Apple 2.0

Covering the business that Steve Jobs built

What it cost Apple last quarter to smooth China's ruffled feathers

May 2, 2013: 12:03 PM ET

In one day, Apple's profit margin went from the high end of its range to the low end.

Screen Shot 2013-05-02 at 11.50.58 AMFORTUNE -- After Apple's (AAPL) quarterly report last week nearly every analyst we heard from pointed out that the company's 37.5% gross margin -- the measure of how efficiently a company turns sales into profits -- was at very bottom of its 37.5%-to-38.5% forecast range.

The analysts offered a variety explanations, but most attributed the reduced margins to increased competition from Samsung and other manufacturers of Android smartphones and tablets.

But there's a simpler answer: China.

I don't know who hit on this theory first, because Wall Street analysts never credit their competitors' scoops.

  • Asymco's Horace Dediu had it in a post called Margin Call 2 that was time-stamped Thursday, April 25 at 2:38 a.m.
  • Wells Fargo's Maynard Um offered the same explanation in a note to clients issued later that morning.
  • Morgan Stanley's Katy Huberty wrote about it on Tuesday April 30, five days later.

The theory is this: On the last day of the quarter Tim Cook, to appease government-owned media outlets that for two weeks had been attacking Apple on a daily basis, issued an apology to his Chinese customers and changed Apple's warranty and return policies -- among other things, extending the warranties on any iPhone brought in for repair in China for a full year.

At the same time, according to the company's SEC Form 10-Q, Apple booked $414 million in so-called warranty accruals to account for the impact of changes to certain unnamed "service policies and other estimated warranty costs." That $414 million came directly out of last quarter's iPhone revenue and reduced the company's overall gross margin by nearly 1 percentage point.

Morgan Stanley's Huberty estimates that if it weren't for China's media campaign and Cook's response, Apple would have reported a gross margin of approximately 38.4% -- just shy of the top of its guidance range.

How the market would have reacted the next day to the higher margins, we will never know.

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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