Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

How Apple Curtailed Its Own Long-Term Opportunity In The Smartphone Market.

|Includes: Apple Inc. (AAPL), SSNLF

On the release of Apple's (OTC:APPL) latest quarterly results CEO, Tim Cook, said, "Our team executed extremely well in the face of strong macroeconomic headwinds." This remark says a lot about the extent of pressure Apple is experiencing in the market, because in normal circumstances the all-around declined in the device shipments (see the table below) would not be considered as an "extremely well execution".

Source: Apple report

Apple's latest result was worse than expected, and so is its guidance for the on-going quarter. To some extent, the challenging macroeconomic trends are a valid excuse. Data from various agencies shows that global smartphone market (unit shipped) went into a consolidation phase during Q1, 2016 (see the table below). China, the world's biggest smartphone market and third largest market for Apple, showed a decline of five percent in the shipments.

Source: Strategy Analytics - Counterpoint Research - IDC

Macroeconomic trends indeed were challenging. However, Apple's shortsighted strategy for the Chinese market played a significantly bigger role than the microeconomic trends in the company's recent dismal performance.

Over the last few quarters, the Chinese manufacturers have emerged as big competitors for Apple. During Q1, 2016, when Apple was struggling to maintain its shipments, the Chinese manufactures showed exceptional growth in their shipments (see the table below). The Chinese manufacturers also showed improvement in the average selling price during the period.

The key reason behind the growing Chinese competition is the growth of 4G in the Chinese market (see the chart below). 4G with its high data speed transforms the way a user uses its smartphone. It increases the capability of smartphones from a communication device to a computing as well as entertainment unit resulting in significant more data transfer and workload for smartphones. To handle the increased workload, smartphones require better quality hardware and software. Otherwise, the users struck with problems such as quick draining of battery, inconsistent performance and heating. All these things make the users to upgrade to the high powered and technologically advanced smartphones. That is why, ever since its entry into the Chinese market, Apple sees the growth of 4G as its key opportunity. The company, however, did not foresee the kind of change 4G will bring to the competitive landscape of the Chinese smartphone market.

The rapid growth of the Chinese 4G user-base increased the demand for the premium smartphones, which reflects from the fact the average selling price of a smartphone in China increased by $50 during the last two years (from US$207 in 2013 to US$257 in 2015).

The rising demand of the premium smartphones in the local market allowed the Chinese manufacturers to put money into the development of technologically advanced products, which they could not do earlier because of limited local demand (primarily catered by Apple) and no meaningful overseas presence.

Unlike earlier when most of the Chinese manufactures were developing entry level smartphones, today more and more Chinese manufactures are focusing on the development of high-end, technologically advanced smartphones, which has challenged the dominance of Apple in China and other Asian markets.

Moreover, the competition from the Chinese players is likely to get more intensify for Apple in the future, not only in the Chinese and Asian markets but also in the developed markets (particularly European markets). After successfully scaling-up its business in the Chinese market, the Chinese companies are aggressively trying to become a prominent player in the developed markets. Huawei is the key example how the Chinese competition can hurt Apple in the global markets.

Emergence of Huawei as a capable and sustainable competitor:

Huawei was among the first Chinese companies to sense the growing market opportunity for the premium smartphones in the Chinese market. It was the only major Chinese company that improved its average selling price as well as market share in 2015 (see the table below). Huawei established itself as a premium brand for smartphones (the company sells its low-mid end smartphones under Honor brand) and shipped 32.4 million mid-high range smartphones in 2015, up 140% from 2014.

Source: IDC

  • Going global:

After successfully establishing as a premium brand in the Chinese market, Huawei is increasing its presence in the developed markets. In the new markets the company is not selling itself as low priced premium product, but as a premium brand with premium pricing. For example, in the UK market the company has priced its latest flagship smartphone Huawei P9 at £449, which is costlier than iPhone SE (£395). The company has kept the price high to establish Huawei as Apple's competitor (not a low priced alternative of Apple).

