Apple and China: A Love Story, With Risk

As iPad and iPhone sales soar, the Cupertino colossus scores record Q2 profits, with 20% coming from China. But doing business in China always come...
David RosenbaumApril 25, 2012

Apple CFO Peter Oppenheimer basked yesterday in the glow of a record quarter that saw his company nearly double its net income over the past year, while its second-quarter revenue rose to a little more than $39 billion, up from $24.7 billion a year ago.

With quarterly profits driven by sales of iPhones (35.1 million in the quarter, an 88% year-over-year increase) and iPads (11.8 million, more than double the volume sold in Q2 2011), Oppenheimer cast the iPad specifically as a wedge Apple is using to pry open the enterprise. In that market, the company’s Mac product line and operating system have historically played a distant second fiddle to Microsoft and Windows. The iPad “opens doors to new customers that Apple previously had no connection with,” said Oppenheimer, citing the U.S. Air Force using iPads for flight crews and trainers, Bechtel using them in the field to display construction blueprints, and school systems buying them in bulk.

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Apple’s increasing enterprise presence is driven by the Bring-Your-Own-Device trend, as business leaders and their employees demand to use their own hardware to do their jobs. (A recent Harris Interactive poll found that 80% of employed adults use their own devices for work.) And, these days, it seems everyone loves Apple products, especially in China.

The company’s quarterly revenue in China was $7.9 billion, or almost 20% of its total. Oppenheimer referred to Apple’s “tremendous momentum” in China, and cited its February agreement with China Telecom to support the iPhone. Along with the company’s previous deal with China Unicom, it means two of the three largest Chinese carriers now sell iPhones.

Apple is currently in negotiations with China’s largest carrier, China Mobile. Analysts expect the two companies to conclude a deal late this year or in early 2013, and that could take the number of units sold in China to more than 1 million a month. However, the deal with China Mobile is uncertain, as are many things in China.

A Black Box
“Remember that China Telecom, China Unicom, and China Mobile are all state-owned,” says Junheng Li, founder and senior equity analyst at JL Warren Capital and a Shanghai native. “There are rumors of an internal leadership struggle within China Mobile that could delay the deal.

“This is a problem for all multinationals doing business in China,” continues Li. “There’s always political risk. China has state capitalism, with the emphasis on ‘state.’ The state will always favor the state.” Also, says Li, the lack of a clear legal framework for doing business in China “will always be a problem.”

Right now, says Li, “Chinese people buy Apple to buy America. It’s a symbol; it’s status for them.” But Apple products are also expensive. They are heavily subsidized by China Telecom and China Unicom. The carriers basically give away the phones in return for locking the customer into two-year data contracts. But, as Li points out, that comes at the cost of the carrier’s profitability. “If the margins get too low,” says Li, “the state may end the subsidies.” While Li doesn’t believe that will happen as long as demand is high, recent dips in China’s (and other emerging markets’) GDP may indicate a general slowdown in growth that could dampen demand.

When (or if) that happens, Li suggests, China’s vast pool of engineering resources may kick into gear to produce an Apple-like product at a much lower price point.  “People are saying that no one can make a premium product like Apple but, really, the value is in the touch screen, and China will figure it out and make a product at one-tenth the price. That’s a real risk for Apple.”

Apple CEO Tim Cook said yesterday that the company was selling iPhones and iPads in China “as fast as we can make them.” On a macroeconomic basis, Cook said he saw an enormous number of people in China “moving into higher income groups, creating demand for goods.” It is, said Cook, “a tremendous opportunity for companies that understand China, and we’re doing everything we can to understand it.”

But despite Apple’s extraordinary success to date, understanding China is not something that comes easily.  “The whole country,” says Li, “is a black box; it’s very opaque. No one has any real visibility for either the short or long term.”

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