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How Will Apple Solve This Big Problem?

June 20, 2014 | About:

In reviewing Apple's (NASDAQ:AAPL) most recent 10-Q filing, it was clear it had done a phenomenal job of growing sales (most prominently the iPhone), and particularly in Greater China. Despite this strength, the company saw a pretty meaningful decline in sales in the non-Greater China Asia-Pacific region in both the quarter and for the first half of fiscal 2014. What's going on here, and what can Apple do to address this problem?

The decline and Apple's explanation
In the quarter, Apple's sales in the rest of the Asia-Pacific region declined 17% on a year-over-over basis. For the first six months of 2014, sales in this region have declined 13%, implying an acceleration of this decline. In the 10-Q, Apple offered the following business drivers for the quarter for iPhone and iPad:

  • Forex headwinds
  • iPhone channel inventory grewfrom the beginning to the end of the second quarter and first six months of 2013, but then declined from the beginning to the end of the second quarter of 2014 and increased less so from the beginning to the end of the first half of 2014
  • iPad channel inventory didn't grow as much during the second quarter of 2014 than during the second quarter of 2013. However, channel inventory grew more during the first half of 2014 than during the first half of 2013

Whew! There's a lot to parse here, but digesting this we can translate it to the following:

  • Weaker currencies against the U.S. dollar impacting revenues reported in U.S. dollars
  • Inventory build for iPhone for the first half of 2014 was far less aggressive than in the first half of 2013 (implying that the sell-through was potentially not as bad as the sell-in numbers suggest for iPhone and perhaps customers are keeping inventories lean)
  • Since Apple stated in the 10-Q that sell-in of iPad was down year over year during the first half of 2014 than during the first half of 2013, and since channel inventories of iPad were up more during the first half of 2014 than during the first half of 2013, this paints a pretty grim picture for iPad, implying a non-trivial decline in sell-through for the first half of the year

Will a larger iPhone help?
While the numbers tell a pretty discouraging story, it's important to try to figure out why sales are as they are. The most likely and perhaps most obvious issue here is that large phones are popular in the rest of the Asia-Pacific region, so a lack of such an offering from Apple is likely to be leading to share declines. Further, since Apple's products are premium-priced and Apple is already growing in the Greater China region as well as Japan (where many of the price-insensitive buyers in the region likely are), the opportunities for smaller, more expensive phones in the rest of Asia-Pacific may be limited.

A larger iPhone most certainly gets Apple the sales of those higher-end customers in the region that simply prefer larger phones, but it wouldn't help much in countries within the region that are sensitive to price. That said, Apple has made it clear that it has no intentions of bringing to market a device that it doesn't feel is extremely high quality, which almost certainly means that the $450 unsubsidized price point of the iPhone 4S represents a solid pricing floor.

What of iPad?
Another problem here is iPad, which saw channel inventory increase and sell-through decrease. Apple doesn't have a form-factor problem here (it's unlikely that those Samsung 12.2" tablets are a problem for Apple right now), but it could be a pricing issue. The cheapest iPad is the $299 iPad Mini. This features a fairly dated Apple A5 chip and a 1024x768 display, which is quite low resolution by today's standards.

In contrast, one can purchase a similarly powerful but Android-based tablet in Asia-Pacific countries such as the Philippines for less than half the price of an iPad Mini. Without carrier subsidies and in areas where price really is a key part of the purchase decision, the iPad is going to have trouble in these countries no matter how good the hardware or software is.

The good news is that the rest of the Asia-Pacific region made up only 6% of Apple's sales so the rest of the company's markets grew at a clip that was more than enough to offset that decline. However, even with this high sensitivity to price that the rest of the Asia-Pacific region seems to exhibit, Apple could still try to reinvigorate growth there on the smartphone side with a larger iPhone. The iPad story, however, is much more difficult.

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