Apple CEO Tim Cook, clutching a remote in hand, stood onstage as the world watched his every movement. He calmly called upon his lieutenants, Craig Federighi and Phil Schiller, to introduce iOS 7 and, not one but, two iPhones. Journalists slumped in their seats, waiting to be blown away.
It didn’t happen. Cook unveiled nothing groundbreaking. The highlight was a fingerprint sensor on the flagship 5S and a few nifty colors to accentuate the plastic, toy-like 5C. The audience, fresh from a pop-infused performance from Lady Gaga, fidgeted in their seats, staring out to the spotlight where the ghost of Steve Jobs began to fade with each poor pun from Apple’s stiff management team.
Cook is smart, though. He knew, as did his nearby lieutenants, that he wasn’t Jobs, and it would be foolish to imitate his captivating presentation style. But business is another matter, and once the event ended, and conversation began to rise, the usual mood of optimism changed in tone to something uncommon during Apple’s nearly decade-long rise to smartphone stardom: doubt.
Apple without innovation is like Mozart without a melody, Picasso without a paintbrush — only much worse, and a mediocre iPhone robs Apple of its crown jewel: its brand. As one analyst put it, those candy-colored iPhones looked more like cheap marketing gimmicks than the sleek, innovation-inspired design that Jobs had meticulously built the company upon.
Who would buy the 5C?
It turns out, a lot of people. Most looked at Apple through the lens of North American consumers, forgetting that the key to Apple’s future lies in the Far East. Jobs had marketed the original iPhone to a generation of teens, eager to buy Apple products to express their own identities, but halfway across the globe in Asia, a billion potential consumers sought it as a symbol of wealth and prestige. Those markets are just beginning to ascend, and to survive, Apple is in desperate need to carve out a substantial slice.
On the surface, Apple’s problems seem simple to fix: just sell more iPhones. But the challenges in China are more daunting, fraught with consumer price sensitivity, fierce competition from cheaper imitators, protectionist government regulations and, of course, Android.
At around $850, the iPhone is out of reach for all but the upper class of consumers, costing more than the average monthly salary in Beijing. But to understand just how popular the iPhone is — and the opportunity Cook wants to capitalize upon — look no further than the burgeoning black market for Apple products.
In 2008, when the company began to fall behind in its fight against counterfeiters, it called on what amounted to a Dream Team of global manufacturing: John Theriault, who had protected Viagra from illegal knockoffs, and his team of security experts.
According to the New Yorker, Theriault, once a special agent for the FBI, quickly found that “factories in Guangdong province were exporting enough counterfeits to single-handedly supply the world with fake Apple products.” But, perhaps more surprisingly, he discovered that Apple hadn’t even registered its trademarks in China, preferring to avoid pursuing criminal prosecutions because, it “wanted to stay away from too much publicity surrounding the issue.”
For Apple, at the time, business in North America was good — so good, in fact, that it didn’t see a reason to challenge the growing spate of counterfeits, which had made their way from Shanghai to Beijing through to India and beyond. These weren’t cheap knockoffs, either, but replicas so exact in detail that exteriors were often flawless. The only hint of their unsavory origins was a measly 1-gigabytes — instead of the customary 8-gigabytes — of memory.
As a consequence of that indifference, Apple today lags in sixth place with about a five percent market share in China, according to Canalys. The company that had the clout, cash and charismatic leader to dictate its own terms — a closed ecosystem, exclusivity deals and eager partners — saw Android run away with a market that represents the next frontier of growth for the smartphone industry.
Last year, China quietly passed the U.S. to become the biggest smartphone market in the world. But before its ascent, Apple and Samsung spearheaded the battle for supremacy by designing expensive devices for affluent consumers in first-world countries. They dominated the high-end sector — defined as phones priced at $450 or more — in North America and China with about a 55 and 40 percent share, respectively, according to Sanford Bernstein, a brokerage firm. But growth in the high-end sector slowed, and Bernstein expects sales to flatten at about 300 million units this year, slightly up from 240 million in 2012.
By contrast, sales of low-end devices — measured as phones priced below $200 — are projected to surge to 400 million units this year, up from 230 million last year, with a further boost to 690 million by 2015 due to the plummeting cost of smartphones. Of that, emerging markets are expected to drive most of the growth for the unforeseen future, as millions of underserved consumers replace old-fashioned feature phones for smartphones, more likely than not running on Android.
