My two and a half year old Blackberry Curve that I’d subjected to a hard life finally died a few weeks back when it’s USB connector came loose and won’t charge. While I waited for my new phone that I bought off of EBay to arrive, I’ve discovered that hoarding old electronics some times pays offs since I can use my old 8700c as a battery charger. The process of buying a new phone got me wondering why unsubsidized phones cost so much.

I can buy a 8GB iPod Touch retail for $199 which has every component that’s need to build a smart phone minus the cellular radio and mic. Seeing as how a basic cell can bought in the third world for less than $40, these components can not be that expensive.  Apple has some of the highest margins in the electronics industry. The latest teardown I can find for the iTouch is for the 8GB touch introduced in in 2007. iSuppli put the cost at $155.04 and at introduction that 8GB iPod touch retailed for $299 which puts the gross margin at 48.1%. In an accounting sense, the gross margin is probably slightly lower to transport and distribution costs which will appear under Cost of Goods Sold on the income statement. But as benchmark for makes a for a very profitable electronics business, materials cost at 48% of retail is a good one.

The 48% hardware margin is steady for Apple as the 16GB wifi iPad has a teardown cost $259.60 according to iSuppi which at $499 retail puts the gross hardware margin at 48.1% By comparison, Nokia which sells many more feature phones rather smart phones had a gross margin of 34.3% in 2008. This is company wide and is probably boosted by non-phones but as a rough benchmark it’s not a bad place to start. Apple is also making money from iTunes store sales so and iPad and iTouch are even more profitable but nonetheless, but 48.1% hardware margins is still indicative of a very profitable business.

The question that puzzles me is why new entrants to the smart phone market do not sell unlocked phones cheaper. The Palm Pre costs $138 to build which at Apple margins would put the retail price at $265.9 but off contract the Palm Pre was $549 at introduction. A similar story for Google Nexus One which has a tear down cost of $174.15 which at Apple margins would have a retail price of $335.55 but instead is sold by Google for $529 unlocked.

I have no doubt the off contract pricing is set by the agreements the device manufactures have with handset manufactures. However, I have to wonder to the wisdom about late entrants (or in the case of Palm, re-entrants) following the established practice of very high unlocked contract pricing. Palm only sold 400,000
for it’s Dec-Feb quarter and Nexus One sales are even worse.

I find Google’s decision to stick to the standard distribution model even more puzzling as Google has a history of upending the pricing and margins of the business it enters. Gmail’s 1GB of storage ended Yahoo Mail’s practice of charging for storage space over 4GB and forced the the whole free email industry to go to essentially unlimited free email storage. Google Map’s free API undermined the pay for access model that incumbent providers like MapQuest had built sizable revenue streams off of. Perhaps since Google’s number one goal to sell as many Android units through multiple handset manufactures as possible to establish Android as major mobile platform, it makes sense not to poke the cell phone carriers in the eye. Palm had no such motivation. Granted Palm probably got great terms on it’s exclusive Spint deal but those terms didn’t stop the meltdown Palm experienced which only ended with their sale to HP.

If I had been able to buy an unlocked Nexus One cheaper, perhaps I would have done that rather than a Blackberry from EBay. I was not in the mood to take a new cell contract so I was in the minority of shoppers who didn’t want to trade low upfront pricing for a 2 year commitment. But perhaps there are more people in this situation than meets the eye. Anyone who loses or breaks their phone early in their contract is in the same situation.  There’s really no good alternatives today for those who don’t want or are already in a contract since all smart phones follow the huge premium for an unlocked phone other than buying a used phone from EBay.