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Apple in China, Part 1: Apple Takes An Unfair Beating On iPhone
By Paul Midler | February 20, 2008
China Mobile announced last month that it ended talks with Apple on a deal involving the new iPhone, and analysts came out in full force to say it was Apple’s problem. Some went as far as to accuse Steve Jobs of misfeasance and suggested that he brush up on his China deal-making skills. Didn’t he realize the potential of the enormous market?
While everyone was slamming poor old Steve, I wished to congratulate him at least for holding his ground. So many have gone to China and given away the store, and here you had a guy who knew where he stood, someone unfazed by all of the China hype. Bravo!
When he delivered his recent keynote, I caught the updates in real time on TechCrunch.com and noted he has done deals with some of the the largest companies around - Microsoft and Google were two names that came up. If Steve Jobs was willing to shrug off a deal with China, maybe he knew what he was doing.
Despite a no-go with China Mobile, an estimated 400,000 iPhones have made their way into China via backdoor channels. The total number of iPhones sold worldwide outside of formal partnership programs is actually closer to a million – or more than 25% of all handsets sold. Because they got it so wrong before, of course, analysts came out - again - to declare the latest news as further proof that Apple doesn’t know what it’s doing in China. Ha!
When China Mobile broke off talks it was supposed to have been because the company had a problem with giving Apple 20-30% in a revenue-sharing scheme… I guess China Mobile didn’t mind losing the other 70-80%. Seriously, who lost? Who gained?
Consumers who got their hands on one of the new phones didn’t need to go with China Mobile. That was my understanding anyway. At the very least, they were not forced into a premium level phone plan. The phone simply works as any phone does: You put the chip in and go. The value of the iPhone as a status symbol is in the phone itself, not in the service, and consumers are happy to use the phone for its basic functions. For this reason, I suspect that Apple sold more units through the backdoor than they ever would have through a partnership deal.
Apple is earning well on the sale of its phones to China, and don’t believe for a second that the company didn’t anticipate the benefits of a distribution plan that included formal and informal channels running simultaneously. Seriously, did analysts think that a million phones went missing in some kind of accounting error?
What interests me is how this will play over the long term, and I am reminded of something Peter Drucker once said: “The purpose of a business is to create a customer.” Not a product, mind you, but a customer. Isn’t that exactly what Apple is doing in China – and without anyone’s help? The China consumer first falls in love with the iPhone, and the next thing you know they are looking at other products made by the same company. Converting informal customers to formal customers is a business strategy familiar to another technology giant, Microsoft.
In the 1990s, Microsoft allowed its operating system to be pirated, and almost overnight the company achieved near total market share. The press cried back then about “billions in lost revenue”, but consider the end result: The average PC user in China is accustomed to Microsoft’s operating system. The company has only to convert remaining bootleggers into paying customers, and it has virtually no competition in China – at least not yet.
One thing the iPhone will likely do is introduce the Chinese to Apple products, including the competing – and better – Apple OS X operating system. What I like about Steve Jobs is that he doesn’t look at the business on a quarter-by-quarter basis. He’s smarter than that, and I expect Apple will do particularly well in China.
Executives at China Mobile must be feeling pretty lousy at this point. The iPhone is a hit, and they had nothing to do with it. And for a company that is convinced its competitive advantage has something to do with its role as gatekeeper, we now have evidence to suggest that they don’t control anything.
At the very least, it was a missed co-branding opportunity for China Mobile. Steve Jobs himself probably couldn’t care less. He cracked the China phone market - and without any help. It is very likely that China Mobile will go to Apple and try to put the deal back together. My bet is that they are already mobilizing (pardon the pun), and that we can expect a deal to be announced in the near future.
Topics: China |
February 20th, 2008 at 12:46 pm
I’m seeing iphones wherever i go in shanghai. I agree with you that Apple kenw that some of the phones would end up in places like china. And i also agree that it was a mistake for China mobile. Good post.
February 20th, 2008 at 6:16 pm
Sir, China Mobile controls 67.5 percent of the Chinese market. The iPhone and revenue-sharing makes sense if the cellular market is highly fragmented, but basically Apple was asking China Mobile to give away money for nothing. How much of China Unicom’s market share would it capture if it agreed to a revenue-sharing plan? And what about the 400,000 hacked iPhones currently in use?
