What's Behind Apple, Inc.'s Weak U.S. iPhone Sales?

Investors dumped shares of Apple, (NASDAQ: AAPL  ) on Tuesday after the company's iPhone sales and March quarter guidance missed expectations. Among a collection of more than two dozen professional analysts, the average December quarter iPhone sales estimate was 54.1 million, yet Apple sold only 51 million iPhones.

The new iPhone 5s was not enough to drive strong growth in iPhone sales last quarter. Photo: Apple.

The changes
Based on comments made by Apple CEO Tim Cook, it appears that recent changes in upgrade eligibility by Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) caused U.S. iPhone sales to drop last quarter. This was the major culprit in holding back worldwide iPhone sales growth. If that's true, it bodes well for a pickup in demand later this year, when more Verizon and AT&T customers will become eligible for subsidized upgrades.

Until recently, Verizon and AT&T allowed smartphone users to upgrade "early." The standard smartphone contract had a two-year term, but subscribers became eligible for upgrades after only 20 months. In April, Verizon announced that it would push back upgrade eligibility to the 24-month mark starting with contracts ending in January 2014. In June, AT&T announced a similar change, affecting customers with contracts ending in March, 2014 and thereafter.

To understand the impact of this change, consider the impact on Verizon customers. If you bought an iPhone 4 in February 2011 (the first month it was available at Verizon), you became eligible for an upgrade after 20 months, in October 2012. At that point, you could have upgraded to the recently released iPhone 5.

On the other hand, if you bought an iPhone 4S through Verizon in February 2012, you won't be eligible for an upgrade until next month because of the new two-year waiting period. In fact, due to the timing of this change, nobody became eligible for an upgrade at Verizon from September to December! If your contract expired in December, you could have upgraded as early as August -- but if your contract expired in January, you had to wait until the following January for your next phone.

Smartphone sales drop... for now
This policy change had a clear dampening effect on smartphone upgrades at Verizon last quarter. Whereas 9% of Verizon's postpaid customers upgraded in Q4 2012, only 7.4% did so in Q4 2013. This caused smartphone activations to decline year over year from 9.8 million to 8.8 million.

Verizon is making customers wait a full 24 months to upgrade their phones.

By contrast, in Q3, Verizon was still growing smartphone sales at a double-digit rate -- from 6.8 million to 7.6 million -- despite feeling the initial impact of the upgrade changes. In Q2, before the upgrade policy changes went into effect, smartphone activations grew more than 25% year over year.

Fortunately, Verizon customers have started to become eligible for upgrades again this month. As a result, I expect Verizon's smartphone sales to return to growth this quarter. With Apple maintaining a very high market share in the U.S, this should also imply a return to iPhone sales growth at Verizon.

The story at AT&T
The upgrade change at AT&T also had a big impact on Apple's U.S. iPhone sales last quarter. This was accentuated by the very high proportion of iPhone users at AT&T. AT&T changed its upgrade policy a little later than Verizon, so the "gap" where no users are becoming eligible for upgrades runs from November to February.

AT&T's smartphone sales plummeted last quarter.

This also had a big impact on Q4 smartphone sales. After selling a record 10.2 million smartphones in Q4 2012 -- of which 8.6 million were iPhones -- AT&T sold just 7.9 million smartphones in total last quarter. The delayed upgrade eligibility will continue to hold back AT&T's smartphone sales this quarter, but should dissipate in March.

Foolish bottom line
Apple's strong market share in the U.S. (and particularly at AT&T) makes it vulnerable to shifts in buying patterns at home. The changes in upgrade eligibility at Verizon and AT&T caused just such a shift.

Very few smartphone users became eligible for upgrades during the October-December period. As a result, both carriers saw a big drop in upgrades last quarter. Many iPhone sales in the U.S. were either pulled forward into the September quarter (when Apple had very strong first-week sales of the iPhone 5s and iPhone 5c) or were pushed back into 2014.

However, by March, a steady of stream of Verizon and AT&T customers will become upgrade-eligible every month. This should help Apple's U.S. iPhone sales bounce back later this year.

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Read/Post Comments (10) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 29, 2014, at 1:34 PM, Renee wrote:

    Excuses and more excuses by the CEO. It's not the lower subsidies. It's the lack of excitement about Apple's products, which have remained largely-unchanged in 3 years. Yes, they are somewhat thinner, somewhat faster, with slightly better screens...but they have few new features/functions (and the ones they do have, have been copied from other manufacturers, who have had some of them for years on their devices).

    Why not just focus on innovation and bringing something new and exciting? And for now, price the iPhones where they should be priced ($400).

    That will bring sales back, not an extra $50 subsidy on a mid-range $700 phone.

