The iPhone's Toughest Competitor Is the iPhone Itself

By Markets Fool.com

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Image source: Apple.

Apple (NASDAQ: AAPL) makes more than 60% of revenue from the iPhone segment, so competitive dynamics in the smartphone industry are remarkably important for investors in the company, especially now that Apple has recently launched its brand-new iPhone 7 and iPhone 7 Plus models.

Interestingly, the biggest competitor for the iPhone is arguably not the latest smartphone from Samsung (NASDAQOTH: SSNLF) or some other industry player, but previous versions of the iPhone itself. This can be a headwind for Apple in terms of growth opportunities in the short term, but it also has big positive implications for investors.

Apple is one of a kind

Apple owns one of the most valuable brands in the world, and Apple users are remarkably loyal to the company. The Fortune Brands Ranking considers Apple the most valuable brand on the planet, with an estimated value of $154.1 billion. Competitor Samsung comes in 11th, according to the publication, the Samsung brand is reportedly worth $36.1 billion.

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Even better, the competitive gap between Apple and Samsung seems to be widening lately, as the iPhone 7 is off to a strong start, while Samsung is facing serious problems with the Galaxy Note 7. The South Korean manufacturer has recalled 2.5 million Note 7s after dozens of cases in which batteries exploded or caught fire. This is an important issue in terms of customer safety, and it will probably inflict considerable damage to Samsung's reputation.

On the other hand, both T-Mobile US (NASDAQ: TMUS) and Sprint Corporation (NYSE: S) announced on Tuesday that demand for the iPhone 7 and iPhone 7 Plus looks encouragingly strong. According to T-Mobile, the iPhone 7 is the biggest pre-order in T-Mobile's history, and Sprint said pre-orders of the iPhone 7 and iPhone 7 Plus are up more than 375% in the first three days over the same period last year.

Apple has a pricing disadvantage versus lower-cost competitors, limiting market share potential in emerging markets where income levels are lower and the carrier subsidy model is not as extended as in the United States. However, when it comes to competing in the higher end of the pricing spectrum, Apple comes second to none.

The iPhone versus the iPhone

Most customers don't renew their smartphone every year. According to a survey from Gallup, only 2% of iPhone users in the U.S. upgrade their devices when a new model is released, while 51% of respondents renew their models as soon as the cell-phone provider allows it, generally every two years. Based on data from this survey, 54% of iPhone customers in the U.S. only upgrade their devices when they stop working or become totally obsolete.

The iPhone 7 is better than previous iPhone models, and it's also superior to most products from the competition. However, the product is no game-changer in comparison with the iPhone 6 or the iPhone 6s. Since many Apple customers already own an iPhone, we could say that the main challenge for the iPhone 7 is persuading customers to get rid of their older phones and change them for the latest iPhone. In a sense, the iPhone is its own biggest competitor, and Apple is a victim of its own success.

The bright side

The fact that previous iPhone models are good enough for many consumers can be a limitation when it comes to introducing new versions. On the other hand, this is a nice problem to have, as its speaks volumes about the quality and resiliency of the business.

The iPhone installed base is gargantuan. Apple announced in July that it has sold over 1 billion smartphones. Once the user becomes entrenched in the Apple ecosystem of software, services, and applications, chances are that such user will continue choosing Apple products when buying a new smartphone, a tablet, a computer, or a smartwatch.

Importantly, a massive installed base of Apple products is a major driver for Apple in the services division. This segment includes revenue from the iTunes Store, the App Store, Apple Pay, Apple Care, and other services. Apple generated nearly $6 billion in sales from this business last quarter, with revenue growing 19% versus the same quarter in the prior year.

The main problem for the iPhone 7 is not necessarily smartphones from the competition, but previous iPhone models that are still good enough for many consumers. This trend can limit growth potential on a short-term basis, but it's also an enormously valuable strategic asset for investors in Apple over the long term.

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Andrs Cardenal owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends T-Mobile US. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.