The iPhone might be light in your hand, but not on your wallet. And that’s great for Apple. Source: Apple.
Some investors have argued that Apple‘s (NASDAQ: AAPL ) high-end pricing strategy is unsustainable. Competitors such as Xiaomi and Samsung (NASDAQOTH: SSNLF ) have gained market share by broadening their product portfolio and offering lower-priced devices.
But those market share gains have not translated into profit share gains. Even Xiaomi — which aims to turn profits by selling high-margin accessories, apps, themes, and other services — just revealed in a regulatory filing that its margins are miserable. Last year, the Chinese company turned an operating margin of just 1.8%.
Meanwhile, Samsung saw its mobile division’s operating margin decline to 18.7% last year, as its high-end phones are overshadowed by its mid-to-low-end devices. Comparatively, Apple posted an overall operating margin of 28.7% for fiscal 2014, and its iPhone units typically carry higher margins than all of its other products.
All about the bottom line
Xiaomi has been wildly successful selling phones in 2014. Last quarter, the company became the third-largest smartphone manufacturer in the world and overtook Samsung as the largest smartphone maker in China, with 14% of market share in that country in the second quarter.
Xiaomi’s triple-digit unit sales growth this year may help its operating margins as it capitalizes on production efficiencies and sells more software and accessories. Still, it’s hard to see it climbing higher than the low single digits.
Those sales increases have directly cut into sales of Samsung’s high-end smartphone devices. Galaxy S5 sales are lagging its predecessor by 50% over the first six months of sales in China — the company’s second-largest market. As a result, the company has had to spend additional marketing dollars to help unload a surplus of units. The impact is clearly visible on the mobile division’s dwindling operating margin.
Last quarter, Samsung reported an operating margin of just 7.1%. That’s a huge decline after 10 straight quarters of 15%-plus operating margin for the division.
So how has Apple performed in China?
With Samsung struggling to sell its high-end devices, one might assume Apple is facing similar issues in light of the low-margin high-end competition from Xiaomi. But Apple continues to prove those assumptions wrong, as the company grew iPhone unit sales 32% in Greater China last quarter despite not launching the iPhone 6 in China until the current quarter. (The iPhone 5s launched at the very end of Apple’s fiscal fourth quarter of 2013, making that growth even more impressive.)
Apple hasn’t bowed to pressure to decrease prices to compete with Xiaomi or Samsung, nor has it spent exorbitant amounts on marketing to move products off the shelves. The company spent nearly $12 billion on sales, general, and administrative expenses last year, or 7% of revenue. That amount is slightly higher than the 6% rate of the previous two years, but it’s nothing compared to Samsung, which spends a similar amount on just marketing.
More importantly, succumbing to market pressure, and moving prices lower or increasing marketing to sell incremental units, would be the worst thing Apple could do. No other smartphone manufacturer — not even Samsung, apparently — is able to consistently maintain operating margins and feed revenue down the bottom line. While Xiaomi seemed to be making a lot of progress in the market, its strategy has yet to prove itself profitable.
A valuable moat
Apple has built a brand that consumers want, no matter what the price of owning a piece of it. In fact, the higher the price for Apple products, the more desirable they become in some cases.
This is a valuable moat that ensures Apple will be able to maintain margins despite pressure from competitors. The company’s high-margin phone business is proving sustainable in the face of low-margin low-price competitors because of this moat. Meanwhile, the low-margin competitors like Xiaomi are looking less sustainable every quarter.
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Another Way Apple Inc. Trounces Competitors: Sustainable Smartphone Profits (AAPL).
