iPhone Sales Fell 16%, Leaving a $10.6 Billion Hole | QDaily Data

And the decline will continue into the first quarter of this year.

In the early hours of January 30 Beijing time, Apple released its results for the fourth calendar quarter of 2018. Revenue for the period was $84.31 billion, down 4.5% from a year earlier; net profit was $19.965 billion, down 0.5%.

It is Apple's first revenue decline in the nine quarters since the iPhone 6s flopped, and the first time in the iPhone's 11-year life that revenue has fallen in a launch quarter — even with the 6s in serious trouble, Apple still grew 3.3% at the end of 2016.

It is also the first quarter in which Apple has withheld unit sales by product line. Having pushed up average prices, it now gives only revenue figures for iPhone, iPad and Mac.

Down as they were, revenue and profit both beat Wall Street's expectations, and Apple's stock rose 5.64% in after-hours trading.

China Is the Biggest Problem, but Apple Fell in Japan and Europe Too

Tim Cook's open letter in early January had already flagged the main reason: weak iPhone sales, with China falling faster than the rest of the world.

Revenue in Greater China (including Hong Kong and Taiwan) was $13.169 billion for the quarter, down 26.7% year on year — a sharp break from the double-digit growth of the previous five quarters.

And that is the result after a frenzy of year-end discounting. In early December, barely two months after launch, the iPhone XS and XS Max were already being sold at a discount; a promotion on Pinduoduo cut the XS Max's starting price by 1,500 yuan, supplied by an Apple-authorized third-party retailer.

In December, Apple began a trade-in promotion for older iPhones on its own website, with the line "iPhone XR from 4,399 yuan" pinned to the top of the page.

It isn't only China. Apple fell in every major region except its largest, the United States: Europe, Greater China and Japan, its No. 2 through No. 4 markets by share, all declined. The rest of Asia-Pacific, including Southeast Asia and India, grew 1% — the emerging market every phone maker is now racing into.

Apple had already started cutting iPhone prices in the shrinking markets. The trade-in offer, aimed at global markets including Europe, began in the United States. Before the US discounts, the iPhone XR had been cut in price in Japan: Japanese buyers prefer the cheap and dependable iPhone 8, so Apple had to subsidize Japanese carriers and bring iPhone prices down by about 30%.

Another form of discount is selling old products. Apple restarted the iPhone X line at the end of the year, and in January cleared out iPhone SE stock in the United States.

The effect of the price cuts will show up more plainly in the first quarter of 2019.

Since January, the discounting of the iPhone XR in China has only deepened — the lowest price at JD.com's own store has dropped below 5,000 yuan. Tmall cut prices ahead of its Chinese New Year shopping festival too; with coupons in a flash sale, the iPhone XR fell to 4,499 yuan, a full 2,000 yuan below its launch price.

The same in the United States. Verizon, the country's largest carrier, launched a "buy one, get one free" deal on January 17, covering Apple, Google Pixel, Samsung and LG. Buy any new iPhone and you got an iPhone XR free.

For Apple, cutting prices this fast and offering deals like these would have been unthinkable before.

The Biggest Problem Is Still the iPhone: Higher Prices Can't Cover the Lost Volume

The iPhone still brings in more than 60% of revenue and remains, beyond argument, Apple's main business. It made $51.952 billion this quarter, down 15.63% from a year earlier — falling faster than Apple's revenue as a whole. That opened a $10.6 billion hole nothing else could fill.

Higher prices did keep Apple's gross margin at 38% and its net margin at 24%; the latter is actually above the 20-22% of the past two years.

Apple has also leaned on its suppliers. Nikkei reported that it asked them to cut component prices by 10%, pushing the cost of the discounts further up the chain.

Revenue from the other hardware:

• Mac: $7.416 billion, up 9% from a year earlier;
• iPad: $6.729 billion, up 17%;
• Wearables, home and accessories: $7.308 billion, up 33%.

The Decline Won't Stop, and 2019 Looks Worse

The iPhone's slide will not end soon. In a note before the earnings, UBS said the slump could last into 2020.

Barring surprises, Apple will shrink again next quarter. Its guidance for the first quarter of 2019 is $55 billion to $59 billion, both below the $61.1 billion it made in the first quarter of 2018.

That works out to a year-on-year drop of as much as 10%, and a quarter-on-quarter drop of as much as 30% (from the fourth quarter of 2018 to the first quarter of 2019).

The price cuts continue, and this year they will set off more knock-on effects, gross margin among them. Apple expects 37%-38% next quarter, down from above 38% now.

The iPhone's own problems are the hard ones.

Users have little reason to upgrade, partly because the phone has become too expensive. Dan Ives, chief technology analyst at the investment bank Wedbush, wrote in a note sent earlier to QDaily that the blame for Apple's weak demand belongs mostly to bad pricing. The iPhone's average selling price has been pulled up: on the third-quarter 2018 numbers it had passed $790, about $100 more than two years before.