If Apple wants to stay alive, it must move down market.
Cook clearly hoped to capitalize on that demand, and his two-pronged approach — the 5S to appeal to loyal customers in developed nations and the 5C for emerging markets — seemed to make sense.
There was only one problem: the 5C isn’t cheap enough. Starting at around $730, it’s just 20 percent cheaper than the high-end 5S, still placing it firmly out of reach for most Chinese consumers, giving an opportunity for rivals to swoop in.
As Cook launched the iPhones, a crop of domestic rivals — from stalwarts Lenovo and Huawei, known for ThinkPad notebooks and network switching gear, to fast-risers unknown in the U.S. — have seized on the opportunity created by Apple’s delay. And one of those companies, called “Xiaomi,” which means “little rice” in Chinese, is waiting in the wings, prepping its own flagship to go toe-to-toe with Apple.
Little known outside of Asia, Xiaomi is a juggernaut in the Far East. With billions of citizens already dubbing its smartphone the “Chinese iPhone,” it will certainly beat out the iPhone in China — a testament to, and thorn in the side of, Apple.
“When Steve [Jobs] was alive, he was the best,” Lei Jun, CEO of Xiaomi, told the New York Times in an interview. “Nobody could surpass him. Nothing could surpass the iPhone.”
If it sounds like he idolizes Apple, he does — or rather, he did.
A large part of phenomenal growth of Xiaomi lies in the DNA of Lei, a trained engineer and billionaire entrepreneur. He is involved with many things involving many people — Kingsoft, his other billion dollar corporation, Joyo.com, the largest online retailers of books, music and movies in China, which he sold to Amazon for $75 million in 2004, and his lesser but still noteworthy investments in several Chinese start-ups — but they all show a mere portion of the power has come to represent in the technology sector in China.
According to the New York Times, while using a Nokia in 2004, Lei said he gave a friend who worked at the Finnish firm over 1,500 suggestions on how to improve its devices. But Nokia did nothing. With that experience, and the realization that smartphones would replace PCs, he founded Xiaomi.
In less than four years, Xiaomi has become major force in the Chinese smartphone market. At the end of last year, it reported eye-popping $1.6 billion in revenue, on sales of nearly seven million units.
With Chinese consumers often idolizing, but unable to afford, the Apple brand, Xiaomi has been a willing alternative in the wings, ready to offer similar products, with a similar set of features, at a much cheaper price. The resemblance is often so uncanny that its smartphone has been called the “little brother of Apple.” But success of Xiaomi also lies in a marketing strategy that rides on the back of Lei’s fascination with the cult of Apple, and gives Chinese consumers an affordable way to buy into that image.
In August, Xiaomi released its newest Android device, a $130 phone called the “Red Rice,” featuring a 4.7-inch 720p screen, 8-megapixel camera and a quad-core processor. With such aggressive pricing, analysts expect it to do so much damage to competitors that they’ve already dubbed it “Blood Rice.”
But why Xiaomi instead of other Chinese rivals?
While Lei looks to Apple’s success as a blueprint, he added his own innovative touch where he sees Cook fail. One difference is its use of consumers to improve design and debug software. Every Friday at 5 p.m., it releases a round of updates for its version of Android. Within hours, thousands of existing customers give feedback on its forums, which it then integrates in its next round of updates. The company has solicited feedback for everything from the amount of memory to include and the preferred thickness of the shell, to whether a flashlight should be added on the back.
“Apple is very conceited,” Lei told the New York Times. “Their attitude is, ‘I don’t need any feedback’.” His next challenge will be to sell devices beyond the mainland in Hong Kong, Taiwan and Singapore by year’s end.
With Xiaomi on the rise, and ready to feed a consumer appetite for all things Apple, the fight in China is of paramount importance for Cook. If he falls to hold a strong position in the region, domestic rivals will secure market share, and use it as a springboard to launch attacks on Apple’s stronghold in the West.
That leaves Cook in a difficult position. As iPhone sales stagnate in the U.S. and shipments slip in China, Apple must take the fight to Asia amid increasingly smart and well-funded competitors. Instead of counterfeiters from yesteryear, the competition has grown to become legitimate multinational corporations, crafting Android devices so advanced and affordable that Apple is finding it difficult to compete without cannibalizing its brand.
