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Is Apple Gouging iPhone Customers?

You’ve read the reports. It costs an estimated $265.83 to buy the raw materials and build the $599 iPhone. So Apple is, therefore, making 55% profit on every unit sold.

Does that mean that Apple is cheating you?

I’ve seen estimates of that sort before on iPods and other Apple hardware, and I’ll accept, for the sake of argument, that the figures are correct. However, there is one critical element that the analysts who have jumped on Apple for making too much money have forgotten: The software.

We all know that Apple worked for several years to create the iPhone user experience? Was it all done free of charge? Did the employees on the iPhone project receive nothing more than nightly pizzas and tofu burgers for their efforts? Obviously not. I don’t have the figures — and Apple will probably not break them out from other R&D expenses — but I wouldn’t be surprised to discover that several hundred million dollars were spent to design and perfect the iPhone’s software.

While the quality of software may not mean much to the wireless industry, simply because it’s almost universally lousy, it lies at the very heart of the iPhone difference, and why it has become such an early, runaway success.

So just how much is the iPhone’s software worth, when you spread it out over, say, 700,000 units sold so far, at least according to the most generous estimates?

That’s a really good question, and I wouldn’t hazard a guess. But I do want to remind those ill-informed financial analysts that iPhone development didn’t stop dead in its tracks when the first units shipped. Apple has, in fact, decided to book its income from the iPhone over a 24-month period, and it’s no secret they plan on ongoing software updates. So there will be continued expenses enhancing the applications and operating system that powers the iPhone, and that has to be reflected in its selling price.

Consider a corollary: How much are the raw materials of a $129 Tiger upgrade kit worth? Take a look at the box, the DVD and the ultra-thin instruction booklet. All told, the costs of manufacturing each unit barely comes to $5, probably a lot less. So is Apple somehow gouging you on each sale? What about the $2,499 you pay for the Adobe Creative Suite CS3 Master Collection, which includes virtually the entire product line, from InDesign to Premiere?

How is Wall Street going to account for what Adobe spends to create products that ship in installation kits that cost only a few dollars, each, to produce?

Of course that takes us all to the heart of the matter, which is that Apple’s software is an integral part of its product line and its main advantage over the competition.

The iPhone may have basic components that it shares with other products, but the vertically-integrated design will pretty much always set it apart.

In fact, I’d be very curious to see how other wireless carriers address their shortcomings? Will they — as they’re doing now — simply provide a laundry list of bullet points designed to demonstrate the iPhone’s missing features, and how they are better equipped to meet those needs?

All that will do is put them in Microsoft’s position, which is to design products based on the number of features rather than consider how well they are integrated and the overall user experience.

Indeed, it’s clear to me that Apple is not overcharging you for the iPhone if you account for that missing factor — R&D.

The other question is, of course, why Apple choose AT&T when there are carriers in the U.S. that have superior customer service and, supposedly at least, more reliable networks. Well, it’s clear that Apple demanded virtually complete control over the iPhone’s user experience, a hard-to-quantify emotional sense of empowerment, which is something no other phone manufacturer has ever understood. Apple clearly didn’t want to be handicapped by the sometimes arbitrary restrictions placed upon the likes of Nokia, Motorola and all the rest.

This doesn’t mean that AT&T has no control over the system. It may even be that some of the missing features, such as the inability to sync your iPhone or download iTunes content wirelessly was, in part, a compromise of some sort. Or it may be that the systems to handle that traffic aren’t in place yet.

As you’ve seen already, AT&T’s network has not been able to fully cope with the initial iPhone demand, particularly for folks switching service from other carriers or changing one of their AT&T plans.

Over time, I expect AT&T’s worst problems in handling the iPhone will lessen. I would also hope that Apple carefully considered the possible handicaps of a poorly-performing infrastructure when they inked that deal with AT&T. Even if the iPhone were otherwise perfect, that could seriously handicap Apple’s long-term success as it strives to gain a big foothold in the wireless phone industry.