How Cheap Will Apple's "Cheaper" iPhone Be?

As Apple's (NASDAQ: AAPL  ) growth has tapered off during the past several quarters, analysts have turned their attention to rumors of a "low-cost iPhone." The smartphone industry still has tremendous growth ahead of it, but most of this growth will be in the low end of the market (phones that cost $200 or less unsubsidized). However, Apple's "entry-level" iPhone 4 sells for $449 unsubsidized in the U.S., which places it in the high-end smartphone category.

By contrast, Samsung (the clear leader in Google's (NASDAQ: GOOGL  ) Android ecosystem) has a strong position in high-end smartphones, but it also has a substantial presence in the low-end market. The growth of mid-range and low-end smartphones has driven an explosion in Android's market penetration in the past few years. If Apple wants to reignite growth, it will need to expand its reach beyond high-end smartphones.

There are many open questions about what Apple's low-cost iPhone might look like, but the big question for shareholders is how the release of a cheaper iPhone will affect Apple's earnings (and thus, its stock price). This, in turn, depends heavily on what Apple decides to charge for the new iPhone. If the price is too low, it will have low margins and will also cannibalize sales of more expensive, higher-margin iPhones. On the other hand, if the price is too high, Apple won't be able to gain much market share. I believe that Apple will err on the high side in terms of pricing, targeting the mid-range smartphone market with a $329 or $349 price point.

The background
Apple reportedly considered introducing a low-cost iPhone as early as 2009. However, rather than building a separate, cheaper iPhone, the company decided to use older iPhones as entry-level models. Nevertheless, by early 2013, most Apple-watchers expected the company to launch a new low-cost iPhone soon, perhaps as early as this year. On Thursday, leaked photos of what could be a prototype low-cost iPhone made their way around the Internet. According to the site that originally posted the photos, this new device will have a plastic case and will share many components with the iPhone 4 and iPhone 4S.

The iPhone 4S, Apple's middle-tier offering. Photo: Apple.

According to a teardown analysis by IHS iSuppli, the total manufacturing cost of the iPhone 4S was $196 as of October 2011. That included the cost of all components and manufacturing, but not the cost of software, logistics, or patent licenses. Component prices have dropped since then, and Apple would save money by moving from an aluminum case back to plastic, as has been rumored. That said, CEO Tim Cook has adamantly stated that the company will not compromise product quality, so there is a limit to how low Apple's production costs can go. It seems possible that Apple could reduce its all-in cost to $150 or $160, but probably not much lower than that.

Hitting a price
If Apple won't be able to meet its high quality standards for less than $150 (including all manufacturing, licensing, and logistics costs), the company won't really participate in the "low-end" smartphone market, per se. One well-known Apple analyst, Piper Jaffray's Gene Munster, predicted earlier this year that Apple would introduce a $199 iPhone this summer. However, it's highly unlikely that Apple would sell a device so close to the cost of production. Resellers would also get a cut of the purchase price, leaving Apple with only $175-$180 in net revenue.

Munster recently revised his expectation and now believes that the cheaper iPhone will cost $300. However, even at that price, he expects it to "cannibalize" high-end iPhone sales. In other words, some customers who would otherwise pay up for a $449 iPhone 4 -- or an even more expensive device -- will choose the cheaper iPhone. Since the iPhone's current average selling price is more than $600, and gross margin is generally estimated above 50%, Apple earns more than $300 of profit per iPhone sold (on average). If Apple makes only $100-$120 in profit per device for the cheaper iPhone, heavy cannibalization could cause the company's earnings to shrink even if iPhone sales grow significantly.

The solution
A potential solution to this conundrum would be to price the new iPhone a little higher, at perhaps $329 or $349. That would still be significantly cheaper than the iPhone 4, and it would place the new iPhone solidly within the mid-range segment. Apple has historically focused on "aspirational" products, and a $329 or $349 price point would be within reach for many customers, while protecting Apple's profits. As my Foolish colleague Evan Niu noted earlier this month, a trade-in program in India that reduced the effective cost of the iPhone 4 from $485 to $360 (or less) caused sales to triple. That suggests that a $100-$150 price drop could have a surprisingly large impact on sales in developing markets.

In other words, I expect Apple to follow a strategy similar to its iPad Mini pricing strategy. Many observers expected Apple to fight Amazon.com's (NASDAQ: AMZN  ) $199 Kindle Fire (now $159) with a tablet priced as low as $249; instead, the base iPad Mini costs $329. Despite the big price gap, Apple couldn't keep the iPad Mini on store shelves during the holiday season because of overwhelming demand, while Kindle Fire sales growth was fairly muted. Apple offers a differentiated user experience, and people will pay more -- up to a point -- for its products. Therefore, $329 or $349 seems like the ideal price point for a cheaper iPhone.

Foolish conclusion
Apple hasn't even confirmed that it will make a cheaper iPhone yet. Nevertheless, it seems inevitable that this product is on the way in the next year or so. It may not be quite as cheap as some analysts expect, but that shouldn't hurt sales very much. If Apple can offer an iPhone at a mid-range price point while also adding major new carrier partners such as China Mobile (NYSE: CHL  ) , the company will probably return to solid earnings growth. With Apple stock having recently fallen below $400, the shares look like a great value in that scenario.

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Read/Post Comments (9) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 20, 2013, at 4:46 PM, AngiesFancy wrote:

    It's not just the cost of the phone that's a problem. It's the cost of the data package that keeps many people from choosing an iphone.

    Groceries, gas, rent and utilities are more important than a high tech gadget.

