Apple bets big on China

Apple fans were on the edge of their seats at a March press event, waiting for details on the company’s first wearable, the Apple Watch. But their enthusiasm had to wait, because CEO Tim Cook wanted to talk about China.

People attending the San Francisco unveiling saw a short video of excited Chinese shoppers crowding into a new Apple Store in Hangzhou, a glimpse of what future stores would look like. Close-up shots showed a customer drawing Chinese characters on an iPhone 6.

“It is an incredible place, and it’s a gorgeous new design,” Cook said of the store.

China has become a key market for Apple, representing one-third of the company’s sales in its last fiscal quarter. Sales in the region, which includes Taiwan, grew 71 percent to $16.8 billion, compared with a year ago. Apple has been bullish in the region, with 22 stores and plans to roughly double that amount by the middle of next year. The iPhone 6 and 6 Plus have been big sellers, as more Chinese shoppers are purchasing the larger screen phones as a status symbol, analysts said.

“I’ve never seen as many people coming into the middle class as they are in China,” Cook said in a call in April with investors. “That’s where the bulk of our sales are going. We’re really proud of the results there and continue to invest in the country.”

Analysts expect that Chinese enthusiasm for iPhones will segue into Apple Watch sales.

“The next step is about wearables,” said Daniel Ives, a managing director at FBR Capital Markets. “When you think about the Apple Watch, one of the biggest opportunities is in China.”

Cook’s travels

Cook opened an account this month on Chinese microblogging site Weibo, similar to Twitter, posting about his China travels in English and simplified Chinese characters on his iPhone 6. “Thanks to all our customers and staff for a great week in China. Zaijian!” Cook wrote on May 14, signing off with “goodbye” in Mandarin.

At the Apple Watch presentation in April, Kevin Lynch, Apple vice president of technology, showcased Watch apps, including WeChat, which is popular in China. He said his “friend from China” had messaged him on WeChat about where they would go for dinner.

China is seen as a key market for technology companies because of its mobile-first culture and a growing middle class primed for smartphones. China’s Ministry of Industry and Information Technology said 1.3 billion people in China use cell phones (its population is 1.4 billion), with roughly half on 3G or 4G networks, according to Xinhua, China’s government news agency. There’s opportunity for Apple to persuade those mobile users to switch to iPhones.

“China at this point is the fuel in the growth engine for Apple,” said Ives. “When we think about iPhone growth and the iPhone 6 product cycle, it’s really all about China at this point.”

Apple held the largest share of China’s smartphone market at 15 percent in the first quarter, according to research firm IDC. Close behind is Chinese manufacturer Xiaomi at 14 percent, followed by Huawei (11 percent) and Samsung (about 10 percent), IDC said. Unlike in the U.S., China’s smartphone market is fragmented, with many more manufacturers in the running, compared with the U.S. market that is dominated by two, Apple and Samsung.

“The competition is pretty much a land grab opportunity at this point,” Ives said. “It’s about converting the Chinese consumers” into Apple users.

High-end purchase

But stretching a month’s salary to include an iPhone purchase may be tough for some workers. Analysts place the cost of an Apple iPhone in China at around $700. The average monthly salary in Shanghai is about $1,163, according to a 2014 article in China Daily.

One advantage that Apple’s competitors have is they also offer lower-priced phones. While an iPhone may cost $700, a Xiaomi phone could cost half that, said David Sullivan, managing director of Alliance Development Group, which helps tech companies expand in China.

As Chinese competitors “sell more globally, they are getting stronger,” Sullivan said. “They are competing around the world. Their products are getting better. Apple’s challenge is to stay up there. In some way, they (may) feel like they are getting boxed into the high-end” market.

Apple released the iPhone 5C in countries including China in September 2013, but it didn’t attract many buyers, analysts said. Part of the problem was that the phone was marketed as inexpensive, but it wasn’t substantially cheaper than the iPhone 5S, the newest version of the phone at that time, they said. Apple did not respond to questions about plans to market a lower-priced version of the iPhone 6 in China.

But some reports suggest that China’s smartphone market is slowing down. Sales of smartphones in China fell 4 percent in the first quarter compared with a year ago, according to IDC. That was the first annual decline in six years, indicating that it may be a mature market like the U.S. or United Kingdom, the research firm said.

“Just like these markets, convincing existing users as well as feature phone users to upgrade to new smartphones will now be key to further growth in the China market,” said Kitty Fok, managing director at IDC China.

Regulatory issues

Analysts also warned that down the line, Apple could face regulatory issues in China, where the government has made it more difficult for Silicon Valley tech firms like Facebook to operate. Those challenges could come when the company starts offering Apple Pay in China.

Besides opening new stores, Apple has been investing in the region. It said developers in China have earned through Apple app sales more than $3.4 billion, with more than half paid in the last 12 months. Apple says it employs 8,000 people in China and Hong Kong, and says it has helped create at least 1.5 million developer jobs or work related to its software. The company also has undertaken major environmental initiatives to protect as much as 1 million acres of forest and build two 20-megawatt solar farms in China.

For now, the iPhone 6 remains a hot item for Chinese shoppers.

“It’s a status symbol,” Sullivan said. “People want the best.”

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