Apple's $1,000 iPhones are turning it into a luxury brand — and it could lose a whole generation of customers (AAPL)

Tim Cook

Apple is increasingly transforming itself into a luxury brand. A year after debuting its first thousand-dollar smartphone, the company replaced it with two more.
At the same time, it cut its lowest-priced iPhone.
The moves could boost Apple's near-term revenue and profits.
But they could lead to stagnating phone sales and could discourage people from becoming Apple customers, which could have long-term consequences for the company.

Apple, it seems, has now fully bought into the notion that it's a upscale brand.

Its move this week to revamp its device lineup by doubling down on thousand-dollar phones, and simultaneously dropping its least expensive model, made clear that it's no longer overly concerned with appealing to customers of more limited means. Instead, the iPhone maker seems to believe that the way forward is to be the Louis Vuitton of consumer electronics.

That focus on the high-end has already started to pay off for the company in the form of near-term profits, even as it recently surged past a trillion-dollar market cap. But it could prove to be a bad bet in the longer term, particularly if it means that fewer consumers turn to Apple to purchase their first phone or other device.

Apple has always commanded a premium

Apple, of course, has always played in the more affluent end of the market. Its Mac computers have typically been more expensive than their Windows-based rivals. And its new iPhones have always carried a premium price over competing smartphones with similar performance.

But for years, particularly under former CEO Steve Jobs, the company made an effort to appeal to more mainstream consumers. When the iPod was its primary product, Apple offered models such as the Shuffle and the Nano, that had prices that put them within reach of average consumers. The iPad's $500 price was considered a bargain when it first launched. And when Apple has introduced new iPhone models, it has consistently discounted older ones, making them more accessible to a wider range of consumers.

The company seemed to be decidedly turning away from that strategy of late. Indeed, its turn to the top of the market was clear at the company's press event on Wednesday. A year after launching its first phone with a $1,000 starting price, the iPhone X, Apple introduced another thousand-dollar model to replace it, the XS, and a jumbo-sized version, the XS Max, which comes with an $1,100 starting price.

The company's other new phone, the XR, starts at $750, which looks like a bargain compared with the other two models. That appearance fades when you compare the iPhone XR with last year's lineup. The iPhone 8, which launched then as a step-down from the iPhone X, had a starting price of $700.

But Apple's move to the high-end was as pronounced by what it did behind the scenes as what it did on stage at the Steve Jobs Theater at its Cupertino, California, headquarters. While launching the new phones, Apple discontinued the iPhone SE. Its least expensive model to that point, the SE had a $350 price. Now, the least expensive phone Apple offers is the iPhone 7, which starts at $450.

Apple's move to the high-end could boost revenue

Apple iPhone Xs line up front face 09122018 This boosting of prices could benefit Apple in the short term, if its recent experience is any guide. Over the last year, the revenue it saw from its smartphone sales jumped 13% from the same period a year earlier, thanks almost entirely to the higher price points on the iPhone X and other models. The average revenue Apple saw per iPhone sold in its most recent quarter was $724; two years ago, it was less than $600.

Longer term, though, this focus on the high end could weigh heavily on the company. With iPhones costing more, Apple fans are likely to hold on to their phones longer, upgrade less often, and trade down for lower priced models when they do replace their devices.

Apple has already seen stagnating demand. On an annual basis, it's sold about the same number of phones in each of the last four years. In fact, the number of phones it sold in the year-long period that ended in June was 2% fewer than the number it sold in the same period that ended in June 2015.

That stagnation has come in the middle of a booming economy with low unemployment. When the next downturn hits, that focus on the high-end could leave Apple exposed. When they're worried about their next paycheck, consumers tend to forgo luxury items.

But the bigger problem for Apple in the future could come from its decision to kill its low-end SE, rather than its introduction of higher-priced phones.

$100 matters a lot in the consumer electronics business

The $100 price difference between what Apple charged for the SE and what it now charges for the iPhone 7 may not seem like it should matter that much, but it does. As just about any market analyst will tell you, when it comes to consumer electronics products, the relationship between price and demand is generally exponential, not proportional.

iPhone SE In other words, if you cut the price of a given gadget in half, you'll typically see sales do a lot more than double for it. Conversely, if you double the price of a gadget, sales will fall by more than half.

Another way of putting that is that the number of consumers around the world who can afford a $450 device is a lot smaller than the number who can afford a $350 one — much smaller, in fact, than the $100 difference might indicate. Thus, by raising the price of its entry-level model, the company is writing off a large segment of potential consumers.

That could have numerous consequences, none of them good for Apple.

The smartphone market in the United States and other developed nations and even in China is fairly mature at this point. Where the market is growing is in developing countries, particularly in India.

To play in those markets, where consumers' incomes tend to be a small fraction of what they are in the US, vendors have to offer affordable phones. Even a $350 phone is priced above what many consumers in India can pay. A $450 gadget is even more out of reach.

Apple can't upsell customers if it doesn't get them in the door

But Apple's move to drop the SE could give it trouble even closer to home. As most retailers know, low-priced items can often be a good way to get customers in the door. Those devices themselves may not be terribly profitable and the retailer may not really want to sell them, but they can use them as a lure. Once they've drawn a customer in, the company has the opportunity to upsell them on pricier, more profitable items. Without them, the company never has that chance with some consumers.

Apple Music That's important because Apple — as much as just about any company — relies on repeat customers. Much of its business model is about getting consumers into its ecosystem. Once they buy one Apple product, say an iPhone, they're much more likely to buy another Apple product, such as another iPhone or a Mac or an Apple Watch.

Increasingly, the company's business has been driven by convincing owners of its hardware devices to sign up for its internet-delivered services, such as Apple Music, or additional storage on its iCloud cloud offering. Apple's services business now accounts for about 14% of its total sales, and grew at a 31% clip in its most recent quarter.

If Apple fails to convinces a customer to buy that first product, the company loses out not just on that initial sale, but on all the subsequent products and services it could have sold them after the fact.

To be sure, the SE might seem like a relatively minor device. It had a small screen compared to more recent iPhones, and was based on a years-old design. But Apple really doesn't have any comparable entry-level products in its lineup right now to replace it.

Sure, you can get an Apple Watch from the company for $280 or its AirPod headphones for $160, but those are accessories. You're not going to buy either device unless you already own an iPhone — in fact, the Apple Watch requires an iPhone just to set up.

While you can now get a new iPad for $330, you're also likely not going to buy that unless you're already into Apple's ecosystem. If you really want a low-cost tablet and aren't already an Apple fan, you're much more likely to buy one of Amazon's low-cost $50 Fire devices.

So don't be surprised if Apple's move to become a luxury brand boosts its profits in the next quarter or so. But also, don't be shocked if the move ends up biting the company down the line.

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