iPhone margins and what they mean

Some analysts have got out there and calculated the margin Apple will likely make on the iPhone. For instance, the 4GB version retailing at $499 (I’ll use US$) will likely cost $245.83 to make. (Here is a break-down just in case you are interested). The margin is about 50 percent. The analysts concluded that Apple would drop its retail price further in the face of competition. Closer inspection suggests that this conclusion is wrong.

A margin is one thing but the incentive to drop price is governed by more. This cost estimate also tells us something about Apple’s belief regarding the elasticity of demand for the iPhone. Ignoring for the moment that it is sold with a call plan (I’ll assume that is at reasonable cost), if it is profit maximising, Apple will set its retail price (P) so that (P – c)/P = -1/E where c is unit cost and E is the price elasticity of demand. So the figures today imply that E = -1.97. What that means is that if Apple raised its price by 1 percent it would to lose almost 2 percent in sales. That seems plausible.
Now Apple also stated that they were targeting about 1 percent of the US market. If the iPhone was the same as other phones then the relevant equation for the market elasticity of demand for phones is:

(P – c)/P = -0.01/E

This translates to an elasticity of only -0.019. This is not a figure I would believe. So this means that Apple is pricing to target a much larger market share (its price is already low) and beyond simply competing for luxury phones. So the analysts would seem to be wrong here and this price is likely to be sustainable under competition. Indeed, it may be set to chill that competition.