Of all the critical arguments put forward by bears about Apple, (NASDAQ:AAPL) the most plausible one is that Apple is heavily reliant on a single product for most of its sales and earnings. Indeed, Apple's iPhone revenue reached $102 billion last year, or 55.8% of total revenue. The iPhone generates an even higher share of Apple's earnings.
Bears believe that this dependence on the iPhone will be Apple's Achilles' heel. While demand for the new big-screen iPhone 6 and iPhone 6 Plus models is extraordinary, future iPhone models are likely to feature more incremental improvements. Could the current surge in iPhone sales turn into a slump by 2016?
The iPhone user base is big and growing
There are two main reasons why the risk of an iPhone sales slump is overblown. The first is that the iPhone user base is already fairly large relative to the number of annual iPhone sales, and that user base is still growing steadily.
During the 2013 and 2014 fiscal years, Apple sold nearly 320 million iPhones -- and it sold another 125 million in fiscal year 2012. Given that most people hang on to their iPhones for at least two years, there are probably at least 320 million iPhones currently in use.
However, many people use their iPhones for more than two years --- particularly in countries where phone subsidies are less prominent than in the U.S. Others trade in their old iPhones, which are then resold in developing countries. Thus, the global iPhone user base is likely higher than 320 million: perhaps 350 million or even 400 million. This is supported by the fact that about a third of all iPhone usage still comes from pre-iPhone 5 models.
This user base has been growing steadily in recent years. By the middle of last year's product cycle, 25% of iPhone 5 buyers in the U.S. -- and nearly half in China -- were purchasing their first iPhone. Older models had an even higher proportion of first-time buyers.
The iPhone 6 product cycle will drive further gains. Samsung phone trade-ins at Gazelle more than tripled in the week after the iPhone 6 and iPhone 6 Plus were announced.
As a result, the iPhone user base could reach 500 million by the end of 2015. Most of these people will still be using pre-iPhone 6 phones -- even in a best case scenario Apple is likely to sell fewer than 200 million iPhone 6 and iPhone 6 Plus units in fiscal year 2015. There will be hundreds of millions of older iPhones waiting to be upgraded in 2016 and beyond.
iPhone batteries don't last forever
Even if there are 500 million iPhones in use by the end of next year, Apple could still face a drop-off in sales if the replacement cycle increases from around two years to three years or four years. Apple bears believe that the iPhone 6 and iPhone 6 Plus represent a massive step forward for the iPhone product line that Apple won't be able to replicate going forward.
The assumption is that once people upgrade to the iPhone 6 or iPhone 6 Plus, they won't have much incentive to upgrade again every two years. (Wireless carriers are also moving away from subsidy policies that encourage upgrades every two years.)
However, this ignores one key driver of the iPhone replacement cycle: battery life. Many iPhone users find that they need to charge their phone daily, and heavy users can't always make it through a full day. iPhone batteries are designed to retain about 80% of their original capacity after 500 full charging cycles.
An iPhone user who charges daily will reach this point in a year and a half. For heavy users who can barely get through a full day on a brand new battery, the battery life of a 2-year old iPhone is simply not good enough.
Apple does offer to replace an iPhone's battery for $79 plus tax and shipping. However, putting nearly $100 into a 2-year old phone is a dubious proposition when you could get $150 or more toward a new phone by trading it in.
As a result, while the iPhone replacement cycle will lengthen over time, it is unlikely to mimic the three year-four year replacement cycle that is typical of laptops and tablets.
Big user base + short device lifespan = big profits
The popularity of the iPhone 6 and iPhone 6 Plus, along with Apple's growing global distribution network, should help the iPhone user base reach about 500 million by the end of 2015. These phones will still need to be replaced every two years-three years as battery life wears down.
This puts Apple in good position to maintain a long-term annual iPhone sales rate above 200 million units -- significantly better than what it has achieved up until now. Could there be a small pullback in 2016? Yes -- especially if Apple manages to sell more iPhones this year than what most analysts are projecting. But a big collapse in iPhone sales is highly unlikely.