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Apple faces a severe potential financial crisis in coming years -- one that dwarfs Microsoft's. They rely so heavily on the premium subsidy for their revenue t

Apple faces a severe potential financial crisis in coming years -- one that dwarfs Microsoft's. They rely so heavily on the premium subsidy for their revenue that if the subsidy is merely brought down to normal levels they will see a huge drop in revenue -- and this assumes that they keep selling the same number of phones. Now that there are viable alternatives in Android, and to a lesser extent Windows Phones, with much lower subsidies, I think you'll see the carriers push these other devices. And if we move to a model where consumers pay for the full price of the phone (which is what much of the world does today), then you'll actually see iPhone sales fall. Sub $200 low-margin phones are the future. Apple can still do well with a premium phone -- especially if the camera is really good, but I think it's a tougher niche than the high-end PC market.

NathanKP 13y ago
My understanding of Apple's business model is that they plan to make most of their money from the 30% commission on in app purchases, and their share from media sales made through iTunes. The sale of the hardware is just a way to get a purchase platform in the hands of the consumer. Apple could probably sell a sub $200 iPhone with no difficulty, and then pay off the subsidy using their other sources of indirect revenue. Of course in that case we will probably see iPhones become even more of a walled garden, and a lot more of a crackdown on jailbreaking.
- 0x0 13y ago
  You're probably right, which is funny since just a couple of years ago the app store was claimed to be a break-even operation. Too bad for Samsung they don't have one.
- bdcravens 13y ago
  My understanding of Apple's business model is that they plan to make most of their money from the 30% commission on in app purchases, and their share from media sales made through iTunes. Actually, it's project to only grow to about 37% of their total profit by 2020, not exactly "most": http://appleinsider.com/articles/14/03/24/itunes-and-app-sales-projected-to-grow-to-20-of-apple-profit-by-2020 http://appleinsider.com/articles/14/03/24/itunes-and-app-sal...
  - NathanKP 13y ago
    To be more clear when I said "most of their money" I did not mean most of their total revenue for the company, I meant most of the money they make from you during their relationship with you as their customer. If you think about it your relationship with Apple as their customer begins with the hardware purchase, but then as you use the hardware you keep feeding money to Apple every time you make an iTunes purchase, in app purchase, buy extra iCloud storage, etc. The goal is that this residual source of income will surpass the initial income from the sale of the hardware. In that case they could give away the hardware at a very cheap, subsidized price, or even for free and then enjoy the steady stream of money from their other services that run on the device.
    - xuki 13y ago
      Apple make money by selling hardware. First they sell you iPod, which you like very much and start looking for their mac. Then the iPhone come out and you like them too. Next one is iPad, guess what, you already know how to use them. They drive apps price to 0.99 and make their OS free, what does that tell you about their way to make money? Apple at heart is a hardware company with very good software engineer.
    - bdcravens 13y ago
      When you factor in free app downloads, the average selling price of iPhone apps is 19 cents: http://appleinsider.com/articles/13/07/18/iphone-users-pay-average-of-19-cents-per-app-android-users-pay-just-6-cents http://appleinsider.com/articles/13/07/18/iphone-users-pay-a... To make even $100 per device, an average user would need to download approximately 1700 apps over the life of the device! Simpler math: $100 in profits would require something like $370 in app/media purchases. (30% commission, 90% margins on operating iTunes/App Store) To say nothing of the fact that this would require Apple to turn their back on the past 37 years.
- kenjackson 13y ago
  Apple makes such huge money off of subsidy, I don't think they can make that money back from app commissions. I've heard the subsidy north of $300/phone. That's a LOT of in app and media purchases to get that back in 2-3 years. Plus remember that the subsidy is on top of the app purchase dollars they make today, since phones with the subsidy still buy apps. There is no real upside to them on this. Sure they make good money on apps, but its hard to replace effectively free money from the carriers.
bdcravens 13y ago
Sub $200 low-margin phones are the future. Wouldn't this be as problematic for Samsung (or any other vendor with high end offerings, but Samsung is the big dog) as Apple? While Samsung has some sub-$200 phones, doesn't the massive profit from the latest and greatest make that possible?
- Mikeb85 13y ago
