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Meet Apple's New iPhone Family

By Evan Niu, CFA - Sep 10, 2013 at 3:59PM

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Over six years have passed since the original iPhone launched. Only now has Apple decided to start a real family out of the product. Say hello to the iPhone 5c.

iPhone 5c. Source: Apple.

Two and a half years after unveiling the original iPod in 2001, Apple (AAPL -0.14%) would aggressively move downmarket and launch the iPod Mini in order to target lower price points, opening up an entire new addressable market segment. Nearly the same time frame played out with the iPad; the Mac maker launched the iPad Mini approximately two and a half years after the first version debuted in 2010.

Yet, here we are over six years after the original iPhone was launched in 2007 and up until now the company has kept the iPhone product strategy limited to one new model per year. The only way that Apple has addressed lower price points has been to progressively move models down the pricing spectrum as new ones are released. Relative to how long Apple took to move downmarket in its other major product categories, this expansion seems long overdue.

At long last, Apple has made the iPhone into a bona fide family affair. Say hello to the iPhone 5c and iPhone 5s.

A tale of two iPhones
Apple's rumor mill is as active as ever, and there weren't any major surprises for investors paying close attention. All of the leaks heading into today's event regarding both the iPhone 5c and iPhone 5s have proven spot on. The iPhone 5c will sport a plastic unibody in five different colors, while the iPhone 5s design remains largely unchanged save for the addition of a new gold color option.

Marketing chief Phil Schiller spent a lot of time discussing the iPhone 5s camera improvements. The iPhone is one of the most commonly used cameras in the world, and Apple knows it. Instead of furthering the megapixel war, Apple has decided to take cues from one of its rivals: HTC. The Taiwanese OEM took a dramatic strategic departure earlier this year with the HTC One by using a 4-megapixel sensor while emphasizing the better low-light performance and other benefits. Apple is now sending the same message and has likewise increased the pixel size in its sensor. HTC's strategy just got an implicit vote of confidence from one of its biggest rivals.

iPhone 5s. Source: Apple.

The integrated fingerprint sensor was also a shoo-in heading into today's event. As if it wasn't immediately obvious that this is what Apple had in mind when it acquired AuthenTec last year for $356 million, the company just made it official. The home button on the flagship model will now come with a "Touch ID" fingerprint sensor for a layer of biometric security, which can then be used to unlock the device, authenticate for purchase, and more. Apple isn't sharing any of this fingerprint data with anyone, even itself.

According to Tim Cook, Apple is now "replacing" the iPhone 5, since the iPhone 5c is built out of the same internals and will now occupy the $99 subsidized price point. The new iPhone 5s will naturally take the $199 subsidized price point common for flagship smartphones, with the expected $100 incremental bumps for additional storage. The iPhone 4S is sticking around to occupy the $0 subsidized price point. Here is Apple's new iPhone lineup on contract.


Subsidized Price Points

Storage Configurations

iPhone 4S


8 GB

iPhone 5c

$99 / $199

16 GB / 32 GB

iPhone 5s

$199 / $299 / $399

16 GB / 32 GB / 64 GB

Source: Apple.

However, it's when we get to unsubsidized pricing that the story gets interesting... and potentially disappointing.

A tale of two choices
Investors were initially quite excited about the iPhone 5c's prospects -- the stock jumped immediately after Apple made the mid-range device official.

The iPhone 5c has been heralded as Apple's key to tapping emerging markets, particularly those where the subsidy model is not utilized. Most investors were hoping for the 5c to price between $350 and $450, which would give it better odds of succeeding in China and India, among other key geographies. In order to meet those expectations though, Apple would face a dilemma.

If the 5c retailed for $450, it would sit at the $0 subsidized price point given its current subsidy level with nothing at the $99 subsidized price point. That could also hurt the 5c's brand perception if Apple released a new product that's given away for free on contract. The alternative would be to retail for $450 but accept a dramatically lower subsidy from carriers in the ballpark of $325 (after volume discounts), which could potentially undermine the roughly $425 subsidy it earns on other models. Decisions, decisions.


Unsubsidized Price Points

Storage Configurations

iPhone 4S


8 GB

iPhone 5c

$549 / $649

16 GB / 32 GB

iPhone 5s

$649 / $749 / $849

16 GB / 32 GB / 64 GB

Source: Apple.

Instead, Apple stuck with the same pricing strategy. The 5c will retail for $549 unsubsidized. All of the cost savings associated with using a plastic casing will go straight toward padding gross margins, instead of being passed along to consumers and spurring greater unit sales. Apple may need to rely on other affordability initiatives such as financing for the 5c to perform well internationally.

A tale of two carriers
In line with a report last week, Apple has finally inked a deal with Japan's No. 1 carrier, NTT DoCoMo (NYSE: DCM), to offer the iPhone. This is a first for the Japanese carrier, while smaller rivals KDDI and Softbank have long leveraged the device to steal customers. With nearly 62 million mobile subscribers, Apple just expanded its addressable subscriber market by a fair amount.

Investors will still have to wait for news on the China Mobile (CHL) front though. Schiller did note that China is on the list of launch countries for the first time ever, without elaborating on specific carriers. There have been reports that China Mobile is postponing its iPhone launch until November in order to put the finishing touches on its new TDD-LTE network, so all's not lost. At 745 million subscribers strong, China Mobile is a much bigger opportunity. Investors have been waiting years for this partnership, and they'll just have to wait another couple months.

Has Apple made a huge mistake?
The iPhone 5c pricing was the biggest unknown, and quite frankly it's a bit disappointing considering what investors are hoping for the device to accomplish. Apple should have discontinued the older iPhone 4S and priced the iPhone 5c at $0 on contract (despite any possible risk to its brand image), while moving the iPhone 5 to the mid-range $99 on contract price.

That would have eliminated the subsidy dilemma, while accelerating the transition away from 3.5-inch displays and unifying the platform with 4-inch screens. There would probably also have been some cost savings, since Apple could have then retired its iPhone 4S infrastructure while the iPhone 5 and iPhone 5s likely share many manufacturing resources due to their similar design.

More importantly, it would have given the iPhone 5c the maximum odds of success exactly where it matters: emerging markets.

Evan Niu, CFA, owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and China Mobile. Try any of our Foolish newsletter services free for 30 days. 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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