Apple's iPhone 3G: Who Needs Carrier Subsidies?

With Apple's (AAPL) iPhone launching on July 11 for $199 in the US with a 2-year AT&T (T) contract, everyone (including me) is assuming that there's a roughly $200 AT&T subsidy baked into that price. That assumption seems especially reasonable since AT&T is raising its unlimited data service subscription price by $10 per month and will no longer share subscription revenue with Apple.

Those two factors means that AT&T is accruing about $480 more ($240 from the higher data service price and $240 from not sharing subscription revenue with Apple) per 3G subscriber over the two-year contract, leaving them plenty of room to pay Apple roughly $399 up front for 3G iPhones and still sell them to consumers for $199.

But there's an intriguing twist to this story that may surprise people. According to Porteligent and as reported by EETimes, the parts cost of the 3G iPhone may be as low as $100. That means that even at $199, Apple's price includes a roughly 50% gross margin over its parts cost, which is in the ballpark of the gross margins on traditional iPods.

If AT&T is adding in a $200 subsidy, then the iPhone 3G is anything but a a phone requiring a carrier subsidy. In fact, if these numbers are true and the carriers are subsidizing the phone, the iPhone 3G could end up being the most profitable product Apple makes.

But more likely, this means that Apple has a lot more pricing flexibility than analysts have given them credit for. Now as one of those analysts, I have to apply a caveat here. It's highly unlikely that Portelligent actually has an iPhone 3G to tear down, so their parts cost analysis is probably just an educated guess informed by current cost data from parts suppliers.

That said, Apple has a history of aggressively buying parts to achieve a market advantage. For example, Apple paid $1.25 billion in 2005 to guarantee flash memory for iPods through 2008; that purchase made it nearly impossible for other flash music players to have competitive supplies and profit margins. Apple reportedly negotiated another similar deal in 2007.

In my opinion, the Portelligent's cost is probably closer to right than wrong, simply because Apple never sells loss-leader products. And given Apple's intent to sell this phone in more than 70 countries this year, it undoubtedly worked hard to ensure low parts costs regardless of significant currency fluctuations too.

So what's the takeaway here? It's simple: Apple's 3G phone isn't a loss-leader product needing subsidies to survive. It's designed to be an Anywhere phone that puts your online life, media, and connections in your pocket, yet be simple enough for your grandma to use. But for Apple, it's a business platform designed to make money -- and the details of that business design may surprise more analysts than the product itself.

Comments

[Benzeene:]

Quite agree. I think that the new 3G is the precursor to the Ultra Maxigallion Mobil device that goes everywhere and does everything we need. The key will be voice control, and we're basically there... And yes, Apple will be the one doing it. They're the best at this kind of integration. Anyone say, "computing appliance?"

2008 Jun 12 05:34 PM

[wallawallab...:]

Great assessment.

Now if the hedge funds would stop manipulating the stock...

2008 Jun 12 05:39 PM

[gadgethound:]

This should have the shorts trembling in their boots. It's a game changer folks, and those who recognize this can get in on the ground floor of a huge rally, once Apple consolidates its ownership of the mobile phone biz, the music business and home and corporate desktops

2008 Jun 12 05:46 PM

[Toni:]

Instant woody.

2008 Jun 12 06:08 PM

[TanToday:]

OK run some additional numbers here:

IF they sell the phone at a $50 discount to the carriers, say $350 and it costs them $125 {a little added parts cost } that gives them a gross margin of 64%, about double the margin on the computer lines.

And that money HITS THE BOTTOM LINE now, instead of being prorated over the 24 months life of the ATT contract as before.

Now we start the GOODIES:

1 - MobileMe, the replacement for .Mac, which is the central hub of the PUSH and SHARE system, annual cost is $99, I would imagine that at LEAST 1/2 of the buyers will opt in on that.

2 - Repair and replacement APPLECARE, if anything goes wrong, for two years they will fix it for free, ANYTHING but abuse. That goes for $70 a unit, say 1/3 opt for that one.

3 - Many of the units will be 16 Gig, not 8 Gig, that adds another 100 bucks, say 1/2 are the upgraded units, that number seems to be what I've seen on the other products, people go bigger, to make the planned obsolescence factor take longer.

4 - Applications store. This is THE SLEEPER, with the unit good for gaming, professional apps, and sharing apps, and apps for this and that all one CLICK away from a purchase, and Apple gets 30% of the revenue for each such purchase. If the average user buys 5 apps a year, at 15 average an app, that is $45 x 0.30 = $13.50.