  It's problematic for a lot of manufacturers, but it's what Google, Amazon, and even MS are pushing for, since their business is software (Google through ads, MS) and commerce (Amazon). Not to mention it's the eventual result of a competitive market (Econ 101).
  - bdcravens 13y ago
    Not to mention it's the eventual result of a competitive market (Econ 101). I like how you appended that course number as a sly insult. In a perfectly competitive market, perhaps. But there are other forces at play. Why does Whole Foods prosper when you can buy food at Wal-Mart? Why do Priuses still sell when they may not be the most cost effective transportation mechanism (after you factor in initial cost)? Why do people still buy Ralph Lauren and Louis Vuitton? Commoditization isn't inevitable in anything other than the theoretical environment you'd find in Econ 101.
    - arjie 13y ago
      Ha ha, excellent stuff. Econ 101 is Econ 101 because it is simplistic. It's like saying "Pi is 22/7. This is high-school mathematics, guys". The whole thing is made simple so you can grasp some concepts. You learn the complexity when you progress through the classes. Realistically then, saying something is Econ 101 is saying that "looking at this without considering any of the subtleties of the situation, we have the following result".
    - Mikeb85 13y ago
      If you'd taken any econ you'd know that differentiating factors exist which essentially create a 'new' market. Whole Foods doesn't compete in the same market as Wal-Mart. Louis Vuitton doesn't compete with (insert nameless brand... Not sure, my wife likes high-end things). Anyhow, the comment was meant tongue in cheek anyhow, don't know why you're so upset. Your retort was bad anyway.
happyscrappy 13y ago
As long as Apple keeps making the best hardware available they will have my money. Are you willing to put your hard earned dollars on the line shorting AAPL? If not why?
- hindsightbias 13y ago
  AAPL is not treated rationally by Wall Street. The stock has been bad mouthed every quarter for years. Last quarter, they ONLY sold 52M iphones instead of the analysts' projection of 54M. Stock drops. As an AAPL holder, it makes me want to get into shorts, but then I'm speculating on the whim of some ass on the TV.
  - waterfowl 13y ago
    and shorts without options to cover your ass are probably more stress for the individual(non filthy rich) investor than they're worth.
  - redler 13y ago
    You can conservatively play an irrational suppression of Apple's stock price by selling out-of-the-money covered calls against your position. Highly liquid market, immediate income in your pocket. Your worst cases are 1) The stock goes down (you were apparently holding anyway, but now you have more cash); or 2) The stock is called away during a run-up (so you pre-sold some fraction of your potential profits to the option buyer). Edit: Clarity
pjmlp 13y ago
I think I already went through this scenario around 20 years ago.
usethis 13y ago
It is a matter of staying ahead of the curve and not let your competitors catch up. Whether that means in terms of marketing, or product quality doesn't matter. So far plenty consumers are convinced that Apple's prices are justifiable and don't have a reason to switch an ecosystem they have invested in. You are right that Apple faces a crisis if their sales drop, so does every other company. The worst reaction though, would be to start competing on prices, and thus quality. This inevitably leads to a race to the bottom, where they're unable to compete against companies that are based in cheap labor countries. Much in the same way as Philips, or Sony couldn't compete against companies like Samsung once they lost their competitive edge in their product categories.
- kenjackson 13y ago
  I think you missed my point. They face a crisis even if their sales do NOT drop. They face a crisis if Verizon says to them, "We are no longer willing to give you a subsidy premium. You will get the same subsidy rates as the Samsung Galaxy Sx." Apple will continue to sell at the same rate, but their revenue will drop substantially. On top of that is the fear of their sales actually dropping if carriers stop doing subsidies altogether (which is the direction they are going).
  - gress 13y ago
    Carriers still get much higher ARPU from iPhone users. While that is true, the subsidy will remain.
anon1385 13y ago
>Why being insanely profitable is bad for Apple Microsoft fans have been making this argument for 15 years or more. They said Apple should copy Dell and sell cheap enterprise desktops with low margins because that was where the money was. Then they said Apple should copy Asus and HP and sell cheap netbooks with low margins because that was the future. Then people said Apple should be making a really cheap ebook reader to compete with the Kindle. People are constantly advising Apple that they should get into low margin markets and compete on price with companies that are barely breaking even. This advice seems to mostly be based on what they want the market to look like, more than how it actually is.
- kenjackson 13y ago
