It’s pretty amazing just how poorly Apple’s(NASDAQ: AAPL ) iPhone 5c did in the market place. When the phone first launched, it seemed that Apple was doing its best to push this device. Why? Well, the problem with Apple’s high-end, expensive-to-make phones is that these same devices end up being sold as cheaper, lower-end devices at some point in their lives. Unfortunately, while the prices drop, the manufacturing costs don’t go down anywhere nearly as much – adding a significant headwind to gross margins. So, how exactly did Apple propose to fix this? Simple – the iPhone…
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It’s pretty amazing just how poorly Apple’s(NASDAQ: AAPL ) iPhone 5c did in the market place. When the phone first launched, it seemed that Apple was doing its best to push this device. Why? Well, the problem with Apple’s high-end, expensive-to-make phones is that these same devices end up being sold as cheaper, lower-end devices at some point in their lives. Unfortunately, while the prices drop, the manufacturing costs don’t go down anywhere nearly as much – adding a significant headwind to gross margins. So, how exactly did Apple propose to fix this? Simple – the iPhone 5c.
The “cheap” iPhone’s real job
Instead of discounting its excellent iPhone 5 and risking potentially cannibalising sales of its higher-end iPhone 5s (since the 5 looks very similar to the 5s – the differences are internal and maybe not important to everybody), Apple took the iPhone 5’s guts and put them into much cheaper plastic cases. This meant that smartphone buyers who wanted the gorgeous “real” iPhone had no choice but to buy the latest-and-greatest iPhone 5s.
What a brilliant risk/reward
This was actually a pretty great move on Apple’s part as the risk/reward was actually quite good. In the best case (and what actually happened), consumers would simply buy up the stack. This means more revenue per unit sold and probably higher gross margins to boot. In the worst case, Apple would sell a lot of the iPhone 5c models in which case, Apple would see lower revenue per unit but more favorable gross margin dollars per unit than if Apple had, say, continued to sell the iPhone 5.
The only case in which Apple could have “lost” is if people looking to buy a cheaper iPhone were so repulsed by the iPhone 5c and were unable to afford the extra US$100 to buy the 5s that the sale went to a player in the Android or Windows Phone ecosystem. While that was certainly a possibility, it’s not as though the Android players are offering anything particularly “better” than the 5c for somebody who is familiar with Apple and wants a well-made phone. The iPhone 5c is plastic? So are all of Samsung’s similarly priced phones, as well as more flagship devices from the likes of Google and LG.
While Samsung (NASDAQOTH: SSNLF ) , Google (NASDAQ: GOOG ) (by way of Motorola), HTC, LG, and many others attempt to get a slice of Apple’s high-end pie, it’s clear that Apple’s high-end moat is wider and deeper than what many bears (including yours truly in a former life) would have expected. While Apple still hasn’t made a real push into the really low end, it’s clear that Apple is probably correct to focus on keeping the cash-cow high end secure since this really is where the majority of the profits are.
More importantly, though, this speaks to the strength of Apple’s management team from a more strategic perspective. Instead of getting in the margin race to the bottom, it instead devised a strategy to lure more of its customers to the high end. It was a stroke of brilliance from a risk/reward standpoint and, frankly, it’s tough to see why some shareholders are so “angry” with Tim Cook.
Foolish bottom line
Apple is a great company and it’s not particularly expensive by any real valuation metric. If the company can further eat into the high-end smartphone/phablet space with a larger iPhone (or an expanded family of higher end iPhones), then the company should actually return to robust profit growth over the next couple of years. However, one thing that is likely to keep Apple’s multiple compressed is the ever-present fear that Apple’s new products will eventually run out of steam and that smartphone do ultimately degenerate into a commodity, price-sensitive market.
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A version of this article, written by Ashraf Eassa, originally appeared on fool.com.