Rumors over Apple (NASDAQ:AAPL) introducing a cheaper iPhone for emerging markets like China have persisted ever since COO Tim Cook dropped a hint to Bernstein’s Toni Sacconaghi in April this year. Some analysts believe this could be a newly designed, cheaper iPhone handset released in September in conjunction with the iPhone 5 while other reports suggest that an older iPhone model (e.g. iPhone 3GS) could serve as a lower priced iPhone. While it’s easy to understand why Apple might want to target emerging markets given low smartphone penetration levels and a long runway for growth, Apple may not feel the rush to introduce a cheaper iPhone in the near term even in the face of increased competition from Google’s (NASDAQ:GOOG) Android, which is gobbling up market share.^[1]

Our $510 price estimate for Apple stock is about 35% above market price.

Market opportunity for a cheaper iPhone huge for Apple

Apple’s share in the global mobile phone market is only about 5% even though it was the largest smartphone vendor in the last quarter.^[2] This goes to show that Apple could be missing a huge market opportunity by not having a large enough presence in emerging markets where smartphone penetration is still low.

Since emerging markets are more price-sensitive, a cheaper iPhone could help Apple gain market share at a much faster rate than its current run rate.

The Impact of a Cheaper iPhone

We believe that the main reason for Apple not rushing to introduce a cheaper iPhone is the danger of its higher-end iPhone sales getting cannibalized from cheaper versions in these newer markets thus eroding some of the brand value and cache associated with owning an iPhone. This will not only hurt iPhone’s average pricing levels but also the associated profits margin. In a scenario where volumes could not offset the impact of margins, this could to lower profits than the iPhone might otherwise earn. In other words there is value in being considered a high end phone !

In a recent note, we shared the results of a small survey performed by Piper Jaffray that suggested that iPhone loyalty stand above 90% while Android users are much more likely to switch to iPhone. Survey Says iPhone 5 Demand is Sizzling. This supports the view that even if Apple loses out to Android to some customers, many of these (the survey suggested half!) would convert to an iPhone. So the opportunity cost of losing these customers isn’t as big as just looking at the difference between Android vs. iOS operating system market share.

In addition, a recent post from Horace Dediu suggested that Apple’s profits have been increasing rapidly and now accounts for two-thirds of the industry’s profits.^[3] Apple’s profit outlook is dependent on high margins and if Apple looks to sacrifice margins for volume, it risk deteriorating some of the appeal of owning an Apple and could ultimately sacrifice profits for market share gains.

Therefore, Apple’s willingness to launch a cheap iPhone targeted towards developing markets may not be as easy of a decision as one might think at first.

See our complete analysis for Apple

Notes: