5.5-Inch iPhone Will Offset iPad Cannibalization

| About: Apple Inc. (AAPL)


Apple is having added difficulty with differentiating its core product line-up.

Despite these difficulties, I expect the iPhone 6 to have a successful launch.

Cannibalization from a larger form factor device may be offset with the $100 price differential.

Assuming demand for the iPad Mini declines due to the phablet, top line sales may be impacted, but gross profit will still improve.

While I admit Apple's (NASDAQ:AAPL) competitive situation could be significantly better, I don't really think it will worsen. Apple still dominates in higher-margin consumer electronics, and its recent move to a 5.5-inch phablet should be gross margin neutral even after cannibalizing demand for the smaller iPad Mini.

Differentiation has become increasingly difficult

Leading up to the release of the iPhone 6, 9To5Mac, got their hands on the front paneling of the iPhone 6. Design wise, it looks almost identical to the Samsung (OTC:SSNGY) Galaxy, but with Apple's standard button in the bottom middle. It's sort of ironic that Apple's upcoming design looks similar to its biggest rival, but with the way the market is structured, it has become increasingly difficult to further differentiate product A from product B.

Quoted from: Mac Rumors

Indeed, we're not completely certain that this is the final design of the upcoming iPhone. But I have reason to believe that it most likely is, as Mac Rumors has become a pretty reliable source of information, and as we get closer to the September launch of the iPhone, product image leaks become increasingly accurate.

"Apple will likely charge a $100 premium for the 5.5-inch version that media reports have suggested will be available a few months after the 4.7-inch version," Raymond James analyst, Tavis McCourt stated in a note (quoted from MarketWatch). I agree with McCourt, because Samsung is able to do the same with the Galaxy S, and Galaxy Note line.

Furthermore, the iPhone 5.5-inch version may slow the penetration of the iPad Mini. Phablet devices like the Galaxy Note 3 are sold for $700 (off contract). The incremental cost of a larger screen is low, and is covered by the higher retail price. When comparing the bill of materials for the Samsung Galaxy Note 3, and the Samsung Galaxy S4 (similar generational components), the differential is a whopping four dollars. IHS estimates that the Galaxy S4 had a bill of materials of $236, whereas Tech Insight estimates that Galaxy Note 3 had a bill of materials of $240.

What this indicates is that the iPhone 6 5.5-inch variation's $100 price differential from the iPhone 6 4.7-inch variation will almost be pure profit. So even if customers decide not to buy a low-end iPad tablet, the company is able to make up for the cannibalization with a device that commands a much higher premium without hardly any incremental cost. The low-end iPad Mini has an estimated bill of materials of $200, when you go with the model that has a Retina display, it's estimated that costs would go up by 30% from the base model, indicating that the bill of material depending on the Mini model would be $200-$260. If that's the case, even if the iPhone 6 5.5-inch version were to completely displace the demand for the iPad Mini, the impact is net income neutral.

Furthermore, just because a consumer buys the larger 5.5-inch display device, doesn't mean that the same consumer will not buy a tablet. In fact, it may encourage consumers to buy the larger tablet (iPad Air), therefore I believe that Apple's upcoming product mix will have a positive impact on net income, and phablet cannibalization will positively impact gross margins.


So the change in mix going forward may be revenue negative, profit neutral. The change in mix will be offset with shipment growth through Apple's various products. Therefore it's safe to assume revenue and net income will grow, while gross profit margin will also improve. The introduction of new product categories like payment services and smartwatch, will add to the company's top-line performance, and since the smartwatch is a high gross profit product, gross margins are also likely to improve in that aspect as well.

I don't think investors should worry about cannibalization, and if anything, the phablet will unlock a pocket of the market that has been demanding larger smartphone devices.

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