This Time, Apple Should Follow BlackBerry's Lead

Following the launch of the iPhone in 2007, Apple (NASDAQ: AAPL  ) quickly grew to be the dominant player in the high-end smartphone industry. In doing so, it decimated the market share of BlackBerry (NASDAQ: BBRY  ) (then called Research In Motion), sending the company into a tailspin.

Up until 2012, Apple seemed to be on a path to smartphone dominance, at least in the high end of the market. However, growth has slowed dramatically in the past year. While growth rates have always been "lumpy" because of timing issues, there has been a clear downward trend in iPhone sales growth recently.

Source: Apple Earnings Releases, http://investor.apple.com/results.cfm.

There has been much talk in the market that Apple will offer a cheaper iPhone to appeal to customers who can't afford a $450 product like the iPhone 4. However, this potential move raises a legitimate concern about cannibalization of higher-priced, high margin iPhones. To solve this dilemma, Apple should (surprisingly enough!) consider following BlackBerry's lead by releasing a mid-range smartphone, but only in selected markets.

Apple's problem
Apple's problem is fairly simple. The iPhone 5 has a starting price of $649 (in the U.S.), and even the three-year-old iPhone 4 retails for $449 if you aren't getting a carrier subsidy. This premium pricing has allowed Apple to maintain stellar margins for the iPhone. Horace Dediu of Asymco estimates the iPhone's gross margin at 48% as of last quarter. That's less than the peak of nearly 60% last year -- before the introduction of a new form factor with the iPhone 5 -- but still well above the gross margins of Apple's other product lines.

Ideally, Apple would like to expand the market for the iPhone by offering a cheaper version that could compete in the "mid-range" smartphone segment. Apple will never be able to deliver a high quality product that can compete on price with the $99 Android phones that are common in developing countries. However, a price point as low as $300 seems feasible.

That said, if Apple delivers a high-quality smartphone for $300 unsubsidized, it risks cannibalizing sales of its high-end phones. Even in the U.S., many people would consider trading down to a cheaper iPhone, as evidenced by the continued strong sales of the iPhone 4 and iPhone 4S.

If this cheaper phone had a gross margin of just 20% (implying a profit per device $200 to $250 lower than the average iPhone sold today), cannibalization of high-end iPhones could more than offset the benefit of restarting unit sales growth. Apple therefore needs to find a formula that would allow it to introduce a cheaper iPhone and grow its global market share while minimizing cannibalization of high-end iPhone sales.

BlackBerry's plan
That's where following BlackBerry's lead could prove useful. BlackBerry recently unveiled its first lower-priced smartphone running the new BB10 OS. The Q5, announced at this week's BlackBerry Live conference, will be very similar to BlackBerry's Q10 high-end smartphone, but it will use some cheaper components.

However, BlackBerry isn't planning a global rollout for the Q5 (at least not yet). According to the company's press release, "The new BlackBerry Q5 smartphone will be available in selected markets in Europe, the Middle East, Africa, Asia (including the Asia-Pacific region), and Latin America."

Conspicuously missing is North America, home to two of BlackBerry's top three markets: the U.S. and Canada. BlackBerry wants to push the cheaper Q5 phone primarily to developing markets, where consumers would be unwilling to pay $600 to $700 or more for a high-end BlackBerry. On the other hand, the company clearly doesn't want U.S. keyboard lovers to trade down, because BlackBerry needs to drive high-margin Q10 sales to return to profitability.  By not offering the lower-cost option in North America, BlackBerry is employing mild price discrimination to boost its margins.

Foolish takeaway
What does this mean for Apple? In large developing markets such as China, India, and Latin America, Apple is locked out of much of the smartphone market, because most consumers can't afford a high-end smartphone. While Apple has had some success in these markets (particularly China), the incremental opportunity from offering a lower price point is substantial and should easily outweigh any "cannibalization effect." For example, a trade-in promotion that reduced the effective cost of the iPhone 4 from $485 to $360 in India led to a tripling of the sales rate.

By contrast, Apple already holds 39% of the U.S. smartphone market, according to comScore. The opportunity to increase market share through a lower-priced product here is outweighed by the potential effect of cannibalization on margins.

