Apple Inc. (AAPL)’s Cheap iPhone Versus a Cheaper iPhone

With all of the hype that Apple Inc. (NASDAQ:AAPL) has gotten surrounding the potential release of a “cheap” iPhone, it’s easy to overlook the fact that older versions of the current iPhone — the iPhone 4 and iPhone 4S — are available at reduced prices.

When The Wall Street Journal reported that the company would release a less costly version of the iPhone — likely to have a plastic shell and be available in multiple colors — the concession to drop a portion of its premium image and compete in the emerging markets was widely applauded. More concretely, Verizon Communications Inc. (NYSE:VZ) reported that it sold roughly 2 million older-model iPhones. Ultimately, having both options could be a big win for Apple Inc. (NASDAQ:AAPL), even though the two devices serve very different purposes.

Apple Inc. (AAPL)

Source: Apple.

The Verizon numbers
At its last earnings release, Verizon reported that of the 7.2 million smartphones activating in the first quarter, 4 million were iPhones. Of the Apple Inc. (NASDAQ:AAPL) smartphones activated, half were iPhone 5s and half were older models. The numbers look favorable for Apple, depending on your perspective. In one sense, on a year-over-year basis, Verizon saw a 25% increase in first quarter iPhone activations — in the first quarter of 2012, Verizon activated 3.2 million iPhones.

The less promising news is that the decline on a sequential basis — 6 million iPhones in the fourth quarter of 2012 to 4 million — was larger than expected. While last quarter saw the release of the iPhone 5, the most popular iPhone yet, many had hoped the numbers would have been stronger into this year. Furthermore, the ratio of iPhone 5 activations versus older versions remained fairly constant across both quarters.

The cheaper iPhone is coming
According to Piper Jaffray’s Gene Munster, when Apple CEO Tim Cook said new products would come online in the fall, the “low-cost iPhone” will be among those products released. This should prove to be a critical device for the company, because it will allow Apple Inc. (NASDAQ:AAPL) to become more competitive in China and emerging markets. Currently, Google Inc (NASDAQ:GOOG)‘s Android is the dominant operating system — largely through Samsung hardware — but Nokia Corporation (ADR) (NYSE:NOK) Lumias running Microsoft Corporation (NASDAQ:MSFT) Windows are starting to gain traction.

In its most recent release, Nokia reported a 27% increase in sales of its Lumia WPs. IDC’s Francisco Jeronimo said: “They are trying to compete on the segment where consumers are moving from feature phones to smartphones, but they want cheap smartphones.” While IDC places Google’s global market share at 70.1%, the growth that Nokia is achieving is coming largely in markets that Apple Inc. (NASDAQ:AAPL) has left untapped. The new, cheaper iPhone will target this segment and give Apple a potential new source of growth.

Cheap versus cheaper
A distinction commonly missed when making this comparison — many in the blogosphere have commented that older iPhones are the lower-cost smartphones Apple Inc. (NASDAQ:AAPL) needs — is that older versions of the iPhone are only inexpensive in the United States. Given the significant subsidies American wireless providers offer, older iPhone models are often $99 or even free with a qualifying service contract. Overseas, this is not the case, and older models of the iPhone may still be well beyond the affordability range of many consumers. These are the subscribers at whom the new cheaper iPhone is aimed.

If your reaction is “well, duh,” the importance of this distinction should not be minimized. Given the reality that most users may prefer the premium look and feel of an iPhone 4S to a plastic iPhone, Apple Inc. (NASDAQ:AAPL) should be able to maintain its premium image at home. There will be no need to limit the sale of the cheaper iPhone to emerging markets, because demand should take care of that distinction. You should expect to see the cheaper iPhone on U.S. shelves — the multiple colors and “newness” may appeal to some consumers — but why buy a plastic iPhone when a 4S is available?