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Haunted empire apple after steve jobs pdf

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Summery & Presentation

Copyright © 2016 Thunderbird School of Global Management, a unit of the Arizona State University Knowledge Enterprise. This case was written by Professor Mary B. Teagarden with research assistance from Caroline Fifi, Ranjit Bhalaero, Brady Rice, and Scott Grindle for the sole purpose of providing material for class discussion. It is not intended to illustrate either effective or ineffective handling of a managerial situation. Any reproduction, in any form, of the material in this case is prohibited unless permission is obtained from the copyright holder. This case was developed using published sources.

Mary B. Teagarden

Apple in China China is an extremely important market for us and we will continue to look at how to grow it further.

Tim Cook, Apple CEO1

China is Apple’s fastest growing market but the road to success has not been smooth. Apple’s products are pre- dominantly contract manufactured in China by Foxconn, a Taiwanese company that was the focus of considerable criticism and negative publicity for poor working conditions and suicides among its young workers. Apple, an aspirational brand in China, was named the top brand in the world in 2015 by Brand Finance—followed by their global nemesis, Samsung. The growing consumer power of the Chinese middle class has accelerated demand for Apple products. Apple’s popularity in China led to considerable counterfeiting or copying of their prototypes, products, know-how, trade secrets, service model, and store concepts. The propensity of some Chinese to show off high-status consumer goods further spurred the activities of Apple counterfeiters and imitators. After more than a quarter century of economic growth, China’s high-growth economy was slowing. Despite these obstacles, Apple CEO Tim Cook maintains that China is key to Apple’s bottom line now and in the future.

Apple Overview In 2001, Apple turned 25 and the consumer electronics domain was experiencing significant changes. The use of digital variants of lifestyle products, such as still and movie cameras, once considered exotic, became com- monplace. Information previously accessed, or media consumed, using a personal computer (PC) was being accessed using portable devices like digital music players; and early smartphones that combined personal digital assistants with mobile phones were available. With the introduction of the iPod followed by the iPhone, Apple underwent a substantial transformation. Apple shifted from their earlier and singular emphasis on the PC to an integrated consumer electronics ecosystem.

That same year, Steve Jobs unleashed the Digital Hub strategy that positioned Apple PCs as an anchor and value enhancer for emerging digital lifestyle devices. For example, a movie captured using a digital camcorder with limited capabilities could be edited using Apple PC application software to create a professional look for personal memories or for commercial purposes. Apple Computer formally renamed itself Apple Inc. in 2007. By 2009, a short two years later, nearly 60 percent of Apple’s sales were from the iPhone and iPod.2 By that time, IBM had exited PCs and sold its PC business to the Chinese multinational, Lenovo. IBM, Apple, and Lenovo were experiencing and responding to the maturation of the PC industry, each taking a different path.

Despite many me-too competitors for digital music players, the iTunes online store and the iTunes sync software for Apple PCs and IBM-compatible Windows-based PCs truly differentiated Apple. The iTunes online digital marketplace provided consumers access to thousands of individual music tracks or albums at an afford- able price, while simultaneously providing a copyright-protected platform for established and aspiring artists whose music Apple made available. Apple’s restrictions on the number of PCs where the music titles could be downloaded and played protected the revenues of the content providers. This feature, not offered by many Apple competitors, allowed the virtual store to thrive by making more and more music available.

Upon launch of the iTunes store, iPod sales shot up by a remarkable 548 percent in the first year. The iTunes success was the precursor for the soon-to-come mobile applications ecosystem—the App Store—that followed the iPhone launch. In 2011, Apple introduced the iPad, an offering designed to integrate the three dominant industry forces of computing, telecommunication, and media simultaneously. In 2015, Apple expanded into wearables and launched the Apple Watch in the United States, China, and other important global markets.

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Tim Cook Takes the Reins Within a day of Apple CEO Steve Jobs’ death, over 63 million tribute messages had already been published on China’s Twitter-like, government-controlled, micro-blogging site Weibo.3

In August 2011, Steve Jobs resigned as Apple CEO and assumed the role of Chairman of the Board due to failing health. Tim Cook, Jobs’ go-to guy, was appointed CEO of Apple. Within six weeks of this transition, Steve Jobs died from complications associated with pancreatic cancer. Industry analysts expressed concern that Cook would not bring the same creative genius to Apple that Jobs brought. Cook had overseen the very successful transition of Apple’s manufacturing from the U.S. to overseas. He was credited with achieving dramatic improvements in Apple’s global supply chain.

