It seems Samsung and Apple AAPL -0.83% at last have something in common. As the Korean giant forecast its profits would be massive, but slightly below expectations, its stock price took a tumble. It appears the industry has crossed through a level some call “peak smartphone” — the point of maximum profit. This is seemingly a disaster for any company deriving its profits primarily from premium smartphones. But things are not always what they seem, especially when an elaborate defensive strategy has been devised to prepare for this moment. And that defense, at least in Apple’s case, seems poised to be used to go on a profit-making offensive.
Earlier in the week, I examined the case around a lower-priced iPhone. How that phone would help Apple is subtle but significant. In the U.S., nearly 40% of all smartphones in use are already iPhones; around the world Apple’s share is less than half that. Consider the kind of things the company would hope to achieve with a lower priced phone: Can it ensure people who buy a new phone stick with iPhone? Can it encourage first-time buyers to choose Apple? Can it get people to purchase music, moves and apps through the iTunes/App Store combo?
In China, India and other emerging markets, there is already a robust market for sub-$200 off-brand Android devices and there is simply no chance Apple will chase those customers. But in the market for $300-400 unsubidized phones, there is perhaps an incremental 50-150 million annual phone sales to be had for Apple. Although that could nearly double iPhone sales, it would like lead to no more than 25% incremental profits from the iPhone division and less than that for all of Apple. So why go to the trouble? The answer lies in a multi-tier strategy the company has been piecing together that all told will garner billions in profits for years to come.
The iTunes/App Store: With 575 million accounts and 500,000 new ones created every day, Apple’s download bazaar with hit songs, e-books, and a plethora of apps is the biggest piece of its $13 billion a year software business. By way of comparison, Facebook FB -0.65% plus Yahoo YHOO +0.39% managed <$10 billion on the top line last year. Apple’s 48% growth in that segment was stronger than the 37% Facebook managed on its own. (I left out Yahoo because revenues there have been flat.) The average iTunes account spends nearly $40 a year on content of some kind and has downloaded a remarkable 83 apps per iOS device, according to Horace Dediu at Asymco. This is the gift that keeps on giving: As long as a device is functioning, it’s generating some revenues for Apple. It should be easy to see why the company wants to add more phone customers to the mix.
Apple even appears to be making a somewhat concerted effort to expand the rest of its software division through selling its “office suite” of Keynote, Pages and Numbers. The latest upgrade will offer access via a web browser in addition to “cloud access” on iOS and Mac OS X. For a total of $90 in one-time fees, you can have all three programs on an iPad and Mac. That compares favorably to Microsoft MSFT +0.56%‘s Office 365 offering, which runs $99 a year and still lacks a true iPad version. Add a marketing push, and there is a billion-dollar opportunity here.
Mobile ads: According to market research firm Velti, iOS had a 64% share of mobile ads in May, up from 59% a year ago. With all the reports of Apple’s market share shrinking, this seems illogical, right? It would be but not for the fact that (a) the market share shrinkage isn’t real in the U.S. and (b) iOS users surf the web way more than Android users. While Google is far and away the leading seller of ads, Apple’s iAd product barely registers, with single-digit market share. The iTunes Radio product, due this fall, is being launched in part to change that equation. Apple will gain a major chunk of advertising inventory and has a good deal of user-targeting data. It’s ability to become a major player in mobile advertising will partly be a function of its desire to do so and willingness to acquire the right assets to compete. Don’t be surprised to see Apple acquire Millennial Media or another player in mobile ad sales.
Leveraging retail: A number of decidedly un-sexy but important changes are coming to Apple retail or are already in place. To date, many phones that come into Apple stores with problems simply get exchanged for new ones. This costs Apple a fortune as it takes a ready-for-sale product out of the channel and forces your phone into the system for refurbishing, which is costly. Going forward, a lot of simple repairs will be done as, well, repairs. That includes fixing the camera, the screen and the main logic board, which previously weren’t done in store. Apple is also expected to offer a more attractive version of its AppleCare warranty program, including allowing customers to purchase a policy that covers multiple devices as a subscription. AppleInsider reports the in-store repairs alone could save Apple $1 billion annually. Selling more warranties could make the company millions more.
Beyond that, though, there are reports Apple will start accepting iPhone trade-ins at its own stores, as many third-parties now do. While these programs seem ubiquitous to tech-savvy customers, a lot of people are either unaware they exist or don’t trust them. With Apple entering the game, it should legitimize the idea, which means more trade-ins handled not just by Apple, but generally. That means more people upgrading to newer models of the iPhone.
Still, CEO Tim Cook wants Apple itself at the nexus of as many sales as possible. He told retail employees that Apple sells just 20% of iPhones but sees 50% of those needing repairs and wanted to bring those figures more in line. The more transactions that occur inside Apple stores, the more chances Apple has to offer iPads and Macs to those folks. At a Verizon store, that’s much less likely (or even impossible) to have happen. The only disconnect here is that Apple would seem to have a great deal more flexibility to roll out more stores in more locations given their profitability, especially smaller format outlets in lower-population areas. Why this hasn’t happened is a bit of a mystery.
Big numbers: These aren’t the kind of glitzy showpieces that Apple is famous for, but from a financial standpoint, all should bring significant growth to the bottom line. Consider that the total number of iTunes accounts is likely to surpass a billion by 2015 and the low-cost iPhone should push iPhone sales in 2014 past the total for 2011 and 2012 combined. Ubiquity, software distribution and retail all play to Apple strengths that are enabled by the supply chain Cook built, the App Store Steve Jobs originally didn’t want but came to love, and retail outlets that everyone but Apple insiders considered folly. While Apple still has far more cash than is reasonable, it has at least put a good deal of it to use in ways that will bring billions in profits in the years ahead.
Tomorrow, I’ll look at how all this has helped Apple build an ecosystem that is nearly impenetrable. And how Apple intends to leverage that to get out of your pocket, purse, briefcase and office and into your living room and car.
Mark Rogowsky, Contributor