Apple, Inc.'s Lower-Cost Smartphone Strategy is Just Beginning

Headed into Apple's (NASDAQ: AAPL  ) 2013 iPhone launch, investors hoped the iPhone 5c would fulfill the media's blind love for lower-cost smartphones. The argument was simple: Apple was losing market share globally to cheap smartphones, and a lower-priced iPhone would help the company's competitive position in the fast-growing market.

But Apple didn't deliver. The iPhone 5c cost just $100 less than the 5s, leaving it among the priciest phones on the market. Since then, the argument for Apple to launch a cheaper iPhone has largely disappeared -- and for good reason: the argument was based on facile assumptions.

iPhone 5c.

Beyond the fact that leading the premium smartphone market has effectively positioned Apple to reap the lion's share of the industry's profit, another benefit to dominating at the high end is less documented: Apple's unyielding pricing power means the company can focus on customer experience to the point that even its older models are among the best options in the market.

The beginnings of Apple's new growth market
The benefit Apple derives from its older models is only now just beginning to be realized. With smartphone technology reaching performance levels in which big leaps in processing power are more difficult to decipher, iPhone models that are just a few years old give emerging markets a way to more easily afford the iPhone while also gaining access to the company's robust and "sticky" ecosystem.

Consider, for instance, how well the iPhone 4s is still selling. Even though the phone is more than two and a half years old, about 11 million units were sold during Apple's most recent quarter, according to Needham analyst Charlie Wolf (via AppleInsider). Eleven million iPhone 4s sales translates to 25% of Apple's total iPhone sales during the quarter. The 4s even significantly outsold the 5c, which Wolf estimates made up just 4% of the quarter's iPhone sales.

The Apple iPhone 4s. The differentiating factor for the 4s over the 4 was a much faster processor and Siri. Image source: Apple.

Apple benefits from this development in multiple ways.

First, Apple is slowly but surely bolstering its competitive presence in the fast-growing emerging markets segment. Even more, since the 4s is several years old it has given the company time to work it significantly down the cost curve. In other words, it's likely Apple still makes significant profit on 4s sales despite a lower price point.

Second, the 4s is bringing a large number of new customers into Apple's ecosystem. Wolf believes that about 10 million of the 11 million 4s sales in Apple's second fiscal quarter of 2014 went to customers who were new to the iPhone platform. And given Apple's impressive retention rates thanks to a comprehensive and customer-focused ecosystem of complementary products, software, and services, every customer who joins Apple's ecosystem is worth far more than the initial profit margin attributed to the sale.

The 4s' success is an early sign of Apple's potential at lower price points, and the potential is looking sweet.

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Read/Post Comments (11) | Recommend This Article (5)

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 May 19, 2014, at 4:59 PM, antonygrow wrote:

    It's hard for me to believe information when words like "facile" are used incorrectly. As smartphones continue to become our main sources of conduits to the internet, phones will need to become cheaper or do radically new things every quarter. Apple revolutionized the way we access information, but even the upcoming iPhone 6 or the possible iWatch will no longer be revolutionary, only an upgrade. Price points will have to fall to remain competitive when other companies are already offering what only Apple could in the beginning.

    The only factor truly driving Apple's recent rise is the increase in dividend and the 1 to 7 split that will undoubtedly cause investors to want to spend more per share. I see this stock starting at $90 in June and heading to $150 by December. After this, we'll see a drop similar to the fall to the $400 range.

    Now that's facile information.

  • Report this Comment On May 19, 2014, at 5:25 PM, TMFDanielSparks wrote:

    The main argument for apple to have a low end strategy was, indeed, based on facile assumptions. The overarching assumption was that market share should be apple's priority. That assumption is facile, or an assumption appearing neat and comprehensive only by ignoring the true complexities of an issue; superficial.

    A deeper analysis of the issue (one based on assumptions that aren't so facile) would remind those making that argument that Apple dominates the lion's share of profits -- and meandering away from this proven strategy could have a negative impact on EPS over the long haul.

    As far as where Apple stock is headed in the next few months or even the next year or two, I'm not in the business of making those predictions; I would have to make facile assumptions to do so.

    But I see a solid business doing very well with an excellent price, so I will hold.

  • Report this Comment On May 19, 2014, at 5:32 PM, imvho wrote:

    1. Facile can mean "superficial" or "effortless" depending on the context.

    2. "$150 by December" means only one thing...

    HOORAYY!!!!

  • Report this Comment On May 19, 2014, at 5:39 PM, TheodoreCleaver wrote:

    fac·ile

    ˈfasəl/Submit

    adjective

    1.

    (especially of a theory or argument) appearing neat and comprehensive only by ignoring the true complexities of an issue; superficial.

    synonyms: simplistic, superficial, oversimplified; More

    (of a person) having a superficial or simplistic knowledge or approach.

    "a man of facile and shallow intellect"

    2.

    (of success, especially in sports) easily achieved; effortless.

    "a facile victory"

    synonyms: effortless, easy, undemanding, unexacting, painless, trouble-free

  • Report this Comment On May 19, 2014, at 5:45 PM, AceOfSaves wrote:

    @antonygrow

    As others have said, the word "facile" was used correctly in this article. Does this mean you will believe the information now?