Cook was considered a superb operations manager; he closed factories and warehouses and replaced them with contract manufacturers, which reduced Apple’s inventory from months to days. These actions combined with Apple’s design and marketing savvy generated huge profits for Apple. Cook ran the company three times while Jobs was on medical leaves. Yet, analysts doubted that he could replace the legendary Jobs at Apple’s helm. Cook heard repeated refrains that Apple could not innovate under his leadership, that Apple needed a low-cost iPhone to thwart the success of Google’s Android, and that he could never replicate the Jobs magic—and that Apple never again would be “insanely great.”4

Analysts attributed much of Apple’s success on Cook’s watch to the momentum built by products released under Jobs’ leadership. Beyond overseeing Apple’s transition from Jobs’ tragic departure, Cook took actions to imprint his leadership on Apple. In a move away from Jobs’ philosophy, Cook announced that Apple would begin a dividend program and stock buy-back of about US$10 billion.5 Cook relied more heavily on supplier technological advances, and focused on crucial technology such as semiconductors than did his predecessor. Cook understood that suppliers were willing to push their innovations to Apple first, ahead of competitors, given their significance in the industry. In 2015, Apple spent 3.5 percent of its US$233 billion revenue on research and development—a lower percentage than every other large U.S. technology company. That same year, Facebook spent about 21percent of its US$12.5 billion revenue, chipmaker Qualcomm spent 22 percent of its US$25.3 billion revenue, and Alphabet spent 15 percent of its US$66 billion revenue on R&D.6

There is no debate that under Cook, Apple has remained financially sound. In Cook’s first three quarters as CEO, Apple’s market value soared, up almost US$140 billion, with profits of US$31 billion. Apple’s market capitalization hovered around US$500 billion, and at this value Apple was worth US$100 billion more than iconic ExxonMobil. Cook also began aggressive efforts to confront Android competitors head-to-head through penetration of the lower end of the China smartphone market, a profit sanctuary for the Android competitors, through the introduction of the iPhone 5C.

The iPhone 5C: Cheap, Colorful, Cool, for China, and Cook’s Idea With cheaper Android phones eating into their China smartphone market share, Apple launched a more af- fordable iPhone 5C in September 2013.7 The move was aimed at wooing price-conscious customers in markets outside the U.S. and countering the Android challenge. This move was motivated by pressure from Apple’s investors.8 The 5C, a Cook brainchild, was designed to be cheap, colorful, cool, and for the China market. Introduction of the 5C assumed that customers buying their first Apple product would continue to buy other Apple products. At that time, Android devices sold for about US$160 in China. By 2018, 70 percent of total smartphone sales were forecasted to come from emerging markets.9 Were the 5C to be successful in China, it would also be successful in other big emerging markets like India, Indonesia, and Brazil. The 5C launch event at Apple headquarters in Cupertino was telecast simultaneously to Beijing, an emerging market, and Berlin and Tokyo, attractive developed markets.

Apple investors hoped for an introductory price of US$350 to make the iPhone 5C attractive to the lower end of the Chinese smartphone market. To control cost, the 5C model was designed with a plastic case rather than the standard metal case of other iPhone models, and did not have features such as an enhanced camera, fingerprint scan for unlocking, and motion-sensor technology. It also did not have Wi-Fi capability as required by Chinese regulation. In the U.S., the 5C model retailed for US$549. In China, a nonsubsidized 5S model

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http://www.msnbc.msn.com/id/44294819/ns/technology_and_science-tech_and_gadgets/
http://weibo.com/zt/s?k=10278&hasori=1?refer=hot_new_tips
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cost the equivalent of US$866, more than a month’s salary for the average urban worker, and a 5C model cost about US$735.

The 5C was targeted at the 760 million customers of wireless service provider, China Mobile. Apple did not have a distribution agreement with China Mobile until January 2014. Unfortunately, Chinese customers viewed the iPhone 5C as an expensive “cheap” phone. Instead, they preferred, and chose, the iPhone 5S model considered a more affordable high-end phone—one that conferred more status than the cheap 5C despite its 15 percent lower price point. The iPhone 5C only achieved a two percent share of all iOS devices sold after four months on the market. This contrasts with the iPhone 5S that achieved a 12 percent share and the iPhone 5 with a 15 percent share in China according to the South China Morning Post in that same four-month period.

Apple had not given adequate consideration to the aspirational quality of the Apple brand in China. Within weeks of launching the iPhone 5C, Apple reduced orders to its assemblers due to a tepid retail customer response experienced by their service provider partners.10 Did Apple fail to read the Chinese market accurately? Did they charge too much for their new iPhone? Had they inadvertently harmed their brand in China? Despite the tepid reception of the 5C in China, Cook was named number 1 in Fortune’s “World’s Greatest Leaders” in March 2015.

Apple’s Long March in China We intend to offer our Chinese customers leading-edge products and an outstanding sales and service network—a combination that will enable us to succeed in the market.

Michael Spindler, CEO, 1993.

In 1993, CEO Michael Spindler announced that Apple was entering China, where the PC industry was expected to grow 20 percent annually. Spindler set an ambitious goal to reach a 15-16 percent share of the China PC market by 2000. As a latecomer to this market, Apple invested aggressively to localize and build their visibility; build their ease of use; and build a solid base of relationships to support future growth.

