Rich customers will help Apple resist the effects of inflation

Rich customers will help Apple resist the effects of inflation
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An employee arranges Apple iPhones as a customer store at an Apple Store.

mike reaping | Reuters

The last time Apple Facing an inflationary environment like this, it had been a public company for less than a year and its best-selling product was the Apple II personal computer.

In May, the annual inflation rate in the US it was 8.6%, the highest level since 1981. Other major markets for Apple sales are experiencing similar or even higher levels of inflation.

Apple faces rising global logistics costs and rising employee wages, as well as the prospect of consumers postponing their iPhone upgrades due to declining purchasing power. Apple is also facing supply constraints related to China shutdowns this year that could result in a $8 billion revenue hit.

Many companies, especially those with pricing power, are able to pass higher costs on to their customers by raising prices, particularly if demand is strong. Apple hasn’t raised the prices of iPhones in the US, but regularly tweaks pricing around the world in response to currency fluctuations. Some years, Apple has changed its product pricing structure for its list of new devices in the fall.

Apple could also absorb some of the costs, hurting its margins, while keeping prices steady to avoid denting demand.

“From an inflation standpoint, we’re seeing inflation,” Apple CEO tim cook told investors in a earnings call in April. “It is or was evident in our gross margin last quarter and in our OpEx last quarter and it is assumed in the guidance that [CFO] Luke [Maestri] gave for this quarter as well. So we’re definitely seeing a level of inflation that I think everyone is seeing.”

rising costs

Cook said there are at least two places inflation shows up on a company’s balance sheet: gross margins and operating expenses.

Apple’s gross margin for the quarter was 43.7%, higher than analyst expectations but slightly lower than the December quarter, which was the highest since 2012, according to FactSet data.

Apple’s margin will decline in the June quarter to between 42% and 43%, Maestri said. But Apple’s margins expanded during the pandemic and are still at historically high levels.

Operating expenses for the quarter were $12.58 billion, a year-over-year increase of nearly 19%. In the June quarter, Apple forecasts a sequential increase of about $12.8 billion in operating expenses.

Tim Cook speaks on stage at TIME100 Summit 2022 at Jazz at Lincoln Center.

Countess Jemal | Getty Images Entertainment | fake images

Freight charges are one source of those costs.

“Freight is a big challenge,” Cook said in April. “From an inflation point of view and from an availability point of view.”

Another rising cost is related to silicon shortages caused by China’s Covid-19 lockdowns during the first half of the year, and a general shortage of less advanced chips needed to complete its products. Cook said, however, that some components are becoming less expensive.

Apple may also be facing higher labor costs. The company is raising salary for its corporate and retail employees in response to market conditions after some rivals, including Google, AmazonY Microsoftmade changes to its compensation earlier this year in a bid to attract and retain top tech talent.

“Other companies we track are losing margins on cost inflation, but Apple sees its cost basket as relatively stable, with lower raw material costs offsetting higher labor and freight costs,” said Katy Huberty. , an analyst at Morgan Stanley, in a note after the earnings report.

Possible slowdown in sales

But rising costs are not the worst case scenario for Apple. The biggest risk is if inflation and other macroeconomic conditions end up hurting demand for Apple products.

Traditionally, during a recession or in the face of declining purchasing power, consumers postpone purchases of durable goods, including electronics, economists say.

In Apple’s case, this could mean that consumers who bought a phone two or three years ago might decide not to upgrade to the newest model this year and defer spending until economic conditions improve.

“Sometimes you just have to be cautious and put off buying,” said Jim Wilcox, an economist at the University of California Berkeley. “Wait and see is a very sensible financial strategy.”

Investors feel more comfortable with Apple’s customer loyalty and thus the likelihood that they will continue to update their devices regularly, but an inflation-related recession could call that belief into question, hurting the multiple. Apple earnings.

“In Apple’s case, they have a very strong ecosystem, their customers are very loyal,” said Toni Sacconaghi, an analyst at Bernstein. said on CNBC this week. “But most of their revenue is generated from product sales and that’s largely due to loyal customers, and if you go into a recession, customers may delay purchases or delay upgrades. So that revenue stream isn’t exactly recurring, it’s largely transactional. “

apple has not yet noted weakness. In April, he said that demand remained high and suggested that he had seen no signs of deteriorating consumer confidence. The biggest problem was producing enough supply to meet the demand for their products.

But the smartphone and laptop markets are showing some signs of slowing down. The high-end part of the smartphone market, where Apple sells, is holding up better than the bargain bin, though overall phone sales have started to fall. micron technologya memory provider for Apple devices, warned on thursday Both smartphone sales and PC sales are expected to be significantly lower than previously estimated due to weakening consumer demand, caused in part by rising inflation around the world.

Unit shipments of so-called premium devices costing $400 or more were down 8% in the first quarter, compared with 10% for the overall market, according to recent estimates. Counterpoint Research.

Rich clients cushion the blow

Apple can afford some additional costs. Its sales have been growing for the last two years and it maintains a healthy margin that is the envy of its hardware competitors.

But Apple may not have to eat those higher costs at all.

Customers tend to have significant disposable income, compared to Android device buyers, who tend to choose based on price.

In the “ultra-premium market,” or phones that cost more than $1,000, Apple took 66% of unit shipments during the first quarter, according to Counterpoint.

“With rising global inflation, the lower price range and entry-level segments are likely to be hit harder,” the Counterpoint researchers wrote.

A June Morgan Stanley survey said 70% of US consumers planned to cut spending over the next six months because of inflation. But wealthy households, Apple customers, were more positive about their finances and the trajectory of the economy.

“Households with an income of more than $150,000 are more resilient; the highest increase in downsizing plans is seen among the mid-income cohort,” the Morgan Stanley analysts wrote.

Over the last five years, Apple has raised the prices of its iPhones multiple times.

In 2017, Apple introduced a $1,000 high-end iPhone model, which attracted a substantial proportion of customers who were willing to pay for a more powerful device. More recently, Apple quietly high prices in 2020 When he increased the starting price of the mainline, the best-selling model, at the time the iPhone 12, from $699 to $799.

Reuters noted on Friday that Apple raised the price of its flagship phone in Japan by nearly a fifth, with the entry-level iPhone 13 now costing the equivalent of £870.

Could the company raise prices more broadly again this year? Cook has not ruled it out.

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