Apple Inc.'s Efforts In India Are Promising But Still A Long Road Ahead

  • Apple faces significant challenges when entering into India, as evidenced by low market penetration.
  • To address this, Tim Cook made a trip to India and initiated plans to open R&D facilities in key cities.
  • I believe Apple’s efforts within India are noteworthy, but it will take time to develop a viable strategy.

Apple Inc.'s (NASDAQ:AAPL) efforts in India are particularly interesting, as the company is likely making moves in anticipation of the last major growth market for smartphones in the foreseeable decade. As it currently stands, there’s no other population demographic as large, or as broad that falls under the classification of “rapidly developing economy” as many economists have mentioned on numerous occasions that India is the next China. However, there are challenges to entering into this market, just as there were with China.

Also see: Here's Why Apple Inc. Got Dismantled By China This Year

Addressing the barriers Of entry

I believe Apple’s greatest challenge is whether it can maintain its premium brand without pricing out the affluent customer base. In other words, Apple’s greatest challenge is to make “made in India” a respectable household label, as they’re planning on building facilities to manufacture handsets out of India. This is to appease the local government so that Apple is sourcing components locally. Apple will need to source 30 percent of components locally if it wants to open retail stores in India. Apple will try to resist this, as much of the global manufacturing base for semiconductors, assembly, and distribution is done out of China.

Gene Munster from PiperJaffray mentioned that the challenges could be addressed via Foxconn:

The Indian government is promoting its Make in India campaign to encourage International companies to manufacture products that they want to sell in India, in India. We note that there have been reports of Apple working with Foxconn on setting up iPhone manufacturing in India, which would seem to address this barrier.

The challenge with opening facilities in India is perhaps labor efficiency and time to market, as India’s industrial base is nascent when compared to China. China is now pivoting its consumer economy to develop and manufacture advanced commercial products, as labor costs have made it prohibitive to manufacture cheap consumer goods. China’s now the hotbed for much of the world’s advanced manufacturing and production of advanced materials and resins. In other words, India’s rise will have to accompany competition with China’s well-established manufacturing base, which has the industrial transport capacity, local material sourcing, workforce, and capital base to make it untouchable to the rest of the world. India’s government is trying to become more like China. This strategy isn’t very compatible with Apple, but must be addressed.

In response to this, Apple is making investments in India via the launch of app developer initiatives in Bangalore, and 4,000 office job openings for the Maps unit in Hyderabad, India. The company has positioned itself in the major IT and high-tech cities of India, and it’s likely that Apple’s presence will expand given its ballooning foreign balance sheet and compelling R&D opportunities in India as opposed to China. I believe Apple will use this as leverage, or perhaps middle-ground, as it could use the argument of providing highly coveted service sector jobs for why it should receive some sort of exemption for sourcing goods locally. Hopefully, it works because India is the fastest growing smartphone market in the world.

Why Apple's approach to India will remain different from China

There are significant differences to Apple’s approach in India when compared to China. I believe Apple looks more for strategic manufacturing partnerships and de-emphasizes development of local R&D as it’s harder to protect its intellectual property rights in China, and repeated incidences of failed IP negotiations involving Qualcomm and various Chinese-based OEMs reinforce that point. In other words, the potential for serious innovation and product development in India is both nascent and real for Apple, but in the case of China, the best path forward has been local manufacturing partnerships and minority investment interests in nascent Chinese start-ups.

There’s also uncertainty in the Chinese regulatory landscape, as Goldman Sachs analyst Simona Jankowski noted in a recent report:

China’s ban of iTunes Movies and iBooks a key new risk to watch – Unrelated to the above headwinds in the March quarter, The New York Times reported on April 21 that China’s State Administration of Press, Publication, Radio, Film and Television had banned Apple’s iTunes Movies and iBooks Store services in the country. Both of these services had been launched by Apple in China in September 2015, just 7 months earlier. We view this development as a new risk for Apple’s presence in China, as much of the iPhone’s value and competitive advantage is derived from its content ecosystem.

With regulation that consistently favors homegrown Chinese companies, Apple is opting to own minority interest in promising start-ups. Much of China’s start-up landscape has been to copy and repeat western concepts, and then brag about the expanding consumer potential to make it seem more compelling than the original tech unicorn. For example, Apple’s $1 billion investment into Didi Chuxing follows much of the same logic and is just another over glamorized Chinese concept that copies Uber. There’s actually very little innovation going on in Mainland China, and contrary to popular belief, technological innovation is mostly in manufacturing, but less so in conventional tech. The Harvard Business Review explains the incremental nature of Chinese tech, which seems consistent with many tech companies avoiding heavy R&D investment in the Chinese mainland. It’s better to adopt pre-existing technologies and develop scalable business models than it is to develop cutting edge intellectual property in China.

Financial impact of India

To sustain healthy top line growth and to pivot from a 2% market share position, Apple has launched a lower-priced alternative. Analysts are getting incrementally positive on iPhone SE and how it may affect Apple’s results in emerging economies going forward:

To put the opportunity in perspective, we believe that India would provide between a 1-4% tailwind to units over the next 5-7 years if smartphone penetration were to approach that of China (17% in India vs 58% in China); however, we also note that GDP per capita in India is 5x lower than in China, making the path more difficult. – Gene Munster from Piper Jaffray

Apple introduced a new 4” phone, iPhone SE, to replace the aging iPhone 5s model in its portfolio. we view the updated specifications and aggressive pricing as modest positives for Apple’s push into emerging markets, while remaining cognizant of potential for pressure on gross margins. – Simona Jankowski from Goldman Sachs

Apple will struggle with maintaining palpable CSR (corporate social responsibility) initiatives within India, even as it attempts to capture the available market opportunity. They must accomplish not only to protect the brand, but must also avoid  scrutiny of anti-competitive practices, which they’ve been able to navigate quite successfully in many emerging economies.

Final thoughts

I do plan on including India into future financial models, but for now, it’s too soon to build long-term estimates inclusive of India. Until Apple is able to overcome regulatory hurdles and is able to sell refurbished prior generation handsets (iPhone 5S) at price points below $250, the market potential is limited. There are still significant differences in discretionary spending, and while the $450 iPhone SE does address the market, it still sits at the very high-end of the market. Furthermore, many handset manufacturers within India oppose Apple selling some of its refurbished prior generation models, which is why India implies great opportunity, but also greater challenges ahead. It’s also difficult to estimate gross margins on refurbished iPhone 5S handsets, which diminishes the viability of accurately projecting the product/margin mix.

I continue to reiterate my buy recommendation and $107.72 price target.

Alex Cho Alex Cho   on Amigobulls :
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