5 - it is ALSO a movie player, and an media/song player, and most will buy a few movies, rent a few, and purchase some song. I'm ignoring this, as most could most likely do that with an iPod before, BUT many of these will be sold in countries without much Apple presence, they will be net new buyers, but factoring that in is tough to compute, so on IGNORE.

ADD these all up:

1 - Profit per sale, with 1/2 8G and 1/2 16G - $250
2 - Mobile Me, with 1/2 buying in - $050
3 - AppleCare, service contract 1/3 buying - $023
4 - ApplicationStore, see math above - $013

MINIMUM TOTAL for YEAR one of ownership - $336 per unit average

NOW... if they sell 10 million that works out to $3.36Billion and that works out to $3.90 per diluted share!

Given that the street is looking for UNDER $6 per share earnings, this is a pretty impressive JOLT flowing towards the bottom line { lots of factors will influence that, but this is a down and dirty looksee }

AND....

AND....

The "Halo Effect" of 70 nations with hands on OS X, the superior operating system, and this will GOOSE the rest of the system hard too. I suspect that the users will see the obvious benefits of this well designed, well executed system, and the sales of Macs, both lap and desk will experience a QUICK and persuasive move in places that had never produced any sales whatsoever.

This is NOT a phone guys, this is a PLATFORM, and like the iPod, it will spawn off software, periperals, third party apps {20,000 in the pipeline already according to some } and be a PARADIGM CHANGER.

{ if anyone catches any mistakes on my math or thinking, PLEASE let me know, and remember I'm doing this off the top of my head here, thinking out loud as I type }

2008 Jun 12 06:46 PM

[John Jung:]

Apple's Iphone will revolutionalize the mobile market, and it will be led by Apple's App Store.
$300 stock coming?

2008 Jun 12 07:28 PM

[User 14414:]

"not sharing subscription revenue with Apple"--> I think that was the problem with China.
They didn't want to share the revenue.
So this door (Great Wall of China) must be open now for the iPhone too!!!

2008 Jun 12 11:31 PM

[TanToday:]

Isn't it 10 cents a month for a mobile connection in China?

How do you share a dime?

2008 Jun 12 11:41 PM

[jmmx:]

I don't really believe it. If that were the case, then the iPod touch would be at something like 300% markup - and don't think so.

Also, if this were true, why would ATT raise the data rate? I think Jobs would scream if ATT did not have good cause to do so. It WILL impact many. Apple gets nothing from the raised rate except lower sales?

No, to my mind there has to be a subsidy. I say Apple get somewhere between $300 - 400.

IMHO

2008 Jun 13 02:36 AM

[samij:]

once upon a time in Schaumburg, Il there was this company and they had a supersexy new cell phone on their hands and they were able to sell them 1m @ $599, but then the demand didn't quite meet their expectations and production ordres, so what do to, what to do...

well they lowered the price to $399 and another 5m, but then the demand dried up, so what to do?

cut the price to $199, what the heck, the production costs had decreased and they sold another 10m, then they dropped the price to $99 and sold 20m more. finally they started throwing the device out for free! and "sold" some 30m more. nice business plan.

2008 Jun 13 03:16 AM

[mollytjm:]

Carl, another great article from you..i was so happy to see it. And TanToday added another great blog too. i've been trying to explain this stuff to people, but i think most don't really understand what this kind of technology and innovation really means and the impact it will have because their view is so limited in scope. Apple knows what it's doing... and let's never forget...they STILL have an even bigger mountain of cash they're just sitting on.

2008 Jun 13 10:41 AM

[King Solomon:]

In a post-conference interview with CNBC, Jobs had a smirk in his face. :-) Almost laughing internally at the questions probing about the future of AAPL and apple.

2008 Jun 13 02:52 PM

[Neil Anderson:]

I'll be signing up for MobileMe as soon as it's available.

2008 Jun 14 03:08 PM

[hardmanb:]

..." since AT&T is raising its unlimited data service subscription price by $10 per month..."

No, they are not. The AT&T unlimited data service subscription has always been $30 per month for ALL their 3G data plans.

Now that the new iPhone uses 3G, they just pay the same 3G data plan price as all other 3G phones. Other carriers charge the same or similar prices.

2008 Jun 17 02:47 AM

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2008 Jul 08 12:31 AM