A budget iPhone is a bad idea

Remember what happened when Dell made a similar move?

By Minyanville.com Apr 8, 2013 1:43PM
copyright AppleWhen Dell's (DELL) market share stalled in 2005, retribution came quickly. The company's stock price began a long decline that year, despite rising revenues and income.  

The message was clear:  Investors wanted growth, not profits. In 2006, Dell cut prices, but the resulting fall in margins -- a bid for achieving that growth -- only drove the stock further underwater. Michael Dell returned to the helm, and under his leadership the company closed factories, commoditized its PCs, and made every attempt to cut prices.  

However, despite doing everything "right," and caving to critics on every point, Dell's troubles had only begun. Revenue peaked in '08, market share dropped off a cliff in '09, and today a much-diminished company is in talks to go private.

It's a cautionary tale for Apple (AAPL), whose position today is uncomfortably similar to Dell's eight years ago. The company is larger and more profitable than ever, just coming off the best quarter in its history, while the stock is down 35% since September 2012 on worries over market share.  

Google's (GOOG) Android is now the dominant player in smartphones, and the iPad, which still accounts for about half of tablets sold, is finding itself under increasing pressure. Tim Cook denied in February that the company was working on a budget version of the iPhone, but the rumors refuse to die, and analysts continue to expect that Apple will introduce a lower-cost handset. Wall Street appears to be subtly (or not so subtly) suggesting that Apple follow Dell's ill-fated strategy, and cut prices.

But would this address the company’s problems? What, after all, is wrong with Apple? I offered my take several months ago, arguing that the marriage between Apple's IOS operating system and its handheld devices -- the iPad and iPhone -- essentially guarantees a minority share for the company's products. The Android ecosystem offers a wider range of hardware and more flexibility in price points, and by addressing a larger market it attracts more attention from software developers. Eventually, Droid will benefit from the same software-driven momentum that made Microsoft's (MSFT) Windows so unstoppable in personal computers. (Microsoft owns and publishes Top Stocks, an MSN Money site.) In the tech world, hardware makers come and go, but platforms are forever. Apple is, and always has been, a hardware company.

A budget iPhone won't change this. Cheap devices have never been Apple's strength, and the company's minimalist approach to its product catalogue -- selling fewer devices, that don't compete with each other -- is the result of a lesson learned in the '90s, when a confused lineup was one of several issues that nearly brought Apple to bankruptcy. On his return in 1997, Steve Jobs said that the era of "competition between Apple and Microsoft is over," and he refocused the company towards the innovative premium products it has proven to be so good at. Few today would question that decision.

It would be a mistake for Apple to chase Google, and an even bigger mistake for investors to believe that the company can compete with Android on market share. The remarkable thing isn't that Apple is losing ground, but that for a few years it was able -- with a single, high-end product -- to dominate the industry so completely. A lower-cost iPhone would sacrifice margins for a questionable growth, and it would dilute the one asset that truly makes Apple different: the loyalty of its customers.

Several different surveys show that iPhone users are largely content with Apple, and less likely than Droid users to make a switch. There are two factors at work here. First, leaving the iPhone means abandoning iOS, and changing operating systems can be a difficult and expensive process. This tends to limit any bleeding of current customers, which explains why, in all the years of competition between Macs and PCs, the battle lines remained relatively constant.

Second, Apple's holistic approach generally results in a smoother experience; its operating system is simpler to use and less vulnerable to malware. This comfortable environment is not without its limitations, but by and large, people are satisfied with it.

Given that the company's customer base is unlikely to exit en masse, the lack of a budget iPhone constitutes an enormous advantage; it guarantees that each of these customers pays a premium price. A low-cost device might win over some Android users, and stave off competition from Samsung (SSNLF), but it will also cannibalize Apple's existing customers, who won't have to switch platforms to take advantage of it. While a cheaper handset may grab share in the developing world, it would mean devaluing the iPhone's core markets -- U.S. and Europe -- in an attempt to grab new ones.

Apple should continue to do what it has always done: sell high-quality products. The company may no longer be the darling of Wall Street, but its position is more secure than investors seem to think; it may lose share, but it's unlikely to lose customers. So long as Apple can pump out $30 billion/year in cash, its stock will provide a compelling value. Growth, on the other hand, will have to come from innovation in new markets, and not from chasing old ones.

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