Innovation is Alive and Well at Apple

in Stock Analysis

Can Apple still come up with breakthrough innovations? In September Apple introduced an iPhone with 3-D touch, Apple TV that has been turned into a gaming device and a larger iPad with a stylus that will take the tech giant into new niches. These products looked awesome, but they were just improvements. There was nothing groundbreaking about them. Apple’s breakthrough innovation was financial — its new iPhone Upgrade Program, which is ingenious on many levels.

Let’s briefly summarize that program. If you were to buy an iPhone 6s with 16 gigabytes of memory outright online or at an Apple store, it would cost you $649. The Apple Upgrade Program will provide you free financing on this phone for two years for $32.41 a month. However, the sum of these payments will add up to $778, because it includes AppleCare+, which is mandatory. AppleCare+ is a fancy name for an extended warranty service that really adds three things: It extends your technical support beyond 90 days to two years; it increases the phone warranty from one year to two; and Apple will replace your phone (for a small fee) if you drown it in the toilet or drive over it — the usual stuff we do to our beloved iPhones from time to time.

But here is the kicker. In 12 months, when Apple comes out with another iPhone (and believe me, they will), you will be able to hand your now “old” (one year, that is) phone back to Apple and get a brand-new one. That will automatically extend your upgrade contract by 24 months, giving you the option to get another iPhone in 12 months, and the cycle will continue. This is a plan that would make even the financial engineers at Goldman Sachs proud.

Here’s why: The program turns Apple into an iPaaS (iPhone as a Service) company. For $32.41 a month your constitutional right to pursue happiness through ownership of each new iPhone will finally be fulfilled. Consumers are encouraged to upgrade their phone every year instead of every two to three years, singlehandedly pushing up iPhone sales in the U.S. much higher.

These higher sales will also come with much higher margins. In the current near-zero interest rate environment, financing will cost Apple, let’s say, around 4 percent, or $26 a year (on a $650 phone). Incidentally, Apple raised the price of AppleCare+ by $30, from $99 to $129 a year. This should more than cover the cost of financing for the first year, and if you keep upgrading your phone, you’ll keep buying AppleCare+.

It gets better. When a customer buys an iPhone through Apple Upgrade, AppleCare+’s so-called attachment rate to that iPhone sale is 100 percent. Apple will not sell you an iPhone without AppleCare+. For iPhones sold by AT&T or even at an Apple store, the AppleCare+ attachment rate is much lower (Apple doesn’t disclose the number). There is certainly value in AppleCare+, but just as with any warranty, its margins are sky-high.

Continue reading at Institutional Investor…