Apple’s Localization In September 1993, Apple launched numerous initiatives to support developers, resellers, and PC customers. Taking a lead from Legend, Apple localized its customer interface by providing an entirely Mandarin-language operating environment for Chinese customers.11 Apple sponsored a computer-training center at Tsinghua Univer- sity, sometimes called China’s MIT, to develop long-term relationships with developers, resellers, customers, the government, and strategic partners. Apple established a master distribution agreement with Legend Computer Group—which later became their competitor, Lenovo. Apple opened an office in Beijing.12 By the end of 1993, Apple had captured two percent of the 190,000 PC Chinese market. Their customers primarily comprised the education sector, the publishing industry, or research institutions.

Steve Jobs left Apple in 1985. Rumors swirled that he was forced out by the board due to his inability to deliver products on time and on budget, and because of his emotional immaturity. The board offered him the role of chairman, and those who worked most closely with Jobs on the Macintosh claim that he resigned instead of assuming the chairmanship. During the next 12 years, Jobs founded NeXT, Inc., where he introduced the workstation; and Pixar, a very successful animation studio now owned by Disney.13 Jobs returned to Apple in 1997 eager to refocus the company on innovation—something he thought had been lost in his absence. Spindler left Apple in 1996 before Jobs’ return. Gil Amelio followed Spindler, serving as CEO for a year until Jobs returned. China was not a priority for Amelio or Jobs.

Fifteen years after Apple entered China, in 2008, Apple opened their first store in Beijing—customers waited in line for hours for the opening, in lines that stretched around many blocks. By this time, Apple’s market had diversified significantly, and they were successfully serving the computer and portable music demands of Chinese customers through PC and iPod sales. There was a notable absence of the iPhone in the 700 million Chinese mobile phone market, notwithstanding Apple’s significant efforts to establish a distribution relation- ship with China Mobile, China’s largest mobile service provider. Despite the absence of iPhones, by 2009 there were an estimated 1.5 million legitimately imported or counterfeit Apple “iPhones” finding their way into the Chinese gray market.14

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After repeated failed attempts to negotiate with China’s leading telecom service provider, Apple struck a deal to distribute its iPhones with China Mobile’s competitor, China Unicom—the second largest service pro- vider in China. In September 2009, China Unicom announced a three-year deal with Apple to cover 335 cities by the end of that year. Unicom’s president, Mr. Lu Yimin, said the company’s goal was to capture more than one-third of China’s 3G market in 2010, a market expected to make up 20 percent of China’s overall mobile phone market. See Table 1 for key dates in Apple’s negotiations for distribution agreements with Chinese service providers. Unicom downplayed the impending robust competition looming on the horizon.

By the end of the year, several Android devices were expected to be on the market, including at least one new release by Taiwanese manufacturer, HTC; new releases from both Nokia and Samsung to be distributed through China Mobile; China Telecom planned to introduce Blackberry handsets from Research in Motion and the Palm Pre handset from Palm, Incorporated. David Wolf, CEO of Wolf Group Asia, a Beijing-based market- ing strategy firm, commented, “By the end of the year, China will be a very different competitive environment than it would have faced a year ago, or even six months ago…The iPhone is not going to be a slam-dunk hit for Unicom. But if Unicom and Apple can work together to put together an experience that is so much better than the cracked iPhones, they’ll do great over time.”15 Cracked iPhones are gray market or imported smartphones that enable use of restricted or unauthorized features, such as Wi-Fi, and normally blocked applications.

A Tepid Launch The 5C iPhone launch met with less than stellar results, selling only 5,000 units its first weekend. Loyal customers claimed that they knew they were getting authentic Apple iPhones through China Unicom. Despite this small band of Apple loyalists, the high price, reports of too many dropped calls, lack of features like Wi-Fi, available on gray market phones, and the widespread availability of gray market, unlocked iPhones operating on other carri- ers were all blamed for the 5C iPhone’s weak introductory performance.16 To complicate matters for Apple, the gray market was certainly expected to persist. This tepid launch drove analysts to question whether an emerging economy with low per capita income could support Apple’s expensive hardware.17

Table 1. Apple’s Negotiations with Chinese Telecom Service Providers

• November 2007: China Mobile’s CEO says at an industry conference that it has started talks with Apple about bring- ing the iPhone to China.

• January 2008: A China Mobile spokeswoman tells the media that iPhone talks with Apple are finished. Domestic media say the reason is disputes over revenue-sharing.

• July 2008: Apple opens its first China Store in Beijing—sans iPhone. China Mobile spokesman is quoted saying talks with Apple have resumed.

• February 2009: Interfax reports that negotiations between China Mobile and Apple have broken down again, after stalemate over sale and distribution of mobile applications.

• March 25, 2009: Chinese website Sina.com cites China Unicom’s Shanghai branch saying its parent has reached a deal with Apple to bring the iPhone to China. The report says Unicom might release the iPhone by May 17.

• June 11, 2009: Chinese media report that Apple is recruiting iPhone training and sales managers for Beijing. • July 15, 2009: Chinese website Netase.com reports that Hon Hai’s (also known as Foxconn) Shenzhen factories had

started mass production of iPhones customized for Unicom to remove Wi-Fi functionality, which Chinese rules restrict on cellphones.

