Apple Inc. (AAPL): What About China?

Going into yesterday’s iPhone announcement, the biggest unanswered question was the iPhone 5C’s pricing. The phone was largely expected to have an unsubsidized price somewhere between $400 and $500.

We were way off mark. Apple Inc. (NASDAQ:AAPL)‘s  iPhone 5C retails for $549 — just $100 less than the iPhone 5S. With shares down about 5% today, investors clearly disagree with the pricing decision. What’s Apple thinking?

What about the important Chinese market?
The mid-tier smartphone market in China is in the $300 to $400 range, according to Wedge Partners analyst Jun Zhang. At $549, Apple Inc. (NASDAQ:AAPL) wasn’t even close. If the company managed to pull off a pricing point in the $400 to $500 range, it would at least be borderline. But $549?

And, of course, U.S. iPhone prices don’t carry over very gracefully into China. According to Apple’s China website, the 16GB iPhone 5C retails for RMB 4,488, or a whopping $733.

There’s no way around it: Apple Inc. (NASDAQ:AAPL) simply isn’t gunning for the mid-tier smartphone market.

Fortunately, however, Apple Inc. (NASDAQ:AAPL) didn’t kill the iPhone 4 in China like it did in the U.S. It’s arguably the only iPhone that lands in the mid-tier with a retail price of RMB 2588, or $423. Even so, the iPhone 4 is a three-year-old iPhone. Will this aging technology continue to sell?

For many investors, Apple Inc. (NASDAQ:AAPL)’s pricing decision for the iPhone 5C is disappointing news. The opportunity in China is enormous. In the second quarter, Apple’s iPhone shipments accounted for just 4.8% of all smartphone shipments in the country, according to recent data from Canalys. There is a large untapped market that Apple isn’t attracting, and it doesn’t look like that’s going to change.

So what is Apple’s strategy?
Margins.

Apple Inc. (NASDAQ:AAPL) will be able to collect much higher up-front profit at $549. Piper Jaffray’s Gene Munster believed that the iPhone 5C would carry a 15% gross profit margin at an unsubsidized price of $300. If his estimates of Apple’s component costs for the 5C were correct, the plastic-backed smartphone would likely boast a monstrous gross profit margin. Even if he underestimated the 5C costs, the smartphone’s $549 price tag still merits an impressive gross profit margin.