Magic Show: Covering Lower Demand with Higher Prices

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A few major U.S. businesses have been working their magic lately to prop up their revenues.

As the U.S. economy keeps chugging along at the start of 2019 (see the December jobs report), some companies have been utilizing consumer-friendly conditions to their advantage. By marking up their prices, these companies have been keeping the good times going even as demand for their products falls. The higher prices have been making up for slower sales, creating a misleading image of continuous growth.

There are two areas specifically where this is occurring that I would like to point out: Apple and the auto industry.

Although higher prices have kept their revenues growing for the past few years, this strategy spells a hard fall for them in the near future.

The $1,000 iPhone

Anyone who has any interest in tech knows about Apple’s absurdly high pricing for the past few generations of their flagship product. The iPhone X came out with a $1,000 tag, followed by the XS and XS Max at $1,000 and $1,100, respectively. These 4-digit price tags have helped push the average iPhone sale price up from $618 in September of 2017 to $793 a year later.

These hefty prices ended up being beneficial for Apple in 2017 and most of 2018. On August 2nd, the company became the first publicly traded U.S. business to be valued over $1 trillion at market close. The valuation followed their strong Q3 earnings report.

Now, this boom for Apple is not fully attributed to these higher prices. A lot of the revenue growth in early 2018 also came from their growing services (Apple Music, the App Store, etc). However, seeing how the iPhone makes up nearly 60% of their revenue, any big gains have to be at least partially attributed to the handset’s performance. With iPhone sales being relatively flat in 2018, the prices appear to have been a driver of the strong earnings.

So Apple clearly made a good move according to these mid-2018 numbers, but how sustainable is the practice? Seeing that the company cut its revenue forecast for the first time in 15 years in early January 2019, it would appear to be a short lived glory. A major contributor here is a simple one: China, where 20% of Apple’s revenues come from.

Apple bet hard on a strong global economy that was driving through 2017 when they unleashed the prices. Sales may be slower, but growing economies will help line people’s pockets and give them the confidence to spend more on their phones.

Come mid-year though and a trade spat coupled with a slowing economy has challenged that idea in China. As consumer confidence continues to fall, these pricey new iPhones become less and less attractive.

Now, if Apple had not bet so hard on their phones being an inelastic good and kept prices where they had been trending, a Chinese slow down might not be as worrisome. Slowing iPhone sales would have led to lower earnings reports in 2018, but without the surge to a trillion dollar valuation, the drop off would have been milder.

Instead, markets are feeling the force of one of the most prominent companies in the world. A drop off of roughly $430 billion since the August peak has surely been contributing to the recent market volatility headlining newspapers and bad news seems to be rolling out on a weekly basis for the tech giant.

Talk about a hard landing.

Bigger Cars, Bigger Price Tag

Apple is not alone in the game of ratcheting up prices. Look no further than the good old auto industry to see the trend continuing.

Even though new car sales have decreased for 5 out of the 8 quarters between September 2016 and 2018, the average new vehicle cost a record high $38,000 in November. These large price tags are helping to weather the costs that American companies are incurring from the steel and aluminum tariffs imposed by the Trump Administration.

Similar to Apple, car companies are not seeing demand fall across all of their products. Used car sales have been increasing even as new sales fall. This has helped companies like GM and Ford keep their profits growing through 2018. New cars make up about 30% of vehicle sales in the U.S. though, so changes in new car demand have a significant influence on the auto industry’s long run performance. Any current revenue growth can be at least partially attributed to the higher new car costs.

Unlike Apple, the good times are still rolling for the Detroit big shots. They are not a point yet where the high prices are coming back to haunt them. The pricier new cars are making up for the revenue lost from lower sales, and the high demand for used cars is helping to put profits healthily in the green.

They should be wary though. Rising interest rates are adding to the cost burden for both new and used cars. If that gets coupled with any sort of slow down in consumer confidence, we could see used car sales drop off from their current surge. This would leave companies with low demand and record prices, a pretty poor combination.

The auto industry is not quite as dramatic of an example as Apple. GM and Ford are not seeing surging stock prices and are not setting any records. However, keeping their prices high have helped maintain modest revenue growth for Detroit in a year where U.S. new auto sales only grew 0.3%. Being prominent companies as well, a downturn in the American auto industry could have an impact on the economy as a whole (remember the bankruptcies?), so it is important to note the cover up of faltering demand that is underway.

We will see 6 months from now whether or not these auto companies can stay in the green or if their record prices will come back to haunt them.

Strong Economy, High Prices

In the end, these higher prices are reflective of the strong U.S. economy that is continuing to grow despite global turbulence. Companies should be wary of trying to make up for lost demand through price increases though. The auto industry has not quite felt the pain yet, but Apple serves as a good example of the long term viability of the strategy.

You may be on top for a short bit, but the fall hurts quite badly.




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