As the high-end smartphone market matures, Apple Inc. (NASDAQ:AAPL) investors have been considering exactly what that means for a company which only addresses the high end of the market. Chief Executive Officer Tim Cook says he doesn’t believe the high end of the smartphone market is saturated, and it sounds like he’s the only one.
However, it’s now beginning to appear that saturation is less of a problem than the simple fact that over time, the average selling price of any product category—and the margins that go along with it—will fall. Apple Inc. (NASDAQ:AAPL) now has a big choice to make. Sacrifice the high-growth capabilities of its stock and focus on products that will keep it in business, or take “the one less traveled by,” to quote Robert Frost’s iconic poem “The Road Not Taken.”
Apple focuses on giving people what they want
A few of the comments made by Cook during Apple Inc. (NASDAQ:AAPL)’s investor call earlier this week were especially interesting. “We start a product because we believe that the most important thing is that our customers love the products and want them. If you don’t start at that level you can wind up creating things that people don’t want.”
So the real question for Apple Inc. (NASDAQ:AAPL) right now is, “What do people want?” The obvious answer would be a smartphone that costs less and brings a lower premium than what Apple Inc. (NASDAQ:AAPL) wants. As such, the company has to find a way to make its wants and needs line up with those of its customers. Or it could take a gamble and speculate about what customers want, as the Steve Jobs-era Apple Inc. (NASDAQ:AAPL) did.
High-end smartphone market maturation? Not so much
As noted by numerous analysts, the average selling price of the iPhone dropped below $600 for the first time. Of course it’s assumed that this is because the mix of older models was greater than the newer iPhone 5, although Apple Inc. (NASDAQ:AAPL) said in its investor call that the iPhone 5 is the best-selling of all the models. CEO Tim Cook also said that he doesn’t buy the widely held view that the high-end market is too saturated.
Gartner provided some data only to The Guardian, which shows that Apple Inc. (NASDAQ:AAPL) isn’t the only one suffering falling average selling prices for its high-end handsets. Charles Arthur reports that saturation of the high-end market is actually less of a problem than analysts realize. In fact, Gartner claims that the premium segment is growing and will go from about 539 million phones this year to 876 million phones in 2017.
Falling average selling prices
The firm suggests that the real problem is that the average selling price of premium handsets is dropping. It’s expected to fall from $433.50 this year to $383.80 in 2017, but those numbers are still much smaller than the prices Apple Inc. (NASDAQ:AAPL) sells its iPhones for. As such, if Apple Inc. (NASDAQ:AAPL) doesn’t find a way to bring its own products in line with what customers want, it could find its market share shrinking.
Analysts at Citi picked up on a similar theme in their report entitled “Device Exhaustion.” Glen Yeung and a full team of analysts point to historical precedent and lifecycle theory which both indicate that average selling prices of any product must fall over time. Of course this begs the question of what constitutes a so-called “high-end” or “premium” handset. Is it purely the price? And if so, when does the average price of these handsets fall?
Apple’s falling margins and declining innovation
Investors have also been concerned about falling margins at Apple Inc. (NASDAQ:AAPL), and Citi analysts pick up on this concern as a broader issue within the technology market. They note that this is entirely normal, but it does mean bad news for Apple Inc. (NASDAQ:AAPL) investors because as margins fall, so do share prices.
Innovation has been the go-to method for tech companies to spur demand for their products, but in the handset market, this is becoming increasingly difficult to do. Users first slowed their replacements of desktop PCs when the market got to a point where there wasn’t much difference from one year to the next. Over time, PCs began to be replaced by smaller, more nimble mobile devices.
At this point, we’re beginning to reach the point where there just isn’t enough to differentiate earlier model smartphones from newer ones. Underwhelming sales of Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930)’s Galaxy S4 handset in the wake of disappointment about the lack of major spec upgrades have shown us that.
Apple’s two paths
So Apple Inc. (NASDAQ:AAPL)’s only hope to remain in the game lies in one of two areas. Either it can give consumers what it’s obvious they want—a great smartphone that costs less—or it can innovate again and create something completely new. One path leads to a more predictable sense of continued profitability, even if it isn’t to the level investors have come to expect. The result is that the stock transforms from being a high-growth stock to being one that trades sideways.
The other path is far more unpredictable, but it brings the potential of greater rewards along with the potential of great failures. We already know which path Steve Jobs took when he transformed Apple Inc. (NASDAQ:AAPL) with the introduction of the iPhone in 2007. So the question we have to ask is this. Which path will Tim Cook choose?