A new 4-inch iPhone is coming. The best way to understand why Apple is releasing a new 4-inch iPhone in 2016 is to look at the changing iPhone user base. Apple is now selling iPhones to an installed base of more than 550 million users with a multitude of wants, needs, and desires regarding their smartphones. Apple is making a bet that it is time to expand iPhone development to three different screen sizes in order to appeal to the 20% of the user base that prefer single-handed iPhone usage over larger screen options. Releasing a new 4-inch iPhone would be an admission by Apple that the only way to maintain a vibrant iPhone upgrade cycle is to expand the iPhone line.
The Old iPhone User Base
Over the span of nine years, the iPhone user base has undergone a significant transformation with much of the change taking place in just the past year and a half. In the early years, the iPhone user base was a relatively "small" group numbering in the tens of millions. The base displayed monolithic tendencies toward technology trends and Apple's mission with the iPhone. Even when the iPhone base grew, the homogenous nature of the user base remained quite resilient. As depicted in Exhibit 1, even though the iPhone has gone on to represent a quite sizable 15 percent of the smartphone market, this 15 percent has been concentrated at the high-end of the market characterized by higher average selling prices and stronger profit margins.
Exhibit 1: Smartphone Industry Price Pyramid (iOS vs. Android)
By targeting the premium segment of the market, Apple spent years developing a loyal iPhone base of hundreds of millions of users willing to spend an above average amount of money and time on their iPhones. This trend stood in stark contrast to the vast majority of smartphone sales taking place at the low-end of the market where consumers used their phones very differently.
The high level of loyalty and usage trends found within the iPhone user base was apparent when looking at hardware and software upgrade patterns. Once Apple released a new flagship iPhone model each year, a significant portion of the iPhone user base showed a willingness to upgrade to the latest device over the following year. A similar phenomenon occured whenever Apple released a new iOS version. Within a few weeks, the vast majority of users upgraded to the new release. In such a world, the belief was that wherever Apple went in terms of iPhone product decisions, be it larger screens or new features, the user base would follow in its entirety.
The New iPhone User Base
Beginning in early 2015, the iPhone user base showed signs of change. After 590 million cumulative iPhone sales, the base was no longer acting monolithic. Even though Apple was still targeting the same premium segment of the market, iPhone users were beginning to show a broader range of opinions and preferences concerning technology and Apple product decisions. The days when the vast majority of iPhone users upgraded to the newest iPhone model in relative short order were over.
One way to highlight the change that has taken place within the iPhone user base is to look at the difference in iPhone mix between the run-up to the iPhone 6 and 6 Plus launch in September 2014 and Apple's most recent quarter. As shown in Exhibit 2, the iPhone user base consisted of two groups in early September 2014: 3.5-inch screen users (iPhone 4s, 4 and 3GS) and 4-inch screen users (iPhone 5s, 5c and 5). In such a world, the difference between the two groups (and screen sizes) were rather minor.
Exhibit 2: iPhone Mix by Screen Size - Early September 2014 (Total User Base)
Jump ahead 15 months, and the current iPhone mix now looks like a cornucopia with four different screen sizes as shown in Exhibit 3. Despite 4.7-inch and 5.5-inch screen phones being in the market for well over a year, approximately 50% of iPhone users are still using either a 4-inch or 3.5-inch screen. In fact, 11% of the iPhone user base is using an iPhone that was released more than four years ago and discontinued in 2014.
Exhibit 3: iPhone Mix by Screen Size - December 2015 (Total User Base)
Factors Driving iPhone User Base Change
While some may look at a changing iPhone user base as merely a byproduct of Apple's move to larger screen iPhones or the result of the iPhone upgrade cycle getting longer, those developments are not the primary drivers of what is taking place within the user base.
iPhone's Changing Role. The iPhone is occupying a much greater role in users' lives, handling additional tasks formerly given to Macs and PCs. Accordingly, the way users look at their iPhones has become more varied. A large 5.5-inch screen may be preferred by those who treat an iPhone as their primary computer while other users place greater value in single-handed use found with a 4-inch screen. This divide marks quite a difference from the early iPhone years when most users treated their small screen iPhones similarly. As the iPhone gains additional functionality and capability, there is much more diversity of opinion found within the user base in terms of what makes for the perfect device. This environment certainly strengthens the argument that a new 4-inch iPhone is needed as not everyone is interested in fitting a 4.7-inch and 5.5-inch screen iPhone into their lives.
