Apple’s Success in China (Part 5): Costs of Doing Business in China

This is Part 5 of a 9-part essay series on Apple’s Success in China. Part 1 introduces the essay series. Part 2 explains Apple’s product-zeitgeist fit in China. Part 3 looks at product localization. Part 4 looks at Apple’s services in China and relationship with Tencent. Part 5 looks at the complexities of operating in China. Part 6 and Part 7 look at Apple’s compliance efforts in respect of the App Store and iCloud respectively. Part 8 looks at Apple’s investment in DiDi. Part 9 concludes with lessons from Apple’s experience in China.

The opportunity of the Chinese market is widely known (e.g. world’s largest middle-class, fastest growing major economy etc.) but the corresponding complexities are less well-known. Apple’s experience shows the costs of doing business that arise from dealing with these complexities are significant and sometimes somewhat unpredictable.

I am using “complexities” somewhat loosely to refer to issues that range as widely as retail difficulties arising from differing demand elasticities, 羊毛党1 and organized fraud, responding to state-linked cyber-attacks and adverse publicity campaigns, and adopting precautionary measures that blur the line between compliance and public relations.

I have spun off three case studies that fall under such “complexities” and are worthy of further analysis, which will be dealt in subsequent parts of this essay series.

There are two themes that recur throughout both this part and subsequent parts of this essay series.

First, the Chinese state is not monolithic, but rather comprises many entities with different interests, objectives, and time horizons. So it is not at all unexpected that Apple simultaneously:

  • benefits from Chinese industrial policy by the local government to promote manufacturing, as briefly touched uppon in Part 2
  • is compelled into striking tough bargains with state-owned enterprises like telecommunications companies and banks, as discussed in Part 3
  • is subject to state-linked cyber-attacks and adverse publicity campaigns, as we will see below
  • must incur significant costs to comply with Chinese laws and regulations, as we will see in Parts 6 and 7
  • has spent significantly to prove its long-term commitment to the Chinese market

In contrast, I believe it is helpful to model Apple as a largely unitary agent that is acting to maximize its long-term profits.

Second, as this essay series relies on publicly available information, it is not meant to be a full accounting of such “costs of doing business”. While I try to provide as much context as possible, should be obvious, many of these interactions concern parties, including Apple, who have an incentive to keep these behind-the-scenes interactions secret. This is only what rises to the surface and thus necessarily incomplete.

Retail Difficulties

While Apple for the most part applies its same general pricing and retail strategy in China, there are some modifications worth noting.

First, consider Apple’s price skimming tactic. It could be argued that Apple’s policy of requiring price uniformity across different retailers is actually not sufficiently discriminating of the different elasticities of demand within China.

On the one hand, when a new product is launched, there is a subset of Chinese consumer who are willing to pay significantly more than the sticker price. This is evidenced by long lines outside the Apple Store, the preponderance of scalpers, and that these products tend to sell out very quickly upon release.

However, if Apple were to increase the price, this would lower the total sales over the annual product cycle. Already, the official price of Apple products in mainland China tends to be more expensive than those sold in, say, Hong Kong, because of differential taxation. This creates an arbitrage opportunity for iPhones purchased in Hong Kong to be resold back in mainland China, thus distorting the sales of both regions. Apple has adopted countermeasures such as requiring advanced registration of intent to purchase and limiting the number of product that can be purchased in Hong Kong and China to thwart the efforts of scalpers.

On the other hand, there is a larger group of Chinese consumer who are more price-sensitive and, because Apple’s services are less of a lock-in in China, that could be reached at a lower price point.

Apple has experimented with different tactics to cater to both the inelastic demand of the high-end Chinese user and the more elastic demand of the marginal Chinese user. For example, Apple had produced multiple cheaper iPhones (such as the iPhone 5c and the two generations of iPhone SEs) over the years. Notably, Apple has reportedly given “resellers flexibility to cut price” and introduced installment-based payment plans and the option to trade-in older models was featured more prominently on its Chinese website. This author has verified that one could find budget e-commerce retailers selling Apple products sold at a significant discount from Apple’s official sticker price.