Further, it’s possible Apple makes no money off the selling of the iPhone devices, instead the money is made off the revenue sharing. For the minimal 1 year contract, Apple receives $1080 from revenue-sharing. That certainly subsidizes selling at a loss.
February 20th, 2008 at 7:02 pm
I agree that Apple is probably happy with the fact that people in China bought 400,000 iPhones, but they’d be a little bit happier if they were getting revenue from the data plans as well. In the long run, I don’t believe Apple will continue to get these cushy revenue -sharing deals, even in the States. I believe the profit margins on wireless Internet connectivity, whether it’s GSM, 3G, WiFi, WiMax, etc, in the future, will shrink in the future thanks to expanding competition, and wireless companies will not be able to afford to make these kinds of deals.
February 20th, 2008 at 9:27 pm
Here’s the pitch Apple might make to China Mobile
http://idannyb.wordpress.com/2008/02/16/400k-unlocked-iphones-heres-the-pitch-apple-might-make-to-china-mobile/
For more details and back story see
China Mobile and Apple: The 2008 iPhone Games
http://idannyb.wordpress.com/2008/01/11/3/
My guess … Circa late Spring 2008 new Euro and Asia / Pacific Rim carrier deals will be announced w locked and unlocked options * (see footnote below). The new model iPhones will be available (my guess) by Summer of 2008 throughout Europe … all current nations + Italy, Spain, Switzerland, Poland, Belgium, etc.
Pacific Rim iPhone launches will cover:
· Singapore Telecom Consortium (Australia, Singapore, Thailand, Philippines, Indonesia, India, Bangladesh).
Separate deals will be announced in …
· Japan
· S. Korea
China deal may come last (late 2008 or early 2009) followed by Taiwan.
* Carriers offering both a locked and unlocked option: Don’t be surprised if we see a two-tiered offering for next-gen iPhones (ala Orange in France where law prohibits handsets from being locked to a network for more than 6 months) - a locked iPhone in each nation and an “official” unlocked iPhone at a modest premium price. If the premium is too high, black-marketers will engage in arbitrage (unauthorized unlocking options at a lower cost). If the premium is modest, or “just right,” buyers will opt for the “official” easily upgradable iPhone that will come with a warranty and w/o the need to hack or jail-break.
February 20th, 2008 at 10:50 pm
Inst -
You raise an important issue that I actually forgot to touch on. The knock-off phones are RETAILING for $125, so you can imagine that they are manufactured for much less. We have some reports out there from reputable journalists that suggest a new product may be marked up as much as 10X. On a phone that sells for $400 in the stores, I would not be surprised if it cost Apple only $50 to make. And I also wouldn’t be surprised if they allowed resellers to make only another $50-100. There is no way that Apple is catching less than $200 per unit on those phones!
If you consider 400,000 phones in China multiplied times $200. Let’s call it a cool $100,000,000. There is no way that China Mobile was going to generate anything like $500,000,000 in fees by Feb 2007. You’re smoking crack…. sir.
February 20th, 2008 at 11:04 pm
AAPL has been taking a severe beating, worse than other big-name tech stocks, such as GOOG, AMZN & RIMM, in the recent downturn, for some very good reasons. On the other hand, NOK is only a bit over 10% from its 52-week high.
Consumers who got their hands on one of the new phones didn’t need to go with China Mobile.
Unless they don’t want to use Internet with their hacked up iPhones. China Mobile is the only game in town if you want a decent EDGE network. They won’t get the visual voicemail but other features will work just fine, all without China Mobile paying Apple a dime. The Chinese mobile ecosystem is different from that of the US. Like many other countries, in China carriers don’t sell subsidized handsets, which is why it’s cheaper to call in China. The pricing structure will be difficult to work out.
Apple’s iPhone sales in Europe have been very disappointing. The coolness factor can easily wear out, if Apple is not careful. Apple needs to pack 3G, GPS, etc. into the iPhone before their greatest advantage, human interface, get caught up by other phone makers.
February 20th, 2008 at 11:40 pm
JXie -
On the stock, there is a lot more going on there than China.
The journalists that wrote about 400,000 handsets in China should have reported on the number who were cruising the Internet. If you know the market, you know that not everyone who owns an Internet capable device actually goes on the Internet. These phones are status symbols more than anything else. The man who buys the iPhone to impress his girlfriend is not going to hear her say, “…but can you go online?”
