The big news this week (ahead of Apple's iPad 2 announcement on Wednesday) is that Apple Chief Operating Officer Tim Cook has admitted that the company is working on developing "lower-priced offerings" for the iPhone because the company doesn't want its products to be "just for the rich." Cook didn't go into detail but at this point we can at least come up with an educated guess about what a cheaper iPhone might look like.
Apple is known for having some of the larger profit margins on a per-device basis of any electronics manufacturer. While the company might be willing to accept a slightly lower margin on a cheaper iPhone with much broader mass market appeal in exchange for higher sales volume (it must now compete with China Unicom's own cheaper Wophone platform, after all), Apple won't be willing to go as far as its competitors. How then will Apple keep quality up, costs down, and prices low at the register?
The bulk of the manufacturing cost of the iPhone 4 (and any iPhone) comes from two things: the device's memory (flash storage and RAM) and the device's display/touchscreen. ISuppli's estimates of the Verizon iPhone 4's bill-of-materials puts the memory cost at a total of $40.40, with the screen at $37.80. These are the areas where cutting costs would provide the biggest payoffs in terms of maintaining a healthy margin for Apple.
Save by Expanding Component Hedging
With regard to memory, Apple can save a number of ways. First, it can continue to expand its NAND flash module component hedging program, buying in bulk to keep prices low. If it could add a device to its lineup that would be available to consumers at an unsubsidized price point (or an affordable prepaid price), it could plan for far more additional device sales and maintain the effectiveness of its hedging efforts.
Apple can also save on costs simply by not advancing performance and hardware specs at the aggressive pace that it currently does with the iPhone. Device RAM can be modest, especially if Apple's software engineers can figure out better ways to coax smooth performance out of fewer available system resources, something they've proven they can do with such technologies as Apple's selective iOS multitasking and Mac OS X Snow Leopard, which in many ways does more with less than its predecessor did.
As for onboard storage, Apple is already making great strides with all-streaming devices, thanks to the latest generation Apple TV. Kevin has speculated that a cloud-based iPhone makes sense, partly because of cost. I don't think we'll see Apple go cloud-only with a cheap iPhone, however, if only because it would end up alienating the very customers it intends to appeal to: People who don't want too pay much for their device don't wish to pay tons each month for data plans.
Easily Accessible Cloud "Locker?"
Instead, I think we'll see Apple offer a device with limited onboard storage (between 4 and 8 GB). It'll have space for a few apps and photos and a modest iTunes library. Apple could alleviate space concerns by reworking iTunes and iOS to make it easier to get apps, media, and photos on and off iOS devices, perhaps by making an easily accessible cloud "locker" for this content available to all iPhone owners through a revamped MobileMe.The company has already taken a few steps in that direction by allowing home screen management in iTunes, and by introducing "install" buttons to previously purchased items in the iPad App Store. Users may still end up feeling that they want more space (as I do with my 16 GB iPad), but if Apple does this right, this will come as an upgrade incentive, not an annoyance.
The iPhone 4's fancy retina display is costly and could get even more so if it goes to 4 inches in size, as Kevin believes it could. But Apple has even more room to play here than it does in the memory area. Screens on its older iPhone 3GS and 3G devices by no means look bad, so something as simple as sacrificing true retina display resolution could result in significant cost savings.
If Apple wants to stick with the high-res screen, it could shave the size to make up costs. The new iPod nano's screen costs only $11.40 to make, so it's clear that sizing down definitely saves money.If Apple is hedging Samsung display components as has recently been reported, display-part prices could fall farther over the next few years.
Save by Eliminating Some Sensors?
There are a slew of areas in which Apple could make small savings in parts costs. Chief among these is probably in the array of sensors to be found in the current iPhone. Apple could easily drop the compass and gyroscope from the device without even prompting so much as raised eyebrows from the majority of consumers. It could possibly even drop the rear-facing camera altogether, playing up the fact that the cheaper device remains camera-equipped and FaceTime-compatible.
Remember, Apple isn't starting from scratch in designing a cheaper device. The iPod touch, despite sharing many components (especially the expensive ones) with the iPhone 4, sells for a lot less and offers most of the same functionality. The iPhone 3GS is available at a subsidized price of $49 as it nears its end-of-life. It's difficult to compare the costs of the iPod touch and iPhone because they chart such different paths in the market; price drops on previous-generation hardware often require accepting a lower margin on products for which existing supply must be liquidated. Still, it's worth considering that Apple isn't looking to jump directly from high-priced, boutique offerings directly into the bargain basement.
Also from GigaOM:
What a T-Mobile iPhone Would Mean (subscription required)