Apple's decision to keep the entry-level storage tier at 16GB for the iPhone 6 and 6 Plus, despite doubling the other capacities to 64GB and 128GB, continues to raise eyebrows. Daring Fireball's John Gruber called it "the single-most disappointing aspect of the new phones." By not doubling the entry-level storage tier to 32GB, I estimate Apple will save $3 billion of profit in 2015. I suspect Apple's bigger concern was the long-term balance between customer's storages needs and maintaining the iPhone's aspirational brand.
Apple's near-term motive behind keeping the 16GB capacity option is pretty clear: get people to buy the 64GB option. From Apple's point of view, consumers would benefit as Apple didn't raise the price of the middle-tier or upper-tier iPhone storage options, despite doubling storage to 64GB and 128GB, respectively. I suspect the issue is a bit more complicated and involves setting precedence for future iPhone revisions, as shown in Exhibit 1. The problem with having three storage tiers in an environment where the lowest storage capacity will soon be able to outstrip customer needs is that Apple risks permanently moving users from higher-priced to lower-priced models, where the cumulative change starts impacting iPhone average selling prices (ASPs) by hundreds of dollars, representing a significant portion of the company's net income.
Exhibit 1: iPhone Storage Scenarios
With Option A, if Apple kept a 16GB storage tier for an additional year (as they are doing now) and got people to upgrade to 64GB (represented by the red arrow), in subsequent years, consumers will likely develop a dependency on that storage level and remain in that middle tier, even after Apple increases the lower tier to 32GB in the future. With Option B, by upgrading all three storage capacities at the same time in Year 2, some consumers will downgrade to the lower storage capacity (represented by the red arrows) as their storage needs would be met with a less expensive model. With both Options A and B, the most popular iPhone model by Year 3 would be the same: 64GB, only with Option A, consumers are paying an additional $100.
Calculating the financial impact from keeping the 16GB model includes a few steps and calculations, highlighted in Exhibits 2 and 3. I have combined the financial impact from the iPhone 6 and 6 Plus in order to not miss the main point of this exercise; finding the difference in iPhone margin, both with and without the 16GB storage capacity tier.
Exhibit 2: Estimated iPhone 6/6 Plus Sales Mix and Margin Data Given Two Case Scenarios
By doubling the middle tier storage capacity to 64GB, while maintaining the price, and keeping the 16GB storage capacity at the bottom tier, I estimate that approximately 30% of previous 16GB iPhone owners will upgrade to 64GB to take advantage of the better deal, resulting in the 64GB being the best selling storage option (48% of sales mix), just slightly outpacing the 16GB version (43%). With the iPhone 5s/5c, I estimate the 16GB tier accounted for 60% of sales. If Apple upgraded the 16GB option to 32GB without changing the price, then it would have continued to be the most popular tier, even enticing some who had previously paid extra for 32GB to downgrade and buy the lower tier.
I estimate Apple's cost to upgrade the 16GB tier to 32GB to be approximately $15/device, leading to a little less than a 100 basis point weighted average decline in iPhone margin (to 48% from 49%).
Exhibit 3: Estimated iPhone 6/6 Plus Sales, ASP, Revenue, and Net Income Data in 2015 Given Storage Scenarios from Exhibit 2
All else equal, I estimate that doubling the iPhone's lowest storage capacity tier from 16GB to 32GB would lower Apple's profit by $3 billion. While the storage differences would likely not have an impact on overall iPhone sales, ASP would decline as users opt for the less-expensive model. iPhone revenue would decline by an estimated $5 billion, leading to an after-tax decline of $3 billion in net income.
While some may say this discussion of purposely limiting storage capacities to help maintain profitability is anti-consumer and a money grab, observers need to look at this process as a bit more than just greed. Apple is able to manage iPhone's brand and image by maintaining the device's high price. A case can be made that Apple is looking to get users dependent on higher storage capacities (at some point in the near future, 64GB will likely seem inadequate), by carefully guiding customers into a particular iPhone model each year. I suspect Apple kept the 16GB iPhone 6/6 Plus around in order to make future storage jumps, across all three tiers, a bit more manageable.
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