iPhone Price Cut Causing Trouble For Apple

Okay, this whole Apple (AAPL) iPhone price-cut issue continues to spiral. The stock continued to fall Friday as analysts incorporated the earnings impact of the $100 in-store credit into their models. It's not often a fast-growing company with a hot product cuts prices by 33% and then takes heat for the decision, so let's talk some more about it.

Three things.

1. As I said Thursday, in a perhaps perverse way the $100 Apple in-store credit troubles me more than the initial price cut. I could handle the latter -- Steve's playing for keeps, and he wants to make a statement in the cellphone market. He's prepared to compete on both price and features, which makes him a formidable competitor in that cut-throat business. Fair enough. But the credit's belated arrival suggested the iPhone price cut was ill-considered and somewhat rash, not part of the original plan. That could mean any number of things, some operational, some political, and some financial, but none of them are appealing to investors and analysts.

2. Most analysts are coming to the conclusion (as Eric summarizes here) that the earnings impact of the price cut is minimal to non-existent. Not zero, but not a large enough drop to justify the current tumble in AAPL shares.

3. Further, in the longer run, this is not (yet) about a problem with Apple's iPhone business. Instead, it is largely a public relations fiasco, with a tone-deaf Apple cutting prices without adequate consideration of the political impact on its existing iPhone customer base. That is not the same thing, folks, as the loopy implicit suggestion that Apple should have kept prices high (a point that Tyler Cowan nails here).

My guess is you'll see a coterie of analysts come out defending the stock shortly on the current weakness. The stock, while off 9% in the last few days, is still up 11% over the last month, so this is going to look to many like a buying opportunity.

For my part I'm still a little unsettled by the rebate, and while I like Apple at these prices, I sure would like to know more about when Jobs decided to cut iPhone prices. I think Jobs needs to get more out in front of this issue and take questions somewhere, not just issue a press release.

Comments

[jgphoto1:]

Analysts are a fickle bunch especially when it comes to Apple. Good news is almost sure to be punished as it was with the iPhone launch, iMac refresh and the resent major iPod updates and the iPhone price cut.

As an early iPhone adopter I chose to purchase at the going $599 price and considered it a fair value exchange at the time. It is an even better value exchange now and the rebate was unexpected but welcome. It is easy enough for reporters and to generate "outrage" on behalf of Apple customers and there is incentive as doing so generates readership. However I have yet to see that outrage from actual customers of whom I know quite a few.

A stronger, broader user base justifies and assures ongoing programming efforts to upgrades and new features throughout the iPhones life cycle so that the phone you own today is better than the phone you originally bought. Broader sales helps existing owners in this regard.

While the timing and the handling may not have been perfect, as an APPL stockholder I applaud the decisive action to respond to competitive and economic influences and seize the opportunity for a blockbuster next two quarters rather than waiting and missing out to a large extent on this holiday season.

Many analysts would do well to get out more and actually do some first hand research rather than following an abstract herd mentality. Go to an Apple store which are usually busy and you will notice that they are now packed (post iPod refresh and iPhone price cut). And new iPhones, IPods and iMacs are briskly walking out the door. Apple has set the stage for an absolutely stellar performance in the next two quarters and beyond.

2007 Sep 09 09:36 AM

[David Lentz:]

I think you may be seeing the iPhone as a product in isolation, as opposed to the upper end of the iPod product line. Take a look at how the iPhone pricing fits into the iPod product line, in the prior and current cases, and I think you'll see a much better fit today. If they were still selling $399 4 GB and $599 8 GB iPhones, how would a $499 16 GB iPod Touch fit in?

The iPod Touch is for those people who either can't stomach the iPhone's required AT&T service contract and lousy network, or who are unwilling to give up their existing cellular provider and want the iPhone's feature set.

Looking at the prior iPhone pricing in the context of the other iPod pricing, it's clear (to me, at least) that it doesn't quite fit and causes unnecessary confusion. Given the relative sales volumes of the other iPods vs the iPhone, it's also clear that changing the iPhone price was preferable to tinkering with the iPod pricing.

