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Apple's Future for Growth: It's All About China

December 16, 2011 | About:
Apple Inc. (AAPL) has 245 retail stores in the U.S. and 112 internationally. AAPL currently has two stores each in Shanghai and Beijing and one in Hong Kong. It has plans to open one more store in Shanghai, two in Hong Kong and dozens more in mainland China over the next year. The company recently lost its star, Steve Jobs, but I still think that as the company sets its sights overseas, the juggernaut he created can prevail.

According to Beijing-based Apple spokesperson, Carolyn Wu, the stores in Hong Kong and China have generated approximately $8.8 billion in revenue in the first three quarters of fiscal 2011 which represents 11% of Apple’s total retail sales.

China has undertaken recent government initiatives to increase minimum wage in order to increase household income. Improvements to social security and healthcare systems to assist low-income earners are also in the works which will give China’s 1.3 billion population more spending power confidence.

All these initiatives are in response to the desire to change China from a source of cheap labor and manufacturing, to an economic power with a growing consumer class that is capable of sustaining economic growth. Rising wages have caused the increase in retail sales, which were $657 billion in the first quarter of 2011, up 17.4% from a year earlier. This growth has fueled an increasing demand for luxury goods, particularly brands such as Coach (COA), Louis Vuitton SA (LVMHF.PK) and Rolls Royce which saw an increase in sales of 600% in 2010.

With this level of growth comes high inflation and an overheated housing market. Chinese banks have begun to issue new loans to the real estate market, and the central banks have increased interest rates to slow the 5.5% inflation rate. However, the banks are planning on cutting back lending to the property market as it is anticipated there will be a bubble which will lead to sharp declines in values. Despite these measures the real estate market shows no signs of slowing down. Five hundred million people are expected to move into Chinese cities by 2020.

The more stable play in China is consumer goods. AAPL’s strength in retailmarketing and merchandising has seen the brand and its products received with open arms by the new consumer class.

APPL took a somewhat different approach to marketing its products in China. It hung on to the exclusivity and scarcity elements but changed approach to the psyche of the Chinese consumer. The jumping off point in North America and Europe was to encourage buyers to think outside the box and be different and innovative. AAPL’s strategy in China was precisely the opposite as it realized that being rebellious is not a desired personality trait in China and people value conformity in order to aspire to purchase Apple products.

In addition, the company has marketed its products as luxury and exclusive products which increase desirability in their society. AAPL made great pains to be seen as the choice of professionals. This strategy has worked as the traffic through AAPL’s stores in Beijing sees up to 40,000 customers per day go through their two shops. These shops are situated near other high-traffic, luxury-brand stores. Buyers remain undeterred by the high price of the iPhone (around the equivalent of $750) in comparison with other low-cost smart phones, which sell around the equivalent of $100.

Consumers remain fiercely loyal to all incarnations and generations of Apple products and are unconcerned about the price of the items. Apple has taken the rare step of accommodating the Chinese market even more by now accepting payments in Chinese currency (Yuan/Remimbi) at its app store. This has cut down on the likelihood of black market apps becoming a mainstay in Asia, as the Chinese currency transactions allow direct and legal purchases of AAPL’s apps.

AAPL has used the hooks of exclusivity and scarcity to drive demand in China and it has worked well. Google (GOOG) and Facebook have not achieved the same success as their unlimited access and wide appeal offer no incentive to Chinese consumers. Also, there are issues of censorship and governmental regulations that prevent GOOG and Facebook from achieving the same success as AAPL. AAPL has managed to operate outside of the regulatory environment in China as it sells in the open retail space and its smart-phone business does not compete with any state-owned manufacturer. Indeed, it has made efforts to partner with state agencies with respect to Wi-Fi services offering iPhones as the hardware for their telecomm carriers. If AAPL decides to move into social networking or cloud computing in China, as GOOG and Facebook have, they will likely face roadblocks from government censors.

The drawbacks to AAPL’s expansion are as many have expected in China. Many counterfeit AAPL products and indeed even counterfeit stores have cropped up in China, and it is expected that this will continue. In addition, Apple recently lost a suit to a company in China that registered the iPad name in 2000, removing Apple’s exclusive right to own that trademark in China. Privately held Samsung of Korea has surpassed Apple in the smart-phone market in North America and may very well do so in the rest of Asia with its Galaxy smart phone and applications products.

In conclusion, AAPL has found incredible success and growth through the Chinese retail markets. The question remains whether that success is sustainable. China’s economy will certainly face challenges going forward. The Western world has seen that the music does eventually stop and rebuilding can be a long and painful process. China’s population may look attractive in terms of pure numbers but the reality is that there are a finite number of consumers who will actually retain the ability to purchase consumer goods, especially luxury items. China’s commercial culture is competitive and has many different avenues and opportunities to either imitate or replicate goods that will present viable alternatives to Apple products. While AAPL has proved to be agile and superior in its ability to appeal to consumers in all parts of the world, there is always room for competing interests to upset the Apple cart.

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