At a high level, Apple could sell the latest products directly to the inelastic high-end user and rely on third-party resellers to sell to the marginal user. Obviously, there is a great deal of detail in navigating the tensions inherent in such a strategy.

Second, Apple’s discount and promotion strategy in China is somewhat inconsistent and I was unable to find any overarching explanation for this.2 But, at least with respect to Apple’s education discounts, where a free pair of Beats headphones was offered with the purchase of another product, these drew the attention of so-called羊毛党, i.e. organized effort to take advantages of deals offered by companies. Students were reportedly bussed to Apple Stores and an assembly line was formed to ensure that these students paid for and handed over the products they purchased to the organizers in an orderly fashion, presumably in an attempt to arbitrage the retail prices of the products separately.

Third, it was reported in 2018 that, at least as of 2013, there was widespread iPhone repair fraud in China and Hong Kong, in which organized crime gangs would buy or steal iPhones, remove valuable components, and get a replacement at Apple Stores. Apple’s internal data analysis in 2013 showed that more than 60% of repairs in China were fraudulent, causing Apple to exceed its anticipated warranty repair costs by $2.1 billion. Thereafter, Apple embarked on a cat-and-mouse game with fraudsters and was able to reduce fraudulent repairs in China to about 20%. I was unable to find statistics on the costs of such activities in the years following 2013, or how these costs compared to other regions.

Regulatory Approvals

As a smartphone manufacturer and an Internet services operator, Apple requires regulatory approvals for its products and services.

iPhone Approval

As China became a significant market for iPhone sales, Apple worked to ensure that China would be among the launch country for its newest iPhones. This was achieved with the iPhone 5s and 5c but, in a strange reversal, not with the iPhone 6. While Apple did not give any explanation for the delay, according to Xinhua, an official Chinese news agency, this was because Apple had not received an additional license for network access before it the iPhone 6 could be sold in China.

The better view informed by speculation is that this seemingly technical regulatory delay was linked to earlier criticisms by China Central Television (CCTV), a state-owned television network, that iPhones presented a security risk by tracking the location of its users and potentially transmitting such data to advertisers and US spy agencies, which cited the Snowden revelations. In response, Apple published a lengthy explanation on its website denying these allegations and explained its approach towards privacy and security.

The relevant approvals for the iPhone 6 were subsequently granted, but this particular incident shows that the Chinese government is not above using regulatory approval for the iPhone, whose sale forms a key source of revenue for Apple, as leverage to influence other seemingly unrelated parts of Apple’s business (here, handling of user data).

Internet Services

As mentioned, App Store and iCloud will be dealt comprehensively in later parts of this essay series.

Sometimes, Apple’s compliance with Chinese regulations of Internet services simply requires shutting down services available in other markets. On September 2015, Apple announced that Apple Music, iTunes Movies, and iBooks were available to customers in China. However, in April 2016, Apple announced that the latter two services were shut down after the State Administration of Press, Publication, Radio, Film and Television intervened.3 While Apple issued a statement that they “hope to make books and movies available again to our customers in China as soon as possible”, to date, these services remain unavailable.

It is unlikely that these services will ever come online and these market segments have anyway more or less been filled by domestic Chinese companies. There is probably a mix of censorship considerations, i.e. unease over a US distributor of movies and books (which are arguably more sensitive/regulated formats compared to music streaming—Apple Music remains available), as well as protectionism.

Public Relations with Chinese Characteristics

To reiterate, this is not a comprehensive list of Apple’s public relations incidents in China, but rather a selection of such incidents to illustrate Apple’s general approach. Furthermore, the methodology of only relying on publicly available information instead of, say, an insider perspective is likely to miss out on more subtle or nonpublic incidents.

