Poor Prepaid Demand For The iPhone Shows The Need For A Cheaper One

by Trefis Team
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Apple’s (NASDAQ:AAPL) maiden attempt to test the prepaid waters in the U.S. seems to have not gone as expected. Last year, the iDevice maker had signed a couple of deals with Leap Wireless’ Cricket and Sprint’s (NYSE:S) Virgin Mobile prepaid brands, which saw the iPhone launch for the first time in the U.S. as a prepaid phone. Having largely penetrated the U.S. postpaid market, Apple was looking to carry the iPhone momentum into the prepaid market. However, a recent SEC filing by Cricket owner Leap Wireless, in which the carrier has revealed that it expects to meet only half its first year commitment to Apple, has put cold water to those plans.

Leap has a $900 million three-year contract with Apple, and if we assume the same to be equally spread over the entire period of contract, the carrier expects to sell only about 230k iPhones in the first year. It is not yet known how the iPhone has performed at Virgin Mobile but considering that the iPhone was costlier at Virgin than Cricket, sales at Virgin may have also been disappointing.

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Subsidies not going anywhere

However, the iPhone’s performance at prepaid carriers is not indicative of its sales in the broader U.S. market. According to market research firm Strategy Analytics, Apple’s iPhone 5 launch in September last year saw it sell close to 18 million units in the U.S. during the holiday quarter, about 40% more than the same period last year. This helped Apple capture about 34% of the U.S. smartphone market last quarter and more than 26% of the market for the full year 2012. However, the overall U.S. smartphone market shrunk by almost 10% last year due to macroeconomic uncertainties and stricter carrier policies which led to fewer smartphone upgrades. The fact that despite the overall market contraction, Apple managed to grow its iPhone unit sales by about 50% last year goes to show the immense popularity that iPhone enjoys among the U.S. postpaid subscribers.

The prepaid snub however shows the value of carrier subsidies in incentivizing smartphone purchases, which has had a direct impact on the demand for mobile data. It should therefore give carriers some pause in considering subsidy cuts for the iPhone given how popular the smartphone is and the adverse impact that a costlier iPhone could have on their sales.

Apple needs a cheaper iPhone

On the other hand, it also indicates how ineffective the iPhone, in its current form, could prove in penetrating the emerging markets, where carrier subsidies haven’t yet become popular and prepaid plans are still the norm. Forget emerging markets, the iPhone seems a little too expensive to be successful in the prepaid markets of developed economies. The iPhone may have proved to be a winning bet in developed markets due to the high postpaid penetration but these markets have become increasingly saturated recently. In order to continue to grow at historical rates, Apple needs to come up with a better strategy for the emerging markets where the iPhone is way too overpriced to make any meaningful dent.

We think that Apple needs to consider a cheaper iPhone for the emerging markets that does not compromise much on the build quality and margins in a move similar to the iPad mini. This will also help lower the per phone subsidy costs and potentially help bring carriers such as China Mobile, that have an issue with the high iPhone subsidies, on board. Such a move would also translate well to other developing markets that may want Apple’s iPhone but, due to the lack of carrier subsidies, find the retail price tag too high. (see Apple Needs A Better Emerging Markets Strategy)

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  • commented 5 years ago
  • Your assumption about iphone5 sales to Virgin is an...assumption. Selling of 4s is a way to offer cheaper iphones
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  • commented 5 years ago
  • Apple needs a cheap phone as much as Daimler (Mercedes) needs to have a mass market entry-level car. No way would it undermine the value of the brand and wreak havoc with the margins and ROIC model. Oh wait, they tried that with Chrysler. Smartphones are now essentially a mature product and competition is becoming more and more about branding than functionality. Apple has the best brand and that support premium margins. Of course growth is slowing, iPhone was a model T moment, a once in a corporate history quadrouple grand slam that can't repeat. But that doesn't mean AAPL is done for. It's 30% cheaper than most mega cap branded consumer goods companies and it has earned more than twice the cohort average ROA despite an insanely lazy balance sheet. For point of reference, in 2012 AAPLs ROA was 25% versus 9% for the peer group. Even if it falls 50-60% as competition continues to increase, it will still generate excellent incremental returns on capital. If they push too far out of the premium market position, the brand will suffer and the returns won't be any better than those of other technology intensive manufacturers, like auto makers for instance.