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Apple Tries to Stimulate Growth With the iPhone SE

By Adam Levine-Weinberg – Mar 23, 2016 at 10:45AM

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Apple is taking a step in a new direction by setting the iPhone SE starting price at $399.

As expected, Apple (AAPL 1.37%) unveiled its new 4-inch iPhone SE on Monday. As far as the hardware goes, there weren't any big surprises. The iPhone SE incorporates a lot of the improvements in processing power and camera performance from the iPhone 6s into the same form factor as the iPhone 5s. (3D Touch is missing, though.)

Apple took the wraps off its new iPhone SE model this week. Image source: Apple.

However, one somewhat surprising aspect of the iPhone SE rollout was its price. Even though the iPhone SE essentially represents a two-year technological leap over the iPhone 5s, Apple set the U.S. starting price $50 lower, at $399. Let's take a look at what this decision means.

Revitalizing the 4-inch iPhone
During the iPhone SE launch event, Apple CEO Tim Cook noted that the company sold 30 million 4-inch iPhones during 2015. That's a relatively small proportion of the more than 230 million iPhones Apple sold during the year, but it's not insignificant.

Furthermore, Apple achieved this result even though it hadn't released a new 4-inch device since the iPhone 5s and iPhone 5c hit the market in September 2013. This meant it didn't have anything new to sell to fans of the 4-inch form factor.

As a result, some iPhone users delayed upgrading their phones. In fact, nearly 40% of all iPhone usage still comes from older 3.5-inch and 4-inch iPhones, according to Fiksu. One key purpose of the iPhone SE is to catalyze an upgrade cycle among people who prefer the smaller iPhones.

The iPhone SE will offer twice the CPU performance and three times the GPU performance of the iPhone 5s, an upgraded 12-megapixel camera, more LTE bands and faster download speeds than the iPhone 5s, and Apple Pay functionality. That should be enough to sell a lot of phones to iPhone 5-series users who have refused to buy the larger iPhones.

Testing price elasticity
Apple has also found that people buying their first iPhone are more likely to opt for a 4-inch model. This may be driven more by price sensitivity than by preference.

Since late 2014, the iPhone 5s and iPhone 5c have been Apple's cheapest models. For people in emerging markets buying their first smartphone or switching from a low-end Android model, the 4.7-inch and 5.5-inch iPhones may be unaffordable.

The iPhone SE will cost much less than the iPhone 6s. Image source: Apple.

With the iPhone SE, Apple will test just how much price has been constraining demand. Apple could easily have given the new phone a $549 starting price: $100 less than the iPhone 6s. After all, the two models are differentiated by their size and one key feature (3D Touch). That's similar to how the iPhone 6s and iPhone 6s Plus are differentiated by size and one key feature (optical image stabilization) -- and those two models are $100 apart in price.

Instead, the iPhone SE will be priced at $399 in the U.S. for the 16 GB model, a full $250 below the iPhone 6s starting price. That makes it $50 cheaper than anything Apple has offered before, at least in the U.S.

Moreover, every previous low-end iPhone was a holdover model -- typically two years old. By contrast, price-sensitive customers can now get an affordable iPhone that's on par with Apple's most expensive models in terms of performance.

This could allow Apple to make more headway with lower-income customers across the world, particularly in key emerging markets like China and India. Given that the smartphone market has matured in most developed countries, Apple will need to succeed in these emerging markets to grow iPhone sales in the years ahead.

In that sense, the iPhone SE fills the role that many pundits expected for the iPhone 5c a few years ago. It's a cheaper -- but still high-quality -- phone that Apple can use to draw in more price-sensitive consumers.

Will there be trade-down?
The risk for Apple in developing a phone that is nearly equal to its top-of-the-line models in performance but much cheaper is that some customers trade down. While the iPhone SE undoubtedly costs less to produce than the iPhone 6s, the cost savings are far less than the $250 price difference.

Fortunately, Apple's core audience isn't very price sensitive, and most people who have already upgraded to larger models don't want to go back. (Of course, there are a few iPhone 6 users who will choose to switch back to the 4-inch model now.) Screen size is enough of a differentiator that the iPhone SE isn't likely to undermine sales of pricier models.

Thus, the iPhone SE gives Apple a relatively low-risk opportunity to test whether offering a slightly cheaper iPhone would attract more customers to its platform. If it succeeds in reigniting iPhone unit sales growth in the next two quarters, you can count that as a big win for Apple.

Adam Levine-Weinberg is long January 2017 $85 calls on Apple. The Motley Fool owns shares of and recommends 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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