Apple Had to Apologize to China

Why did Apple apologize to China? And was it really necessary?

Those are questions many are asking after Monday’s unusual act of public contrition from the company, in which it pledged to amend its warranty and repair policies in China after nearly three weeks of attacks from state-run media. And there’s an easy answer to both.

• Apple apologized because it can’t afford a prolonged war of words with the Chinese establishment in what is now the company’s second-largest market.
• Yes, Apple’s apology was absolutely necessary. If it wasn’t, you can be certain Apple wouldn’t have bothered.

So why did Apple bother? Short answer: The company’s sales in China hit $22.5 billion in fiscal 2012. That’s more than double what they were in 2011, and it represents about 15 percent of Apple’s total revenue for the year. China is crucial to Apple’s future growth. Indeed, it’s so important that the company recently made Greater China a new operating segment. As Apple CEO Tim Cook said earlier this year, “China is currently our second-largest market. I believe it will become our first. … It’s a very, very important country to us.”

In other words, China is not just a top priority in Apple’s global expansion. It is the top priority. That being the case, any altercation with the Chinese government — whether its origins be real, imagined or manufactured — is decidedly unwise, and almost certainly not good for business.

Recall that Apple isn’t the only tech company to suddenly find itself at odds with China’s state-run media, and the precedents others have set don’t exactly suggest a favorable outcome. As Citi analyst Glen Yeung notes, Hewlett-Packard went a few rounds with Beijing back in May of 2010 and, as a result, the company lost an estimated 42 percent of its market share in the country over the next 12 months.

If you view HP’s 2010 experiences is China as a template for what Apple might face were it not to address the state-run media campaign against it, things could have gotten very ugly, very quickly.

“Apple derives ~16 percent of its sales in China (CY12) and China accounted for ~24 percent of Apple’s revenue growth in the past 2 years,” Yeung explains. “If Apple were to lose as much as 50 percent of their China market share, this would equate to ~$13.1 billion / $3.62 in revenues/EPS.”

Even if Yeung’s estimate were only halfway accurate, that put Apple in an untenable situation. Better to act quickly and publicly make amends than to risk more “Destroy Apple’s ‘Incomparable’ Arrogance” editorials in the People’s Daily, and the prospect of increased regulatory scrutiny from Beijing. Because neither of those things are going to help reach the goal of turning China from Apple’s second-largest market into its first.

Apple’s apology in China cost the company very little; indeed, the changes made to its repair policies in the country were relatively minor. But what it stands to gain from such a public mea culpa from Tim Cook could be significant, extending well beyond a simple easing of tensions in Beijing.

My guess is we’ll see some sort of rapprochement here pretty soon.

Update: And, like clockwork, here’s the rapprochement. From the People’s Daily, via Reuters: “[Apple’s] apology letter has eased the situation, softening the tense relationship between Apple and the Chinese market … Its reaction is worth respect compared with other American companies.”