Business

How Inflation Will Affect Apple

Mike Segar | Reuters
  • Apple faces increasing costs from global logistics and rising employee salaries, as well the possibility that consumers will put off their iPhone upgrades.
  • China shutdowns this year tied to Covid-19 and other challenges could result in an $8 billion revenue hit.
  • "We're definitely seeing some level of inflation that I think everybody is seeing," CEO Tim Cook said in April.

The last time Apple faced an inflationary environment like this, it had been a public company for less than a year and its best-selling product was the Apple II home computer.

In May, the annual inflation rate in the U.S. was 8.6%, the highest level since 1981. Other major markets for Apple sales are seeing similar or even higher levels of inflation.

Apple faces increasing costs from global logistics and rising employee salaries, as well the possibility that consumers will put off their iPhone upgrades because of declining purchasing power. Apple is also facing supply constraints related to the China shutdowns this year that could result in an $8 billion revenue hit.

Many firms, especially those with pricing power, can pass increased costs onto their customers by raising prices, particularly if demand is strong. Apple hasn't raised prices for iPhones in the U.S., but regularly tweaks pricing around the world in response to currency fluctuations. Some years, Apple has changed its product pricing structure for its slate of new devices in the fall.

Apple could also eat some of the costs, taking a hit to its margins, while keeping prices stable to avoid denting demand.

"From an inflation point of view, we are seeing inflation," Apple CEO Tim Cook told investors on an earnings call in April. "It is or was evident in our gross margin last quarter and in our OpEx last quarter and it is assumed in the guidance that [CFO] Luca [Maestri] gave for this quarter as well. So we're definitely seeing some level of inflation that I think everybody is seeing."

Rising costs

Cook said there are at least two places where inflation is showing up on the company's balance sheet: gross margins and operating expenditures.

Apple's gross margin for the quarter was 43.7%, higher than analysts' expectations, but down very slightly from the December quarter, which was the highest since 2012, according to FactSet data.

Apple's margin will go down in the June quarter, landing between 42% and 43%, Maestri said. But Apple's margins expanded during the pandemic and they are still at elevated levels on a historical basis.

Operating expenses for the quarter were $12.58 billion, a nearly 19% year-over-year increase. In the June quarter, Apple forecast a sequential increase to around $12.8 billion in operating expenditures.

Tim Cook speaks onstage at the TIME100 Summit 2022 at Jazz at Lincoln Center.
Jemal Countess | Getty Images Entertainment | Getty Images
Tim Cook speaks onstage at the TIME100 Summit 2022 at Jazz at Lincoln Center.

Freight charges are one source of those costs.

"Freight is a huge challenge," Cook said in April. "From an inflationary point of view and from an availability point of view."

Another rising cost is related to the silicon shortage driven by China's Covid-19 lockdowns during the first half of the year, and an overall dearth of less-advanced chips needed to complete its products. Cook said, however, that some components are getting less expensive.

Apple may also be facing increased labor costs. The company is lifting pay for its corporate and retail employees in response to market conditions after some rivals, including Google, Amazon, and Microsoft, made changes to their compensation earlier this year in a bid to attract and retain top tech talent.

"Other companies we follow are missing margins on cost inflation, but Apple views its basket of costs as relatively stable with lower commodity costs offsetting higher labor and freight costs," Morgan Stanley analyst Katy Huberty said in a note after the earnings report.

Possible slowing sales

But increased costs aren't the worst scenario for Apple. The bigger risk is if inflation and other macroeconomic conditions end up hurting demand for Apple's products.

Traditionally, during a recession or in the face of decreasing purchasing power, consumers put off purchases of durable goods, including electronics, economists say.

In Apple's case, this could mean that consumers who bought a phone two or three years ago might decide not to upgrade to the newest model this year and put the expense off until economic conditions are better.

"Sometimes you just exercise some caution and postpone purchases," said Jim Wilcox, a University of California Berkeley economist. "To kind of wait and see is a very sensible financial strategy."

Investors have largely become more comfortable that Apple customers are loyal and therefore likely to continue upgrading their devices regularly, but an inflation-related downturn could throw that conviction into question, hurting Apple's earnings multiple.

"In Apple's case, they have a very strong ecosystem, their customers are very loyal," Bernstein analyst Toni Sacconaghi said on CNBC this week. "But most of their revenue is generated from product sales and that's driven largely by loyal customers, and if you get in a recession, the customers can delay purchases or delay upgrades. So that revenue stream isn't exactly recurring, it's largely transactional."

Apple has not yet signaled weakness. In April, it said demand remained high and suggested that it had not seen signs of deteriorating consumer confidence. The bigger problem was producing enough supply to meet demand for its products.

But the smartphone and laptop markets are showing some signs of slowing. The high-end part of the smartphone market, where Apple sells, is holding up better than the bargain bin, although overall phone sales have started to slide. Micron Technology, a supplier of memory for Apple devices, warned on Thursday that it expected both smartphone sales and PC sales to be significantly lower than previously estimated because of weakening consumer demand, partially caused by rising inflation around the world.

Unit shipments of so-called premium devices that cost $400 or more declined 8% in the first quarter, compared to 10% for the overall market, according to recent estimates from Counterpoint Research.

Wealthy customers cushion the blow

Apple can afford some additional costs. Its sales have been growing for the past two years, and it maintains a healthy margin that's the envy of its hardware competitors.

But Apple may not have to eat those higher costs at all.

Customers tend to have significant disposable income, compared to buyers of Android devices, who tend to choose based on price.

In the "ultra-premium market," or phones that cost over $1,000, Apple took 66% of unit shipments during the first quarter, according to Counterpoint.

"With global inflation rising, the entry-level and lower price band segments are likely to be harder hit," Counterpoint researchers wrote.

A Morgan Stanley survey from June said 70% of U.S. consumers were were planning to cut back on spending over the next six months because of inflation. But wealthy households — Apple's customers — were more positive about their finances and the trajectory of the economy.

"Households with an income of $150K+ are more resilient; the highest uptick in plans to cut back is observed among the mid-tier income cohort," Morgan Stanley analysts wrote.

Over the last five years, Apple has raised prices for its iPhones several times.

In 2017, Apple introduced a high-end $1,000 iPhone model, which drew a substantial proportion of customers who were willing to pay up for a more powerful device. More recently, Apple quietly raised prices in 2020 when it increased the starting price of the mainline, best-selling model — at the time the iPhone 12 — from $699 to $799.

Reuters noted on Friday that Apple has lifted the price of its flagship phone in Japan by nearly a fifth, with the entry level iPhone 13 now costing the equivalent of $870.

Could the company raise prices more broadly again this year? Cook hasn't ruled it out.

WATCH: China lockdown could could cost Apple $8 billion

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