The only mystery to me is all the angst and confusion in the analyst/blogger camp. I guess it was a slow news week.

2007 Sep 09 10:03 AM

[David Lentz:]

Whoops -- I meant a $399 16 GB iPod Touch. That makes the case even stronger.

2007 Sep 09 10:06 AM

[ThinkFirst:]

The iPhone was announced at MacWorld on January 9th this year. The pricing was announced then as well. It was also announced that it would be available in June. Sales began on June 29th. As far as I know, Apple has never announced a product 6 months before the date of first sale. Even the new iPod touch will be available in just under a month.

I believe Apple would have preferred a shorter gap between announcement and first sale. But, this was their first foray into the cellphone market and they needed to work with another company (AT&T) to make it successful. And they need FCC certification. They would not have been able to keep the product a secret much beyond January 9th.

For the early adopters, the price cut came 2 months after the day of first sale. From Apple’s perspective, the price was cut 8 months after the pricing was first announced (Steve explained the pricing logic in his MacWorld keynote). In the consumer tech world, 8 months for a price cut is not unusual. I think therefore that Steve was genuinely surprised at the strong negative reaction from early adopters.

The $100 store credit is a great response to placate angry Apple fan(atic)s. The cost will be much less than the estimated $85MM. In fact, Apple may even come out ahead. But, Apple needs to make it clear that this is a one-time only deal and that they will change product pricing as and when they see fit as part of overall business strategy.

Many commentators have jumped to the conclusion that iPhone sales must have slowed down. Although that may be true, I think a more reasonable explanation is that Apple needed to realign iPhone pricing to the rest of its iPod product portfolio and to upcoming iPhone product announcements. And, to take advantage of higher production capacity of their suppliers, to generate higher sales volume and, to lower manufacturing costs of common components. That is just Business Strategy 101.

But, more than that, I think that Apple initially saw the iPhone as a product quite separate from the iPod (Steve sort of said that to Walt Mossberg at D5). Yes, it had features of the iPod, but it was mainly a phone with a terrific touch-screen interface. At some point, probably long before MacWorld, they must have realized that there would be a significant market for an iPod touch. Certainly from those who did not want to switch to AT&T. But, logically, its introduction had to wait after that of the iPhone. With the introduction of the iPod touch, there is now a continuum (more or less) from the shuffle to the iPhone. Apple needed a rational price structure. And, so the iPhone price cut.

If you now look at the pricing of all its new iPod/iPhone products, it makes a lot of sense. For $299, you can get an 8GB iPod touch. Pay a $100 more and you get an 8GB iPhone with its additional calling, email and other features.

According to a recently leaked T-Mobile Germany ad, a 16GB 3G iPhone will go on sale in Europe for 499 euros. I expect that before the end of the year, and perhaps in time for the holidays, Apple will announce a 16GB 3G iPhone for the US as well. And, logic dictates that it would be priced in the $499 to $599 range. If this announcement happens, Apple will have a formidable product portfolio: from the $79 1GB iPod shuffle to the $499 to $599 16GB 3G iPhone.

And at some point within the next few months, or maybe the next holiday season, will come the $199 2GB iPhone nano. No iPod features, no WiFi, just a cute little phone. I am just speculating but it makes sense to me.

2007 Sep 09 12:12 PM

[StreetSweeper:]

Response to your three things:
1. Yes, Apple is making a statement, not to just the cellphone market but the computer market as well. The reduced price and fast growing sales rate firmly will place Apple as a leading contender in a few years. And the iPhone is now seen as a reasonably priced "on sale" item for the Christmas sales. To the computer market, Apple is stating that the future of data interaction is slowly moving away from desktops to handheld.

2. The pricing will actually promote a greater profit as estimated by a number of analysts rather than a earnings drop.

3. The price cut and give-back were not a fiasco at all. Jobs came off looking like a compassionate business leader with his next day announcement of the give-back. If he had announced the give-back on Wednesday, recent purchasers would have asked for more. Most customers did not show displeasure at the cut, realizing that the "I-got-one-first" buyers pay a premium but the news-sensationalizing media jumped on the few very vocal dissatisfied customers.

