A Cheaper iPhone Would Confirm A Lack Of Innovation And Declining Margins At Apple

| About: Apple Inc. (AAPL)

According to a report by Digitimes that was subsequently corroborated by The Wall Street Journal, Apple (NASDAQ:AAPL) is working on a low-cost version of the iPhone that the company may launch as early as within 2013. Such a device would be perfect for Apple in targeting consumers within the emerging and developing markets, including China, India and Russia.

While Apple's current iPhone continues to be a popular and well received device, the iPhone's high cost is expected to push the average developing market consumer towards cheaper competing smartphones, especially as the differences between the iPhone and smartphones running Google's (NASDAQ:GOOG) Android OS diminish. Competition for the lower end of the global smartphone market may only increase as new Microsoft Windows 8 phones also begin to enter the global market. Nonetheless, the iPhone does continue to sell well in China, with the company noting that it sold over two million iPhone 5 smartphones during the product's weekend launch for China.

If the rumor of the new, cheaper iPhone is true, the device would certainly position Apple to better compete in developing markets, where consumer adoption of smartphones is still in its infancy. Many Android smartphones are already on the market, with some models competing at the high end alongside Apple, and others selling at prices comparable to the traditional mobile phones from which consumers are now upgrading.

Current speculation states that the low-cost iPhone would have a larger screen than the iPhone 5, which has the largest iPhone screen yet, though a smaller screen than many new, popular Android smartphones. While a larger screen would seem more expensive, it may be the case that the lower cost model would have a lower resolution screen that would be cheaper even at a larger size. Other speculation includes Apple potentially using a cheaper plastic case and housing for the smartphone, replacing its current aluminum construction.

According to a research report issued by Barclays (NYSE:BCS) the bank estimates that the iPhone 5 costs Apple about $215 in parts. This cost excludes the cost of manufacturing and distributing the device, as well as the cost of providing a product warranty and other external costs. Barclays estimated that the iPhones display represents about 20 percent of the total cost, and that the company may be reducing these component costs through the scale of its purchasing. The report also estimates that "the iPhone and related revenue accounted for about 51% of Apple's revenue in FY12 and will grow to about 54% of revenue in FY13."

Competing on price is not Apple's traditional move. The company has a long history of selling mostly higher-end computers that work better than competing products and/or with newer features that competitors will not yet offer. Competing on the price-point appears to be a sign of slowing innovation.

If the company is innovating new technology, it has not released it recently, and not just within its smartphones. In 2012, Apple intentionally kept obviously desired and already existing advancements off of their newest products. For example, Apple's high resolution Retina Display-branded liquid crystal screens have existed for a while now, but Apple did not include it in all models of MacBooks that it released in the summer of 2012, and also left it off the iPad mini that it released in the fourth quarter or 2012. The absence of the Retina Display from these new models is inexplicable, except for the insincere intentional withholding of the advancement for yet another forthcoming update. This is also why it would appear probable that a lower priced iPhone would revert to a lower resolution display.

Moreover, this intentional slowing of innovation has allowed Apple's competitors to catch up to it, and now offer competitively featured and priced products. And this intentional technological limitation was not missed by its competitor, Amazon.com (NASDAQ:AMZN), which is happy to point out that its seven inch Kindle Fire HD "features 30% more pixels and 33% more pixels-per-inch than iPad mini," and that "with Kindle Fire HD, you can watch HD movies and TV-you can't on iPad mini because it's not an HD device." Amazon's 7" Kindle Fire HD is priced at $199, compared to $329 for the iPad mini. And while that Kindle is slightly smaller than the iPad mini, the slightly larger 8.9 inch Kindle Fire HD "features 193% more pixels and 56% more pixels-per-inch than iPad mini," and is also priced below the mini, at $299. All of this indicates that further margin compression should occur in the near future.

In addition to Amazon's Kindle, there are now several other market options running Google's Android OS on smartphones and tablets that are quite competitive with Apple's, including a great many options made by Samsung (OTC:SSNLF) and Google's own Nexus 7 tablet. More competition will come, and as the technological capabilities approach one another, price will become a differentiating factor of growing importance. Price will be of greatest importance in emerging markets, where the most growth is to be expected going forward.

Investors should note that on October 25, Apple reported earnings that missed expectations and stated that its gross margin had contracted to 40 percent, compared to 40.3 percent for the same quarter last year. Though this minor contraction in Apple's profit margin was at least partially due to the necessary expenses involved in ramping up production and related marketing expenses for new products, such expenses existed last year too.

Current estimates for future earnings growth largely presume Apple will be able to maintain its still uncharacteristically lofty profit margins. The recent launch of the iPad mini and its probable cannibalizing of at least some of Apple's higher margin iPad sales, if not also MacBook sales, could accelerate further declines to its profit margin. A cheaper iPhone would likely have a similar effect, only accelerating such margin erosion, especially within the higher growth developing markets.

New competing products such as the recently released low-priced Google Chromebooks and coming Windows 8 products should only further compress margins. As a result of all this, Apple's margins and/or market share should begin decline. With declining margins, Wall Street projections for Apple's future earnings will also face pressure, as might its leadership.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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