Is Apple losing its cool in China?

UBS analyst Steven Milunovich notes that the iPhone is a luxury brand in China and that bad news could lie ahead if Apple doesn't lower its price and differentiate itself from the increasing competition.

Is Apple losing its cool in China? Jason O'Grady

Although sales of the iPhone 4S have slowed significantly, most of that can be attributed "seasonality" -- a.k.a. anticipation of the iPhone 5. Apple's new hotness is rumored to be announced on September 12  and begin shipping on September 21 .

According to UBS analyst Steven Milunovich smartphone penetration in North America and Western Europe is over 60 percent and growth has slowed to 15-20 percent. Meanwhile, Asia-Pacific has smartphone penetration of only 30 percent and growth of 77 percent in Q1 2012.

In comparison to North America and Europe the Asia-Pacific market is virtually untapped because it's half as saturated. UBS estimates Chinese iPhone users have climbed steadily from 2 million in 2010, to 8 million in 2011 to upwards of 25 million currently. iOS penetration exceeds 10 percent in Beijing, Shanghai, and Guangzhou.

That's the good news. 

The bad news is that although the iPhone's enjoyed early success in China it's very much a luxury brand and customers have to dip into their savings to purchase one.

To compensate for the extra expenditure, upper middle-to-high income urban households would need to use 30-45% of annual savings to afford an iPhone, whereas the top decile urban household would need to deplete 19% of annual savings to afford an iPhone.

Beyond the issue of cost, Milunovich suggests that the Apple brand might not be as popular as it was 6-12 months ago. Although there's a "cool factor" to carrying an iPhone in China because it suggests a level of affluence given its cost, that "coolness" might be waning.

Another factor that might contribute to the iPhone's cooling in China is the perception that the Galaxy S has "trumped the iPhone in features." Heavy competition from less expensive phones (from the likes of Huawei and Xiaomi) that are considered "good enough" only makes matters worse.

Milunovich notes that Apple must "earn its premium brand reputation every product cycle." 

Another factor holding the iPhone back is Apple's lack of a carrier agreement with China Mobile, the nation's largest wireless carrier which has  688M customers as of July 2012. Although the iPhone 5 is expected to support TD-SCDMA, China's 3G network, Milunovich doesn't expect China Mobile and Apple to form a strategic alliance anytime soon.

China Mobile even might not ink a deal until it receives an LTE 4G license, which could come in 2014. Also, discussions with China Mobile suggest less interest in the iPhone today.

It's hardly an epidemic though. The iPhone 5 is certain to sell well, but will it be different/better enough to justify spending 30-45 percent of one's annual income to own? Or will the Chinese opt for significantly less expensive smartphones that are "good enough?"