Why Apple Can’t Rely on Upgrades for Growth

by Brad Moon | February 26, 2013 12:56 pm

Why Apple Can’t Rely on Upgrades for Growth

Gizmodo published an interesting piece last week entitled “Apple’s Upgrade Dilemma[1].” The gist of the article is that the abrupt halt to Apple’s (NASDAQ:AAPL[2]) phenomenal stock performance is tied to the Western market becoming saturated with iPhone and iPad users.

With a dwindling number of net new customers available, Apple is becoming more reliant on existing customers upgrading their mobile devices. The problem, according to Gizmodo, is that Apple’s products “are so good, people aren’t upgrading fast enough.” The prospect of future sales and dedicated customers is good for the long-term health of a company, but it’s a massive increase in sales numbers now that results in quarterly revenue jumps of 70% or more and a stock price that increases 75% in a year.

There’s plenty of evidence supporting the theory that relying on upgraders will slow Apple’s growth. For one, it releases a new iPhone every year, but most U.S. customers are on two-year wireless contracts;. It only makes sense that the majority of these people are not going to pay extra to upgrade before the end of their term.

Even more damning is the fact that after the first month of iPhone 5 sales, 32% of Apple buyers were choosing older models[3] instead — presumably because they are less expensive, but still good enough to do what they want. Used iPhones are holding their value well too[4], and there’s a booming market for them. More new buyers are losing the incentive to buy the latest, greatest and most expensive, which can impact Apple’s margins and has the effect of thinning those opening weekend product launch numbers investors look to.

In terms of quality, a report released last week comparing smartphone manufacturers found that Apple’s iPhone was the most reliable by a wide margin[5], with a score three times better than that of Samsung (PINK:SSNLF[6]), which placed second. So maybe there’s something to the “so good” argument.

Looking around my own home, I’m a textbook case of being part of Apple’s long-term success, yet also representative of the upgrade challenge that’s dampening the company’s stock. I have a personal preference for Apple gear and I have a lot of it, going back decades (yes, there’s even a Newton[7] in my desk drawer). However, I’ve never lined up for a product launch in my life.

Between my kids, my wife and myself, there are five iPads here, but they’re all first-generation models. They’ll be upgraded to new ones eventually, but there’s no compelling reason to do so yet. And our AppleTVs? All first-generation as well. For most programming 720p is fine; if I want a movie in the 1080p current AppleTVs offer, I buy it on Blu-ray.

The iMac that’s my primary work computer was five years old (and still going strong) when Apple released its new super-thin iMacs last year. Did I pre-order one of the sexy new all-in-ones? No. Instead I picked up a previous generation model that’s easier to repair and upgrade than the new models with their fused-glass displays. Apple has my money and I’m a good prospect for being a long-term customer, but I’m not contributing to the new product release hysteria that’s fueled its stock growth in recent years. And I suspect I’m not alone.

So what’s the way out of the upgrade dilemma if Apple’s stock is to resume its interrupted climb?

There are a few possible solutions. Planned obsolescence — by arbitrarily cutting off recent hardware from new OS upgrades, for example — is one, although this would likely result in a backlash that could damage that relationship with long-term customers. Apple does do this in a limited fashion, sometimes limiting key new OS features like Siri to newer models, but it hasn’t been particularly aggressive to date.

There’s also the strategy of making sure each product release is so innovative and packed with new features that owners feel compelled to upgrade. Apple has been having trouble on this front. New iPhones, iPads and computers have, for the most part, been improved incrementally for years.

If we’re writing about it, you can bet Apple’s done the math too. And rather than of any of the above, it’s instead choosing to cast its net wider. The company’s current focus on China[8] has everything to do with the fact that there’s a massive market of potential first-time iPhone owners, if they can just get past the cost issue (average incomes being much lower in China than in the West).

That’s also a major factor driving the iWatch[9] that we’re expecting to see this year. A brand new product from Apple means the potential for starting the cycle it began in 2001 with the iPod, in 2007 with the iPhone and in 2010 with the iPad — another round of lineups for the latest must-have gadget.

I’ll probably buy an iWatch too, but not until after a few years, when incremental upgrades have fleshed out its capabilities.

So if you’re buying Apple stock now around $440 thinking you’ll turn a tidy profit when it recovers to the $700-level or beyond, you’d better hope the iWatch is a huge hit, that the Apple television[10] finally sees the light of day (and does better than other TV-makers have lately), that China pans out or that Apple looks to another big market like India (which it’s largely ignored to this point[11]).

Because relying on upgrades just ain’t going to cut it.

As of this writing, Brad Moon did not own a position in any of the aforementioned securities.

Endnotes:
  1. Apple’s Upgrade Dilemma: http://gizmodo.com/5985284/apples-upgrade-dilemma
  2. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  3. 32% of Apple buyers were choosing older models: http://bgr.com/2012/12/03/iphone-profit-margin-analysis/
  4. Used iPhones are holding their value well too: http://techcrunch.com/2012/02/08/iphone-android-resale-value/
  5. Apple’s iPhone was the most reliable by a wide margin: http://news.yahoo.com/iphone-found-300-more-reliable-samsung-smartphones-170006490.html
  6. SSNLF: http://studio-5.financialcontent.com/investplace/quote?Symbol=SSNLF
  7. Newton: http://gizmodo.com/5452193/the-story-behind-apples-newton
  8. current focus on China: http://techcrunch.com/2013/01/10/tim-cook-meets-with-china-mobile-says-china-will-soon-become-apples-most-important-market/
  9. iWatch: http://investorplace.com/2013/02/wednesday-apple-rumors-100-designers-working-on-iwatch/
  10. Apple television: http://investorplace.com/2012/12/will-apple-tv-be-steve-jobs-salmon-of-doubt/
  11. which it’s largely ignored to this point: http://www.examiner.com/article/is-apple-foolishly-ignoring-india

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