It’s more than just the trade war. Apple’s China business has been under pressure for a while

Finance news

Apple CEO Tim Cook partially blamed a slowdown in China when he cut guidance for the smartphone-maker — but the company’s troubles in the world’s second-largest economy began even before trade tensions escalated.

China has been Apple’s “headache” for the last two years, said TuanAnh Nguyen, analyst at smartphone research company Canalys.

The iPhone-maker’s business strategy has focused more on a “tightly-locked ecosystem” of services and devices, which may work in mature markets such as the U.S., he noted. But it may not work as well in China, where the market is more fragmented and local rivals offer innovative alternatives for a lower price, he added.

Greater China is Apple’s third-largest market by revenue, accounting for about 18 percent in the fiscal fourth quarter.

The iPhone’s status as a highly sought-after brand in China has also turned the regional sales figure into a closely watched indicator of the country’s economic health. But even as Cook slashed the company’s revenue guidance and blamed it on Greater China’s economic struggles — exacerbated by trade tensions — there are other challenges Apple is facing.

According to Strategy Analytics, global smartphone shipments fell for a fourth-straight quarter in the third quarter of last year. But despite an overall industry slowdown, Chinese players have been gaining market share.

In the second quarter, Chinese telecom giant Huawei overtook Apple to become the world’s second-largest smartphone vendor, according to Strategy Analytics. Huawei maintained that edge in the third quarter, while other Chinese players Xiaomi and Oppo grew their global market share, the data showed. South Korea’s Samsung remains the global leader.

“There are … currently low incentives for end consumers in China to buy new phones in 2019 as they can wait for the 2020 5G smartphones,” Macquarie analysts said in a Dec. 12 note. The firm’s China technology and telecom research team expects domestic manufacturers to gain market share amid an expected third straight year of declines in China’s overall smartphone shipments.

For Apple, that competition may only grow.

Vishnu Varathan, head of economics and strategy at Mizuho Bank, said Chinese advancements in technology is creating a more competitive market at home, which may push local companies to innovate further. “What’s more, an antagonistic U.S. may only tip the balance in favor of Chinese consumers adopting home-made devices rather than products like Apple,” Varathan said.

Several Wall Street analysts have been cutting their iPhone production forecasts in the last few weeks amid reports of lackluster demand for the latest models.

In November, Apple also said it would no longer break out iPhone sales.

Then came Wednesday’s announcement, when the California-based iPhone maker lowered guidance for fiscal first quarter revenue and gross margin, hit primarily by “economic deceleration” in Greater China. The stock, which has already plunged more than 35 percent from a record high it reached this fall, dropped more than 7 percent in after-hours trading.

“We believe the economic environment in China has been further impacted by rising trade tensions with the United States,” Cook said in a letter to investors.

“As the climate of mounting uncertainty weighed on financial markets, the effects appeared to reach consumers as well, with traffic to our retail stores and our channel partners in China declining as the quarter progressed,” he said. “And market data has shown that the contraction in Greater China’s smartphone market has been particularly sharp.”

Chinese consumers have been holding back on spending due to uncertainty about the domestic economy, but analysts say trade tensions are just one of many other factors affecting growth.

The bigger question for the markets is whether tying Apple’s China struggles will tilt either administration’s hand in trade negotiations, which are set to begin in earnest early this month. As the leader of one of the largest listed companies in the U.S., Cook has also been trying to play the role of a mediator between Beijing and the White House as the two countries announced tariffs on each other in the last several months.

He remained optimistic about the Chinese market in Wednesday’s letter, saying he believes Apple’s business there still has a “bright future” and the company’s services revenue has reached a record. “We are proud to participate in the Chinese marketplace,” he said.

China’s Ministry of Commerce did not immediately respond to a faxed request for comment on whether Cook’s letter will have an impact on trade talks. A White House spokesman did not immediately respond either.

Apple’s challenges will remain complex regardless of how the trade issues are resolved.

“Even if one can look past the likely weakness in unit sales this cycle, there does not appear to be much new” coming in 2019, especially when compared with competitors, said Junheng Li, founder of China-focused equity research firm JL Warren Capital. She also noted that her firm’s research shows greater softness for iPhone sales in the larger markets of U.S. and Europe.

In China, professionals, government workers and the male population prefer Huawei phones since the company’s specialty in back-end equipment results in better connectivity, Li added. “There is no tipping point,” she said, “the trend has been ongoing for a long time.”

— CNBC’s
Huileng Tan
Eustance Huang
contributed to this report.