C is for Choices

Posted on Author by Ben Thompson

I have to admit, it was a bit of a thrill breaking the news to the western world of the latest iPhone leak:

Still, it really wasn’t anything new (although I did learn the reason for dual flash), and certainly nothing of strategic import.

So let’s analyze.

It’s tempting when thinking about price to start with, well, the price. After all, that’s the entire point, no? However, I think it may be fruitful to approach the 5C from the opposite direction, by considering Apple’s strategic objectives, historic choices, cultural preferences, constraints, and only then dollars and cents.

Why is Apple Building the iPhone 5C?

The iPhone has been one of the best businesses of all time, and one uniquely suited to Apple: build the best possible phone you can without regard to end-user pricing. After all, the customer is only ever going to see $199, and the carriers have no choice but to play along.

The result was truly absurd margins – over 50% for hardware – and astounding profits for Apple. But, and this is the key point, this model by definition relied on carrier subsidies, and only some markets have a subsidized model. Those markets are being increasingly saturated, and Apple simply doesn’t have a competitive offering for the rest of the world.

Thus the iPhone 5C, and thus we can rule out extremely high prices.

What has Apple done historically?

There are three product lines to consider: the Mac, iPod, and iPad. All are pertinent, because customers pay full price for all of them (as they would in a non-subsidized phone market).

The Mac has stayed resolutely high-end – the cheapest offering is significantly higher than the vast majority of Windows computers. There certainly is room to go lower, particularly if Apple were to use Intel i3s, mechanical hard disks, and plastic enclosures, but Apple has chosen to optimize for i5s and i7s, solid state drives, and aluminum.

The iPod, on the hand, was always price-competitive. The lines did differ based on storage type and capacity (mechanical/high-capacity on the high end, flash/low-capacity on the low end), as well as basic functionality on the low end (the screenless shuffle). Not coincidentally, the iPod had the greatest market share of any Apple product.

The iPad has ventured down from the high end to a more middle-of-the-road offering in the form of the iPad mini. Apple sacrificed screen resolution and processor power relative to the high end, but not the aluminum body.

In this context, it’s striking that the iPhone 5C is expected to be plastic, a material Apple has otherwise eschewed. To me this signals a broader market play, for which plastic makes sense: it is cheaper not only from a raw material perspective, but also from an ease-of-manufacturing one, and it’s a lot more durable. Moreover, it lends itself to “fun” colors even as it preserves the 5S’s high-end appeal.

Apple likes to make clean breaks

The original Macintosh keyboard did not have arrow keys; users had to use a mouse. This was by design. Apple is famously aggressive about moving users to new technologies or experiences, and on the software side, Apple is poised to do just that with iOS 7.

I suspect they want to make similar progress on the hardware front. The most obvious is moving all iPhones to Lightning adaptors. Beyond being significantly more cumbersome in day-to-day use, 30-pin adaptors are also much more likely to break, short, or simply become too dirty, driving up warranty and replacement costs.

Another is screen size; the iPhone 5 shifted to 16:9, but Apple has continued selling the 3:2 iPhones 4 and 4S. I suspect Apple would prefer to standardize sooner rather than later.

For all of these reasons, I expect Apple to stop selling both the iPhone 4 and 4S.

Apple needs to sell the iPhone 5C worldwide

It’s unfathomable to me that Apple would not sell the iPhone 5C in subsidized markets such as the United States. I expect the iPhone 5C to become the free-with-contract phone at most post-pay carriers.

However, said carriers, particularly in the US, do require that all phones on their networks be LTE. If anyone could break this rule, it would be Apple, but I think they’ll go along; I expect an LTE-capable iPhone 5C.

The bigger question is if there will be a non-LTE version as well. Selling LTE and non-LTE versions could allow them to preserve their margins with free-with-contract phones in subsidized markets. Currently, the “free” iPhone is the iPhone 4, which actually costs $450. Imagine an LTE iPhone 5C sold to post-pay carriers, and a non-LTE iPhone 5C sold at a significantly lower price to the rest of the world.

Still, this is the prediction I’m the most uncertain about. After all, the additional cost of LTE is a cost that will assuredly decrease over time, thanks to Moore’s Law and Apple’s scale, and Apple’s operations are predicated on decreasing SKU complexity, not increasing it.

At a higher, more theoretical level, there’s the question of “good enough.” When a product is “good enough,” customers increasingly don’t appreciate or value increases in performance, and will instead focus on other attributes, particularly price. There is an argument to be made that today’s smartphones, the iPhone 5 in particular, have reached this point.

With that in mind, another interesting thing to note about the iPhone 5 is that its processor, the A6, is the first processor fully designed by Apple. Who knows what special sauce was baked into the A6, but I can imagine it’s meaningful to Apple, and probably to iOS 7.

And so, I already noted that Apple likes to make clean breaks, and I think this is another one: I think the iPhone 5C – and every iOS device sold1 from here-on-out – will have an A6 chip (or better).

An A6 chip is likely more expensive than the A5, but, just like broadband chips, the cost will go down, and I expect the A6 chip – which is good enough – to be the baseline chip for iOS devices for multiple years.2

To put it another way, the cost of today’s iPhone 5 fall into two categories: chips, including the A6, DRAM, broadband, memory, etc; and physical hardware, such as the case, antenna, battery, touchscreen, camera, etc. I think Apple will be aggressive with the former, setting a baseline for its software with the knowledge that costs will come down, and “cheap” with the latter, keeping costs down and allowing the 5S to differentiate on hardware.

My Prediction

  • iPhone 5S: aluminum, in-cell touch screen, high-end camera, dual flash, A7 processor, LTE – $650 ($199 subsidized)
  • iPhone 5: aluminum, in-cell touch screen, current camera/flash, A6 processor, LTE – $550 ($99)
  • iPhone 5C LTE: plastic, separate touch interface and screen3, mid-grade camera/flash, A6 processor, LTE – $399 (free)
  • iPhone 5C: plastic, separate touch interface and screen, mid-grade camera/flash, A6 processor, 3G – $2994

Given the technology, $299 is aggressive, yet the absolute maximum if Apple’s focus is unsubsidized markets. Moreover, those costs will go down, and I expect the 5C’s “good-enough” internals to be the baseline for iOS going forward.5

UPDATE: I’ve changed my mind on the LTE/3G split, and am hearing the price will probably be higher. See more at C is for Changing My Mind.

  1. To consumers. I’ve heard the arguments in favor of the iPad 2 in education ↩

  2. Moving all devices to the A6 also clears up the mystery of the “new” A5 chip in the Apple TV; it makes sense to build a single-core A5 specifically for the Apple TV if you can’t count on dual-core rejects in the future ↩

  3. Thus the rumors that it is thicker ↩

  4. If this version is sold in the US, perhaps it will only be available in Apple Stores. This would explain why Tim Cook is putting such an emphasis on selling iPhones there. Still, this is complete speculation ↩

  5. Update: Apple Daily posted a new video suggesting the 5C would have an A5 and would cost ~$450. In other words, the exact opposite of what I’m predicting here. It’s certainly plausible though, and the experience with an A5 and iOS 7 is not bad at all.

    This choice would suggest that Apple is primarily motivated by discontinuing the iPhone 4/4S form factor and 30-point connector, and perhaps making a push for more free-with-contract customers and the absolute top of the non-subsidized market while maintaining margins. Still, it strikes me as awfully conservative.

    It goes without saying that the price in the video is total speculation; I suspect the internals are as well. That doesn’t make them wrong of course ↩