Does the iPhone 5's screen point to an iPhone nano?

There are three great unicorns in Apple's product pipeline: a smaller cheaper iPad (which seems pretty likely), a television (which I think is very unlikely) and a cheaper model of the iPhone. 

The argument for a cheaper iPhone is pretty straightforward: the iPhone sells at a super-premium price, averaging over $600 where Android and all competitors are much cheaper.

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This premium is partly masked in the US by the pricing environment, which makes the iPhone appear to be little more expensive than competing products (see this post), but not elsewhere and not at all in prepay markets, which is half of Europe and almost all of China and India. Meanwhile, the discounted older iPhone models clearly do not sell in significant volume, since if they did the iPhone ASP would have fallen since they went on sale, and it has not. This is hardly surprising; the 'free' iPhone 3GS was actually $375 before subsidy, a high-end price, and the new entry-level model, the iPhone 4 (released in June 2010) is $450 - more expensive than most new Android phones. Outside the US these prices flow directly through to higher contract prices, and of course for prepay users they are the price. 

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Hence, Apple is effectively leaving the bottom 75% or so of the smartphone market (which is rapidly becoming the phone market) untouched for Android to scoop up by not offering a cheaper device. This is not what Apple did with iPods: it beat off the cheap Chinese manufacturers by going cheap itself, while maintaining quality and segmenting the product line-up very effectively. 

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The problem with a cheaper iPhone, though, is that very segmentation. How does Apple sell both the cheaper and the more expensive device at the same time? This was easy with iPods, since you could put less storage in the cheaper models, but the cheaper iPhone has to run all the same apps and have Apple-level build quality. So what do you leave out? Apple has tried selling the older models, but that doesn't work: people aren't buying them. 

Two new aspects of the iPhone 5 offer possible ways to answer this: 

  • The larger screen
  • LTE

Using the old smaller screen size, as used in the iPhone 4 and 4S, would offer Apple ways to split the 'new' iPhone product without creating meaningful fragmentation for developers. Apple would be able to offer a cheaper model with the smaller screen and no LTE that would be 'new' and cheaper but still leave a clear reason for less price-sensitive customers to buy the high-end model. All the apps would run on both. 

LTE and screens are major cost drivers in the ways that flash storage was for the iPod. The iPhone is a 50% gross margin product: changing those components and accepting a lower but still substantial margin on the cheaper product could produce a significantly lower pre-subsidy price. Apple has already shown it's willing to accept lower gross margins in exchange for profit maximisation; data from the patent lawsuit with Samsung showed that the iPad makes just 20-25%. 

Quantifying this:

  • The US iPhone ASP in Q2 was $615 with, say, a 55% gross margin: $277 COGS
  • The iPad ASP was $506 with just over 20% gross margin; say 22.5%, for a COGS of $392
  • A $300 iPhone nano with a 22.5% gross margin gets to a COGS of $233: $44 below the high-end model. Screen + LTE might make up most of that: a little salami-slicing would get the rest

These are obviously back-of the envelope figures: the real question, though, is how low would Apple need to go? An 'iPhone nano' for, $300 would have little or no impact on prepay and would still be a very expensive phone in China. And of course, you need to have LTE (or perhaps TD-SCDMA) to sell in higher volumes in China. At $300 it would still need to be sold with a contract and subsidy. The really interesting part of the smartphone marker now is being driven by MTK-based commodity manufacturers at $100 or below. I'm not at all sure Apple can go quite that low and still maintain build-quality. Still, that would mean that Android OEMs would be pushed much more towards the ultra-cheap and ultra-low margin part of the market, which is not a pleasant prospect.