Apple’s Cheaper iPhone 5c and New iPad Strategy Fail to Address its Core Problems

Apple (NASDAQ: AAPL  ) recently launched an 8GB version of its lower-end iPhone 5c in Europe, China, and Australia, then replaced its aging iPad 2 by bringing back the iPad 4.

Both moves fail to address Apple's two biggest problems -- its overdependence on the iPhone and iPad, and its steady loss of market share. Let's take a look at why Apple's half-hearted attempt to boost demand for the iPhone 5c and the iPad won't really help the company recover any of its lost market share or boost margins.

The iPhone 5c. (Source: Apple)

Apple's market share and weakening sales growth
Many discussions regarding Apple's iPhones and iPads gloss over the company's troubling declines in global market share when compared to Google (NASDAQ: GOOGL  ) Android devices:

 

2012 market share

2013 market share

% point change

iPhone

36.1%

30.6%

(5.5%)

Android phones

51.5%

55.7%

4.2%

iPad

52.8%

36%

(16.8%)

Android tablets

45.8%

61.9%

16.1%

Global market shares. Sources: Kantar, Gartner.

Apple bulls generally use two arguments to counter this information -- that sales of iPhones and iPads are still rising amid a growing mobile market, and that margins matter more than market share. However, Apple's slowdown in year-over-year sales is obvious:

 

2011

2012

2013

iPhones sold

72 million

125 million

150 million

iPads sold

32 million

58 million

71 million

Source: Apple annual reports.

The number of iPhones sold between 2012 and 2013 only represented a 20% year-over-year increase, compared to the 74% jump between 2011 and 2012. A 22% year-over-year jump in iPad sales in 2013 also doesn't measure up to the 81% increase that occurred in 2012.

Apple's slumping margins
Meanwhile, Apple's margins are contracting. During the first quarter, Apple's gross margin came in at 37.9%, down from 38.6% in the prior year quarter. That decline shouldn't surprise Apple investors -- simply take a look at this comparison of Apple's gross margins over the four quarters of the last two fiscal years:

 

1Q

2Q

3Q

4Q

2012

44.7%

47.4%

42.8%

40%

2013

38.6%

37.5%

36.9%

37%

Source: Apple quarterly reports.

Therefore, we've established Apple's three core problems -- its shrinking market share, slower sales growth, and declining margins.

The iPhone 5c's non-existent market
Considering those three key problems, Apple faces two big dilemmas. To gain market share, it needs to release a cheaper phone on par with Android devices. To grow margins, it must maintain a stronger hold on the high-end market. The iPhone 5c solves neither problem.

The iPhone 5c's unlocked U.S. price of $549 (16GB) and $649 (32GB) makes little sense when compared to the iPhone 5s and other Android devices. The iPhone 5s, for example, costs between $649 (16GB) and $849 (64GB). However, storage capacity consistently ranks near the bottom in must-have features for smartphone users.

A poll recently conducted at Phone Arena (assuming the prices of the phones were equal) of over 2,000 visitors showed that only 5.5% thought that storage capacity was the most important feature for a new phone -- 23.3% cared about the battery capacity, 17.9% cared about the processor speed, and 17.7% thought design and physical size mattered.

That means that when given a choice between the equally priced 32GB iPhone 5c and 16GB iPhone 5s, the average customer will likely purchase the 5s. Meanwhile, Samsung's (NASDAQOTH: SSNLF  ) Galaxy S III, which has a larger display and uses removable flash memory (up to 64GB), costs less than $300 unlocked.

(Source: Apple)

Why a cheaper iPhone 5c doesn't matter
Apple does not disclose the total amount of each iPhone model (4s, 5s, 5c) sold. However, the fact that it just introduced a cheaper 8GB 5c in China, Europe, and Australia strongly suggests that sales are slumping. The price cuts won't be relevant to U.S. users, since the iPhone 5c is already the cheapest in its home market.

For example, the 16GB iPhone 5c costs £469 ($778) in the U.K., and the 8GB model will cost £429 ($712) -- still considerably more than the unlocked 32GB model in the U.S. The 8GB iPhone 5c will reportedly cost $779 in Germany and France, $616 in Australia, and $660 in China.

If Apple implements the same price reductions in the U.S., the price of an unlocked 8GB iPhone 5c could drop to $499 -- but that still keeps it in a much higher price range than low to mid-range Android devices.

But what about the margins?
According to Cross Research analyst Shannon Cross, the 8GB iPhone 5c will result in lower gross margins for Apple, since the cost to Apple for 8GB of NAND is $5 to $10. In other words, the cost saved by swapping out the memory is more than offset by the big price drops.