China Mobile could have created a separate plan that would have increased costs so much that China Mobile would not have lost anything. It would have sealed up the market and retained its position as a “gatekeeper”.
It’s a loss of face for China Mobile. Apple has all of the face - and so do Chinese customers who managed to find an iPhone.
One thing that China Mobile will ask Apple is if it knows how to disable those phones which were purchased outside of any pre-approved plan. Apple is going to say “gee, guys, we really don’t know how to do that”. Brilliant, and well played by Apple.
February 20th, 2008 at 11:50 pm
Alex -
I agree with you that these more expensive “plans” may go away after awhile. But isn’t that the nature of technology businesses? Early adopters willingly pay more when a product first comes out. China Mobile could have capitalized on that and squeezed customers who wanted the phone ahead of everyone else. Instead, they missed the boat. And by the way, it’s not only customers who are willing to pay a premium. Partners also should be willing to pay something extra for the privilege. China Mobile would have benefitted by at least SOMETHING with an iPhone deal, but they were willing to give up NOTHING. This should prove to the markets that China Mobile doesn’t understand the value of technology.
I seriously believe that this worked out better for Apple. If they would have entered into a deal with China Mobile, they would have had 50,000 in sales from CM (low because of high fees) and only 100,000 in sales through backdoor channels (lower because some would put off their purchase decision, others would have felt it wrong, or that China Mobile would come after them). It worked out so much better for Apple in fact, that I wonder if the deal Apple laid out for China Mobile was purposefully meant to be rejected. These 400,000 phones in China look like China Mobile’s fault, after all.
February 21st, 2008 at 12:00 am
No, I’m just addled and probably really bad at math. When it was first reported that Cingular, now ATT, made a deal with Apple, insiders leaked a figure of 18 dollars per month as a revenue share. If the iPhone was bound to a 12-month contract, then Apple would receive $216 per year per user.
Another rumor, take it or leave it, calculated the component cost of the iPhone 4GB model this time last year at 230 dollars a piece. Since the 4GB model has since been discontinued, the cheapest iPhone available is now the 8GB model, selling for 400 dollars off the Apple Store. That’s below 200 dollars profit, and if Cingular would tighten their contract security, Apple could pretty much sell it at 100 dollars per unit and still profit $50 from the revenue sharing, provided all the figures are accurate.
February 21st, 2008 at 12:28 am
Inst -
It would be difficult to come to a conclusion on the business model with numbers that are estimates, and I can only suspect that Apple makes more through its business model, which has some going through an approved distributor while others go off the plan.
It is very hard to calculate how many of the 1,000,000 in “unofficial” sales would have been prevented had there not been an informal channel in place.
Also, why get so hung up on the near-term revenue stream? Look to Peter Drucker. There is value in creating millions of new Apple customers.
What assumptions to you make for a “conversation rate”. Some new iPhone users will become Apple notebook computer users, or they may end up downloading hundreds of dollars worth of iTunes products each year. Also, some of those who have bought a phone through an informal channel can come back to a formal channel later on their own.
What Apple has done with this two-tiered plan is create a means of price discrimination. Those who can afford to go on a real plan can go there, and those who cannot afford it, or who are unsure about making a serious commitment, can go this other route. I doubt that anything has been lost on Apple. And, again, I commend Steve Jobs for not building his business around what he thinks analysts wish to see. Solid company, solid technologies, and proven business savvy.
February 21st, 2008 at 2:03 am
Inst - You seem to know something about numbers. Why not open Excel and plug in some numbers. In each period, place a $200 revenue number to represent a sale made, and then starting in the second period place $20 in revenue for each unit in the marketplace. Run that out and tell me how many periods it takes for revenue from subscriptions to equal total revenue from unit sales. Skip the part the time value of money for the moment, but add in a more critical assumption for increases in demand on that hardware. You will easily find that selling units matters more than collecting subscriber fees.
February 21st, 2008 at 4:57 am
Has anyone thought about the fact that Apple’s own manufacturers might be the ones selling phones into China. Does anyone know how makes the iPhone in China?
February 21st, 2008 at 7:28 am
Paul, Apple’s stock drop has a lot to do with its lackluster sales figures coming out of Europe, and its disappointing channel order. Consumers are fickle. If Apple isn’t careful, iPhone can be the cool phone of last year.