• July 28, 2009: Chinese media cited unnamed sources saying China Unicom had signed a three-year exclusive deal with Apple to sell iPhones in China, with Unicom guaranteeing annual sales of one-to-two million phones. Unicom says the companies are still in talks.

• August 11, 2009: A senior executive in Unicom’s Guangdong subsidiary is quoted saying first batch of iPhones ex- pected to be sold in Carrefour stores in China in September. Unicom later issues a denial.

• August 12, 2009: Chinese media report cites a Hon Hai (Foxconn) employee in Shenzhen saying the factory is pro- ducing a non-Wi-Fi iPhone to be released in China in September.

• September 2009: China Unicom announces a three-year deal with Apple to cover 335 cities by the end of that year. • December 2012: Apple and China Telecom announce a distribution agreement. • December 2013: Apple and China Mobile announce a distribution agreement. • December 2014: Apple and China Telecom announce a data storage agreement.

Source: http://blogs.wsj.com/digits/2009/08/27/a-brief-history-of-iphones-in-china/, and author.

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Adding another Chinese service provider would significantly grow Apple’s iPhone sales, but contract ne- gotiations with China Mobile had bogged down over disagreement on a range of issues from revenue-sharing models to basic shipment agreements.18 Further complicating the iPhone’s market penetration was the fact that in China, while mobile subscriptions were high, 3G subscriptions remained relatively low. In early 2012, China Unicom only had 36.5 million 3G subscribers and China Telecom only had 33.4 million.19

Beyond the contracting and subscription challenges were the technology requirements of the different car- riers. In the lead up to 4G, the closest match to Apple’s current technology at the time was with China Telecom, which required CDMA technology similar to Verizon’s in the U.S., but they also required a separate network access licensing process.20 China Mobile, on the other hand, used proprietary technology that would require Apple to develop a unique iPhone offering for that partnership. This was highly unlikely since Apple anticipated a quick rollout of China Mobile’s 4G LTE platform, although it was still in development.21

Apple’s Brand Image In addition to high cost, limited partner access, and technology synchronization challenges, Apple had brand image challenges. Apple’s branding history presented serious hurdles in the China iPhone market. The history of commercials in the U.S. mocking information purification directives and commercials that featured the Dalai Lama, considered a criminal in China, was problematic. These issues, coupled with their self-styled rebellious image, did not position the Apple brand favorably in China, especially in the 1990s.

Regardless, the high-end, sophisticated Chinese customer desired goods that projected high status. Luxury goods. In response to this segment in 2008, Apple repositioned their products as luxury goods in the China mar- ket. To execute this repositioning, Apple located their Chinese stores next to high-end, global brand boutiques such as Louis Vuitton and Ferragamo. Repositioning Apple products and services as luxury goods turned the tide in Apple’s favor. Apple products became the choice of top professionals with affluent lifestyles.22 One way of showing face, referred to as mianzi in Mandarin, is by showing off through the conspicuous consumption of status-conferring luxury goods like the latest Apple iPhone. It is common for a Chinese professional to place his or her iPhone on the table at a meal so that everyone can see it—the newer and more expensive the iPhone, the more face it provides.

Despite initial challenges, Apple’s share in the Chinese market grew quickly and dramatically after reposi- tioning their products as luxury goods. Positioning changes and drivers such as the rapid growth of the Chinese smartphone market had a positive impact on iPhone sales. By Q1 of 2012, Apple reported sales of 37 million iPhones in China, an 88 percent increase over 2011 Q1 results, and 11.8 million iPads, over double the number for the same period.23 These numbers are impressive when compared to worldwide iPhone sales of 68.5 million units in 2011.24 “It was an incredible quarter in China,” CEO Tim Cook told Wall Street analysts. “It is mind- boggling that we could do this well.”25 Smartphone sales had a positive spillover benefit for Apple; they drove growth in purchases of Apple laptops, desktops, and accessories. Apple’s combined revenue in China surpassed that of China’s indigenous high-tech manufacturer Lenovo by 2011.26 Apple was identified as the top Chinese consumer brand, surpassing competition like Samsung and Sony, as well as other well-known brands such as Starbucks, Cannon, and Nestle.27

After six years of negotiations, in December 2013, Apple and China Mobile finally announced that they had reached an agreement to make the iPhone available to over 760 million China Mobile subscribers and ac- cess to hundreds of additional China Mobile sales points throughout the country. This was a major coup for Cook, one that finally gave Apple agreements with all three Chinese carriers, while providing an outlet for the 5C iPhone. He had done something that Jobs had never done—he made three trips to China to establish deep relationships in a market he considered very important to Apple’s future.28

By the Q3 of 2015, Apple’s revenue in China grew to US$13.2 billion, up from US$6.2 billion in 2014. Revenue in the Greater China regions—China, Hong Kong, and Taiwan—was Apple’s second largest after the Americas region with 98 percent of this coming from China alone. Cook told analysts that iPhone unit growth was up 87 percent in the Greater China region in 2014 with the iPhone 6 Plus contributing significantly to these sales. Mac sales increased 33 percent in the same period. App Store revenues had more than doubled. Apple

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announced plans to add 40 stores in China in 2016 to the 25 they currently had.29 More than 20 years after entering China, Apple’s long-term investment in the China market paid off.

