50

Speculation Regarding the Pricing of and Strategy Behind This Year’s New iPhones

I created a bit of a stir the other day when I suggested the OLED iPhone “Pro” could start at $1,500.

Let’s take a serious look at this. $1,500 as a starting price is probably way too high. But I think $1,200 is quite likely as the starting price, with the high-end model at $1,300 or $1,400.

First, consider the problems Apple faces with any new iPhone. Here are the prices for the iPhone 7:

  • iPhone 7 32 GB: $649
  • iPhone 7 128 GB: $749
  • iPhone 7 256 GB: $849

And 7 Plus:

  • iPhone 7 Plus 32 GB: $769
  • iPhone 7 Plus 128 GB: $869
  • iPhone 7 Plus 256 GB: $969

These prices have remained unchanged ever since the “Plus” era began with the iPhone 6 models in 2014. [Update: Several astute readers have reminded me that the 6 Plus and 6S Plus were $749/849/949 — the prices went up by $20 with the 7 Plus, presumably due to the cost of the dual camera module, but perhaps also as a small test of the iPhone’s price elasticity.] Apple reports its company-wide profit margin each quarter, which tends to hover around 37 or 38 percent. Apple does not report margins per-device or per-product-line, but considering that the iPhone accounts for around 70 percent of all Apple revenue, the margins for new iPhones almost certainly are somewhere between 35–40 percent. The exact number doesn’t really matter for the sake of this argument, so let’s just say that any new iPhone must have a profit margin of at least 35 percent for Apple to maintain its company-wide profit margin, and let’s further assume that maintaining company-wide margins in the high 30s is non-negotiable for the company.

Based on reactions to my post earlier this week, I think many people assume that the only thinking that goes into iPhone pricing is how much it costs for Apple to produce each iPhone. In other words, that the specs for the iPhone 7 were decided by how much Apple could put into them with $649/749/849 retail prices while achieving a profit margin of at least 35 percent. And that the specs for this year’s new iPhones have been set by the same logic.

But that’s too simplistic. You can’t talk about iPhone specs and pricing without considering scale. It’s not enough for Apple to create a phone that can be sold for $649/749/849 with 35 percent profit margins. They have to create a phone that can be sold at those prices, with those margins, and which can be manufactured at scale. And for Apple that scale is massive: anything less than 60–70 million in the quarter in which it goes on sale is a failure — possibly a catastrophic failure.

In short, new iPhones aren’t defined by what Apple can build for a certain price, but by what Apple can make for a certain price at a certain incredibly high quantity.

The iPhone’s scale — particularly the incredible popularity of the new high-end models each year — is Apple’s biggest financial strength but simultaneously its biggest potential strategic weakness. It prevents Apple from using any components in new iPhones that can’t be produced at a rate of 20-25 million per month, or roughly a rate of 1 million per day. The differences between regular and Plus models complicate this a little — only the Plus models need the dual camera systems, for example — but to date, even considering the Plus models, it has been true that all new iPhones need to be able to be produced in sufficient quantity to meet massive demand.

Based on the rumor mill this year — particularly reports from KGI Securities analyst Ming-Chi Kuo — it sounds like Apple is trying to expand the iPhone product line at the high end to get out of this trap. The best available iPhone should be, at least arguably, the best phone in the world. That might not be possible if all new iPhones must be capable of being manufactured in the same quantities as in recent years.

What Apple has traditionally done is make one new iPhone each year, priced at the same points as the previous year’s models. And the previous year’s models move down $100 each in the lineup, and the two-year-old models move down to the entry level. A lot of people seem to expect Apple to do the same this year, with the OLED minimal-bezel new iPhone starting out at the same or roughly the same prices as the iPhone 7 and 7 Plus. I think that’s why so many people are referring to this phone as the “iPhone 8”.

But that’s not what the rumors are saying at all. Ming-Chi Kuo’s overall record is a bit mixed, but his record on the iPhone (or perhaps better put, for Apple products assembled by Foxconn) is excellent. And Kuo has been reporting all along that Apple is creating three new phones for 2017:

  • A new 4.7-inch phone with an LCD display, same or similar form factor as iPhone 7.
  • A new 5.5-inch phone with an LCD display, same or similar form factor as iPhone 7 Plus.
  • An all-new form factor with a tall, skinny OLED display and new edge-to-edge bezel-less display.

In other words, marketing-wise, an iPhone 7S, iPhone 7S Plus, and an iPhone Deluxe. The iPhone 7S and 7S Plus sound like exactly what you’d expect from an S model year: same form factors as last year, with upgraded components and a new A-series system on a chip. There is no reason to expect these phones to cost less than today’s iPhone 7 and 7 Plus do. If Apple were going to sell the fancy new OLED iPhone Deluxe at the same prices as today’s iPhone 7 models, there would be no 7S or 7S Plus — they would just keep the existing 7 and 7 Plus and lower their prices by $100.

But that’s not what the rumors are saying.

Furthermore, Kuo has been saying all along that the fancy new OLED iPhone is going to be supply-constrained compared to previous new iPhone launches:

We predict October-November & August-September as production ramp-up schedules of OLED iPhone & LCD iPhone, respectively. “For optimized promotional effect, we think Apple may unveil the three models simultaneously in September, though the launch date of the OLED version may trail that of LCD models, and supply tightness may not improve before 1H18.”

We forecast shipments of the three new models in 2017F will be 80-85mn units, with an equal split between OLED & LCD versions.

