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Apple (AAPL) has a plan to remake itself. Its new business model is all about leveraging its hardware ecosystem to sell software services. Unfortunately, hardware isn’t what it used to be.
Investors have been grumpy about Apple shares since iPhone sales set records in the middle of last year. Paradoxically, the reasoning then was it couldn’t possibly get any better. So far, that’s true. In fact, expectations were so low going into last week’s earnings report, even terrible year-over-year numbers looked great.
For example, sales in China, once thought to be the engine of future growth, collapsed 33%. Overall revenues fell 15% to $42.4 billion. iPhone sales were down 15%. That was made worse by a decline in average selling prices as its 4-inch retread, the $399 iPhone SE, outsold the iPhone 6 and 6S.
Beyond phones, iPad sales fell for the tenth consecutive quarter. Sales of Mac computers tumbled 11%, the third consecutive decline for that category. And Apple Watch — the product that CEO Tim Cook promised would change the wrist — warranted no more than a few passing thoughts on the conference call despite separate reports pointing to a massive 55% sales decline.
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Apple customers have begun keeping their old iPhones longer |
However, all of those numbers, as bad as they are, looked fine next to dramatically lower expectations. Cue the short covering rally.
There was a bright spot though, and it’s the key to Apple’s future plans. The subscription business is booming. Apple Music, App Store, Apple Pay and all of the other bits and pieces Cupertino throws under the Services heading are now almost a $6 billion-per-quarter business. Tim Cook promises that by 2017 Apple Services will be a business big enough to make the Fortune 100 all by itself.
That would be amazing. However, investors should be very wary. Apple builds wonderful hardware products people love. In the past, they have been very loyal. However, by all accounts, they’re keeping their beloved iStuff longer or worse, switching to less-costly alternatives. All of the Apple hardware categories are now declining.
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The new business model depends on increasing numbers of new people becoming stuck in the hardware ecosystem and then buying services. To get substantial growth beyond the base, Apple needs sales growth to offset normal attrition. The data says that’s not happening. In fact, sales growth is negative.
This is not just a bad secular trend Apple is patiently riding out. It is building out retail stores in China at a furious clip yet sales are still falling. As Apple loses, China’s Huawei — a conglomerate with global aspirations and with the tacit support of its Communist government — is flourishing. That same Chinese government, by the way, is throwing obstacles in Apple’s way like services bans and dubious patent infringement claims.
In the United States, Apple is fighting a war on two fronts. It’s losing market share at the high end to Samsung’s critically acclaimed, fast selling Galaxy S7 line. At the low end, inexpensive Chinese imports are nipping away at its bottom line. In the past, Cupertino has paid little attention to that part of the market. Those days are over. To make Services gains, it needs to expand the ecosystem. The iPhone SE is a direct response to those ankle biters.
Tim Cook is prone to hyperbole. Cheerleading seems to be part of the job description for modern corporate leaders. He has continually talked about the rate of Android switchers to iOS despite all of the evidence to the contrary. He also recently opined about the growth rate for Apple Watch being on par with the early days of iPhone. Although he’s understandably optimistic about Apple’s future, building a business model based on declining sales growth has never been a great idea.
While it’s tough to bet against the world’s largest company and its pile of cash ahead of a product cycle, reducing exposure into strength is the best course of action right now. Just as investors became too pessimistic about earnings this quarter, they’re likely too optimistic about the prospects for the next iPhone.
Best wishes,
Jon Markman
{ 21 comments }
I plan to keep my 6LS until it or I die! The best one in my view!
Hmmm… is this transition similar to Amazon and its AWS cloud biz? After all, other than PRIME, where is the growth at AMZN? If AAPL can grow the software biz at double digit multiples, does it offset the need for 2 year cycling to hardware upgrades which add little benefit to the consumer at the margin?
What is the ticker symbol for China’s Huawei ?
What exchange does it trade on ?
Good to see the Apple-haters back at it. In prior times, that was a certain tell for the stock to rise.
Coming to understand what is wrong with this world today. I noticed Chipotle stock fell from a high of $748 A SHARE last August to $414 as of today. This in itself I find insane even at $400 and change. Today I watched a program on the NHK channel showing a worker in Indonesia. He was at the bottom of the food chain scrounging for recycling material and his wages came to $25 A MONTH!! The Joker sorry Jokwi or something that runs the country has assured O’Bama that he will sign onto the TPP. What a boon for American industry looking to dump their high priced help. Here is an opportunity to access really cheap labor and still sell their crap for the same price as in the USA. I see it first hand here in Thailand. in fact its more in some cases. The Thai SET has listings of good companies as do other Asian countries that sell for 1/40 the price of Chipotle or a lot less. You can buy shares in the Singapore rail system for about $1 a share why in Gods name would you pay $414 for Chipotle at a time when the restaurant index is in decline. The Thai baht has hit a peak against the American dollar so investors maybe its time to look elsewhere for good investments instead of paying for overpriced American ones.