Of course, Cook knows all that, and as he stepped onstage to unveil the iPhones, he understood that success or failure of the low-cost 5C would create ripples for years, or even decades, to come.
Did Cook overcharge for the 5C and effectively price Apple out of the world’s fastest-growing market? No — not really. Its business model isn’t to try to sell as many phones to as many people. Rather, its very success had been to avoid that strategy.
China, no doubt, has a lot of consumers — many with smartphones, but many more without. Of the nearly 300 million subscribers already with high-end mobile services, according to the Wall Street Journal, the next war will be centered on less-expensive devices, leaving Apple in a strategic quagmire over whether to chase the entry-level and risk its image or stay in the smaller, but higher-margin luxury segment.
Ideally, Apple should sell iPhones to the masses, but the reality is, even if it wanted to, it can’t compete with the likes of Xiaomi on price. China’s tariffs and protectionist measures against foreign imports drive up costs that domestic rivals take advantage of. So even if Apple could sell an iPhone at, say $250 — a price that significantly cuts into its margins — competitors could, and do, go even cheaper.
Instead of competing in the low-end trenches, Cook is willing to wait for the market to catch up, so that leaves Apple with only one route: take the high-end.
Just like Louis Vuitton or Mercedes-Benz, one of Apple’s greatest strengths has been its perception as a luxury item, an expensive gadget that confers upon its owner an unparalleled aura of high-class style. Having an iPhone, especially in China, is a symbol of status, wealth and power, something rivals like Xiaomi, simply cannot imitate.
Only the wealthiest tier can afford the 5S, but as the country’s economic growth continues to pull up hundreds of millions of citizens into an affluent middle class, the 5C will be within reach of a growing number of consumers.
As Apple waits for the Chinese middle-class to gain momentum, Google is dominating market share, and third-party apps are growing at a faster rate for Android than iOS. Compounding the problem, according to Flurry, U.S. developers are losing their grip on the global app ecosystem, accounting for just one-third of all programs published across the world, down from 45 percent just two years ago.
Meanwhile, Chinese developers are gaining clout, building apps not just for the mainland, but exporting them to neighboring markets like Southeast Asia, India and Indonesia.
That spread is due largely to consumers buying domestic smartphones that run on Android. Chinese developers, like all developers, follow the money, and consumers follow the operating system with the most apps.
Really, that’s the big challenge for Apple. To stay competitive, Cook must release a lower-priced iPhone or risk losing its share of developers. Without developers, it would lose its key advantage in apps, landing a devastating blow that could magnify its crisis in the years to come.
But of course, it can’t compete strictly on price. It also needs to defend sales of the high-end without diluting its brand. Constrained between two fronts, what is Apple to do? Well, if you’re Cook, you unveil the 5C — a cheaper, but not really that cheap, iPhone.
Apple has always chosen the high-end, but it faces a juggling act to succeed in China, and by extension, the world. It must be accessible, but stay luxurious. It must become the mainstream, while remaining exclusive. It must cleverly dilute, or at least widen, its carefully-groomed brand, without sacrificing a rabidly-loyal fanbase
In other words, it must solve two fundamentally opposing problems.
By contrast, Google focuses strictly on Android, giving away its operating system to any handset maker that wants to develop for it — from high-end Samsungs to the cheapest of Xiaomis, leaving branding and pricing to its hardware partners. Meanwhile, it concentrates solely on expanding market share and attracting developers.
By fighting both sides, Apple is unable to effectively support a luxury brand while expand its market share. And if that sounds familiar, it is. Two decades ago, Microsoft and its allies — from the highest-end Dells to the lowest of the no-name clones — handedly beat the Mac in the computer wars. Microsoft didn’t care who ran Windows, just so long as they ran it.
In a way, history is repeating. The battles are the same, but the names have been changed. And in China, as in North America decades ago, the future of an industry will largely depend on the strategies Apple employs in the next few years.
To those that sat at the iPhone event, the 5C, on the surface, seemed like a cheap, colorful plastic gimmick. But it represents more — a more affordable trophy in the eyes of a group of consumers growing in number and global importance. Whether they’ll reach out and grab it, though, or go for its homegrown “little brother,” will be the question that Apple’s future hinges upon. ♦