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Apple needs you to upgrade your phone (pretty please): Gadfly editorial

Apple is about to take the covers off a new (sorta) kind of iPhone. It's a still unexplained bit of sorcery that could only come from a company staring at its first ever down year for iPhone sales.

[NEW YORK] Apple is about to take the covers off a new (sorta) kind of iPhone. It's a still unexplained bit of sorcery that could only come from a company staring at its first ever down year for iPhone sales. 

Breaking from its typical September smartphone launch window, Apple is holding an event on Monday to show what is expected to be a new iPhone that flashes way, way back - to 2013. This new model, perhaps called the iPhone SE, is likely to have the same basic dimensions as Apple's two-and-half-year-old iPhone 5S, but with updated computer chips and features to make the throwback feel fresh.

The big question is why this iPhone Throwback needs to exist at all. The new device essentially slides in as a replacement for the 5S, which Apple continues to sell for a base price of US$450 - or US$200 less than the latest iPhone 6S. The iPhone Throwback may even have the same price as the 5S.

It's not likely to pad iPhone sales by much. UBS expects the tweener phone could add about 12 million incremental iPhone units to Apple's total this year. That's roughly 5 per cent of total expected iPhone sales for the fiscal year ending in September.

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But the new/old phone does expose Apple's soft underbelly: Too many iPhone owners haven't been swayed by the latest and greatest (and most expensive) models and have stuck with their old devices. Apple is smart to try every trick it can to budge the Un-Upgradeables, who have blown a hole in the company's revenue this year.

About 18 months after the introduction of the larger-screen iPhone 6 line and its successors, about 40 per cent of existing iPhone owners have bought one of the newer models. That's an underwhelming share for what was the most momentous and anticipated change to the iPhone ever.  The Un-Upgradeables aren't only in economically troubled countries, either. In the US, at least 55 per cent of iPhones are models that are least two and half years old, according to January estimates from research firm Kantar Worldpanel. 

UBS analyst Steven Milunovich recently conceded he was too optimistic in forecasting that 70 per cent of existing iPhone owners would trade up to the 6 or 6S line by the end of Apple's fiscal year. The upgrade canyon has a huge impact on Apple, which sells the majority of new iPhones to people who already have one.

Share of existing iPhone owners who stuck with 2013 or earlier models is 60 per cent, and luring the Un-Upgradeables is critical to Apple for three reasons.

One, the newest models have higher average price tags, helping Apple gobble roughly 90 per cent of the profits in the smartphone hardware world even with just 15 per cent market share.

Two, spurring people to trade in their used - but not ancient- iPhones gives Apple a stockpile of devices it can resell at manageable prices in places like India, where more than a billion people are just starting to catch the smartphone wave. 

Third, and most critically, selling new iPhones is essential to Apple's effort to change the company's complexion. More people with shiny new iPhones mean more happy Apple loyalists who give the company more chances to squeeze money from them in the form of more app downloads, Apple Music subscriptions and payments to store photos and files on iCloud.

Apple CEO Tim Cook has emphasized how important Apple's US$20 billion-a-year "services" business is to the company's future. The strategy hinges on Apple making sure the iPhones its customers carry are as new and awesome as possible. If it can't persuade people to buy a brand new US$650 iPhone 6S, maybe it can interest them - yes, you, the guy with the iPhone 4 held together with duct tape - to pony up US$450 for a new iPhone SE.

The big worry for Apple is that people are resisting upgrades not because of money troubles or preference for a phone that is smaller than a slice of toast but because each year the new and improved smartphones aren't that much of an improvement.

What if we've switched into a period when people hold on to their phones for longer? AT&T executives have said they noticed this phenomenon. Longer replacement cycles crushed companies that made personal computers, and more recently Apple has acknowledged iPad owners are sticking with older versions for longer than the company expected. In part because of this trend, iPad sales have fallen for eight consecutive quarters.

The end of carrier smartphone subsidies in many countries has also exposed that the true price of a new iPhone isn't US$200 but US$650 or more. AT&T has said more than two-thirds of its smartphone subscribers now are on contracts that make them pay full freight for a new phone.  So Apple is wisely experimenting with a hybrid iPhone that has many of the hallmarks of a new edition, but without the painful price tag.

The iPhone SE maybe stands for "special edition?" It's time for Apple to change its increasingly untenable naming conventions for the iPhone. Please, please, please. The same rationale is behind Apple's iPhone financing and trade-in programs, which let people spread out the payments for an upgraded phone.

Jan Dawson, chief analyst at industry research firm Jackdaw Research, said the iPhone SE also helps prop up iPhone sales between now and when the next iPhone model (presumably iPhone 7) will be introduced in September. A smaller screen iPhone also has the added benefit of lower component costs, and therefore higher margins for Apple.

This column does not necessarily reflect the opinnion of Bloomberg LP and its owners.