    As far as your statement regarding the only factors (as you stated two separate factors) for the recent rise in the stock price, I'm sure that the strong iPhone sales had something to do with it as well.

  • Report this Comment On May 19, 2014, at 6:24 PM, JokerJoey wrote:

    Everyone who tries to discount the effect of older model sales is missing the real point: It's not about price point, low-cost versus high end, or anything else of that nature.

    It's about market penetration for the Apple ecosystem.

    Every time someone new adopts the Apple platform whether it be by iphone, iPad, or Mac, it represents a recurring source of income to the company, one which carries LITTLE OR NO COSTS. That's the real key. Add another 10 million users and you likely add another 100 million or more app or book or content-of-some-kind-which-costs-$$ downloads. And all those downloads mean only one thing: Cash in the bank!

  • Report this Comment On May 20, 2014, at 8:03 AM, Cintos wrote:

    Remarks here about ecosystem are pertinent to lower-cost phone sales. Increasing the user base does help Apple make $$$, but more importantly, 70% of those app sales go to the developer community. THEY are the "ecosystem". Mr. Market was concerned at one point that developers would abandon the iOS platform and stampede over to the Android camp, allowing Apple's users to languish with little content. Hah. Now THAT was a facile deduction.

  • Report this Comment On May 20, 2014, at 5:06 PM, henrystar wrote:

    "difficult to decipher" Surely you mean deliver, not decipher!

  • Report this Comment On May 20, 2014, at 5:22 PM, dilaarka wrote:

    IMHO Apple's low cost phone strategy would be under a "lesser" label.....Perhaps more in line with Toyota/Lexus ...Perhaps the rumored "Dre" acquisition is going to be developed as the lower cost label.....I wouldn't want to dilute the brand ...Ahrendt's wasn't exactly hired to run Apple retail as a cheapo depot.

  • Report this Comment On May 21, 2014, at 12:31 AM, gone4lunch wrote:

    Seriously, iCrapple is done. I was with 5 of my friends last night and none of them had iClones. The product is really made for less sophisticate users (ie: media and artists). The working class use Android and the rich people / managers and up use Blackberry. The only reason you see iUsers on their 3 or 4 device, is because this group is trendy and not the smartest organisms in the petri dish...It takes two things to dislodge an iClone from a iUsers hands. A damaged screen from dropping it and paying for a replacement one to many times or new fad. iCrapple didn't change the way people use the internet...that was Blackberry (formerly RIM). Android's got everything else, which is the lion's share of the market (75%-85% depending on which source you're using).

    Enough with the history lesson...on to the article. The bottom line is that iCrapple is about goodwill and how much people will pay for it. That's what Steve Jobs was good at doing. He knew how to enter the market at the right time with the lowest risk and how to humanize the product so people would get attached for it and pay ridiculous prices for the product. This group is not as big as you would expect, but big enough to turn at $2/share company back into a $600/share company. I am sure we'll see the stock slide south of $400 by the end of the year. Especially without the Hedge Fund support it had in 2013. The idea of product dumping to expand the ecosystem is ridiculous. Sure, it's true that iClones haven't change that much since the first release, this will help drive up the resell value as we see with other high end consumer based products like automotive companies that do not dramatically change the design of their models from year to year (like Porsche). Sure, there will be some sales of older model iClones (since they all look the same anyway). This is by design (Steve Jobs), but the cost:performance ratio makes it hard to justify by the emerging market as we have always seen in the premium market. Google's been swallowing this market up (hence it's the champ in the emerging market). Blackberry is entering the emerging market with the Z3, so we'll have to see how this all shapes up. I don't have a crystal ball, just the facts and based on that, I wouldn't be buying iCrapple stock any time soon. Maybe pick up some put options and see what happens.

  • Report this Comment On May 22, 2014, at 10:07 AM, 1ponder wrote:

    gone4lunch, you're right, Apple is about goodwill...so many techies miss that point. You write it and even you dismiss it. My mom and MIL (71 and 68) both have multiple Apple products. Design and support, ease-of-use for the non-experts -- those are the main things. You ever call the Apple help line? A person picks up the phone and helps you -- no routing, no entering your account number three times, no selecting from an endless maze of options. The person who answers the phone is trained, pleasant, patient and fixes your problem -- it's amazing!

    When it comes to competitive differentiation, new features are a distant second in the eyes of most consumers who use 5% of the features that are available on their old phones. And the brand extends to the rest of the world -- the Chinese want iphones not droids.

    Stock analysis: the current price bakes in the split, and the price will retreat when it actually happens because splits don't add value. Unless/ until Apple creates a new product, the stock will perform somewhat better than the market due to expansion in China and ongoing tactical periodic financial re-engineering.

    However, AAPL price does not include any expectation for new products, so if Apple launches a successful product it will be all gravy -- I estimate 20% annual total return without a product, 20% + one-time 25% for successful new product launch. Then in two years you decide if you still want to own, but hold on for now.

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