iPhone 7 Could Be Less Profitable For Apple

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Apple (NASDAQ:AAPL) is slated to unveil its latest iPhone (presumably called iPhone 7) on Wednesday. The iPhone product line has been facing challenges, amid competition from well-received Android based-devices and slowing demand in China, resulting in falling shipments and weaker ASPs. While the iPhone 7 – which is rumored to sport improved cameras, better water resistance and performance upgrades – may improve iPhone demand in the interim, we believe that it could put pressure on Apple’s margins. Below, we outline some reasons for this.

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Higher Storage Can Skew Demand Towards Base Models

Apple has been offering its base iPhone 6 and 6S series with just 16 GB of memory (under 12 GB of usable space – barely enough for mainstream customers), with 64 GB and 128 GB versions priced at $100 increments. This has worked out very well for Apple’s margins, as a large portion of customers opted for the higher-end models, driving up ASPs. The 64 GB device, for instance, likely costs an additional $15 to $20 to manufacture compared to the 16 GB device, while retail prices are $100 higher. However, Apple is rumored to be offering the iPhone 7 with 32 GB of base storage – which could be sufficient for most typical users, with price points likely being left unchanged.  This could skew the sales mix towards the entry-level device, lowering margins and ASPs. Moreover, there could be incremental costs associated with doubling memory across the product line (32/128/256GB).

iPhone Plus Bill Of Material Costs Will Rise

The iPhone Plus models have also been significantly accretive for Apple’s margins. For instance IHS estimates that the iPhone 6S Plus cost just about $20 more to manufacture compared to the iPhone 6S, although it retails at a $100 premium. While we expect price points on the new Plus devices to remain similar to last year’s models, it is possible that it could get more expensive to manufacture. For instance, the dual-lens camera – rumored to be the marquee feature of the iPhone 7 – is likely to be exclusive to the Plus device. Yield rates on these components– which are still uncommon in the smartphone industry – are likely low, making them potentially expensive. KGI Securities analyst Ming-Chi Kuo estimates that these cameras could raise Apple’s costs by about $40. [1] This could hurt Apple’s margins.

Dated Design May Hinder Apple’s Pricing Power

By most accounts, the iPhone 7 is likely to sport an industrial design that is largely similar to the iPhone 6 (introduced in 2014) and 6S (2015), as Apple focuses on developing technologies for next year’s 10th anniversary iPhone. The dated design could hurt Apple’s pricing power, as smartphone customers have become increasingly accustomed to design innovation from Apple’s rivals, who have been offering modular devices, bezel-free designs and curved displays. Apple had to resort to promotions and discounts during the 6S cycle, as customers saw the device as being very similar to iPhone 6. It’s possible that the iPhone 7 could face similar issues if it doesn’t offer sufficient design differentiation. 

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Notes:
  1. iPhone 7 to Include Five Colors, IPX7 Water Resistance, Dual 12MP Cameras on Plus Model, Mac Rumours, September 2016  []