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The iPhone Needs China

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Apple's (NASDAQ: AAPL) CEO, Tim Cook, recently visited China. In an interview with a Chinese paper, he suggested that China will become his company's number one market. While “face” is important in China, resulting in such silly terms as “Most Favored Nation,” Cook's comments are far from posturing. If the country doesn't become a big market, Apple is in trouble.

The Chinese Story
While the size of China's population, which is massive, is often highlighted as the reason why the Chinese market is so attractive, it isn't the real reason to get excited about that market. It is the country's industrialization that is truly the driving force, as it moves from a largely agrarian economy to an industrialized one.

The same shift took place in the United States, and in other industrialized nations around the world, so there is a clear picture of what is going to happen. As the country continues its steady march toward developed status, its population will start to have more money to spend. And they will gladly spend it, perhaps not in the same way as in the United States, but companies in the market with desirable products will see above average sales growth. The best part is that the shift should last a long time yet.

Apple's Problem in China
Apple hasn't executed particularly well in China. It has partnered with smaller cell phone providers and, thus, has been left with a relatively small share of the smart phone market. Oddly, there is notable demand for the company's products, for example, hucksters have opened up fake Apple stores and the risk of riots caused store closures when Apple introduced the iPhone 4S. While neither of these are actually good things, they do speak volumes about the potential being missed.

This is why Cook met with China Mobile (NYSE: CHL), a provider of cellular phone service in China and Hong Kong, on his recent trip. This telecom giant is among the largest cell providers in the world, and will continue to see more subscribers as more and more people in its markets can afford to use its technology. The shift to increased data usage will also help spur results.

Apple, however, can't touch any those customers because it doesn't have an agreement with China Mobile. One stumbling block to a deal could be the fact that China Mobil is, basically, state owned. This has likely led to China Mobile's use of technology that isn't an industry standard in the world, which has been a competitive disadvantage of late. And it could also make a deal with Apple more complicated to consummate for both companies.

Apple's Bigger Problem
Apple's primary smart-phone operating system rival Google (NASDAQ: GOOG) has a much different strategy. It basically gives its operating system away so that it can sell advertising. This allows the company to work with any manufacturer and any cell provider. Apple, on the other hand, doesn't let anyone use its operating system and tightly controls its product sales.

Advantage Google. This also helps explain some of Apple's price swoon, as investors have come to realize that the company isn't going to grow forever. The start of a dividend was also a notable signal that the company doesn't see as much opportunity going forward, though the it would probably dispute the market's perception.

Apple's business model makes it more of a device seller than anything else. While this has worked very well for the company as the smart-phone market has heated up in the United States, now that the market is pretty much saturated, growth is likely to slow unless it continually convinces customers to buy the newest phones it sells. That can only last just so long without material upgrades, which the last iPhone notably lacked.

The success of the iPad has helped sales materially. However, after introducing three revolutionary products, expecting the fourth, fifth, and sixth products to be as big becomes a harder proposition to put one's money behind. Especially since other products, like Apple TV, haven't been smashing successes.

China to the Rescue
So how is a device maker to make more money if its primary market is saturated? Find a new one with lots of customers, that's how. China is a ready-made market, if Apple can crack into the big leagues there. So far it's stuck in the minors. So, Tim Cook needs China to become its biggest market a lot more than China needs to be Apple's biggest market.

Investors in Apple, whose Achilles heel seems to have been exposed, have to hope that Cook is right if they want to see Apple continue to grow sales.


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ReubenGBrewer has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, China Mobile, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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