The Future of the IPhone Is Boring
(Bloomberg View) -- There are objective reasons why some of Apple's new smartphones, to be unveiled on Tuesday, will sell for more than $1,000. The iPhones, including the top-of-the line X model -- the 10th anniversary edition -- will have some cutting-edge components, which are expensive and rare. Prices are increasing for all leading smartphones that come ever closer to combining computer and camera in one perfect device. But Apple also needs the higher margin to meet the enormous expectations of an increasingly competitive market.
To differentiate itself, a modern phone, especially a flagship one, needs an impressive screen, a processor able to handle some relatively advanced gaming, and a camera that can take pictures comparable to those of the best amateur cameras. It's getting increasingly difficult -- even for Apple, with its superior supply chain management and ability to make or break suppliers -- to source the right components in the necessary quantities. That drives up the cost of producing phones. According to IHS-Markit, the iPhone 6s cost $188 to manufacture, and the 32 GB iPhone 7 cost $220. The manufacturing cost of iPhone-X is expected to rise to a hefty $387.
Manufacturing costs are also going up for Samsung -- to $307 for the Galaxy S8 from $264 for the S7 -- and for the makers of cheaper phones, such as Huawei, Lenovo and other Chinese manufacturers. Even though less is expected from their products, they cannot afford to lag too far behind in terms of features. But while the average prices of a phone sold by Apple and Samsung have held steady in the last couple of years, the makers of cheaper handsets, which have less of a profitability cushion, have noticeably increased prices.
Apple, however, is not just trying to keep its admittedly wide profit margins stable. If it made $550 on every iPhone 7 it sold (with only production cost, and not the company's other expenses, taken into consideration), a price of $1,000 for the X will bring in $613. Is Apple actually getting greedier, figuring its customers, hooked on the company's closed ecosystem and constantly improving services, can't go anywhere?
I doubt it. This is a difficult environment for greed. Apple knows that its installed base is getting older; according to one estimate, by mid-2018, 35 percent of working iPhones will be at least two years old. There are two reasons people aren't upgrading to the new model as fast as they used to: Mobile operators in the U.S. and Europe have stopped subsidizing handsets, and the annual changes to the smartphones have ceased to make a difference to many users. A 2015 phone can pretty much do the same things as a 2017 one. Apple managers understand they are running a risk with a $1,000-plus price tag: People will wonder whether any phone, no matter how advanced -- even one that's all screen, even one that's equipped with facial recognition like a Microsoft Surface and wireless charging like a Samsung -- is worth that much money.
The decision to market an ultra-expensive device likely stems from necessity. Apple needs to keep showing growth in order to maintain its lofty valuation. The iPhone is still the mainstay of Apple's business, steadily generating about two-thirds of the company's revenue in the quarter immediately after a new model is released, and it's important to shore up its sales. Increasing prices is the only way to post significant growth in a mature, relatively slow-growing market where your market share is stagnating. According to IDC, Apple's market share by value, 27.6 percent in the last full quarter, was slightly lower than at the same point in the product cycle last year. That's also been a pattern for the other market leader, Samsung. The only big manufacturers showing market share increases are Chinese ones -- Huawei, Xiaomi, and BBK Electronics brands Oppo and Vivo.
Apple, ever the crafty marketer, is trying to maintain sales volume by releasing its usual incremental update, the iPhone 8, along with the $1,000 iPhone X. Only the biggest admirers of the brand and those who like to show off their wealth will go for the anniversary model -- and their purchases should give the whole line a revenue boost. The end result may well prove euphoric to markets.
It's already impressive that Apple has avoided steep revenue drop-offs everywhere except China, where the trend has been negative for quite some time. There's really no good reason for anyone to indulge the company's fat profit margins in the absence of operator subsidies. Chief Executive Officer Tim Cook has done a stellar job of maintaining the brand's cachet and expanding the model range to appeal to a range of incomes. The Apple services ecosystem, which Cook has worked hard to expand, gives the company a long-term edge over Samsung, whose software efforts keep falling flat. It's much harder for the Korean company to push prices over the $1,000 line, and it needs to do that for the same reasons as Apple -- rising costs and stagnating market share.
But the Chinese threat to both leaders remains: The option of not paying for familiar logos, just for the actual phone, is there for consumers to pick until the leaders come up with something that truly adds value. That, most likely, won't be a brighter screen, a better camera, a slightly faster processor or even the ability to graft one's facial expressions onto emojis -- one of iPhone X's probable features. The incremental game, even if played with Cook's mastery, is increasingly boring and harder to buy into.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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