China’s Telecommunications Competitive Landscape The market for mobile phones in China, by the end of 2015, was the largest in the world with almost 1.3 billion subscribers. The China market was the world’s largest and most rapidly growing smartphone market, having outstripped U.S. vendor shipments in Q3 of 2011. China’s three major telecom service providers are China Mobile, China Unicom, and China Telecom. China Mobile is the world’s largest carrier with more than 803 million subscribers, and accounted for 66 percent of China’s total mobile service subscriber base.30 Apple’s original iPhone distribution partner, China Unicom, sits at second place with just under 300 million subscribers. Third place is China Telecom, with the world’s largest number of landline accounts—over 216 million and over 43 million mobile subscribers. Only about 10 percent of Chinese mobile subscribers used 3G. Most subscribers simply used their phones for calls and text messaging.

Five competitors—Nokia, HTC, Samsung, Motorola, and Apple—dominated the 2011 smartphone in- dustry in China.31 Foreign manufactures were the most competitive at that time. Nokia dominated, but had a rapidly and precipitously declining market share, down from 50.3 percent in 2011 to three percent market share in 2011. In contrast, second place Samsung’s market share quadrupled from Q1 2010 to a 19.2 percent market share. Apple’s market share more than doubled over the same period. However, Apple was still in third place at the end of 2010. It slid to fourth place at 10.4 percent in Q3 2011.

Apple’s relatively fixed price structure and limited mobile phone offerings limited its growth potential in China. Apple remained focused on the high-end luxury market. Other foreign and local competitors with more flexible pricing and a wider range of product offerings were beginning to dominate the market. However, the smartphone market in China was very dynamic and the foreign majors—Samsung, Apple, and Nokia—faced looming competition from indigenous smartphone manufacturers like Huawei, Lenovo, and Xiaomi. Table 2 shows worldwide smartphone market share dynamics.

By 2012, Apple had a 7.5 percent market share in China for smartphone sales by volume, compared to Samsung that had 24.3 percent. Samsung secured this lead by supporting all three service providers: China Telecom, China Unicom, and China Mobile. By 2014, Samsung’s share had slipped to 7.9 percent, Nokia’s was below three percent, and Apple’s grew to 12.3 percent of the China market.

While Apple enjoyed success at the high end of the China smartphone market, they faced stiff competition from regional and local competitors. South Korea’s Samsung was a fierce head-to-head competitor—together, Samsung and Apple formed an OS and Android duopoly that dominated over 70 percent of the global smart- phone market. China’s indigenous competitors—Huawei, Xiaomi, Lenovo, and smaller local competitors, not well known outside of China—produced and sold smartphones to mid-tier and low-end customers.

Xiaomi’s rapid rise is changing the smartphone landscape in China and potentially the world. While industry giant Apple’s attention was focused on overtaking industry leader Samsung for the fast-growing China market, Xiaomi burst onto the mobile phone scene catching both giants off guard. In five years, since their founding in 2010, Xiaomi rose to be the world’s third largest smartphone company based on units shipped. Samsung and Apple hold the first and second spots, respectively. Table 3 shows the top Chinese smartphone manufacturers in 2015.

Table 2. Worldwide Smartphone Market Share

Samsung Apple Huawei Xiaomi Lenovo Others 2015 21.4% 13.9% 8.7% 5.6% 4.7% 45.7% 2014 24.8% 11.6% 6.7% 4.6% 8.0% 44.3% 2013 31.9% 12.9% 4.3% 1.7% 5.7% 43.6% 2012 32.2% 16.6% 4.1% 1.0% 5.9% 40.2%

Source: IDC, August 2015.

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Table 3. Top-Selling Chinese Smartphone Brands 201532

• Xiaomi: The top smartphone brand in China. • Huawei: Huawei is a well-respected global telecommunications equipment manufacturer that competes with Cisco

for a share of the telecommunications equipment market. This company is the biggest smartphone manufacturer. Although smartphones are not its flagship product, Huawei is regarded as the second best Chinese smartphone brand in 2014.

• Meizu: The third best Chinese smartphone brand, Meizu, launched the Meizu MX4 and the Meizu MX4 Pro in 2014. Meizu smartphones are well known for their quality construction and high-end specifications at mid-range prices. Meizu has a well-respected music app and a Meizu fan base that helps to propel this brand to greater heights.

• Oppo: Oppo is considered the fourth best Chinese smartphone brand. In 2014, it developed the first motorized rotating camera and the world’s slimmest smartphone, which measured 4.85mm in thickness. Its flagship brand for 2014, Find 7, runs on Android 4.3 operating system, has 1440p display, and a Snapdragon processor.

• OnePlus: OnePlusOne is the flagship smartphone for fifth place OnePlus. This smartphone possesses high-end speci- fications, a stylish design, durability, and is sold unlocked at less than half the price of other high-end smartphones. The approximate selling price is $299. The smartphone’s operating system is either Android 5.0.2 OxygenOS or Cynogenmod. OnePlus has built a strong following through an exclusive marketing strategy: Consumers could only purchase the smartphone if they received an invitation to do so.

