Still bullish.

Photographer: ChinaFotoPress/Getty Images

Apple's Dependence on China Could Be Dangerous

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The stocks of most big tech companies are down 10 to 15 percent this month, but the erasure of 13 percent of Apple's market capitalization may make the most sense. If China has awakened the bears, Apple, whose dependence on that market has increased significantly in recent years, is prime bear bait.

Expansion into the Chinese market has been one of Chief Executive Officer Tim Cook's signature achievements. In the first quarter of Apple's 2011 fiscal year -- a year before founder Steve Jobs died -- the company broke out data about its performance in greater China for the first time: 9.2 percent of total revenue, 11.1 percent of operating income. By the third quarter of 2015, China accounted for 26.7 percent of revenue -- Europe brought in just 20.8 percent -- and 29.9 percent of operating profit, approaching the 35.9 percent Apple garners from the Americas, its home market.

China accounted for 60 percent of Apple's revenue growth during that period.

"Our focus has very much been on China," Cook explained on an earnings call in April 2011. "We wanted to understand that market and understand the levers there." The learning has never stopped, and it has affected some of the principles that were established under Jobs -- for example, his commitment to keeping the iPhone's screen relatively small or the refusal to accept third-party software keyboards.

Chinese consumers wanted Samsung-like big-screen smartphones, so Apple made the iPhone 6 Plus. Sure enough, China is the biggest market for it, and Apple has routed Samsung there. Chinese users wanted a choice of keyboards, like on Android, and they got it. So did the rest of the world, of course, but it would have had to make do with just one keyboard had it not been for China.

The same goes for golden phones, and now laptops, too. The next-generation iPhone will apparently be available in an extra hue -- rose gold -- and that, too, is a nod to what Cook says will be Apple's biggest market someday.

On the most recent Apple earnings call, last month, Cook was asked whether he saw a threat in the recent disastrous performance of the Chinese stock market. He said that it could "create some speed bumps in the near term" but that he remained "extremely bullish" on China. He cited a McKinsey study that said the share of upper-middle-class households in China would increase to 54 percent in 2022 from 14 percent in 2012. "So we're within that period at this moment, and you can see for all of us that travel there so much, with every trip you can see this occurring," Cook said. "And so I think we would be foolish to change our plans. I think China is a fantastic geography with an incredible unprecedented level of opportunity there." He reiterated his commitment to China in an email to CNBC's Jim Cramer on Monday, saying Apple saw strong growth there over the summer. 

The McKinsey study is from 2013, though, when China boosterism was much more fashionable than it is now. Since then, some international companies, primarily the owners of luxury brands, have discovered the downside of being big in China. According to Bain, the management consultancy, Chinese consumers now account for 30 percent of global luxury spending, but they are growing more price-conscious, so the Chinese luxury market is expected to shrink 2 to 4 percent in real terms this year. The recent corruption crackdown has also affected demand and driven the prices of luxury items down in China. 

This is directly relevant to Apple because, since China became a leading market, it has been turning into a kind of tech luxury or fashion company. Apple Watch, the only significant product launched under Cook, is more of a fashion accessory than a useful device, and it was initially marketed like a luxury product: People had to sign up for a demonstration at a boutique.

Despite posting excellent numbers in China, Apple cannot miss the shift away from inexplicably expensive items toward more practical ones. In the second quarter of 2015, according to tech analysis firm Canalys, Apple dropped a notch in market-share rankings for smartphones in China. It is now in third place behind local producers Xiaomi and Huawei.

The recent devaluation of the yuan poses another challenge: Should Apple accept thinner margins or risk losing even more sales to Xiaomi, Huawei and other budget competitors? Cook's company is, according to Bloomberg Industries, the most exposed to China of all non-Chinese handset makers. While it will benefit from a reduction in its considerable yuan-based costs, the danger of market-share loss is potentially more dangerous given the competition's vigor and local knowledge.

Apple's concentration on China has meant that it hasn't made much headway in other emerging markets. It has only a 3.7 percent share of handset shipments in Latin America, down from 4.8 percent in the final quarter of last year, and a 3.2 percent share in the Middle East and Africa, also down from the level at the end of 2014. It's growing in India, but from an extremely low base -- it has about 2 percent market share there.

Like any dependence, Apple's love affair with China can easily become a drag on it performance if the Chinese economy settles into a pattern of lower growth and the country's consumers become less motivated by prestige than by rational concerns. We're seeing the first signs that this is happening. Apple has become too Chinese, and it's time for the company to spread its attention more evenly among geographies.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Daniel Niemi at dniemi1@bloomberg.net