Since Apple started officially selling iPhones in China in 2009, it has been the envy of its Silicon Valley rivals. Where Google and Facebook were sent into exile and Uber conceded defeat to a Chinese rival after a long and costly battle, Apple seemed to be flourishing. Its iPhone thrived as the most visible (and often attainable) status symbol in the world’s largest smartphone market.
But Apple has reached its turning point. Research published in February shows that 2016 was the first year in which the iPhone dropped in the rankings of smartphone sales in China, falling from 15 percent of market share to 11 and selling fewer units even as demand for smartphones grew. With the iPhone now on shakier ground, Apple and outside analysts have talked up the “services” business as the fastest-growing source of revenue. But that hasn’t been going well in China, either. After a chat with government regulators, Apple shuttered two of its services, iTunes Movies and iBooks, a mere six months after their launch. That shutdown — one year ago this week — coincided with the beginning of Apple’s decline in smartphone sales in China.
A question emerges: Did government intervention trigger Apple’s stunning reversal of fortune, or was it bound to happen anyway?
“You begin to see that Apple is approaching that ceiling in growth,” says Z. John Zhang, professor of marketing at the Wharton School of the University of Pennsylvania and executive faculty director of the Penn-Wharton China Center. “Whether that is because of what the company is doing, or what the Chinese regulators are doing, or the general Chinese business environment, that’s something that is up for debate.”
With any Silicon Valley-goes-to-China story, it’s easy to assume that the American hotshot is doomed to play a rigged game. Though elements of that narrative are true, it’s not always the whole story. In Apple’s case, other services, namely Apple Music and Apple Pay, have been allowed to continue to operate. But they are deeply unpopular. China’s native competitors have grown to fill every niche in which Apple has dabbled with more useful features, more local relevance, and therefore more users.
Though the whims of Beijing continue to pose a threat, the popular narrative of Big Government may have overshadowed a more fundamental challenge to Apple’s business. The Cupertino company hasn’t been a victim to regulation so much as a victim of its own failure of imagination.
With competition over smartphone sales growing more intense, in September 2015 Apple broadened its ecosystem of services by introducing Apple Music, iTunes Movies, and iBooks to China. Services are central to Apple’s business strategy. During this year’s first quarter earnings report, CEO Tim Cook said the company’s goal is to double its services revenue by the end of 2020. In addition to providing new revenue streams, services help cement iPhone owners’ loyalty.
But this time, the gambit didn’t work. A mere six months after their roll-out, Chinese regulators from the State Administration of Press, Publication, Radio, Film, and Television stepped in, and the company promptly shut down iTunes Movies and iBooks.
At the time, most news reporting focused on how China’s big government was stepping in to slow Apple’s momentum. The New York Times, for example, pointed out that both iTunes Movies and the iBooks Store had competed directly or indirectly with Chinese services such as Tencent Video and Youku Tudou for video and China Reading (Yuewen Group) for ebooks. Apple Music and Apple Pay seemed like they could be up next on the chopping block.
Yet Apple Music continues to straggle along. So does Apple Pay, the mobile payment and virtual wallet service that launched in China in February 2016. Neither has enjoyed success of the sort that might cause either Chinese competitors or the Chinese government to take much notice. (To be fair, though, neither iTunes Movies nor iBooks was a runaway hit, either.)
In the case of digital music, Tencent controls more than 70 percent of market share with its streaming apps QQ Music, Kugou, and Kuwo, says Alex Taggart, general manager of Outdustry, a Beijing-based music industry services company. Chinese competitors such as NetEase, Alibaba, and Baidu make up the bulk of the remaining 30 percent.
Apple Music could still claw out a niche for itself, if it revised its approach. China has more than half a billion users who often have more than one music streaming app installed on their mobile devices. But Apple’s strategy is at odds with local needs in two key ways. “First off, streaming services in China live and die by the size of their local catalog, and given that the majority of mainland Chinese catalog is tied up in high-value exclusive deals with China’s domestic streamers, there are some gaping holes in Apple Music’s catalog,” Taggart says.
Then there’s the issue of cost — most consumers are used to getting their music for free. For Tencent and the other companies providing them, the streaming apps are just another bridge into a broader ecosystem of services. Apple Music, by comparison, charges a monthly subscription fee for a more limited catalog of Chinese music. In short, Apple’s monthly subscription was “late to the market with an inferior product that is overpriced,” says Robert Lyons, a former digital media executive who is now a visiting lecturer at Northeastern University in Boston. He pointed out that Apple Music’s competitors in China offer customers far more flexibility with different tiers of free and paid streaming. “It’s like you’re living in a big apartment building and there’s a cool party going on in the penthouse,” he says. “They’ve got mixologists and craft beers and craft whiskeys. Apple is you showing up four hours into the party and trying to sell cans of Bud Light.”
Apple Pay faced similar problems when it rolled out in China. Alibaba and Tencent already dominated 90 percent of the Chinese mobile payments market with Alipay, WeChat Pay, and Tenpay. These services are “slick as shit,” says Lyons, and tightly integrated with the social media platforms owned by the same Chinese tech giants.
There’s a technical issue, too. Apple Pay relies on near-field communication technology to transmit encrypted information. Most Chinese customers are accustomed to simpler QR codes that can be easily produced and used by any small business. Chinese businesses interested in adopting Apple Pay must invest in NFC scanners.
Apple would have done better to focus on China’s regional trends rather than develop the payment service for a global market, says Kitty Fok, managing director of the China group at the market research firm International Data Corporation. For example, Apple Pay lagged behind Chinese competitors in providing promotions timed with the Chinese cultural tradition of exchanging red envelopes (“hong bao”) filled with money during the Lunar New Year. That was a “missed opportunity,” argues Fok, during the biggest Chinese holiday season.
“I honestly don’t think Apple understands the local culture enough to achieve local penetration,” Fok says.
The one bright spot for Apple in China has been the App Store, where users download apps and often make in-app purchases. Most revenue from Apple’s services business comes from the App Store, where it can take a cut of any app sales, whether through upfront purchases or micropayments, without bearing costs other than curating and maintaining the App Store’s virtual shelves.
Last year, China overtook the US to become the largest market for App Store revenue. Macquarie Research analysts predict App Store sales in China could more than double by 2020 if Apple simply retains its current Chinese market share. Yet that’s not assured, either. App Store sales in China are primarily a reflection of Google’s absence from China and Apple’s current iPhone market share — a slice that is shrinking already. The App Store may also face a class-action lawsuit from Chinese app developers for allegedly monopolizing access to iPhone apps.
“I don’t see a positive path to large-scale growth for Apple aside from the App Store, and that success was partly created by China’s government decapitating their competitor,” says Lyons. “The App Store is not related to content. It’s just a platform that is really popular.”
Apple seems determined to learn from its Chinese hosts. In March, the company announced it would build two new research and development centers in Shanghai and Suzhou on top of prior plans to build such centers in Beijing and Shenzhen. The company is committing half a billion dollars to its research efforts in China. The key to its success will depend on how well Apple can tailor its existing and future services to better serve Chinese customers. “Apple needs to think about a local strategy, which is more important than anything,” says Fok.
Of course, if Apple ever does figure out its China game plan, it might find itself again staring in the face of Beijing regulators. But until that day comes, don’t blame the government for Apple’s woes in China. Look to the leadership in Cupertino and the mismatch between what they’re offering, and what Chinese users actually want.
Science and technology journalist. Military history enthusiast. Asian Groot in Brooklyn. I grew up with video games.
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