Image source: Apple.
Ever since Apple (AAPL -0.81%) launched the iPhone SE in March, the 4-inch smartphone has been the center of a lot of questions. Would it boost iPhone sales? Would it cut into sales of higher-priced iPhone units? Would it convert Android users?
With Apple's fiscal third-quarter earnings release in late July we got some answers. Despite data suggesting that the iPhone SE is cannibalizing the iPhone 6s and 6s Plus in the U.S. and isn't producing many Android switchers, Apple suggests the global story is different. Additionally, it appears the smaller form factor helped Apple sell more iPhones than analysts had expected.
Apple sold 40.4 million iPhone units last quarter, versus analyst estimates of 39.9 million units. The average unit price fell to $595, down from $660 in the third quarter last year and below the consensus estimate of $612. That indicates that the iPhone SE is a success.
Said CEO Tim Cook in the company's conference call: "At its launch, we said that the addition of the iPhone SE to the iPhone lineup placed us in a better position to meet the needs of customers who love a 4-inch phone and to attract even more customers into our ecosystem. In both cases, that strategy is working."
What is a success for the iPhone SE?
The iPhone SE fills a hole in Apple's product lineup on the low end -- that is, Apple's low end. It's priced lower than Apple had been pricing its 2-year-old model, but it brings the capabilities of the iPhone 6s, which play toward Apple's service business (e.g. Apple Pay). Ultimately, the iPhone SE is about bringing more customers into Apple's ecosystem and feeding its services business. Doing that would qualify it as a success.
Said Apple CFO Luca Maestri in the conference call: "... we believe that the SE is doing exactly what it was intended, which is we are seeing a higher rate of new to iPhone customers, which is obviously very important to us as we bring new people into the iOS ecosystem."
The iPhone SE was also intended to open the wallets of existing Apple customers who hadn't upgraded their devices in over two years, so that they could more easily access Apple's newest services. That appears to have happened, according to a recent CIRP survey. The research firm found that 33% of iPhone SE buyers were upgrading from an older iPhone, including some models dating back to 2011 and earlier. That compares with just 17% of purchasers of the newest models and 12% of buyers of last year's iPhones. Cook told investors on the earnings call that the new model is "convincing some people to upgrade that wanted a smaller form factor but wanted to stay with iPhone."
Furthermore, it provides a better entry point for first-time smartphone buyers. Indeed, the CIRP survey indicates a significantly larger percentage of iPhone SE buyers were first-time smartphone owners. That was sentiment was perhaps echoed in Cook's prepared comments on the earnings call: "We added millions of first-time smartphone buyers in the June quarter."
Finally, the iPhone SE is priced to attract customers looking for a phone priced in the midrange, between $200 and $500. Previously, those customers could either buy a 2-year-old iPhone or an Android model. Most opted for the latter. So a high switch rate would indicate that the iPhone SE is succeeding.
The CIRP survey indicates a smaller percentage of iPhone SE customers were switching from Android compared with the larger-screen models in the United States. On the earnings call, Cook noted that "the percentage of iPhone SE sales going to customers who are new to iPhone is greater than we've seen in the first weeks of availability for other iPhones launched in the last several years." While that includes first-time smartphone buyers, Cook added that "switchers accounted for the highest percentage of quarterly iPhone sales we've ever measured."
What about cannibalization?
The biggest concern for investors is that the iPhone SE is too good -- that customers who might have bought a higher-priced iPhone will opt for the low-end SE. That's what the CIRP survey suggests, however, Maestri told analysts, "We have not seen clear evidence of cannibalization from iPhone 6s or 6s Plus." But then he qualified that statement: "Of course, there's always going to be some level of cannibalization, but really to us what is much more relevant is the much bigger opportunity to bring more people into the iOS ecosystem."
Do you think Samsung (NASDAQOTH: SSNLF) worries about whether its lower-end smartphones are cutting into sales of its flagship Galaxy devices? No. It's trying to figure out how much it will cut into sales of Apple's flagship devices. That's how it manages to maintain its global market share lead.
The opportunity with the iPhone SE is to take share from Android and allow Apple's services business to continue growing at a steady clip. Last quarter, services revenue grew 19%.
So while it might cannibalize a few sales of the higher-priced flagship model, that's offset by the additional iPhone unit sales and services revenue.
