Crunching the numbers: What Apple's iPhone strategy should be

While reading AppleInsider today, I came across two stories about analyst opinions on the current state and future of the iPhone. And while both provide some valuable information about where Apple may stand in its contract with AT&T, they made me think -- what should Apple be doing to maximize profit and shareholder value?

And while my conclusion is based upon some complicated mathematical calculations, the result had nothing to do with bricking iPhones and everything to do with Apple maintaining its relationship with AT&T as well as iPhone unlockers. In fact, the result of my calculations may surprise you.

Source Data

According to an analyst at Piper Jaffray, Apple will lose some revenue sharing from AT&T as people continue to unlock iPhones. But according to the analyst, the amount lost will not have much of an impact on Apple's bottom line.

The analyst explained that the actual amount of revenue lost from iPhone unlocking is (at most) 10 percent. For the sake of my argument, I used this figure to make it as conservative as possible. Using that number, the analyst found that with an expected iPhone revenue of $7 million in this quarter, the company should expect a $700,000 loss in AT&T revenue sharing income.

Next, another AppleInsider story discusses what another Piper Jaffray analyst believes the actual revenue sharing deal with AT&T really is. According to the analyst, Apple may receive $3 per month per existing AT&T customer on all iPhone plans, or $11 per month per new AT&T customer on iPhone plans.

Following this logic, the analyst believes 52 percent of customers were new to AT&T in June and this number will continue to decline as the iPhone becomes more popular. According to Piper Jaffray, the amount of new customers expected in September should amount to 44 percent.

Finally, I set out to find just how much each iPhone may cost Apple. According to most sources, the iPhone probably costs Apple in the $250 range, which at this point, would suggest a $150 profit off of each iPhone sold. It should be noted that this profit should be expected to increase over time as the cost of manufacturing dwindles and iPhone costs stay the same. Further, this $250 figure was taken when there were two iPhones on the market. And with Apple's decision to drop the price of the 8GB version by $200, the cost is probably substantially lower than that $250 figure. Regardless, I tried to stay as conservative as possible in my estimate and used $250 as the cost of the iPhone.

Crunching the numbers

Based upon my calculations, it would actually behoove Apple to allow users to unlock iPhones. The reason is simple: the incremental gain in profit from the sale of unlocked iPhones is actually higher than the incremental loss in quarterly AT&T revenue as long as the company sells roughly 5,000 unlocked iPhones in the September 2007 quarter.

First off, unlocked iPhones represent a loss in expected quarterly AT&T income of 10 percent (at most). And while this may suggest that most people are not unlocking iPhones (which is true), it also suggests that Apple isn't losing too much money when people do. To a massive company with no debt in its capital structure, $700,000 is a cost of doing business.

Now, assuming there are iPhone unlocks that are readily available and easy to use, most people say that Apple can expect 2 percent of the population to buy iPhones and immediately unlock them. Assuming that logic and using the 1 million iPhones sold already (although many more probably have been sold), we should assume that 20,000 iPhones will be sold in this quarter with unlocking as the main goal. Multiply that number times the amount of profit Apple expects from each iPhone sale, and the company nets a profit of $3 million. Compare that to the amount of revenue lost from AT&T, and the company still realizes a profit of $2.3 million. Even further, if you assume all of the owners are not AT&T customers, Apple's lost AT&T revenue from the sale of these 20,000 iPhones is only $660,000 for the quarter, which still keeps Apple well into the black.

Of course, that calculation assumes extreme conservatism on my part. More than likely, the ability to unlock an iPhone would probably result in the sale of many more iPhones than just 20,000. In fact, I would venture to say that Apple can expect anywhere from 50,000 to 100,000 unit sales due to iPhone unlocking.

Along those lines, there is also a significant halo effect that should be factored in. As I've mentioned before, the iPhone is a gateway device that will lead people to purchase more Apple products. As iPhone sales rise (which unlocked devices would help to create), Apple can expect an increase in Mac sales as well. Unfortunately, there is no figure to show this growth, but rest assured it offsets any loss in AT&T revenue.

Interestingly enough, it was estimated that the number of new AT&T subscribers in June was just 52 percent. By now, that figure has probably dropped to 44 percent and we should expect it to continue to decline over time. As that becomes true, Apple's incremental gain in AT&T subscription revenue will also fall, although overall revenue will increase. Because of this, the incremental gain in unlocked iPhone sales will only become larger as per unit profit soars and AT&T incremental revenue falls. In other words, an unlocked iPhone should be at the central of Apple's plans.

Apple's Strategy

Based upon my findings, Apple stands to make a significant amount of profit by benefiting off of unlocked iPhones. And while many speculate that AT&T will stand in the way of this revenue gain, I think Apple should capitalize off of AT&T's drive for a locked down phone and let hackers do what they do best -- unlock the iPhone.

I'm sure Apple is well aware that an unlocked iPhone means greater revenue. Sure, the company will lose money due to AT&T defectors, but with such a small amount of people leaving, the impact on both AT&T and Apple's revenue is minuscule at best. But we must not forget that the amount of AT&T revenue loss is greater than Apple's (although it's the same proportion -- 10 percent at best) and the carrier has a vested interest in maintaining a locked down iPhone. But if that's what AT&T wants, Apple should give it to them.

Simply put, Apple should continue to make public attempts of stopping iPhone unlockers. Not only will this make AT&T happy, it'll discourage the majority of iPhone owners from leaving AT&T. After all, Apple wants AT&T subscribers and iPhone unlockers to maximize revenue -- not one or the other.

Each time Apple releases an iPhone update, it should make it simple enough for hackers to get the unlock back in place within a week. Once again, this solves two problems -- hold up its side of the contract with AT&T and keep unlocking revenue coming in.

I don't think there is any debating the fact that Apple and AT&T have struck a deal that maintains Apple's responsibility to do what it can to stop iPhone unlocking. Along those lines, I'm sure it doesn't say anything that Apple should go out and arrest every iPhone hacker in the world.

In essence, Apple should form a silent partnership with iPhone unlockers where once a firmware upgrade is released, the hackers will be able to get around it in due time. It makes sense -- how can any cell phone company expect to fully stop unlocking and AT&T has been in the business long enough to know that it should expect iPhone unlocking to some degree. That said, it doesn't want it to be endorsed by Apple or become the norm.

An unlocked iPhone can open a number of doors for Apple. It should realize that its partnership with AT&T is not only a revenue generator for the sharing agreement, but for iPhone unlocking as well. If the iPhone wasn't locked down, would we even be having this discussion?

As a public company, it is incumbent upon Apple to maximize profit and shareholder value. And if it continues to work alongside AT&T while secretly forming an understanding between itself and hackers, the company's incremental and total revenue will explode.

Sorry folks, but regardless of where you stand on this issue, business is business, and Apple should look out for itself -- no one else.