The Inevitability of Apple's Current Predicament

It’s been a tough week for Apple, as it had to revise revenue projections for the first time since 2002, stating that it is now aiming for $84 billion in revenue in the latest quarter, compared to the original target of $89 to $93 billion. The stock plummeted 10% on the news, declining almost 40% from its 52-week high in September, before recovering only slightly on Friday.

I already covered Apple and the problems it’s currently facing in my last post, and have no intention to reiterate the same points. To sum it up for those of you who haven’t read it, I am fairly pessimistic about Apple’s future, at least when it comes to continued growth, and I believe that this latest news confirms my assessment.

Still, I was surprised to see quite a few articles citing the lack of innovation on Apple’s part as the reason for the missed forecasts, or implying that raising the prices for iPhone X and XS was the wrong move on the company’s part. I believe both of those statements are incorrect, and, more importantly, arguing that the current slowdown is Apple’s fault (and thus could have been avoided by employing a different strategy on the company’s part), means missing the key point here — which is that what happened was simply inevitable, and there was absolutely nothing Apple could have done to prevent it from happening (well, aside from forecasting revenue growth less aggressively, of course).

When iPhone was first presented to the public in 2007, it essentially marked the creation of a new category of devices. True, the smartphones had existed before, but most of those devices were so different from the new iPhone (esp. after the introduction of App Store) that one could argue that lumping them under the same name wasn’t fair to either type of device. Moreover, the fact that iPhone was a new product meant that by definition, nobody had anything like that before (and a lot of people wanted to get one). Therefore, iPhone got to gain its first customers in a new product category with very limited competition, which — not to take anything from the brilliancy of the device itself — was a great (and a very rare) position to be in for any product.

Fast forward, and in 2018 we found ourselves in a world with 3 billion smartphones. To be fair, this number is still growing, and is expected to reach 3.8 billion by 2021, but this growth simply can’t be compared to what we’ve witnessed in the early days of the category — the market today is mature, and most users already own a smartphone. Moreover, the new devices come with fewer compromises and opportunities for improvement, provide a better customer experience, and last longer — in other words, the hardware is now mature as well, reducing the pressure to upgrade. This situation isn’t unique to smartphones — pretty much the same thing has previously happened to the PC market, as well as dozens of other products, — rather, it’s something to be expected for every product category, at a certain stage.

Now, if the market isn’t growing fast enough anymore that means that there are generally only two ways to continue to grow — either increase your market share by drawing the customers away from competitors, or raise prices. Going back to Apple, the first wasn’t really the option — the company historically has been producing premium hardware products, and going after the margins rather than the market share. Moreover, this isn’t unique to just iPhone — instead, the entire company’s strategy is predicated on this.

I would argue that even if Apple wanted to try and grow its market share, even if at the expense of its margins, it was never a viable option for it to begin with. Flagship devices from other manufacturers it competes against often cost only slightly less, and are instead chosen by the customers for reasons other than just the price — by reducing iPhone prices, Apple would have likely gained only a limited number of new users, and at the same time risked depressing its margins for the entire iPhone user base, leaving it worse off, not better, than before. And going after the lower-priced competitors would mean that Apple would have had to get in a different business altogether, having to compete in lower margin categories for the customers who were unwilling or unable to pay a price premium for Apple’s products. While it’s possible that Apple could have gained additional market share this way, it takes a completely different mindset to compete in this segment — one that Apple doesn’t have, and that goes against a lot of things that made Apple successful in the first place.

So, if the Apple had no real way to grow its user base in the recent years, the only viable strategy it was left with was to raise prices to extract higher rents from its existing user base, which is exactly what it has done over the last few years. Arguably, the company’s financial performance last year proved that it was the right strategy too — despite the higher prices, it managed to sell the same number of iPhones as it did in 2016, proving that the customers were willing to pay the higher prices (the growth in the number of devices sold waned the year before that, making it hard to argue that, if not for the price increase, Apple would have sold more devices).

As to what happened in 2018, it had nothing to do with the price hike — rather, with the maturing hardware and longer upgrade cycles, it was simply inevitable that at one point Apple would face a decline in sales no matter what it did. iPhone X might have been innovative enough to incentivize users to upgrade, but it’s arguably impossible to spit out large updates like that every year (which was also the reason for Apple’s 2-year product cycle in the first place, with the company releasing a significant update to the iPhone in one year, and then making iterative improvements upon it the next year). So it’s not that iPhone XS wasn’t a worthy successor to iPhone X (some improvements, especially to the camera, were actually quite remarkable compared to the changes typically seen in -s generation of iPhones before), it’s just that the users no longer have the need to upgrade the device as frequently as they did before.

Finally, one might argue that instead of raising the prices, Apple could have kept them steady instead or even lowered them, in order to make it easier for its current users to justify the more frequent upgrades to the new hardware. The issue with this logic goes back to the point made in the previous paragraph — with the maturation of the smartphones as a category, the users simply see no reason to upgrade as frequently as before, and keeping the prices at the same level or slightly lowering them wouldn’t magically create the need to do so. And on the contrary, with the longer upgrade cycles, a lot of Apple’s customers (who, arguably, weren’t particularly price sensitive to begin with) might have easier time swallowing the higher price tag, if it means getting a device they’d be happy with in the years to come.

P.S. While writing this article, I found a great post from John Gruber where he argues essentially the same point; I strongly suggest checking it out for anyone interested.

Disclosure: This article expresses my own opinions, and my opinions only. I am not receiving any compensation for it. I have no business relationship with Apple. I hold no position in Apple stock, and have no plans to initiate one within the next 72 hours.