Cheaper iPhones: A Good Idea for Apple?

Feb.18.11 | About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) is expected to release a cheaper version of the iPhone during 2011. [1] These models could be half the size of the iPhone 4, and would presumably be available for half the price of standard iPhones. Apple primarily competes with Research in Motion (RIMM), Motorola Mobility (NYSE:MMI), and Nokia (NYSE:NOK) in the mobile phone market.

On the face of it, this move should present the opportunity for Apple to sell more iPhones and further establish itself in the highly competitive smartphone market. Google (NASDAQ:GOOG) Android OS-based smartphones have seen tremendous adoption growth over the past year, and the recent partnership agreement between Nokia and Microsoft (NASDAQ:MSFT) could pose another long-term threat to Apple (see Nokia Partnership Provides Upside for Microsoft Stock).

The move to offer cheaper iPhones should help Apple gain smartphone market share, but this could come alongside lower average pricing and reduced profit margins. Below we analyze this effect in relation to our $420 price estimate for Apple stock, which is roughly 20% above market price.

iPhone Sales are Key for Apple

Apple’s smartphone market share has stagnated over the past few quarters, with Google’s Android making rapid strides and recently surpassing Apple’s iPhone in U.S. market share according to ComScore data. [2] However, we do expect an increase in iPhone’s global market share from around 3% in 2010 to 12% by the end of our forecast period.

(Chart created by using Trefis' app)

The cheaper iPhones could certainly help Apple target developing markets, where the company’s premium products may not yet have fully established a customer base. Developing markets, especially emerging markets, tend to be more price sensitive. Another issue with these markets is that consumers are accustomed to buying mobile products without a contract from telecom providers.

Long-term contracts allow telecom providers to absorb premium pricing and pass subsidized pricing along to consumers. This means that Apple’s premium products sold without contract are always priced much higher than its competitors offerings. Hence, the introduction of cheaper iPhones makes a lot of sense for developing markets. To demonstrate the sensitivity of Apple’s equity value to this metric, we note that a scenario in which Apple is able to grow its global market share to around 25% by the end of our forecast period (vs. our 12% base forecast) would imply 60% upside to our price estimate for Apple stock. Clearly, this metric is critical to Apple’s valuation.

Reduced Pricing and Margins Could Present Downside

According to a report from The Wall Street Journal, the cheaper iPhones could be available for half the price of standard models. [1] The average iPhone pricing for 2010 was around $610, and although we expect the pricing to decline to around $410 by the end of our forecast period, this decline could accelerate if the cheaper iPhones become a big hit.

(Chart created by using Trefis' app)

Pricing cuts would hurt profit margins on the iPhone. Apple generates substantial value from its ability to generate high margins on iPhone sales (over 50% as of 2010). Although we already expect iPhone gross margins to decline to around 39% by the end of our forecast period, the reduced average pricing would add further pressure to this metric.

(Chart created by using Trefis' app)

There could be a downside of 25% to our price estimate for Apple’s stock if average pricing and gross profit margins both decline to half of their current levels, reaching $300 and 25% respectively by the end of our forecast period.

Overall, potential reductions in average iPhone pricing and gross profit margins would be more than offset by expected increases in iPhone sales. In aggregate, the scenarios mentioned above would imply net upside of 8% to our $420 price estimate for Apple stock.


  1. Wall Street Journal report: Less-Pricey iPhone in the Works, February 2011.
  2. InformationWeek: Google Android Surpasses Apple iPhone Market Share, January 2011.

Dislcosure: No position