Apple (NASDAQ:AAPL) has a history of being able to ask for (and receive) high prices for its devices. iPads still cost more than a variety of comparable devices from various competitors and MacBook laptops are priced higher than comparable Windows machines. But can the company get consumers to pay $299 for a new iPhone when its user base has become accustomed to spending $199 to upgrade?
"Our checks indicate Apple has started negotiating with carriers on a $100 iPhone 6 price increase. The initial response has been no, but there seems to be an admission that there is no other game-changing device this year," said Jefferies analyst Peter Misek, according to Business Insider.
Whether Apple would want a higher price for the base model of the iPhone 6 or if the company expects to charge the premium only for the rumored larger "phablet" version of the device is unknown. There is some precedent for passing on a higher cost to customers for a device that straddles the line between a phone and a tablet -- Samsung's phablet, the 6-inch Galaxy Note 3, sells for $299 (with a contract) or $100 more than its 5-inch Galaxy S5.
In the United States the biggest wireless phone companies, AT&T (NYSE:T) and Verizon (NYSE:VZ), as well as smaller player Sprint (NYSE:S), subsidize the cost of phones, selling them to customers at a low up-front price but building the cost of the device into the price of a two-year contract.
T-Mobile, which is behind the big two but roughly equal to Sprint, does not use subsidies in the same way; it either charges more up front or spells out the monthly breakdown of phone charges to its customers.
Subsidies hurt the wireless companies
Neither Apple nor the various wireless companies spell out exactly how much they pay for an iPhone, but the deal clearly benefits Apple more than it does the wireless carriers, which have to sell the devices at a loss and wait to recoup their investment over the life of the two-year contract.
The 16GB iPhone 5S, which features a fingerprint sensor, costs Apple at least $199 to build, according to IHS, and it retails from AT&T, Verizon, and Sprint for $199. The iPhone 5C, which the three carriers retail for $99, only costs a little less, with IHS' teardown of the phone showing it costs around $176 to produce.
The phone carriers make deals with Apple to buy a certain amount of devices whether they sell them or not. Apple is so powerful and has such a devoted following that it can largely dictate terms.
When Sprint first became an iPhone carrier in 2011 the company detailed its deal to CNNMoney. According to the report, Sprint agreed to buy a set amount of phones that it estimates will cost around $15.5 billion. "The company did not say exactly how many iPhones it would have to purchase, but it noted that its cost per added iPhone subscriber would be 40% higher than the average non-iPhone customer," CNNMoney reported.
That's a heavy price to pay but at the time Sprint executives acknowledged that offering iPhones was a way to retain and gain customers.
There are other options for smartphone users now as lower-end Android phones are where the real growth is, but iPhones are still a powerful lure to high-end customers.
How does this help Apple?
Apple sold 51 million iPhones in the fourth quarter of 2013, according to company filings. Imagine if it makes a deal with the companies selling its phones to charge customers $100 more and the parties split that extra money. For every phone Apple sells under that deal, the company would net an extra $50 (while also relieving some of the pain for its partners). If Apple sells even 30 million phones in a quarter it would take in an extra $1.5 billion -- or roughly $6 billion in a year [Editor's note: We had a decimal-point problem previously. We apologize for the confusion.]
If Apple makes an even better deal -- say for 75% of the cost increase -- the company would take in $9 billion. That may not be an enormous amount of money to a company that had $170 billion in net sales in 2013, but it's a lot of money and it's pure profit.
Apple has its user base
Raising prices when cheaper Android-based phones have been driving growth in the smartphone industry may seem like an odd choice that's likely to cost Apple market share, but iPhone users have been especially loyal.
Some customers would of course switch premium phones (or wait longer to upgrade) if Apple raised the price of its phone to $299 with a two-year contract. But if the $299 price were attached to a super-premium model -- be it a phablet or something else -- and a new $199 model was also offered, Apple might be able to have its cake and eat it too. That's a risky strategy -- the last thing Apple wants people to think is that a new release is a "budget" or "low-end" phone. That concept clearly failed with the struggling iPhone 5C.
But if Apple releases a new phone in two sizes, it should be able to command a premium price for the bigger screen while not casting the regular size phone as inferior. That will leave Apple with the $100 premium on some sales and protect the value proposition the company has in people wanting its new phone as soon as it's released.
Apple has to tread carefully here because there are good alternatives to iPhones so the company needs to avoid opening that door for its most loyal customers. If Apple handles this well and there is a perceived value for the extra $100 that doesn't take away from the glow of owning the lower-priced new phone then the company should be able to grab some significant extra cash.
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Daniel Kline has no position in any stocks mentioned. He might switch phone providers if Apple charges $299 for the next iPhone. 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.