Quick Thoughts: The still not so cheap iPhone

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–          As everyone expected, Apple’s big event introduced an incremental update to its high end iPhone, the 5S, and a slightly cheaper plastic alternative, the 5C

–          The 5S adds a beefed up 64 bit processor, an improved camera, a fingerprint ID sensor, and new gold color tailor made for the Chinese market – nice to have, but nothing game changing

–          The 5C’s $550 price means good margins but it is out of reach for emerging market customers. The whimsical plastic case and iPhone 5 guts could drive cannibalization of the 5S.

–          Surveys suggest Apple will sell a lot of phones this fall, but the 5S and 5C are probably not enough to stop the iPhone’s global market share slide

We haven’t seen Apple CEO Tim Cook and team launch a new product in a while, but today’s iPhone centered presentation was hardly a surprise with bloggers and the tech press publishing leaked photos of iPhone cases and components throughout the summer. As expected, the company released its anticipated iPhone 5C and iPhone 5S models. The iPhone, which now makes up over 51% of Apple revenue, is undoubtedly the company’s most important product and iPhone keynote presentations have become a barometer for the company as a whole. This generation of iPhones feels particularly important, coming on the heels of a quarter when the company’s YoY sales growth dipped below 1% and margins continued a 2 year slide. Apple is at a crossroads with the iPhone having been run down by a pack of rivals with segmented product ranges, faster update cycles, and more aggressive price points. iPhone market share has stagnant in most major developed markets where overall smartphone sales are beginning to slow, and Apple premium pricing has put them largely on the sidelines in high growth emerging markets, like China and India. The fan boys are beating the drums for the 5C and 5S announced today, and analyst surveys suggest a lot of pent-up demand for upgrades from the installed base, but I can’t help but worry that after the end of the year rush, we may look on these products as disappointments.

The iPhone 5C is clearly a response to competitive pressures that have dogged iPhone growth in recent quarters. During today’s keynote, Apple executives led by marketing SVP Phil Schiller spent 10 minutes explaining the iPhone 5C’s features which are largely identical to those of the no longer produced iPhone 5. Essentially, the guts of the phone have been in production for the past year with the only major differentiators being the product’s plastic colored casing and an enhanced front facing camera. The iPhone 5C even had a Jony Ive montage extolling the virtues of a plastic unibody case. The surprise with the iPhone 5C is the price, which while at $99/16GB and $199/32GB under 2 year contract, translates to $549 and $649 unlocked respectively. In emerging markets where unlocked phones are the standard, Android phones equipped with dual core processors and large high pixel density displays regularly sell in the range of $250-$350. The initial pricing on Apple’s web site suggests a Chinese launch price of $773 for the 5C, but even at the US unlocked price, the product wouldn’t seem likely to move the needle. With a sub $200 bill of materials, gross margins on the new phone are still in excess of 64%, but do give Apple some room to revise pricing in the future should it need to. As the company is staggering launches and also prioritizing key emerging markets such as China, a pricing revision could happen depending on sales momentum in those markets.

Next up, Apple focused the remaining 30 minutes or so of the presentation the new flagship phone, the iPhone 5S, which as expected comes in a third color: gold. The new 5S brings forth three major innovations in processing power, camera, and security, though none of them are earth shattering. The new model boasts a new 64-bit A7 processor and a motion co-processor that measures output from the accelerometer, compass, and gyroscope for applications using those sensors. While processing improvement is always sexy for techies, it may not be all that helpful to the average iPhone customer. 64 bit processing seems a bit of an overkill for a product with a 4 inch screen – I’m not sure that the boost to the performance of “Candy Crush Saga” would be noticeable to the typical player. The A7 may be a sign that Apple will move to a common processor family across the Mac family as well, welcome news to ARM investors. As for the motion co-processor – this could be a precursor to the introduction of the rumored iWatch. If so, the interest in processing the output of motion sensors could at least make some sense.

In terms of camera, the iPhone 5S is still equipped with an 8MP image sensor and the major innovations are incremental: a larger aperture and sensor area within the hardware, enhanced software, and new warmer LED lights to enhance color in photos taken on the iPhone 5S. The larger aperture and sensor area result in larger pixels that Apple boasts will make for better pictures. New software in iOS 7 will enable the camera to take multiple shots and pick the sharpest photo and even shoot video at a high frequency enabling slow motion effects, but these capabilities will accrue to any iPhone that upgrades to the new software. Finally, the addition of s secondary warm light LED is said to make for more natural flash photography by balancing light. It’s also certainly not innovated above Nokia’s pixel packed 41MP Lumia 1020. Again, these are only modest changes and may not be enough to sway an average consumer also considering the lower priced iPhone 5C.

Finally, in probably the first innovation of its kind, Apple introduced a fingerprint ID sensor that scans sub-epidermal layers sensing at 550 ppi. It is marketing the innovation as Touch ID, to secure phone locking and iTunes store purchases. To reassure users of security and privacy issues, Apple also stressed that fingerprints are encrypted and not shared with Apple servers or iCloud. While this is our favorite innovation in the phone, it could have complemented a more powerful security offering had Apple offered a more compelling vision for its Passbook e-wallet app. This feature though might also not be enough to sway consumers. A Harris interactive survey last year found that only 25% of smartphone users use a locking feature on their device.

Aside from a rush of upgrading customers in the late third and fourth quarters, this new line may not be enough to sustain growth in the longer term. The new line of iPhones also portends to cannibalization of the flagship phone as its features may not be enough to tip the scales for price sensitive customers. And finally, we don’t see a significant share shift occurring in emerging markets because of the price point. A $550 phone simply cannot not compete with a similarly equipped indigenous Android phone at $300.

For our full research notes, please visit our published research site.

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