The Wall Street Journal published an article this week quoting me saying “The high end of the smartphone market where Apple is dominant is very mature,” and that the large increases in unit growth are “dead”. While large unit growth is indeed likely in the past, we think the company can continue to generate significant and growing value for both its customers and shareholders.

As we’ve discussed in past posts here, here, and here, we believe that Apple’s iPhones provide a very compelling value proposition for its customers, with the cost of owning an iPhone being in the range of $0.50-$1.00 per day for a device consumers look at hundreds of times a day and spend 2-5 hours on every day.

Source: Statista and Business Insider

According to IDC, Smartphone market growth was roughly flat for all of 2017 compared to 2016 while 1Q 2018 saw shipments decline nearly 3%. Our view of unit growth for Apple’s iPhone business is consistent with a maturing global smartphone market (though iPhone continues to gain modest share), but what still makes Apple an attractive business to own is the high loyalty rate among its customers, reliably bringing back customer to buy new iPhones every 2-4 years, and the profitability of those customers due to Apple’s ability to create products that customers desire emotionally, as they would luxury goods, not just need as a utility. This results in the iPhone’s ability to command 4x pricing over the average utilitarian smartphone enabling Apple to capture around 85-90% of profits in the smartphone market with its 14-15% share of units.

The success of its flagship iPhone X model at a $999 starting price (the top selling smartphone in the world)  has driven the average selling price of iPhone up 14% since its introduction and iPhone revenues up 14%, demonstrating that Apple can still grow its revenue and earnings despite a flat unit market in its largest business, because its products deliver such high value to customers for a reasonably low price. The ability to continue capturing a greater share of that “surplus” value is what will enable Apple to continue growing its revenue and profit over time, albeit at a lower growth rate than in the past. Not to be overlooked is the additional value that Apple is able to provide to its customers with add on services, such as the App Store, AppleCare warranty services, Apple Music, iCloud storage, ApplePay, and iTunes content, and complementary wearables products, such as the Watch, AirPods, and Beats products. Services are a $33B business growing rapidly at over 20% for the past two years and accelerating while the Wearables business is the size of a Fortune 300 company (estimated at $9B revenue) and growing nearly 50%.

In concluding, we believe that despite the maturation of the Smartphone market, Apple still has multiple ways to continue adding value for its customers while generating revenue and profit growth for shareholders. With all of its core capabilities in bringing technology into the lives of consumers in an easy to use way combined with the emotional desire it creates with the design of its products for consumers, we believe it continues to be one of the world’s most competitively well positioned companies.

As of the date of the post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Apple (AAPL). This company represents only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

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