What Apple really means when it says it has “sold” a product

When can you count a smartphone as “sold” and when can you count it as “shipped”? For mobile industry reporters, this rather arcane argument never fails to come up each quarter when discussing the health of the players in the smartphone or tablet markets. And it always revolves around (who else?) Apple.(s AAPL)

It’s almost gospel in the mobile tech media and among mobile enthusiasts that Apple reports the actual number of iPads, iPhones (and Macs and iPods) it sells directly to consumers during each quarter in its earnings reports. Those numbers are often used disparagingly against other mobile companies when third-party market research firms like IDC report shipment estimates. Still, it’s difficult to get a totally accurate picture of the market; we’ve struggled with it here along with everyone else.

The most common interpretation is that Apple is being open about its shipment totals while its competitors are too shy or scared to share their actual sales numbers. The latter is partly true: Samsung and Amazon,(s AMZN) for example, two of the most prominent Android(S GOOG) device vendors, famously refuse to share either shipment or sales totals in their quarterly results. There are no legal requirements that companies do so. But that secrecy can be used to imply that Samsung or Microsoft or ZTE or whomever are “channel stuffing,” which is retail lingo for shipping a bunch of products to a distributor even if a business can’t or won’t sell them, just to make it look like there’s demand for its product.

But in this case, it’s not quite that simple.

Apple’s “sold” numbers are really its shipment numbers, according to several prominent financial analysts who obsessively follow every word and number that emerges from Cupertino. Horace Dediu, who writes the Asymco blog, told me that “Apple’s reports show shipments not sales.” He added, “All vendors as far as I know report shipment data since that is what they can record.” He has written about the nuances of what being “sold” actually means as well.

When is a sale a sale?

An Apple store in China.

An Apple store in China.

An Apple spokesman pointed me to the company’s earnings statements. Here’s what it says about how it recognizes revenue from the sale of a product:

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Product is considered delivered to the customer once it has been shipped and title and risk of loss have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped. For online sales to individuals, for some sales to education customers in the U.S., and for certain other sales, the Company defers revenue until the customer receives the product because the Company retains a portion of the risk of loss on these sales during transit.

Apple is certainly different from companies like Samsung: it has a pretty enviable outlet through which to hawk its own products. There are a little over 400 Apple Stores worldwide and they, along with Apple’s own website, do a lot of the heavy lifting when it comes to getting Apple products in the hands of customers. And products sold through Apple’s retail channels are indeed products sold directly to customers.

But Apple doesn’t only sell direct: it has retail partners too. We’re talking about big companies like Best Buy,(s BBY) Walmart,(s WMT) Target,(s TGT) to name just a few, and mobile carriers worldwide. Note that in Apple’s most recent earnings release, it reported $5.2 billion in net sales through its retail channel, but about $38 billion in net sales through all of its geographic regions, which represent the location of customers when they purchased products.

When Apple says it sold 37.5 million iPhones and 19.5 million iPads, as it did in its second fiscal quarter press release, this is often interpreted as Apple declaring that 37.5 million iPhones and 19.5 million iPads have been purchased and are currently in purses, pockets, backpacks and briefcases somewhere. But Apple, as several financial analysts pointed out, reports something called “channel inventory too,” which it announces during those same earnings calls.

“Their reported numbers are ‘sell in,'” Toni Sacconaghi, research analyst who follows Apple for Bernstein & Co., said. That number includes product sales to retail partners. “They typically state during their earnings call how much channel inventory changed in the quarter, allowing one to compute to sell out units for both iPhone and iPad.”

Verizon storeThe “channel” is its collection of retail partners, which have grown steadily over the years to include retail powerhouses like Walmart and Best Buy. Apple knows how many iPhones and iPads it sent to AT&T(s T) or to Best Buy — during the most recent earnings call, CFO Peter Oppenheimer noted the company had “11.6 million iPhones in channel inventory, a sequential increase of about 1 million iPhones” during the quarter. Apple also said it had about “four to six weeks of channel inventory.” That means it takes about four to six weeks for its inventory going to retailers to sell out.

Making it count

But Apple has already marked those 11.6 million iPhones as “sold,” since the company has transfered the product to its retail partners, in this case the “customer” as outlined in the revenue recognition criteria above. Therefore, to understand the bigger picture of how Apple is doing versus its competition, it’s best to count those 37.5 million iPhones as “shipped:” Apple doesn’t technically know if all 11.6 million iPhones sold to retail partners have actually been sold to end users, and for the purposes of recording a sale, it doesn’t care.

Obviously Apple doesn’t want iPhones or iPads piling up on store shelves, and there is certainly no reason to believe that is actually happening. It’s a good indication to Apple whether those products sold based on how often the retailer partner reorders products. So while demand for Apple products remains pretty high, automatically assuming that Apple sold all 37.5 million iPhones to actual people during that three-month period is wrong.

It seems like a small thing, but it is important to keep in mind when evaluating the mobile market, especially as it matures and multiple sales channels are employed. In order to present the clearest possible picture of how demand for Apple’s products stands in relation to its competitors, we will be referring to Apple’s announced numbers as “shipped” from now on.