If you want to win customers, you must have a strategy. There are two kinds: low-cost producer, meaning you charge the lowest price for a good product, and differentiation, in which you charge a price premium for a world-beating product.

What do you think Apple's strategy was? If you guessed differentiation, you would be partially right. In 2012, I found that the iPhone was priced 44 percent higher than the Nokia Lumia.

But there was an interesting twist to Apple's strategy -- it was also able to make the iPhone for a very low cost. The difference between Apple's high price and its low cost was gigantic. In fact, Apple's gross margin was 71 percent -- much bigger than the 54 percent gross margin that Nokia made on its Lumia.

Apple's ability to charge such a huge premium over the competition came from its business strengths, what I call capabilities. These included:

  • Product development -- its beautifully designed and manufactured hardware targeted at large existing markets, such as the iPod for the MP3 player market, the iPhone for the cell-phone market, and the iPad for the tablet market
  • Marketing and customer service -- its ability to market that hardware in a way that made Apple customers feel like they were part of an elite club
  • Partnering for killer apps -- Apple's skill at working with third parties to create killer apps, like iTunes and the App Store
  • Efficient supply chain -- Apple outsources manufacturing to Foxconn, which makes products at a low cost

Apple's high price-low cost strategy works as long as Apple can come up with a new product that gains share in a different market. While Apple has introduced a watch since Tim Cook became CEO, its revenue is not significant to Apple's top line.

That leaves Apple dependent on the 11-year-old iPhone for the bulk of its profits. And the smartphone industry has powerful competitors and is maturing.

Apple has been producing new iPhone versions and raising its prices on them. But its high price is not holding for the latest version, the iPhone X, so, as Bloomberg reported, Apple is offering customers a 40 percent discount.

How so? On December 2, Apple added a new banner to the top of its website advertising the iPhone XR for $449, $300 less than its official sticker price. The deal, noted with an asterisk and described at the bottom of the page, requires customers to trade in an iPhone 7 Plus, a high-end handset from two years ago.

O, how mighty Apple has fallen! 

To put it in perspective, the plunge in the iPhone gross margin has been precipitous. As I mentioned, in 2012, the iPhone had a 71 percent gross margin. Before the 40 percent discount, the iPhone X had a much lower gross margin of 48 percent -- its price was $749 and the cost of the parts was $390, according to IHS Markit.

By discounting the price to $449, the iPhone gross margin drops to 13 percent.

In January 2016, Apple's chief financial officer, Luca Maestri, argued that Apple would make up for the declining iPhone revenue with services revenue.

But that is sure to reduce Apple's margins even more. How so? According to Bloomberg, Maestri said that investors don't appreciate that Apple's "services business -- which includes music streaming, the App Store, and Apple Pay -- is growing rapidly and will help make up for slowdowns in other areas."

Maestri boasted that Apple generated "$31 billion in services revenue in fiscal 2015, and in the past 90 days about one billion Apple devices connected to them."

But services don't generate the kind of profit that hardware used to generate for Apple. As Abhey Lamba, an analyst at Mizuho Securities USA, told Bloomberg, "while Apple makes about $300 for each iPhone sold, it takes about 60,000 transactions via Apple Pay to make $100." 

If Steve Jobs could see Apple now, I think he would be sorely disappointed that it has been unable to come up with a new groundbreaking hardware device that would create a large, new profit stream.

Absent that, Apple's high price-low cost strategy is broken.

Published on: Dec 7, 2018