The iPhone is at a crossroads. It's been four years since Apple first released its super-duper-wonderphone, and you don't have to be a fanboy to appreciate how thoroughly this single gadget has upended the tech industry. The iPhone wasn't the first smartphone, it wasn't the first touchscreen device, and it wasn't the first app-enabled mobile computer (indeed, the first iPhone didn't run apps). Still, the iPhone was something novel—a smart, intuitive, beautifully designed, futuristic-seeming gizmo that was immediately lapped up by consumers and wholly copied by rivals. For Apple, the iPhone has been a godsend. In 2010, the company reported $25 billion in revenue from the iPhone alone—that was about 40 percent of its total annual revenue—and the phone's growth shows no signs of slowing.
The trouble is, Apple's main rival, Android, also looks unstoppable. Andy Rubin, who heads up Google's phone division, just reported on Twitter that there are 500,000 "activations" of new Android devices every day around the world, and the number is growing by 4 percent per week. Some of these devices are tablet computers—where Android still lags far, far behind Apple's iPad—but the vast majority are phones, a sector where Android's share of sales far surpasses Apple's. According to the research firm IDC, Android's worldwide share of the smartphone market is about 40 percent, compared to around 16 percent for Apple's iOS. In the United States, Android has nearly 50 percent of the smartphone market, while Apple has 29.5 percent. (Android's share stateside declined by a couple points over the last year, mainly due to the introduction of the iPhone on Verizon.)
What's fueling Android's growth? Sure, it's a terrific operating system, and over the last year it's gotten lots of new apps, too. But in all sorts of ways, Android phones can't match the polish and power of the iPhone. The main reason that Android is capturing a bigger slice of the phone market is price. Every major American mobile carrier now offers at least a few Android phones for free with a contract. The iPhone 4, by comparison, sells for $199 with a contract (you can also get the 2009-era iPhone 3GS for $50 with a contract). Apple's prices look even steeper if you consider the market for "unlocked phones"—that is, phones that sell for full price, without a contract. A new, unlocked iPhone 4 will set you back $649. There are dozens of unlocked Android phones that sell for less than $200.
The numbers seem to mark a clear path for Apple: It needs to make a cheaper iPhone. And it needs to do it now.
But how? What would a cheaper iPhone look like, what would it do, and how would Apple make sure that such a device doesn't eat into its revenues? Tech pundits have been predicting the release of a low-priced iPhone for many years—this week, Chris Whitmore of Deutsche Bank told investors to expect Apple to add a cheap iPhone to its lineup this year. Whitmore, like many others, predicts that Apple will sell the low-priced phone alongside the standard iPhone rather than replace the expensive model. This makes sense when you consider Apple's strategy with the iPod. The iPod Mini, which the company released in 2004, was a smaller, cheaper version of the original. It quickly became Apple's best-selling music player. (The Mini was replaced with the Nano in 2005.)
Of course, an iPhone Mini wouldn't be a very good device. Apple was able to shrink its music player because the screen wasn't a big part of its utility. The iPhone, though, is a visual gadget, and reducing its screen size would make for a terrible experience. Because its screen will have to be the same size as the expensive iPhone, and because the screen is what makes the iPhone the iPhone, a cheaper version won't look very different from the expensive one. Apple could certainly add a few design cues to differentiate the two—it could make the cheap one thinner, or it could give it a plastic skin—but the main differences are likely to be internal: The cheaper iPhone might have a slower processor, less RAM, and less onboard storage space. Some wags predict that Apple's next full-fledged iPhone—presumably called the iPhone 5—will be able to access faster 4G networks, so that could be a another point of differentiation. The "iPhone lite," as TechCrunch's MG Siegler has taken to calling the mythical cheap iPhone, might only run on 3G networks.
Apple's goal, with such a device, would be to sell it at a price of between $200 and $300 without a carrier contract—less than half the price of an unlocked, full-fledged iPhone. This is certainly doable: Apple sells the iPod Touch, which is essentially an iPhone without a cellular radio, for $229. Since the components for adding a radio cost only $16, a $200 unlocked iPhone isn't a pipe dream. And if Apple can reach that price, it will see huge sales. Horace Dedieu, the smartest Apple analyst on the Web, points out that the vast majority of cell phones across the world are sold without a contract. (The United States and Canada are unique in selling most with a plan; a cheaper, unlocked iPhone could push a lot of people to ditch their mobile contracts, which will anger the carriers—but I doubt Apple cares much about the carriers.) What's more, growth in the smartphone business will come via the hundreds of millions of people who are expected to switch from dumb phones to smartphones over the next few years. A cheap iPhone that sells without a contract will be irresistible to many of these customers—it could boost Apple's sales by several hundred percent.
But there's a danger in this model, too. Because the cheap iPhone would be visually and functionally similar to the expensive iPhone, you'd have to imagine that many (if not most) customers who would otherwise have purchased the expensive phone will choose to go with the cheaper one. Financially, this wouldn't be a disaster for Apple—you can bet that it would make healthy profits off the cheap iPhone. It would, however, represent a fundamental shift to Apple's business model. So far, the iPhone has been all about profit, even at the expense of market share.
The other potential danger is that the cheap phone could fuel consumer disappointment. Apple markets the iPhone as the best phone anywhere. But how would it market a cheaper model—one that looks nearly identical to the expensive phone but does a lot less? The company would need to walk the tightrope of proclaiming the cheapie phone's amazingness without creating the expectation that it would do as much as a pricier iPhone. Maybe the tag line could be, "iPhone Lite. Relax—it's slower!"
Given the risks of releasing a cheaper iPhone, would Apple be willing to turn its mobile strategy on its head? Its history suggests two opposing theories. On the one hand, there's the Mac, where Apple decided to forget about market share and stick with profits. That led Apple to "lose" the PC wars, but it was a pretty good loss—Apple now makes more money selling a single Mac than HP does from selling seven PCs. The other path is what Apple did with the iPod—it relentlessly lowered cost and diversified its line-up, making sure that there was a music player for every budget. That worked out fantastically as well: At its peak about five years ago, the iPod represented more than half of Apple's revenue.
After weighing those two possibilities, I'm betting that Apple goes downmarket. It's not just because the financial opportunity in releasing a cheap phone seems too good to pass up. As Dedieu points out, Steve Jobs seems to regard Apple's Mac strategy to have been an enormous blunder. In 2004, Jobs told Newsweek that at "the critical juncture in the late '80s, when they should have gone for market share, [Apple's management] went for profits." He added: "They made obscene profits for several years. And their products became mediocre. And then their monopoly ended with Windows 95. They behaved like a monopoly, and it came back to bite them, which always happens."
If Android is the new Windows, then the path for Apple is obvious: It can't afford to rest on its profits any longer. A cheap iPhone has got to be around the corner.