According to research firm IHS, via a column published in Tech Insider, Apple (NASDAQ:AAPL) is said to make an additional $88 in gross profit whenever a customer steps up from a model with 16 gigabytes of storage to a model with 64 gigabytes of storage.
This number likely comes from an estimate of the incremental hardware cost to go from 16 gigabytes of NAND flash to 64 gigabytes.
This is fair, but it's important to keep in mind that there's one thing that also increases along with the selling prices of iPhones.
One of the things that makes cellular-capable devices a little trickier to sell than Wi-Fi only devices is that to sell such devices, a company generally has to pay royalties to wireless patent giant Qualcomm (NASDAQ:QCOM) -- typically in the ballpark of 3% of the selling price of the device.
This, for example, is a widely cited reason for why PC makers have been hesitant to include cellular functionality directly embedded in their devices.
Now, back in 2009 analysts with Sanford Bernstein said that Apple doesn't actually pay royalties on the prices that customers pay for iPhones; rather, the royalty is paid on how much Apple's contract manufacturers charge the iDevice maker for the finished phones.
It's not clear if that's still true or not (seven years is a long time and Apple is secretive), but let's for a moment assume that Qualcomm has found a way to put an end to this particular loophole.
In that case, if we assume a 3.5% royalty rate on the iPhone, Apple has to cough up $22.72 on the sale of a 16 gigabyte flagship iPhone. A 64-gigabyte model that Apple charges customers $749 for would yield a royalty payment of about $26.22 -- about $3.50 per unit.
Doesn't hugely change the numbers, but it's important to consider nonetheless
The additional $3.50 in wireless royalties that Apple might have to pay to Qualcomm means that the bump from a 16 gigabyte model to a 64 gigabyte model doesn't yield quite the $88 incremental profit that has been reported; it's more like $84.50.
This might not seem like much, but if we consider that Apple now sells more than 200 million iPhones each year -- with a significant proportion of them likely the 64-gigabyte and 128-gigabyte models -- a couple of dollars per unit can still have a significant impact on Apple's bottom line.
How Apple can extend this strategy further
At this point it's quite clear that Apple is able to make something of a killing by up-selling customers to greater amounts of storage -- assuming that they're willing to pay.
Down the line, Apple is going to need to raise the storage capacity of its base-model iPhones, but it can't do so without continuing to compel users to buy up the product stack. I really like what Apple is doing with its iPad Pro lineup; base storage sits at 32 gigabytes (up from 16 gigabytes), with the higher tier options offering 128 gigabytes and 256 gigabytes of storage capacity, respectively.
I can't see Apple bringing such tiers to the main iPhone lineup this year, but something similar could make sense for the iPhone Plus models or even the rumored iPhone Pro models, as I outlined here.