Meanwhile, Apple discontinued the iPad 2, which has remained immensely popular since its release in 2011, then brought back the iPad 4 (iPad with Retina Display) at the same price point of $399 as the new entry-level device. The iPad Air, which originally replaced the iPad 4, now becomes the "premium" device with a price range between $499 (Wi-Fi, 16GB) and $929 (Wi-Fi, Cellular, 128GB).

It's easy to see that Apple is sacrificing margins, once again, to force users to upgrade from the iPad 2.

Failing to address the real issues
In closing, the price cuts for the iPhone 5c and the shuffling of the iPad lineup do little to address the company's core problems of its dwindling market share, slower growth, and contracting margins.

Considering that the iPhone and iPad account for 76% of Apple's revenue, CEO Tim Cook needs to concentrate on diversifying Apple's product line with new devices such as wearables, make a concrete decision on pursuing or abandoning the lower-end market, and use Apple's cash hoard of $40.8 billion to acquire promising companies, rather than buying back its own shares.

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Read/Post Comments (5) | Recommend This Article (0)

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 March 19, 2014, at 11:51 AM, isawutrip wrote:

    Recycled bear noise that offers few fresh insights. An ongoing sentiment I have seen from the Fool on this particular stock.

  • Report this Comment On March 19, 2014, at 12:16 PM, rigoberto26 wrote:

    Why exactly does apple need to recover market share if the market share Google Android has is the junk market? In-fact, Android is a junk OS, its placed on the worst junk available on the market. I think its better to sell a product at reasonable prices and maintain the company producing great quality, then going after market share that generates no profits. And the user experience with Android is awful, you buy a phone from one manufacture which most likely will be junk, then another and it goes on and on. While Apple, you get top notch products that actually work and you can upgrade them. You may pay a bit more up front, but in the long run you save more money.

    Its like when you buy cheap junk at walmart, especially tools, they break so easily, when compared to going out and paying more for better made tools that do not break. In the long run you save money, because you are not constantly breaking the tools and frustration associated with something that does not work correctly. The same applies to smartphones, pay more, enjoy more and save in the long run.

  • Report this Comment On March 19, 2014, at 12:29 PM, jdmeck wrote:

    Another misguided bunch of information. Android is not a company... not a manufacturer. How about a real comparison. Any problems you think Apple has are way overblown.

  • Report this Comment On March 19, 2014, at 1:57 PM, yragsapo wrote:

    I guess you also criticize Rolex for not being able to capture market share from Casio. Those who are trying to look smart, but aren't, talk market share. Those who know important metrics talk net profit and revenues. Compare sales of the iPhone 5S with the Galaxy 5, if you want to compare anything. To put the iPhone up against an open-source operating system with numerous iterations (lacking compatibility with each other) and used by multiple manufacturers is not an analysis an intelligent person would make, unless they were stacking the deck to make Apple look bad, intentionally. I'll give you the benefit of the doubt on intelligence... unless I see you write more drivel like this.

  • Report this Comment On March 20, 2014, at 9:58 AM, vernr75 wrote:

    That's not the full extent of Apple's core problems. It's more serious than that. Their fundamental problem is that the number of people buying Apple's mobile products as first time customers is shrinking rapidly and Apple's sales growth is now actually being fuelled more and more by replacement purchases in a handful of markets. That's why their sales growth is slowing drastically year on year. Their ecosystem membership is actually plateauing.

    For instance, while they sold more iPhones in 2013 than in 2012, fewer of those devices went to people who didn't own one before than in the past. The last study I saw concluded that more than 4 out of every 5 iPhones sold last year was bought by an iPhone user who was simply upgrading. That gives Apple record profits as usual...but that's why Apple still only has about 260 million active iPhone users worldwide (with most of these living in just a few countries) despite all those iPhone sales. Their bigger problem is that growth of their installed base is trending rapidly towards a net rate of zero within the next 2-3 years and they're only going to be able to hide behind global sales figures and global hardware profits for that long. That's in contrast to Android and Windows Phone ecosystems, where sales are mostly fuelled by new buyers of smartphones instead of just the replacement folks.

    As a result, it's technically not impossible for Windows Phone to eventually become a larger and more globally relevant ecosystem than iOS. Without the new buyers, Apple can't grow its installed base relative to any other platform (hence the constantly declining global usage figures for iOS), and if Windows Phone continues to grow its installed base at the current rate, it's just a matter of time before it becomes a more relevant platform than iOS in at least 150 countries, since iOS has an insignificant installed base outside of its few key markets.

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