Apple Reportedly to Begin Trial Production of New iPhones Next Quarter

A new report from DIGITIMES claims that Apple (NASDAQ: AAPL) will begin trial production of its upcoming iPhone models in the second quarter of 2018 "at the earliest," citing sources "from Taiwan-based [integrated circuit] design houses."

This trial production schedule, the publication explains, is expected to allow Apple to attempt to "avoid a repeat of the mishap caused by the initial low yield rates on production of 3D sensor modules for those models introduced last year."

Yield rate refers to the percentage of the devices manufactured that are good enough to be sold to customers.

The "mishap" in this case was that Apple didn't begin selling its 3D-sensing iPhone X until early November 2017, despite the device being announced in mid-September.

Here's how Apple's plan to begin trial production in the second quarter of 2018 will help it avoid a product delay and what that means for Apple's business.

Tuning manufacturing yield rates

In this case, "trial production" will likely involve building a small number of the iPhone models ahead of true mass production. The purpose of that smaller scale production is to allow Apple and its various manufacturing partners to ensure that the devices can be built to the desired specification at high yield rates.

If any problems arise during this trial production, Apple and its manufacturing partners can work to make adjustments to the relevant manufacturing processes to solve those problems. Once the issues are worked out and yield rates are acceptable, then Apple and its partners can start building the devices on a much larger scale.

There are two reasons that a company would want to ensure high manufacturing yield rates. The first is simply profitability: The higher the percentage of units manufactured that can be sold, the lower the average manufacturing cost.

Let's put some hard numbers to this: If it costs $100,000 to manufacture 1,000 smartphones and every one of those phones is salable, then the average cost to manufacture the phones sold is $100,000 divided by 1,000, or $100. If only half of the phones that are built are salable, then the average cost of the phones sold is $100,000 divided by 500, or $200.

Manufacturing yield rate plays a huge part in manufacturing cost and, ultimately, profitability.

More than just manufacturing costs

Beyond per-unit profitability, yield rate can determine if a company can build enough devices to meet demand. Typically, manufacturing companies put in a certain amount of manufacturing capacity to support the peak demand that they expect to see. The capacity that gets put into place also contemplates a certain, often reasonably high, yield rate.

If yield rates come in well below expectations, then the effective manufacturing output is commensurately lower. In that case, a company might not be able to meet all the demand for its products in a timely fashion, crimping product sales.

In Apple's case, everyone knows that new iPhones are announced in the fall. This means that any new generation of iPhone is most desirable shortly after launch and gets significantly less desirable as the year goes on (since customers know that newer, better iPhones are on the way). If Apple can't meet the high initial demand for its new devices early on in the product cycle, it risks having customers simply give up and wait for the next-generation models (or potentially buy smartphones from competitors).

It's imperative that Apple make sure that its latest-generation iPhones can be manufactured at high yield rates. With trial production reportedly beginning in the second quarter of 2018, Apple should -- barring any surprise problems -- be on track for a launch late in the third quarter of the year with good availability.

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Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.