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Apple and the iPhone nano (and what will it look like)

|Includes: Apple Inc. (AAPL)
Rumors are swirling that Apple will make an iphone nano. While there has been a lot of speculation on the shape, thinness and looks of this future product, I'm more interested in the cost and business justification for an iphone nano. Apple needs a product that is appreciably different from the existing (or new) iphone 4/5, yet helps them commercially. Maybe the best way to think about this is to ask the question: 'What does Apple want from an iphone nano?"

1. Most important - more iOS users (we are in the race that will decide the prevailing computer OS(s) for the next 10 years).
2. Therefore, they need a cheaper price.
3. But they also need to keep apps compatible (which means keeping certain display tech, sensors and processing speeds).
4. Maintain customer experience at superlative levels (Steve Jobs has always striven for outstanding customer satisfaction)
5. It has to be significantly lower in spec than iphone 4/5 if Apple wants to keep also selling the more expensive phone.
Please note that none of these things implies a smaller iphone! As far as I can see it the ONLY reason to have the phone be smaller would be if that smallness saved money. In fact I believe that if Apple could make a profit selling an iphone for $200 off contract that was BIGGER than the iphone 4 then they would do that. Cost is the primary driver (partly because lower cost drives greater sales, which increases iOS market share, and leads to more developers).
To me this suggests that an iphone nano compared to iphone 4/5 will have:
1. Same resolution display (compatibility) but smaller size (price): say 3 inches. At this size the cost is substantially cheaper than 3.5 inches but still usable.
2. A4 processor (cheap but fast enough for most apps)
3. 8G flash memory (or even 4G)
4. Both front facing and rear cameras but lower quality than iphone 5 (they want to encourage Facetime)
5. Keep GPS, wifi, bluetooth, magnetometer, gyroscope (maybe they'll drop the gyroscope though I doubt it)
6. They ABSOLUTELY will use iOS, offer itunes and the appstore.
Current price to build iphone 4 is about $180 (using iSuppli data) and Apple sells to carriers for $600. Of this cost: memory is $40, touchscreen is $40, boards and power management $26, communication chips $25, camera $14, A4 $8, sensors $8, battery $6, and others.
Let's assume they cut memory, touchscreen, camera, battery by 50% (smaller, and using Moore's law) and boards, sensors, A4 by 25% (just Moore's law). That would give them savings of 20+20+7+3+6.5+2 = $59 cheaper. That would equal a cost to build of about $120. Apple's overall margins (macs, iphones, ipads, ipods etc) are about 40% (though MUCH higher for iphones). But if we assume that they will be willing to accept lower margins on iphones in order to expand iphone and iOS share then they may accept 40% instead of 60% margins. If that is the case, then they could sell a $120 iphone mini to carriers or off contract for $200 and maintain 40% margins. BUT they better make damn sure the more expensive iphone 5 is much different and cutting edge (4" display, 64G memory, dual core processor, 8 MP camera, other ideas?) if they want to keep selling it for $600.

Disclosure: I am long AAPL.