Chinas More Important to Apple Inc. Than You Might Think

Apple's iPhone 6 (left) and iPhone 6 Plus (right) have proven to be a hit in China.Image source: Flickr userKarlis Dambrans.

For Apple's recently reported second-quarter, China was the big story. And for good reason, Apple grew revenue in China 71% year over year while the company's overall revenue grew 27%. Matter of fact, nearly 57% of Apple's year-over-year revenue growth can be attributed to its Middle Kingdom operations. In the process, China surpassed Europe as Apple's second-largest geographical market this quarter as the company benefited from Chinese New Year and continued demand from the iPhone 6 and iPhone 6 Plus.

Mostly forgotten in the headlines were Apple's performance in the Americas. Although Apple's home market was still its largest this quarter -- producing $21.3 billion in revenue versus $16.8 billion for Greater China -- and still registered strong 19% year over year growth, very little ink was spilled on Apple's operations there. Oddly enough, the Americas are quickly becoming Apple's Jan Brady market as the attention focuses on "China, China, China."

Unfortunately for Apple fans in the Americas, it appears that China is not only more important for Apple's growth story it also appears China is more important to Apple's net income too. For Apple investors, China's revenue appears to be higher-margin, all other factors equal.

Operating margin is the largest in ChinaA brief look into Apple's recently filed quarterly report outlines the differences between Apple's operating income by market. Although this is different from Apple's highly watched gross margin percentage -- and isn't the same as a consolidated operating income figure because Apple's deducts research and development and other corporate expenses over the total segment income instead of by geography -- the figure is still an important proxy to gauge profit by geography. Here's a breakdown by geographical segment for Apple's second fiscal quarter:

Source: Apple's 10Q. Revenue figures in millions.

As you can see, of the largest markets China is substantially higher margin than Apple's operations in the Americas and Europe. The company boasts an operating-income margin 6.2 percentage points higher than the other two major geographies. Japan stands as the highest-margin performer but from an overall revenue growth and total operating income standpoint, China appears to be more important going forward.

A simple, but reductive, argumentApple's higher-margin China operations are easy to understand, but worrying if these margins drop may not be wise. The differences between the two geographies' operating income are most likely due to product mix -- in China, a larger portion of its revenue mix is higher-margin iPhones whereas in America Apple sells a more diverse, lower-margin product mix (iPods, Macs, and iPads). And while Apple is happy with China's voracious appetite for the iPhone, CEO Tim Cook would love to expand sales of all products there. Eventually, those higher margins should fall in-line with the Americas and Europe as other products find eager Chinese shoppers.

However, thinking that China's margins falling in line with those from the Americas is a bad thing is a reductive argument. Earlier in his career, CEO Tim Cook once referred to the iPhone as a "gateway product" in terms of its effect with new customers. Once Apple is able to lock users into its sticky ecosystem with its signature product, it can then work on selling its host of iDevices.

In the end, increased demand from China's growing middle class should allow Apple to maintain pricing power and allow Apple to work with suppliers to lower production costs per unit by buying in bulk. If Apple is to become as popular in China as it is in the Americas, those two margins will probably converge as well.

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Jamal Carnette owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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.

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