Used/Leased iPhones. Apple currently has an iPhone installed base of 554 million users. However, when including iPhones purchased in the grey market and hand me downs, there are well over 600 million iPhone users in the wild (the complete methodology behind how these numbers were derived is available for Above Avalon members here). With Apple moving quickly into iPhone recycling programs and annual upgrade programs, there has been an increasing supply of one and two-year old used iPhones that have eventually found their way back into the wild. This trend has resulted in the iPhone user base becoming more diversified in recent years when it comes to opinion and philosophy towards technology.
With used iPhones effectively serving as the "cheap" iPhone, Apple has begun addressing lower price segments with less expensive iPhones. As a result, the uniformity in ideas and preferences found within the iPhone user base concerning iPhone screen size and usage is disappearing. Apple now has a wider range of users that crave vastly different things from their iPhones.
It's Time for a New 4-Inch iPhone
Similar to how the iPad Pro was rumored to be released for well over a year, Apple has been rumored to be working on a new 4-inch iPhone ever since introducing 4.7-inch and 5.5-inch screen iPhones in 2014. Why has Apple given the green light for a new 4-inch iPhone now? Management's attitude towards 4-inch screens has changed. The verdict is in: the iPhone user base has not fully embraced larger screens. Over the past year, Tim Cook has provided a crucial metric for measuring how many iPhone users have upgraded to a larger iPhone. Exhibit 4 highlights the rate iPhone users have upgraded to either an iPhone 6, 6s, 6 Plus or 6s Plus.
Exhibit 4: iPhone Upgrade Rate to 4.7-Inch or 5.5-Inch Screen (Installed Base)
According to Cook, approximately 60% of the roughly 400 million users that made up the iPhone installed base in early September 2014 have still not upgraded to 4.7-inch or 5.5-inch screen iPhones. This number is likely higher than management was expecting, especially when considering that the average iPhone upgrade cycle is approximately 20 months. The evidence would seem to suggest that approximately 20% of the user base has no interest in moving to larger screen iPhones. As a result, iPhone sales have taken a hit, the iPhone upgrade cycle appears to be getting longer, and a significant portion of the iPhone user base does not have access to new Apple services such as Apple Pay due to sticking with old 4-inch screen iPhones.
For some, the thought of using a 4-inch screen iPhone instead of its 5.5-inch screen sibling makes little sense. To these users, the 4-inch iPhone's small form factor makes the device look and feel like a toy. Meanwhile, other users look at a 4.7-inch iPhone as simply too large for single-handed use, not to mention mobility. These users consider the 5.5-inch screen iPhone more like a tablet than phone. It is this varying degree of opinion that is new to the iPhone base as the differences between 3-inch, 3.5-inch and 4-inch screen iPhones were never too significant over the years.
Apple's decision to release a new 4-inch screen iPhone is an admission that the only way to get everyone to upgrade their iPhone is to expand the iPhone line. More than 200 million users have continued to use their iPhone 5, 5c, and 5s instead of buying a larger iPhone. Instead of looking at that as a sign that the iPhone business is trouble, it is a clue that the iPhone business is maturing, and it is time for Apple to increase screen size options in order to appeal to as many users as possible.
This diversification in screen size perference is the same reason why Apple is simultaneously moving just as fast at the high-end of the iPhone line with the iPhone Plus model. In the future, it is not unfathomable for the larger screen iPhone to see greater differentiation compared to its siblings, and the possibility of Apple releasing an even larger iPhone is no longer a stretch.
The iPhone line will eventually consist of a range of screen sizes each having their own strengths and weaknesses. For a 4-inch iPhone, single-handed use and mobility will be the marquee features. The iPhone 5 ad narrated by Jeff Daniels concerning a 4-inch screen appearing to be perfectly sized for thumb use may still have relevancy in today's market. Meanwhile, at the other end, Apple could play up the 5.5-inch screen iPhone as being a different kind of productivity device where the additional screen real estate comes in handy. As shown in Exhibit 5, there will likely be dedicated segments of the iPhone user base that prefer different sized screens.
Exhibit 5: Future iPhone Mix by Screen Size
While the iPhone nomenclature will likely change in the coming years, the idea of Apple selling at least three different iPhone screen sizes will continue. We will get a pretty good look at this future when Apple unveils a new 4-inch iPhone.
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Additional commentary and analysis on defining and estimating the iPhone installed base and iPhone user base is available for Above Avalon members here.