China Mobile has never been a “gatekeeper” — you can get a GSM-capable phone and buy a chip from China Mobile, and you are on. Like I said, it’s a different ecosystem.
February 21st, 2008 at 9:14 am
The China strategy is brilliant. AAPL confirmed in the January CC that iPhone sales would be at least 10mm units for 2008. (We can debate CY vs. FY another time). The current phone will only go so far outside the US without 3G capability. So what to do?
AAPL has tapped into worldwide demand for the iPhone with what will be, in hindsight, an inferior product. Once a 3G phone is available expect to see many more foreign carriers on-board. (Is this the rumored Feb 26 announcement?) Foreign sales will start as soon as the phone is introduced, US sales will be delayed pending FCC certification.
How many users in China, India, Brazil, the EU, etc. will upgrade to a 3G phone when available? How many unlocked phones will be lured into the
“official” mode once compelling software is available following the release of the SDK and iTunes becomes the purchasing conduit?
Perhaps the most compelling point of this article is that AAPL is negotiating in China on its terms, apparently. This may change. But for now, AAPL is working in the long-term interests of its shareholders. As the author stated, “What I like about Steve Jobs is that he doesn’t look at the business on a quarter-by-quarter basis.” I couldn’t agree more.
This is my personal opinion. Please do your own research.
February 21st, 2008 at 9:33 am
Apple gets no benefit - from the stock analysts - from the deferred revenue. Look at the last quarter’s earnings.
Yet Apple gets punished for ‘losing’ deferred revs?
And why don’t the analysts consider how much revenue Apple will garner if they grab a mere 5% of the 375 million China mobile subscribers. That’s 18 million phones. Locked or not, that’s a significant amount of revenue.
February 21st, 2008 at 9:48 am
I have gotten beaten up pretty badly with this recent dip so I’m hanging on till it recovers some of my losses before I dump this stock. Hopefully something nice will come to light between China Mobile and Apple this coming week.
February 22nd, 2008 at 2:29 am
Your analysis is way off regarding China mobile being on the losing end. Apple’s business model has no chance of succeeding in China. Most people in China do not lock themselves into any phone plans and those that can afford the upscale phones change them like underwear. Whatever the latest fad is, they will buy. So… why would China Mobile want to give ANY money to Apple at all? They are not in the business of selling phones or phone plans like the business model for phone companies in the U.S. It doesn’t matter what phone their users use, they still make money… whether it be a 100rmb phone or a 12,000rmb phone, they still use the same phone network. What exactly is Apple offering China Mobile? A phone currently the most wanted but not forever? What are they bringing to the table that will make China Mobile want to pay them (via revenue sharing) for? The answer is nothing. Whether or not there is an official distribution channel in China for Apple doesn’t matter… the phones will still make it into the country and those phones will use the phone networks. Apples gets profit on the phones and China Mobile gets more users. If your argument is that China Mobile would sell more phones then your wrong because that is not their business. Whether it be the iphone or some other brand, the Chinese will still buy a phone and China Mobile will still get their share of customers. The only argument for China Mobile even considering dealing with Apple is to show face… show that they can make deals with a high profile foreign company… that’s about it. They don’t need Apple as much as Apple needs them. Also, Apple doesn’t make much money on the sale of the iPhone… most of the revenue they were banking on are from the revenue sharing. Even assuming your argument that China Mobile would make money off the sale of iPhones in China, the profit would definitely not offset the amount that would be paid out to Apple via a revenue sharing program… they would actually lose. They already have most of the market in China and control most of the infrastructure… why pay some foreign company just so they can sell their phones (which isn’t even their business model)?
February 22nd, 2008 at 3:26 am
Joe,
China Mobile offers phone plans that “capture” customers. I signed a twelve-month contract with them myself once upon a time. It was painful, and they are still sitting a $400 deposit I was required to place (and I had to go through a Chinese citizen since foreigners were required to do so then).
I will agree with you that cell phones can become fadish. This is one reason why iPhone found its way into China despite (or because) of a lack of distribution. If the average hot phone has two years, Apple has that much time to come out with the next new thing.
You are suggesting that as a monopolist, China Mobile doesn’t need to be concerned, but monopolists need love, too! There are ways for a monopoly to maximize their economic take. One way to do this is to get people to use their product more. If the iPhone is such a pleasure to use, then consumers will naturally want to increase the amount of money they spend on related services.