Producing a cheaper iPhone that's available only in "selected markets" would therefore make a good deal of sense for Apple. The company could introduce the product in developing countries and test it in a few smaller developed markets to judge the effect on "regular" iPhone sales. That would allow Apple to pursue the vast mid-range smartphone market opportunity it's currently missing, without raising the bears' fears of massive margin compression. In this one case, Apple should definitely consider taking a page out of BlackBerry's playbook.

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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 May 18, 2013, at 2:14 PM, H3D wrote:

    Apple makes 65% of all profits made in the mobile phone industry.

    Profit this is in part achieved by not making a whole pile of low end junk that in reality nobody makes a profit on anyway.

    Problem? I don't think so.

  • Report this Comment On May 18, 2013, at 3:22 PM, HelpIsHere wrote:

    Apple is dead, they continue to sell the oldest OS in the world. Who wants such stale software on their phone. So far, Apple has nothing to complete with any more. Avoid Apple stock.

  • Report this Comment On May 18, 2013, at 3:55 PM, k1moops wrote:

    Great shoemakers had always taught their sons not to sell expensive leather shoes to the peasants.

    Blackberry had always been selling to peasants, even if the peasants are managing lower peasants. Apple is never meant for peasants, Apple is designed and made to sell to the rich, affluent, and to the talented few. Apple never stoops low to the peasants. What Apple needs is to go beyond the iPhone / iPad, and sell something more premium for more money, and profits. The world today has more rich, affluent, and talented people than ever before. China alone now has more millionaires than America. Apple is wise to stop focusing on the iPhone / iPad which are predominantly North American, as of this fall Apple will be releasing products targeted for the rich and affluent Chinese of China who own the largest debts that America has borrowed, and make a lot more money selling to China. India is a lot poorer than China. Apple is doing the right thing.

  • Report this Comment On May 18, 2013, at 3:59 PM, k1moops wrote:

    For the ones not in the know. China's Chinese have hundreds of billions of dollars in pure cash, they would never buy Blackberrys, and nearly every rich Chinese owns either an iPhone and/or a Samsung Galaxy latest model. Look or ask around and you will find out that is the truth. Chinese do not want Blackberrys.

  • Report this Comment On May 18, 2013, at 6:35 PM, TMFGemHunter wrote:

    @k1moops: your shoemaker analogy doesn't really make sense, since no shoemaker could make enough shoes to satisfy even all the potentially wealthy customers. Apple needs to expand its market reach, not by making some junky $99 or $199 phone, but with a nice $329 or $349 phone.

    Based on the reception of previous price drops, I think this could double the overall market opportunity for Apple. The only problem with doing so is the potential for cannibalization. Pushing these phones only to developing countries seems like the best strategy for growing the market without allowing a lot of cannibalization.

    Adam

  • Report this Comment On May 19, 2013, at 1:00 AM, k1moops wrote:

    To Adam. my favourite comparison to smartphone is shoes and in some ways they are quite similar, but that takes too long to elaborate here. A good pair of shoes are never cheap. Rich affluent people often have lots of expensive shoes while developing countries especially the poor ones often have a lot of shoeless people. Apple will never make enough smartphones or iPads to satisfy all the wealthy, but within this lies my main point, are the Apple smartphones or iPads good enough to entice the wealthy? Making $329 or $349 may entice a few wealthy people but in the eye of the wealthy community Apple runs the risk of stooping too low. In my analogy, Apple should maintain enough iPhone 4 and iPhone 4S to establish the lowest limit it would go but at the same time Apple has to go back into its main business of wowing the wealthy with new top models. iPhone 4 and 4S are already cannibalizing the iPhone 5 to some extent because the iPhone 5 is not 'high' enough. Apple has to make a high enough newer model that sells around $729-$849 which is the sweet range that the wealthy people can wave around and tell the world 'see my nice iPhone?', not the other around.

  • Report this Comment On May 19, 2013, at 2:10 PM, TMFGemHunter wrote:

    I don't dispute that there would be some value to differentiating at the top, perhaps with a larger-screened phone at $750 with more bells and whistles. However, I think you have to recognize that Apple is far more successful than any shoemaker... or any other company in any industry in the world. I have serious doubts about whether Apple could really capture (sustainably) more than 30%-40% of the global high-end smartphone market.

