Apple’s Cheaper iPhone 5c and New iPad Strategy Fail to Address its Core Problems

Apple (AAPL 0.64%) recently launched an 8GB version of its lower-end iPhone 5c in Europe, China, and Australia, then replaced its aging iPad 2 by bringing back the iPad 4.

Both moves fail to address Apple's two biggest problems -- its overdependence on the iPhone and iPad, and its steady loss of market share. Let's take a look at why Apple's half-hearted attempt to boost demand for the iPhone 5c and the iPad won't really help the company recover any of its lost market share or boost margins.

The iPhone 5c. (Source: Apple)

Apple's market share and weakening sales growth
Many discussions regarding Apple's iPhones and iPads gloss over the company's troubling declines in global market share when compared to Google (GOOGL 1.27%) Android devices:

Global market shares. Sources: Kantar, Gartner.

Apple bulls generally use two arguments to counter this information -- that sales of iPhones and iPads are still rising amid a growing mobile market, and that margins matter more than market share. However, Apple's slowdown in year-over-year sales is obvious:

Source: Apple annual reports.

The number of iPhones sold between 2012 and 2013 only represented a 20% year-over-year increase, compared to the 74% jump between 2011 and 2012. A 22% year-over-year jump in iPad sales in 2013 also doesn't measure up to the 81% increase that occurred in 2012.

Apple's slumping margins
Meanwhile, Apple's margins are contracting. During the first quarter, Apple's gross margin came in at 37.9%, down from 38.6% in the prior year quarter. That decline shouldn't surprise Apple investors -- simply take a look at this comparison of Apple's gross margins over the four quarters of the last two fiscal years:

Source: Apple quarterly reports.

Therefore, we've established Apple's three core problems -- its shrinking market share, slower sales growth, and declining margins.

The iPhone 5c's non-existent market
Considering those three key problems, Apple faces two big dilemmas. To gain market share, it needs to release a cheaper phone on par with Android devices. To grow margins, it must maintain a stronger hold on the high-end market. The iPhone 5c solves neither problem.

The iPhone 5c's unlocked U.S. price of $549 (16GB) and $649 (32GB) makes little sense when compared to the iPhone 5s and other Android devices. The iPhone 5s, for example, costs between $649 (16GB) and $849 (64GB). However, storage capacity consistently ranks near the bottom in must-have features for smartphone users.

A poll recently conducted at Phone Arena (assuming the prices of the phones were equal) of over 2,000 visitors showed that only 5.5% thought that storage capacity was the most important feature for a new phone -- 23.3% cared about the battery capacity, 17.9% cared about the processor speed, and 17.7% thought design and physical size mattered.

That means that when given a choice between the equally priced 32GB iPhone 5c and 16GB iPhone 5s, the average customer will likely purchase the 5s. Meanwhile, Samsung's (NASDAQOTH: SSNLF) Galaxy S III, which has a larger display and uses removable flash memory (up to 64GB), costs less than $300 unlocked.

(Source: Apple)

Why a cheaper iPhone 5c doesn't matter
Apple does not disclose the total amount of each iPhone model (4s, 5s, 5c) sold. However, the fact that it just introduced a cheaper 8GB 5c in China, Europe, and Australia strongly suggests that sales are slumping. The price cuts won't be relevant to U.S. users, since the iPhone 5c is already the cheapest in its home market.

For example, the 16GB iPhone 5c costs £469 ($778) in the U.K., and the 8GB model will cost £429 ($712) -- still considerably more than the unlocked 32GB model in the U.S. The 8GB iPhone 5c will reportedly cost $779 in Germany and France, $616 in Australia, and $660 in China.

If Apple implements the same price reductions in the U.S., the price of an unlocked 8GB iPhone 5c could drop to $499 -- but that still keeps it in a much higher price range than low to mid-range Android devices.

But what about the margins?
According to Cross Research analyst Shannon Cross, the 8GB iPhone 5c will result in lower gross margins for Apple, since the cost to Apple for 8GB of NAND is $5 to $10. In other words, the cost saved by swapping out the memory is more than offset by the big price drops.

Meanwhile, Apple discontinued the iPad 2, which has remained immensely popular since its release in 2011, then brought back the iPad 4 (iPad with Retina Display) at the same price point of $399 as the new entry-level device. The iPad Air, which originally replaced the iPad 4, now becomes the "premium" device with a price range between $499 (Wi-Fi, 16GB) and $929 (Wi-Fi, Cellular, 128GB).

It's easy to see that Apple is sacrificing margins, once again, to force users to upgrade from the iPad 2.

Failing to address the real issues
In closing, the price cuts for the iPhone 5c and the shuffling of the iPad lineup do little to address the company's core problems of its dwindling market share, slower growth, and contracting margins.

Considering that the iPhone and iPad account for 76% of Apple's revenue, CEO Tim Cook needs to concentrate on diversifying Apple's product line with new devices such as wearables, make a concrete decision on pursuing or abandoning the lower-end market, and use Apple's cash hoard of $40.8 billion to acquire promising companies, rather than buying back its own shares.