Apple and the China Conundrum


In the recent earnings conference call, Apple CEO Tim Cook made no secret of the fact that China is a major area of focus for the company moving forward -- so much so that figures for the region will now enjoy their own break down when the company reports in the future. The question that has not been answered -- or even really addressed -- is how Apple will approach its China strategy. The conundrum which has emerged is between two disparate plans of attack: build a cheap iPhone to compete with less-costly Google Android options, or maintain its status as the ultra-premium brand in the space in hopes that sales will be sufficient.

The Android domination
Android's global domination by market share is not new information. In a recent SFGate article, Caleb Garling explains:

In the third quarter of 2012, worldwide manufacturers -- among them Apple, Samsung, HTC and Research in Motion -- shipped 181.1 million smartphones, according to market analytics group IDC. Google's Android operating system was installed on 75 percent of them, says IDC; Apple's system, iOS, was on about 15 percent. That market share for Android was a 91 percent jump from the previous year's third quarter.

This follows an earlier IDC report that placed Android's global market share at 68.3% compared to 18.8% for iOS, and echoes the sentiment of Raymond James' Travis McCourt, who explained that "there are parts of the world where a smartphone is simply a touch screen with an effective web browser, and in those parts of the world, Android is dominating."

The real takeaway here is that at the lowest-cost part of the spectrum, Google is running away with the show. This is of particular importance when you consider that while global smartphone sales growth is roughly 46%, in emerging markets that number spikes to 63%. These markets, like the one that exists in China, are largely driven by price. In mature markets, like the U.S., the relative sales figures are much closer between the top two players, but Apple is not even in the fight for the lower end of the market.

Good news coming from the East
The China section on Apple's earnings call was largely considered the bright spot of the announcement. For the quarter, China accounted for $6.83 billion in sales, and CEO Tim Cook pointed out that iPhone sales doubled. The sales figure represents a 66% increase over the $4.08 billion in sales from a year earlier. The enhanced reporting for China is a further indication of how important the region is to the company.

But it's not all wine and roses
It is hard to talk smartphones in China without considering the activity of Samsung. The company recently reported a 76% boost in sales that was driven, according to a Bloomberg article, "by sales of low-cost smartphones to Chinese consumers unable to afford Apple's iPhones." The company has been a regular thorn in Apple's side as it does battle for supremacy in both the marketplace and the courtroom. Estimates place Samsung's fourth-quarter sales around 63 million units, easily ahead of the 47.8 million iPhones sold by Apple. IDC places Samsung at the top of the heap of smartphone purveyors in China, relative to sixth place for Apple. Overall, Apple may be looking to China as a solid source of growth, but Samsung is standing squarely between Apple and the 1 billion wireless users up for grabs in the region.

Time to get cheap?
The success of both Google and Samsung in China begs the question of whether Apple needs to release a cheaper iPhone to get competitive. A definitive "yes" was the near-immediate response from various sources upon hearing the less-than-stellar news of Apple's quarter. It is important to note that 47.8 million units sold is a formidable figure in its own right. Failure to meet the hope or expectation for a 50 million unit number is the stiffer infraction than the figure standing alone.

The logic behind the cheaper iPhone is very sound. Competitors are stealing market share and sales by offering affordable phones to many who simply cannot afford an iPhone. Ever since Nokia signed its deal with China's largest wireless carrier, ChinaMobile, Apple's tenuous position in the market has become increasingly apparent. While Nokia's flagship offering, the Lumia 920T, is specifically targeted at the premium market, the company offers lesser, but more affordable models. Given the fact that most Chinese wireless customers are still on a 2G device, the market for top tech is limited. The cheaper bottom is wide open.

On the other hand, a major part of Apple's success is couched in its ability to remain an aspirational brand. Obviously in many emerging markets, the iPhone may as well be a Ferrari, but Google seems to have addressed this issue. As long as Apple stays premium, it will miss this large (and growing) market segment. If it dives into that market, however, there may be no coming back. Apple needs to be cautious before it starts chasing.

Ignore the hype
Ultimately, I think Apple should stick to its roots. The product pipeline is not awe-inspiring from this distance, but if Apple cheapens its brand, it may lose those who have remained faithful. If the company wants to offer a cheap option, finding a way to offer older versions for less seems more advisable. While I believe the stock would spike on a cheap iPhone announcement, I think this is the wrong move for the company. I want to see where the stock settles, but still think there is great potential here.

There's no doubt that Apple is at the center of technology's largest revolution ever, and that longtime shareholders have been handsomely rewarded with over 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company (and more importantly, your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.

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Fool contributor Doug Ehrman has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, China Mobile, and Google. Try any of our Foolish newsletter services free for 30 days. 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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