Following the launch of the iPhone in 2007, Apple (NASDAQ:AAPL) quickly grew to be the dominant player in the high-end smartphone industry. In doing so, it decimated the market share of BlackBerry (NYSE:BB) (then called Research In Motion), sending the company into a tailspin.
Up until 2012, Apple seemed to be on a path to smartphone dominance, at least in the high end of the market. However, growth has slowed dramatically in the past year. While growth rates have always been "lumpy" because of timing issues, there has been a clear downward trend in iPhone sales growth recently.
There has been much talk in the market that Apple will offer a cheaper iPhone to appeal to customers who can't afford a $450 product like the iPhone 4. However, this potential move raises a legitimate concern about cannibalization of higher-priced, high margin iPhones. To solve this dilemma, Apple should (surprisingly enough!) consider following BlackBerry's lead by releasing a mid-range smartphone, but only in selected markets.
Apple's problem is fairly simple. The iPhone 5 has a starting price of $649 (in the U.S.), and even the three-year-old iPhone 4 retails for $449 if you aren't getting a carrier subsidy. This premium pricing has allowed Apple to maintain stellar margins for the iPhone. Horace Dediu of Asymco estimates the iPhone's gross margin at 48% as of last quarter. That's less than the peak of nearly 60% last year -- before the introduction of a new form factor with the iPhone 5 -- but still well above the gross margins of Apple's other product lines.
Ideally, Apple would like to expand the market for the iPhone by offering a cheaper version that could compete in the "mid-range" smartphone segment. Apple will never be able to deliver a high quality product that can compete on price with the $99 Android phones that are common in developing countries. However, a price point as low as $300 seems feasible.
That said, if Apple delivers a high-quality smartphone for $300 unsubsidized, it risks cannibalizing sales of its high-end phones. Even in the U.S., many people would consider trading down to a cheaper iPhone, as evidenced by the continued strong sales of the iPhone 4 and iPhone 4S.
If this cheaper phone had a gross margin of just 20% (implying a profit per device $200 to $250 lower than the average iPhone sold today), cannibalization of high-end iPhones could more than offset the benefit of restarting unit sales growth. Apple therefore needs to find a formula that would allow it to introduce a cheaper iPhone and grow its global market share while minimizing cannibalization of high-end iPhone sales.
That's where following BlackBerry's lead could prove useful. BlackBerry recently unveiled its first lower-priced smartphone running the new BB10 OS. The Q5, announced at this week's BlackBerry Live conference, will be very similar to BlackBerry's Q10 high-end smartphone, but it will use some cheaper components.
However, BlackBerry isn't planning a global rollout for the Q5 (at least not yet). According to the company's press release, "The new BlackBerry Q5 smartphone will be available in selected markets in Europe, the Middle East, Africa, Asia (including the Asia-Pacific region), and Latin America."
Conspicuously missing is North America, home to two of BlackBerry's top three markets: the U.S. and Canada. BlackBerry wants to push the cheaper Q5 phone primarily to developing markets, where consumers would be unwilling to pay $600 to $700 or more for a high-end BlackBerry. On the other hand, the company clearly doesn't want U.S. keyboard lovers to trade down, because BlackBerry needs to drive high-margin Q10 sales to return to profitability. By not offering the lower-cost option in North America, BlackBerry is employing mild price discrimination to boost its margins.
What does this mean for Apple? In large developing markets such as China, India, and Latin America, Apple is locked out of much of the smartphone market, because most consumers can't afford a high-end smartphone. While Apple has had some success in these markets (particularly China), the incremental opportunity from offering a lower price point is substantial and should easily outweigh any "cannibalization effect." For example, a trade-in promotion that reduced the effective cost of the iPhone 4 from $485 to $360 in India led to a tripling of the sales rate.
By contrast, Apple already holds 39% of the U.S. smartphone market, according to comScore. The opportunity to increase market share through a lower-priced product here is outweighed by the potential effect of cannibalization on margins.
Producing a cheaper iPhone that's available only in "selected markets" would therefore make a good deal of sense for Apple. The company could introduce the product in developing countries and test it in a few smaller developed markets to judge the effect on "regular" iPhone sales. That would allow Apple to pursue the vast mid-range smartphone market opportunity it's currently missing, without raising the bears' fears of massive margin compression. In this one case, Apple should definitely consider taking a page out of BlackBerry's playbook.
Fool contributor Adam Levine-Weinberg owns shares of Apple and BlackBerry and is long January 2014 $13 calls on BlackBerry. The Motley Fool recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.