Daily Ticker

Apple’s Cheap iPhone Is A Great Move For The Company

Daily Ticker

At the end of this year, when Apple's cheap iPhone comes out, it is going to be amusing to listen to all the Apple (AAPL) fans who consoled themselves about Apple's loss of market share

View gallery

.
by dismissing competitors' phones as "cheap plastic crap."

Because the new cheap iPhone is supposed to have a cheap plastic back.

(Presumably, Apple fans will regard Apple's cheap plastic back as having been designed perfectly, unlike the usual cheap plastic crap.)

But more importantly...

Apple's decision to finally launch a cheap iPhone is a great move by the company.

Related: Apple Has A Lot of "Tricks Up Its Sleeve" in 2013: David Kirkpatrick

It's a move that is at least a year late, unfortunately, which has helped Apple lose a lot of global market share to competitors like Samsung.

But it's still a great move.

Why?

Because the explosive growth in the smartphone market has now shifted to emerging markets like China and India, where there are few carrier subsidies and most people can't afford phones that cost $600.

By insisting on maintaining the premium prices of its phones, Apple has missed out on this growth in the past couple of years. (And Apple has also lost its edge at the premium end of the market, but that's a different story.)

To be sure:

Apple's decision to offer a $99-$149 phone will reduce the amount of profit that Apple makes per phone. And, relatedly, it will likely reduce Apple's profit margin.

But that's okay.

Apple's profit margin is still extraordinarily high--the highest in the industry, by a mile.

Apple's profit margin, even after accruing for taxes that the company mostly doesn't pay, is an astounding 26%.

Apple profit margin: Too high.

No other hardware companies have margins that are anywhere close to that high.

Apple's profit margin, in fact, is too high.

Apple has sacrificed revenue growth and platform growth by deciding to confine itself to the "premium" market. And, meanwhile, Apple has raked in such an astounding amount of profit that Apple has no idea what to do with the cash piling up on its balance sheet. Apple has so much cash that it doesn't know what to do with, in fact, that it has decided to start paying a dividend.

In other words, Apple has traded off long-term investment

View gallery

.
opportunities for short-term profits. And, on a global market share basis, it's paying the price for that.

Related: Apple Could Fall Below $500 a Share: Barry Ritholtz

Compare this "short-term profit-maximization" approach to the approach of another great company, Amazon, which continually reinvests its profits in future opportunities and lower prices.

When Amazon has enough resources to make a bet on a big new opportunity--the Kindle, for example, and Amazon Web Services--Amazon goes ahead and invests the money. This reduces its profit margin, which causes some short-term shareholders to scream, but over the long haul, as long as some of these bets pay off, it creates more value. And even when it isn't making big bets, Amazon continually reinvests potential profits by reducing prices for its customers. This increases Amazon's value to its customers and its competitive advantage. And those, too, help create more value over the long all.

Even if it sells hundreds of millions of super-cheap iPhones, Apple will still have a healthy profit margin. And its global market share, which is important in a "platform" business (third-parties build services and apps on top of the iPhone), will increase.

This is a worthy tradeoff, even if it causes some short-term investors to jettison the stock in disgust.

The growth in the smartphone market is moving to lower-priced phones. And Apple can afford to reduce prices even on its premium phones. So the fact that Apple is acknowledging at least the former trend is very encouraging.

It shows that Apple does not want to make the same mistake it made in the 1990s: Focusing on pricing and profit over market share.

And it shows that Apple, unlike many companies that under-invest in the future just to deliver bigger profits today, is worthy of its reputation as a great company.

SEE ALSO: This Trend Is Very Worrisome For Apple

Rates

View Comments (108)