Apple (NASDAQ:AAPL) is on a roll. There's no doubt about that. Revenue soared 30% year over year last quarter, while EPS jumped 48%.
It's also no secret which product line is doing the heavy lifting: the iPhone. Last quarter, iPhone unit sales and revenue increased 46% and 57% year over year, respectively.
That said, even bulls are nervous about when iPhone growth will peter out. For example, Credit Suisse analyst Kulbinder Garcha raised his Apple target price yet again last week -- this time to $145. Yet Garcha expects iPhone sales growth to grind to a halt next year. He projects that Apple will sell 236 million iPhones in the current calendar year, but only 238 million iPhones in 2016.
How can Apple continue to grow sales of its highly profitable iPhones -- especially if game-changing improvements are harder to come by in the future? To do so, Apple may want to take a page from luxury automakers' playbooks.
Developed markets are the weak spot
Apple's recent success in China demonstrates that there is demand for its products in developing countries, especially among the emerging middle classes. In China, the iPhone has been a prime beneficiary of the shift to 4G wireless service. This trend has taken off in the last year. There's still plenty of runway, with hundreds of millions of Chinese wireless customers still using slower 2G and 3G connections.
The opportunity in developing markets goes well beyond China, though. So far, Apple has only scratched the surface in big markets like India and Indonesia. As the middle class grows in these countries over the next decade, more and more people may become interested in buying iPhones as a sort of status symbol.
Apple is likely to keep growing iPhone sales in emerging markets for some time. The real risk to iPhone growth is if sales in developed markets fall due to a slowdown in the upgrade cycle.
The endless leasing cycle
Automakers have routinely confronted this same problem. A good car can last 15-20 years or longer, but automakers -- especially in the luxury segment -- need to get customers to upgrade more frequently in order to keep unit sales up.
This is particularly difficult because auto models are typically redesigned just once every 5-7 years, with a facelift (consisting mainly of cosmetic changes) occurring midway through the cycle. Otherwise, there are only minor changes from one model year to the next.
Yet luxury automakers in particular have succeeded in getting their customers to upgrade to new cars every 2-3 years due to leasing programs. Analysts estimate that 50%-60% of luxury cars in the U.S. are leased, compared to just 30% of all vehicles. Rather than buying their car at the end of the lease, most leasing customers upgrade to a new one -- even if it's objectively not that different from what they already have.
There are two keys to keeping this endless leasing cycle going. First, it's important to maintain the residual value of cars coming off lease. The higher the selling price for a lightly used 2-to-3-year-old car coming off lease, the lower the lease payments needed to recover the car's initial value.
Second, auto dealers try to get potential buyers to focus on monthly payments rather than the long-term cost of ownership. By highlighting relatively low monthly lease payments, it becomes easier to convince customers to upgrade.
Lessons for Apple
Apple has historically benefited -- in the U.S. and several other markets -- from wireless company subsidies. By reducing the base price of the newest iPhone from $649 to $199, the subsidy system encouraged customers to upgrade every other year.
More recently, trade-in programs have reduced the "down payment" to zero in some cases. iPhones already hold their value fairly well. Despite the shift in customer preferences toward larger phones, the year-and-a-half-old 4-inch iPhone 5s (with 16GB of storage) still fetches $175 for a trade-in through Gazelle.
By contrast, Samsung's Galaxy S5 has a 5.1-inch screen and is less than a year old. Yet its trade-in value at Gazelle is just $5 higher, at $180.
As carriers de-emphasize smartphone subsidies, creating or encouraging lease-like programs could help Apple keep iPhone sales steady in developed markets. Spending $749 to buy a new iPhone seems like a much bigger decision than agreeing to pay $20/month or so to lease it for two years. Promoting a low monthly payment could persuade more users who are on the fence about upgrading to spring for a new phone.
From a leasing perspective, it doesn't matter as much if the pace of innovation slows down. For example, suppose the iPhone 7 doesn't provide as big an improvement over the iPhone 6 as the iPhone 6 did compared to the iPhone 5.
This would reduce the inherent upgrade demand. However, the iPhone 6 would maintain its value better in this scenario, due to the lack of game-changing improvements. This higher residual (i.e. resale) value would allow Apple or its retail partners to offer lower monthly payments to customers trading in an iPhone 6 in order to convince them to upgrade anyway.
Luxury automakers have shown that it's possible to consistently sell customers new vehicles every 2-3 years even when they don't offer much in the way of objective improvements. By applying these techniques to the smartphone market, Apple might be able to keep its customers on an endless iPhone upgrade cycle even if the pace of innovation slows over time.