While Apple has said little historically about individual product profitability, the patent lawsuit between the company and Samsung provided one small window into just how valuable the iPhone franchise has been. In just 18 months between October 2010 and March 2012, gross margins on iPhone were between 49 and 58%, an almost unheard of figure for a consumer electronics product. Consider that in the same period, the iPad saw margins between 23 and 32%. A major reason, of course, is that consumers only pay a small portion of the more than $600 Apple was averaging per iPhone sold during that period while iPads are typically sold without subsidy.
A one-trick pony?
If we assume that a similar set of circumstances still exists (Apple's overall gross margins are a bit lower these days), it's likely iPhone alone accounted for nearly $9 billion of the $13 billion in margin Apple earned last quarter. iPhones sold for around $580 each, according to Apple's financial filings. When you look at those numbers, it's easy to see why the company is eager to keep that money flowing. The iPhone 5c will likely be the mainstream iPhone for quite a while as the more expensive 5S is expected to be in short supply and the company's launch suggested marketing was going to flow heavily toward the less-expensive, colorful model.
It's also likely that the 5c is going to be the featured model at China Mobile, a new carrier for Apple with its 700 million prospective customers, once the iPhone becomes officially available there. Even in the U.S., the top-end iPhone 5 had been barely accounting for half of iPhone sales as people find the lower entry prices for last year's models good enough. Normally, that's a bad thing for a company that's got a reputation for delivering the next big thing and wowing customers. But Apple's iPhone strategy has been the opposite for quite some time. The last 4 models atop the lineup are all similar looking, each a refinement of what came before.
The new 5S certainly fills that bill, with a significantly better camera, better processor and fingerprint sensor in a body that is a near clone of the iPhone 5. But the 5c represent a departure, albeit a small one. It takes that iPhone 5 and makes it cheaper, both to build and to buy. It then adds just enough Apple magic, in the form of colorful plastic that has met with good first impressions, to make it an object of desire.
Naysayers will shrug it off as nothing new and they're right to a significant extent. The 5c's entire list of new features is a slightly better battery, what seems to be the ability to use the data connection and talk at the same time on Sprint and Verizon (unconfirmed, but the FCC filings imply it in one place I could find) (update: Apple says no go on that, still can only use data and talk at once when on WiFi or when making voice calls on Skype or Google Voice) and the plastic exterior. Everything else new is software (iOS 7, free iWork apps, iPhoto and iMovie with purchase) or rather mundane accessories (Apple-branded cases and a long-overdue dock so you can keep your phone standing up on a counter again).
Departing ways
For Apple, the 5c represents something important, though. It's actually a new model instead of being last year's phone kicked down to the $99 entry price here. It can be marketed around the world as something fresh, unlike a year-old iPhone 4S could be, and though the price has only dropped $100, that's not nothing for many people. With Japan's NTT DoCoMo also joining China Mobile, Apple has added three quarters of a billion potential new customers and the small price cut adds some more. Together, they don't radically alter the equation, however, for Apple. The iPhone is still far too expensive for most people in China, India, Russia, Brazil and elsewhere.
While iPhone unit sales seem certain to grow from the 145 million recorded over the past 4 quarters, the real chance to double them that a $299 phone would have presented doesn't exist with the current lineup. And that's true even though the 4s remains for sale in most of the world and apparently, at least for the time being, the even cheaper iPhone 4 is still for sale in China.
As for this "missed opportunity," Apple simply doesn't care.
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It's content to be a premium-priced phone maker that has a relatively small market share and an outsized presence in its home country, where it holds around 40% overall, more than twice its global presence. The risk is that the relatively small user base costs it control of the app market that has helped make the iPhone such an object of envy and desire. To better understand that, Ben Thompson at Stratechery and Tero Kuittinen here at Forbes go into great detail. But in short, developers look to how many people are out there to buy or use their app and Apple has far fewer prospective customers than Android. What has historically made it attractive to build for iOS first has been the large presence of developers here in the U.S. and the spending of iPhone customers on apps. Over time, those advantages are less significant as development becomes more global and the giant Android customer base increases its spending. Apple takes a grave risk by choosing to stay relatively small.
But it's worth noting that Apple's strategic choice is confounding for another reason. Consider the lucky man who builds a great business and finds himself wealthy beyond imagination. He builds a grand palace overlooking the ocean. Over time, though, he realizes the cliffs are eroding beneath his palace. He could do something radical, like move his palace to higher ground or spread his real estate holdings across many different regions. Instead, he orders new chooses to buy some new carpet and repaint.
