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Apple's Worst Nightmare May Be Coming True

By Daniel B. Kline – Jul 21, 2016 at 10:19AM

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The company may be cannibalizing sales of its most important product with a cheaper version of it.

For many years Apple (AAPL 1.48%) avoided the low-price market, choosing to let consumers looking to save a few bucks on an Apple device buy older models of its iPhones, iPads, and Macintosh computers.

That was a sensible strategy that may have cost the company some customers while preserving its premium image. Apple devices were not Windows or Android machines that could be had cheaply. The company was akin to luxury automobile brands, which do not slap their name on low-end models. 

Apple, however, deviated from its premium strategy when it released iPhone SE earlier this year, a lower-priced version of its popular phone. That may have proven to be a bad idea as new research shows that owners of older phones often chose the SE rather than the current, pricier 6s and 6s Plus models.

Ultimately, that could eat into the company's bottom line because iPhone accounts for about 65% of Apple's total revenue.

Apple offers the high-end iPhone 6s and 6s Plus as well as the budget-friendly SE. Image source: Apple.

What does the research say about iPhone sales?

New research from Consumer Intelligence Research Partners (CIRP) estimates that in the most recent quarter -- the first quarter when the new, cheaper iPhone SE was on sale and the third full quarter for iPhone 6s and 6s Plus -- the SE accounted for 16% of total iPhone sales in the United States, with iPhone 6S at 39% and iPhone 6S Plus at 26%. The iPhone 6 Plus, 6, and 5s are also still selling. The latest sales estimates would be good news for the company if the SE buyers brought new users into the company's fold, but that does not appear to be the case. At least for this U.S. data.

"In this quarter, the iPhone 6s and 6s Plus accounted for 65% of total sales," said CIRP partner Josh Lowitz in a press release [opens in PDF]. "In contrast, a year ago, in the June 2015 quarter, their predecessors, the iPhone 6 and 6 Plus had 82% of total sales. A year ago, the iPhone 6 and 6 Plus grew their share of total iPhone sales relative to the previous quarter, up from 78% in the March 2015 quarter. In this quarter, the iPhone 6s and 6s Plus saw their share shrink relative to the March 2016 quarter, from 71% to 65%."

Basically, instead of upgrading to the current top-tier phone, people with older Apple models have elected for the cheaper SE. CIRP reported that among iPhone SE buyers, 33% upgraded from an older iPhone while 17% of iPhone 6s and 6s Plus buyers upgraded from an older iPhone and the number was only 12% of iPhone 6 and 6 Plus buyers.

That would still be fine for the company if the new model was also converting Android users, but that does not appear to be what's happening.

"iPhone SE appears to have appealed to owners of much older iPhone, and less to switchers from Android and other operating systems," said CIRP partner Mike Levin in the press release. "On the one hand, the SE may have persuaded these owners of older iPhones to upgrade to a new phone, and possibly remain with Apple iOS. On the other hand, with its much lower retail price, iPhone SE also may have diverted these customers from purchasing a more-expensive iPhone 6/6s series phone, which will likely lead to a lower ASP [average selling price] in the quarter."

Why is this bad news?

With the SE, Apple walks a very narrow tightrope. The company wants to use the cheaper model to keep users of older phones with the company while also luring in Android users. What it does not want to do is give people who would have bought a top-tier model a path to spend less.

The company appears to be successful in getting users of old iPhones to consider the SE rather than leaving for a cheaper Android phone. That's good news, perhaps, but it's also possible many, if not most, of those customers would have eventually upgraded to a more expensive Apple model.

The vast majority of iPhone users -- 88%, according to research from Kantar -- intend to buy another Apple phone. Where Apple has fallen short with the SE is the new model has not grown the user base but has apparently hurt sales of its higher-priced sister phones.

Apple has made it cheaper for people to be in the iOS ecosystem, but in doing so has cost itself sales of its premium product at a time when the company was coming off its first down quarter for iPhone since it was introduced in 2007. Ultimately that's bad news for shareholders because it's really Apple selling against itself by giving consumers a cheaper option.

Daniel Kline owns shares of Apple. He has an iPhone 6s and will be getting a 7 when it comes out. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. 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.

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