  To be clear I think Apple has a great model, but they need to be realistic that it won't last. The only markets in the world that the iPhone has substantial market share is in countries with subsidies (at least I believe so). In markets with no subsidy, Android is killing. As the US (and the world) moves more to a non-subsidy model I think this disproportionately impacts the iPhone. All OEMs will have to deal with this, but Samsung, LG, Huawei, Coolpad, are used to this world already as they sell really well worldwide. iPhone hasn't figured out how to sell full price phones around the world.
  - gress 13y ago
    That 'android' that is killing is AOSP, not GMS, and the accompanying users are the least valuable to operators. Where the market is not saturated, any customer is a win, but in saturated markets, the competition is to skim premium customers out of the churn. If anything this situation is likely to become more prevalent, not less so.
  - blktiger 13y ago
    Apple doesn't focus on market share and it never has. Instead they focus on profit. Take (for example), the personal computer market. According to wikipedia, Mac OS X has around a 7% market share[1] yet Apple's larger competitors like HP and Dell are barely making any money while Apple is still making huge profits. (Not as much as on their iOS businesses of course.) [1] https://en.wikipedia.org/wiki/Usage_share_of_operating_systems https://en.wikipedia.org/wiki/Usage_share_of_operating_syste...
smackfu 13y ago
>And if we move to a model where consumers pay for the full price of the phone (which is what much of the world does today) It's coming pretty fast. AT&T is pushing Next pretty hard, which is essentially an interest-free repayment plan spread over 20 or 26 months. If you go to buy a phone now, that installment price is listed first, rather than the contract prices. You still don't see the "real" retail price, but you sure do see that an iPhone is $25 a month and a Moto X is $15 a month. (The Moto X is the cheapest current gen phone they have, I think. Something like a Nexus 5 would be even less but isn't on Next.)
waylandsmithers 13y ago
Maybe someone can correct my uninformed opinion on this (plus I've had the same iphone 4s for about two and a half years), but doesn't it seem like all the cool stuff is happening on Android? Android: Pause video when you look away, send data by bumping two phones, run multiple apps at once, watch/wrist devices iPhone: Now in five different colors
- cloudwalking 13y ago
  The problem is, these "cool" things you mention are mostly just marketing and don't work very well. I have only heard complaints about Galaxy Gear. Same for the eyeball tracking stuff on the new Galaxy phones--it just doesn't work very well.
bunderbunder 13y ago
At the peak, Microsoft's profit margins on their core products where hovering around 90%. If I remember right, Apple's profit margins on the iPhone peaked at a bit short of 75% with the 4S, and have generally been sub-60%. Furthermore, Apple hoards cash in a way that Microsoft never did. What this means is that Microsoft was sinking the cash into other business ventures - in other words they created a heavy reliance on those wide profit margins by creating a bunch of units that needed to be subsidized by other units' wide profit margins to survive. By contrast, Apple's taken a strategy of building up an enormous nest egg that they can use to help get them through the lean times should that ever become necessary. Who'd you say is living at greater financial risk? Someone who makes an enormous salary but is only a brief period of unemployment away from foreclosing on their palatial house and having their Porsche repossessed? Or someone who relatively recently fell into a very high-paying (if not quite so enormously lucrative) job but has stuck with a relatively frugal lifestyle and instead devoted the extra money to investing in more liquid assets?
- 300bps 13y ago
  Someone who makes an enormous salary but is only a brief period of unemployment away from foreclosing on their palatial house and having their Porsche repossessed? So, in this part of your analogy, it seems Microsoft is the company you're comparing to a person that is ready to have their possessions repossessed. Is that right? If so, I humbly invite you to look at the facts regarding Microsoft. Microsoft's most recent quarter saw literally record revenue and they blew away everyone's profit expectations. http://www.bloomberg.com/news/2014-01-23/microsoft-s-second-quarter-profit-sales-top-estimates.html http://www.bloomberg.com/news/2014-01-23/microsoft-s-second-... Microsoft also has more cash on hand than the U.S Government: http://finance.yahoo.com/news/microsoft-starting-hoard-cash-now-194453195.html http://finance.yahoo.com/news/microsoft-starting-hoard-cash-...
  - bunderbunder 13y ago
    Microsoft wasn't always so prudent with its money. I was meaning to compare to when Microsoft's favorite thing to do with cash was to burn it. Remember Skype? I wouldn't be surprised if this (welcome) new strategy isn't at least partially inspired by observing how Apple does things.

