Apple Will Solve a Major Problem With the iPhone and Preserve Its Margins at the Same Time

Apple will soon fix one of the iPhone's biggest shortcomings, and it could do it in a way favorable to shareholders -- at least in the short-run.

iOS 9, the next version of Apple's mobile operating system, includes a software feature that allows users without enough storage space to update their phone's operating system over Wi-Fi. This was a significant issue last year, and it may have limited iOS 8 adoption. Some expected Apple to fix this problem in a simpler, more straightforward fashion, but doing so could've taken a toll on Apple's earnings.

iPhone 6. Photo: Apple

A software solution for a hardware problemiPhone owners who want to upgrade to the latest version of Apple's mobile operating system have two options. They can plug their iPhone into their PC or Mac and install the latest version of iOS using iTunes, or they can download and install the update directly over Wi-Fi. The second option is easier and less complex, but it requires an iPhone to have a certain amount of free storage space.

Last year in particular proved challenging for many iPhone owners that wanted to upgrade over Wi-Fi. iOS 8 requires 5.7GB of free storage space to install, a tall order for anyone with a 16GB iPhone. Unsurprisingly, iOS 8 suffered from a slower rate of adoption than its predecessors -- last fall, Mixpanel found that iOS 8 was only half as popular as iOS 7.

But Apple has found a way to solve that problem. Beginning with iOS 9, iPhone owners looking to upgrade their handset's operating system will have the option to delete, then automatically reinstall, apps on their iPhone. As apps expand in size -- up to 4GB -- that will allow iPhone owners the ability to free up the space necessary to upgrade their operating system.

Apple's margins and the iPhone's ASPLast year, with the launch of the iPhone 6, Apple changed the storage space tiers available to iPhone buyers. The iPhone 5s shipped with 16GB, 32GB, or 64GB. The iPhone 6 and iPhone 6 Plus offer 16GB, 64GB, or 128GB.

This is a noticeable shift, one that makes the prospect of paying for additional storage far more attractive. For an extra $100, iPhone owners can now get four times as much storage -- previously, they were only getting twice as much. For Apple, most of those extra dollars flow directly to its bottom line. Last year, analysts at IHS found that Apple spent about $47 more to build a 128GB iPhone than a 16GB version, but charged $200 more to consumers.

The last two quarters were the best in the iPhone's history, as buyers were enticed by the larger displays. Apple sold 135.7 million handsets from late September through the end of March. During that time, the average selling price of the iPhone also surged -- in Apple's fiscal first quarter it was $687, a new all-time high, and in the second quarter it was $659, up more than 9% year over year.

The more expensive iPhone 6 Plus was obviously a driving factor, but the change to the iPhone's storage tiers likely contributed to this ASP growth as well. In a survey conducted last September, analysts at Piper Jaffray found that early iPhone 6 buyers were opting for models with more storage than early buyers of the iPhone 5s.

Short-term profit for a better user experience?For an entry-level handset, 16GB seems increasingly inadequate. Some observers, even those generally favorable to Apple like Daring Fireball's John Gruber, criticized Apple's decision to stick by 16GB. Most of Apple's competitors, including Samsung, have upgraded their entry-level flagships to 32GB. The Galaxy S6is offered with 32GB, 64GB, or 128GB of storage.

Apple prides itself on offering a best-in-class user experience. With last year's iOS 8 debacle, it may have seemed likely that Apple would upgrade the base storage to 32GB for the next-generation iPhone. But with iOS 9's new feature, that may not be the case.

Other reports have suggested that Apple intends to stick by 16GB. Earlier this month, 9to5Mac posted images of an allegedly leaked iPhone 6s logic board, one that included just 16GB of storage. And at Apple's Worldwide Developer Conference last month, marketing head Phil Schiller defended the iPhone's 16GB base storage, arguing that ever more powerful cloud services were slowly making local storage obsolete.

Apple should unveil the next iPhone in September. Offering a 16GB base model could attract some criticism, but with creative software solutions, it may not matter.

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