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Does Apple Need to Worry About Slowing Smartphone Sales in China?

By Adam Levy – May 15, 2015 at 9:00AM

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China is Apple's fastest growing market, but for how long?

When Apple opened the doors to its new West Lake, China store, consumers packed every square foot. Source: Apple

China is the world's largest smartphone market, and last quarter it became Apple's (AAPL -2.12%) second largest market by revenue surpassing Europe. Meanwhile, a new study from IDC claims China's smartphone market has reached penetration as total smartphone sales declined year over year.

After increasing sales 71% in the country last quarter, fueled largely by the new iPhone 6 and iPhone 6 Plus, a slowdown in smartphone sales represents a significant threat to Apple's fastest growing market. Should Apple investors worry that Apple's biggest growth market is buying fewer smartphones?

How saturated is China's smartphone market?
During the first quarter of 2015, smartphone sales in China totaled 98.8 million units, down 4.3% year over year. Comparatively, smartphone sales in the country grew 19% in the fourth quarter of 2014. So, the sales slowdown is abrupt and surprising considering the first quarter includes China's holiday season.

But more surprising is that IDC is saying the slowdown is due to saturation. Estimates pegged smartphone penetration in China at just 43% at the end of 2014. Looking at the U.S. market, smartphone penetration reached 77% at the end of March, according to Comscore. More importantly, that number is still climbing relatively quickly. It was at 68.8% last March.

There's no reason to believe that Chinese consumers are that much less likely to purchase a smartphone than U.S. consumers -- even if they're not buying one right now. But 43% penetration is well off the mark where we should assume the market for first-time smartphone buyers in China has completely dried up.

But won't growth come from the low end?
Even if China's smartphone market is still well below the saturation point, some may reasonably assume that any future growth will come from the low-end devices, which are much more economically accessible to current feature phone users. And it might be true that feature phone users upgrade to low-end smartphones, but at the same time low-end smartphone users may upgrade to high-end devices.

We've seen this pattern in the U.S. as well. Apple's share of the smartphone market has grown from 36.3% at the end of 2012 to 42.6% at the end of the first quarter this year. This has come at a time when carriers are switching to pricing models, which make consumers more conscious of the price of smartphones -- similar to pricing models in China. Additionally, we saw Apple expand to all four major wireless carriers -- just as it now reaches all three major carriers in China.

The trend is already taking shape in China, as Apple took the crown for total smartphone shipments in the region -- topping local vendors Xiaomi and Huawei. Meanwhile, Xiaomi just released its most expensive smartphone yet -- the Mi Note Pro -- in an attempt to capture more high-end customers.

Indeed, Apple's bigger threat when China hits market saturation is competitors moving up to make high-end devices, where Apple dominates the market in China. At that point Apple's brand loyalty will be key to its continued market share gains. The release of companion devices like the Apple Watch, which has potentially major appeal to Chinese consumers, will keep customers coming back to the iPhone again and again as well, even as Apple draws new customers.

Growing even as the market shrinks
Right now, investors have nothing to worry about with Apple's smartphone business in China. Long term, China still likely has hundreds of millions of consumers that will start buying smartphones every couple years. In the meantime, Apple hit a homerun with the iPhone 6 and iPhone 6 Plus, which catapulted it to the top of China's smartphone market. Sales grew an estimated 62.1% last quarter despite the decline in the overall market.

Apple's strong brand and high-end devices will help it continue growing its overall sales in China for some time still, regardless of when China hits saturation.

Adam Levy owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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