NathanKP 13y ago

My understanding of Apple's business model is that they plan to make most of their money from the 30% commission on in app purchases, and their share from media sales made through iTunes. The sale of the hardware is just a way to get a purchase platform in the hands of the consumer. Apple could probably sell a sub $200 iPhone with no difficulty, and then pay off the subsidy using their other sources of indirect revenue. Of course in that case we will probably see iPhones become even more of a walled garden, and a lot more of a crackdown on jailbreaking.

0x0 13y ago
You're probably right, which is funny since just a couple of years ago the app store was claimed to be a break-even operation. Too bad for Samsung they don't have one.
bdcravens 13y ago
My understanding of Apple's business model is that they plan to make most of their money from the 30% commission on in app purchases, and their share from media sales made through iTunes. Actually, it's project to only grow to about 37% of their total profit by 2020, not exactly "most": http://appleinsider.com/articles/14/03/24/itunes-and-app-sales-projected-to-grow-to-20-of-apple-profit-by-2020 http://appleinsider.com/articles/14/03/24/itunes-and-app-sal...
- NathanKP 13y ago
  To be more clear when I said "most of their money" I did not mean most of their total revenue for the company, I meant most of the money they make from you during their relationship with you as their customer. If you think about it your relationship with Apple as their customer begins with the hardware purchase, but then as you use the hardware you keep feeding money to Apple every time you make an iTunes purchase, in app purchase, buy extra iCloud storage, etc. The goal is that this residual source of income will surpass the initial income from the sale of the hardware. In that case they could give away the hardware at a very cheap, subsidized price, or even for free and then enjoy the steady stream of money from their other services that run on the device.
  - xuki 13y ago
    Apple make money by selling hardware. First they sell you iPod, which you like very much and start looking for their mac. Then the iPhone come out and you like them too. Next one is iPad, guess what, you already know how to use them. They drive apps price to 0.99 and make their OS free, what does that tell you about their way to make money? Apple at heart is a hardware company with very good software engineer.
  - bdcravens 13y ago
    When you factor in free app downloads, the average selling price of iPhone apps is 19 cents: http://appleinsider.com/articles/13/07/18/iphone-users-pay-average-of-19-cents-per-app-android-users-pay-just-6-cents http://appleinsider.com/articles/13/07/18/iphone-users-pay-a... To make even $100 per device, an average user would need to download approximately 1700 apps over the life of the device! Simpler math: $100 in profits would require something like $370 in app/media purchases. (30% commission, 90% margins on operating iTunes/App Store) To say nothing of the fact that this would require Apple to turn their back on the past 37 years.
kenjackson 13y ago
Apple makes such huge money off of subsidy, I don't think they can make that money back from app commissions. I've heard the subsidy north of $300/phone. That's a LOT of in app and media purchases to get that back in 2-3 years. Plus remember that the subsidy is on top of the app purchase dollars they make today, since phones with the subsidy still buy apps. There is no real upside to them on this. Sure they make good money on apps, but its hard to replace effectively free money from the carriers.

bdcravens 13y ago

Sub $200 low-margin phones are the future. Wouldn't this be as problematic for Samsung (or any other vendor with high end offerings, but Samsung is the big dog) as Apple? While Samsung has some sub-$200 phones, doesn't the massive profit from the latest and greatest make that possible?

