Apple's iPhone Elixir: Cut Prices

Updated from 6:09 a.m. EST

Apple(AAPL) CEO Steve Jobs will need to work some magic to hit his sales target of 10 million iPhones this year.

Since the iPhone's launch in June, Apple has sold about 4 million devices, including 2.3 million during the important holiday season.

To reach the 10 million mark, it needs to average 2.5 million phones in sales a quarter over the next four quarters -- or 200,000 more than what it sold during the big holiday season.

"The number is a challenge, but unless the global economy slows down profoundly, Apple will make it happen," says Ezra Gottheil, an analyst with Technology Business Research.

Apple May Look at a iPhone Price Cut

Some analysts say Apple will have to cut deals with more phone carriers outside the U.S., upgrade the iPhone and most importantly, drop the price in order to reach its ambitious sales target.

Apple's sales efforts have been stymied by a sour economy that could put these pricey $400 phones beyond the reach of some consumers. There's also the problem of some 1.7 million "missing" phones -- the difference between phones that were sold by Apple and those that were activated by AT&T(T), the telecom carrier with exclusive rights to the iPhone.

Activiation of the phones is crucial to Apple's bottom line because it gets a 10 percent of the cut in monthly fees charged by AT&T.

Apple investors are understandably worried about the situation, though iPhone sales represent a fraction of the company's revenue. Total revenue recognized during the quarter from sales of iPhones, iPhone accessories and payments from carriers was $241 million compared to $1.75 billion in overall revenue.

Apple's stock has fallen nearly 35% since it closed at a 52-week high of $199.83 less than a month ago. Apple shares closed up $1.53, or 1.2%, to $131.54 Tuesday.

Jobs unveiled the iPhone at the Macworld conference last January to much fanfare.

The sales target of 10 million iPhones generated much discussion. Asked later by an analyst during the company's first-quarter fiscal whether Jobs was referring to calendar year 2008 or fiscal 2008 (which for the company started October 2007), Apple COO Tim Cook replied, "Calendar year '08 is what Steve referenced in his keynote."

"The point that he made was that the worldwide market for total cell phones is somewhere around 1 billion and our objective of getting 1% of it would yield 10 million units across the calendar year," Cook told analysts on the call.

Apple stock soared nearly 132% last year, mostly on strong interest in the iPhone before pulling back to its current levels.

Many analysts then deemed as low the target of 10 million phones in 2008. They saw the phone as a "game-changer" with the potential to take away market share from rivals such as BlackBerry maker Research In Motion(RIMM) and Nokia(NOK).

But now, some company watchers fear a softening economy and limited carrier agreements for the iPhone could take its toll on consumer interest in the device.

That's where dropping the price of the iPhone could help. Gottheil believes Apple could shave $50 off the 8-GB iPhone's current price of $399 by the middle of the year. Apple saw a 20% to 25% improvement in sales when it cut the iPhone price by $200 in September.

"There is room in the iPhone margin to cut price now," he says.

A price cut is a possibility, agrees Mike Abramsky, an analyst with RBC Capital. But what's more likely to happen, he says, is that Apple will upgrade the software in the existing iPhone and offer new models, including the much-awaited 3G version of the phone.

"I think everything, including a price cut, is on the table but Apple is pleased with the performance of the product and maybe more inclined to add capabilities such as GPS or location-based services, and Bluetooth for the same value in the iPhone, as well as offer 3G," says Abramsky. RBC Capital makes a market in Apple shares.

Despite investor fears, Apple's iPhone sales have been solid, says Abramsky. iPhone sales in the quarter ended Dec. 30 were up 107% from the previous quarter, while the smart-phone industry is estimated to have grown at 13% to 15%.