Apple Inc. (AAPL)’s iPhone 5: Is It About To Disappear?

Since the introduction of the iPhone in 2007, Apple Inc. (NASDAQ:AAPL) has reliably updated the device once a year. For the past several iterations, beginning with the release of the iPhone 3GS in 2009, Apple Inc. (NASDAQ:AAPL) has dropped the price of the previous model by $100 to provide a lower-cost option for price-sensitive customers. Thus, the typical price structure for the current iPhone options in the U.S. — assuming a two-year contract and a carrier subsidy — is the following:

Standard U.S. iPhone Pricing

Model Price
iPhone 5 $199
iPhone 4S $99
iPhone 4 Free

Last week, The Wall Street Journal reported that the next-generation iPhone, thought to be called the “iPhone 5S,” will enter production this quarter. Analysts believe that time frame puts Apple Inc. (NASDAQ:AAPL) on track to release the iPhone 5S in June or July. But I don’t think Apple Inc. (NASDAQ:AAPL) will follow its previous custom by dropping the iPhone 5 subsidized price to $99 this summer.

The iPhone 5. Source: Apple.

Instead, the company may choose to discontinue the iPhone 5 when its replacement arrives. That would line up with the strategy Apple Inc. (NASDAQ:AAPL) followed for the most recent iPad update: The fourth-generation iPad replaced the third-generation iPad as the high-end model, with the iPad 2 remaining in production as a cheaper alternative.

New iPhone coming
The main rationale for a new high-end iPhone is to keep the pressure up on Apple Inc. (NASDAQ:AAPL)’s competitors Research in Motion (NASDAQ:BBRY) finally released its new Z10 all-touch smartphone in the U.S. last month, and CEO Thorsten Heins has publicly called the iPhone “outdated.” Meanwhile, major Google Inc (NASDAQ:GOOG) Android vendors such as Samsung and HTC are releasing new flagship phones this spring. Last year, Samsung used the gap between its spring release of the Galaxy SIII and the iPhone 5’s fall debut to pick up significant market share.

Apple Inc. (NASDAQ:AAPL) needs to update the iPhone sooner rather than later to keep its products in the spotlight and bolster its position vis-a-vis Android phone vendors. However, it needs to do so without putting further pressure on its profitability, which has become a concern recently.

Gross margin is the key
The introduction of the iPhone 5 dented Apple’s gross margin, which dropped 610 basis points year over year, from 44.7% to 38.6%, in the fall quarter. Some of these increased costs relative to the 4S were temporary, as the iPhone 5 required a new manufacturing process, new equipment, and other upfront costs. However, while those initial cost headwinds may be subsiding, the iPhone 5 still includes more expensive components than the iPhone 4S — better screen, LTE modem, and the like.