Mikeb85 13y ago
It's problematic for a lot of manufacturers, but it's what Google, Amazon, and even MS are pushing for, since their business is software (Google through ads, MS) and commerce (Amazon). Not to mention it's the eventual result of a competitive market (Econ 101).
- bdcravens 13y ago
  Not to mention it's the eventual result of a competitive market (Econ 101). I like how you appended that course number as a sly insult. In a perfectly competitive market, perhaps. But there are other forces at play. Why does Whole Foods prosper when you can buy food at Wal-Mart? Why do Priuses still sell when they may not be the most cost effective transportation mechanism (after you factor in initial cost)? Why do people still buy Ralph Lauren and Louis Vuitton? Commoditization isn't inevitable in anything other than the theoretical environment you'd find in Econ 101.
  - arjie 13y ago
    Ha ha, excellent stuff. Econ 101 is Econ 101 because it is simplistic. It's like saying "Pi is 22/7. This is high-school mathematics, guys". The whole thing is made simple so you can grasp some concepts. You learn the complexity when you progress through the classes. Realistically then, saying something is Econ 101 is saying that "looking at this without considering any of the subtleties of the situation, we have the following result".
  - Mikeb85 13y ago
    If you'd taken any econ you'd know that differentiating factors exist which essentially create a 'new' market. Whole Foods doesn't compete in the same market as Wal-Mart. Louis Vuitton doesn't compete with (insert nameless brand... Not sure, my wife likes high-end things). Anyhow, the comment was meant tongue in cheek anyhow, don't know why you're so upset. Your retort was bad anyway.

happyscrappy 13y ago

As long as Apple keeps making the best hardware available they will have my money. Are you willing to put your hard earned dollars on the line shorting AAPL? If not why?

hindsightbias 13y ago
AAPL is not treated rationally by Wall Street. The stock has been bad mouthed every quarter for years. Last quarter, they ONLY sold 52M iphones instead of the analysts' projection of 54M. Stock drops. As an AAPL holder, it makes me want to get into shorts, but then I'm speculating on the whim of some ass on the TV.
- waterfowl 13y ago
  and shorts without options to cover your ass are probably more stress for the individual(non filthy rich) investor than they're worth.
- redler 13y ago
  You can conservatively play an irrational suppression of Apple's stock price by selling out-of-the-money covered calls against your position. Highly liquid market, immediate income in your pocket. Your worst cases are 1) The stock goes down (you were apparently holding anyway, but now you have more cash); or 2) The stock is called away during a run-up (so you pre-sold some fraction of your potential profits to the option buyer). Edit: Clarity

pjmlp 13y ago

I think I already went through this scenario around 20 years ago.

usethis 13y ago

It is a matter of staying ahead of the curve and not let your competitors catch up. Whether that means in terms of marketing, or product quality doesn't matter. So far plenty consumers are convinced that Apple's prices are justifiable and don't have a reason to switch an ecosystem they have invested in. You are right that Apple faces a crisis if their sales drop, so does every other company. The worst reaction though, would be to start competing on prices, and thus quality. This inevitably leads to a race to the bottom, where they're unable to compete against companies that are based in cheap labor countries. Much in the same way as Philips, or Sony couldn't compete against companies like Samsung once they lost their competitive edge in their product categories.

kenjackson 13y ago
I think you missed my point. They face a crisis even if their sales do NOT drop. They face a crisis if Verizon says to them, "We are no longer willing to give you a subsidy premium. You will get the same subsidy rates as the Samsung Galaxy Sx." Apple will continue to sell at the same rate, but their revenue will drop substantially. On top of that is the fear of their sales actually dropping if carriers stop doing subsidies altogether (which is the direction they are going).
- gress 13y ago
  Carriers still get much higher ARPU from iPhone users. While that is true, the subsidy will remain.

anon1385 13y ago

>Why being insanely profitable is bad for Apple Microsoft fans have been making this argument for 15 years or more. They said Apple should copy Dell and sell cheap enterprise desktops with low margins because that was where the money was. Then they said Apple should copy Asus and HP and sell cheap netbooks with low margins because that was the future. Then people said Apple should be making a really cheap ebook reader to compete with the Kindle. People are constantly advising Apple that they should get into low margin markets and compete on price with companies that are barely breaking even. This advice seems to mostly be based on what they want the market to look like, more than how it actually is.

