Apple has done something almost unprecedented: In a letter to investors, CEO Tim Cook announced Apple is revising its guidance for Q1 2019, lowering revenue projections from the previously stated 89 to 93 billion, down to 84 billion.

That's an 8% difference, which translates into 5-9 billion dollars. Billion with a b. Yeah. Ouch.

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Q1 2019: The Numbers

The last time Apple revised guidance down was a decade and a half ago: Q3 2002, before iPod became a runaway hit and before iPhone was even a purple project.

It's not all bad news: Cook announced revenue for everything other than iPhone was up 19% year-over-year, including a record-setting $10.8 billion in revenue for services.

Wearables, which is Apple Watch and AirPods, grew 50%, and new Macs and iPads Pro led to year-over-year revenue growth for those as well.

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Apple still expects to report a new all-time record for earnings per share, and even with that "Terrible No Good Very Bad Earnings Warning" on iPhone, it's still almost certainly going to be Apple's second biggest quarter. Ever.

But, that "Terrible No Good Very Bad Earnings Warning"

According to Cook, there were 4 potential problems already baked into Apple's previous forecasts:

  1. Where iPhone X shipped in this quarter last year, iPhone XS and XR had both already shipped this year, meaning no launch bump and a tougher year-to-year compare.
  2. The strong U.S. dollar would hurt them in international exchange and reduce revenue growth by 200 basis points.
  3. The sheer number of new products released towards the end of the year would result in supply constraints, especially for iPad Pro, Apple Watch, and MacBook Air, and also AirPods.
  4. Economic weakness in some emerging markets.

Cook claims the first three played out pretty much as expected. The fourth one, though… that wrecked.

Q1 2019: China Factor

Tim Cook:

China's economy began to slow in the second half of 2018. The government-reported GDP growth during the September quarter was the second lowest in the last 25 years. We believe the economic environment in China has been further impacted by rising trade tensions with the United States. As the climate of mounting uncertainty weighed on financial markets, the effects appeared to reach consumers as well, with traffic to our retail stores and our channel partners in China declining as the quarter progressed. And market data has shown that the contraction in Greater China's smartphone market has been particularly sharp.

China was the last quote-unquote easy growth sector left for iPhone. After moving from AT&T to Verizon and all the U.S carriers, and spreading across Europe and most of the rest of the world. After NTTDoCoMo in Japan, the biggest prize was China Mobile and, once Apple got that, there were no markets left to conquer. No quote-unquote easy markets at least.

But China has never really been that easy. It's a market that's second only to the U.S. in terms of size and will one day be second to none. And it's also very different market.

Ben Thompson outlined Apple's advantage in China as a status-conferring brand, but also its risk:

The fundamental issue is this: unlike the rest of the world, in China the most important layer of the smartphone stack is not the phone's operating system. Rather, it is WeChat.

in China, [Apple] is simply another smartphone vendor, and being simply another smartphone vendor is a hazardous place to be. To be clear, it's not all bad: in China Apple still trades on status and luxury; unlike the rest of the world, though, the company has to earn it with every release, and that's a bar both difficult to clear in the abstract and, given the last two iPhones, difficult to clear in reality.

When you add the current economic conditions in China, the uncertainty around U.S. / China trade, and any negative, the anti-American brand sentiment that might be rising there as a result of it, especially with increasingly strong and home-grown alternatives like Huawei, and you get almost all of the current shortfall.

That the extent of China fall-off caught Apple by surprise, though, even given the current volatility of both economies and regimes, is in and of itself surprising. Though that's also likely indicative of problems far beyond Apple and its earnings.

Despite all this, Apple did manage to not only grow its install base in China but also hit new records for services, which could indicate brand loyalty and ecosystem are more nuanced in the market than popular analysis would have us believe.

Q1 2019: Other Factors

Tim Cook didn't stop with China, though. He also highlighted some issues in the U.S. market.

While Greater China and other emerging markets accounted for the vast majority of the year-over-year iPhone revenue decline, in some developed markets, iPhone upgrades also were not as strong as we thought they would be. 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.

And that was where the internet lost its collective mind last night, with far too many people using the news to justify their own personal pet peeves. In other words, any particular decision they personally didn't like over the last decade was now proof positively coming home to roost.

  • Apple removed the headphone jack and now they're paying for it. If they'd just kept the headphone jack…
  • Apple cancelled the iPhone SE and now they're paying for it. If they'd just updated the iPhone SE…
  • Apple software has gotten buggy and now they're paying for it. If they'd just fixed the damn software…
  • Apple prices have gotten too damn high and now they're paying for it. If they'd just kept prices low…
  • Apple's too proprietary and now they're paying for it. If they'd just open sourced iOS…
  • Apple deleted the Home button and now they're paying for it. If they'd just kept the Home button…
  • Apple didn't stick with the floppy drive and now we're all getting bad Superman movies!

I get it. We're human. If something doesn't bother us specifically we have a hard time understanding why it's any issue at all but if something does bug us, hot wow must it be the root of all evil. Because we're all the centers of our own perfect little universes.

But markets, like life, are usually just a little more complicated than that.

So, let's start with what Cook actually said. Now, there's been some criticism of how he handles these things, especially when compared to Steve Jobs' style.