If it seems like I'm accusing Apple of redecorating in the face of impending chaos, that's a fair reading. But keep in mind, I chose erosion for a reason. Apple's profit growth ended last year, but its profitability didn't. Perhaps the iPhone 5c and 5s reignite the growth a bit and Apple collects double-digit billions quarterly again instead of high single digits. So what? If there's a criticism to level at Cook that's fair at this point, it's that he has demonstrated a spectacular lack of imagination as to how to spend Apple's riches. The company announced a $50 billion share buyback and seems to be responding to every hedge-fund manager's call for shareholder returns, whether it be David Einhorn or Carl Icahn. Yet the company's stock price languishes 30% off its all-time high.
A stock and a hard place
Rather than tell Cook to manage the stock price, which is beyond his control, I'll note instead that the stock remains moribund even though he's taken all the "responsible steps" to do what Wall Street wants. Protecting gross margins with the new iPhones seems like more of the same in that regard; it satisfies the finance guys but is irrelevant as an end goal. Apple is suffering a classic case of The Innovator's Dilemma. It invented the modern smartphone, profited wildly, and is watching the industry change beneath it. But it can't seem to do anything about it except try to wring out as much profit from the existing business model as possible.
Today's inexpensive iPhone competitor might be inferior, but it gets better every year. While recent rumors Amazon was going to give away smartphones proved false, the reality is that Microsoft/Nokia, Google/Motorola, China's Xiaomi, and countless others are all dragging down the price of those phones -- and improving their quality -- every year. Getting $600 for a smartphone that's a slightly improved version of last year's model might work in 2014. It might work in 2015. But it will stop working.
When it does, Apple will find itself with smaller market share than Android. It guarantees that outcome by passing on even the middle of the market, never mind the low end. Until then, it will either continue to buy back more stock -- a tactic that has yet to provide any discernible strategic value for Microsoft, Cisco, IBM or anyone who has spent billions doing so -- or will wind up with perhaps $200 billion in the bank. Either way, it will failed to buy itself a future.
It's hard to be the one to kill your own golden goose and it's much harder to know when the right time to do that is, but increasingly it feels like the time has already come for Apple. People keep believing there will be a "next big thing" at some point, but the fact is there is no next iPhone, at least in terms of the amount of value it has created in such a short time. And even if iPhone endures, the hardware itself won't produce the kind of profits in the second decade as it did in the first. The subsidy model is showing signs of breaking down even here in the U.S., upgrade cycles will lengthen as phones get to be "good enough" and features like unbreakable screens make them more durable, and , finally, competing products are relatively more appealing every year. In Asia, Samsung's desirability matches Apple's; it's not terribly far behind in Europe or North America, either.
If Apple were playing a game of Monopoly, it would be winning. It's still more valuable than any of its competitors and can buy nearly anything it wants. But it seems to have no idea what to do with that embarrassment of riches except to try to grow it just a bit more and that isn't a strategy, it's score keeping. Apple is often compared to BMW, because it sells goods at a premium price, but car pricing is stable and even BMW is preparing for a future where consumers buy fewer cars and instead buy "mobility" from the company. Apple's more than $15 billion annually from apps, music and software seemed like it could be the $50 billion business of its future, with money coming in annually whether or not people buy new phones. But pursuing that model meant growing the iPhone customer base a lot more than the 5c will do and slicing those margins now.
In the end, Cook chose to spare the golden goose. But the goose will eventually be cooked. Whether the CEO has a plan for that remains to be seen.
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For much more Forbes coverage on the new iPhones, check out some of these posts:
Apple’s New iPhone ‘Touch ID’ Makes Fingerprint Scans Easy, But Don’t Ditch Passcodes Yet
The Winners And Losers Of New iPhone Leakers And Rumors
Apple iPhone 5S Debuts New Camera Features
Apple Hands App Market Leadership to Google
How The M7 Motion Co-Processor Will Improve The iPhone 5s Battery Life And Performance
The Luxury Brand Of Apple Is Enhanced By The $99 iPhone 5c
Even With A Higher Than Expected Price iPhone Sales Should Be Strong In The December Quarter
iPhone 5S And ‘Infinity Blade 3′: A Match Made In Heaven
