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Why Apple's Troubles In China Seem Likely To Worsen

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© 2019 Bloomberg Finance LP

Apple shocked investors on Thursday by trimming its revenue guidance due to weak sales in China. The rare step by the tech giant marks the beginning of what may turn out to be a longer-term decline in the world’s largest smartphone market, analysts say.

The company now expects revenues of $84 billion for the first fiscal quarter of 2019, down from earlier estimates of between $89 and $93 billion. Apple’s CEO Tim Cook blamed weak iPhone sales, primarily in China, for “all of our revenue shortfall to our guidance,” he wrote in a Jan.2 letter to investors. But analysts see more problems on the horizon: Apple’s revenue streams may fall even further due to increasingly fierce competition combined with weakening demand amid the country’s economic malaise.

“Apple has seen an obvious shipment decline from last year,” says Canalys analyst Jia Mo. “If the company doesn’t change its strategy, then it would be very hard to have any turnaround from China.”

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The Cupertino, California-based company has only just acknowledged the macro headwinds the company is facing. Two months ago, Cook said in an analyst call that the company’s performance in China was “very strong,” but the economic slowdown there had been impacted by the trade war with the U.S. Analysts say local consumers are now staying away from purchasing expensive, American-branded items like the iPhones.

Apple generates about one-fifth of its revenues from the Greater China area, according to Counterpoint Research. The market research firm said Apple shipped 44.6 million units in China last year, a 10% decline from 2017.

Moreover, Apple’s devices are also vulnerable to tariffs as a manufacturer because its products are assembled in China and sold globally, meaning they can be hit by tariffs from either side.

“While we anticipated some challenges in key emerging markets, we did not foresee the magnitude of the economic deceleration, particularly in Greater China,” Cook wrote in the Jan. 2 letter.

But analysts say Apple’s rivals pose the bigger challenge. The American tech giant has long dominated the market for premium phones, but its aura is being eroded as Chinese brands move up the value chain and launch equally good but cheaper devices.

The iPhone XR, the more affordable version of Apple’s latest phones and designed for mass market appeal, has been particularly hard hit. With a base retail price of 6,499 yuan ($947), the XR lacks innovative features and pales in comparison with other models. For example, the Huawei Mate 20 X, priced at $728, sports a four-camera module that promises better photo quality. The Oppo Find X, which also starts from $728, is built with a sliding and bezel-less screen that can elevate the top portion of the phone when one uses the camera.

© 2018 Bloomberg Finance LP

The gap in hardware innovation will be further narrowed this year, says James Yan, research director at Counterpoint Research. Chinese brands will launch phones that have foldable screens or are built to support the next-generation 5G technology, which promises to make mobile connections as fast as fiber-optic cable. Although it remains to be seen whether these devices will become mainstream, such efforts will help Chinese brands to boost brand value and establish an image of being a premium device maker, he says.

“Apple’s China performance can be even weaker in 2019,” Yan says. “Its phones don’t have a lot of innovation, but sell for a very high price. There is a lot Chinese brands can do to encroach on its market position.”

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But Apple isn’t without a few bright spots. The company’s revenues from online services, wearable devices and the Mac computers have been growing, and in China, the company is still No. 1 when it comes to the most premium segment --- phones that retail for more than 10,000 yuan ($1,457). But as these devices are considered more of a luxury product alongside Gucci handbags and Louis Vuitton purses, they won’t help much in boosting the numbers of smartphone shipments.

“The most expensive iPhone XS Max is performing well, but it isn’t a mass market product,” says Canalys’s Jia. “Apple is losing China’s mid-market segment, and this has really hurt performance.”