Samsung‘s (SSNLF) smartphone lead on Apple Inc. (AAPL) widened during the first quarter; it was the effect of an aggressive pricing strategy for the Galaxy S7 and S7 Edge smartphones. Given Apple’s recent troubles in the smartphone arena, many analysts and investors are looking to Samsung’s success and demanding that AAPl follow a similar strategy in order to boost Apple stock.
Furthermore, with Apple’s success in the services business, it has provided activists with the needed ammunition to spark real debate regarding this iPhone discount conversation.
After all, Apple may not make as much money from the sale of hardware, but it can get more people on its ecosystem to consume services. Although all of this thinking is logical, it would be a bad idea for the company and Apple stock.
Apple Stock Doesn’t Need Reduced iPhone Prices
In the first quarter of 2015, Samsung sold 21 million more smartphones than Apple. But in the first quarter this year, Samsung’s lead jumped to nearly 30 million devices, sparked by what Kantar’s Lauren Guenveur called the “most heavily promoted phones, ever“. That’s saying a lot.
While it may seem that Apple should follow suit, the biggest reason Apple should not follow Samsung is because it does not need too.
Yes, Apple’s unit sales declined by more than 8 million year-over-year. That seems alarming, but investors have to remember that Apple is in an “S” year for iPhones, and this year is being compared to Apple’s best performing 12-month period for iPhones in half a decade.
For example, unit sales for smartphones in Apple’s fiscal second quarter last year jumped 40% to 61.2 million units and revenue jumped 55% to $40.3 billion. Those were huge jumps, and a reflection of Apple entering new markets and launching two smartphones — the 6 and 6 Plus — at the same time, versus one (the 5s) in the year prior.
Given how “S” years tend to underperform “number” years for iPhone launches, 2015 was the perfect storm for AAPL to deliver unprecedented results.
With that said, if you look solely at Apple’s fiscal second quarter, and remove last year’s “perfect storm,” its $32.9 billion in revenue from iPhone sales this year is 26% greater than the same period in 2014. And the 51.2 million devices represents a 17% increase.
In other words, iPhone revenue and unit sales have grown 26% and 17%, respectively, over the last two years, which is a very impressive compound annualized growth rate for a company of this size. Therefore, consider that 2016 is an “s” year, and that the 7 and 7Plus are sure to be superior launches. And then, realize that Apple does not need to discount unit prices.
The fact is that iPhone sales are still very, very strong.
A couple other things to consider
When you really think about it, AAPL would be insane to reduce iPhone prices. Yes, services are growing at a 20% annual rate, but account for just under 12% of total revenue versus 65% of total revenue from iPhones. Therefore, if AAPL bets wrong on iPhone prices, it could cause far more harm than good to total revenue.
In addition, if AAPL reduces iPhone prices, margins are going to fall, therefore earnings per share are going to fall, and there is no guarantee that it can gain enough new market share to counter these reductions. Lastly, once a company reduces prices for primary products and services, it is kind of an admission of defeat, and is very difficult to come back from.
Specifically, how does Apple then raise prices if it reduces them?
I think it would be an immature, short-sighted move on behalf of Apple management, and is thereby virtually impossible.
The fact is that it would do more harm to Apple stock than good, because at the end of the day, iPhone sales are fine and Apple stock will be better than ever once the iPhone 7, 7 Plus launch proves all doubters wrong.
As of this writing, Brian Nichols was long AAPL.
