Analysis – Calling the iPhone a cellphone isn’t fair. We here at TG Daily actually believe that it is the prototype of Intel’s mobile Internet device (MID) category that happens to be about 3 years ahead of its time. And, if you think about it, pricing this MID at $199 means that the iPhone 3G is a real bargain – in any way you look at it. In fact, it is such a bargain that some were wondering how Apple could make money on this device. But look a bit closer and you notice strategic tweaks that are likely to turn the iPhone into a gold mine for Apple, much more than it was the case with the first-gen iPhone. Here’s why.

It is an obvious thought that Apple is cutting into its profit margin by reducing the price for the iPhone by 50%. Considering the fact that Apple's profit margin on the first $400 iPhone was somewhere between 30% - 50% (which, by the way, is the usual profit margin for most Apple products), the reduced price of the new handset, which arrives in combination with upgraded features (3G, GPS), could mean that Apple is making dramatically less money on the $200 iPhone 3G, even if the production cost of the device went down (Apple typically finds ways to reduce the production cost in successive product designs).
 
But then, we know that Apple isn’t in the money-losing business. As it turns out, Apple is likely to make quite a bit of make money on the 3G device, probably more than with the first-gen device (AT&T makes more money as well.)  

In short, it all comes down to the fact that the 50% price cut is designed simply to get you through the door. Once you are in the store and you have fallen in love with the iPhone, you will have to commit to a two-year contract with AT&T (realistically, you are likely to stay much longer with AT&T, at least if you don’t jailbreak your iPhone.) By the time the contract expires you will have paid a $240 premium (compared to the first-gen data plan) for services due to the fact that AT&T has put a $10 per month premium on its unlimited data plan - justified through the 3G network upgrade. This data plan price increase isn't iPhone-specific, most carriers now charge $30 a month for unlimited 3G data access for PDAs and mobile phones in the U.S.

It is generally assumed that the iPhone price remains at $399 (as mentioned by TG Daily before), with AT&T covering a $200 subsidy (AT&T told its investors that this subsidy will actually mean that it will take a hit on its profit margin initially). Count in potential production and cost efficiency gains and you have a device that delivers higher margins than the first-gen device. The estimated bill of materials for the iPhone 3G is $100. If that is true, there could be a profit margin even Apple should be celebrating.


AT&T: Between $240 and $360 premium in services revenue

Since AT&T does not share service revenue with Apple anymore, the carrier takes in an estimated additional $240 over the time frame of the two-year contract. It also collects $240 more as a result of the $10 premium for the unlimited 3G data plan (we assume at this point that every iPhone buyer will subscribe to a data plan.) So, the $240 over two-years for not sharing revenue with Apple plus $240 more for $10 a month premium over data service adds up to a remarkable $480 premium (minus the $200 Apple has to come up with for each iPhone 3G) over what AT&T was making with the first iPhone and its entry-level $60 service plan over the two-year contract.

So, even if AT&T pays Apple $400 upfront, the company collects $199 (+$36 activation) from buyers and subsidizes the remaining $200 – which means that AT&T still ends up with a $240 premium after the two-year contract expires, plus a portion left over from the fact that it is not sharing its service revenue anymore. If you are picky, then you could claim that fronting Apple $200 and cutting into the profit margin carries extra cost (interest!), but we have a good feeling that this cost is covered by the service premium and the additional service revenue.  So, we don’t feel sorry for AT&T.

These numbers, by the way, assume that a customer signs up for a basic voice and data plan. If a customer wants 200 text messages (previously included in the entry-level $60 plan for the first iPhone), he has to upgrade to a service that is priced at an additional $5 per month, adding an additional $120 over the two-year period, raising AT&T's service premium to at least $360 when the contract expires. You might argue that text messaging should be part of an unlimited data plan, especially when the complete package is priced at $70 per month (and could cost close to $100 per month in some areas, if taxes are included.) In that view, the $5 price increase is actually sneaky AT&T’s part, but you always can use the iPhone’s email service instead.

Of course, the $200 subsidy is not officially confirmed. But even if we assume that $200 is what Apple charges AT&T for each iPhone 3G, a recent EETimes report suggests that even at $199, Apple's price includes about 50% gross margin over its parts cost, putting the handset in line with traditional iPods.

Read on the next page: iPhone tear-down, Apple's most profitable product ever