Cook blamed China on a worsening economy. With mortgages to pay and rent, education and health care all costing more, Chinese households' real spending power is likely to keep weakening, and that will squeeze the willingness to buy further still.

At the least, this quarter's results show that discounts and promotions were not enough to reverse the decline within two quarters.

The whole phone industry has run into an innovation wall. The edge-to-edge screen the iPhone X brought in 2018 was the last time Apple stirred up demand. That has stretched the iPhone's big-redesign cycle again, from two years to three. The 2019 iPhone can hardly change its design now; from what has leaked so far, it will still be a follow-on to the iPhone X — notch, narrow bezels, one more camera.

Cook's other explanation for the decline is shrinking carrier subsidies. But those generous subsidies rested on carriers taking the industry's main profits, from things like games and ringback tones. That money now goes to the phone makers, and more and more to internet companies, so carriers have no real reason to keep subsidizing handsets.

The iPhone cannot go back to the days when Apple laid down the law to carriers. In its early years Apple relied on a hard-nosed market strategy, requiring partner carriers in each market to spend heavily on advertising and on subsidizing new phones. AT&T in the United States and China Unicom in China let users buy an iPhone and a plan for a low monthly fee.

Now carriers are not only cutting or scrapping subsidies but taking subsidies from Apple to sell iPhones cheaply. In Japan, at the end of 2018, NTT Docomo, the country's largest mobile carrier, said it would cut the starting price of the iPhone XR on a two-year contract from 39,528 yen (2,480 yuan) to 25,920 yen (1,600 yuan), a 30% discount.

Cook's Apple built a strict system of control over suppliers and sales channels, and iPhone prices were usually very stable. Now the speed and depth of the cuts across third-party channels in China go far beyond anything before: the iPhone is losing its hold over the people who sell it.

The New Story Apple Wants to Tell Is Still Internet Services

On the earnings call, Apple pinned its hopes on the two businesses still growing — services and accessories.

Services revenue, which covers iCloud, Apple Music and AppleCare, was $10.875 billion this quarter, up 19% from a year earlier. That is down from 28% growth last quarter, but still double digits.

Apple disclosed the services margin for the first time: 63%, far above the 34.3% on hardware.

The question now is whether services can become the growth engine after the iPhone. Services are only 15% of total revenue, a quarter of the iPhone's. Which means that when the iPhone falls 16%, services revenue has to rise 84% just to hold revenue level. Even counting profit alone, services would have to grow twice as fast as the iPhone falls.

The day before the results, Apple talked up the outlook for services, saying it had paid developers $120 billion since the App Store opened in 2008 — implying cumulative App Store revenue of $400 billion. The press then ran a string of stories on the services business. Cheddar, the tech outlet run by BuzzFeed's former CEO, reported that Apple plans a gaming subscription service; The Information reported that Apple plans to revamp its TV app in April, including a paid subscription TV service along the lines of Netflix.

Neither the filing nor the call gave active user numbers. The contradiction is this: the installed base of devices is enormous, but one user may own several devices and will not pay for the same service more than once. How many people actually use Apple's services? That is the key to the real size of the business.

On the call, Cook said that as of January 2019 the number of Apple devices in active use had reached 1.4 billion, 100 million more than a year earlier. Of those, 900 million are iPhones — a figure Apple had never given before.

Listen to how Apple describes its services business and the phrase that keeps returning is "active devices," which says Apple still cannot let go of hardware.

Apple said Apple News has 85 million monthly users, 15 million more than two years ago; iCloud revenue grew more than 40%; and Apple Music, the best performer, has more than 50 million users.

Across its services Apple counts more than 360 million paid subscriptions, 120 million more than the year before, and expects to pass 500 million by 2020. Against 900 million iPhones in use that is a lot, though the numbers overlap — one person buys iCloud storage because the phone is full and subscribes to Apple Music as well.

If Apple is only in the business of serving its 900 million iPhone users, the paying share is already high. Measured against a market of 4 billion smartphone users, though, Apple's internet services are still small — too small to hold up the trillion-dollar valuation Apple once reached.

For years Apple's internet services existed mainly to make the iPhone, iPad, Mac and iPod better to use, with the money coming back through hardware.

But now that hardware sales have hit a ceiling, tying services to hardware limits how far they can grow. Spend the same $8 billion on film and television rights and Netflix reaches every phone, every television, every tablet. If Apple builds a new video service, can it treat rivals' hardware as an equal, and offer better content and a better experience than Netflix?

Apple has already adjusted its content strategy, quietly. At CES in early January, Samsung announced that its televisions would be able to reach iTunes films and shows directly, content that until then required Apple's own hardware. That is a start.

Apple's stock jumped after the results because revenue beat expectations. It may say little about the longer term — Cook's warning a month earlier had already prepared everyone for a bad quarter.

Graphics: Feng Xiuxia

Cover image from Pixabay