Apple's iPhone 3G: who needs carrier subsidies?

[This post also appears on the Yankee Group Blog at http://blogs.yankeegroup.com] With Apple's iPhone launching on July 11 for $199 in the US with a 2-year AT&T contract, everyone (including me) is assuming that there's a roughly $200 AT&T subsidy baked into that price. That assumption seems especially reasonable since AT&T is raising its unlimited data service subscription price by $10 per month and will no longer share subscription revenue with Apple. Those two factors means that AT&T is accruing about $480 more ($240 from the higher data service price and $240 from not sharing subscription revenue with Apple) per 3G subscriber over the two-year contract, leaving them plenty of room to pay Apple roughly $399 up front for 3G iPhones and still sell them to consumers for $199. But there's an intriguing twist to this story that may surprise people. According to Porteligent and as reported by EETimes, the parts cost of the 3G iPhone may be as low as $100. That means that even at $199, Apple's price includes a roughly 50% gross margin over its parts cost, which is in the ballpark of the gross margins on traditional iPods. If AT&T is adding in a $200 subsidy, then the iPhone 3G is anything but a a phone requiring a carrier subsidy. In fact, if these numbers are true and the carriers are subsidizing the phone, the iPhone 3G could end up being the most profitable product Apple makes. But more likely, this means that Apple has a lot more pricing flexibility than analysts have given them credit for. Now as one of those analysts, I have to apply a caveat here. It's highly unlikely that Portelligent actually has an iPhone 3G to tear down, so their parts cost analysis is probably just an educated guess informed by current cost data from parts suppliers. But that said, Apple has a history of aggressively buying parts to achieve a market advantage. For example, Apple paid $1.25 billion in 2005 to guarantee flash memory for iPods through 2008; that purchase made it nearly impossible for other flash music players to have competitive supplies and profit margins. Apple reportedly negotiated another similar deal in 2007. In my opinion, the Portelligent's cost is probably closer to right than wrong, simply because Apple never sells loss-leader products. And given Apple's intent to sell this phone in more than 70 countries this year, it undoubtedly worked hard to ensure low parts costs regardless of significant currency fluctuations too. So what's the takeaway here? It's simple: Apple's 3G phone isn't a loss-leader product needing subsidies to survivie. It's designed to be an Anywhere phone that puts your online life, media, and connections in your pocket, yet be simple enough for your grandma to use. But for Apple, it's a business platform designed to make money -- and the details of that business design may surprise more analysts than the product itself.