An employee organizes Apple iPhones as a customer shop in an Apple store.
Mike Segar | Reuters
The last time Apple faced an inflationary environment like this, it had been a public company for less than a year, and its best-selling product was the Apple II personal computer.
In May, the annual inflation rate in the United States was 8.6%, the highest level since 1981. Other markets important to Apple’s sales are experiencing similar or even higher levels of inflation.
Apple faces rising costs from global logistics and rising employee wages, as well as the possibility that consumers will delay their iPhone upgrades due to declining purchasing power. Apple is also facing supply constraints related to China’s shutdowns this year, which could lead to an $8 billion drop in revenue.
Many companies, especially those with pricing power, can pass on increased costs to their customers by raising prices, especially if demand is strong. Apple hasn’t raised prices for iPhones in the United States, but regularly changes prices around the world in response to currency fluctuations. In some years, Apple has changed its product pricing structure for its fall slate of new devices.
Apple could also absorb some of the costs, affecting its margins, while keeping prices stable to avoid depressing demand.
“From an inflation perspective, we’re seeing inflation,” Apple CEO Tim Cook told investors on an April earnings call. “It is or was evident in our last quarter gross margin and last quarter OpEx and it is assumed in the guidance that [CFO] Lucas [Maestri] given for this term as well. So we are definitely seeing some level of inflation that I think everyone is seeing.”
Cook said there are at least two places where inflation shows up on the company’s balance sheet: gross margins and operating expenses.
Apple’s gross margin for the quarter was 43.7%, better than analysts’ expectations, but down marginally from the December quarter, which was the highest since 2012, according to FactSet data.
Apple’s margin will decline in the June quarter to between 42% and 43%, Maestri said. But Apple’s margins have grown during the pandemic and they’re still at high levels on a historical basis.
Operating expenses for the quarter were $12.58 billion, an increase of nearly 19% year over year. In the June quarter, Apple forecast a sequential increase to about $12.8 billion in operating expenses.
Tim Cook speaks onstage at the 2022 TIME100 Summit at Jazz at Lincoln Center.
Countess Jemal | Getty Images Entertainment | Getty Images
Transportation costs are one source of these costs.
“Freight is a huge challenge,” Cook said in April. “From an inflationary point of view and from an availability point of view.”
Another cost increase relates to silicon shortages caused by Covid-19 lockdowns in China during the first half of the year, and an overall shortage of less advanced chips needed to complement its products. Cook said some components are getting cheaper, though.
Apple could also face increased labor costs. The company is raising the salaries of its corporate and retail employees in response to market conditions after some rivals including Google, Amazon and Microsoft changed their pay earlier this year in a bid to attract and retain top tech talent.
“The other companies we track lack margins on cost inflation, but Apple sees its cost basket as relatively flat, with falling raw material costs offsetting rising labor and transportation costs.” , Morgan Stanley analyst Katy Huberty said in a note after the earnings report.
Possible slowdown in sales
But rising costs aren’t Apple’s worst-case scenario. The biggest risk is that inflation and other macroeconomic conditions will eventually hurt demand for Apple products.
Traditionally, in times of recession or when faced with a decline in purchasing power, consumers postpone purchases of durable goods, including electronics, economists say.
In Apple’s case, that could mean that consumers who bought a phone two or three years ago might decide not to upgrade to the newer model this year and postpone spending until economic conditions change. are improving.
“Sometimes you just have to be cautious and postpone buying,” said Jim Wilcox, an economist at the University of California, Berkeley. “Waiting and seeing is a very sensible financial strategy.”
Investors have largely become more comfortable that Apple customers are loyal and therefore likely to continue to upgrade their devices on a regular basis, but an inflation-driven slowdown could challenge that belief, hurting multiple of Apple’s earnings.
“In the case of Apple, they have a very strong ecosystem, their customers are very loyal,” Bernstein analyst Toni Sacconaghi told CNBC this week. “But most of their revenue is generated from product sales and is largely driven by repeat customers, and if you go into a recession, customers may delay purchases or delay upgrades. So that revenue stream isn’t exactly recurring, it’s largely transactional.”
Apple has yet to report any weakness. In April, he said demand remained high and suggested he hadn’t seen signs of deteriorating consumer confidence. The biggest problem was producing enough supply to meet the demand for his products.
But the smartphone and laptop markets are showing signs of slowing. The high-end part of the smartphone market, where Apple sells, is holding up better than the bargain, although overall phone sales have started to decline. Micron Technology, a memory supplier for Apple devices, warned on Thursday that it expects smartphone and PC sales to be significantly lower than previous estimates due to weaker consumer demand, in partly caused by rising inflation around the world.
Unit shipments of so-called premium devices that cost $400 or more fell 8% in the first quarter, compared to 10% for the overall market, according to recent estimates from Counterpoint Research.
High net worth clients cushion the blow
Apple can afford additional fees. Its sales have grown over the past two years and it maintains a healthy margin that is the envy of its hardware competitors.
But Apple may not have to bear those higher costs at all.
Customers tend to have a large disposable income, compared to Android device buyers, who tend to choose based on price.
In the “ultra-premium market,” or phones that cost more than $1,000, Apple took 66% of unit shipments in the first quarter, according to Counterpoint.
“As global inflation rises, the entry-level and lower price-range segments are likely to be hit hardest,” the Counterpoint researchers wrote.
A Morgan Stanley survey from June indicated that 70% of US consumers plan to cut spending over the next six months due to inflation. But affluent households – Apple’s customers – were more positive about their finances and the trajectory of the economy.
“Households with incomes of $150,000 and above are more resilient; the greatest increase in curtailment plans is seen among the middle-income cohort,” Morgan Stanley analysts wrote.
Over the past five years, Apple has repeatedly raised the prices of its iPhones.
In 2017, Apple launched a high-end $1,000 iPhone model, which attracted a substantial proportion of customers willing to pay for a more powerful device. More recently, Apple quietly raised prices in 2020 by raising the starting price of the top-selling mainline model – at the time the iPhone 12 – from $699 to $799.
Reuters noted on Friday that Apple had raised the price of its flagship phone in Japan by nearly a fifth, with the entry-level iPhone 13 now costing the equivalent of $870.
Could the company still raise prices more widely this year? Cook didn’t rule it out.
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