Today’s unscientific and friendly castigation of Apple’s iPhone 5C costly stumble: misdirected differentiation without enough regard for actual customer aspirations.

Here’s a quick snapshot of Apple’s numbers for the quarter ending December 2013, with percentage changes over the same quarter a year ago:

307TABLE JLG

We can disregard the iPod’s “alarming” decrease. The iPod, which has become more of an iPhone ingredient, is no longer expected to be the star revenue maker that it was back in 2006 when it eclipsed the Mac ($7.6B vs. $7.4B for the full year).

For iPhones, iPads, and overall revenue, on the other hand, these are record numbers.... and yet Apple shares promptly lost 8% of their value.

Why?

It couldn’t have been that the market was surprised. The numbers exactly match the guidance (a prophylactic legalese substitute for forecast) that was given to us by CFO Peter Oppenheimer last October:

“We expect revenue to be between $55 billion and $58 billion compared to $54.5 billion in the year ago quarter. We expect gross margins to be between 36.5% and 37.5%.”


(Non-normals can feast their eyes on Apple’s 10-Q filing and its lovingly detailed MD&A section. I’m sincere about the “lovingly” part -- it’s great reading if you’re into it.)

Apple guidance be damned, Wall Street traders expected higher iPhone numbers. As Philip Elmer-DeWitt summarizes in an Apple 2.0 post, professional analysts expected about 55M iPhones, 4M more than the company actually sold. At $640 per iPhone, that’s about $2.5B in lost revenue and, assuming 60% margin, $1.5B in profit. The traders promptly dumped the shares they had bought on the hopes of higher revenues.

In Apple’s choreographed, one-hour Earnings Call last Monday (transcript here), company execs offered a number of explanations for the shortfall (one might say they offered a few too many explanations). Discussing proportion of sales of the iPhone 5S vs. iPhone 5C. Here what Tim Cook had to say [emphasis mine]:

“Our North American business contracted somewhat year over year. And if you look at the reason for this, one was that as we entered the quarter, and forecasted our iPhone sales, where we achieved what we thought, we actually sold more iPhone 5Ss than we projected.


And so the mix was stronger to the 5S, and it took us some amount of time in order to build the mix that customers were demanding. And as a result, we lost some sort of units for part of the quarter in North America and relative to the world, it took us the bulk of the quarter, almost all the quarter, to get the iPhone 5S into proper supply.


[…]


It was the first time we’d ever run that particular play before, and demand percentage turned out to be different than we thought.


In plainer English:

“Customers preferred the 5S to the 5C. We were caught short, we didn’t have enough 5Ss to meet the demand and so we missed out on at least 4 million iPhone sales.”


Or, reading between the lines:

“Customers failed to see the crystalline purity of the innovative 5C design and flocked instead to the more derivative -- but flattering -- 5S.”


Later, Cook concludes the 5S/5C discussion and offers rote congratulations all around:

“I think last quarter we did a tremendous job, particularly given the mix was something very different than we thought.”


... which means:

“Floggings will begin behind closed doors.”


How can a company that’s so precisely managed -- and so tuned-in to its customers’ desires -- make such a puzzling forecast error? This isn’t like the shortcoming in the December 2012 quarter when Apple couldn’t deliver the iMacs it had announced in October. This is a different kind of mistake, a bad marketing call, a deviation from the Apple game plan.

With previous iPhone releases, Apple stuck to a simple price ladder with $100 intervals. For example, when Apple launched the iPhone 5 in October 2012, US carriers offered the new device for $200 (with a two-year contract), the 2011 iPhone 4S was discounted to $100, and the 2010 iPhone 4 was “free”.

But when the iPhone 5S was unveiled last September, Apple didn’t deploy the 2012 iPhone 5 for $100 less than the new flagship device. Instead, Apple “market engineered” the plastic-clad 5C to take its place. Mostly built of iPhone 5 innards, the colorful 5C was meant to provide differentiation... and it did, but not in ways that helped Apple’s revenue -- or their customers’ self-image.

Picture two iPhone users. One has a spanking new iPhone 5S, the other has an iPhone 5 that he bought last year. What do you see? Two smartphone users of equally discerning taste who, at different times, bought the top-of-the-line product. The iPhone 5 user isn’t déclassé, he’s just waiting for the upgrade window to open.

Now, replace the iPhone 5 with an iPhone 5C. We see two iPhones bought at the same time... but the 5C owner went for the cheaper, plastic model.

We might not like to hear psychologists say we build parts of our identity with objects we surround ourselves with, but they’re largely right. From cars, to Burberry garments and accessories, to smartphones, the objects we choose mean something about who we are -- or who we want to appear to be.

I often hear people claim they’re not interested in cars, that they just buy “transportation”, but when I look at an office or shopping center parking lot, I don’t see cars that people bought simply because the wheels were round and black. When you’re parking your two-year old Audi 5S coupe (a vehicle once favored by a very senior Apple exec) next to the new and improved 2014 model, do you feel you’re of a lesser social station? Of course not. You both bought into what experts call the Affordable Luxury category. But you’re self-assessment would be different if you drove up in a Volkswagen Jetta. It’s made by the same German conglomerate, but now you’re in a different class. (This isn’t to say brand image trumps function. To the contrary, function can kill image, ask Nokia or Detroit.)

The misbegotten iPhone 5C is the Jetta next to the Audi 5S coupé. Both are fine cars and the 5C is a good smartphone - but customers, in numbers large enough to disrupt Apple’s forecast, didn’t like what the 5C would do to their image..

As always, it’ll be interesting to observe how the company steers out of this marketing mistake.

There is much more to watch in coming months: How Apple and its competitors adapt to a new era of slower growth; how carriers change their behavior (pricing and the all important subsidies) in the new growth mode; and, of course, if and how “new categories” change Apple’s business. On this, one must be cautious and refrain from expecting another iPhone or iPad explosion, with new products yielding tens of billions of dollars in revenue. Fodder for future Monday Notes.

-- JLG@mondaynote.com

@gassee

 

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