Apple Inc. Has Another China Problem

The Greater China region was once widely viewed as one of the largest growth opportunities for Apple (NASDAQ: AAPL). After all, for a time, the smartphone market in China was booming, and Apple was widely viewed as an aspirational brand in the region.

However, as smartphone growth in China cooled off, and as local Chinese brands like Xiaomi, Oppo, Vivo, and Huawei began bringing flagship features and design elements to lower-cost products, Apple began to see its sales in the region drop. Apple reported a 17% drop in revenue in the region during fiscal year 2016 (iPhone 6s cycle) and another 8% drop there in fiscal year 2017 (iPhone 7 cycle).

Apple got off to a strong start there in the first quarter of fiscal year 2018, with revenue growing 11% year over year there. However, according to research from analyst Katy Huberty (via Barron's), Apple's iPhone business faces yet another significant problem in the region.

Older iPhone models aren't holding up

According to Huberty, demand for Apple's older-generation iPhone models (iPhone 6, iPhone 6s, and iPhone 7) is "fading as Chinese brands respond to significant loss in the mid-market during 4Q17."

Indeed, Huberty claims that the Chinese smartphone makers are cutting prices to blow out inventory, and that such price cuts are set to "intensify" in service to those efforts.

On Apple's online store in China, a 32GB iPhone 6s -- that's an iPhone that launched in Sept. 2015 and is far from cutting edge -- sells for 3,788 RMB, which converts to roughly $596. An entry level iPhone 7, a device that's a year newer, sells for 4,588 RMB, which translates into about $723.

Considering the steep prices for these devices in China, and considering the availability of smartphones from local Chinese manufacturers with better hardware specifications than Apple's lower-end devices at lower prices, it's not hard to see why the older iPhone models are failing to hold up in the region.

For some context, one report claims that the best-selling smartphone in China during 2017 was the Oppo R9s.

The phone looks very similar to an iPhone 6s Plus and sports a display with a similar size to the one on the iPhone 6s Plus. It doesn't run iOS, and the internals are inferior (though it does have more RAM and twice the storage of the entry-level iPhone 6s), but it's a "good enough" emulation of the iPhone 6s Plus that launched at just 2,799 RMB (roughly $440).

Considering that the Chinese smartphone market is replete with devices that look similar to Apple's older iPhone models but sell for substantially less, is it any wonder that Apple is having a hard time selling anything but its halo models in the region?

What can Apple do about it?

At this point, it's hard to see what Apple can do about this problem over the long term. Apple's best bet is to try to fortify its position in the premium portion of the China smartphone market with innovative products at higher price points.

Apple seems to be doing just that with this year's rumored lineup -- it's reportedly planning to launch a successor to the current iPhone X, a larger version of that successor to the iPhone X (in China, larger-screen phones are quite popular), as well as a lower-cost device that incorporates most of the goodness of the new iPhone X, but with some cost optimizations (e.g., lower-cost display technology, use of an aluminum frame instead of a stainless steel one).

I don't see a way for Apple to win in China at lower price points, so it will have to simply do its best to win the hard-earned cash of China's most affluent smartphone users.

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Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.