The company is also playing on the pricing front but indirectly. The company while keeping the retail price higher is still offering P9 at lower price through its relationships with carriers. When one buys Huawei P9 through the carriers like EE, O2, and Vodafone it mostly costs less than iPhone SE (see the table below). Most notable thing is that the company is also delivering on product quality front as P9 is delivering better camera performance, which is its USP, than most of the other competing smartphones.

Source: EE - O2 - Vodafone

Huawei is answering the quality concerns that may have arise due to its presence as a Chinese manufacture by collaborating with the brands that hold prestigious and premium position in their relative fields. For example, Huawei is marketing its latest P9 smartphone with tag line "Co-engineered with Leica". This strategy is a close resemblance of extremely successful Apple's marketing strategy of selling its manufactured in China products under "Designed in California" tag line.

  • R&D based company:

Actual threat for Apple from Huawei is not from its marketing strategy, but from Huawei's mobile communication expertise. Huawei is a mobile communication player, and most of the things it designs and sells is related to mobile communication. Moreover, the company spends more than Apple on R&D.

Source: Apple - Samsung - Lenovo - LG - HTC

Today, the success in the high-end smartphone market primarily relies on the innovation and new advanced features. The higher R&D spending significantly increases the probability of better products and long-term success for Huawei.

  • Financial strength:

Another thing that makes the emergence of Huawei much more significant for Apple is the financial position of Huawei. Most of the existing players in the mid-high end segment of the smartphone market lag way behind Apple and Samsung in the financial terms. LG and HTC operate with much lower margins than Apple and Samsung. Financially, Huawei is strong enough to retain and gain its market share. It enjoys above 40% gross margins, and its operating margins are better than Samsung.

Huawei is a player that can not only compete on pricing and strategic front but also on technological and financial front. Huawei is focusing more and more on premium segment, and with its high R&D spending and established brand name the company may well continue to trouble Apple in the foreseeable future, at least in the Asian and European markets. The latest data from IDC showed that Huawei has already become second biggest player in the Polish market (for Q1, 2016).

Conclusion:

Apple was so overwhelmed by its success in the Chinese market that initially it totally ignored the competitors, and even the consumer requirements. Despite the price sensitive nature of the Chinese market, the company never tried to address pricing concerns and continued to operate with exceptionally high margins (see the table below). For its competitors, Apple's ignorance opened the window of opportunity, which they use to near perfection, first by offering product for the price sensitive consumers, and then later by offering advanced technological products for the tech-savvy consumers. All these events significantly increased the number of smartphones that can compete with iPhone in the quality terms and can beat iPhone in the pricing terms leading to decline in the iPhone sales.

Apple made a critical mistake in China. It treated the Chinese market as any other market. It forgot that the China is a mass production hub, and once given the opportunity the Chinese players can challenge anyone. The company failed to foresee the changing competitive landscape of the Chinese smartphone market and made the situation much more challenging for itself by not adapting to the change in a timely manner. The company could have significantly reduced the opportunity for the Chinese players by addressing the pricing issue earlier. Apple could have launched iPhone SE much earlier (with iPhone 6s), but instead the company decided to focus on the margin expansion. By doing so, Apple curtailed its own long-term opportunity at least in the Chinese market.

Today, Apple is desperate to regain its growth momentum in the smartphone market, which is highly unlikely to happen with its present product portfolio. The only thing that can once again reinstate its growth in the market is the success of upcoming iPhone. The launch of iPhone SE has given some more time to Apple for planning a perfect iPhone that can replace iPhone 6. The company has to beat its competitors on quality front while keeping cost and price in check. This task has become difficult than ever before as the competitors are setting the bar higher and higher on technology and quality front. Moreover, the pricing is becoming an increasingly prominent factor even in the premium smartphone segment. It's due to the pricing factor that Apple discontinued 32 GB variant rather than 16GB variant for its latest iPhones.

The future of Apple depends on the extent of the success of upcoming iPhone. As of now, the company may continue to struggle with investors' expectations.

Disclaimer: Investments in the stock markets carry significant risk, stock prices can go up or down without any understandable or fundamental reasons. Enter only if one has the appetite to take risk and heart to withstand the volatile nature of the stock markets.

This article reflects the personal views of the author about the company and one must consult its financial adviser before making any decision.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.