Apple's Loser Strategy

| About: Apple Inc. (AAPL)

On Tuesday, September 10, Apple (NASDAQ:AAPL) reaffirmed a strategy for its most important product line (iPhone) that will go down as one of history's dumbest. Despite all of the rivers of ink spilled on this subject in the past couple of years, Apple's mobile phone strategy can be boiled down to two sentences:

1. Charge ultra-premium prices for products that are no longer ultra-premium.

2. Charge prices that are so high that you are effectively priced out of the world's largest and fastest growing markets.

Ultra-Premium Prices, Non-Ultra Premium Products

Supporters of Apple's iPhone pricing "strategy" like to cite the example of the premium pricing of luxury brands such as Lexus or BMW. Their argument is that Apple should continue to cultivate its "image" as a premium brand, keeping prices and gross margins high. The problem with this argument is that Lexus and BMW products truly are superior products relative to Cadillac (NYSE:GM) or Lincoln (NYSE:F) in virtually every relevant respect, and so premium pricing is both appropriate and sustainable. The same cannot be said today with respect to Apple products versus top-end Samsung (OTC:SSNLF) or even Nokia (NYSE:NOK) phones that are much more affordable.

Mobile phone aficionados can argue for weeks about whether the iPhone, Galaxy or Lumia are better on this feature - that one, or a combination. People can argue for hundreds of hours about whether the Apple's iOS, Microsoft's (NASDAQ:MSFT) WP or Google's (NASDAQ:GOOG) Android operating system are superior with respect to one or more characteristics. And people do have these arguments ad nauseum. That is really the point: Reasonable people can differ about whether iPhone hardware and software are really a superior product. By contrast, nobody seriously argues whether a BMW or a Lexus is superior to a Lincoln or a Cadillac.

Sure, there is a niche consumer market out there from which AAPL can continue to milk some excess margin based on memories of AAPL's golden era when its mobile phone products were clearly superior. But those memories are quickly fading, and competitors are essentially taking over the industry while Apple and its fans reminisce about the good ol' days.

Apple is losing market share and losing relevance. As a result, within two years, iPhone margins will inevitably plummet. The issue is that this is going to happen not on Apple's own terms, but because price cuts will be forced on them by the market.

Insisting on charging ultra-premium prices for non-ultra-premium products is a losing strategy. Apple should have used its once dominant position to capture and defend the world's largest market share across global markets. That would have been a winning strategy. Apple still could have preserved a premium product niche, just as Toyota does with Lexus. By controlling market share, Apple could have controlled margins across market segments and thereby could have controlled its own destiny for much longer. Now, Apple's destiny is in the hands of competing mercenary hardware and software developers that are trying to win a competition in a narrow segment of the market and for the most demanding users. And frankly, the evidence is that AAPL has not been able to maintain enough of an edge in this competition for dominance in the ultra-premium segment of the market - much less in the wider market which it has essentially abdicated.

Apple Does not "Get" Emerging Markets

Emerging markets represent the largest market in the world for mobile phones, by far. Furthermore, emerging markets represent virtually all of the future growth in the mobile phone industry. AAPL's dramatically declining volume growth rates in developed markets is testament to the fact that developed markets are already relatively saturated with mobile phones for all tastes. So the growth today in the mobile phone industry is in emerging markets.

By pricing its 5C at over $700 (unsubsidized), AAPL has effectively thumbed its nose at the majority of the world. Apple is essentially throwing away a generation of customers that will never know or become loyal to its products and its sticky eco-system. The idea that AAPL should maintain its positioning as an "aspirational product" in these markets is pure bunk. People in emerging markets aren't stupid. If the iPhone is not truly superior to less expensive products by Nokia and Samsung, it will not retain its status as "aspirational."

That is exactly the problem AAPL faces today in emerging markets. AAPL is losing its attraction as an "aspirational product" because there is really no compelling reason to actually aspire to it. In the meantime, competitor products are developing equally "sticky" features and ecosystems that those customers are unlikely to abandon in the future - even when they have the money that would allow them to buy an iPhone.

A high-end smartphone is not like a luxury watch or a purse. The high price paid for a Rolex or a Cartier is almost all about aesthetics and image. Functionality is a secondary consideration for those who buy these categories of luxury goods. By contrast, the functionality of mobile phones is absolutely key in a consumer purchase decision because these technologies are intimately woven into the functional fabric of peoples' everyday work lives and personal lives. People can abandon a Gucci bag or a Rolex with no loss of functionality or productivity in their lives. People cannot easily abandon a high-end mobile phone with all of the "sticky" and even critical work-related, entertainment and personal features without incurring substantial costs in terms of time, money, effort and enjoyment. History has proven time and time again that consumers strongly resist abandoning products that have become deeply intertwined into the fabric of their lives.

By throwing away a generation of mobile phone users in emerging markets, Apple is essentially throwing away these customers forever. And as emerging markets gain more and more global share, Apple is relegating itself to become a small niche player in a relatively small legacy market.


The enormity of the long-term strategic errors currently being committed by Apple management is breathtaking. Before our very eyes, we are witnessing corporate self-mutilation on a legendary scale. Apple's current global ultra-premium pricing strategy for mobile phones will go down in history as a case study in corporate folly.

Without a new revolutionary line of products, such as the much-dreamed-about iTV, AAPL is likely to be in the $300s again within the next year or two. Factoring in the inevitable mobile phone margin compression in developed markets and a failure to capture a comparable share of emerging markets as it has in developed markets, at today's prices, Apple is really not the great value play many people believe it is.

At the rate Apple is going, margin compression will overwhelm volume growth in Apple's existing product lines. That implies many years of earnings contraction in its current core business.

At a share price of above $450, AAPL stock is implicitly pricing in success in unknown product lines, because given the trajectory its existing lines of business and the company's abysmal strategy for them, the stock is not worth much more than that.

I am not recommending that anybody short AAPL. I am saying that with this kind of abysmal strategy in place for its most important product line, AAPL stock is simply not worth the bother. Unless, of course, you have the inside scoop on some revolutionary new line of products that Apple will release in the future and that are comparable in scale to the iPhone and/or iPad.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.