February 1st, 2014
by George Leong, Profit Confidential
Apple sold a whopping record 51 million "iPhones" and 26 million "iPads" in its fiscal first quarter, which is great stuff at first glance. So why did investors scramble for the exits?
The problem is that the market expectations placed on Apple are enormous. But that's what happens when you're the top seller of smartphones in the United States. Wall Street wanted to see the company sell 55 million iPhones, so its four-million-unit miss was a disappointment.
What's failing the company is its reluctance to sell a really cheap iPhone that caters to the emerging markets, which is, in reality, where much of the growth is for smartphones.
Apple has a deal with China Mobile Limited (NYSE/CHL) to mass market its phones in the massive Chinese market, where there are more than 750 million users. (Read "Apple Finally Takes Step That Will Take the Company to the Next Level.") But while the deal was only recently formalized, the early indications are that sales of the iPhone in China aren't all that great.
The problem is (as I have discussed on numerous occasions) Apple's reluctance to sell a cheap iPhone. Price points are critical when selling products in the emerging markets, so the lack of a cheaper offering from the company will hurt its sales in China. China is not like America, Japan, or Europe as far as available discretionary income. When the per-capita income in China hovers around US$6,500 or so annually and Apple wants to charge $600.00-plus for an "iPhone 5S," there's clearly a disconnect.
CEO Tim Cook doesn't seem to get it or it's simply an issue of not wanting to reduce the company's gross margins by cutting the price of phones. Apple continues to be focused on margins and not what is required for a breakthrough in the Chinese and emerging markets. In its fiscal first quarter, management reported a gross margin of 37.9%, which was in line with the 38.6% reported in the year-ago fiscal first quarter.
For Apple to fare better, it needs to boost its sales in the emerging markets, but this can only be achieved by offering lower-priced iPhones and, of course, accepting lower margins.
The company has more than $40.0 billion in cash, so it really needs to look at cutting prices in the emerging markets to drive sales; otherwise, the company could languish. Being the top dog at home is not the same as being the top dog globally, which is what Apple and its shareholders want.
Infamous hedge fund investor Carl Icahn is pressuring the company to increase its dividend and buy back shares. (But of course he does, as Icahn owns somewhere around five percent of the company's stock.) But I don't agree with Icahn, as I feel Apple should use its money to allow the company to cut its iPhone price in the emerging markets and build market share.
Only by reducing its focus on margins can Apple take the next step forward.