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Summary

  • Apple is rumored to be asking $100 more for its latest iPhone 6.
  • This is a problem, because Apple has lost its ecosystem advantage and its phones are already too expensive.
  • While the larger display is welcome, a larger price will make the share problem larger at a point where Android is already dominating.
  • There seems to be no way out for Apple. Either it sacrifices margins or volume, and both are bad outcomes.

The latest news is that Apple (NASDAQ:AAPL) is negotiating with mobile carriers on a $100 iPhone 6 price increase. This, along with something which I am about to explain, is a problem. Indeed, increasing the iPhone 6 price makes a growing problem worse.

Background

In a way, the problem Apple is facing is not a surprise. It's not something unknown to Apple itself. Indeed, an internal Apple presentation put the problem under the spotlight and even called it "Consumers Want What We Don't Have" (Source: 9to5Mac)

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So put simply, all the smartphone growth is coming from devices with screens larger than 4" and costing more than $300, and from smartphones costing less than $300. And Apple does not have either.

Furthermore, Apple recognizes that carriers are not happy with its subsidy premium (that is, subsidies on iPhones being larger than on competing Android handsets). And worse still, Apple recognizes that Android makers made large strides not just in hardware, but also in their ecosystem.

Apple fights back

Predictably, if Apple recognizes these challenges internally, Apple is going to do something about them. The answer here will be the iPhone 6, rumored to carry a 4.7" display. For once, Apple will have a contender in the larger-display area. But seemingly, according to the latest news, this contender is only going to be available at a higher price.

Therein lies the problem

The market is not just falling over itself to buy somewhat larger displays. When Apple bundles everything above $300 in its research, this somewhat misses the point that $300 is a lot different from $600 or $700. And while the carrier subsidies mitigate the problem that the customer sees, a lot of the market (particularly outside the U.S.) still buys these things unsubsidized as well. And furthermore, talking to the carriers about a $100 increase actually makes the subsidy premium worse, something which the carriers were already fighting against.

Also, the problem goes well beyond cost and display size. I will be citing anecdotal evidence next, but I am in a good position to do so. In my close family, my daughter has an iPhone 5S, while my wife carries a Nexus 5. If we go by specs, these phones are nearly equivalent.

The iPhone 5S beats the Nexus somewhat in GPU power, but loses in display size, resolution and "beauty". The iPhone 5S also loses in CPU power and battery size. And it actually "looks" a bit dated when compared to the Nexus 5. The camera on both devices seems comparable from a consumer standpoint. The iPhone 5S does win in having a slow motion capability which teenagers can love.

These are all technical specs, but then the surprise happens: The Nexus 5 is as usable as the iPhone 5S. It is as agreeable to use, if not more so. And worse still, the apps that are available for the iPhone 5S are overwhelmingly also available to the Nexus 5. And you know how women are fussy about brands; if the Nexus 5 was in any way worse my wife would have hated it, especially since it was I that convinced her that it was up to the task. Yet, my wife loves her phone and its Android 4.4.2 OS. She misses nothing from Apple's iOS at this point, and browses, organizes her life, uses apps, etc., without skipping a beat.

Put simply, there's no practical reason to opt for an iPhone 5S over the Nexus 5. Especially when you consider that the Nexus 5 costs about half what the iPhone 5S retails for. Plus, a large part of what I said above isn't even subjective - just check app availability, one of the main reasons to run an iPhone not so long ago (Source: Infragistics.com):

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Of the top 100 iOS apps, 96% were available on Android. And this is from late 2013, the situation is always improving for Android given its much larger share of smartphones worldwide. Indeed, Strategy Analytics put Android's 2013 worldwide share at 78.9% versus Apple's 15.5%. While software producers could temporarily ignore Android's larger share given iOS's larger buying power per customer, the chasm has grown so wide that developers can no longer ignore it. And the end result is that iOS has, for the most part, entirely lost its ecosystem advantage.

A larger iPhone is thus not going to cure this problem. And a more expensive iPhone is only going to make it worse, by limiting adoption.

There is no escape

At this point, Apple has no easy way out. Producing a cheaper and decent iPhone (not a colorful piece of plastic like the 5C) would eat into margins. But not having that device eats into volume and increases the ecosystem problem. Android is now so far ahead that a Macintosh/PC dynamic is not out of the question - leading Android not only to match the iOS ecosystem, but surpass it over time.

Conclusion

Slowly but surely, a problem is eating into Apple. Not only does Apple not have what the customers want (either large displays or cheap smartphones), but Apple is about to make things worse by providing them with a larger-display iPhone 6 that's substantially more expensive.

At this point Apple is facing phones that are as useful as its flagship, but are significantly cheaper. This will not be solved by a more expensive model. Apple might have no way out of this problem given that it either sacrifices margins, or it sacrifices volume thus growing the ecosystem problem.

Apple's ecosystem no longer seems to have an obvious advantage over Android, and Android's much larger worldwide volume seems set to make things worse over time. Apple is cheap on an earnings multiple basis, but those earnings will probably be under threat in the years to come, even if a temporary blip is achieved by the iPhone 6.

Brand alone is unlikely to allow Apple to fight off Android when Android devices are comparable and trade for as much as 50% off, while having a now-similar ecosystem. While I understand Apple's attractive valuation, I wouldn't invest in it.

Source: Apple Faces A Problem And Increasing Prices Will Make It Worse