After Its Battery Replacement Debacle, Apple Changes Strategies For Its Current iOS Problems

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About: Apple Inc. (AAPL)
by: Robert Castellano
Summary

Apple's iPhone battery replacement cost the company an estimated $11 billion in lost replacement iPhone sales.

Recently, Apple's iOS 12.1.2 and 12.1.4 have caused iPhone 7 phones to become nonfunctional.

While Apple is repairing these phones, the company is using this opportunity to convince customers to trade in these defective phones with a new iPhone XR at a deeply discounted price.

85% of Apple's iPhone revenues are driven by replacements.

Apple’s (NASDAQ:AAPL) much-maligned battery replacement program that ended in 2018 has received a great deal of attention in the press following Apple CEO Tim Cook’s warning that its revenue in the December quarter was going to fall short of its previous expectations.

Of course, he gave a standard “it’s the economy stupid,” stating:

While macroeconomic challenges in some markets were a key contributor to this trend, we believe there are other factors broadly impacting our iPhone performance, including consumers adapting to a world with fewer carrier subsidies, US dollar strength-related price increases, and some customers taking advantage of significantly reduced pricing for iPhone battery replacements.”

In the statement containing 1,360 words, I want to address the last 12 words in the quotation above.

I discussed the battery issue shortly after it came to light in a January 16, 2018, Seeking Alpha article entitled “Apple's iPhone Battery Replacement Could Consume Enough Cobalt To Make 26% Of EVs Sold In 2017.”

The third bullet from the article tie directly to Cook’s above statement, which I highlight:

  • Apple's battery replacement program affects 650 million iPhones made since the iPhone 6 in September 2014.
  • The battery replacement has been shown to also improve performance of the iPhones.
  • Apple's income will be impacted by the cost of the replacement batteries and by delays in purchases of newer phones, thereby impacting income of its supply chain.
  • Based on an average of 10 grams of cobalt, a key element in iPhone lithium ion batteries, the 650 million iPhones corresponds to 26% of all EVs sold in 2017.

In my investor takeaway section I note:

Apple’s iPhone battery replacement will impact its revenues on two levels – (1) cost of the replacement of as many as 650 million batteries and (2) lost sales of new iPhones since the older phones with a new battery would delay an upgrade.

Obviously, only a percentage of the owners of qualifying iPhones will opt to replace the batteries. But for owners without a WOW factor mentality, a $29 investment to delay by several years a $1,000 upgrade is worth the cost.”

When I wrote this article, the issue was in its infancy, so it would have been pure speculation for me to project the revenue implications of the battery replacement program.

Exactly one year later, some estimates are coming to light. According to John Gruber writing at Daring Fireball,

Tim Cook said Apple replaced 11 million batteries under the $29 replacement program, and they’d have only anticipated about 1-2 million battery replacements normally.”

As I noted in my article, the replaced battery will result in lost sales of new iPhones. If we multiply 11 million phones by $1,000 per phone, then Apple would have lost $11 billion in 2018. Apple also charged $29 per battery replacement instead of the regular price of $79, so Apple lost an additional $50 per iPhone. If we deduct the normal replacement rate of 1–2 million, as Cook stated, then multiplying 9.5 million phones (11 million–1.5 million) by $50, then Apple lost an additional $47.5 million.

Apple’s Newest iOS Problem

Now Apple is facing another issue. When iOS 12.1.2, introduced in mid-December, is downloaded to an iPhone 7, some phones turn into a brick - including my son's. The 12.1.4 upgrade not only introduces some new bugs, it also carries over serious WiFi and cellular data problems from previous releases. Since my son had automatic software upgrades turned on I’m assuming the problem came about with 12.1.4.

With my son and iPhone 7 brick in hand, I made an appointment with the local Genius bar. The Genius emphatically told me this was not intentional when I prompted him, but no sooner did the last word of my question leave my mouth than he exclaimed, “Did you ever think about upgrading? You can get more than $300 off an iPhone XR.”

Immediately he pushed a button in his iPad and a screen came up showing the “discounted trade-in price” of an iPhone XR. It detailed pricing of the XR for different earlier phones. In fact, the data on his iPad is from Apple’s website, which can be found here.

I asked if there was a discounted price on the XS, since I liked its OLED display brightness compared to the LCD display of the XR. The Genius went on to say the screen brightness was inconsequential during normal operation of the phone, and only important for gaming or viewers with poor eyesight.

In other words, Apple is changing its strategy by using a Genius, who is supposed to fix iPhones, to promote an upgrade while at the same time promoting the much cheaper XR instead of the XS.

When I said no, the Genius had me sign a liability form, that since the iPhone 7 was caused by Apple, the company would defer the repair price, which was $349. He then gave my son an iPhone 6 loner and said it would take about two weeks to repair.

Investor Takeaway

While Apple's battery replacement program was never openly communicated as an upgrade opportunity, either when I replaced the battery on my iPhone 6 or my son's iPhone 7, the company's current strategy is to turn a "sow's ear into a silk purse," by attempting to persuade customers with problematic phones to upgrade with significant savings. I think it will be a success.

Why Replacements are Important To Apple

The replacement cycle of the iPhones has been increasing. On a global basis, that cycle has increased to about 3.5 years, but varies by region – the U.S. and Europe 3 years, China 3.5 years, ROW 4.5 years, as shown in Table 1.

Table 2 shows the number of iPhone sales between CY2014 and CY2018 segmented by Net New Customers (some leaving for Androids, some coming from Androids) and Replacements (existing customers upgrades). Note that the number of net new customers is decreasing between 2014 and 2018 while the number of replacement phones is increasing.

Additional data from The Information Network show that replacements by region were constant during this period. Also, the number of new customers in China and ROW was constant while the number of new customers decreased dramatically in the U.S. and Europe starting in 2017 and continuing into 2018.

Since 85% of Apple’s unit sales were replacements in 2018, it is critical for the company that it continues its efforts to keep customers and offer deals for trade-ins.

Apple’s Used iPhone Market

One of the benefits of iPhone replacement is that it creates a market for used phones. I estimate the total iPhone installed base hit 1 billion units in 2018, including an installed base of 750 million iPhones purchased new and 250 million second-hand devices. The installed base is growing at 15-20% per year, driven by the growth in second-hand iPhones, which grew 50-60% per year in the past few years. Some of these used iPhones are sold on places like eBay (EBAY), GameStop (GME) or Best Buy (BBY), while others are sold as refurbished units directly from Apple.

Disclosure: I/we 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.