3 January 2019Apple:
Lower than anticipated iPhone revenue, primarily in Greater China, accounts for all of our revenue shortfall to our guidance and for much more than our entire year-over-year revenue decline. In fact, categories outside of iPhone (Services, Mac, iPad, Wearables/Home/Accessories) combined to grow almost 19 percent year-over-year.
While Greater China and other emerging markets accounted for the vast majority of the year-over-year iPhone revenue decline, in some developed markets, iPhone upgrades also were not as strong as we thought they would be. While macroeconomic challenges in some markets were a key contributor to this trend, we believe there are other factors broadly impacting our iPhone performance, including consumers adapting to a world with fewer carrier subsidies, US dollar strength-related price increases, and some customers taking advantage of significantly reduced pricing for iPhone battery replacements.
Apple’s initial revenue projections were lower than many analysts had predicted, and now it transpires the reality is even worse than Apple’s original estimates. On top of the year-over-year revenue decline, companies have to be able to show that they understand their business and can forecast results reliably. Apple’s corporate team screwed up on that part, plain and simple.
Getting guidance wrong spreads investor uncertainty and it’s much harder to dig out the seeds of doubt from the ground than it is to plant them. This is why Cook’s letter is as fastidious and detailed as it is. It’s serious stuff. The problem with a letter this long is that people get lazy, pull out one part that confirms their own beliefs, and essentially ignore every other word.
I think if you read this report and come away with the idea that Apple’s strategy of jacking up iPhone prices to the $1000 level has backfired, you are not interpreting what Cook wrote accurately.
Nowhere does it allude to Apple pricing its products out of reach of consumers. In fact, it says “categories outside of iPhone combined to grow almost 19 percent year-over-year”. Apple raised prices on basically every product last year, and it seems to be mostly working. They are going to hit all-time revenue records in many regions, including the United States. If iPhones were 10% cheaper, they would have sold more of them of course, but would they have sold >10% more units to increase the overall total? That is not a sure thing.
The note does call out foreign exchange fluctuations causing price increases in some international developed markets, which compounded the rise in the US dollar prices. Perhaps we will see price cuts in select markets which are particularly impacted by tariffs and/or unfavourable exchange rates. Notably, Apple did not include the United Kingdom in the list of record-setting regions, a market where the iPhone is usually resilient. Weakness in the pound hasn’t helped Apple’s sales performance here recently.
The China issue is hard to parse. It is staggering to me that sales in a region could change course so quickly, so much more dramatically than any worldwide trend. I guess we will wait and see whether other smartphone companies announce similar shortfalls in China, to determine if it really is a macroeconomic concern or a fundamental weakness in the appeal of the iPhone.
Most interestingly, Cook mentions the iPhone battery replacement program as a factor for iPhone upgrades not being as strong in some developed markets. A year ago, on the Q1 2018 earnings call, Cook said that “we did not consider in any way, shape, or form what it would do to upgrade rates … we did it because we thought it was the right thing to do … I don’t know what effect it will have”.
With this letter, Apple acknowledges that some people elected to upgrade their battery for $29 and opted not to buy a new iPhone which would cost them hundreds of dollars. Shocker. The combination of iOS 12 and fresh batteries is of course going to make some people hold off. This is absolutely fine. A couple million units lost in short-term sales should pay back in spades with the loyalty earned by these policy efforts. Apple also loves to expand the install base at the moment, which has a positive knock-on effort on services income.
To be fair, Cook’s writing does not say that the battery replacement program is a problem. It’s candidly mentioned because it is a contributing, secondary, factor to lower demand in the current quarter and they have to be transparent about it. Some investors will no doubt get upset about it, but Apple should never cave to that kind of opportunistic pressure.
Overall, I think the letter is a pretty good reply to a bad situation, which arose primarily by Apple’s own errors in forecasting. The next earnings call is going to be a great listen, and I can’t wait to see how “undertaking and accelerating other initiatives to improve our results” comes to fruition over the next few months.