Apple earnings highlight iPhone growth challenges

The online rumour mills have been buzzing with speculation around the possible launch of a product called the “iPhone Math” in June. Which is kind of ironic, because based on the company's Q1 earnings report, numbers have not been kind to Apple this week.

Although the company managed to hit a new record in quarterly net profit of US$13.1 billion on revenue of $54.5 billion, financial analysts were expecting $54.88 billion. And even though this past quarter was slightly longer, at 14 weeks, earnings per share were also down to $13.81 vs. $13.87 compared to the same quarter last year. Perhaps most disappointing to the street, however, were iPhone sales, which did not hit the 50 million units that some had hoped. Apple shares sank as much as 10 per cent in after-hours trading.

Apple in real trouble?

For those of us who have been following Apple since its near-life-threatening financial slump in the mid-1990s, it’s hard to be alarmed by the company’s current challenges. This is what happens when you go from being an industry underdog to market leader, and much of the hand-wringing that will take place over the next few days will probably overlook what Apple has achieved, and fail to understand why it may not continue to grow as it has in the last few years.

Start by recognizing what Apple is not. It is not Samsung, LG or any of the many other Android handset makers who position their products at all ends of the consumer spectrum. The iPhone shot to success in part because Apple was able to successfully establish it as a premium device, for a premium kind of user. Despite some traction in China, that could mean some limits to growth in overseas markets where people want less costly smartphones.

“When you look at Apple’s marketing, there isn’t much talk about the benefits of the A6 processor. Their marketing is on that status symbol sell,” said Michael Morgan, an analyst with Oyster Bay, NY-based ABI Research. “One could say having a high sticker price almost reinforces it as a status symbol.”

As recently as last week, ABI predicted that Apple’s market share would peak at 22 per cent in 2013, remaining flat for the next five years. Morgan said that’s also partly because Apple is going to face a number of new competitors such as Mozilla, which is reportedly planning a Firefox phone. If these kinds of new entrants can offer cool devices at a low cost, it will be increasingly difficult for Apple to justify its premium. Don’t forget that as mature as the smartphone industry appears, there are still a lot of people out there without anything as sophisticated as an iPhone.

“You need to eat up the feature phone user base and translate them into smartphone users, but doing it at a price point where that could happen,” Morgan said.

Pricing is key

In Apple’s Q1 conference call Wednesday afternoon, Apple CEO Tim Cook insisted the company isn’t averse to giving customers cheaper devices, but suggested that it won’t do so to please Wall Street.

“We aren’t interested in revenue for revenue’s sake. We want to make only the best products,” he said. “What does that mean for market share? I think we have a great track record here at offering iPods at different price points. I wouldn’t view the things as mutually exclusive as some might.”

Well, there’s cheap and then there’s cheap. It’s difficult to imagine Apple ever launching something like the Kindle Fire, which entered the market at a price of US$199.99. That’s because Apple is also not Amazon, which earns its revenue primarily from the software, services and other content it offers through channels like the Kindle. For Apple, the big money comes from the hardware, but as the iPhone enters into successive generations, customers will be looking more for familiarity and reliability, not radical changes.

“Anyone who wants an iPhone and can afford it already has one,” Morgan said. “You eventually enter into more of a replacement cycle.”

In the meantime, Apple is left having to make excuses to investors for failing to meet the demand it’s managed to build up. Repeatedly on the earning call, Cook blamed the company’s disappointments on industry problems. “If you look at the iPhone sales across the quarter, we were very constrained for much of the quarter on iPhone 5,” he said, suggesting the operational issues were nearly impossible to surmount. “Yields might vary, supplier performance can vary. There is just an inordinate long list of things.”

Those are the problems Apple has today, but the challenge tomorrow will be to put forward a vision for appealing to a wider assortment of buyers while maintaining its standards of excellence. For decades now, this is the company that has acted like an in-crowd everyone should want to join. But maybe everyone who has interested already has, and now Apple is starting to get crowded out.

Apple Q1 EPS $13.81 vs. $13.47 Est.Apple's Q1 earnings are out, with Gene Munster, Piper Jaffray; James Brehm, Compass Intelligence; Daniel Morgan, Synovus Trust; and CNBC's Jon Fortt.