Apple and Samsung both issue profit warnings, but get close on TV

The two biggest announcements concerning Apple, around the turn of the year, were a shock profits warning, and a TV alliance with Samsung. The two are not unrelated. As Apple comes under pressure because of trade wars with China, market slowdown and over-reliance on one product, so it will have to become less rigid about keeping its walled garden intact. Hence at least a glimpse of a more open Apple ecosystem, as provided by the Samsung announcement at this week’s Consumer Electronics Show (CES) in Las Vegas.

Samsung may operate in more open ecosystems than Apple, but it has its own challenges – defending its leadership of the smartphone market, especially against Huawei, and now weakness in some of the core semiconductor segments which have rescued its profits in recent quarters. Earlier this week, the Korean vendor followed its smartphone rival in issuing a profit warning.

The two companies have always had a love-hate relationship. Apple has tried but failed, so far, to cut the ties with Samsung in terms of buying displays, memory and foundry services. But it also fights the Korean firm tooth and nail in the smartphone market and sometimes the law courts.

But at CES, it was announced that, from this spring, users will be able to watch movies and TV shows from Apple iTunes on Samsung TVs, not just on Apple devices and PCs. Apple will gain an important new channel for iTunes, which will be supported by default in new Samsung TVs, while 2018 models will be able to add this support via a firmware update. As long as the deal remains exclusive, it will give Samsung a point of differentiation from competitors like Sony and LG in the Internet-connected TV space.

For Apple, making it easier to consume its content and services on non-Apple devices may go against its whole philosophy of controlling the user experience within a walled garden, and thus forcing users who love that experience to remain locked into Apple hardware. But it is also a logical way to boost its services business among those who are not in love with the Apple experience, but are attracted by its content (Amazon learned the same hard lesson when it tried to emulate the integrated device/services approach with its ill-fated Fire Phone).

To date, with the iPhone accounting for over 60% of revenue, the first priority has been to protect the hardware lock-in. But in light of the recent profit warning, which relates mainly to slowdown in the smartphone business, Apple now needs to boost its services side – only 13% of total revenues, but growing rapidly (services revenues were up 27% year-on-year in Apple’s most recent quarter, to $10.8bn).

Apple said it was expecting revenues of $84bn for the quarter that ended in December, down sharply from previous expectations of $89bn to $93bn. This is particularly serious, given that the holiday quarter is the strongest for iPhones, although Apple was mainly blaming slowdown in China, whose new year holiday (and associated buying spree) falls in the current quarter. Citi Research slashed its estimate for iPhone production in the first calendar quarter by 5m units, to 45m; and nearly halved forecasts for the most expensive iPhone, the XS Max.

In a letter to shareholder’s, Apple CEO Tim Cook, said that China was by far the biggest factor in the downgrade. “Most of our revenue shortfall to our guidance, and over 100% of our year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac and iPad,” he wrote. He said the poor performance was a natural result of the country’s slowing economic growth, and a failure to “foresee the magnitude of the economic deceleration… in Greater China”, exacerbated by “rising trade tensions with the US”.

Many Wall Street analysts were critical, saying Apple had failed to communicate its issues quickly enough to shareholders (a common criticism of this secretive firm), and that it should have paid more attention to the situation in China – both the slowing growth in consumer spending and smartphone growth; and the impact of new US tariffs on good made in China, as well as broader trade wars between the two countries.

In a commentary by Shira Ovide of Bloomberg, the reporter wrote: “Apple failed in the number one mission of being a public company: being honest with investors about its business. The company simply denied the reality that was staring it in the face, until denial was no longer an option.”

The problems in China are coinciding with a more global slowing of growth in smartphones, and an 18-month period of flat iPhone sales. Apple has mitigated that with higher average sales prices, but clearly that tactic will run its course, especially when the biggest market for the products, China, is experiencing consumer spending reductions.

Mike Feibus, principal analyst with FeibusTech, commented that Apple has been “particularly unsuccessful in China, where domestic suppliers are producing such high quality products at such compelling prices” – even though China accounts for a hefty slice of iPhone sales, and CEO Cook said last fall that the Chinese business was “very strong”.

Meanwhile, Apple has failed to take a new category – with higher growth potential – by storm in the way it did in music players and then smartphones. It has launched the TV, the watch, the iPad and other gadgets but its growth has been in services and content – and those depend, for maximum growth, on being accessible from all devices, as noted above. Competing with Netflix and Amazon Prime will be very different from competing with Samsung in a smartphone market whose rules Apple made itself.

Assuming Apple does not wave its magic wand and create a new industry again – and that its efforts in virtual reality, AI-driven experiences and so on are incremental rather than transformative – it will need to adopt a variety of approaches in parallel to weather the storm. It will need to communicate better and so reset investor expectations as its core market matures; it will need to learn how to compete in a cloud content world where its garden walls cannot stay in place, but where its brand will still count for much; it will need to tap into iPhone markets where there is still growth available.

India is in its sights in terms of the last of these strategies. This has been a difficult market for Apple because of the expectation of low prices, even among relatively affluent consumers. It has launched somewhat cheaper models, as well as financing schemes, to make the iPhone more accessible to buyers, and there is a considerable second-hand trade. But many Indian buyers have preferred a low cost smartphone from a local or Chinese vendor – packed with features and only lacking the Apple brand – to an older generation iPhone. Apple plans to start assembling high end handsets, including the iPhone X, at a Foxconn plant in Tamil Nadu in southern India, to help lower its costs. Foxconn will add a $356m iPhone production line to a factory in which it currently assembles handsets for Xiaomi of China, among others.

Apple’s plans to manufacture in India were rejected by the Indian government in 2017, because the US firm demanded special treatment – duty exemption and a relaxation of the country’s requirement that 30% of components must be locally sourced. However, it is believed that ministers requested new proposals and are close to a compromise solution, which may be announced at the Davos economic summit later this month.

Apple already sells the iPhone 6S and 6E in India, made by Taiwanese manufacturer Wistron in Bengaluru, but its higher end models are imported, which adds to logistics costs and duties.

Samsung’s profit warning said that fourth quarter sales are expected to be about KRW59 trillion ($52.4bn), which would be an 11% year-on-year drop, while operating profit is set to fall by 29% to KRW 10.8 trillion Korean won ($9.6bn). Analysts had been expecting revenues of KRW63.5 trillion ($6.4bn) and operating profits of  KRW13.8 trillion ($12.2bn).

The company blamed “mounting macro uncertainties” and, especially “intensifying competition” in the smartphone market. Even more worrying for the markets was the mention of “lackluster demand” for its memory chips, since these have been the main way that Samsung has buoyed up revenue and profit, amid smartphone challenges, in the past year or more.

Samsung used CES to show off other products which it hopes will offset its troubles in handsets and chips. These include new TV sets, including 8K models, and a connected living platform based on 5G, IoT and artificial intelligence technologies. It also showed off a new user interface for its smartphones called One UI, with 5G models due to follow later this year, probably at next month’s Mobile World Congress.