It's Time To Admit Apple Knows Exactly What It's Doing With Its iPhone Business

What a difference a year makes for Apple.

In 2013, Apple's stock was in a tail spin, analysts were slashing EPS targets, and there were daily reports of Apple cutting its iPhone production (or it felt that way).

At the same time, Samsung was the most beloved company in the tech media. It was praised for its innovation and its forthcoming Galaxy S4 was all anyone cared about. It had stolen Apple's thunder.

This year, Samsung is not quite the bright shining star it was. Its Galaxy Gear was a flop, and anticipation for the Galaxy S5 is relatively muted.

As for Apple, its stock isn't screaming to the moon, but it's not in a downward spiral, either. Analysts are fairly steady on the company, and there is a sense of optimism, albeit low-level optimism, about the year.

It really feels like 2013 was a down year for Apple as it reset itself to launch new product categories in the next five years or so. If ever there was a year for Apple's rivals to leap past the company, it was 2013, and it didn't happen. (Although, these things don't happen over night. If Apple really screwed the pooch in 2013, we'll probably realize it in 2016.)

Another big difference for Apple as we enter 2014 is that it seems much more clear that the company really knows what it's doing with the iPhone business, despite the various cries from the pundit class.

Ever since Android started making noise people have been warning Apple that the iPhone was in danger. There is, of course, no louder proponent of this notion than our own Henry Blodget. (I don't mean to pick on Blodget, he just happens to be someone that I work with, and is the best at articulating this commonly held view that Apple needs to tweak its iPhone business model.)

For the last three years Blodget, and people like himself, have been pounding the table that Apple was about to get smoked by Google, just like it got smoked by Microsoft.

Last year looked like the year Blodget and his people were going to be right. In the March quarter, Apple's iPhone sales only grew by 7%, a stunning crash in the company's annual quarterly growth. In August, Android captured 79.3% of the smartphone market, up from 69.1% the year prior. Apple, meanwhile, had just 13.3% of the smartphone market, down from 16.6% the year prior.

In November, Blodget wrote another post admonishing Apple, and it supporters, saying, "Come on, Apple Fans, it's time to admit the company is blowing it."

I think Blodget's wrong, and it's actually never been clearer that Apple's decision to stay the course with its iPhone business has been the exact right decision. While there were many scary statistics for the iPhone in 2013, they've turned out to be largely superficial. The underlying performance of Apple's business remains strong.

Let's start with market share, which is the biggest cudgel used to bludgeon Apple.

Each quarter we get an uglier and uglier market share number for Apple's platform. The latest, as we noted, shows Android phones are outselling iPhones by a wide gap.

Despite the bad market share numbers, iPhone sales in absolute terms are still doing well. The iPhone generated $19.5 billion in revenue for Apple in the September quarter. It sold 33.8 million iPhones, which was ahead of expectations, and up 26% on a year-over-year basis.

Now lets put that in context:

• Google's total revenue for the quarter was $14.9 billion, a 12% jump year-over-year. (If you just look at Google's ad business revenue was $12.5 billion, up 15% year-over-year.)
• Microsoft's total revenue was $18.5 billion, a 7% jump.
• Amazon's total revenue was $17.09 billion, up 24%.

Apple's iPhone business is bigger, and importantly, growing faster than Microsoft, Amazon, and Google, the three giants Apple is competing against in mobile.

But, the critic might say, who cares about those companies? Apple's iPhone business is not growing as quickly as the overall smart phone industry.

And yes, this is true. But there's no reason for Apple to chase every single smartphone customer. It is focused on the profitable high-end of the market. Or, as Apple CEO Tim Cook put it, "There's always a large junk part of the market. We're not in the junk business."

Look at the companies like Motorola that are going mid-to-low tier. They're not making money, and not making much of an impact on the market. Even Samsung, which is considered the all things to all people phone maker is focused on the mid-to-high tier. The reason? That's where the money is.

But, the critic might protest, Apple is giving up precious market share!

And yes, it is giving up market share. But, so freaking what?

This is a platform war! (Shrieks the critic.) If Apple loses the market share war, then it loses the platform war. And if it loses the platform war, then it loses developer interest. And if it loses developer interest, then it gets sub-par applications. And if that happens, then consumers tune out the platform.

Well, even with Apple only getting 12% of smartphone shipments in the third quarter, it remains a dominant platform when it comes to usage.

