Apple China

Apple Inc. (NASDAQ:AAPL) and China; what role does the country play for the tech giant? In mid-2012, Goldman Sachs published an in-depth report on Apple’s iOS platform, in which they attempted to provide a framework for understanding the switching costs and loyalty of iOS users, as well how this can be used to determine the value of Apple’s installed base.

They also investigated the possible bear cases that could still take hold of a successful platform. They concluded that Apple’s business model is far more resilient than a hardware-centric analysis would imply, and that the risks are more than captured in the stock’s valuation. This analysis, however, was based on a survey of US customers, and many investors have asked how Apple’s platform and installed base dynamics may differ in emerging regions, particularly after Apple’s recent share price correction.

In an effort to address these questions, Goldman conducted a follow-up survey towards the end of 2012, this time in China. They believe investors will be surprised to see how much stickiness Apple’s platform appears to have in this market, in contrast to the widely held perception.

China is becoming Apple’s most important end market

Apple generated $23.8 billion of revenues in China during FY2012, amounting to 15% of overall revenues. Sales into the country have growth dramatically since FY2009, when they were under $1.0 billion for the year. Apple has said that its rapid growth in China is the result of years of planning and the “enormous energy” put into it. To grow sales in China, Apple overcame legal and regulatory hurdles, added numerous points of distribution including several of its own retail stores, and adapted its software and user interface to the usage patterns of the local customer base.

Even with Apple’s enormous success so far in China, its penetration rate there is still low compared to developed regions, and they see much remaining headroom for further expansion. Moreover, Apple’s basic game plan for growth in China is applicable across other emerging regions, and as the company hits its stride in China, Apple should be able to direct more efforts toward other promising, under penetrated regions.

Key findings of the survey

Goldman surveyed 801 consumers who own an iPhone, an iPad or both. Using an online questionnaire in Mandarin, the survey targeted respondents in multiple regions throughout China, asking questions on topics such as purchasing intentions and device usage. This survey  was completed before the iPhone 5 was launched in the region, but the analysts believe that it provides a solid baseline for the characteristics of Apple’s existing user base.

The key findings of survey were as follows:

China iOS user base more loyal than meets the eye.

The survey of iPhone and iPad users shows that 62% are “highly likely” to choose an Apple device for their next tablet or smartphone purchase, while 28% are ”likely” to stick with the platform. While the US base is admittedly even more committed (according to the prior survey),  these results appear to indicate that Apple Inc. (NASDAQ:AAPL) still appears to have an enviable level of customer loyalty in China.

More price sensitivity, but still requiring significant discounts in order to switch to a competitor’s platform.

Five percent of respondents said “there wasn’t a discount that would make it worthwhile” to leave the Apple Inc. (NASDAQ:AAPL) platform, less than the surprising 21% who chose that answer in the earlier US-focused survey. The Chinese consumers who would consider switching, however, cited an average required discount of 27%, which isn’t far from the average discount required by US customers that would consider a lower-priced alternative, which was 33%.

Switching costs increase when the user owns both an iPhone and an iPad.

The survey found that 72% respondents who own both an iPhone and an iPad said that it was “highly likely” that their next smartphone or tablet would also be an Apple product, as compared to just 47% among those who owned just one or the other. In this respect, the results in the China survey began to approach those of the US survey, where 75% of respondents who owned more than one device reported that they were “highly likely” to have another repeat purchase.

Uptake of apps and iCloud is encouraging. Fifty nine percent of respondents said they download from the Apple App Store “frequently”, and another 33% said they do so “sometimes”. The vast majority of respondents also use iCloud, or plan to in the next 12 months. These usage trends are important to monitor as the lack of an officially supported iTunes Store shifts the responsibility for switching costs to the App Store and iCloud.

Strategic implications

The unexpected level of loyalty of the Chinese customer base is encouraging and provides confidence that the platform can be leveraged into emerging regions. Nevertheless, limited penetration relative to developed regions suggests the key will still
be new user growth. This, coupled with aggressive competition (particularly from Samsung) and the higher price sensitivity of the customer base, suggests price points may need to be more attractive. There are several ways Apple could go about this, such as discounting prior generation devices and pulling for richer carrier subsidies. The company has employed both methods to great success.

Much like the balance between the iPad and the iPad mini, the lower-cost iPhone would need to be compelling despite the lower price point, while still leaving a noticeable value gap between itself and the original. If Apple were to pursue a lower-cost iPhone, they expect that this would initially reignite investor concerns about market demand, iPhone cannibalization, and gross margin dilution.