In-depth analysis on Credit Writedowns Pro.

On Apple’s China Strategy

Morgan Stanley had a very good note out earlier today reporting that Apple needs to issue an iPhone mini to capture share in China. This is what I have been advising as the market share margin trade-off is favourable for Apple’s bottom line. Morgan Stanley estimates that a cheaper emerging market-oriented iPhone for the Chinese market would cut Apple’s margins down to 49% from 51% while the new handset would boost the pre-tax bottom line by $2.4 billion and triple Apple’s market share in China.

Last week, in my post on the mobile market, I wrote “what declining handset sales mean for the mobile industry“. And this is declining emphasis on mobile adoption and increased focus on handset upgrades, a shift that will lower handset average selling price. This should put increased emphasis on emerging markets for growth as mobile manufacturers can take better advantage there of handset upgrades to smartphones. Apple needs to get into this market as Android is already tapping $50 smartphone market in a big way and every price point in between.

[private_gold]

Apparently, this is a big part of Samsung’s strategy because the Irish Independent reported last month after Samsung’s earnings that a Samsung executive “said that the strongest growth in the future would come in the market for low cost handsets in developing countries.” And clearly they are concentrating much of their effort there.

Now, Morgan Stanley is not talking about a $50 iPhone, rather they mentioned a $330 price point for an iPhone mini. Their analyst Katy Huberty believes that prices in the smartphone market have stabilised somewhat, making now a good time to enter the market at a lower price point. I disagree that prices have stabilised as I believe the market dynamics favour increasingly lower prices to maintain growth. Nonetheless, I do agree that Apple can take share without significant cannibalisation if it lowers its price point for China and other emerging markets where household incomes are lower.

Huberty writes:

“Even in a scenario of low 40% gross margin and 1/3 iPhone cannibalization rate (flattening legacy iPhone shipment growth), which we view as conservative, the iPhone Mini adds incremental revenue and gross profit dollars.”

Tim Cook was seen in China talking to the head of China Mobile recently and there has been much speculation about China launching a cut-rate iPhone. So this analysis makes sense given that background and the positive economics of such a move. I don’t understand why Apple hasn’t done this already. Morgan Stanley claims that a big impediment here is the proprietary technology standards in China. 40% of the market for 3G-enabled smartphones use a different version of the CDMA standard used in the US by Verizon and Sprint called TD-SCDMA. Most of the world uses GSM. But Apple has already released the iPhone to Verizon’s CDMA-based network in the US, so this shouldn’t be a huge obstacle. 

The bottom line here is that in emerging markets, phones may be the major way consumers connect to the internet in the future. As these consumers gain more wealth, they will upgrade feature phones to smartphones, making this switch to mobile-based Internet happen. We’re talking not just about China but India, Brazil and other emerging markets. If Apple continues to maintain its premium pricing, Android will grab so much share that Apple could be permanently relegated to also-ran status.

[/private_gold]

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.