25 October 2016
With slowing sales of iPhones and other devices, Apple may need to step up focus on the services segment. Photo: Reuters
With slowing sales of iPhones and other devices, Apple may need to step up focus on the services segment. Photo: Reuters

Good Apple, bad Apple

There is a saying that a bad apple spoils the barrel. Now, what if there is only one good apple in a barrel of bad apples?

Well, this is the dilemma being faced by Apple Inc.

The US tech giant has seen its earnings growth hit a wall in its fiscal second quarter, with sales of iPhones, iPads and Macs slumping. By contrast, services revenue including iTunes, iCloud and Apple Pay jumped by 20 percent to nearly US$6 billion, exceeding the sales revenue of that of Macs and iPads.

Apple’s overall revenue fell 12.8 percent in the second quarter compared to the corresponding period a year ago, and net profit plunged by 22.5 percent.

America, Europe, Greater China and Asia Pacific regions saw sales decline by 10 percent, 5 percent, 6 percent and 25 percent respectively. By contrast, the Japan market saw year-on-year growth of 24 percent in revenue, due mainly to a weaker yen.

Interestingly, CEO Tim Cook told analysts in an earnings call that “the vast majority of the weakness sits in Hong Kong”.

“The Hong Kong dollar is pegged to the US dollar, and therefore it carries the burden of strength of the US dollar. That has driven tourism, trade and international shopping down significantly compared to what it was in the year ago,” he said.

His remarks actually do not make sense. The penetration rate of smartphones in Hong Kong has reached 79 percent in people aged 14 and above — a population segment that stands at 6.4 million. If we assume that iPhone has around 40 percent share of the market, it means that around 2 million people are using the iPhone.

Now, even if we presume that half of the users would be willing to upgrade to new model, it would generate demand for one million units per year or 250,000 units per quarter. The 250,000 units would represent only 0.4 percent of Apple’s current quarterly iPhone unit sales of 51.19 million.

In that sense, the Hong Kong market actually has minimal impact on the company even if there is no incremental demand from the city.

Cook actually means something else. The three industries named by him — tourism, trade and international shopping — are underpinned by parallel traders who buy tax-free goods in Hong Kong and resell them on the mainland.

But as the Hong Kong dollar strengthened and the Japanese yen weakened, the traders are seen to have moved to Japan for their purchases.

Frankly speaking, the explanation is not quite convincing given that four out of the firm’s five main markets have seen slower sales growth of iPhone, iPad and Mac.

The real reason for the slowing sales is that new models of Apple products are less attractive as smartphone segment gets commoditized.

Apple’s services revenue came in at US$5.99 billion for the second quarter, outstripping those of Mac (US$5.1 billion) and iPad (US$4.41 billion) for the first time.

It’s now the second biggest segment in terms of revenue, only after iPhone. And the gross margin of the services unit has reached 60 percent, while the hardware sector only has gross margin of 30 to 40 percent.

Given the latest figures, some industry observers believe Apple will follow the path of IBM, which has shifted its focus to software services after losing advantage in hardware.

However, we should bear in mind that the strong growth in the services segment came on the back of the wide use of the firm’s hardware. 

If Apple wants to expand the market for its services, it should allow users of other brand devices to access its software.

This article appeared in the Hong Kong Economic Journal on April 28.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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