Here's probably the best example from John Gruber on Daring Fireball:

I think Cook's genuine and inherent humility holds Apple back on days like today. Apple needed less "I'm sorry, let me explain" and more "Fuck you, this is bullshit, let me explain". What people took away from Cook's letter and TV appearance today is that the iPhone laid a turd last quarter. Properly delivered, the takeaway should have been that China is crazy but the iPhone is still kicking the shit out of the entire rest of the handset industry and is only pulling further ahead. 

John even takes it a step further, laying how a Jobs-style Cook "allow me to retort" could have played out:

I'd typically argue that Cook's relative openness is better for customers and market analysis both, but given the inherent cynicism of most coverage, Cook's candor often gets treated as dissembly while the outright lies of other CEOs get passed along as gospel, so who knows?

What we do know is what Cook said:

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. 

What Cook is referencing first is that, in a world with no subsidies, more people see the full sticker price of the iPhone. And that price is higher than ever.

That's worth parsing. Because feels aren't facts and facts are important. A lot of people see Apple charging higher prices as putting profit ahead of market or customers. The truth is, Apple isn't making iPhones more expensive. They're making more expensive iPhones. Everything from the OLED screens to the Face ID modules are more expensive than LCD and Touch ID, and the cost for other components, like memory, have gone up as well.

Far from Tim Cook milking products, Apple margins have gone down slightly since the height of the Steve Jobs era. And Apple's margins are only high to begin with because almost no one else makes any money in the smartphone market.

Apple could certainly have made less expensive iPhones or eaten even more margins to keep prices in-line, but it's unclear if they would have made it up in volume or just have to have released the same or even greater downward adjustments.

My guess is that iPhone prices will drop as the currently expensive new components scale and become the new normal.

But it's unclear if Apple can solve for the US dollar strength, especially as it manifests in massive hikes in international iPhone prices, without weaning themselves and Wall Street off the exceptions of those margins remaining — at least in the smartphone business.

Customers taking advantage of reduced pricing for iPhone battery replacements is something else that's proven difficult to parse. Here's my take: In February of 2017, Apple had a problem with older iPhones shutting down when power demand spiked. To solve it, they began aggressively managing to performance to prevent those spikes. In other words, throttling speed to preserve longevity.

Because Apple never properly explained what they were doing, slowdowns on older phones ended up being far worse than anyone including Apple ever imagined, and people were justifiably outraged by the whole thing, in December Apple announced a cheap battery replacement program.

Before then, awareness of battery replacements was low and prices were high. After that, awareness skyrocketed and cost plummeted. So, some percentage of people chose to have the battery replaced on their old iPhones instead of buying new iPhones.

Add to that iPhone X likely pulling some number of upgrades forward, like iPhone 6, because it was so new and different. And, on the opposite end, some number of people who dislike change either sticking with their existing Home button phones longer than they would otherwise, or electing to buy older, lower margin iPhones instead, and you have a smaller but just as perfect a storm in established markets as you do in China.

It's nowhere nearly as big but because we're in those markets, it's getting the vast majority of the coverage.

But, neither China nor the U.S., not trade or tariffs, not pricing or pet peeves really explain what's going on.

Q1 2019: What's next?

So, now, finally, here's the simple, terrifying truth:

Complaints about pricing, price points, home buttons, headphone jacks, batteries, upgrade cycles, etc. are all totally valid but are also all totally besides the point, which remains this:

The smartphone market is now mature. What I've been writing about since at least 2010 and what I covered in a video just last month, and what many people have been saying if not really mapping out for years, is something everyone, not just Apple now has to face.

And part of it — a lot of it — is Apple's own damn fault. As much as conspiracy theorists love to say Apple plans obsolescence, Apple has actually been not just planning but enacting the exact opposite:

Planned longevity.

Everything from the higher priced iPhones that use hardware that just lasts and lasts and chipsets that are designed to provide overhead for a good half-decade to software like iOS 12 which specifically focused on improving the performance of old iPhones going back 5 years, Apple is doing everything it can not to keep people happy with their existing iPhones for longer than ever.

So the question becomes this: Can Apple transition iPhone from growth driver to platform that enables more growth drivers?

There are signs that they can. That Apple actually understands the phone market is staturated and has for a while. That Apple spent a decade building up the iPhone and now they need to spend the next decade using the iPhone to build up everything else.

They'll still sell new iPhones, of course, and thanks to the focus on longevity, older iPhones will get handed down and remain in use — which is why Tim Cook is stressing things like:

Our installed base of active devices hit a new all-time high—growing by more than 100 million units in 12 months. There are more Apple devices being used than ever before, and it's a testament to the ongoing loyalty, satisfaction and engagement of our customers. 

Once you've sold everyone an iPhone, you start selling things to people with iPhones.

Things like AirPods and Apple Watches, and apps and subscription services. Music and television for now, but increasingly Apple Pay and expanded financial, and expanded Health services into the future.

Exactly what Apple is still reporting record earnings for right now. What remains to be seen is how high and how fast that grows.

At least that's what I think. Now I'd love to know what you think. Is Apple doomed or doomed all the way to the bank?

VECTOR | Rene Ritchie


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