How Apple Will Defend Its Margins

With the release of the next wave of Apple (NASDAQ: AAPL  ) iPhones growing ever-closer, it seems a near certainty that Cupertino will be releasing two models: the iPhone 5S and the iPhone 5C. So confident have the pundits and prognosticators become that a recent Financial Times article details the release of the two handsets as fact. Investors are concerned that rolling out a lower-cost device will seriously cut into Apple's margins. The concern is not without merit, but I think there are two real ways that the company will defend its margins: improving product mix, or by making margins significantly less important.

A quick look at the iPhone 5C
While the existence of the iPhone 5C is not even officially confirmed, FT's Tim Bradshaw offered some possibilities. Essentially, Apple is targeting a lower-cost device, available in multiple colors, that doesn't degrade the cool factor, demonstrates Cook's leadership style, and will allow Apple to achieve better market penetration in China. What this has to do with margins is that if the strategy is successful, which I believe is likely, then Apple will sell a lot of iPhone 5Cs. Selling a large number of units is a cornerstone of the first line of defense for Apple's margin.

Improving product mix
In June, Morgan Stanley's Kathy Huberty release a research note defending the idea that a cheaper iPhone could actually help Apple's margins. Her thesis was very straightforward: The margins on iPhones (even a cheaper one) are better than Apple's margins on its other products, and if the company can significantly increase the number of units it sells, the product mix shifts favorably and the company's overall margin can actually improve. While the idea has a bit of "that's just so crazy it might work," her numbers are both reasonable and compelling. By upping the overall sales figures for iPhones, Apple could see a small improvement in margins, and see revenues soar.

Why it doesn't really matter
Even if Huberty's calculations prove to be somewhat off, there is a very real argument that Apple's margins are not what matters this quarter. Much ado was made when Samsung made more money selling handsets in the second quarter than Apple -- Sammy made $5.2 billion against Apple's $4.6 billion, according to Strategy Analytics. Likewise, IDC recently announced that Google Android has increased its market share to 79.3% globally over Apple's 13.2%. What these two statistics fail to encompass is that Apple makes a profit both from selling handsets and from its operating system. Additionally, as IDC's Ramon Llamas notes, "The iOS decline in the second quarter aligns with the cyclicality of iPhone."

With the release of two new models, investors should expect to see sales spike, revenue follow, and the overall profitability of the company improve. The undisputed saturation of smartphones in developed markets will inevitably put pressure on margins. While this statistic has merit, its decline is not catastrophic. I expect Apple to put up a few solid quarters on the release of the new devices and heading into the holidays. That gives Apple some breathing room to release the next "wow" product before investors should feel concerned. Whether the new product segment comes from the iWatch, an iTV, or something yet unimagined, Apple has a little time to dazzle us with its innovations. If investors haven't seen something new by next summer roll around, then I might get concerned.

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