The Exchange

The iPhone 5C: Cheap Plastic Case, Not a Cheap Price — and That’s the Point

The Exchange

“We could not make enough…We were constrained every week…We were very constrained for much of the quarter…significantly constrained…Our sales would have been materially higher if those constraints would not have existed...ignificant shortages due to robust demand… short to demand until late in the quarter."

-Apple CEO Tim Cook and CFO Peter Oppenheimer, Jan. 23, 2013

Apple (AAPL) shocked the world last week when it introduced its new plastic-clad iPhone 5C at the same price as some of its prior metal-clad models. What in the world was Tim Cook thinking?

Cheaper iPhones were going to make Apple competitive in the fastest-growing smartphone markets such as China and India, or so everyone thought.

View photo

.
new iphones

But a cheaper-looking phone at the same old price? Not much help – and Apple’s stock price has dropped 11% since the announcement.

An immediate challenge

Instead of breaking into emerging markets, turns out there was another, more immediate challenge facing the iPhone line, one the plastic iPhone should solve perfectly: producing the complicated aluminum shells for the iPhone 5 is no easy feat and it limits production. These shells are made on highly specialized factory equipment, which analysts believe Apple helps pay for in the factories of its Asian contract manufacturers.

Plastic cases are a lot easier – and less expensive – to manufacture. Girding the 5C in a polycarbonate shell helps ensure Apple will be able to make as many iPhones as customers want to buy this year – and in a choice of five new colors.

“I'm sure the plastic case is far more scalable for volume than the milled metal version,” says Don Scansen, a partner at IP Research Group.

Without the plastic 5C, Apple’s standard strategy would have meant shifting the current top-line model, the iPhone 5, to the middle price tier. Apple would have had to be able to make enough aluminum shells for both the new top model — the iPhone 5S — and the older 5. That strategy risked running into major supply constraints again.

Inside, the 5C is almost exactly the same as the iPhone 5 it replaces, except for an improved front-facing camera. Instead of the 5C establishing a new, lower price tier, it simply took the spot the 5 would otherwise have slid into.

To be sure, Apple has never discussed exactly why it couldn’t make enough of all its popular products last year. Shortages of other components such as screens, processor chips or memory could also have been a factor. An Apple spokeswoman declined to comment.

Avoiding shortfalls

The goal is to avoid the shortfalls Apple experienced last holiday season. Apple collected $54.5 billion of revenue for the last quarter of 2012, falling short of Wall Street forecasts and pummeling its stock price. And it was the second disappointing quarter in a row. So on their call with analysts, CEO Tim Cook and CFO Peter Oppenheimer offered excuses, repeatedly blaming the lower-than-expected sales on problems at the factory.

Apple couldn’t make as many new iMacs as customers wanted, nor enough iPad minis, iPhone 5’s or iPhones 4S’s. All those popular products except the 4S had one thing in common: They were clad in the aluminum shells.

A repeat in 2013 would enrage investors and call into question Cook's reputation as the supply chain wizard who helped Steve Jobs pull Apple back from the brink of bankruptcy.

Ignoring the low end

The assumption that Apple planned to make a play for the low end of the market helped drive its stick price up 20% in the two months prior to its unveiling.

But instead of offering the new plastic iPhone at $350 or less, Apple priced the model at $549, or $99 with a two-year contract — exactly in the middle of its existing lineup.

Cook and company obviously believe they have more time before the truly cheap phones represent a real competitive threat to the iPhone. Many analysts and investors disagree, but Apple has a long track record of successfully introducing lower-cost products in time to avert threats.

“Successful companies historically have consistently chosen better over cheaper, for which Apple is the poster company,” UBS analyst Steven Milunovich wrote on Monday. “Management might have sufficient confidence in a growing global middle class being attracted to its aspirational brand or in coming new product categories to not chase low-priced phones.”

The 5C also likely carries a higher profit margin at $549 than the 5 would have, helping bolster Apple’s bottom line.

Brand image

By offering a plastic-cased iPhone, Apple also runs the risk of tarnishing its premium brand image. Apple fans have long derided Samsung Galaxy phones for having a plastic casing, for example.

But Apple’s manufacturing prowess and attention to detail should allow for a high-quality plastic that won’t feel cheap, says Harvard Business School Professor Willy Shih.

“Don't underestimate the care they take making plastic parts,” Shih says. “They are very detail oriented around everything plastic.”

“Look at the plastic chargers that Apple uses; definitely a premium product compared to the competitions' chargers,” he adds.

Plastic solves an immediate problem for Apple. And the company may have enough of a lead on the competition to sell a cheaper phone at a not-so-cheap price for a while longer.

To keep up with all the latest tech industry news, follow Aaron Pressman on Twitter and Tumblr.

Check out more Yahoo! Finance content here on Tumblr.

Rates