Pricing a low-cost iPhone: How ‘cheap' is cheap?

Though still unsubstantiated, a low-cost iPhone is now widely seen as a possible product announcement in early September, along with a new high-end phone. And it’s finally possible to create a coherent explanation of why such a move makes sense for Apple in 2013.

Analyses by a range of Apple watchers and others now paint a picture of a lower-cost iPhone, often dubbed “iPhone C,” selling for under $400, and as low as $300. It would have full support for the soon-to-be-released iOS 7, but lower-end hardware and features compared to the current top of the line iPhone 5.

Such an average selling price would put the low-cost iPhone close to the range of Android phones globally, but not at the very bottom of their price range. The price paid by consumers could be even lower through promotions, special offers, and by offering it with a two-year mobile contract.

The new phone hardware features would be contrasted with the expected high-end “iPhone 5S,” the 2013 iPhone model, which presumably will have the same starting retail price as the iPhone 5: $649 for the 16-Gbyte model. The 5S could have a more powerful processor, improved camera, and possibly a fingerprint scanner integrated with the phone’s home button, all setting it apart from the low-cost phone, and from the existing iPhone 5. By contrast, iPhone 5C can realize cost savings by using a plastic instead of metal body, possibly using the iPhone 5’s existing A6 processor (or a tweaked version of it), less memory, and having only a front-facing camera. Yet it would give the “full iPhone experience” by virtue of supporting all of iOS and its attendant cloud services.

Between these two, Apple can then discount the iPhone 5, offering just the 16-Gbyte model at $549 full retail, or lower via promotions and two-year contracts.

As Apple watcher John Gruber argues, Apple’s model for the low-cost iPhone could be the iPod Touch, which starts at $229 for the 16-Gbyte model, introduced earlier this year without the rear-facing 5 megapixel camera still found on the 32- and 64-Gbyte Touch models (but it retains a 1.2 megapixel at the front for FaceTime video chatting, and for video and still photos.

“Take an iPod Touch and add cellular networking components. Boom, there’s your lower-priced iPhone,” he writes.

Apple charges $130 to add a cellular radio to the Wi-Fi-only iPad. At that price, a cellular-equipped 32-Gbyte iPod Touch would be $429, or $359 for the 16-Gbyte Touch. But Gruber believes the $130 is a premium and the actual cost of the radio is much less.

“All told, I think Apple could build and sell an iPod Touch-caliber iPhone 5C for $399, possibly as low as $349,” Gruber concludes.

That’s a lower price point than suggested in this analysis – “How will iPhones 5S and 5C be priced?” — by Asymco’s Horace Dediu, an independent analyst who covers the mobile market.

He drew on Apple’s data on average selling price for both iPhone and iPad models, made a number of assumptions about the mix of models, and compared how the ASP tracked over time for both product lines.

As he notes, the iPad 3 was replaced with a “‘bracketed’ portfolio of the higher-priced iPad 4 and the lower-priced iPad mini. Note also that the mini reflects similar pricing to the legacy iPad 2.”

Based on this iPad bracketing, Dediu assumes that Apple will do the same with the upcoming 5S and 5C. “This means that the 5C will take up the [average selling price] trajectory of the 4S while the 5S will take up the upper bracket around $650,” he concludes.

The end result: 5S starts in the $650 range at the high end, the discounted 5 at about $550, and the low-end 5C at something under $500, perhaps close to $450.

The final price for the low-end iPhone will hinge in part on the savings Apple can achieve in hardware, and in part on how much lower a profit margin it will accept for the cheaper handset.

Apple may be willing to quite aggressive with regard to margin and price for the 5C, according to an analysis by Benedict Evans, who writes about mobile technology for, among other outlets, Enders Analysis, a subscription research service. In his own blog, Evans posted an excerpt, “Defending iOS with cheap iPhones,” from his more extensive Enders analysis.

Evans argues that the key change in the competitive dynamic between Android and iOS is not mainly the larger number of Android devices sold compared to iOS devices – raw market share. What’s really important is that Android users are finally starting to do more with their Android smartphones.

“Android has had a larger installed base than iOS since mid-2011, but [user] engagement remained far behind,” Evans writes. “Until well into 2012 publishers and developers tended to see app download rates on Android of a half to a quarter of what they experienced on iOS, in absolute terms, while payment and purchase rates were a quarter or lower of iOS rates.”

That has now changed, he says, with engagement measures rising for Android. “Hence, by the first half of 2013 Android cumulative downloads caught up with iOS (both at around 50bn), and both now see a run-rate of something around five apps downloaded per active device per month.”

“If total Android engagement moves decisively above iOS, the fact that iOS will remain big will be beside the point,” Evans writes. “This is a major strategic threat for Apple. A key selling point for the iPhone (though not the only one) is that the best apps are on iPhone and are on iPhone first. If that does change then the virtuous circle of ‘best apps therefore best users therefore best apps’ will start to unwind and the wide array of Android devices at every price point will be much more likely to erode the iPhone base.”

A successful low-priced iPhone can block that erosion. “A new, cheaper, high-volume iPhone would have the potential to mitigate or even reverse this trend,” according to Evans. “Clearly, like current low-end Android, [iPhone 5C] would sell to a demographic with a lower average engagement and purchase rate and so the average iOS rates would drop. However, it would mean that iOS’s reach would expand significantly at the expense of Android. How would a $200 or $300 iPhone sell? Easily double digit millions, possible up to 50m units a quarter.”

Clearly that projection would change if the iPhone 5C was priced higher. If Evans is right, the iPhone 5C is intended to counter this “strategic threat,” and not simply add incremental revenue and profits.

“This means that the financial value of a cheaper iPhone cannot be considered in isolation,” he concludes. “A large part of its purpose is to defend sales of the high-end model.”

Many had expected that the iPad mini would be priced under $300. Instead, Apple slapped on a $329 price tag. It’s possible the low-ball estimates for the low-cost iPhone will also prove too low. Evans himself says Android phones average $250-300 globally versus $600 for the iPhone. A low-cost iPhone for around $350 may achieve Apple’s goals.