    Finding 50 million wealthy people who are willing to pay up for a better iPhone doesn't sound as promising to me as introducing a mid-range phone for the developing world. This addressable market is probably several hundred million units per year. If Apple can also generate iTunes/service revenue or "halo" effect purchases from this market, that increases the value of getting in here.

    In really simple terms, Apple needs to change its playbook because its market penetration is so much higher today than it was five years ago --- or even two years ago. It used to be that every new iPhone drove exponentially higher sales because the potential market was so big and grew up from nothing in 2007. Apple and Samsung have now captured most of the opportunity in the $500-plus market. Fighting tooth and nail for the marginal customer in this market will at best keep Apple's profit stable for a while. Returning to growth requires finding new markets.

    Adam

  • Report this Comment On May 19, 2013, at 6:14 PM, spaceguru wrote:

    For decades people with no knowledge of Apple's plans or strategies have been telling Apple what to do. Everyone was WRONG!

    Apple's Profit & Loss Statement says it ALL!

    You don't know what your talking about and I'm not listening to no 2 bit advise/opinion about . . . . Blackberry? Are you kidding me?

  • Report this Comment On May 19, 2013, at 7:14 PM, k1moops wrote:

    A pair of Kathryn Wilson's pretty pumps can cost $418450 with 21.18 carats of diamonds, to be exact, covering the heels. What I am saying is while there is no real 'top end' to the high end, the 'bottom end' is very uninteresting and limited. Apple has very deep and big talent and resources that see no rival in the entire world and you want these Apple Leonardo da Vinci's to sit on the benches while Apple pumps out $329 machines for the cheap? That's like asking BMW to make $12000 hatchbacks to compete with the $2000 Tata Nanos.

    In my view, Steve Jobs had killed himself fashioning Apple to be the BMW or Kathryn Wilson of the world with unlimited 'top end' markets to exploit selling to hundreds of millions of rich and affluent clientele. iPhone is the very rare undisputed rich and affluent symbol among the high societies, Apple must not waste away its diamond mine that the peasant-like smartphone industry is digging itself into. Blackberry is certainly not the only peasant in the field digging deep trying to find cheap potatoes, Nokia and Samsung have decades of lead designing and making cheap phones making pennies.

    Just look at an iPhone 5 and look at that cheap Q5 Blackberry just released, it is unfathomable for the premier Apple brand to make and sell such monstrosities.

    There are currently 1426 billionaires in the world, and about 3% of global population, or 210 million people with income of $220000 or more. These are the population Apple should be targeting. It is obvious to me that Ron Johnson did a poor job in fashioning the Apple Retail Stores. To my shock, none of the Apple Geniuses can show me the absolutely stunning powers of the Apple Siri. In fact, no one I had come in contact with is fully aware of the awesome differences between Apple Siri, and the league of vastly inferior Siri clones that do great injustice comparing themselves to Siri. Lately General Motors has advertised its Siri integration as part of the new driver experience, it would not take long for the GM customers to wake up to Siri's awesome powers but why is GM doing Apple's job in showing Siri to the world?

    Apple's problem lies mainly with its Ugly Duckling complex, not knowing that it is a beautiful swan that has no business following ugly ducklings the likes of Blackberry.

  • Report this Comment On May 19, 2013, at 11:15 PM, AdamChew wrote:

    Blackberry is so yesterday and their fans are abandoning it for the others OSs.

    Sorry to say this only the up is down Wall Street and pundits don't see it.

  • Report this Comment On May 20, 2013, at 1:45 PM, TMFGemHunter wrote:

    @k1moops: I think you and I have very different opinions of what Apple is all about. In my eyes, this is the company that came out with the iPod Shuffle and Apple TV as well as the iPhone and iPad. Apple makes expensive products when it needs to spend a lot of money to do something right. Otherwise, it tries to appeal to the mass market.

    I can't think of a lot of useful features you could add to a smartphone to make it more high-end than the current iPhone. Samsung is basically doing this with the S4, but most of the new features are hokey, buggy, or both. Simplicity is Apple's game.

    Adam

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