Why the iPhone 6 is the most important product for Apple in years

The upcoming iPhone 6 is a huge product for Apple.  They need to knock it out of the park if they want to maintain their revenue growth and hold onto recent gains in the stock price.  There are a number of factors contributing to this: the overall health of the smartphone market, the slow-down of the tablet market, the rise of phablets, and more.  Let's get into some of the details.

The smartphone market is more lucrative than tablets or computers

In general, the smartphone market is performing much better than the tablet or PC market.  It is much larger (on a unit basis) than the other two put together and is still growing.  PC's have been flat or slightly declining for a few years, and tablet growth has slowed down enough in the last six months that some analysts think iPad sales will be flat in 2014.   I've already given my thoughts on why growth in the tablet market is stalling.  There's still a lot of room left for growth in the smartphone market too:  only 30% of the world's 5.2 billion mobile phone users have smartphones.

Smartphones also typically sell for higher prices than tablets and carry higher gross margins (selling price minus manufacturing costs), than tablets or computers, thus making them a more profitable product category.

Customers also tend to upgrade their smartphones more frequently than other gadgets.  This is especially true in the US where many people are on two-year contracts and phone prices are subsidized.

Smartphones are basically a dream market:  huge potential customer base, high prices, good margins, etc.  For companies that can sell mid to high-end smartphones in high volume the financial rewards are outstanding.

iPhones are Apple's most important product category - by far

If smartphones are Apple's most important market, then they only really have one chance per year to address that market with the new iPhone.  The smartphone market is more competitive than ever with lots of great choices from competing platforms.  Even with the astronomical rise of the iPad, iPhones have steadily grabbed a larger and larger portion of Apple's revenues (and profits we can safely assume too).

Note: these are Apple's fiscal years and 2014 includes only the first two quarters of the year.

Since the iPad was introduced in 2010, the iPhone's share of Apple's total revenue has steadily climbed and now sits at around 55%.  iPods have been a declining business for several years now, and Macs have been about flat in a very challenging PC market.  The iPad went through a period of rapid growth, but is now slowing down.  These are still profitable businesses, but the iPhone is outgrowing them significantly.  Trefis estimates iPhones account for a disproportionate 47% of Apple's stock price (22% is from cash).

A larger iPhone is needed to combat phablets

In leaked slides, Apple admitted that 'consumers want what we don't have': cheap phones and high-end phones with big screens.  I don't see Apple going much further down-market than the $550 iPhone 5c.  However, they can make a high-end phone with a bigger screen, and that's exactly what they're rumored to be doing with 4.7" and 5.5" models of the iPhone 6.

Some industry observers have also hypothesized that as phones get bigger there is less of a need to own a tablet.  Over 50% of the tablet market is devices that have just 7"-8" screens.  Most people probably don't need to own two devices with similar capabilities that are so close in size.  As iPad sales slow down, it's important for Apple to have a larger phone to sell to those consumers want a big screen or those that can only afford one mobile device.

Apple will work to make a richer iOS ecosystem

In summary, iPhones are very important to Apple because it is their largest and most profitable market, still growing steadily, and is increasingly making up a larger portion of their revenue and profit.  They need to get the one new model in their most important product category right.

Apple will also concentrate on making a richer iOS ecosystem to lure in new customers and keep them loyal.  Initiatives such as HealthkitHomekit, and Carplay are good examples of this.  I also expect more official iPhone accessories, both Apple branded and through official 'made for iPhone' programs.  A spec for making lightning cable headphones was recently revealed.  Perhaps this provides some hints at what they were thinking with the Beats acquisition.  This is also why I fully expect to see a smartwatch and/or fitness tracker introduced later this year.  I could also see them doing an Amazon Prime-like service that includes more iCloud storage, a music streaming service, and perhaps exclusive monthly discounts on iTunes or App Store content.  iPhones are incredibly important to Apple's health.  They will do whatever they can to protect their position without lowering prices.