The high end of the smartphone market -- one in which Apple (AAPL 0.87%) plays pretty much exclusively -- appears to have saturated. Now, while some may mistake this for "on the decline," the fact of the matter is that this segment as a whole isn't growing anywhere nearly as much as the broader smartphone market. In order to grow, Apple needs to gain more share at the high end. The upcoming iPhone 6 is Apple's best shot at a return to profit growth.
The iPhone 6 will be more expensive to make
A faster processor, more RAM, larger chassis, bigger/higher resolution screen, and other goodies don't come cheap. Apple needs to pay for it. Now, there's no doubt that it will squeeze its suppliers to the extent that it can, but even still, it would be remarkable if Apple actually found a way to keep the cost of its next-generation iPhone 6 flat relative to the 5s.
That said, despite an increase in the bill of materials, Apple could end up growing its sales pretty significantly as a result of share gains at the high end against Samsung, HTC, and other Android players. So, just what kind of market share gains does Apple need in order to offset a bill-of-materials increase? This is tricky to forecast as we need to come up with good estimates for the following:
- The underlying secular market growth at the high end
- What kind of potential market segment share gains at the high end Apple could get with a 4.7" iPhone
- How much more expensive the iPhone 6 (4.7") will be relative to the iPhone 5s.
Projected iPhone 6 specifications
To help understand (3) above, it's worth building upon the analysis presented in "Apple's iPhone 6 Specs Revealed" to try to come up with a potential bill-of-materials cost for the iPhone 6 relative to the iPhone 5s (iPhone 5s numbers from IHS iSuppli).
|
Components |
iPhone 5s (16GB) |
Cost |
iPhone 6 (16GB, Projected) |
Cost (Projected) |
|---|---|---|---|---|
|
NAND flash |
16GB NAND |
$9.40 |
16GB NAND |
$9.40 |
|
DRAM |
1GB LPDDR3 |
$11.00 |
2GB LPDDR4 (?) |
$25.00 |
|
Display + touch screen |
4-inch 1136x768 touch display |
$41.00 |
4.7-inch, 1600x900 touch display |
$52.00 |
|
Processor |
Apple A7 + M7 co-processor |
$19.00 |
Apple A8 + M8 co-processor |
$22.8 |
|
Camera(s) |
8MP + 1.2MP |
$13.00 |
8MP + 1.2MP |
$13.00 |
|
Wireless (Cellular) |
Qualcomm MDM9615 + WTR1605L + RF Front End |
$32.00 |
Qualcomm MDM9x25 + WTR1605L + RF Front End |
$35.20 |
|
UI + sensor |
Touch ID |
$15.00 |
Touch ID |
$15.00 |
|
Connectivity |
Broadcom-based, Murata 802.11n module |
$4.20 |
Broadcom-based, Murata 802.11ac module |
$5.00 |
|
Power management |
Dialog + Qualcomm |
$7.50 |
Dialog + Qualcomm |
$7.50 |
|
Battery |
~1570 mAh |
$3.60 |
~2300 mAh |
$5.00 |
|
Mechanical/Electro-Merchanical |
$28.00 |
$34.00 | ||
|
Box Contents |
$7.00 |
$7.00 | ||
|
Total cost |
$190.70 + $8 manufacturing |
$230.90 + $8 manufacturing |
Data source: IHS.
Now, if Apple ends up selling these at the same $649 (16GB) price as the iPhone 5s, then it is clear that there will be some margin compression in going from a device that costs about $200 to build against one at $240. However, the effects of this margin compression diminish with the size of the flash memory on board as the $40 delta becomes a smaller part of the selling price. Also, it is likely that Apple will offer a 128GB version at an even higher price point that'll carry even better margins to help offset the decline in the smaller ones.
How much volume does Apple need to grow?
For simplicity's sake, let's assume that 80 million of the 150 million iPhones sold in a given 12-month period is the latest and greatest. A $40 increase in cost over 80 million units suggests a hit to gross profit on the order of $3.2 billion a year. However, given that the iPhone 6 will still likely generate at least $400 in gross profit per unit, Apple needs to sell at most 8 million incremental iPhone units to maintain similar levels of profitability (in reality it could be less depending on the mix of 16/32/64GB models).
Now, 8 million incremental high-end units imply approximately 10% growth. The 4.7" screen should entice buyers of Android handsets to switch (as the iPad Mini did in tablets vis-a-vis the Android tablets of the time), and hitting that target is likely more than achievable. The question is whether Apple can do more than that in order to grow gross profits.
Foolish bottom line
At the end of the day, even a more expensive to make iPhone 6 will probably drive enough revenue growth to at least hold the line on raw gross profitability. Of course, to command a meaningfully higher multiple, Apple will need to grow high-end units in excess of that 8 million mark, but this should be achievable given the underlying secular trends and the market share growth opportunity.
