Analyst: A Cheaper iPhone Is A Terrible Idea

Does Apple (NASDAQ:AAPL) need cheaper devices to grow in volume or should the company stick to its status as a seller of high-end products that are coveted before they’re bought? This debate has raged ever since word got out that with falling growth rates and growing competition, the company needed a new play to remain relevant and profitable.

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For Pacific Crest analyst Andy Hargreaves, there is no debate. Hargreaves believes the possibility of the existence of a new, low-cost iPhone is a bad one for Apple and will not only result in a loss of status for the company, but also cannibalization of its much higher-margin sales. Such a device violates Apple’s “core operating principles,” according to Hargreaves, because there was not “a single thing that a low-priced iPhone would do better than the current iPhones.”

The analyst was making the comments in a note sent to clients on Monday, where he addresses what he calls “the illusion of a low-cost iPhone.”

According to Hargreaves, while moving “down market” with an iPhone that sells for under $300 would expand Apple’s unit growth and revenue opportunity, it would not increase the company’s long-term profit potential meaningfully. So even though at that price point Apple could possibly increase its unit total addressable market by 74 percent, a cheaper iPhone does not fulfill a functional gap, as did the iPod Nano and the iPad mini.

“Outside of China Mobile (NYSE:CHL), which operates on a unique network technology, we do not believe geographical diversification is a compelling solution to the risk of cannibalization,” he writes.

“The high-end smartphone market is finite, and [the] iPhone’s extraordinary success is driving it very quickly toward saturation, in our view,” Hargreaves adds. “However, we believe the company would be much better served by continuing to focus on capturing and maintaining share of the most profitable customers in the world.”

The analyst does not believe Apple can possibly build a low-cost iPhone of “reasonably acceptable quality” for less than $180. In such a scenario, at a selling price of $250 or less, the device would generate maximum gross profit per unit of approximately $70. This would compare fairly disappointingly with an estimated current gross profit per iPhone of $295. This would put at risk not only Apple’s market-high margins, but also its brand value.

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“A low-cost iPhone would risk cannibalizing the company’s high-end SKUs and damaging its brand equity, which we believe would threaten Apple’s total earnings potential and represent a significant risk to the shares,” he concludes.

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