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Tough balancing act for Apple as it faces iPhone decline

Smartphone vendors rush out high function, affordable models to kickstart upgrade cycle; Apple braces for first ever iPhone sales drop

The high end smartphone market is saturated, and slowing upgrade cycles are likely to hit even Apple’s results when they are announced on Tuesday night. But a race to the low end of the market, where there is growth but very little profit, has been a disaster for many manufacturers over the years (a push into sub-$30 handsets in 2006 was one of the factors which derailed Motorola).

Goldilocks-like, the major smartphone brands need to find that ‘just right’ formula, which can deliver growth and margins, and that is proving increasingly difficult. Most are trying to deliver most of the functionality of their top end models, with one or two critical design compromises so that they can lower the price without cannibalizing their premium sales.

This, they hope, will encourage users to upgrade more readily. Research group Gartner thinks smartphone sales will grow by only 7% this year, the slowest rate ever, with 150m users in Asia delaying upgrades to wait for lower prices. Those are the sort of customers targeted by the new high function, affordable handsets.

Apple, of course, introduced the $399 iPhone SE, which has most of the qualities of the iPhone 6S but with a smaller screen. Samsung is reported to be readying the Galaxy C, to launch in China next month and then in other markets like Brazil. This will have a 5.2-inch screen and cost around $300, offering – Samsung will hope – enough of the brand and functionality allure of the high end S7 to see off alternatives from low cost rivals, but not enough to tempt S7 buyers.

And LG is preparing an affordable smartphone which looks like the flagship G5 but with a smaller screen and cheaper parts. This will be launched first in Latin America and Russia and then in China, India and Europe.

These new models from the big brands will still face intense competition from the increasingly successful locally based smartphone makers, from Huawei in China to MicroMAX in India. A major test of their appeal will be the roll-out of the iPhone SE, which was too late to impact Apple’s first calendar quarter – whose results it is about to announce amid widespread investor despondency – but will be significant in the current Q2.

“As the budget model, iPhone SE will support Apple’s overall shipments in the second quarter before the next major iPhone release,” said Avril Wu, an analyst at Taiwan-based TrendForce, which recently calculated that Apple would suffer a 44% drop in iPhone shipments between the holiday quarter of 2015 and Q116 (which would be far worse than the equivalent quarter-to-quarter seasonal fall a year earlier, of 18%).

Wu and others believe that the SE will not be enough to prevent Apple reporting a fall in full-year iPhone shipments for 2016. It has already warned investors that its earnings report for its second fiscal quarter, which it announces on Tuesday, will include bad news about iPhone sales, and in January it forecast that revenue would fall, year-on-year, for the first time in over a decade.

Apple is likely to be managing expectations skilfully, and with the iPhone slowdown already built into investors’ assumptions, even a slightly better-than-expected report will help boost a stock price which has fallen by 18% over the past year. But this will be not be enough to change the underlying concerns for shareholders –that, after the high impact large-screened iPhone 6 Plus, there will be limited innovation in this year’s iPhone 7; that Apple has no profitable answer for the mass market; and that new devices, like the Watch and TV, are unable to compensate for decline in the iPhone, by far the company’s biggest revenue generator (the iPad, once tipped for that role, is already on the wane).

The way forward for Apple does not seem to lie in another ‘magical device’ to repeat the iPhone’s success, but in building on the iPhone’s installed base, even if that is being upgraded less often, to increase its services and content sales – a pattern already aggressively set by Amazon.

But it will be tough for services, despite their inherent profitability, to make up for falls in iPhone revenues. Mark Moskowitz, an analyst at Barclays, wrote in a client note last week: “Our research indicates [iPhone 7] prototypes do not suggest any must-have form factor changes. In such a case, IP7 could be more of a replacement cycle versus a mega cycle. If iPhone slows for more than 2-3 quarters, we do not expect services or any other segment to provide ample offset, even if services revenue has a one-year lag from device install.”

In January, Apple said that revenue in its fiscal Q216 quarter would be between $50bn and $53bn, compared with $58bn a year earlier, the first quarterly decline since 2003. Analyst estimates compiled by Bloomberg are looking for sales of just over 50m iPhones, down from 61.2m in the year-ago quarter. And even if early sales of the iPhone SE, at the end of the quarter, were rapid enough to cushion the blow, they will depress average selling prices – perhaps by $10, according to Nomura Securities’ estimates.

The market remains very hard to call however. Apple may pull a rabbit out of the hat in its results call, as it has done before. For the year, analyst forecasts vary wildly – while Moskowitz, for instance, predicts a 1.8% decline in iPhone sales for 2016, Warren Lay of Maybank Kim Eng is braced for a 15% drop.

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