Over the holiday shopping period, IBM reported that Apple's iOS usage smoked Android's usage in the U.S.: "iOS traffic reached 28.2 percent of all online traffic, compared to 11.4 percent for Android. iOS sales reached 18.1 percent of all online sales, compared to 3.5 percent for Android."

Simon Khalaf, CEO of Flurry, a mobile app analytics company confirmed this in December, telling us, "We have seen and published reports that an Android user is worth 1/4 of an iOS user, but that is based on virtual goods sales (mainly games). The IBM data seems to suggest that this is almost the same ratio for sales of physical goods (m-commerce)." He added, "Basically one iOS user buys four times more than an Android user."

Khalaf thinks the reason is that Android phone buyers are mostly treating their phones like dumb phones, not smartphones. They're not taking advantage of the platform.

If Android users aren't taking advantage of the platform, if they're not engaged, then there's no reason for developers to relegate iOS to a second tier platform in favor of Android.

Another reason developers aren't leaving iOS any time soon: It's lucrative to make iOS apps. Apple just announced that App Store sales were $10 billion last year, which is up 136% year-over-year. Of that, developers get $7 billion. The non-search portion of the mobile ad market is estimated to be $8 billion for 2013. Let's say that Android developers got 80% of those ad dollars. That still means Apple is the more lucrative platform for an app maker. (And there is no reason to think Android draws more ad dollars since IBM and Adobe both say there is significantly more commerce happening on iOS. Advertisers spend where the dollars are spent.)

When you think about it this way, market share doesn't matter. This is year six of the App Store, and despite all the Android market share gains, developers still love iOS because people pay for, and use, iOS apps. The developers aren't leaving.

So why should Apple chase market share? If Apple can generate more revenue from the iPhone than its rivals can from their entire businesses, while still growing faster despite only owning 12% of quarterly smartphone sales, then what's the problem?

What about the future? Could Apple collapse in the future? Of course, but this is year seven of the iPhone and it's still growing at a double digit clip. This business model isn't a fluke. And it's not going to dry up suddenly.

Oh, I also forgot to mention that Apple generated $9.9 billion in cash in the last quarter, largely thanks to the iPhone business. Which is nice.

Could Apple lower prices? Of course it could. As a person that buys stuff Apple makes, I would love to see the company lower its prices. It would make my life better.

But from a business perspective, it's hard to make the case that Apple needs to lower prices. Developers aren't leaving and sales remain strong.

Another argument from people that think Apple should lower prices is that carriers are either going to shut out, or screw-over Apple. Therefore it should preemptively capitulate.

Please.

Even carriers, who play hardball with Apple, know that the iPhone is a big deal.

On Friday, Japan's largest carrier NTT Docomo added 279,100 net users. Why? From Bloomberg's report: "The main reason Docomo added more new users than other carriers is because it began offering the iPhone, said Hiroko Shimoyama, a company spokeswoman." Docomo didn't have the iPhone until recently.

This isn't an anomaly. In the U.S., before T-Mobile had the iPhone, it said it lost 700,000 subscribers in one quarter because customers were bolting for carriers that offered the iPhone.

It's not just Japan and the U.S. where the iPhone is a big deal.

People who think Apple needs to change its iPhone business (and I have been one of those people in the past) look at China and think Apple is totally screwing up.

It's possible Apple has erred in China, but it just signed a deal with China Mobile, the biggest carrier in the country. China Mobile had long resisted Apple, but eventually it caved. Why? From the New York Times: "[China Mobile] showed signs of warming up to Apple only after it began losing customers to competitors that offered the iPhone."

Despite the high prices, consumers in developed and developing nations want the iPhone. Carriers know it, and Apple knows it.

As we enter 2014, things look bright for Apple and its iPhone business, despite the doomsayers of 2013.

It has a new deal with China Mobile to sell phones to over a hundred million Chinese consumers.

It is likely to release a new phone with a bigger screen, which has been one of gripes from users. Heck, it might even release two iPhones with bigger screens! (We're skeptical, but you never know...)

And even with just a sliver of the market it's generating mind numbing sums of cash, and its iPhone business is growing faster than its rivals' overall businesses.

It's time to admit Apple knows exactly what it's doing with the iPhone.

(And, one final parting note: None of this is to say that iPhone is beating Android. We're just saying that Apple is doing well doing what it's doing As freelance analyst Benedict Evans said, "I am rapidly losing interest in 'iOS versus Android' as a discussion. Both Google and Apple have won.")