• Zopo: Zopo, in sixth place, is a high-quality smartphone manufacturer, but does not have the consumer following of better-known Chinese brands. As a result, the outlook for this company in such a highly competitive market is not very promising.

• Elephone: In seventh place, Elephone targets the low end of the smartphone market by the production of inexpensive phones. However, they manufacture low-cost phones with good specifications. So, the future prospects for this brand look quite bright. (See Exhibit 1 of the Elephone P7000).

• Lenovo: Lenovo, in eighth place, is known for producing reasonably good products, including smartphones, but the company does not create marketing hype for its smartphones, nor does it develop cutting-edge phones. It is a worldwide player in the smartphone market.

• ZTE: ZTE is in ninth place. Founded in 1985, the Shenzhen-based manufacturer is China’s largest publicly traded telecommunications equipment company, listed on the Hong Kong and Shenzhen stock exchanges. ZTE is commit- ted to research and development, having been recognized by the International Data Group as one of China’s top 10 competitive brands and the most innovatively competitive brand among the top 10 holders. ZTE has been recognized by the World Intellectual Property Office as one of the world’s largest originators of technology patents. They spend 10 percent of their annual revenue on research and development—with research centers in China, France, and India. ZTE has a reputation for making quality, affordable, and customized phones.

• UMI: UMI, in tenth place, is known for delivering quality metal smartphones. They have positioned themselves in the high-end of the market, and analysts expect them to become much more popular in 2015.

Source: Adapted from: http://chinese-smartphones.com/top-10-best-chinese-smartphone-brands/. Retrieved July 4, 2015.

Exhibit 1. Elephone’s Flagship Smartphone for 2015 P7000

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Chinese Telecommunications Service Provider Dynamics While the China market was booming for foreign handset companies, Chinese telecom service providers were reconsidering their earnings from the sales of high-end devices. Within the industry, a common justification for pushing smartphones has been increased average revenue per user (ARPU) since smartphones require higher priced data plans to fully utilize the phone’s functionality. However, the more expensive foreign phones also required higher subsidies, offsetting the increased ARPU, thus driving down margins.33

China Unicom reported that its EBITDA margins for mobile phones dropped from 48 percent in 2008 to 24 percent by the end of 2011. Given downward pressure on margins, Chinese service providers trended toward the promotion of less expensive smartphones where the subsidies were much lower. This allowed them to reduce their subsidy costs while keeping their ARPU rates high.34

China Telecom announced its intention to purchase 45 million cheaper smartphones from a variety of local Chinese champion firms such as ZTE, Huawei, and Lenovo.35 As Chinese firms gradually increased the quality of their products, they were beginning to compete with Apple’s aspirational handsets, but with a greater market reach potential than Apple because of their lower prices. These national champions were able to strike the ideal price point, about 70 percent of workers’ monthly salary, as opposed to the two-month’s salary required to purchase an iPhone.36 As a result, Huawei unseated Apple’s third place market share position in 2011, reaching 11 percent. By 2014, Apple had pulled ahead of Huawei and secured the second place market share position.

To further complicate Apple’s position in China’s smartphone industry, as they and other foreign smartphone manufacturers began to significantly penetrate the vast Chinese market, local mobile phone manufactures felt threatened. To counter the external pressure from foreign competitors and with encouragement from the Chinese government to pursue indigenous innovation, several Chinese mobile manufacturers, including Lenovo, Coolpad, Konka, ZTE, and TCL, formed an alliance to strengthen their global positions and create a patent portfolio.37

The extraordinary growth in China’s smartphone industry is reflected by the increase in the manufacture of smartphones from 1.3 million units in 2003 to approximately 488.6 million units in 2014. From 2009 to 2013, revenue for the smartphone manufacturing industry in China grew at an average annual rate of 53.9 percent, and revenue was forecasted to grow 21.2 percent and total $68.9 billion in 2014. Table 4 shows China’s smartphone shipments by vendor in 2013 and 2014.

Increased consumer demand for third and fourth generation smartphones, as well as greater exports, were the drivers of the upsurge. Other significant drivers include the continued growth in sophistication of the mar- ket’s technology in 3G and 4G. To this end, China Mobile, China Telecom, and China Unicom all obtained 4G licenses by the end of 2013. Chinese smartphone manufacturers are attuned to consumers’ price sensitivity and have responded with highly competitive pricing to the extent that their offerings are often less than half the price of products from established foreign competitors. The extensive range of smartphones available in the Chinese market at low, middle, and top-tier prices is another contributor to industry growth.

