Hardware Margins Overlook the Real Profit Opportunity of iPhone

Implications: 1. Apple and AT&T will earn more after the sale than on it
2. The cost of making the phone is not the cost of goods to providers



Analysis: iPhone represents a new opportunity for both Apple and AT&T to increase the volume of content sold to consumers. While their previous collaboration with Motorola's ROKR handset last year was not a breakout success, the technical superiority of the iPhone, along with its ability to playback more than 100 songs at a time (a major limitation of the previous ROKR) as well as Video content (another missing feature of ROKR) suggest that it will do much better in this marketplace.

While Apple has done a good job of creating many different types of iPods, causing most consumers to own more than one at a time, it is unlikely that most consumers will own more than one iPhone, as most consumers only own one mobile phone at a time. If Apple has their way, it will replace their current iPods and become their PRIMARY source for portable media playback, in addition to email and internet content. What this means for Apple is increased sales of songs, music videos, TV shows and movies over iTunes. What this means for ATT is significantly higher usage of data services on the phone, data services are billable at much higher rates than phone minute usage with most carriers.

Given that the iPhone will run the Mac OS natively, it is likely that customers will be able to purchase directly from the iTunes store to the phone, which was not an option with the ROKR phone and is not an option on Apple's other new product announcement, AppleTV. By eliminating the need for a computer as the front end for transactions on iTunes, Apple is making the ability to buy a movie as easy as it is currently to buy a ring tone, which has proven to be a very lucrative market for cell phone carriers.

I would argue that the opportunity for profit for both Apple and AT&T lies in the increase of content consumption (for Apple) and data usage (for AT&T) than it does in the margin of the hardware.

The other factor in this equation, is that the 50% margin is based purely on components costs and does not take into account Apple's actually pricing of the product for distribution and resale.

While it is true that Apple has retained 40-50% manufacturing profit margins on the iPod line for some time, there is a reason that wherever you look for iPod pricing, the price is always within 10% of the retail price, which is hardly the case with most other consumer electronics products.

The reason for this is that Apple very tightly controls the cost to distributors and resellers, so there is a very limited amount of front end profit margin, and thus much less room to discount the product.

As the iPhone will be sold through a variety of outlets, the likelihood of significant discounts is only a factor for ATT locations directly, as they may choose to take a loss on the sale of the phone, in order to engage the consumer in a long term contract where there they stand to make back significantly more profit through the use of data services as mentioned above.

But for Apple's resellers and distributors, there will be very little margin to discount from, and no back end revenue stream to compensate for selling the product at a loss, so you will not see discounting of more than 10% off of the $499 or $599 MSRP, as that is about what most of Apple's distribution channel is provided.