Apple depends on the iPhone flywheel effect to draw consumers into its proprietary ecosystem and throw off iPad, Mac, Apple Watch, Apple TV, App Store and iTunes revenues. When that effect doesn’t work, things go south, as we’ve seen in Apple’s first decline in 13 years.
The decrease, in fact, marks the beginning of the end of the iPhone 6 product cycle. iPhone 6 growth spiked because of pent-up demand for iPhones with larger screens that Android competitors proved consumers wanted. Former iPhone users that became large-screen Android users returned to Apple, increasing iPhone sales. For iPhone sales to rebound from this current decline, though, the iPhone 7 must have a vital growth-reigniting feature–something really important to consumers that hasn’t been invented by a competitor.
Between now and September when Apple is rumored to announce the iPhone 7, Apple will be under top-line pressure. Whether the iPhone 7 is the elixir of growth won’t be known until Apple’s earnings call in January 2017, after the company has a full quarter of iPhone 7 shipments.
Why iPhone revenue dropped
Apple’s revenue woes came from both a decline in average selling price and nearly flat unit shipments. A total of 51.2 million iPhones shipped, compared to 51 million a year ago. Average selling prices were down to $642 compared to $670 last year.
CEO Tim Cook put much of the blame on the impact of a strong U.S. dollar in foreign markets, especially China, when he said, “Despite the pause in our growth, the results represent excellent execution by our team in the face of strong macroeconomic headwinds.”
But given that the iPhone is built in China with components built mainly in China, iPhone costs should trend down with China’s Yuan, not the stronger dollar, pointing again to the end of the strong iPhone 6 product cycle as the problem.
iPhone SE misses
The new $400 iPhone SE (an iPhone 6s in a 4-in. iPhone 5s form factor) couldn’t work its entry-level magic of attracting millions more consumers to make up for its lower price. Putting the guts of a $650 iPhone 6s into the SE clearly has put downward margin pressure on Apple’s 40 percent gross margins that historically defied the gravity of cutthroat mobile competition. Apple predicted lower gross margins in the coming quarter of 37.5 percent to 38 percent compared to investor expectations of 39.2 percent.
Competition from lower-priced Android phones could be squeezing Apple into trading gross margins from lower average selling prices and increased iPhone unit shipments. Apple predicted disappointing revenues in the coming quarter too: $41 billion to $43 billion compared to investor expectations of $47.6 billion next quarter.
At $400, the iPhone SE is one of the best smartphones in this price range. Its differentiation is Apple’s brand and a superior camera. However, if the consumer doesn’t value the Apple brand and camera, budget-priced shoppers can buy a lot of value for under $200 from companies such as Motorola and LG. This value proposition exaggerates in fast-growing, emerging country markets such as India and Malaysia where Android phones sell for $100.
Apple faces challenges in the coming quarters that might be mutually exclusive: attract new consumers to fuel the Apple flywheel effect or higher gross margins, or hold its margins and attract fewer consumers, especially in emerging country markets. It may find some relief in gross margins from the maturing iPhone SE manufacturing learning curve. And the iPad Pro may, as I have predicted, fuel an iPad renaissance with creative professionals (engineers, designers, architects, graphics artists, etc.) who are loyal Mac users.
The iPhone 7 will have to be amazing to reignite interest in the phone, and that will be a challenge. If Apple fails to do that, it will have to look to one of the many new products that have been rumored, such as autonomous cars, or expand into entertainment. Or it may need to find a new product that has the scale to impact its $200 billion in annual revenue with double-digit growth.