It was bound to happen at some point.
For the first time since Apple launched its flagship smartphone in 2007, the company sold fewer iPhones than it did in the same quarter the previous year. Sales dropped 16 percent in the first quarter of the year—and an even more dramatic 32 percent from the last quarter of 2015. The world's most valuable company still moved 51 million smartphones, more than anyone not named Samsung can boast. But that doesn't soften the impact of a product that’s never gone any direction but up finally taking a dive. In fact, the iPhone’s so critical to Apple’s balance sheet that its fall led to a 13 percent drop in the company’s revenue.
In the company's earnings announcement, Apple CEO Tim Cook attributed the decline to "strong macroeconomic headwinds," citing unfavorable currency exchange rates and a grim global economic outlook. But behind the corporate-speak, it’s worth examining what’s really happening—and how worried Apple should be about the future.
For now, Cook strikes an upbeat note. "We see a business that is healthy and strong," he said of the iPhone during an earnings call Tuesday. He argues that iPhone upgrades are strong, customers are loyal, Apple continues attracting Android users at a high rate, and there's plenty of growth to tap in emerging markets. All of which is fair, but belies the reality of a very down quarter.
You don’t need to be an Economist subscriber to know the global economy has been in rough shape. Every week seems to introduce a new pocket of uncertainty, whether it’s China's plummeting stock market or a power crisis in Venezuela. For a company that depends upon international reach—especially one selling premium products—any turmoil impacts the bottom line.
As a US company, Apple’s exchange rate woes are also real. The dollar has been strong—up 20 percent in the last two years or so against other major currencies—which effectively makes US exports more expensive in foreign markets. Shelling out for a pricey iPhone is a big ask for many parts of the world under ideal conditions; inflating that cost could do even more to make people opt for a cheaper phone, or even inspire them to (shudder!) keep their iPhone 5S a little longer.
“The global smartphone market is slowing as penetration of smartphones in major mature markets reaches saturation, and even markets like China start to see slower growth,” says Jan Dawson, president of Jackdaw Research.
That decline is real, and it has hit pretty much everyone; Gartner estimates that worldwide smartphone sales saw their slowest growth since 2008 at the end of last year. So, yes, broader economic conditions have hurt iPhone sales. Such forces are beyond Apple’s control. If that were the whole story, it would be easy enough for Apple to shrug and ride it out. It’s not.
It’s not like iPhones have somehow gotten worse. Other phones, though? They’ve gotten a whole lot better. And they’re cheap. “The phones we have right now are good enough, to the point where I don’t need a premium phone to do everything I need to do,” says Gartner analyst Tuong Nguyen. “Even if I got a mid-tier phone, that’s probably more than I need.”
In truth, many affordable smartphones have moved beyond “good enough” and many, like the (currently discounted) $300 Nexus 5X, are excellent. This shift comes as US carriers abandon the two-year contracts that long masked the true cost of phone ownership. An entry-level iPhone 6S costs $650, and buyers feel every penny of that, either up front or through monthly installments.
Dawson sees cheaper Android devices eating into high-end Android sales more than iPhone sales, especially in non-US markets. Even if Android and iPhone users tend to stay in their lanes, though, the price gap between the two creates a median that’s much harder to cross. An iPhone 6S may be better than a Nexus 5X, but is it $350 better? That’s a question Apple must answer to win converts.
The $400 entry-level iPhone SE could help, but not yet. “I don’t expect an immediate boost from the iPhone SE, which was designed for late adopters” says Avi Greengart, research director at Current Analysis. “Nobody should expect blockbuster sales numbers in its launch quarter.”
In fact, Apple didn't even make enough of its budget iPhones to service all those who wanted one. "We’re thrilled with the response that we’ve seen on it," said Cook of the iPhone SE. "It is clear that there is demand there even beyond what we thought."
Meanwhile, the death of the two-year contract has had another significant impact: It removed an artificial prompt to buy another phone. “People are holding onto their smartphones longer,” says Dawson. As a function of getting better, smartphones now also last longer. If you can postpone shelling out for a new phone, why wouldn’t you?
Most of this applies to North America, which represents about one-third of iPhone sales. Another third, though, comes from China. And that’s where Apple faces an altogether different kind of trouble.
Sales of the iPhone have grown so steadily, and in such volume, that it’s easy to forget how much of that growth stems from expansion into new markets. Every inch of the world map that Apple conquers represents more potential customers.
The importance of the Chinese market to Apple is tough to overstate. Gartner’s Nguyen says the country represented 32.1 percent of Apple’s sales at the end of 2015. In the summer of 2015, iPhone sales in China popped 87 percent year-over-year.
While Apple has sold the iPhone in China for several years, the recently gaudy numbers are the result of Apple’s first deal with China Mobile—a carrier with 800 million mobile customers—that took effect in early 2014. In a single day, Apple broadened its potential customer base by more than 2.5 times the entire US population. Unless fish start buying iPhones, Apple will never again benefit from so big an expansion.
"China, [we] may not have the wind in our backs that we once did, but it’s a lot more stable than what I think the common view of it is," said Cook. But "stable" doesn't make for big bounces.
“Apple’s made a lot of big inroads into China. There’s still room to grow,” says Nguyen. “But Apple’s not going to double their sales anymore.”
What's more, China’s economy is not in great shape. “Chinese consumption is down overall,” says Greengart, who also notes that local companies like Xiaomi mimic Apple’s design aesthetics at “a fraction of the iPhone’s price.”
Cook says emerging markets remain a pocket of potential strength, and iPhone sales in India rose 56 percent year over year, and that as the country continues to develop its LTE infrastructure, the iPhone should attract a lot more customers. But just as China couldn't grow at 87 percent for more than a couple of years, Apple shouldn't expect India to either.
All of this might sound grim. It's not, as long as you’re comfortable with an ascent that’s slow and steady instead of meteoric.
“I don’t think either Apple or its investors should be worried,” says Dawson. One down quarter does not a crisis make.
And this quarter, specifically, shouldn’t cause undue alarm. While it’s early days for the iPhone SE, the phone should eventually bolster Apple’s performance in a market segment the company has until now largely ignored. And more importantly, Apple is well into an S-product cycle, meaning customers have been staring at the same basic design for 18 months, while holding out a little longer probably will land them an iPhone 7.
“It is important to remember that Apple’s sales have been consolidating around new product launches—everyone knows that the next big iPhone launch is in September,” says Greengart. “People are waiting for it.”
Those macroeconomic trends will remain an issue, but so will this one: Many emerging markets have expanding middle classes full of people who may not be able to afford an iPhone today, says Nguyen, but may be able to in a few years.
What we’re really seeing is the start of a new normal for Apple, one in which the iPhone grows either slowly or even, potentially, not at all.
“The question is just whether sales go back to a modest but decent growth rate later this year, or whether that growth stays negative or very low,” says Dawson. “Even that isn’t that problematic for Apple—it’s still going to make lots of money on the iPhone and its other products.”
Oh, speaking of which, Apple reported that iPhone revenue last quarter was $32 billion. That's nearly as much as what Google and Microsoft took in---combined.
