On Sept. 12, Apple (NASDAQ: AAPL) announced the iPhone X, which Apple calls "the future of the smartphone."
Over the past three product cycles, Apple released two new iPhones: a standard iPhone with a 4.7-inch display and a larger 5.5-inch iPhone. The 4.7-inch iPhone models have typically started at $649, while the 5.5-inch ones started at between $749 and $769. Customers could, of course, pay more for variants of these smartphones with additional amounts of storage capacity. It was usually a $100 premium to move up each storage tier.
This year, Apple flipped the script.
In addition to the two iPhones priced mostly in line with prior years' models, Apple introduced a more advanced smartphone, the iPhone X. This device starts at $999 for the base models with 64 gigabytes of storage capacity and goes up to $1,149 for the variants with 256 gigabytes of storage capacity.
Some potential customers and members of the press alike balk at the notion that Apple is charging more this year for its best new iPhone. Apple CEO Tim Cook, on the other hand, recently argued that for the features the company is delivering with the iPhone X, the phone comes at a "value price."
Here's why I fully agree with Cook.
Paying more to get more
The iPhone X includes several novel features and hard-to-build components. The full-face OLED display -- especially one that meets Apple's rigorous standards for color accuracy, brightness, and uniformity -- is surely much more expensive to build than either of the liquid crystal displays found on the iPhone 8 or 8 Plus.
The iPhone X also includes what Apple markets as a TrueDepth camera system, which integrates more components than what Apple, or any other smartphone maker, typically integrates into its front-facing camera subsystem.
The iPhone X also has a superior rear-camera subsystem to the one found in the iPhone 8 Plus, thanks to a wider aperture on the telephoto lens as well as optical image stabilization on the lens.
And finally, the iPhone X uses a stainless-steel frame, rather than the aluminum frame found on the iPhone 8 and 8 Plus.
All these additional features add to the cost of the iPhone X. Moreover, since the very industrial design of the iPhone X appears much more complex than the designs of the iPhone 8 and 8 Plus, I would imagine that the cost to assemble all these components into a finished device that meets Apple's standards is higher.
Apple, of course, wants to sell as many iPhone X smartphones as it can. But at the same time, it needs to ensure that it's generating reasonable profits per device. If Apple sees dramatically increased manufacturing costs for the iPhone X, then it would almost certainly see a large drop in its gross profit margins -- and, therefore, overall net profit -- were it to try to sell the new devices at the same price points as the iPhone 8 or 8 Plus.
To avoid this scenario, Apple increased pricing on the new phones. Apple also, of course, released significantly improved smartphones at familiar price points to cater to customers unwilling to pay a premium for the iPhone X.
Here's the thing that investors also need to keep in mind: A great business such as Apple can inflate its price points if it can add features that customers are willing to pay for. It's clear that flagship smartphone buyers value additional camera features, sleek form factors, and innovative display form factors and technologies. So with the iPhone X, Apple delivered big improvements across all those areas and is charging a bit more for them.
The added features in the iPhone X won't be of value to everybody -- people can and will buy one of Apple's many other cheaper iPhones. But Apple's betting that a large enough portion of its potential customers will be willing to pay more to get substantially better phones.
While the iPhone X won't be cheap in absolute terms, at least within the world of smartphones, I do think it packs enough innovative new features and technologies such that the $999 base price -- or even the $1,149 price for the versions with 256 gigabytes of storage -- will truly be "value priced" to tens of millions of prospective iPhone buyers.
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