Table 4. China’s Smartphone Shipments by Vendor, 2014Q4 vs 2014Q3 and 2013Q3

Rank Vendor 2014Q4

Market Share 2014Q3

Market Share 2013Q4

Market Share Year-on-Year Unit Growth 2014Q4

1 Xiaomi 13.7% 14.8% 6.5% 150% 2 Apple 12.3% 5.0% 7.4% 99.7% 3 Huawei 11.0% 9.1% 10.2% 28.3% 4 Lenovo 9.5% 12.8% 13.2% -14.3% 5 Samsung 7.9% 11.0% 18.8% -49.9%

Others 45.6% 47.2% 43.9% 23.5% Total 100% 100% 100% 19.1%

Source: IDC Asia/Pacific Quarterly Mobile Phone Tracker, February 2015.

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Industry distribution channels are telecommunication operators, e-commerce, electronic retailers, mobile phone stores, and domestic agents. Apple and Samsung entered into strategic alliances with telecommunication operators to sell their phones. By 2015, Apple and Samsung had distribution partnerships with China Mobile, China Telecom, and China Unicom. Apple also sells through brick-and-mortar stores and through large agents. Samsung, on the other hand, uses domestic agents in addition to carriers. Leading indigenous competitor Xiaomi has mastered the use of an e-commerce platform as the primary vehicle to build its brand and record astounding sales. Apple’s parity with Samsung was the result of their distribution deal with China Mobile that enabled them to make inroads in China that were once believed to be impossible. As revealed earlier, Apple’s brand simply did not hold the same cachet as Chinese and regional smartphone makers.38

The industry is quite fragmented as the listing of the top ten Chinese smartphone makers above reveals. The outlook is that as e-commerce reduces barriers to entry, the entry of new Chinese players will continue, thereby intensifying competition and potentially lowering already cutthroat pricing. Notably in 2013, industry profitability stood at approximately 3.4 percent of turnover.

Telecommunications operators are in a controlling position in the Chinese market because they provide subsidies, mostly to low-end smartphone producers. This aids in depressing prices further as smartphones become commonplace in third- and fourth-tier Chinese cities.39 The scope for greater margins seems to lie in high-end smartphones to meet the needs of the nation’s growing middle class. Analysts anticipate that indigenous competi- tors will soon position themselves in the high-end product portfolio.

Apple’s Other China Apple has a behind-the-scenes manufacturing presence in China in addition to their visible sales efforts. Beginning in the 1980s, electronic hardware component contract manufacture in Asia experienced rapid growth with an industry-wide migration to offshoring manufacturing.40 Apple resisted this offshoring trend. In 1990, Jobs said, “I’m as proud of the factory [in America] as I am of the computer.” But, for the electronics industry, computer component manufacture was shifting to Germany, Taiwan, Japan, Korea, and China. Assembly quickly followed.41 One example is the Taiwanese electronics contract manufacturer Hon Hai—better known as Foxconn, an early mover in this trend. By 2015, Foxconn employed 1.4 million people in China, making it China’s largest private employer. Foxconn manufactures electronic products for Sony, Hewlett-Packard, and Dell, among others, and smartphones for Nokia, Motorola Huawei, Cisco, and Xiaomi. By 2015, Foxconn’s China operations produced more than 40 percent of the world’s consumer electronics.42

By 2004, Apple had succumbed to the lure of offshoring. Cook, then COO, orchestrated the transition of Apple’s major manufacturing operations from the U.S. to China. Part of this shift was driven by lower factor costs and availability of China’s abundant semi-skilled labor, though most tech companies agree this is only a small fraction of the overall supply chain costs. What really drove Apple’s decision, according to Cook, was that factories could scale to meet demand faster than in the U.S., and the Asian supply chains feeding these contract manufacturers had surpassed those of the U.S. The entire supply chain could be co-located in China, scaling up and down as needed.43

One example of the extreme supply chain flexibility occurred when a Chinese contract manufacturer was asked to overhaul iPhone manufacturing to add a new faceplate just weeks before a critical retail launch. New screens arrived at the plant at midnight. The plant foreman went to company dorms and roused more than 8,000 workers. Within half an hour, after being provided with tea and biscuits, workers started on 12-hour shifts. Within 96 hours, the contract manufacturer was producing 10,000 of the new iPhones a day.44

The majority of Apple products and components are now manufactured in China where their low value- add inputs are sourced and final assembly occurs. The high value-add activities, including product design, soft- ware development, product management, marketing, and other high-wage activities, are done in the U.S., not China—but this too is starting to change.

Foxconn is Apple’s largest contract manufacturer in China where Apple contributes between 40 percent and 50 percent of Foxconn’s revenue. Foxconn assembles Apple’s iPhones in Shenzhen, Henan Province, and

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Shanxi and iPads in Chengdu. Apple also uses Pegatron in Shanghai to assemble iPhones and iPads. Pegatron manufactures accessories for Apple from contractors BYD also uses in Shenzhen, and iPads from Compal Elec- tronics in Nanjing.

