Apple Stock: The Surprising Upside of iPhone Installment Plans

iPhone 5s. Source: Apple.

The domestic smartphone industry is undergoing significant structural changes as we speak. One of the more meaningful shifts is a move away from the subsidy model that carriers have used for over a decade toward financing and installment plans. T-Mobile is very much responsible for the current direction of the industry. How do installment plans affect Apple's (NASDAQ: AAPL  ) iPhone prospects?

In theory
Apple's premium pricing for the iPhone is masked by subsidies as carriers absorb the extra cost. A $650 iPhone might cost the same as a $500 Android phone after subsidies. Apple devices tend to generate more data usage (and fees), which the Mac maker undoubtedly uses in subsidy negotiations.

With the move toward financing plans, the theory was that revealing the full retail price would make consumers more price-sensitive, even though that would be spread over 24 months.

In reality
According to new survey results released by Consumer Intelligence Research Partners, or CIRP, the exact opposite is happening. The figures are based on a survey of 1,500 respondents between July 2013 and March 2014. CIRP finds a considerable shift toward higher-priced iPhones when purchased under interest-free financing plans. The flagship iPhone 5s grabs 73% of financed iPhone sales, compared with 61% of subsidized iPhone sales.

Source: Consumer Intelligence Research Partners.

Under the subsidy model, Apple gets the same carrier subsidy regardless of which model consumers buy. That means moving up to a pricier model translates directly into an upfront out-of-pocket cost to the consumer.

Model

Subsidized Price

iPhone 4s

Free

iPhone 5

$99

iPhone 5s

$199

The appeal of installment plans is that the price difference also gets spread over 24 months, which encourages buyers to splurge for the latest and greatest.

Premium

Spread Over 24 months

$99

$4.13 per month

$199

$8.29 per month

Paying $8 per month for two years for the best model sure beats $200 upfront. Since the monthly difference is negligible, the increased price sensitivity theory doesn't play out.

Bringing it home
Last quarter, Apple posted a surprisingly strong gross margin of 39.3%, above the high end of its guidance range (38%). The company cited a favorable product mix, among other factors, that helped profitability. iPhone average selling prices did drop precipitously, but that was primarily due to the iPhone 4s's outperformance in emerging markets. CIRP's findings apply only within the U.S., and it estimates that Apple's domestic weighted average retail price for financed iPhones was $27 higher than subsidized models.

Domestic carriers used to report iPhone activations, which served as a proxy for Apple's domestic sales when aggregated. Activations don't equal sales, but over time the difference averages out around 1%. The last time that the biggest three domestic carriers provided this data was Q1 2013, and domestic activations comprised 28% of total iPhone unit sales. T-Mobile became a carrier the following quarter.

The U.S. should be approximately 30% of Apple's iPhone business and could even be trending lower as Apple grows in emerging markets. Additionally, Apple is enjoying tailwinds from the recent carrier additions of China Mobile and NTT DoCoMo.

Apple has been pursuing a lot of initiatives in emerging markets to make iPhones more affordable, but in those cases consumers are just trying to buy any iPhone at all. Because of lower income levels, the 5s is still cost prohibitive in many of these markets, hence declining global average sales prices. CIRP's findings are good news for Apple's domestic business, but at this point two-thirds of Apple's revenue comes from abroad, which is why Apple is rightly focusing its efforts there.

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