It should be obvious that Apple (Steve Jobs) has never paid much attention to the price of the stock, knowing it will eventually climb with sales of a good product regardless to the lack of splits, dividends, or investor messages. He seldom announces anything without it being a major Apple event, timing it perfectly to get the maximum spin and hype. I do not doubt that everything he did since the iPhone release was scripted from day one of the iPhone announcement. Including the price cut and the give-back. For gosh sakes, it's a 115 billion dollar company, he can afford to have pre-planned strategies for every scenario. And remember, most importantly--he is a perfectionist.

2007 Sep 09 03:21 PM

[crowdofchee...:]

I would never, ever buy any of this crap until Apple works it all out and reasonably prices all of it. The technology isnt that advanced, and Apple better sell a lot of them, because I think something else is going on in that company.

2007 Sep 09 09:24 PM

[StreetSweeper:]

"Until Apple works it all out..."
The recent announcement that Apple has already sold a million iPhones at a price range of $500 to $600, sort of nullifies your concerns over reasonable prices. People still bought them. Now by lowering the prices, he guarantees huge sales figures for the next two quarters. As for the technology not being advanced, ah...what handheld do you have that matches the functions that the iPhone offers? It is ranked as the fastest selling handheld of all time with the fastest increasing market share. Let us in on exactly what you think "is going on in that company," the suspense is killing me.

2007 Sep 11 02:14 PM

[Ezzyme:]

The rebate may be insubstantial but the price cut translates into an earnings cut of $1.73 for next year if they sell the 10 million phones they planned on selling and the analysts have been counting on them selling. I hardly call that insubstantial. At the current P/E of 38 that translates into $65 of share value, almost 50% of it's current value.

2007 Sep 09 10:11 PM

[Turley Muller:]

I don't see how you come up with 1.73 number. A lower selling price-> increases unit volume-> reduces cost per unit-> Higher or Lower EPS. We would have to know the slope of the cost curves and elasticity of demand to forecast the change in net income. Also since iPhone sales are recognized over 24m there impact is spread out. I am certain that the analysts had modeled price cuts, but most likely not this soon. So, In terms if what the Wall Street estimates, it's just a slight reduction. No one expected that the price would stay @ 600 all the way until Jan 2009.

2007 Sep 09 11:26 PM

[Ezzyme:]

Well, if you average the $100 price drop for the discontinued 4 Gb and $200 for the 8 Gb models, say $150 bucks times 10,000,000 Apple estimates to sell next year you get $1.5 BILLION dollars. The reduction in price does not facilitate a reduction in cost of goods. Therefore it only reduces PROFIT. $1.5 billion divided by 869,640,000 shares outstanding gives you $1.72 ($1.73 if you leave off the 640,000).

Increased volume? How much? Or did they reduce the price because they might not have met their 10 million unit goal next year? It took them 74 days to sell 1 million. At that rate they would sell less than 5 million units next year.

Reduced cost per unit? How much have costs fallen in 2 months? Do you think these costs aren't locked in for more than two months? Hedging works both ways. Lastly, I doubt there would be a serious component price decline in the unit volumes we are discussing and I would think Apple has all their internal projections covered.

Did all the analysts anticipate this price drop? Did they anticipate it this early? How many units did they expect to be sold before this price adjustment? What was the rate of decrease in product adoption they projected versus when the price decrease would required?

Yes, they are accounted for on the subscriber form. So my $1.72 is ONLY a $1.72 reduction in cash flow. It's a bit less in GAAP earnings. OK, a bit less than half. But why isn't anyone else making note of this? Am I missing everything? A $1.5 BILLION reduction in cash flow and the analysts dismiss it!

I love Apple products, have since 1986. But can we call day day and night night?

2007 Sep 10 10:31 PM