Contract Manufacturing Controversy Contract manufacturers like Foxconn are not without controversy. Controversies involving labor protests, threats of mass suicides, and factory explosions leading to work-related deaths continue to mount.45 Supply chains, such as Apple’s, face increasing customer, media, and investor scrutiny, and the realities of contract manufacturing have brought other challenges. Often highlighted or exposed for poor working conditions and dirty environmental practices in a Pulitzer-Prize winning article, contract manufactures have proven to be a public relations liability.46

Apple’s major contract manufacturer, Foxconn, is at the center of much of the electronics industry’s off- shoring controversy. It is not uncommon for the most visible brands like Apple and Foxconn to take the heat for the entire industry. At Foxconn’s Shenzhen compound, a location that employs more than 300,000 people supported by three hospitals, a fire station, supermarkets and restaurants, a string of 10 suicides brought in- ternational media attention. This heightened scrutiny raised awareness of problems ranging from the claims of dangerous; dehumanizing, mechanical, highly routinized work; drudgery of compound life; low wages; and crowded conditions in dormitories.47 Despite reports of negative conditions, hopeful Chinese employees seem undaunted; they continue to line up for employment opportunities.48

Responding to what has been described as the human cost of contract manufacturing, Apple addressed the issues facing its supply chain in part by joining the Fair Labor Association, an independent association that sets global standards, monitors and reports plant performance, and supports compliance. Apple worked to ensure that suppliers met its standards of safety, pay, working conditions, and environmental practices—requirements for working with the company—through Fair Labor Association audits that have doubled since Apple became aware of problems at Foxconn.

Apple launched environmental initiatives in China and across its supply chain, as part of an increasing focus on the importance of China as a market and manufacturing hub. Apple expanded its environmental aspi- ration to include a commitment to move all of its supply chain—including activities in China—to 100 percent renewable energy. They committed to a five-year project with the World Wildlife Fund to increase the amount of responsibly managed forests in China. These sustainable forests will be used for the pulp, paper, and wood that goes into Apple’s products, and allow it to create the packaging and other materials for its devices without damaging the environment.

In addition to addressing their own supply chain, Apple encouraged “good and green” conditions at those suppliers that feed their supply chain. Apple hoped that other companies in China would adopt the model used in their supply chain. Apple “will encourage others to join in making smart investments in clean energy to match consumption.” Foxconn, for example, announced plans to build huge solar panel facilities, and announced tie-ups with other suppliers that will help build solar energy projects.49 Will Apple’s focus on “green” provide sufficient evidence of corporate responsibility for its customers?

Counterfeits and Copycats Apple experienced numerous problems associated with intellectual property (IP) leakage ranging from coun- terfeit products sold on the gray market to industrial espionage. As revealed earlier, Apple relied predominantly on Foxconn for sourcing components, manufacturing products, and more recently for some aspects of R&D. Foxconn serves other smartphone, computer, tablet, and accessory manufacturers—those with which Apple competes—such as Xiaomi. An examination of Xiaomi’s component sourcing practices revealed opportunity for the leakage of common parts and processes from Apple to an indigenous competitor. Xiaomi sourced many core smartphone components from Apple’s suppliers and contracted with the same smartphone assemblers to make them.

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Apple faced IP challenges regionally. In 2011, Apple claimed that Samsung had copied their iPhone design and sued them in the U.S. courts. The court found in favor of Apple and in 2012 ordered Samsung to pay US$1 billion in damages. Samsung appealed and the damages were reduced and split into two—US$548 million for technology patents that the court found Samsung copied, and US$382 million for the package design that the court found were also copied. In December 2015, Samsung agreed to pay Apple US$548, one part of the settle- ment upon receipt of an invoice. Disposition of the remainder was still tied up in the courts by 2016.50

Fake Apple Stores Pulled by the demand from customers who sought the face that Apple products would give them, counterfeit Apple stores began popping up around China—in some cases reselling actual Apple products from factory overruns.51 Bloomberg reported in mid-201152 that Chinese authorities investigated 300 counterfeit shops for licenses. After this investigation, Chinese officials closed two shops for the unauthorized use of the Apple logo. The authorities identified 22 additional shops that used the Apple logo without Apple’s permission; these were not closed because the shops had operating permits. The government closed 1.6 percent of the shops investigated. About 47 percent, or 502,900 iPads, sold in Q2 2011 through retail stores were not authorized by Apple.

Apple operates in Shenzhen where they have one official store and five authorized dealers. There are more than 30 stores that look just like Apple’s signature outlets and carry Apple’s iconic white logo. These stores have sales staff dressed in blue T-shirts bearing the Apple logo who take orders for the new iPhone 6 Plus, and demon- strate iPads and iWatches on sleek wooden tables. The fake Apple store model is so lucrative that it has spawned a cottage industry servicing such businesses. In a giant tech mall near where the fake stores are concentrated, there are two shops that sell the logos, uniforms, display shelves, and shopping bags to make an unauthorized outlet look and feel like a genuine Apple store. An owner of one of the shops that helps unauthorized dealers set up specialized phone stores suggested that it might be time for fake Apple dealers to think about switching to other brands like Huawei or Xiaomi.53

The Future of Apple in China The progress in China has been amazing. Certainly in my lifetime, I have never seen a country with as many people rising into the middle class that aspire to buy products that Apple makes. I think it’s an area of immense opportunity, and it has quickly become number two on our list of top revenue countries…the sky is the limit there.54

Tim Cook, CEO, 2014.

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