Apple’s Missed Opportunity

The pundits will go on about the initial weekend sales for the new iPhones, but one thing is clear: Apple (NASDAQ: AAPL  ) has missed an opportunity here.

It's no news that the iPhone 5s is the new flagship model, with a blazingly fast processor, and breakthrough fingerprint sensor. The colorful 5c models have replaced the previous flagship iPhone 5, with only small changes aside from the plastic bodies.

So what's been missed? Apple stock dropped after the September 9 announcement that the 5c would be priced just $100 below the 5s. Investors had been looking for a drop into the lower price range. Personally, I agree with Apple that the 5c should be priced exactly where it is.

What is missing, however, is the iPhone 4c.

There should have been another model added that would relate to the 4s just as the 5c does to the 5s, priced $100 bellow the 4s, unsubsidized at $350.

Model Unsubsidized Price
 iPhone 5s $650 
 iPhone 5c $550 
 iPhone 4s $450 
 iPhone 4c $350 

Source: Apple.com and author's estimates.

Rationale
Apple iOS's main competitor is Android, built by Google. Recently they have pushed their global smartphone market share to almost 80%,  largely by dominating the low end market, a segment that Apple does not care to enter – and rightfully so. However, to drop below 14% looks bad. It makes them appear marginalized. A 4c entry would allow Apple to enter a lower tier, and regain significant share.

Features
The theoretical iPhone 4c would sport these feature changes:

  1. Case: colorful plastic
  2. CPU: A5 chip of 4s
  3. Screen: Revert to pre-retina display resolution (163 ppi)
  4. Memory: Revert to 8 GB
  5. Camera: 6 Megapixel

It's quite possible that Apple could produce such a device for under $150 in hardware and component costs, which suggests that a $350 iPhone 4c could fetch hardware margins of over 57%. In contrast, IHS iSuppli estimates that the new iPhone 5s costs $199 to build after including manufacturing costs, while the iPhone 5c total is around $173.

Sales
With the strongly reduced feature set, I do not think that the 4c would significantly cannibalize higher priced models. This is seen in the new 5s. Reports have sales of 5s outnumbering 5c by 2.4 to one. It shows that the existence of a lower priced model does not necessarily cannibalize the higher priced one when there is significant differentiation.

Fortune's Philip Elmer-DeWitt wrote a few weeks ago of Apple's low end opportunity:

In a note to clients Thursday, RBC's Amit Daryanani used Strategy Analytics' market research to estimate what a $300 iPhone 5C might do to Apple's bottom line...

And he quotes Daryanani:

"From an EPS perspective we believe the Company can add $4.00+ in EPS to our CY14E estimate of $39.74, with a successful launch of an affordable iPhone. On a 12x multiple, this would add roughly $50 to Apple's stock-price. We believe our ~56M unit estimate is conservative given that it represents 12% of the total low-end Smartphone market."

Granted, he is talking of a sub $300 price point, so let's round his 56 million units down to 50 million. Even if there was some cannibalization from the 4s, this would bring in more than $17.5 billion new revenue. . This could potentially add over $4.40 in earnings per share.

Margins
Some would argue that this would only increase Apple's woes by further compressing margins. But there are two points to make here. First, the gross margin is significantly lower for the 5, but not horrendously lower. More importantly, $17.5 billion is a large number for incremental revenue, and would go a long way to reducing overhead and operations as a percentage of overall revenue, so it is likely that this would counteract the slightly lower gross margin.

Conclusion
Apple has a great game plan and will probably thrive on its new iPhone product line. Still, it seems to have thrown away a great opportunity to expand its reach into the smartphone culture and bring in millions of new customers. This would reach into the growing share of Google's Android operating system led by Samsung, and Apple could have done this without sacrificing the quality that they prize so much.

Apple will thrive, but I believe they could have done even better.

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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 October 18, 2013, at 2:03 AM, fauxscot wrote:

    An Onion version of this article would be headlined:

    "Guy with Computer Thinks He Can Run Apple Better That Current Management"

    Not a bad article, but really, do you think maybe this has come up for discussion in Cupertino? It may come as a surprise, but they have computers there, too, so that means lots of skilled folks, in say, Marketing, where such decisions are often made.

    Apple, unlike Google, has complete control over what it produces and what prices it sets.

    So far, so good. Another $4 in EPS? Maybe. Maybe not.

    (Note: Google does not MAKE Android and is NOT Apple's main competitor. The Android OS is primarily developed by Google, forked off for various (hundreds) of different phones, many of which are sold profit-free by a variety of manufacturers, many of which are on the verge of collapse from rushing to the profit free low end. That includes Motorola, recently acquired by Google. Google mostly sells ads. See how that's different? )

  • Report this Comment On October 18, 2013, at 2:38 AM, skippywonder wrote:

    The author is just a year early. The 5c *IS* the 4c, only next year. Apple has chosen to branch off with a top of the line 64 bit series and will retain the 32 plastic cheaper version into the future. By next year at this time, it will be obvious they planned all along to have the 5c be a very capable and appealing entry model. It will not be seen as a cheap piece of junk because it was offered for a year at a higher price. It will simply be seen as a bargain.

    So the 5c going forward will get progressively cheaper and less expensive to manufacture. Apple is playing the long game and is doing a brilliant job.

  • Report this Comment On October 18, 2013, at 2:51 AM, zippero wrote:

    Don't worry about Android's 80% market share among poor people. Apple rules corporate executives, enterprise workers, corporate IT departments, upper-income families, doctors/lawyers, and college/high school students. The market is "bifurcating" just like Tim Cook said and 90% of smartphone profits are at the high-end anyway. Poor people don't even have money to buy data plans or apps, so it doesn't even make economic sense to market an app ecosystem to them. Enterprise workers all have iPhones and iPads, and corporate IT is provisioning more of them and building custom business apps 20:1 in iOS favor vs. Android or Windows phone. Unlike the Windows PC age where corporate IT imposed crap Windows on enterprise workers from which it spread to everyone else, consumers and business people themselves are voting for quality and pushing for iOS in the enterprise.

  • Report this Comment On October 19, 2013, at 5:52 AM, flybywire54 wrote:

    Outside of Asia , android popularity is 10 miles wide but only one foot deep . If Apple don't take away market share from them , Microsoft/Nokia will , it has already started in the EU .

    In Asia Microsoft has to give its WP8 for free and it wont take long for manufacturers there to adopt it .

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