How did Apple get blindsided by China? Here’s one theory.

Jean Louis Gassée asks a good question. Horace Dediu suggests an answer.

From Gassée’s latest Monday Note:

By the end of October 2018, Apple was on its way to a decent quarter. Sixty days later, $7B in revenue is missing. Tim Cook writes to his shareholders but leaves one or two key questions unanswered.

A more serious issue [than battery replacements] is Apple’s blind spot regarding China. I distinctly recall Cook telling analysts during a quarterly earnings call that, having studied the country for 30 years, he knew China. This is true and relevant. Cook’s ascension to the COO and, later, to the CEO job is due to his prowess building and managing Apple’s nonpareil Supply Chain Management (SCM) system. Imagine the thousands of parts inside an iPhone, and then picture building ten iPhones per second, 24 hours a day at the peak of the Holidays season, and shipping them to 130 countries… No question, one has to know China, the people, the culture, companies large and some small to make the SCM magic happen year after year, with only the rarest of hiccups.

With all of these strengths, how could Apple, which is more embedded than most Western companies, not see a Chinese economy slowdown that started well before the 2018 Holiday quarter? More specifically, what did Apple know and not know when they issued a guardedly optimistic Q1 revenue guidance in the $89B to $93B range on November 1st? What did they learn in the following 60 days, how much, how fast?

From Dediu’s The Critical Path 216: Tim’s Letter. He’s trying to explain a sudden 70% drop in consumer spending on luxury goods in China, not convinced that the trade war is to blame:

My suspicion is that it’s far more fundamental, dealing with anxiety people have about their assets. They may worry that they don’t have as much money as they thought they had. If you ask yourself “why would you cut your spending by 70%”? Why would you hunker down, expecting the worst? … People react with extreme anxiety only to some existential threat to their finances.

My hypothesis is that you have to know how Chinese consumers actually deal with their personal finances. I’m not an expert, but I’ve seen a few informative videos on the subject. One has to do with real estate.

Real estate in China is actually a deep deep sink of capital. Meaning that people put money there the way we might put money in a bank or the stock market. In China if you are a consumer and you have a little bit of excess cash… the average person is going to try to put it in a safe asset, and the safest asset for most Chinese has been real estate. Most people are buying second and even third homes as investments. And many are going unoccupied. In fact, there are about 50 million homes in China which are unoccupied. Think about it. 50 million is about half the household count of the entire United States…

People have been possibly over-investing in real estate, and there isn’t enough demand for what’s being built. So the Chinese government has been trying to figure out ways of slowing this down and changing the economics of real estate. One of the oddest things is there is no real estate tax [in China]… So if they were to introduce a real estate tax, people would panic. They’d have to sell their properties probably because they couldn’t afford the cash flow. And if they were to sell their properties there would be a market crash.

My take: It’s just a hypothesis, but he’s not making this stuff up. For background, see Can China fix its runaway housing market? in the South China Morning Post.

5 Comments

  1. Gregg Thurman said:

    “why would you cut your spending by 70%”

    Maybe a minor point, but I don’t think the Chinese cut spending by 70%, they cut non-essential, elective spending by 70%.

    I think that over the long haul Apple benefits from this to a greater extent than do Android suppliers. That’s because Apple products are designed to last longer.

    Lasting longer means that, for whatever reason, consumers upgrade the Apple product there continues to be economic life in the “castoff”.

    In a market that’s has reached saturation it is unreasonable to expect ever increasing unit sales numbers. However, nobody has 100% of the total addressable market, a market that is divided into many different price tiers.

    Android only has one price tier and a limited economic life, while Apple (with its focus on the high end and a culture of product and user experience excellence) has multiple (hand me downs, used and refurbed over time) price tiers. The Apple product remains aspirational even as it passes through its pricing tiers, much the same way that people buy used BMWs, Mercedes Benz or Cadillacs.

    Those 2nd and 3rd (4th?) tier product owners consume expendable products aka Services, and there are far more of these (2nd tier, etc) consumers in the total addressable market than there are purchasers of new (the only limit being availability of pre-owned product.

    I’m starting to ramble a bit, but Apple has positioned itself to exploit that fact far better than the competition. Instead of relying on selling an ever increasing number of products with razor thin margins, Apple is positioned to sell consumables to an increasing hardware installed base.

    I don’t think it coincidental that hardware performance and market saturation occurred at the same time Apple’s long term (since before the iPhone was first introduced) Services strategy became apparent. Taking control in house production of essential technologies (A-Series processors, et al) was critical to that long term strategy. This leads me to believe that Apple wants to bring cellular radio development in house, which means breaking Qualcomm’s control of essential radio technologies/patents. If this last thought is true, then it shouldn’t be a surprise that Apple’s dispute with Qualcomm emerged just before 5G cellular networks are deployed.

    In my estimation Apple has significant plans for 5G capable products and Services utilizing Apple developed (proprietary functionality) 5G modems.

    Thank you for reading. I’ll stop here.

    4
    January 16, 2019
    • Dan Scropos said:

      Outstanding post, Gregg. Cutting out Qualcomm would be a monumental move and once again prove Apple’s ability to innovate.

      0
      January 16, 2019
  2. Fred Stein said:

    Two more factors: Trade war / Huawei; And WeChat

    Our tariffs and threats may be seen as attacks, prompting strong defensive protective responses.

    Users experience WeChat, not iOS nor Android.

    0
    January 16, 2019
  3. David Sauceda said:

    I didn’t realize the Critical Path was back. Thanks PED!

    0
    January 16, 2019

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