The Mathematics and Worthiness of a Mid-range iPhone

Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Another Apple (NASDAQ: AAPL) rumor, and this time it was about a cheaper iPhone. Considering how accurate the guesses and leaks around Apple’s products have become of late, it seemed that the Cupertino-based giant might actually make something of that sort to target emerging markets. However, Apple's senior VP Phil Schiller put speculation to rest by telling Shanghai Evening News that Apple would never make "cheap" smartphones.

But, as Ars Technica pointed out, "Cheap smartphones are one thing. Cheap-er iPhones are another." If we try to read between the lines of Schiller's comments, then the possibility of Apple developing a low-cost version of the iPhone, rather than a cheap phone, remains open.

However, a cheaper iPhone won’t probably be a “mini,” since it would be a “dead on arrival” as bigger screens are becoming the order of the day. Also, it would probably be more of a mid-range device, targeted at the growing middle-class in emerging markets, and hence won't be priced in the ridiculous range of $100-$150, since that will make the phone "cheap" in the true sense.

The current iPhone is already at the sweet spot as far as size is concerned, so going small is certainly not an option for Apple. If the fabled product indeed sees the light of the day, it would be probably made of cheaper or recycled material to keep margins and the user experience intact as The Wall Street Journal reported. It had reportedly cost Apple $198 (including manufacturing) to make an iPad mini, 37% lower than the cost of the 3rd generation iPad (which cost $316), while the selling price of the mini at $329 was 34% lower than its bigger brother.

Thus, Apple managed to save (or even improve) its margins on the smaller iPad successfully and produced a terrific product that’s been selling very well. But, will it be able to do the same with a cheaper iPhone? Let’s try and calculate.

Let’s Do Some Math

The iPhone 5’s production cost comes in at $207 (including manufacturing costs) for the base model. According to sources on the web, a cheaper iPhone might sell for $149, which translates into a 77% drop over the iPhone 5. Assuming Apple wishes to keep its margins intact, the cost of production would have to go down by the same magnitude to $47.61, which is highly unlikely. Moreover, Apple won’t probably price a cheaper iPhone at half the cost of the iPod Touch 5G, which retails at $299 and carries a 32GB storage capacity, as we saw with the iPad mini.

Also, considering the fact that the iPod Touch costs around $150 to make, and is essentially an iPhone without calling features, it would be impossible to produce a device at one-third of that cost. However, considering that a cheaper iPhone would be modeled on an iPod Touch more than the iPhone 5, Apple could manufacture a good device at around $150 or even less.

Imagine replacing the aluminum casing on the iPod touch with a polycarbonate plastic casing, or using the A5 processor instead along with recycled parts from older phones, or using a 5 megapixel camera instead of an 8MP shooter. If Apple manages to create the device at even $150 at most, it could probably retail the base model for $349 without contract in the market and make a profit of around 130% on every unit. However, this is lower than the 213% it makes on every unit of the iPhone 5.

A Gamble Worth the Risk?

Thus, it would be very, very difficult for Apple to pull of an iPad mini in this case, but this is a risk it needs to take to tap emerging markets successfully where the current iPhone is more of a luxury commodity. A $349 price tag seems to be an ideal one, as it would put it in striking distance of the likes of the Xiaomi Phone 2 in China and cheaper than the Meizu MX2. However, a lot will depend on how the final product turns out to be, and if made well it could certainly make its presence felt in the Chinese market by catering to a larger audience.

Apart from this, it could help Apple crack smartphone riches in India, even though the final price could go up to as much as $450 in equivalent currency after taxes and duties. Mid-range smartphones are priced around $450 in the Indian market, and phones in this range do pretty well. Moreover, the presence of an Apple logo at the back at an affordable price would probably knock the wind out of even high-end devices of other manufacturers. For instance, Sony’s (NYSE: SNE) mid-range Xperia phones would probably cost more than a cheaper iPhone, and might even provide competition to the high-end Xperias.

I cited Sony’s example since they are quite well-regarded in the country, and the advent of a cheaper iPhone would spell trouble for them. Moreover, Apple would be able to challenge Research In Motion’s (NASDAQ: BBRY) in the country as well. BlackBerry Messenger (BBM) happens to be one of the main reasons why BlackBerry devices still have a huge following in India. However, exorbitant pricing of high-end phones has proven to be a problem for RIM, and the arrival of a low-cost iPhone with iMessage and tons of better features would dent BlackBerry sales in all probability.    

Final Words

We should remember that we are still talking about a fabled Apple product here, but as I said in the beginning, it can’t be ruled out. Considering the track record of Apple’s rumor mill nowadays, it would be unwise to completely brush it off as another rumor.

Moreover, Apple is dominating in the U.S., but it needs to look at emerging markets as well to keep driving its top line higher and eliminate the risk that saturation of its existing markets might create. Margins would most probably take a hit, but it seems like a rewarding trade-off as the world’s most valuable company will open up more avenues for itself to drive its top line higher.

TechJunk13 has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. The Motley Fool is short Sony (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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