PS Ask Larry he is in Bangkok
I guess China as in Apples case vs Hauwei is showing their true colors. Why anybody would want to invest there is beyond me. Every competitor there has a business partner or manager in their corner called the Chinese government.
Another factor in declining hardware sales is that Apple products, particularily iPads do not turn obsolete. I am still using my original ipad2 and it still serves my needs well. Yes, I am thinking about upgrading to a 9.7″ (I like that screen size) iPad Pro, although I really have no good reason why.
Great idea, except none of the devices you’re worried about work directly off satellites. Satphones exist, but they’re not what “regular folks” use, due to extremely high cost.
You’d need a whole fleet of satellites to handle cellphone volumes, and there isn’t enough orbital real estate up there to make it possible. Otherwise, they’d have already done it.
Tell that to my wife, whose iPad can’t be updated beyond iOS 5.0, and most apps won’t even run on it anymore, due to their own updates requiring those changes.
Enjoy reading your Apple thoughts looking ahead. What’s the next move for the investors future
Part of the reason for Apple’s declining sales in its Mac line is tied to the age of the current product line. The aluminum iMacs era has lasted nine years. The candy-colored iMacs were phased out after four years. My 2010 iMac still works fine. I’m reluctant to replace it until it wears out or Apple comes out with their next iMac redesign. The aluminum era Macs look nice and are very functional, but a totally new Mac would soon make the current ones look old and obsolete.
Apple makes great products. Eventually a market reaches the point of saturation. Market saturation happened a long time ago with desktops and laptops. Tablets are reaching the point of saturation. It is now possible to find capable Android tablets for under $50 at discount stores. That’s great news for consumers but not so great for those hoping to sell large numbers of a premium product.
Hi Jon: Thanks for your excellent analysis. It is apparent that smartphones & Broadband have topped out,Apple being the last “Mohican” Huawei seems to have a jump with its pending 5G to perform 100 X of 4G for IoT. All these smartphones Titans( Huawei,China Mobile,Alcatel,Nokia,AT&T, have not noticed Apple) making full court presses to develop 5G before 2020,for IoT. We have an incredible jump ahead of all of them. Of your 7 Mega Trends we are 1&5. I would like to bring you up to date since we had connected sometime ago, we have developed unprecedented Green Wireless to Transform Broadband Platforms: GSM/Nokia, CDMA/Qualcomm with our unparalleled Green Spectral Efficiencies of >120Mbps/500Hz=240,000 X Efficiencies vs 3G GSM Edge 480Kbps/280KHz=1.37 X Efficiencies, 4G CDMA 1.25Mbps/1.25MHz=0 Efficiency. Cheers. William Chan
All this future growth sounds great until one realizes it will all come to a screeching halt once the grid goes down. And down it must go because there are so many goons and bad guys out there that want the US to go back to living in 1875. However, I have wondered if it’s possible for a far sighted company like Apple, to place their own satellite’s in orbit, but I suppose the Gov. would move in and take that away from then in an emergency.
We need to start punishing these dam Chinese, tell them to keep their junk out. It is so hard for American companies to do business over in China, UBER is the latest example. We need to counteract their barriers, with our own barriers. These commies have been sticking it to us for too long now!!!
New slogan— AMERICAN JOBS MATTER !!!
Technically, we need to get the communists out of office here in America before anything will really improve. We need a paradigm shift in our rule of law, and a part of that would include dealing with these communistic trade agreements. I mean, really? Not mentioning names here, but when the fbi will not prosecute treason, what does that say to all our enemies, economic and idealogical?
Answer: Ignore the laws, they do not matter.
Hence, we should expect increases in communistic governance, the very goal of our enemies.
Unless we can produce a paradigm shift in the rule of law.
Apple’s more rabid followers have always been a kind of cult. Maybe even they’re starting to realize that the emperor had no clothes, and moving on to better technology and better prices.
It was a great thing for those who don’t want to know anything about their devices, but I think folks got tired of the compromises, and are willing to learn a little more than “Hey, Siri, How do I turn this thing on?” Probably a good sign for humanity, if not for Apple investors.
Quality Sells because everyone can appreciate quality when they encounter it… even if they can’t define it… It just feel’s good to own and operate apple products.
At a small business conference last year, an owner explained he was bidding on a piece of business that he had held for many years. He needed to spend $5 million on new equipment to be competitive with a South Korea based company. The South Korea government subsidized the competitor’s purchase of the needed equipment. I’m a small government person but this shows how tough it can be for many U.S. based companies in this global world to be competitive without some help from somewhere. Wish I had the answer.
Apple has it coming, selling nothing but overpriced quirky proprietary everything….hardware and software. The Itunes interface made everything difficult with my Windows computer, there was no easy way to do simple tasks, like transfer files to without navigating a load of meaningless and worthless pop-culture icons and functions. Was so happy to get rid the Iphone 4 for an Android Galaxy while it was still worth something and end 6 months of agony.
I love Apple but they seem to have lost their way, faffing around with different sizes of iphones is a million miles away from genuine creativity.