The iPhone: Lessons on Industry Pricing Power

A few days ago, I reviewed Chris Mayer’s book, “Invest Like a Dealmaker.”

One very brief section of the book that I enjoyed, but did not mention in my review, came back to me upon reading news that Apple (AAPL) once again cut the price of the iPhone – essentially, that some industries offer inherently poor returns. Citing a presentation from J. Carlo Cannell of Tonga Partners, Mayer writes:

Cannell then chose several industries that have not made money for investors, on average, for years… By the way, these numbers make things look better than they actually were for most investors. These losses are only the losses experiences by surviving investors – incredibly, these numbers don’t include the big zeroes… Let’s take a look at computer hardware manufacturers, another graveyard of investment returns. There are 68 names in this index… with negative 13 percent annual returns. Computer hardware has been a tough business for investors.

It would be short-sighted to lump Apple in with a contract PC manufacturer, but there’s a grain of truth here: tech devices tend to have a very short shelf life where they can maintain pricing power, and thus provide much in the way of value to shareholders. Motorola (MOT) and the Razr come to mind as a classic example, but the price trajectory of the iPhone (from $500 and $600 launch models, to the present $99 to $299) is stark and hard to overlook. Further, since the late June 2007 launch of the iPhone, shares have actually slightly underperformed those of smartphone competitor Research in Motion (RIMM). This could be due to a myriad of factors, not the least of which is that the iPhone hasn’t exactly killed the Blackberry in units shipped:

I also find it telling where Google’s (GOOG) focus on the mobile handset device is: the operating system. As a company, they’ve been shrewd operators about which part of the value chain they target, as can be seen in where their focus is regarding content. Likewise, there’s been more value to be had in software than hardware, which is why the existing strategy used for the iPhone makes me think it’s underutilized.

Now, I’ve been critical of the valuation on AAPL (and RIMM) at several points over the last two years. As they are now, both seem priced to deliver modest intermediate-term returns at best. Though I love my Blackberry, and Research in Motion hasn’t had to cross this bridge yet, Apple looks to have much better long-term prospects because it has a more diverse reach into digital media – what Research in Motion will do to avoid becoming “just another handset” company, with much-reduced ASPs, is still unclear at this point.

Disclosure: I own a Blackberry, but no stocks in any company mentioned. Data provided by Gridstone Research.

Comments

[stockpiler:]

I think you've missed an important point when it comes to the pricing of Apple's iPhone. They're still getting the $500 and $600 price for it. The $99, $199, and $299 prices you cite are subsidized by the phone carriers (and ultimately, the customer via their monthly bill).

Jun 10 09:08 AM

[Stocx:]

Your price power comparison ("from $500 and $600 launch models, to the present $99 to $299") is neglecting is the fact that the original phones were un-subsidized and the lower priced 3Gx phones have a $200 subsidy.

So, a fairer price comparison would be $499 and $599 on the original iPhones down to $299 to $499 for the current lineup.

Not such a loss in price power.

BTW... the subsidy is coming from AT&T not Apple.

Jun 10 09:12 AM

[brewer:]

I think the lesson here is how well the iPhone price holds up over time. If you are counting that introductory price on the original iPhone, well, you are delusional. That shouldn't even be counted, that was like the 'back stage pass' price you pay to be the ultimate early adopter. They dropped that price within weeks.

Other than that, the iPhone has held it price. As component prices increase with new functionalities, common parts become cheaper and more commoditized. i.e. Don't be foolish and compare the cost of 8Gb as a constant over time, it's not.

Jun 10 09:30 AM

[mollytjm:]

Apple continues to make PROFIT on it's products by selling so many and being able to order parts more cheaply as time goes on so you have to figure that in with pricing...what does it actually cost to make the item now?
Apple is well positioned because it's not a one-trick-pony, has a great reputation and continues to innovate well and quickly... no Vista here!
So it's a good long term stock.
Long APPL

Jun 10 10:36 AM

[Charlie P:]

If you would get rid of that Blackberry and try using an IPhone 9 (not to mention the app store) your eyes would be opened to the long term prospects for Apple.

Jun 10 11:23 AM

[rajsekar:]

I am waiting for a $49 iPhone for the holidays, or may be buy one iPhone for $99 and get one free offer from AT&T. What idiots! People were eager to get an iPhone because it was a rare gadget in July 2007. It slowly became a mainstream phone with release of 3G in June 2008 and price reduced to $199. Now it becomes a bulk commodity with $99 price range. Didn't everyone see this phenomenon with Moto Razr phone four years ago. Demand for iPhone will drop with this price cut because of this psychological issue. What's the big deal if every Tom, Dick and Harry has an iPhone? People would rather use a Pre, RIM, Nokia thin phone or something else. Apple has made a Porche into a Toyota within two years and this is going to hurt them badly. In the same argument, why not reduce Macbook prices to match Dell, HP and Toshiba. Am I missing something here?

Jun 10 01:38 PM

[jack dee:]

As the OP stated the price has fallen fast, this is to be expected with all tech. It has nothing to do with apple being good or bad it is just simply econo 101.

Apple has done great with its phones, they have shaken up the market and gotten comp moving again. every so often a new super cool phone comes out, this has gone on for decades , as the market grows these hits become bigger and bigger.

Can Apple push all others aside and run away with the smart phone market? Of course not, but they can continue to do well and compete unless of course margins become too thin..


As to googs OS, well it is a start, but only a start.

(long goog, msft and mot for short term gains. )

Jun 10 03:11 PM

[NR:]

Just look at the iPod price evolution over past five years... result - dominant, long lasting market position with fat margins... and yes, iTunes provide the "blade" of the "razor & blades" business.

iPhone is on the same trajectory.. with app store.

Jun 12 03:03 AM

[Zoltan L. K...:]

Apple is wel positioned for the competition and they seem to have the right mindset and strategy for the current economic environment. It looks like they will be able to keep fine margins while lowering their prices. The new product portfolio is simply great and better nuanced. Now all aluminium MacBooks are Pro except for the Air.

Jun 12 05:04 AM