Among news of poor performance in the Chinese economy, one of the most distressing signals for foreign retailers and manufacturers is Apple’s (AAPL: NASDAQ) announcement on Wednesday that the company had reduced revenue expectations due to poor iPhone sales in China. Revenue projections are estimated to be $4.3 billion short of the previous estimate of $89-$93 billion for 2018, according to Apple chief executive officer Tim Cook.
Apple’s announcement caused its stock to fall seven percent Wednesday evening and 10 percent on Thursday. The Dow Jones Industrial Average fell 660 points as news of Apple’s sale slump permeated the market, particularly affecting stocks exposed to the Chinese market like Boeing (BA: NYSE), Deere (DE: NYSE), Qualcomm (QCOM: NASDAQ) and Tiffany (TIF: NYSE). Apple itself has lost $300 billion in stock value since becoming the first company to reach a market capitalization of $1 trillion in October 2018. Cook attributes weak sales in China to decreased traffic in its more than 40 retail outlets in the country.
China’s economic slowdown was sparked by a more conservative monetary policy enacted by the central government. President Xi Jinping began his second term in 2017 by signing off on tightening credit among Chinese banks to prevent rapid growth from triggering market volatility. This had the effect of driving down consumption and subsequently tax revenue. Beijing is not promising any stimulus packages to ward off the current economic challenges.
China’s ongoing trade dispute with the United States is another pressing concern for Apple. U.S. President Donald Trump has publicly criticized Apple and other American companies for manufacturing goods in China instead of the United States. Many tech companies have expressed disagreement with the unpredictability of Trump’s methods in trade negotiation with China.
“Apple prices may increase because of the massive tariffs we may be imposing on China – but there is an easy solution where there would be ZERO tax, and indeed a tax incentive,” tweeted President Trump in response to Apple’s criticism of a 25 percent tariff on Chinese goods that would impact Apple products manufactured in China. “Make your products in the United States instead of China. Start building new plants now.”
However, Apple maintains that the U.S. lacks skilled workers and advanced facilities to produce iPhones affordably, suggesting the consumer price could jump between 20 to 35 percent if the supply chain was transferred from Asia to the U.S. Apple could avoid Section 301 of the Trade Act of 1974 by moving final assembly operations out of China to competing low-cost labor markets such as Taiwan, Vietnam, or Malaysia.
Apple’s supply chain is structured to purchase components for products such as the iPhone from domestic and foreign partners. According to Reuters, the largest cost in manufacturing the iPhone X (roughly $110 of the $378 total cost) is purchasing the touch-screen module from Samsung (SMSN: BXE), which is based in South Korea. Apple then sells components to its Taiwanese contractor Foxconn (FXCNY: OTC US) for final assembly into finished products. Final assembly in China costs $8 and battery packs sourced in China cost $6.
Over the past 40 years China has undergone a transformation from one of the world’s poorest and most isolated nations to a manufacturing and exporting leader, especially in the electronics sector. Apple manufactures the bulk of its iPhone products through Foxconn in the Chinese city of Shenzhen. Credit for China’s success in consumer electronics manufacturing is based on inexpensive labor and a workforce that is highly flexible to changes in production.
As China became wealthier through industrialization and global trade, the country’s middle class grew to an estimated 400 hundred million people. China is now the world’s largest market for smartphones and contributes up to 20 percent of Apple’s total sales. iPhone sales worldwide account for over half of Apple’s revenue.
Apple’s revenue derived from sales in China reached a peak of nearly $60 billion in 2015, placing the market ahead of Europe (at around $50 billion) and second behind the Americas (at over $90 billion). Since 2016, Apple sales in China have retreated to $52 billion while sales in Europe have increased to over $60 billion and sales in the Americas have rocketed past $100 billion.
Beyond economic fatigue and trade disputes, another reason for Apple’s struggle in China is the rise of local competitors. Rival smartphone manufacturer Huawei grew 33 percent from the third quarter of 2017 to the third quarter of 2018 despite local economic trouble. Huawei’s focus on expanding beyond the domestic market increased sales by 60 percent in foreign markets while sales in China also rose by 13 percent. The second quarter of 2018 saw Huawei surpass Apple in Chinese market-share and overall sales for smartphone manufacturing.
Apple has not announced plans to build factories in the United States, but it has committed to repatriating roughly $250 billion from its foreign holdings due to recent reductions in the corporate tax code. Last January, Apple announced a $350 billion investment in the U.S, 20,000 new domestic jobs, and the establishment of a new campus.
While China’s economic slowdown has had a negative impact on U.S. retailers and manufacturers, the country will likely remain highly relevant in the global electronics industry.