Apple will announce its quarterly earnings later today. In the meantime … pop quiz. True or false:
1. Apple dominates smartphone profits.
2. The number of people using smartphones has reached 1 billion.
3. Future growth in smartphones will come in developing countries, where the price (and therefore profits) will have to be lower.
4. To adapt to this changing market, Apple will have to create (indeed, already has) a lower-price smartphone.
Items 1 through 3 are all true. Apple still dominates the profits of the smartphone industry, to the tune of 57 percent (41 percent accrues to Samsung Electronics (005930:KS), leaving a couple of percentage points for everyone else). And as smartphone users pass the 1 billion mark, that means most people who can afford an iPhone or Galaxy S4 already have one.
This was always bound to happen—markets mature, growth slows. Meanwhile, there are still 5 billion other people who don’t have smartphones, so there’s a tremendous market out there for the company that can make a cheaper phone faster. This is usually the part in this narrative when companies like Huawei Technologies (002502:CH), ZTE (763:HK), and Lenovo (992:HK) come up, because they have the inside track on cheap phones and their razor-thin profit margins.
But what’s Apple going to do? Apple (AAPL) could maintain its share of industry profits, but that’s cold comfort if the pie is shrinking. Is there a $99 iPhone in the company’s future? New stories seem to announce that possibility every day (almost as often as they proclaim a new stage in the development of Apple TV). I’m going to do something daring and say I have absolutely no idea, but there are two examples in Apple’s own history to suggest the way forward for Cupertino.
The first example is the growth of the iPod line. What started with one device (now called the iPod Classic and, miraculously, still for sale) turned into a product line ranging in price from $49 (iPod Shuffle) to $399 (64GB iPod Touch). If the iPod line can increase in price by a factor of eight, surely the iPhone line can support a cheaper phone. That’s one school of thought.
But iPods are not iPhones, and so Apple’s history as a PC manufacturer is more instructive. Apple has consistently and dramatically lagged the big players in the PC industry, such as Dell (DELL), Hewlett-Packard (HPQ), Acer (2353:TT), Asustek (2357:TT), and Lenovo when it comes to market share, but not when it comes to profits. At the close of 2012, Apple made more profit from PCs than all five of those manufacturers put together.
Apple has never been about volume. It’s been the Porsche of tech companies—comparatively low volume, industry-leading profits. The past decade or so—which saw the rise of the iPod, followed by the iPhone and iPad—has been great for the company, but when you listen to the leadership of Apple, you don’t get the sense that overall unit sales are what really move the needle internally. That the numbers have been so great is, well, great. That doesn’t mean the entire company’s strategy has changed.
For that reason, Apple seems highly unlikely to join other manufacturers in a race to the bottom. First off, they would probably lose to lower-cost Chinese manufacturers (which will, in some years time, lose out to even lower-cost Vietnamese manufacturers, which will lose out to Nigerian manufacturers, and so forth). Furthermore, what exactly would it win? Samsung is already slugging it out in this sector, and its stock price is, in part, getting slammed for it. The future of Apple may, in some ways, resemble the past: industry-leading technology, a loyal customer base (now comprising hundreds of millions of people), and a premium set of products that sell for a goodly amount of cash.
It’s not a bad strategy. Per financier Bernard Baruch: “Nobody ever lost money taking a profit.”