Why Apple may be losing its edge

The iPhone 5. / Apple

(MoneyWatch) Apple (AAPL) has become the company that the world expects, in a twist on the Energizer battery slogan, to keep on growing and growing and growing. With an assembly line of hit products churning out massive earnings, what could go wrong? Gross margins on the iPhone, that's what, according to Pacific Crest analyst Andy Hargreaves, reports tech blog AllThingsD.

If Hargreaves is right, there's a serious downward trend in iPhone gross margins -- that's the money left over from the sale of a device after you deduct the costs of making the phone. The problem for Apple is that the iPhone, for a number of reasons, has been the company's profit gravy train. None of the company's product lines come close to generating iPhone-sized margins. If that pattern continues, then even if sales of Apple products remain strong the company couldn't maintain the levels of profit that make it beloved by investors.

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The iPhone became a profit powerhouse because Apple was able to harness innovative design, consumer desire, wickedly smart negotiations, and AT&T's (T) insight that the device could become a major way to gain customers. Carriers in the U.S. had always subsidized consumer phone sales to some degree. Instead of paying the real cost for a device up front, a person would pay only a portion, with the carrier footing the rest of the cost and building that amount, over time, into usage fees.

AT&T agreed to pay Apple a significant bonus to sell the iPhone. The amount Apple collected per device -- the average sales price (ASP) per unit -- was north of $650. As the iPhone became more coveted and Apple moved into other countries, it struck similar deals. Whether it got the same amount as AT&T paid isn't clear, but there was always a premium on iPhones.

Over time, as happens with all consumer electronics, the iPhone has become cheaper to make, producing an ever fatter gross margin for Apple. It because a self-reinforcing profit making machine. But Hargreaves says the gross margin dollars per iPhone unit probably peaked in the second quarter of this year and is now declining.

It's difficult to know for sure whether his numbers are correct. Apple doesn't report gross margin per product line. However, if Hargreaves is right, then one of Apple's big advantages -- the cash it can keep pulling in -- could see some slowdown.

The question is why. Although he points to a higher than expected costs of making the iPhone 5, is it reasonable that the per unit amount would continue to drop after the new product hit the market? Perhaps carriers, a number of which had been complaining about subsidizing Apple's profits at the price of their own, finally said enough.

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The iPhone 5 topped the Android this last month even the the Android phone is sold in more places.

There was more online shopping generated from an iOS device (phone or tablet) than any of its competitors by a wide margin.

Are there problems? Sure. Apple is a company. The recent shake ups have given me hope that Apple still "gets it".

[TheCorrector55]

The main problem for the network providers is that they have to pay Apple hefty subsidies upfront and cannot make any money for nearly 2 years. As the now average contract is 24 months, the network providers as losing for most of that period. AT&T are paying around $15billion to Apple in advance which is killing their cash flow and it is the same with every other network provider. This is also the reason why China Mobile has not signed a deal with Apple.

Now you could argue that as most iphone users access the internet from their phones, the network providers can make money from data charges, however, if you look closely, you will see that contract deals are offering higher data usage rates in their contracts for lower costs to stay ahead of the competition, so their income becomes reduced and the costs they pay up front to Apple become much less affordable.

This is less of a problem in the US, UK and Europe, although is does have an impact, but where it will really hammer Apple is in the emerging countries. Most of their populations are unable to afford high monthly contract charges and the network providers in these countries, in general, have less income per customer to play with, therefore, they are very unlikely to go with a phone manufacturer where they have to pay a huge subsidy.

This is why their margins on the iphone will fall because to continue selling the large quantities of products they have been, they will simply have to reduce them. Their margins are totally unrealistic anyway and the iphone 5 has shown that they are no longer the innovators that they were, so as more and more people begin to question the high price they have to pay for what is, at the end of the day, nothing special, so they will lose sales. It wont happen overnight, but the tide is already turning.