Hitting a price
If Apple won’t be able to meet its high quality standards for less than $150 (including all manufacturing, licensing, and logistics costs), the company won’t really participate in the “low-end” smartphone market, per se. One well-known Apple analyst, Piper Jaffray’s Gene Munster, predicted earlier this year that Apple would introduce a $199 iPhone this summer. However, it’s highly unlikely that Apple would sell a device so close to the cost of production. Resellers would also get a cut of the purchase price, leaving Apple with only $175-$180 in net revenue.
Munster recently revised his expectation and now believes that the cheaper iPhone will cost $300. However, even at that price, he expects it to “cannibalize” high-end iPhone sales. In other words, some customers who would otherwise pay up for a $449 iPhone 4 — or an even more expensive device — will choose the cheaper iPhone. Since the iPhone’s current average selling price is more than $600, and gross margin is generally estimated above 50%, Apple earns more than $300 of profit per iPhone sold (on average). If Apple makes only $100-$120 in profit per device for the cheaper iPhone, heavy cannibalization could cause the company’s earnings to shrink even if iPhone sales grow significantly.
The solution
A potential solution to this conundrum would be to price the new iPhone a little higher, at perhaps $329 or $349. That would still be significantly cheaper than the iPhone 4, and it would place the new iPhone solidly within the mid-range segment. Apple has historically focused on “aspirational” products, and a $329 or $349 price point would be within reach for many customers, while protecting Apple’s profits. As my Foolish colleague Evan Niu noted earlier this month, a trade-in program in India that reduced the effective cost of the iPhone 4 from $485 to $360 (or less) caused sales to triple. That suggests that a $100-$150 price drop could have a surprisingly large impact on sales in developing markets.
In other words, I expect Apple to follow a strategy similar to its iPad Mini pricing strategy. Many observers expected Apple to fight Amazon.com, Inc. (NASDAQ:AMZN)‘s $199 Kindle Fire (now $159) with a tablet priced as low as $249; instead, the base iPad Mini costs $329. Despite the big price gap, Apple couldn’t keep the iPad Mini on store shelves during the holiday season because of overwhelming demand, while Kindle Fire sales growth was fairly muted. Apple offers a differentiated user experience, and people will pay more — up to a point — for its products. Therefore, $329 or $349 seems like the ideal price point for a cheaper iPhone.
Foolish conclusion
Apple hasn’t even confirmed that it will make a cheaper iPhone yet. Nevertheless, it seems inevitable that this product is on the way in the next year or so. It may not be quite as cheap as some analysts expect, but that shouldn’t hurt sales very much. If Apple can offer an iPhone at a mid-range price point while also adding major new carrier partners such as China Mobile Ltd. (ADR) (NYSE:CHL), the company will probably return to solid earnings growth. With Apple stock having recently fallen below $400, the shares look like a great value in that scenario.
The article How Cheap Will Apple’s “Cheaper” iPhone Be? originally appeared on Fool.com.
Fool contributor Adam Levine-Weinberg owns shares of Apple and is short shares of Amazon.com. The Motley Fool recommends Amazon.com, Apple, and Google and owns shares of Amazon.com, Apple, China Mobile, and Google.
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