The 2013 Warranty Controversy

On 15 March 2013, on World Consumer Rights Day, CCTV ran an investigative report that targeted Apple’s policy on after-sales repair services. It alleged that Apple’s warranty policy for China is more stringent compared to that for other countries and contravened the minimal guarantees provided in Chinese law. On the same day, several celebrities posted critical comments about Apple, with evidence suggesting their comments were coordinated. Over the next two weeks, other state media companies stepped up their criticisms, accusing Apple of arrogance. China’s State Administration of Industry and Commerce called for “strengthened supervision” of Apple. The China Consumer Association publicly exhorted Apple to respect consumer rights and rectify its problems.

Apple’s initial response, on the same day of the CCTV’s report, was somewhat generic and did not address the substantive claim. In its subsequent response on 23 March 2013, Apple claimed that its warranty policies are in compliance with local laws and regulations and are largely the same as those in the US and other parts of the world. On 1 April 2013, Apple released a letter from Tim Cook apologizing to Chinese consumers announcing improvements to Apple’s warranty policies. The letter also mentioned that Apple “had much to learn” in terms of its Chinese operations and communications.

Side Note: the actual merits of the allegations against Apple are tricky to analyze without greater knowledge of Chinese laws and regulations and the relevant facts on the ground.

As I understand it, Chinese laws require warranty periods to be renewed if the retailer chose to replace, rather than to repair, the defective item. At that time, it was Apple’s policy to replace defective iPhones, even if repairing was possible, so that users can have a functional phone more quickly. However, to prevent the renewal of the warranty period, Apple chose to retain the back cover of the previous phone, so it was not technically a “full replacement” under Chinese law.

For context, at that point in time, Apple’s revenues in China were accelerating, with significant room for growth ahead, and Apple had yet to launch its phone on China Mobile, the carrier with the most subscribers in China. With the benefit of hindsight and subsequent reporting in 2018, we know now that Apple had also discovered widespread iPhone repair fraud in China in 2013. (See above.)

I am unable to form a view on whether Apple’s warranty policy in China in 2013 was actually meaningfully different from that in other countries and, if so, whether this was motivated by anti-fraud considerations.

Focusing on the merits of the allegations would be missing the point. First, in this instance, managing public relations in China is an extension of dealing with the Chinese government, given the obvious coordinated public relations campaign against Apple. The actual message of the campaign almost definitely goes beyond the semantic emphasis on consumer rights but is necessarily speculative to decode. Plausibly, the actual intention is a protectionist desire to help domestic smartphone manufacturers, or to retaliate against the US government’s new restrictions on ZTE and Huawei’s operations, or to simply take Apple down a notch.

Apple’s shift in tone—from its earlier insistence that its warranty policy is in compliance to its later decision to promise improvements—is arguably a savvy move. This orchestrated campaign against Apple is unlikely to be hugely interested in the substance of its claims (especially if Apple was, at that time, facing a widespread repair fraud). Rather, Apple’s priority was to get out of the crosshairs and return to business as usual. In light of subsequent accelerating Chinese revenues in 2014 and 2015, Apple had arguably pulled this off successfully.

Responding to State-Sponsored Cyber-Attacks

Similar savviness was displayed in Apple’s public relations effort in the aftermath of a cyberattack allegedly by the Chinese government, which was first confirmed by Apple on 20 October 2014. It was a man-in-the-middle (MITM) attack against Apple’s iCloud service, which sought to gain access to usernames and passwords that could be used to access iCloud data using insecure certificates. The attack coincided with the launch of iPhone 6, which was already pushed back from its pre-scheduled 19 September 2014 date because of delay in regulatory approval (see above). As such, this MITM attack—a not particularly subtle attack that would be flagged by most browsers and detected by Apple—is likely intended as a message to Apple and preceded a meeting between Tim Cook and Vice Premier Ma Kai.

After this attack was brought to light, Apple once again adopted a restrained response. Apple changed the DNS of iCloud and posted a support article advising users on how to avoid the attack on their iCloud account on its website, which was only available in English and Chinese. It did not specify the identity of the attacker or rebut the Chinese government’s claims denying responsibility for the attack.

