In 2012, I published a book on Amazon called “Apple and Samsung: A Love Story.” It had first started as a book in where I take a deep look at the entire company, its environment, and its products. That part of the book was quickly overtaken by the section on Samsung Electronics, which I had then identified as Apple’s foremost challenger in the cell phone space. Samsung is a company that does not have a lot written about them by journalists and such, but there was a lot of case studies and academic material available on Google Scholar and I was able to mine that for a lot for information about the company’s culture, its structures, and its history. Some great papers include “Samsung Motors”, “Samsung’s Ownership Structure”, and “Samsung’s Mobile Phone Business”.

A lot of what I wrote in the book about the company’s culture of innovation and relentless competitiveness is still relevant. After all, Samsung has taken a big bite out of Apple’s iPhone market, which I identified as pretty much the only revenue/profit engine that matters in the company. From what I understand though, it seems like some new factors have started to be thrown into the mix. I did not want to go back into the book and write it all out so here it is as a post on the site. The first one since I left App Academy.

Summarizing the Book

In the book, I suggested that Apple should take its iPhone schedule and split it into two. At the time as it is now, Apple releases 1 iPhone a year. This used to be in July or so (with WWDC) before switching it to the fall with the iPhone 4S presumably so that it could take advantage of the holiday buying season. The problem with this is that an entire year goes by without a new iPhone. There are advantages to this of course. The new iPhone is always hard to make (The CEO of Foxconn, Apple’s supplier, has said that the iPhone 5 in particular is the most difficult product that the company has ever put together) and the long season gives them time to get it down to an art, improving yield.

The problem with this schedule is that it is just too much time in between new products on the market. It gives opportunity to Android competitors to iterate and come out with a lot of features, leaving the iPhone behind. I suggested that Apple should switch the iPhone to a two-tiered schedule. The “S” version of the phone - the ‘4S’, ‘3S’, and such where the upgrade is on the software side rather than the hardware side, would be released in July and the hardware upgraded phone - a numbered iPhone - would be released in September/October (September better than October. The 4S was in October and it was late even then). This way there would be two phones every year that could be sold to the market. Apple did not take up this schedule. The new iPhones continues to be released 1 year apart, though it might seem to be the case that there are two models this time.

The second thing that was essential to Apple’s growth and continued dominance would be its performance in China. Apple in 2011-2012 had been absolutely growing gangbusters in China. The performance of the Asia Pacific unit had grown from some several hundred million to $8 billion in Q2 2012. To continue this growth, I wrote that Apple should look to open a whole bunch of new stores (they talked about dozens several years ago) as well as complete a deal with China Mobile, the biggest telecom operator in the world. Considering that China Mobile is larger than Unicom and Telecom combined and the new iPhone 5 has shown itself capable of connecting to and using the telecom’s unique cellular standard, it seemed that it was important that Apple was to get on that network and that the company knew it.

What is the iPhone to Apple?

The statistics have not borne this out though, as the gross margins have declined from last year and the first quarter with the new iPhone 5 on the market and net income for the 3 months ended June 29th declining some $2 billion from the previous year.

It used to be that the iPhone was the company’s main driver of profit growth. The 4S version of the phone had some 50% gross margins and sold in the millions. Because of the unique arrangement it has with the telecom operators like Verizon and AT&T, the iPhone was a $800 product that sold like it was priced some $500 less. This is pretty much unique in the consumer electronics world. The 5 though is something different. It seems like the gross margins are much lower for this product. I checked through the cost of the bill of goods and it is not all that much different from that of the 4 and 4S so it probably has something to do with the yield of the phone’s manufacturing. If yield is low, the bad products’ costs are rolled into the costs of the phones that do make it to the market. The iPhone’s scratchable metal case and really thin screen seems to have impacted its manufacturing yield.

It used to be that when Apple sells a lot of iPhones, it makes a whole lot of money and we did not have to worry about anything else, so overwhelming did the iPhone’s profits dominate the company financial condition. In 3Q2013, this did not seem to be the case. Apple overperformed on the iPhone, selling over 31 million when some analysts were expecting in the twenties. What happened though was that this did not immediately lead to a huge beat in the net revenue numbers. In fact, it missed those estimates. People are buying the cheaper 4S over the 5 as ASP declined. It is true that it is cheaper to make a 4S than a 5, but that does not seem to be enough to outweigh the drop in price (usually about a $100 decline from one model to a year older).

