A Low-cost iPhone?
By Tony Clark, 2-Dooz Inc. – February 19, 2013 (Original Publication Date)
The recent slump in Apple’s stock price has resulted in an onslaught of articles regarding what ails the company. Prescriptions are plentiful and include the call for Apple to release a lower cost iPhone. Proponents of this remedy argue the following: (1) Apple will be better able to compete with Samsung in markets outside the U.S. and (2) it will solidify Apple’s appeal to mobile carriers’ who are looking to reduce device subsidies by emphasizing lower cost phones.
Though contradicted by Apple’s most recent quarterly results, critics maintain that a lower cost iPhone is imminent. Moreover, they argue that because Apple must release a lower cost smartphone the company’s margins are going to suffer and because their margins are headed lower their growth will be negatively impacted, which, in turn, justifies the weakness in the stock price. This is a nice piece of circular reasoning, but it is flat wrong. Three major deficiencies, excluding the most obvious one, which is the supposition that Apple must do a lower cost phone, are presented below.
Low cost doesn’t necessarily mean low margin
Even if Apple were to sell a lower cost iPhone, it doesn’t necessarily mean that their overall margins will suffer. For example, the cost of goods sold (COGS) portion of the margin equation for a lower cost phone could be considerably lower than their existing iPhone if the lower cost phone is based on a design having a higher level of hardware integration. The reason for this is because fewer discrete components generally result in lower overall costs. Also, both the amount of memory offered and the processing capacity provided in a lower cost phone could be less than the existing model, further reducing the COGS for such a device.
In its most recent quarter, Apple’s high margin iTunes business generated a record $2.1 billion in revenue. Apple reported, “We significantly expanded the footprint of our ecosystem during the quarter adding iTunes music stores in 56 countries, including Russia, Turkey, India and South Africa.” They are now in a total of 119 countries. I’m not recommending that they do so, but the continued growth of iTunes affords Apple the opportunity to pursue an Amazon Kindle like model for a lower cost iPhone. A lower cost iPhone could further turbo-charge iTunes and propel it to a bigger role in the company’s overall margin mix. Therefore, the growth in iTunes revenue due to a lower cost iPhone could more than offset any hit to margins resulting from offering the lower cost iPhone in the first place.
The Apple Retail Store
Arguments regarding how the mobile carriers are going to force Apple to accept a lower subsidy, possibly by emphasizing a lower cost iPhone, fail to account for the fact that Apple’s phones are not just distributed through the carriers; their phones are also sold through the Apple Retail Store. Apple recently reported that for its most recent quarter, sales through the Apple Retail Store hit an all time high of $6.4 billion—more than 10% of the company’s total revenue. The importance of this can be seen in Apple’s Greater China results. The company saw triple digit revenue growth in that region in spite of the fact that they still do not have a formal agreement with China Mobile to sell the flagship iPhone product.
Taking the above into consideration, it is clear (at least from my perspective) that Apple can afford to be deliberate about the introduction of a lower cost iPhone model. And, assuming that they do decide to sell such a product, any negative impact on their margins should be negligible.
Those are my thoughts. And, as always, I invite and look forward to learning what you think.