The end of upgrades: why Apple's woes run deeper than China

Consumers are holding onto their older iPhones for longer than before. Photo/Getty Images.

Shares of Apple plummeted more than 8 per cent in early trading Thursday after chief executive Tim Cook said the company lowered quarterly sales estimates for the first time in more than 15 years, pinning the shortfall on a deteriorating economy in China, inflamed by President Donald Trump's trade war.

But as Cook acknowledged, Apple's woes extend beyond shifting preferences in foreign markets. Not only does Apple's warning highlight the consequences of a slowing global economy, it brings to centre stage enduring concerns about the company's ability to innovate and maintain its position as a cutting-edge technology company despite crucial changes in the smartphone market and the relationship people have with their costly devices.

"[I]n the modern iPhone era last night was clearly Apple's darkest day in our opinion and represents a challenging growth period ahead for the company (and its investors)," Daniel Ives, an analyst at Wedbush Securities, said in a note to clients Thursday. The biggest fear for Apple investors, Ives said, is a customer base that stalls out, failing to grow over the next few years and triggering a "nightmare scenario decline." To stave off that possibility, Apple could bank on future iPhone redesigns and hope that more people choose to upgrade, or it could slash prices ahead of the next iPhone release, with aims to boost demand in China.

But Cook's warning was alarming to investors for reasons that hit closer to home. "[I]n some developed markets, iPhone upgrades also were not as strong as we thought they would be," he wrote. Cook went on to describe factors "broadly impacting" sales of its flagship product, including fewer sweeteners from carriers to reduce the cost of buying a new phone, higher prices, and the tendency for iPhone owners to hold on to their devices for longer periods of time, instead of indulging the latest upgrade.

As The Washington Post reported last month, Apple extracts more money from frequent upgraders, but as product innovation slows, people are holding on to their iPhone for three years or longer. That's a drastic change from just four years ago, when American consumers would pony up for the newest phone after about 24 months, according to the mobile analytics firm BayStreet Research.

To make up for flat iPhone sales, Apple has simply started charging customers more money on average for newer models.

"Perhaps in part because there are no easy fixes, Apple failed to acknowledge the possibility that current iPhone prices are simply too high," Toni Sacconaghi, an analyst at Bernstein Research, said in a note to investors Thursday. "The other real issue that Apple's press release did not mention explicitly is that the high-end smartphone market is increasingly mature (having declined for 3 straight years ) and the overall market contracted for the first time in 2018."

This insight is perhaps more concerning to Apple and says more about the company's trajectory than the immediate impacts of slowing growth in China and Washington's trade battle with Beijing. If people who want a newish iPhone already have one and don't intend on buying the next one, then Cook's ominous note isn't alarming because it came with unexpected urgency, it's alarming because it arrived so late. "It's possible conditions in China changed quickly, but the broader trends in smartphone activity are not new. "Why didn't Cook make any of these admissions before now?" wrote Bloomberg's Shira Ovide.

Cook, who appeared on CNBC to play damage control after disclosing the revenue shortfall, was "not that convincing," Ross Gerber, the president and chief executive of Gerber Kawasaki, said on Twitter. Gerber described Cook's leadership at Apple as a series of risks-not-taken, as other tech companies have soared by on genre-defining innovations or are betting on breakthroughs to come: "Lost IOT in the home to Amazon. No # EV future, missed Tesla. No streaming future. Missed Netflix. Still could pick up some Disney. Time for Tim to go," he said, referring to Apple taking the bold step of buying Disney.

Cook ended his note by saying the company is as confident as ever even as it exits a challenging quarter. That may be true, but that is what some experts see as precisely the problem.