of their growth is tied to that country. They really need a more balanced product portfolio.
That balance sure isn’t coming from the iPad. The tablet’s 20% tumble year over year is the biggest indication that Steve Job’s sequential hit model is failing. The iPod gave way to the iPhone, which should have been massively supplemented by the iPad; but the iPad is falling off sharply and is in trouble now. Folks are perfectly happy keeping these things for years, and there are increasingly decent products like the new large Kindle coming into the market at or below half of the iPad’s price. The end result is the iPad isn’t carrying its weight.
There is hope that the new iPad Professional will take up the slack, but it’s very similar to the enterprise model that Apple tried and failed with before Steve Jobs returned in the late 1990s. The reason it failed is that Apple doesn’t work well with corporate buyers. This time Cisco and IBM are going to try to help, but this has to be a far better partnership than Apple has ever done. Fortunately, Cook should be better at this than Jobs was, but it’s still a huge stretch.
The fact they still aren’t breaking this product out from the iPod, Apple TV, and Beats suggests it is doing very poorly. The designers broke from Apple’s model of simplicity with this product, and it is getting mixed reviews. The surveys I’ve seen suggest the market is below $300, which means that the Apple Watch is priced over market and that price, along with the watch’s relative complexity, seems to be severely limiting demand.
Wrapping Up: Apple the iPhone Company
So what these financials tell us is that Apple has become the iPhone company. Products like the Apple Watch, iPad, and even their entire PC line just aren’t providing enough diversity to hedge against any smartphone fall. Next year we’ll have a maturing and very compelling Project Fi, we’ll have the Qualcomm 820 phones with massive improvements in performance, and we’ll have the new Windows Phones which should be able to leverage the success of Windows 10 (and the idea of a smartphone as a PC) to create a compelling threat. (And, as a brief aside, I do think Microsoft seems to be out-advertising Apple at the moment).
I think the big problem for Apple is that the company currently is the leading bellwether for the tech market and China has a lot of say over what goes on with Apple. If they wanted to get the US’s attention, an embargo against Apple would do horrid things to the entire US tech sector. And with US warships challenging China’s new islands, this could become a powerful weapon to get the US to back off.
We’ll see, but it is clear Apple is doing everything they can think of to mitigate the risk. I’m just not sure it will be enough.
President and Principal Analyst, Enderle Group
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