Apple (AAPL) announced Monday a 6% price cut across all Chinese consumer electronics. This price reduction in handsets doesn’t come at the expense of profits though, as it was driven by a reduction in the VAT (value added tax). The reduction in pricing comes at a time when investors have been struggling with a progressively weakening growth thesis tied to lengthened product refresh, and more importantly, weakness in Asian smartphone sales.
The recovery in the stock price reflects growing optimism in the core tech franchise, though some of the selling was sparked by the recent pullback across equities. With markets more optimistic or paying a higher premium for tech companies in general, Apple has been able to recover. Though, the fundamentals of the tech franchise have to reflect some improvement in the next couple quarters to make the recent stock price gains more sustainable.
This shifts the focus back to China, where in its Q1’19 earnings call, Luca Maestri (CFO) blamed the weakness in Greater China for its recent earnings woes:
On a geographic basis, most of the decline from last year came from Greater China and other emerging markets with difficult macro and foreign exchange conditions affected our results. We also believe that the reduction of carrier subsidies and our battery replacement program had an impact in a number of countries around the world. And as Tim mentioned we had a lower number of upgrades than we had anticipated at the beginning of the quarter.
The 6% reduction in pricing in China could drive demand, as it’s the first time we’ve seen pricing come down for its various consumer electronic categories over at Apple. Though, the extent to which it might impact demand is a bit subjective, generally speaking, pricing sensitivity should translate to some unit demand growth in the Chinese segment, which we should hear more about when the company reports sales or earnings as we progress throughout the fiscal year. The consumer electronic category has a price sensitivity ratio of around 2.0 to 3.0, so a 6% drop could translate to 12% to 18% growth in units from just the pricing reduction alone.
Though, this alone might not drive a meaningful change long-term, the near-term headwinds from a more mature installed base of iPhone users, and a delayed transition from older iPhone variants has a lot to do with the controversy of the updated iPhone line-up, which is priced significantly higher than prior-generation models, and with removed features (like the lack of a home button) and the removal of the headphone jack, as well.
Despite these changes, Apple diehards have upgraded in the prior-years, and in turn contributed to Apple’s shipment figures, though there are lingering concerns that the smartphone category has matured to a point where the industry feels and looks a lot like the desktop and notebook computing market where shipment growth has remained stable, or grows by single-digit percentage points.
Since Apple’s high-end iPhone X S variants price at $999 to $1,100, which is very similar to notebooks and desktops, there’s not room to demand more in the way of pricing. Apple’s recent efforts to bring down pricing in China could spark some much-needed shipment growth, though efforts to reduce pricing across all geographies should be explored.
iPhone revenue declined from $61 billion to $51 billion between Q1’19 versus Q1’18 (prior quarter figures). The drop-off was tied to China, so if pricing is a factor, we should see some recovery in Chinese demand in the next couple quarters. If not, Apple needs to explore price optimization yet gain, as the weakness in shipments has everything to do with the flagship line-up pricing relative to generations prior to the iPhone X line-up.
Perhaps the market can’t support higher-prices, so an effort to do the reverse by lowering prices could return shipment growth back to the iPhone business.
Disclosure: The author has no position in AAPL. The information contained herein is for informational purposes only.
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