Technology: Choice of Margins vs. Market Penetration for Apple

The conventional wisdom regarding Apple is that it has lost its way and these complaints have only grown louder following the release of the company’s two new iPhones, the 5S and the 5C. This cynicism is reflected in Apple’s stock price, which, while relatively healthy at $472.69, is over $200 lower than at the same time last year.

The focus of today’s post is to discuss the direction of the Cupertino-based company and what is more beneficial: new market penetration or protection of high margins?

The one thing that I am not considering for the purposes of today’s post is the release of a new market-changing product since that is unforeseeable for someone with no access to the company’s development line.

This past week, following its annual tradition, the Cupertino-based company unveiled two versions of its flagship iPhones, 5S and 5C.

The mid-cycle iPhone 5S is aimed at the traditional iPhone market in that its price point matches the iPhone 5. It’s new advances include a more powerful processor, an upgraded camera and a fingerprint scanner and, while these are all positive advancements, they aren’t anything out of the ordinary and not enough to generate real excitement from consumers.

The big cultural shift is the range of colors. The traditional black and white phones have now been joined by five new colors and this change is clearly designed to attract new customers in the west and, more importantly in the developing markets of China and India.

Speaking of developing markets, the second version of the iPhone, the 5C, is squarely aimed at consumers in these markets. Priced lower than the 5S, its designed to allow Apple to grow its presence where penetration remains weak, competition remains high and future uncertain.

Will the 5C help the company achieve this goal? The signs don’t seem very positive. Firstly, the 5C, while cheaper than the other products in the company’s portfolio, is much more expensive than its competitors in those markets.

Clearly, Apple’s expectation is that consumers will pay a premium for an Apple product versus that of an Asia-based global competitor or local company. Unfortunately, that may be true only for a sliver of the entire market and may not help the company achieve the level of penetration that it wants or needs.

Secondly, is the lack of agreements with major carriers. If Apple wants consumers to buy its higher-priced products then it will have to provide them through the biggest carriers and China Mobile, with its 700 million customers, holds the key to that castle. (Apple has been granted a license for the mobile network but there is signed deal between the two companies as of today.)

Regardless of if/when any agreement is signed, the 5C price shows Apple’s commitment to healthy margins. This is great news for existing shareholders since they can expect strong profits in the short to mid-term. The question, though, is if the company is sacrificing long-term growth at the altar of these margins.

In addition, even if the company signs agreements with new service providers, the high prices of its products means it will face very strong competition from companies whose products are priced lower but provide relatively the same level of service to a mass market of price conscious consumers.

The second question is whether Apple has accepted its position as a very profitable but niche player in the technology industry. That wouldn’t be a surprise given its history in the personal computer market but a disappointment following the progress it had made with its mobile products.

The third question is if the company is comfortable sacrificing future consumers who may enter the Android ecosystem through a cheaper phone and then transition to a wider ranger of more expensive products instead of transitioning to the iOS world. That will make it exponentially more difficult for Apple to attract these consumers to its future products, especially given the very short exclusive life periods of new market-changing products.

The bottom line is that Apple’s newest releases show that unless it unveils a new product for a hitherto untapped market in the next 12 months, the company has accepted its position as a very profitable niche company which means the current shareholders should count their blessings but new investors should look elsewhere.