Could Cheaper iPhones Improve Apple Inc. (AAPL)’s Profit Margins?

Though it’s cloaked in complex analyst lingo, Morgan Stanley (NYSE:MS) analyst Katy Huberty has uncovered a simple way Apple Inc. (NASDAQ:AAPL) might be able to preserve its coveted profit margins after all: “Based on a 100M C2H13 unit build (vs. our current 77M) with 50% mix of a new low-priced iPhone at a $399 starting price point, we see 6% gross profit dollar and 10bps gross profit margin upside to our C2H13 model.”

Translation: Cheaper iPhones may slightly boost profit margins while increasing absolute gross profit substantially.

The argument
Apple Inc. (NASDAQ:AAPL)’s definitely facing a gross profit margin problem. Investors are right to be concerned; gross profit margins are down a whopping 1,000 basis points from the year-ago quarter. But if Huberty is correct, the downward trend could soon be ending. Better yet, it could improve.

How? Even if Apple’s gross profit margin on a cheaper iPhone is less than the gross profit margin on its full-priced iPhone, it will still likely have a much higher gross profit margin than Apple’s other product lines. Lower-priced phones, of course, will increase sales — especially in emerging markets like China, where more affordable options are making significant inroads. The result? Greater sales in Apple’s highest-margin business.

Specifically, Huberty predicts that a $399 iPhone without a carrier subsidy would increase iPhone units sold by 30% for the second half of 2013, compared to her model that doesn’t include a low-cost iPhone. Total revenue, therefore, would be 5% higher and total gross profit would increase 6%. Overall margins? They would see a paltry 0.1% bump — but an increase nevertheless.

Another alternative
A report from Bloomberg that surfaced yesterday reveals yet another way Apple Inc. (NASDAQ:AAPL) may advance in the Android-dominated emerging markets: An Apple endorsed trade-in program, in which customers can trade in their old iPhones at Apple stores to get credit toward purchasing a new one.

With a web-based recycling program already in place, trade-ins definitely aren’t a new Apple phenomenon. In addition, companies like Amazon.com, Inc. (NASDAQ:AMZN), Gazelle, and Brightstar eagerly pay large sums for used Apple Inc. (NASDAQ:AAPL) products. But with trade-ins soon to be encouraged at Apple’s own retail stores (if Bloomberg’s sources are accurate), the company is now taking on this option as a primary strategy.