Here is an example of an opportunity that has been lost. Go to the Internet and search [google + iphone + 50x] for articles reporting that iPhone users search the internet fifty times more (!!) than with rival phones. In the end, I guess I give more credit to a fantastic piece of technology than to any monopolistic hold on a marketplace. If monopoly control were all that it took to win the game, China wouldn’t be Communist. Oh, wait a minute.
I apologize for believing in free markets, and in the power of technology…
February 22nd, 2008 at 6:05 am
The Emperor Jobs knows what he is doing. I agree with you that he deserves a little respect for not giving away the farm. What he is doing is negotiating. Sometimes you need to walk away from the table to show your resolve. Jobs will get his deal in China, and hopefully for the benefit of shareholders, on his terms.
February 23rd, 2008 at 5:34 pm
Joe,
You said …
“Apple’s business model has no chance of succeeding in China. Most people in China do not lock themselves into any phone plans and those that can afford the upscale phones change them like underwear. Whatever the latest fad is, they will buy.”
“No chance” Joe? I give Apple at least “a chance.” Here’s why … The rich (China Mobile) want to get richer, and they certainly don’t want to lose ground to competitors.
Soon after the Olympics there will be a series of announcements detailing the restructuring of the China telecom industry (this is happening). One key move will be China Telecom’s acquisition of China Unicom’s wireless GSM division. There will also be an announcement about a newly combined Telecom/Unicom being granted the rights to build out the W-CDMA 3G network. China Mobile will battle for the W-CDMA rights (because they are very anxious about TD-SCDMA), however, the Ministry of Information’s is (if my intel is correct) supporting Telecom’s bid. What does this mean? Real, actual, legitimate, serious competition in wireless! Apple is well aware of these developments and this is why (IMO) there has been no rush to conclude a deal with China Mobile. The game is about to change big time!
Here’s why Apple has “a chance”:
• 287 million of China Mobile’s 356 million subscribers are monthly “pay as you go” vs “on contract with a data-plan.” It should come as no surprise that China Mobile very much wants to grow its “on contract with data-plan” customers … they are far more profitable/important to China Mobile’s future. NOTE: China Mobile has been growing subscribers at a clip of 5 to 8 million per month. While this number is impressive, their revenue per subscriber has actually been dropping.
• The future growth in wireless will come from mobile video and mobile TV (CCTV on your phone). To grab this business, you need a reliable 3G or WiFi (LTE in the future) network, and subscribers who own handsets with excellent audio/visual capability.
• There is no phone that offers audio/visual and boosts data use like the iPhone! Period end of story. Net surfing increases 50 times and overall data-usage doubles or triples!
• A combined Telecom/Unicom w 3G license + W-CMDA with an iPhone exclusive, can steal a large slice of China Mobile’s customers (no jail-breaking or hack necessary).
• The new 3G iPhone will be far more difficult (expensive) to hack.
• To further combat hacking, Apple can work out (with China Telecom/Unicom’s blessing) a two-tier offering … Specifically, a locked iPhone w 2-year contract (and presumably some rev share) and a premium-priced unlocked iPhone in the same market. This would follow the iPhone in France via Orange model (French law prohibits handsets from being locked to a network for more than 6 months). Such a move by Apple would preserve revenue sharing model (albeit slight less rev), as 70 to 80% would go with the locked phone, and at the same time deliver a death-blow to the black-market for hacked and jail-broken iPhones.
• Telecom/Unicom would likely offer an attractive “amnesty plan” for China Mobile’s existing iPhone “pay as you go” owners. They will be enticed to go on contract with Telecom/Unicom with many TBA incentives and knowledge that they can upgrade their iPhones for free … no need to pay a black-market hack-a-phone shop for future Apple or developer upgrades.
• The soon to be unveiled iPhone SDK will come with many cool apps. All Apple and developer community apps will be delivered via iTunes (Apple apps will be free … no cost to iPhone owner, no cost to carrier, no black-market hack necessary).
Again … The rich want to get richer and they (China Mobile) don’t want to lose ground to competitors. Given the dynamics in China’s telecom industry and important growth strategies (mobile video watching, contract data-plan customers) … I give Apple a chance.