On 29 August 2019, Project Zero, a team of security analysts employed by Google tasked with finding zero-day vulnerabilities, published research showing that iOS vulnerabilities were exploited “to hack the users of iPhones in certain communities over a period of at least two years”. In Apple’s released statement, it downplayed the scale of the attack by noting that it “affected fewer than a dozen websites that focus on content related to the Uighur community” and the attacks were operational for “roughly two months”. From a security perspective, this revelation was significant because the attack used “fourteen zero-days exploits” and thus upended earlier beliefs that such exploits “were used sparingly by governments only against high-value targets”.

From a public relations perspective, Apple’s acknowledgement that the attack targeted Uighur users is all but an admission that the attack is conducted by the Chinese government. (Notably, the Chinese version of Apple’s statement contains exactly the same information.) Might this be construed as an intentionally less subtle response, compared to its previous refusal to identify the Chinese government as an adversarial actor? Nonetheless, in its statement, Apple arguably has sought to downplay the scale of the attack, emphasized that it fixed the vulnerabilities quickly, and did not condemn the Chinese government for its attack or its activities in Xinjiang. This perception has created a public relations risk in the West.

On the point of cyber-attacks, it should be noted that a Bloomberg report of Chinese hardware attack on Western companies, including Apple, and government agencies has been categorically denied by all the companies involved and no corroborating evidence has been produced. In my judgment, is not a credible example of cyber-attack by the Chinese government. Strangely, this report remains unretracted and it is not clear what to make of it.

Precautionary Measures

In light of China’s political environment, Apple has further taken additional measures that are likely aimed at generating goodwill—or, at least, avoiding backlash—from Chinese consumers and the Chinese government.

Since as early as 2014, sensitive terms (e.g. state leaders, dissidents, political slogans, vulgarities) cannot be engraved on Apple’s products sold in Hong Kong and mainland China. The specific policy differs for each market. It is unclear to what extent this measure a result of compliance with Chinese laws and regulations or a proactive measure against potential public relations fallout. Unfortunately, the line between the two is sometimes blurred.

In early 2018, Apple senior executives reportedly gave guidance to the creators of exclusive shows for Apple TV+, Apple’s TV streaming service, “to avoid portraying China in a poor light”. On the one hand, as China has become the largest market for films, many studios in Hollywood do this as standard practice, in the hopes that their films would be approved by Chinese censors. On the other hand, this is notable as Apple TV+ is unlikely to be available in China. As such, Apple’s guidance could be seen as an attempt to protect its standing with the Chinese government more generally.

In October 2019, the software update for iOS 13.1.1 restricts the display and input of the flag of Republic of China (🇹🇼) for iPhones sold in Mainland China and on iPhones signed in with an Apple ID region set to Hong Kong, and Macau. Again, it is unclear to what extent this measure is because of compliance with Chinese laws and regulations or a defense against potential public relations fallout.

On the whole, Apple’s careful compliance and public relations strategies in China has largely paid off. An editorial published by People’s Daily on 13 January 2018 praised Tim Cook for his adherence to the principle of abiding to the local laws and regulations of a market that the company has chosen to enter, in contrast to other companies that have listed Taiwan, Macau, Hong Kong and (bizzarely) Tibet as countries separate from China on their Chinese websites.

  1. This roughly refers to organized efforts to take advantage of deals and discounts offered by a company, sometimes in a manner that might be inconsistent with the offer.[]
  2. Since 2012, Apple had conducted a “Red Friday” sale in Asian markets that celebrate the Lunar New Year, a sale analogous to the “Black Friday” sale in North America and Europe. However, the frequency of “Red Friday” sales is somewhat irregular. They were held from 2012 to 2014, cancelled in 2015, subsequently brought back in 2017, but has since been ostensibly discontinued.[]
  3. Since April 2018, this entity has been re-organized into the State Film Administration, the State Administration of Radio and Television, and the State Administration of Press and Publication, but the substantive regulations remain.[]