The iPhone Air Won’t Kill The iPad

A big fear, and a reason cited for Apple's caution in launching a "big" iPhone, is that such a device will kill the iPad.

Jan 14, 2014 at 10:30AM

One of the arguments that Apple (NASDAQ:AAPL) bears routinely make is that if Apple were to introduce a larger iPhone -- let's call it by its sexiest rumored name, the iPhone Air -- it would significantly eat into iPad shipments. That would make Apple reluctant to introduce such a product, they argue. While on the surface this seems like a legitimate fear, digging deeper suggests that these fears may be overblown.

iPad has a much lower margin than iPhone
While Apple's iPad lineup is the single best-selling brand of tablet today, it's important to note that Apple generates far more revenue and operating profit per iPhone sold than per iPad. Why's that? An iPad is just an iPhone with a larger, higher-resolution screen and a larger chassis. For cellular models, this is where the differences largely end, although for the Wi-Fi only version, Apple saves about $30 on the bill of materials.

Further, even though the iPad simply has more stuff to it, the cheapest off-contract, latest-generation iPhone runs users $650, while the cheapest iPad Air sells for $500, and the cheapest iPad mini with Retina Display runs for $399. Clearly, there's much more margin to be had in selling an iPhone -- particularly through a carrier -- than an iPad.

The worst case: iPhone Air completely eliminates an iPad sale
The big fear and the worst-case scenario is that the sale of something like an iPhone Air -- which, given the current Samsung (NASDAQOTH:SSNLF) Galaxy Note 3 prices – should start at $299 with a 2-year contract (implying an unsubsidized price of $749 given the current iPhone 5s pricing). This means for what is likely to be at worst a slightly larger bill-of-materials than the iPad mini with Retina Display, Apple is making significantly more margin per unit.

The worst case, then, is that Apple loses a flagship iPhone sale ($649) plus an iPad mini with Retina ($399) for a $749 hypothetical iPhone Air. Do note, however, that if users are going to really go with "one device to rule them all," then they're probably not going to buy the minimalist 16 GB model for $749 and would instead likely be willing to pay the $100-$200 premium to get 32GB to 64GB models. Apple could also conceivably sell a 128GB model that could appeal particularly to business users.

The more likely case: cannibalization modest, smartphone share moves up meaningfully
Assuming that there will be no cannibalization seems a bit optimistic, but a more realistic scenario where such an iPhone Air cannibalizes an iPad mini with Retina to some degree is likely (a 4.5 - 5.7-inch iPhone does not seem like a substitute good for a 9.7-inch iPad), but the cannibalization is likely to be minimal. Why? Here are a couple of reasons:

  • Consumers that want "one device to rule them all" have had multiple very credible options from Samsung, LG, HTC, and others. It is likely that Apple lost share to these (particularly Samsung, which markets very aggressively), so Apple could really just be gaining back phone share rather than necessarily "losing" tablet sales to a big degree
  • There will be a large group of users that prefers a "smaller" phone (for aesthetic and/or practical reasons – and given that the iPhone 5s sells well, this could still be a major part of the iPhone market), so they will still opt for an iPhone + iPad combo – even if the "standard" iPhone gets a size boost to 4.5 – 4.7-inches

The wildcard: Samsung
The biggest risk is that consumers may be "used to" large Samsung phones. If this is true (and this really doesn't seem too likely), then an iPhone Air will still only appeal to the group of users that would buy Apple anyway and wouldn't expand Apple's TAM. However, while this is a risk, the launch of the iPad mini and its follow-on, the mini with Retina display proved this – in the "premium" device category, if there's a suitable Apple product, an Apple sale is likely.

However, Samsung is moving quickly with the more "headline" hardware features (high resolution displays, faster processors, more RAM, etc.), so depending on what consumers really value (and when Apple plans to launch the larger iPhone), the ultimate financial impact of an iPhone Air is unknown (i.e. how much share can Apple take back?), but still likely to be positive.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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