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Wall street analysts who have never visited China are providing estimates for a culture they don't fully comprehend. The objective of this paper is to explain why their estimates are grossly insufficient.

Apple (NASDAQ:AAPL) strategically released its iPhone4s in China on 1/13/12 coinciding with the beginning of the Chinese (Lunar) New Year, which is by far the busiest shopping period of the year. Imagine an extended Christmas shopping season in western nations whereby people are off of work for two weeks to shop and celebrate. Look deeper into the culture and one can understand why iPhones are in such feverish demand.

The traditional Chinese New Year's gift is cash presented in a red envelope, which in turn is used by the recipient to purchase goods for themselves and their superiors. The market demand for the iPhone comes from the upper class, the middle class, and the middle class gifting to the upper class. Allow me to elaborate:

"Guanxi" or personal relationships determines who is promoted within a company. Guanxi is the root of all business in China. Nurturing guanxi occurs on New Year's AM. That's how you move up in the company, by "begging the cow's butt," a literal interpretation. Custom dictates that you give your superior a gift that is subtly packaged in, for example, a box of candy. If your co-worker gives your boss an iPhone 4s, the hottest item on the market, you may be compelled to match that. After all, your boss can always give that phone as a gift to his superiors as part of his guanxi! Or, your boss can pass it onto his own relatives.

Functionality is not emphasized in China, as Apple is already integrated into Chinese culture as a luxury good. It is a status symbol in a country that is about to surpass Japan as leading consumer of worldwide luxury goods. People purchase Apple products not because it has a cool app or new function or innovation; Chinese buy Apple products because in a culture which emphasizes "mianza" or "maintaining face" it symbolizes wealth, power, and success. That is why you see the frenzy in the streets of Beijing and Shanghai.

The tragic Great Leap Forward resulted in a generation of poor and uneducated youth who now have children of their own. Naturally, in raising their kids, they place a heavy emphasis on education and money. Now add a one child per family policy (yes, forced abortions are real) and you can see why success is paramount. Success in Chinese culture depends on "guanxi" which means strength of your business relationships. It is not what you know, it is who you know, and having the latest luxury goods gives you visibility, credibility, and power.

How large is the Chinese upper class? Take it from my friend, a Ph.D statistician from China:

It will be hard for me to answer these questions. Actually, I don't think anyone has a good idea about these statistics. China is different. You can't think of it like this country where a lot of things are well tracked and documented. Nevertheless, I would guess that there is 5% of upper class in the overall population. Let's say there are 1.4 billion people in China. 5% would be 70 million people. That would be a huge number for iPhone sales but obviously not all of them will buy iPhones. I think in the end it's just anyone's guess regarding how many iPhones will be sold in China.

My take: If the USA can sell 11 million domestic units to a wide socioeconomic audience of 300 million, how many can China sell to a group of 70 million upper class elite? It is hard to fathom, and this doesn't even include the youth that I mentioned above.

Currently, there are 81 million 3G subscribers between China Mobile (NYSE:CHL) and China Telecom (NYSE:CHA). There are 15 Million unlocked iPhone users on China Mobile 2G with 40 million smart phone users waiting for Apple 3G compatibility. Now assume wealthy elite make up 5% of China's 1.4 billion population. That's 70 million prospective high end buyers for locked and unlocked Iphone4s regardless of network. Lastly, consider that there are another 600 million China Mobile users that have yet to make the transition into smart phones, and you can imagine the potential for expansion throughout the decade.

The only thing can hold Apple back is Apple itself and not being able to keep up with demand. Enter Mr. Tim Cook, guru of supply chain economics. Steve Jobs almost certainly foresaw the supply issues ahead in endorsing Cook as his successor. Cook is intelligent, humble, and approachable, all key traits that Chinese look for in a business partner. Jobs' bravado would not have been well received. Make no mistake about it, the Chinese government is in control and Apple is a visitor. No "guanxi" means no business. Remember how Google (NASDAQ:GOOG) suffered after questioning China censorship. Cook, as an astute businessman, even more so than Jobs, understands the rules of negotiation. For these reasons, I believe Apple will continue to thrive.

That said, please read "Why Apple Bulls Are Wrong About The Impact of A New CEO" by Rocco Pendola. I highly respect Mr. Pendola and it's very important to understand both sides of this debate as we discuss Apple's future.

Disclosure: I am long AAPL.

Source: Why Apple Will Dominate China