Posted by Greg Mills

Rumors of a second, smaller, cheaper iPhone have been making the rounds for a while now. There are some rumors the cheaper iPhone might be the older 3Gs. There are compelling reasons for Apple to add another cheaper model of the hot selling iPhone to their product line. Those reasons are market share and Android specifically. See:$350-iphone-report-says/

There are top end smartphones, like iPhone where the customer pays a portion of the cost of the phone and the carrier pays the remainder. There are the freebie phones with a two year contract. Then the third option is the prepay market, you buy the phone outright and just pay for service, in advance.

My wife has an AT&T prepay deal where she buys a $100 card each year and loads a cheapo cell phone for emergency use. She has a cell phone for what works out to be about $10 a month. There isn’t much money in that for the carriers. Will Apple offer a cheaper iPhone for the prepay market? See:

The cell phone industry really cut its teeth on the free dumb phones you could get with a two year post pay contract. For the networks to be able to do that, there has to be a wholesale price point of between $250 and $350. If you figure $10 to $15 a month goes to pay for the “free” phone you got, the monthly bill is still competitive with other carriers. This is the money maker for the industry. People who use their cell phones a lot normally are willing to pay for an upgraded smartphone and a relatively higher monthly bill.

At $650, the top of the line iPhone is just too much for the carriers to absorb with a free phone with a two year contract program. The market need to offer a freebie iPhone is however, in direct opposition to another market force. The profit margin on iPhone is, by industry standards, incredible. It has been stated by analysts that Apple sells 1/4 of the world’s smartphones but pockets 1/2 the net profit. If Apple feeds the freebie iPhone market with even an older iPhone, the over all margins are not likely to stand up. It still cost a lot to build even an older version of iPhone.

The freebie for a two year contract is the opening in the market where a lot of Android phones live. If you consider Android as a lower cost substitute for iPhone that people buy when they really want the iPhone but won’t or can’t pony up the $300 premium, can Apple ignore that market forever?

The long term income from every iPhone sold is based upon first the hardware transaction and then the sale of apps, music and other digital download stuff Apple sells. More iPhones, more iTunes and App Store sales, where Apple pockets 30%. Can Apple have it both ways? If the patent suits can derail the Android run away train, Apple can ignore the freebie market. If Android can’t be stopped in court, the market is the only way to compete with cheaper smartphones.

AT&T (no bars in more places) has begun to sell the iPhone 3Gs for $50 with a two year contract. While Apple might be able to produce that older model cheaper than when it was first launched, it still won’t have the margin the top of the line iPhones have. To some extent, the cheaper iPhone marketing plan may be underway with AT&T in the US.

Will Apple be able to come up with an iPhone that is really up to date and also cheap enough to give away? That remains to be seen. If Android was always sold at a price point near iPhone, the market share pie chart would look far different. The Android handset makers are paying royalties to Microsoft and others, while facing net profits half what Apple pockets. Add the cost of being sued into the ground by Apple and the calculous isn’t as rosy as one might imagine.

Rumors are that Microsoft is pocketing more in patent royalties from the Android handset makers than they are making licensing their Mobile OS. That isn’t hard to imagine when they had to pay a billion dollars to Nokia to bribe them into going with Microsoft instead of Android.

The Android handset makers are trying to buy patents and figure out a work around for the Apple technology that was found to have been infringed. HTC’s CEO did an interview with the BBC that I found interesting. See:

All of the above information is certainly swirling around the management at Apple. Can Apple build and sell a cheaper iPhone? Will Apple sell a cheaper iPhone? That is a question no one knows the answer to but Apple.