Apple, Inc. Has an Unusual Solution for People Who Can't Afford an iPhone

iPhone 6s. Photo: Apple

Low-cost smartphones have come a long way in recent years. For less than $200, consumers can purchase critically acclaimed handsets powered by Alphabet's (GOOG -1.96%) (GOOGL -1.97%) Android, like Motorola's Moto G or Xiaomi's Redmi 2. They certainly don't offer the same level of performance or features as a $649 flagship, but they're capable of accomplishing most tasks. 

Apple (AAPL 0.52%) has long resisted the urge to release a low-cost iPhone. It discounts older models, but only slightly: the iPhone 5s, at $450, is still considerably more expensive than the average Android smartphone. This isn't much of a problem in developed economies, where consumers are able to afford Apple's high prices, but it limits emerging market demand. In the past, analysts have regularly called on Apple to release a cheap iPhone aimed at this market -- but those calls have been ignored.

Still, Apple's management sees the value in expanding the total number of iPhone owners. On the company's last earnings call, it laid out an alternative strategy -- one that could help put more iPhones in the hands of budget-constrained consumers.

A byproduct of more frequent upgrades
Apple is expected to sell around 70 million iPhones this quarter. Some of those handsets will go to first-time smartphone owners, but most buyers -- especially in the U.S. -- will be upgrading from an existing smartphone (and more often than not, an older iPhone). Those used smartphones could be headed to junk drawers or landfills, but an increasing number will make their way to emerging markets.

Firms like Gazelle, Glyde, HYLA Mobile, and Brightstar have been buying and selling used iPhones for years. Generally, phones are purchased from wireless carriers or directly from consumers in developed economies, then resold in emerging markets. If you participated in an iPhone trade-in program anytime this year, someone in Vietnam or Bangladesh might be using your old handset at this very moment.

Historically, however, most consumers have held on to their old handsets, even if they didn't intend to use them. In 2013, HYLA Mobile (via Bloomberg) estimated that only 15% of consumers traded in their old smartphones when they purchased new ones. That figure has likely risen in the last two years, and should rise significantly in the quarters to come.

New plans adopted by U.S. wireless carriers that allow for more frequent upgrades also force consumers to trade in their old handsets. Verizon will give iPhone 6s owners the ability to upgrade to an iPhone 7 next year, but only if they're willing to trade in their existing iPhone. The same is true for similar plans from T-Mobile, Sprint, and AT&T. The popularity of these early upgrade programs is expected to rise in the coming months -- Piper Jaffray believes more than half of U.S. iPhone owners will soon begin upgrading on an annual basis. That should mean tens of millions more used iPhones available to emerging market consumers.

U.S. wireless carriers remain the driving force behind this shift, but similar plans are increasingly being offered in other countries, and by Apple itself.

A boon for the App Store and Apple's platform
Apple's CEO Tim Cook spoke about this trend on the company's most recent earnings call, arguing that it should provide a significant tailwind for Apple's App Store business.

"I would also point out that some of these upgrade programs that are in the market, they sort of began to look more like a subscription business in terms of the way they operate...we think that, in the aggregate, that they may reduce upgrade cycles...also, the iPhone that has been sold to someone else hits the price point that we're not hitting today, largely, which could help further fuel the services revenue which we did quite well on last quarter."

Later in the call, Cook reiterated the point, arguing that used iPhones could provide tough competition for handsets powered by Alphabet's mobile operating system:

"We do like the fact that [early upgrade programs create] a market for...iPhone at a different price point...[that used iPhone is probably a] better product than [what the] customer may be currently buying, which would further help from an ecosystem point of view and that's not to be underestimated."

A used iPhone sold to a consumer doesn't benefit Apple's iPhone business directly, as it collects no revenue on the sale, but it does benefit the company in other ways. A consumer who buys a used iPhone might still purchase some apps from the App Store. Apple's Services segment, which includes the iTunes app store, is now Apple's third-largest business. Last quarter, it generated almost 10% of Apple's total revenue, rising 10% on an annual basis. 

The growing number of used iPhones available in these markets could cannibalize some of Apple's own iPhone sales, but given the high price of new iPhones, it's more likely that they'll steal business from low-cost Android vendors. Alphabet's mobile operating system powers about 81% of the smartphones sold globally, with most of its success attributable to emerging market buyers. There won't be enough used iPhones available to make a significant dent in Android's market share, but every additional iPhone user helps as the iOS platform becomes that much more attractive to mobile developers.

Used iPhones may not be the emerging market answer analysts were looking for, but it seems to be the one they'll get.