It was early morning eight months ago when Tim Cook shot an email to TV personality Jim Cramer telling him the company was doing fine in China. The global markets roiled amid broader macroeconomic concerns, yet Apple’s shares quickly recovered on Cook’s optimism.
Two quarters later, things are far from rosy.
Sales in the Greater China region plunged 26% in its fiscal second quarter, marking the biggest percentage decline of any of Apple’s geographic regions. Total sales fell for the first time since 2003, while the iPhone suffered its first-ever quarterly decline.
“Whereas China accounted for half or more of the company’s revenue growth for several quarters, it’s now accounting for half its year-on-year shrinkage,” said Jan Dawson, founder of tech consulting company Jackdaw Research.
Apple blamed the slowdown on macroeconomic issues and tough year-over-year comparisons, with the iPhone 6S flailing next to the huge success of the iPhone 6 and iPhone 6 Plus. Cook also blamed Hong Kong, which accounted for the vast majority of declines in Greater China, because its dollar is pegged to the U.S. dollar, which has strengthened significantly over the past two years, thus making it more expensive for international shopping and tourism in the country.
But there are reasons to believe the quarter’s troubles aren’t just cyclical and isolated. People in China are buying more phones from local manufacturers, such as Huawei Technology Co. and Xiaomi. And the Chinese governmentrecently banned certain media services from Apple, as it clamps down on distributed content, a move that could weigh heavily on Apple’s next big revenue driver: services. When excluding Hong Kong, mainland China sales still fell a whopping 11% during the quarter.
“Only super rich, really high-paid professionals buy iPhones in China — you’re not talking about lots and lots of people,” said John Zhang, faculty director of the Penn Wharton China Center, and a professor of marketing. “That means at some point, you’re not going to be able to grow unless you put out new innovative products to keep your people engaged, which is not the case with Apple.”
While the company released the Apple Watch last summer, those sales still pale in comparison with Apple’s more traditional products. The four-inch iPhone SE was released last month in part to target China’s sprawling middle class, yet the phone’s starting retail price of $399 is still expensive compared with the Xiaomi’s sub-$200 phones, and analysts have said it doesn’t appear to be growing in-line with expectations.
“It’s almost like a fashion designer who runs out of ideas and is making clothes tighter and looser and there’s no new design,” said Zhang. “When you set the phone downward, you’re reaching out to people who don’t want to pay the higher price, but then you get into the territory that many other Chinese manufacturers feel very comfortable with, such as Xiaomi.”
Competition in China is increasing across the board, with lesser-known Chinese manufacturers OPPO and Vivo making IDC’s list of the world’s top five smartphone manufacturers for the first time in the first quarter, ousting Lenovo and Xiaomi, which slipped to the sixth and seventh spots.
Those companies offering mid-tier phones in China priced below $250 are growing in line with the improving wages of the middle class. However the majority of those wages are still far below the premium market that Apple’s phones target in China.
“Lenovo benefited with ASPs below US$150 in 2013, and Xiaomi picked up the mantle with ASPs below US$200 in 2014 and 2015. Now Huawei, OPPO, and Vivo, which play mainly in the sub-US$250 range, are positioned for a strong 2016,” said Melissa Chau, senior research manager with IDC’s Worldwide Quarterly Mobile Phone Tracker team.
The China slowdown can’t be dismissed, especially since other U.S. companies, including McDonald’s and Caterpillar , have recently reported improving conditions in the region.
Shares of Apple plunged 6.2% to $97.87 in afternoon trade, pushing the stock down more than 26% on the year. The stock was on track for its eighth decline over the last nine trading days.
But there are analysts who believe things will start to recover once the economy starts to improve and wealthier Chinese customers get ready to upgrade their phones, potentially starting with the iPhone 7 in September.
“The [high-end] segment they are playing in is still growing much faster than the market,” said IDC analyst Ryan Reith. “In 2015 we saw China smartphone growth slow to 2.5%, yet the premium segment (>$400) grew close to 50%, and this was largely dominated by Apple.”
When it comes down to it, said Pacific Crest analyst Andy Hargreaves in a note to clients on Wednesday, iPhone customers “remain extremely loyal.”
That’s an obvious benefit for Apple, especially as it tries to roll out increased pay-for services such as music and payments. The data suggest Apple is “likely to continue growing iPhone unit sales over several years, albeit modestly,” he said.
Written by Jenniger Booton of MarketWatch