iPhone sine qua non
Last week I made an attempt to measure the iPhone’s manufacturing cost given new data points from the Foxconn field trip. The post generated a great amount of new knowledge and the feedback was very valuable.
The main value to me came from stepping back and looking at the entire cost and value structure for the iPhone. Putting costs into perspective is as valuable as knowing what they are.
The following diagram shows my estimates for this cost structure for the fourth quarter given both bill of materials estimates and the other parts of the cost of goods sold and operational expenses and even ancillary sources of revenue.
Source for BOM estimate: iSupply.
There are several observations easily made from this view:
- The manufacturing cost ($15 may be very generous i.e. high) but it still amounts to a tiny fraction of the device cost and hence value-add. The direct labor part of that cost is tinier still.
- Depreciation on capital equipment (Apple owned) amounts to $10 per device, probably higher than the direct labor cost.
- External developers as a group receive more app income than the salaries and costs associated with Apple’s own developers working on the product.
- The gross margin percent is 58%.
- The operating margin is estimated at 51%
The high margin that the product generates is even more surprising given the industry average as seen in this summary view of the industry’s performance over three years’ fourth quarters.
The operating margin is the ratio of solid colors to the entire bar.
As someone pointed out on twitter: one of these is not like the others.
The question should be: How is this possible? What does this product have that gives it such a pricing advantage? Note the the ratio was preserved through the three years shown and has persisted for nearly five years.
The answer to this paradox is in data that is not visible in any of the diagrams above: The largest revenue attached to the iPhone comes into the mobile network operators. We don’t have global averages but the revenue the iPhone generates over its lifetime is probably two to three times the revenues that Apple directly receives. The ARPU iPhones are attached to allows for a substantial subsidy, but more importantly, loyalty (or churn)
As seen in the small but clearly visible US market, being an operator having iPhone exclusivity generates above-average growth and being the only operator to be excluded from the product generates above average subscriber losses.
It quickly becomes obvious that ranging the iPhone has moved from being an advantage to not doing so becoming a serious disadvantage. The product and its high up-front costs are “hygiene factors” for operators. The sine qua non status means that it can still be priced with the extraordinary built-in margin shown above.
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“The answer to this paradox is …[that t]he largest revenue attached to the iPhone comes into the mobile network operators.”
This plays nicely into the observation that, at least in the US, essentially all phones except Apples’ are specified, purchased, branded and distributed as wireless carrier products. Motorola just happened back in 2008 to be an independent company when Verizon was using it to build the Verizon Droid brand; the proper unit of measurement for growth, profitability, etc., is by carrier.
Except for Apple, which figured out how to avoid the carriers’ “barefoot and pregnant” oligopsony policies of treating manufacturers. Maybe all those Jobs jabs at “orifices” were more important in defining the company’s future success than we realized.
I think it isn’t quite so simple. What Apple figured out is that AT&T and VZN are willing to pay a great deal in subsidies to defend the “long expensive contract” business model. With less-generous subsidies, more people would just buy and unlocked phone from Apple and then start looking for lower-priced prepaid or unbundled plans. (As is the usual setup on the Continent, where the iPhone also has worse market share.)
The iPhone’s desirability makes the relationship with Apple more important than that with the MNOs for customers, which should drive down prices. In the US, what happened instead is the MNOs handed over a lot of their revenue to Apple as a way of avoiding a price war.
I really have to agree with this, you make a good point. I think Apple stands to gain in an environment where phones are sold subsidized rater than at full cost. Essentially, the high price of the phone is “hidden” from the consumer, because it’s hidden in the monthly contract you agree to. It makes it extremely tempting to keep re-upping your contract every two years to get the newest and exciting iPhone. It’s actually quite a brilliant psychological play by carriers and Apple.
So my question is: do iPhone owners in the U.S. have a more frequent iPhone-purchasing rate than European iPhone owners? It seems like the answer would be yes, since the average consumer finds it easier to stomach $200 every two years than $600+ every two years. Which is precisely why it seems to me that Apple must prefer the U.S. environment over the European environment, all things being equal.
Except, Apple originally sold the iphone as unsubsidized
with low rate sub. Three months later reduced the price.
a year later AT&T renegotiated and Apple relented.
and now Carriers are crying about giving their profits to Apple.
I don’t know how common this is with other users, but I didn’t upgrade my iPhone 3G until the 4S came out (about 3 years), and my wife only upgraded her original iPhone at the same time (about 4 years), so AT&T made off just fine with all our extra subsidy money. Just because we *could* upgrade our phones didn’t mean we actually *wanted* to. This may be an example of Horace’s “good enough” in action.
