Apple's (NASDAQ: AAPL ) 5% selloff on Wednesday seems justified, even tame, compared to the possible ramifications of its iPhone announcement.
Neither of Apple's two new iPhones -- 5C and 5S -- address the challenges facing the company's handset business. Although the iPhone's market share has been declining rapidly, there is no low-cost iPhone coming; despite the fact that large screens have been popular on Android handsets since mid-2012, it won't be until late 2014 that a big iPhone goes on sale -- if it ever does.
Apple investors appear disappointed with the company's latest phones, and for good reason.
Apple has ceded the emerging market to Android
Contrary to widespread speculation prior to Tuesday's event; Apple did not change its pricing strategy. The iPhone 5C is $550 off contract (over $700 in China). It's less expensive than the iPhone 5S, but on par with what Apple has charged for its year-old iPhones in the past.
In fact, it basically is just a year-old iPhone: specs wise, it's virtually identical to last year's iPhone 5, except with a colorful, plastic body. I'm guessing that plastic makes it cheaper to build, and thus more favorable to Apple's margins, but those margins could come at the expense of market share.
While the iPhone has held up in countries like the US, the same can't be said for emerging markets like China and India. Here, Google's (NASDAQ: GOOG ) mobile operating system rules the roost, as Android OEMs are able to offer phones at sub-$100 price points.
Many consumers in these economies simply cannot afford to purchase expensive phones. By offering a cheaper iPhone, Apple could've won back some market share -- but it appears that management doesn't care about that.
The extra inch matters
Unlike a cheaper iPhone, a larger one wasn't expected. Still, it would've been nice. If Apple sticks to their typical time frame, the iPhone 6 will be announced next September -- and by that point, it will have been more than two years since Samsung (NASDAQOTH: SSNLF ) released the Galaxy S3.
Although Samsung is often derided for copying Apple, this is one area where the Korean tech giant has been the innovator. The GS3 was the first phone to popularize the concept of a larger screen: at 4.8-inches, the GS3 is massive compared to the iPhone. The GS4 is even bigger, and Samsung's lineup of Note phablets absolutely dwarfs the iPhone.
Other companies have followed in Samsung's footsteps. HTC, LG, Nokia and Motorola all have flagship phones with screens at least 4.5-inches, as do major Chinese smartphone makers like Lenovo and Xiaomi. Apple is the only major smartphone manufacturer missing from the list.
Back in May, hedge fund manager David Tepper warned that if Apple didn't do either of those things -- launch a larger phone or a cheaper phone -- he was selling. It will be interesting to see if he makes good on that statement.
Regardless, the reasoning behind Tepper's assessment was sound. The lack of both those products could wreak havoc on Apple's iPhone business, which accounts for about two-thirds of the company's profits.
There are plenty of reasons people buy the iPhone, but the app advantage is definitely high on the list. Mobile app developers favor iOS, and the iPhone generally gets the latest and greatest apps far ahead of rival platforms.
But if Apple's market share continues to dwindle, that could change. When it comes to operating systems, market share matters: Developers won't waste their time and money coding for a platform few use. This is why BB10 and Windows Phone, with their small base of users, continue to lag far behind iOS and Android.
Research firm Flurry warned that Apple's deteriorating position in emerging economies could spill over to the rest of the globe. Chinese developers favor Android due to its dominance in their home country, and crucially, they've begun to export. Chinese-made apps are becoming popular in South Korea and Japan, and should they make it to the West, they could give Android a leg-up over iOS where it matters most.
Lack of a larger screen shouldn't affect Apple's market share in emerging economies, but it could start to weigh on its popularity in key Western markets. Anecdotally, I've noticed a lot of Apple fans complain about Apple's continued use of the 4-inch form factor; having to wait yet another year for a bigger phone might prompt some of them to switch.
Samsung is certainly not taking chances. Its Galaxy Note 3, which will go on sale around the same time as the iPhone 5S and 5C, sports a monstrous 5.7-inch screen. If that's too big, consumers can always go for the smaller, 4.9-inch GS4 or the 4.3-inch GS4 Mini. And if for some strange reason that's not big enough, Samsung's Galaxy Mega just recently arrived in the US.
The entire advantage to having a smartphone lies in its ability to do things other than make calls -- browse the web, use apps, watch videos. Here, larger screens excel, making it easier to accomplish those tasks. And given that Americans now spend more time watching their phones than their TVs, it's little wonder that larger screens are increasingly preferred
Investing in Apple
Clearly, the market was disappointed by Apple's announcement, and it isn't hard to see why. Apple's decision not to release a bigger or cheaper iPhone could weigh on sales in the long-term.
Ultimately, when it comes to smartphones, market share matters. Without it, Apple will lose its software advantage, something that sets it apart from the competition. Neither the iPhone 5C nor iPhone 5S will do much to improve Apple's position; instead, Apple continues to allow Android to dominate in emerging markets, and Samsung to lead in screen size.
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