Not only that, the decline in profits from the shift from the iPad Jumbo to the iPad mini seem to be hitting the bottom line. In the book I argued that the iPad’s profits were nice but did not move the needle. The margins, which were estimated to be something like 30%, were too small in comparison to the iPhone. Well I did not expect the iPad Mini - a product I love a whole lot personally by the way - to start a downward trend in profit margin. The product was popular and the result was a decline in profit. The profit we expected to come from the iPad division was lost and it was not made up by the iPhone.

So now instead of having two great products delivering profit, there are two headaches. The iPhone is getting older and its product line is maturing. Customers no longer need to have the latest model. And the iPad tablet computer space has grown faster than any product before, but as I feared in my heart, it was not because the market was necessarily bigger. It was because the infrastructure - from the retail stores to the Foxconn assembly line - already existed to make tapping that market faster. The stats that talked about the iPad growing faster than the iPhone ever never really did say anything about the legitimacy of the entire market. It grew faster than anything else before but that only meant that it hit the wall that much faster.

The China Issue

As for China, the once-growth engine is now a drag on growth. In 2012, Apple delivered $8 billion in a single quarter from its Apple sales. One year later, revenues in that area has dropped some 43%. It has been a year and none of the things that we pointed out should happen strategically in Apple has happened. There are still only 8 flagship Apple stores in China, a country with over 1 billion people.

Additionally, the iPhone remains missing on China Mobile. Who knows why this is the case. Since the technical hurdles have largely been cleared, it seems to be something about the terms of the agreement. Perhaps there is some sort of demand that Mobile wants that Apple is absolutely not willing to give like a China Mobile branded iPhone or pre-installed apps on the home screen. Whatever the reason and however legitimate such a reason would be, iPhone’s competitors from Xiaomi, ZTE, and Samsung are on that platform and being actively sold. Considering that I wrote in the book that I considered Apple’s biggest strategic dropped ball was to allow the rise of Android by not releasing a Verizon version of the iPhone as soon as possible, this is probably hurting Apple in China. To what extent? Who knows. Not all of China Mobile’s customers can afford an Apple iPhone and the majority of the network’s customers are not on 3G either, which cuts down on the number of potential customers available. However, it still means much that the iPhone is not on the biggest network on the planet.

New issues have arisen in China. The government has criticized the company for its arrogance, tarnishing the brand and forcing the company to issue an apology for some of its actions over there. Personally I found the actual tiff - something about return and guarantee policies - just that, a tiff, but it seems that it was the ripe thing for the government to take advantage. In the end it could have been anything but it seems like having an American company dominate such a vital part of the Chinese market was troubling to the Chinese. They took efforts to curb Apple’s growth in China, something that I thought about while writing the book but did not mention. In my heart, I suppose I did not want to believe it. In light of the new revelations about Apple’s cooperation with the NSA and other American government agencies for intelligence, the Chinese government is going to take bigger and bolder steps to curb Apple’s growth in China. Many tech companies I knew were going to get hurt by these revelations, but Apple - so reliant on the China market - had the most to lose. It lost badly.

The Future

AllThingsD broke the report that the new iPhone was to be announced to the world September 10th, 2013. It is the first set of news to come out in a while. Will people line up for it as they did for the 5 or the 4s? In some numbers yes … but enough?

I had scarcely thought about Apple’s new products in 2013. For the entire year they had basically vanished and stayed under the radar. They released just 1 new memorable product, the new 12 hour MacBook Air in the summer (I guess the new Mac Pro too but few people are going to buy that). It is troubling to think that the company has gone through nearly 9 months in 2013 selling the same thing that they sold back in November 2012. True they went through a near total refresh that holiday season, but it seems like that they had shot their wad too soon. The benefit from having all those refreshes in the holiday season led to their biggest revenue quarter ever, but it left them spent for the rest of the year and the loss in mind share probably outweighed the financial gains of having all those bullets in the air during the holidays. The biggest Apple stories in the first half of 2013 to me was their huge buyback, their bond sales, and increased dividend.

I do not really have answers for the future of Apple and the iPhone. I sold my stock a long time ago so I no longer have a financial interest in the company but I still like Apple products. I write apps in RubyMotion and sell books on their iTunes Bookstore. I could suggest a few things, but I do not think that Apple will take any of those suggestions. I could suggest some sensible things, but I am not sure that the company will take up even those. It is tough to project what the company will do in the future, a negative sort of uncertainty that I think is troubling. Very troubling. It is more likely that they will do nothing and stay the course, whatever that may be in their minds. Who knows what it might be in their minds.