Presuming you want to treat your carrier commitment as permanent, the CW is that as soon as you can upgrade, you do so for your $200 or whatever, then turn around and sell an only-slightly-depreciated 3GS for more than $200.
Your strategy may be good if your time to sell the old one is worth more than minimum wage, but if you have an easy buyer (e.g., a child who will gratefully accept it, even as an iPod Touch), the subsidization model encourages over-consumption.
Partly I was hoping to see some more carrier choice, but as it turned out, a choice of black, black, or black for basic plans isn’t much incentive to switch carriers.
I wound up sticking with AT&T mostly because their data service is faster, at the moment. I frankly don’t like any of the major carriers, but we’re unlikely to get much choice here in the US unless there’s an unseen disruptor in the works who can bypass the major carrier lock on spectrum somehow. Not holding my breath on that one.
Don’t have a link but look up Martin Geddes (sp?) maybe at GigaOm for “the end of telcos” type story. I think it fits Horace’s understanding, too, that telcos have very expensive cap ex but they aren’t really in command of “value” that people look for, any more. The argument is that our spectrum allocation is really FUBAR (haven’t evaluated it myself but I’m receptive) so carriers over-spend to keep users rather than provide service. Sound familiar?
It appears this is exactly the case, as the WSJ wrote yesterday: iPhone’s Crutch of Subsidies
online.wsj.com/article/SB10001424052970204653604577247471036145902.html
Having seen VZ from the inside a little bit, I’m pretty sure there were dead VZ executive bodies on the floor before they accepted Apple’s terms for the iPhone. They do *not* play nice with vendors….
I, of course, do NOT have that inside info, but it sure sounds right.
Incidentally, I had a nice chat with an airplane seat mate a while back; he said that some half dozen VZ staffers took especially early retirement after turning Apple away back in ’06. Yes, the reaction to Jobs & Co. was probably “don’t let the door hit your butt on the way out,” but the iPhone caused a major shift in competitive positioning in wireless in ’07 & ’08; had Android not been available it could’ve been EXTREMELY expensive to Verizon.
I wasn’t very inside… I wasn’t in the telco itself, but in a small R&D appendage where I got to deal with some of the mainstream VZ folks a little, and saw a bit of how the management thought of things. (I will also note in passing that I think quite highly of their engineering team, in general.)
Hey, dumb question: does “memory” refer to NAND flash storage or RAM? I’m assuming the former. If so, we’re does RAM costs fit into this? Is it lumped into “processor” since it’s (I believe) part of the system-on-chip?
iSupply’s original iPhone tear downs showed RAM and Flash as approximately equal costs, adding up to MORE than the CPU, IIRC.
The teardown analysis I used is here: www.isuppli.com/Teardowns/News/Pages/iPhone-4S-Carries-BOM-of-$188,-IHS-iSuppli-Teardown-Analysis-Reveals.aspx
Ok, so for anyone else interested, it looks like iSupply (per Horace’s link above) groups both the NAND flash and the RAM under “memory”.
There must be some good reason you thought your question important … care to share?
Sure, but it’s not too interesting: I selfishly would like some more RAM on my next iPhone
MobileSafari on the 4S (and all previous iPhones) kicks webpages out of memory too frequently for my liking. More RAM would be nice, and I wonder how expensive of a proposition that would be for Apple. Admittedly, I don’t hear average Joe user complaining about this.
I can’t/wouldn’t disagree with your thinking. However, …
Doubling RAM might cost an additional $25 or so per handset. The maybe 10% of us who keep lots of apps/pages going might notice an improvement, while 90% wouldn’t notice any benefit, meaning that it would have to provide $250 of benefit to the one person out of ten who’d be subsidized by the other nine.
If Apple employs any logic roughly like this, we can understand why their choice. I don’t think that *I* would pay an extra $100, but maybe. Apple has always been extremely tight with RAM on its iPhones and I think this exemplifies why.
Now, as to whether people would pay an extra $50 for upgraded memory? That’s more interesting. It could have the effect of encouraging app developers to write for a much bigger RAM partition, with effects up and down the system.
I suspect it’s not a cost issue — more likely it’s a battery issue. Flash doesn’t take power when it’s not being accessed, but DRAM does, and the more memory that needs to be refreshed, the more power it takes. I believe many of the Android phones have more DRAM memory than the iPhone (possibly because of a larger OS footprint), and this may be one of the reasons why their battery life often isn’t as good. (As an aside, I think this DRAM power observation first surfaced over on AppleInsider.)
The power issue isn’t a simple linear relation, due to various design tradeoffs and process effects, but DRAM from the same technology generation will generally use more power the larger it is.