kenjackson 13y ago
To be clear I think Apple has a great model, but they need to be realistic that it won't last. The only markets in the world that the iPhone has substantial market share is in countries with subsidies (at least I believe so). In markets with no subsidy, Android is killing. As the US (and the world) moves more to a non-subsidy model I think this disproportionately impacts the iPhone. All OEMs will have to deal with this, but Samsung, LG, Huawei, Coolpad, are used to this world already as they sell really well worldwide. iPhone hasn't figured out how to sell full price phones around the world.
- gress 13y ago
  That 'android' that is killing is AOSP, not GMS, and the accompanying users are the least valuable to operators. Where the market is not saturated, any customer is a win, but in saturated markets, the competition is to skim premium customers out of the churn. If anything this situation is likely to become more prevalent, not less so.
- blktiger 13y ago
  Apple doesn't focus on market share and it never has. Instead they focus on profit. Take (for example), the personal computer market. According to wikipedia, Mac OS X has around a 7% market share[1] yet Apple's larger competitors like HP and Dell are barely making any money while Apple is still making huge profits. (Not as much as on their iOS businesses of course.) [1] https://en.wikipedia.org/wiki/Usage_share_of_operating_systems https://en.wikipedia.org/wiki/Usage_share_of_operating_syste...

smackfu 13y ago

>And if we move to a model where consumers pay for the full price of the phone (which is what much of the world does today) It's coming pretty fast. AT&T is pushing Next pretty hard, which is essentially an interest-free repayment plan spread over 20 or 26 months. If you go to buy a phone now, that installment price is listed first, rather than the contract prices. You still don't see the "real" retail price, but you sure do see that an iPhone is $25 a month and a Moto X is $15 a month. (The Moto X is the cheapest current gen phone they have, I think. Something like a Nexus 5 would be even less but isn't on Next.)

waylandsmithers 13y ago

Maybe someone can correct my uninformed opinion on this (plus I've had the same iphone 4s for about two and a half years), but doesn't it seem like all the cool stuff is happening on Android? Android: Pause video when you look away, send data by bumping two phones, run multiple apps at once, watch/wrist devices iPhone: Now in five different colors

cloudwalking 13y ago
The problem is, these "cool" things you mention are mostly just marketing and don't work very well. I have only heard complaints about Galaxy Gear. Same for the eyeball tracking stuff on the new Galaxy phones--it just doesn't work very well.

bunderbunder 13y ago

At the peak, Microsoft's profit margins on their core products where hovering around 90%. If I remember right, Apple's profit margins on the iPhone peaked at a bit short of 75% with the 4S, and have generally been sub-60%. Furthermore, Apple hoards cash in a way that Microsoft never did. What this means is that Microsoft was sinking the cash into other business ventures - in other words they created a heavy reliance on those wide profit margins by creating a bunch of units that needed to be subsidized by other units' wide profit margins to survive. By contrast, Apple's taken a strategy of building up an enormous nest egg that they can use to help get them through the lean times should that ever become necessary. Who'd you say is living at greater financial risk? Someone who makes an enormous salary but is only a brief period of unemployment away from foreclosing on their palatial house and having their Porsche repossessed? Or someone who relatively recently fell into a very high-paying (if not quite so enormously lucrative) job but has stuck with a relatively frugal lifestyle and instead devoted the extra money to investing in more liquid assets?

300bps 13y ago
Someone who makes an enormous salary but is only a brief period of unemployment away from foreclosing on their palatial house and having their Porsche repossessed? So, in this part of your analogy, it seems Microsoft is the company you're comparing to a person that is ready to have their possessions repossessed. Is that right? If so, I humbly invite you to look at the facts regarding Microsoft. Microsoft's most recent quarter saw literally record revenue and they blew away everyone's profit expectations. http://www.bloomberg.com/news/2014-01-23/microsoft-s-second-quarter-profit-sales-top-estimates.html http://www.bloomberg.com/news/2014-01-23/microsoft-s-second-... Microsoft also has more cash on hand than the U.S Government: http://finance.yahoo.com/news/microsoft-starting-hoard-cash-now-194453195.html http://finance.yahoo.com/news/microsoft-starting-hoard-cash-...
- bunderbunder 13y ago
  Microsoft wasn't always so prudent with its money. I was meaning to compare to when Microsoft's favorite thing to do with cash was to burn it. Remember Skype? I wouldn't be surprised if this (welcome) new strategy isn't at least partially inspired by observing how Apple does things.