  • Report this Comment On January 29, 2014, at 1:50 PM, GaryDMN wrote:

    The analysts are just down on Apple because they can't be forced into the commodity smartphone business, which is crazy, considering Apple makes more profits in the smartphone market that all the Android smartphones combined. Why would they want to go after a low margin business that will soon turn into price wars, between commodity Android vendors. Besides Apple and a slew of other companies will be making money off their patent infringement wins, on every Android phone sold, without even competing in that market.

  • Report this Comment On January 29, 2014, at 2:26 PM, Renee wrote:

    GaryDMN:

    I disagree with you. There are MANY high-priced phones out there that do very well. The reason that those other phones do very well is because they actually offer a lot for the consumer, unlike the iPhones (which ride a brand image and customer loyalty, which can only go so far to justify such a high price for a mid-range device).

    As for the patents, yes, Apple is champion in patenting everything and its mother, disregarding the obviousness of the patent and prior art. And the US justice system is in bed with Apple, always siding with them, no matter how blatently-wrong Apple is.

  • Report this Comment On January 29, 2014, at 2:29 PM, TMFGemHunter wrote:

    @Renee: the fact is that the iPhone is already a great phone. You're not going to see the same kind of improvements each year that you had in the first few years it was out. Cutting the iPhone's price will just devastate earnings. Apple might sell an extra 50 million phones a year, but it would still come out with something like $10 billion less in earnings!

    @GaryMDN: I basically agree. I just hope that Apple keeps buying back a lot of shares, which will lead to an even bigger earnings boost in future quarters.

    Adam

  • Report this Comment On January 29, 2014, at 2:45 PM, Renee wrote:

    @TMFGemHunter:

    Please explain how the " iPhone is already a great phone", compared to similarly-priced (or even $50-$100 cheaper) phones from the competition.

    As for making less money, sure, no argument there, but the article talks about the NUMBER of iPhones sold, not the revenue generated by those sales.

    My original point that Apple needs to actually innovate or make meaningful changes in newer models of the iPhone, rather than some minor (if any) changes, that they focus all their marketing on, would bring meaningful interest and increase in sales (at the prices that Apple asks for their devices).

  • Report this Comment On January 29, 2014, at 2:56 PM, SageWren wrote:

    Adam, I'm a bit confused. How is most ever sold in any quarter considered "weak"? Reality is not in the minds of people making overoptimistic estimates.

  • Report this Comment On January 29, 2014, at 3:00 PM, AceOfSaves wrote:

    @Renee

    Could you please give examples of innovations or changes meaningful enough to be added in the next models of iPhones (or any smartphone in general)? I feel like any improvements made to the iPhones will never be good enough for the critics.

    AoS

    "Save more. Save often. Save now"

  • Report this Comment On January 29, 2014, at 4:15 PM, jabstrat wrote:

    I could say alot here, but the sad fact is that Apple's iphone days are numbered. They make great products, but that clearly is not enough in this market. Their fate is sealed at this point, UNTIL if/when they change the game with a new product(s). They absolutely will NOT win this smartphone war. Their China Mobile deal is just prolonging the downward spiral. The buildout over there with the 4G network will bring in province after province, but the progress will be too slow. Meanwhile, other phone makers will "dazzle" with lower-priced phones offering the same or better features.

    In a nutshell, Apple MUST move ahead with the next generation products and services, or their fate will be written permanently in the history books.

  • Report this Comment On January 29, 2014, at 4:36 PM, Renee wrote:

    jabstrat:

    a bit dramatic with 'iphone's days are over', as there are many Apple customers that will buy an iPhone no matter how bad it is or inferior to other phones.

    I do agree that they will continue to lose marketshare and possibly start decreasing in sales numbers, as per what you said.

  • Report this Comment On January 29, 2014, at 8:26 PM, TMFGemHunter wrote:

    @SageWren: Total global sales missed the average analyst estimate by about 6%. The growth was single digit and was mostly driven by increases in channel inventory, not sales to end users.

    But looking at the U.S. specifically, sales actually dropped, and that offset very strong performances in markets like Japan and China. Apple doesn't break out iPhone sales by market exactly, but Apple's North American revenue was down year-over-year and U.S. iPhone sales were clearly the cause.

    If you look at AT&T, total smartphone sales last quarter were lower than the carrier's iPhone sales alone in Q4 2012. I think it's safe to say there were declines at AT&T and Verizon, and those two carriers still dominate the industry so that it's basically impossible to overcome weak performances there.

    @Jabstrat: What do you mean by "win"? I think that Android will outsell Apple by maybe 5:1 or 6:1 long-term in China. That means that Apple will be selling about 60-70 million iPhones a year to China in a couple of years, which would be an annual profit stream of $15 billion or so, even assuming that Apple needs to get more aggressive on pricing to get market share into the low teens. As an Apple shareholder, I'd love for Apple to "lose" the smartphone war in that way.

    Adam

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