A Cheaper iPhone Is Good News for Apple Investors

According to several recent news reports, Apple (NASDAQ: AAPL  ) has finally decided to launch a cheaper iPhone model. The Cupertino giant may announce both its high-end iPhone 5S and the lower-priced iPhone 5C at an event scheduled for Sept. 10.

Wall Street analysts are concerned about falling profit margins over the last quarters, and a cheaper iPhone won't help at all in that department. However, Apple is making the right move by putting long-term growth prospects ahead of short-term profit margins, so investors should welcome the iPhone 5C as smart strategic decision.

The changing smartphone market
Apple is still the market leader in the U.S. smartphone market, with a market share near 40%, versus less than 24% for Samsung (NASDAQOTH: SSNLF  ) according to data from comScore. The carrier subsidy model means that consumers get to buy the iPhone for a relatively low price, and the company has a remarkably loyal customer base.

But in other countries, especially in emerging markets where carriers don't usually subsidize the purchase price, the iPhone is just too expensive for many customers. Gartner estimates that Apple's market share on a global scale has fallen to 14.2% in the second quarter of 2013 versus 31.7% for Samsung.

As the smartphone revolution expands to emerging markets, pricing is a big issue to consider. Apple's faced with a tough decision: If it's going to maintain its prices, it will almost undoubtedly continue losing market share to Samsung and other lower-cost manufacturers.

During the last quarter, the average selling price of iPhones was down to $580 from $613 in the previous quarter as more consumers chose cheaper versions like the iPhone 4 and 4S over the more expensive iPhone 5.

The company sold 31.2 million units during the quarter, a 20% increase versus 26 million iPhones sold in the same quarter of 2012, so the iPhone is still in demand, but the sequential decrease in prices shows that consumers are more price conscious.

The pricing issue is not only related to international expansion; smartphones are moving beyond the early adopter phase, and quality exigencies are usually reduced when a product is adopted by the masses. Many users simply want a smartphone providing basic functionalities like access to email and social networks, and they feel no need to pay for an iPhone when they can find cheaper alternatives which are good enough for them.

Regardless of the reasons for this change, the fact remains that the smartphone market is changing, and pricing is a much more important competitive element that it was a few years ago. Apple will need to choose between market share and price,  it can't have them both in the current environment.

Margins and growth
Consumers are already choosing previous iPhone models due to their lower prices, and this is taking its toll on margins. The iPhone 5C will reportedly be made of plastic, which means lower raw material expenses and probably an easier manufacturing process, too.

Maybe the iPhone 5C won't be so bad for margins, at least not compared with the alternative case, which would be a growing proportion of older iPhone models in the overall sales mix.

Assuming a price tag $200 or $300 below the high-end version, the iPhone 5C could be much more attractive to consumers than the older iPhone models. It would still have the Apple brand, it would be at a similar price to competing alternatives, and it would be a new product.

Growing sales volumes tend have positive effects on profit margins, so a combination of lower manufacturing costs for the iPhone 5C and growing volumes could partially offset margin pressure due to lower prices.

Even if margins are going to be lower in the mid term, Apple is playing this game for the long term and focusing on growth over years to come. The company is well known for its halo effect, meaning that consumers who buy Apple products tend to stay within the Apple ecosystem when it comes to their next purchase, so building a large customer base in emerging markets is far more important than margins over the next few quarters.

Different iPod models have their own margin implications, and the iPad Mini has been a big success for the company even if it has lower margins than bigger iPad models. There is no reason to believe the company shouldn't follow the same strategy with its iPhone line of products and provide different options to fit different consumers.

Foolish bottom line
Profit margins are already falling at Apple as consumers choose previous iPhone versions over the latest iPhone 5. Maybe the iPhone 5C, with its lower costs and higher growth potential, won't be so detrimental to margins in comparison with the alternative scenario, which would be increased sales from older iPhone models in the overall sales mix.

Besides, even if margins will be falling in the middle term, gaining market share in emerging markets is enormously important in terms of long-term growth prospects. Apple is moving in the right direction with the iPhone 5C.

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Comments from our Foolish Readers

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  • Report this Comment On August 30, 2013, at 9:37 AM, dwilh51183 wrote:

    It will increase their iPhone sales by 20 million per quarter. That is huge! add that to the 55 billion remaining stock buyback program and Apple stock is a screening BUY now.

  • Report this Comment On August 30, 2013, at 10:25 AM, yikesboy wrote:

    Finally a well reasoned article on the upcoming iPhone refresh and the rationale for it. Ridiculous expectations of the great unwashed for Apple to keep pulling magical rabbits out of their hat doesn't jive with reality. Sure margins will be pressured down but China and growing share in emerging markets should be the focus now. Sticky ecosystem is the foundation of this company's ongoing greatness. Look for $600 share by January...

  • Report this Comment On August 30, 2013, at 1:02 PM, vernr75 wrote:

    FTA- "But in other countries, especially in emerging markets where carriers don't usually subsidize the purchase price, the iPhone is just too expensive for many customers."

    Precisely. But the 5C changes nothing because it's going to be at the same price level as the iPhone 4, which is one of those phones that is hundreds of dollars too expensive to appeal to the vast majority of developing world consumers. A different phone at the same price point is just going to give Apple the same end result. Why pretend otherwise?

    Furthermore, there are TWO costs to consider - the upfront cost of the iPhone and the cost of the iPhone data plans in the developing markets. No matter what Apple does, it will not be able to overcome the fact that the carriers in the developing world are using the iPhone's premium brand and price to charge premium per MB fees for the data that's supplied to them. In fact, the iPhones with the lowest price tags tend to get the most expensive data plans. And the prepaid data plans are the worst of all. Theoretically, the most cost-effective way to use an iPhone would be to use it with an ordinary 2.5G - 2.75G(EDGE) prepaid data plan that is much much cheaper and is often supplied on a prepaid per-use basis. But those prepaid plans are distributed to consumers via mini Sim cards which are the standard Sim used in the developing world. iPhone 4 and 4S use micro Sims and the iPhone 5 (and logically the 5S and 5C) use nano Sims. Therefore the very obscure nature of the iPhone Sim slot itself serves to lock developing world consumers into the higher data charges - and higher costs with no workaround is something that these folks reject absolutely. Add it all up and what you get is very low iPhone adoption rates in the regions of the world where more than 70% lives. Meanwhile, Android devices at prices below $200 are allowing folks to walk into a corner store, buy an Android smartphone and simply slip their current mini Sim into it without the need to deal with a carrier agent. That will never be possible with an iPhone.

    Don't believe the media hype machinery. Nothing is going to change, folks.

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