Apple’s 2017 financial year ends September 30, so I’m assuming that “2017F” means the fourth quarter of the 2017 calendar year. But I don’t see how an even split between LCD and OLED iPhones makes sense if the OLED model’s “supply tightness may not improve before 1H18”. If supply is tight for six months or longer, how can half of Apple’s iPhone sales be for the OLED model?

It sounds to me like the OLED iPhone is a phone which Apple can’t make 40 million of per quarter, at least not today. And if that’s true, that means it should be more expensive. Not should in any moral sense, but simply because that’s how the principle of supply and demand works. When supply is constrained and demand is high, prices go higher. The higher prices alleviate demand.

Intriguingly, regarding device storage, Kuo also says:

Three new models will all come with 64GB and 256GB storage options

Assuming that’s true and that Kuo means the phones will only come in 64 and 256 GB configurations, I can see two ways this plays out for the 7S and 7S Plus:

Scenario 1:

  • 32 GB 7, no-S: $549
  • 64 GB 7S: $649
  • 256 GB 7S: $749
  • 32 GB 7 Plus, no-S: $669
  • 64 GB 7S Plus: $769
  • 256 GB 7S Plus: $869

Scenario 2:

  • 32 GB 7, no-S: $649
  • 64 GB 7S: $749
  • 256 GB 7S: $849
  • 32 GB 7 Plus, no-S: $769
  • 64 GB 7S Plus: $869
  • 256 GB 7S Plus: $969

If it wasn’t for the fact that I’m basing this analysis on Ming-Chi Kuo’s reporting, I would expect 32/128/256 configurations of the 7S models, at the same prices as today’s 7 models. Apple was very slow to move beyond 16 GB base configurations; it seems odd to me that they’d be so quick to move beyond 32 GB base configurations. It also seems odd that Apple would move away from the successful good-better-best strategy of having three storage tiers. But that’s what Kuo is reporting.

So in my Scenario 2, where the 256 GB 7S and 7S Plus cost $849 and $969 respectively, the base model 64 GB OLED iPhone would have to cost at least $999, and I think more likely $1099, and the 256 GB model would cost at least $1099 or $1199.

But if Apple expects severe supply constraints on these iPhones, I think prices of $1199 (64 GB) and $1299 (256 GB) are more likely. I honestly don’t think something like $1249/1399 is out of the question.

The prices for these iPhones need to be high enough so that tens of millions of people still want to buy the iPhone 7S and 7S Plus. If the “iPhone Pro” or “iPhone Edition” or whatever it is that Apple is going to call this phone starts at $800 or even $900, who is going to buy an iPhone 7S or 7S Plus? Not enough people, that’s who. Apple needs tens of millions of people to buy the 7S and 7S Plus because they aren’t going to be able to produce the “Pro/Edition” model in sufficient quantity.

Think about it: if Apple thought they were going to be able to produce the iPhone Pro/Edition model in sufficient quantity (say, at least 50 or 60 million per quarter, starting this year) and could do so for a $700-800 starting price point, and maintain their desired profit margins, why would the 7S and 7S Plus even exist?

Conversely, if the iPhone Pro/Edition were something Apple suspected it could only manufacture at a quantity of, say, 10 million or so units per quarter (perhaps simply by maxing out the world’s OLED production capabilities), wouldn’t the rumor mill look exactly like it does today: with the Pro/Edition model looking like a new premium tier and the new 7S and 7S Plus models set to occupy the existing “regular” price points for new iPhones?

What many people want, obviously, is for the new OLED iPhone to simply be the “iPhone 8” and wow us with a new design at the same old prices. But what is Apple supposed to do if, say, Samsung can only produce 10 million OLED displays for Apple per quarter? Apple can’t magically produce whatever it wants in sufficient quantity at current prices.

Furthermore, why shouldn’t there be a deluxe “Pro” tier for phones? For many people, phones are every bit as much an essential professional tool as their laptops. For some people, even more so. And I’d bet my bottom dollar there are more people who consider their iPhone a “pro” tool (and are willing to pay “pro” prices) than who think so regarding their iPad, and we’ll have had iPad Pros for two years by the time new iPhones are announced in September. If there are iPad Pros and MacBook Pros, why not iPhone Pros?

If you want to argue that Apple should never create an iPhone with a higher starting price than what we have today, you’re implicitly arguing that Apple should never put any components into a new iPhone that can’t be made at iPhone 7 scale. I think that’s dangerous strategically, leaving Apple open to attack from competitors making premium phones with components (cameras, displays, new sensors, new battery technologies, etc.) that can only be produced in single-digit millions per quarter.

On the other hand, without question, this “new premium tier” strategy that I’m suggesting poses its own significant risk for Apple. The mere existence of the new edge-to-edge OLED iPhone could dampen excitement for the iPhone 7S and 7S Plus, leading to a decrease in overall sales. “I don’t want a 7S because it’s boring, but I don’t want to spend $1,200 on an iPhone Pro/Edition because that’s too much for a phone, no matter how nice it is.” That sentiment could be trouble for Apple.

Personally, I think this strategy makes sense, and arguably is overdue. In the same way it made sense for Honda and Toyota to create their Acura and Lexus divisions to sell higher-end cars without eroding the value or popularity of their best-selling Accords and Camrys, it makes sense for Apple to create a premium tier for the iPhone, the best-selling product the company has ever made and likely will ever make. But Apple won’t have the luxury (pardon the pun) of doing so under an Acura- or Lexus-like new brand. They’ll have to do it as Apple.