  • Report this Comment On April 20, 2013, at 4:52 PM, TMFGemHunter wrote:

    Well, there's no reason why the data package for an iPhone should have to be any more expensive than the data package for an Android phone. Yet Android has seen incredible growth, particularly in developing countries, while iPhone is still a niche product. That's the opportunity that Apple could go after with a cheaper iPhone.

  • Report this Comment On April 20, 2013, at 5:19 PM, wesvzw wrote:

    Think about what you just said Angiesfancy. It is the price of the phone and here's why. Why do you think you have to pay the data fee every month? It's because the phones cost the cell phone company so much! If verizon pays 600$ for the phone then gives it to you for free verizon loses 600$. How do they make up for that loss? By charging the data fee thats how. All one big circle my friend.

  • Report this Comment On April 20, 2013, at 6:03 PM, Burstedbladder wrote:

    The cellfoen companies are the ones that stop me from getting an iFone. first, these iFones are locked with each individual company, and second, you are stuck with ridicoulous data plan prices.

    Until the cellfone companies make all data, text, and minutes, web in one package deal for 50 bucks a mth, I wouldn't even consider an iFone purchase.

    I have an unlocked Samsung Captivate, and pay 50 bucks a mth with unlimited web, data, text, and minutes. And it works great! I can also have them to just bill me each mth. instead of buying a prepaid card each mth.

    ATT, Verizon and all the other cellular companies are a rip off. You get faster mbps in other countries for less and ore with your cellular companies as well. Only here in America, the people are getting ripped off with these bs prices from your cellular companies.

    The same with cable. I'll be rid of them in one week and doing internet TV from here on out.

    Cable shouldn't be no more than 25 bucks a mth imo.

    Just buy yourselves an unlocked fone over the internet and buy yourselves prepaid cards and do away with your current cellular companies. Eventually they will get the message and offer a one package deal for 50 bucks a mth, but as long as you are willing to give them your hard earned cash, they will continue to price gouge the consumers.

    jussayin-

  • Report this Comment On April 20, 2013, at 6:50 PM, crash3085 wrote:

    I'm so tired of hearing about the iPhone. I'm ready to hurl...

  • Report this Comment On April 20, 2013, at 7:13 PM, TMFGemHunter wrote:

    It's possible that the high cost of data plans in the U.S. (which is primarily caused by high subsidies for expensive smartphones) has slowed down the market's growth. But most Americans have smartphones nonetheless, and are apparently willing to pay the high data charges.

    Apple's big problem is not that people cannot afford smartphones or cannot afford data plans. It's that the iPhone is competing in developing countries with locally produced budget Android phones that cost (in many cases) around $99, while an iPhone 4 might cost around $500.

    Adam

  • Report this Comment On April 20, 2013, at 10:07 PM, phmenard wrote:

    Apple has been doing this for years ... they hate that fact that they always seemed to miss the boat ... Boy I wanted that first PC ... at the time was the mac ... way early 80's ... but it was to expensive. So what were my parents to do ... well how about the bad ass Atari 800XL ... lol ...nice!!!! I plugged it in and never looked back ... loaded up MS Dos on my 720 ... learned everything I wanted to learn ... booted up to basic and learned to program. To get to the topic ... I always felt Apple (which makes great products) never catered to the guy like me ... I could play games ... write my own software, distribute that software ... at no extra cost. If I want to build an app for the IPhone I have to first buy one (and that's not happening) then, its a bit unsettling to me that I will be forced to pay so much to become a registered developer and again to sell my creation.

    I can get a good Android for less that half the price ... does everything you will ever need it to do out of the box, choose from many service providers ... and, if I want build all the apps I could ever need with all free development tools ... and list them on Google Play at no cost.

    HELLO!!!!!!!

    Listen I loved Steve Jobs ... brilliant man "Stay hungry ... Stay foolish". I get the vibe everything apple does puts to many people out of the reach of there product. I believe they will eventually fade away like VHS tapes. As for the PC ... its not going anywhere soon ... how would you run the office with no PC's ... just your whole staff on the Apple IPhone?? Just saying.

  • Report this Comment On April 21, 2013, at 4:15 AM, doawithlife wrote:

    AngiesFancy wrote:

    "It's not just the cost of the phone that's a problem. It's the cost of the data package that keeps many people from choosing an iphone."

    Exactly why I never got one. Always thought they looked interesting, and possibly functional for more things then play. Just not going to pay the money. Now I pay $35/month for unlimited 4G on a W8 Pro tablet. Still use a dumb phone($10 month added onto mother-in-laws plan).

  • Report this Comment On April 23, 2013, at 10:33 AM, Wynnielady wrote:

    " I always felt Apple (which makes great products) never catered to the guy like me ... "

    Thankfully they catered to me. Let's see I still Have my old Performa, iMac, EMac, first Mac Mini and am on my second Mac Mini. They all work and my grand kids love to play the old games they have. I use the old Mac Mini Apple Works to perform easy and creative art functions to print out Photo pages and cards.

    When I retired from teaching my classroom K class had an area of donated Apple 2Es and Performs working away. My kids were great trouble shooters because I was too busy to handle issues that came up when a child was using a program.

    Love my iPad but it makes my purse a little heavy. As soon as Apple makes a smart case for the IPad Mini I'll buy it. So far I haven't worried about malware because I'm not very knowledgable how to protect myself. Of course being an old duffer I don't do on line banking.

    As I've said before, Apple, just keep on trucking.

    A Mac Fan with a little disposable income.

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