How the iPhone 6 Plus Could Boost Apple, Inc.'s Margins

iPhone 6 Plus in landscape mode. Source: Apple.

Phablets are expensive. This we know. That's why Apple's (AAPL +0.56%) long-anticipated entry into the market for larger phones has so much potential to grow the bottom line. At a $100 premium compared to the regular iPhone 6, the iPhone 6 Plus will carry some juicy margins.

Thanks to new estimates from supply chain researcher IHS, investors can get an idea of how profitable the new iPhone 6 Plus really is.

Dollars and sense
IHS estimates that the component bill of materials (BOM), plus manufacturing costs, totals $200.10 for a 16 GB iPhone 6. That figure jumps to $215.60 for a similarly configured iPhone 6 Plus.

Source: IHS and author's calculations.

It gets even better once you consider Apple's aggressive new storage pricing structure. Apple is resisting the broader trend among handset manufacturers to make 32 GB standard, and by keeping the entry-level models at 16 GB, it will encourage upsells to 64 GB and 128 GB models.

The difference in cost between a 16 GB model and a 128 GB model is $47, according to IHS. Meanwhile, the difference in retail price is $200.

Source: IHS and author's calculations.

I've included the implied gross margin in both dollar and percentage terms, because each figure is important in different ways; but more on that later. Also, I say "implied," because Apple's actual reported gross margin includes other costs beyond components, such as warranty expense and infrastructure depreciation, among others.

All the moving parts
Like most consumer-oriented companies, Apple's holiday quarter is typically its busiest. Thanks to operating leverage, that usually entails margin expansion, as revenue increases sequentially during the fourth quarter (and subsequent contraction due to the loss of leverage coming out of the fourth quarter). Apple spreads its fixed costs over a larger volume of units, translating into lower total average cost per unit.

Inside the Retina HD display. IHS estimates the iPhone 6 Plus display assembly costs $52. Source: Apple.

Meanwhile, newly designed products start at the height of their cost curves, because Apple has to purchase and install new manufacturing equipment. For instance, Apple expects to spend $11 billion on capital expenditures in fiscal 2014, with the bulk of that total dedicated to manufacturing gear.

This presents a margin headwind whenever Apple introduces brand new, or redesigned, products. From a cost structure standpoint, Apple has stepped back a little from its tick-tock cycle of iPhone releases, since it has introduced brand new models in each of the last three years (iPhone 5 in 2012, iPhone 5c in 2013, and iPhone 6 and 6 Plus in 2014).

Apple conservatively expenses software development as incurred, as opposed to capitalizing and amortizing over time. That means that software development costs primarily affect operating margin instead of gross margin; but software is inherently very scalable.

Here's where the dollar-based gross margin per unit becomes significant. Due to the aforementioned leverage, and other expenses included in cost of sales, percentage-based gross margin doesn't scale linearly with volume. As unit volumes ramp up during the holiday quarter, the dollar-based gross profits will quickly add up, particularly for upsells. An upsell from 16 GB to 128 GB translates into approximately $150 in additional gross profit per unit, even though the gross margin percentage is only modestly higher.

There should be little doubt that Apple will set a fresh record this holiday season with the new iPhones. It will need to sell more than 51 million units to do so. Operating leverage combined with that level volume could help boost Apple's margins.