We are just on the verge of the launch of Samsung's (NASDAQOTH:SSNLF) next generation Galaxy S5 flagship phone. The rumors are running rampant and it's hard to get a good read on exactly what this smartphone will feature or what it even looks like, but it's pretty clear that it will be a state-of-the-art design from a hardware perspective. On the software front, Samsung is still well behind Apple, but could dramatically improve its "TouchWiz" interface for the S5. At any rate, the key takeaway is that Apple (NASDAQ:AAPL) can't afford to wait until September to counter.

The big iPhone – sooner is better than later
It's clear that a fairly large portion of the smartphone market (no pun intended) is moving toward these larger smartphone form factors. While many users prefer the svelte 4-inch iPhone, Apple certainly has the capability to expand its iPhone product stack. Given the company's willingness to release something like the iPhone 5c to address lower price points, it stands to reason that larger phones (perhaps a 4.7-inch and a 5.5-inch as rumored) would form a pretty compelling product stack.

That being said, Apple probably needs to move quickly if it is to truly capitalize on this opportunity. Samsung's next generation Galaxy S5 is the poster child for popular, large phones, but the competition from the likes of Motorola/Lenovo, HTC, LG, and others is intensifying. Now, the obvious reason that Apple may not be so excited to pursue such phones is that it would likely take a gross margin hit, but the company really has no choice if it wants to maintain/expand share in the premium segment of the market.

Gross margin hit?
While Apple's CEO has a strong background in supply chain management, and while the company is likely to be able to squeeze the component vendors for lower prices (after all, it's Apple), there are some harsh realities from a component cost perspective that Apple is going to have to deal with, including:

  • Increased cost of a 20-nanometer applications processor (which is rumored to be built exclusively by TSMC as Samsung hits yield problems with its 20-nanometer process)
  • Larger/higher resolution display (this will hike up the display cost)
  • More RAM, particularly given how reluctant the DRAM industry is to increase capacity (to keep ASPs/margins nice and fat)

The offset, however, is that while Apple would probably take a gross margin hit on the "smaller" of the new iPhones (i.e. the 4.5-inch-4.7-inch one) since it would need to come in at roughly the same price point as the current one. However, the incremental cost adder to go from a 4.7-inch design to – say – a 5.5-inch design is likely less than the additional $100 or so that Apple would be able to charge for the base 16GB model (given the Galaxy Note 3's $299 baseline price on-contract). This could help offset a potential margin hit on the hypothetical 4.7-inch model, depending on, of course, the unit volumes Apple is able to push.

At any rate, Apple can't afford to wait
The innovation engine across the industry at large is already moving extremely quickly (even if the rest of the market is bludgeoning its margins in order to compete in this increasingly crowded market), so Apple is unlikely to be able to wait until September before it has to pretty aggressively cut prices on the iPhone 5s in order to maintain its market share at the high end.

Apple is going to need to "wow" consumers with a next generation iPhone in order to fend off the Android hordes from eating into its outsized portion of the smartphone industry's profits. There's no question that Apple can do it – it's proven itself time and again as the designer of the world's best smartphones – but the question is whether Apple would rather milk the current design for all its worth or move quickly to a next generation design more quickly.

As always, time will tell.


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.