Apple is a master of design tradeoffs between software, hardware, cost, and function, and I expect this one is quite deliberate, but not particularly cost-driven.
I believe that Apple has constrained the RAM on all iOS devices not so much because they are cheapskates but because RAM burns power. We’ve finally hit the point where the amount of RAM that can be kept alive given the overall power budget is not painfully low, but I don’t think you’re going to see Apple throwing more RAM in devices just because “what the heck” for a while. With mobile, you ALWAYS have to think of the power costs of any addition you make.
Now, if Apple or ARM could add features to a CPU+chipset that somehow changed this equation —the ability to simply power off blocks of RAM, or run them much slower, the tradeoffs would change. But with current technology it seems to me this would also require changes in how RAM is delivered — something like individual independent sub”blocks” of RAM on a given DRAM chip — and that is a substantial change from what the DRAM vendors are set up to deliver today.
So, building an “user desirable” cell phone, with an [almost] “user desirable” refresh rate (yearly) while keeping the OS updated for a [certanly] “user desirable” period (3+ years) and not paying attention to telcos is a good business for [almost*] everybody! (even to the telcos!)
* Exclude competence from this “almost.”
In Germany, you can buy an iPhone for €650 or so from Apple. There are then any number of €10/month prepaid data plans, putting your total cost per month, if you don’t talk much on the phone and use iMessage, in a zone where Apple gets more revenue over two years.
So the paradox resolution seems to depend in a fundamental way on the US market being split between two serious players who offer only expensive long-term contracts for data. They are willing to heavily subsidize buying the iPhone as a way of protecting the business model, which has to be much, much more profitable for them than competing against 10 different MVNOs.
You can buy an unlocked iPhone in the US as well. Not many do.
Since there is no cheap data contract, why would you?
This is the anomaly. The only benefits to buying an unlocked device in North America is the ability to buy local SIMs when travelling and to be able to change carrier in North America if you want to. The data plans are identical whether you buy locked or unlocked. This is clearly a carrier incentive to lock-in subscribers. The up-front subsidy is relative peanuts compared to the 2 year data subscription return. The cost to accrue a new subscriber (in other words the cost in losing a subscriber) is also significant, compared to the loyalty costs of subscriptions.
Few consumers do the math on subscriber costs!
Actually my wife bought an unlocked iphone in the U.S., and she signed up for T-Mobile with a $50 plan with unlimited data and minutes. The iphone can only use the older Edge network, but now that most people have moved over to the 3G networks, the Edge network is very usable.
I considered it, but since the only carrier the unlocked iPhone is fully-usable on is AT&T, and they don’t allow different plan options (i.e. they’ll charge you for the subsidy even though you’re not getting it), so there’s little point to buying the unlocked phone unless you travel to Europe a lot.
Once the cross-carrier LTE iPhone is available, there may be more incentive to customers to buy it, but for now carrier-hopping to get better deals is a non-starter.
Another problem is that the smaller carriers apparently can’t get decent data agreements with the national carriers, which means that smartphone users are pretty much stuck with the big oligopoly boys, and an unlocked LTE iPhone won’t fix this problem.
In the US, carrier hopping will be a non-starter until there are carriers to hop to. This may well be never, given the American regulatory environment. Nobody would move around in Europe if there weren’t a wide variety of MVNOs trying to drive down the price.
Horace seems to have completely whiffed in his response to my other post: nobody—by which I really mean the Chinese people lined up at the store who buy all of them—buys unlocked iPhones because you pay the same monthly charge anyway. You are, essentially, giving away $450 for little in return.The point with respect to the analysis from Horace is that the iPhone’s consistently high ASP reflects, mainly, it’s dominance in markets where *any* smartphone *usage* is expensive. Because the iPhone is the best smartphone, Apple is then able to demand, via subsidies, an outsized chunk of the resulting revenue from the MNOs. (Hence eroding margins from AT&T and VZN.)What I do not see is the kind of conflict between the MNOs and Apple that some are imagining: both have benefitted quite a lot from markets where the MNOs can demand $80+/mo just to have a smartphone. It is the revenue stream that’s being fought over, but not the basic setup.Further, if we look at Apple’s new China deals, the announcements all seem to be that the distribution model isn’t based on unlocked sales by long-term contracts.On the flip side, the iPhone is not nearly as dominant in Germany—though my informal U-Bahn experience is that it’s the most popular phone—but the MNOs aren’t collecting nearly as much money from smartphone users either.
I would like to see side-by-side with iPad, both with and without 3G if significant. I would think the margins on iPads are notably thinner, since iPads have more pressure to be cost effective since they are not subsidized by the carriers.