The solution to Apple's problems is easy: Release a cheaper iPhone

Tim Cook Jony Ive iPhone XRGetty

  • Apple blamed a collapse in China for an unprecedented revenue shortfall in its most important quarter.
  • Apple missed its own revenue projection by at least $4 billion.
  • There are a lot of factors, but one is clear: Apple's iPhones have gotten more expensive and it's starting to hurt demand.

When Apple pre-announced the bombshell that it would miss its own revenue target - by at least $4 billion - for the first time in 16 years, it provided a lot of reasons why.

The primary reason given by Apple CEO Tim Cook is that new iPhones did not sell well in China, because the economy is not doing well there.

But he also mentioned a strong dollar, supply constraints, and fewer smartphone subsidies from wireless carriers as reasons for the unprecedented shortfall in Apple's revenue.

One thing he didn't mention? That Apple raised prices for the iPhone across the board this fall. The least expensive new phone, the iPhone XR, is 7% more expensive than last year's entry-level new phone, the iPhone 8. That's in addition to releasing the most expensive smartphone ever, the iPhone XS Max, which starts at $1,100, and can be configured to cost as much as $1,459.

In fact, there's a simple solution for Apple's problems: It could release iPhones at lower prices to increase sales. It's basic economics - people buy more widgets as prices goes down.

Read more: Goldman Sachs called Apple's bombshell miss for the holiday quarter way back in November

If iPhone prices are eye-watering for Americans, they're even more expensive abroad, thanks to that strong dollar and prices that are often higher overseas than in the United States. For example, an iPhone XS costs 8,338 Chinese yuan. That works out to $1,220 for a phone that retails in the US at $999.

Analysts generally buy the fact that economic conditions in China declined quickly between November 1, when Apple said demand was good, and January 2, when it implied in its guidance it would sell about 7 million iPhones less than it had expected in the holiday quarter, according to an estimate from Above Avalon analyst Neil Cybart.

While lots of signs are pointing to a rapidly declining economy in many parts of China, partially fueled by the Trump administration's tariff threats (which have not gone into effect) that's still a huge miss - suggesting that the rising iPhone price is a factor, too.

"While Tim Cook blamed a slowing China economy and trade tension, we maintain that in our opinion the iPhone average sales price is the biggest problem given uninspiring specs and rising competition in China and in Europe," Nicolas Baratte and Cherry Ma, analysts at Hong Kong-based CLSA, wrote in a note on Friday.

"In particular, we think the Huawei P and Mate are a problem for Apple given similar hardware specs at 2/3rd or half the price," the analysts continued.

There are reasons to keep iPhone prices high, some analysts suggest.

"It's extremely easy to say Apple should just cut product pricing to boost demand," Cybart wrote on Thursday. "However, it's not clear how such a move leads to greater customer satisfaction and loyalty."

Skyrocketing average sales price

Apple earnings: iphone ASP 2q18 chart BII

The average price of an iPhone has been growing prodigiously. In the fourth quarter of 2017, the average iPhone sold for $793, a massive rise from the $618 Apple said it cost a year ago.

(Going forward, Apple announced in November, investors won't have access to average selling price numbers.)

"The answer is absolutely that [average sales prices] increases affected demand. Not only was I wrong on my optimism that higher ASP would offset weakness and result in better than expected sales performance, but they were too aggressive in their price increases," Tom Forte, senior research analyst at D.A. Davidson told Business Insider.

Some analysts wonder if Apple will see its average selling price decline going forward.

"We believe that focus should now shift to ASP decline potential in 2019," Goldman Sachs analyst Rod Hall wrote on Thursday. "Weaker macro and [foreign exchange rates] may push consumers toward less expensive iPhone models."

Those less expensive iPhone models are the older models, which do not get heavily marketed, and which are facing sales bans in Germany and China due to the global legal battle with Qualcomm.

Even Apple's marketing now focuses on price, for the first time in memory. Apple's advertising now often highlights the iPhone XR for a price below its $749 retail price after factoring a trade-in device, suggesting that Apple knows its customers are price sensitive.

Screen Shot 2019 01 04 at 10.31.21 AM

Services as the bright spot

Apple did highlight some bright spots in its letter to investors: that products like online services, AirPods, Apple Watch, and Mac computers all reported record revenue. In fact, they grew by 19% annually.

But all of those products essentially require an iPhone. It's unlikely someone would buy cloud storage or Apple Music if they weren't already in Apple's ecosystem. AirPods and Apple Watch basically don't work unless the customer already has an iPhone, and the Mac is a premium laptop that works best with an iPhone.

iPhone 5CFlickr/Gadgetmac

That's why Apple emphasized that the number of iPhone users out there remains growing. "Our installed base of active devices hit a new all-time high - growing by more than 100 million units in 12 months," Cook wrote in his letter.

The installed base number is the number that's going to continue driving all of these other products that Apple sells. And if Apple is serious about becoming a company that makes a lot of its money by selling online services, as it signaled in November, it needs the installed base to continue rising.

That means introducing lower-cost iPhones, some analysts believe.

"This year's iPhone XR is 7.5% more expensive than the 8," Forte said, "If we were having this conversation prior to the pre-announcement, Apple still lacks in its product portfolio a low-priced smartphone to fully exploit emerging markets."

"This still shows there's a hole in the product strategy not having the lower-price device," he said. "But that hole might never get plugged. It might be their permanent strategy."

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