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Consumers' shift to older iPhones raises concerns on Wall Street

How strange to think that Vicki Macchiavello's decision to buy an iPhone after years of using a BlackBerry could be bad news for Apple Inc.

How strange to think that Vicki Macchiavello's decision to buy an iPhone after years of using a BlackBerry could be bad news for Apple Inc.

And yet, because the Oakland, Calif., resident opted to buy a cheaper, older iPhone 4 rather than the latest, pricier iPhone 5, she represents a trend that has become a growing concern on Wall Street.

In recent months, such an unusually large proportion of consumers are opting to buy older iPhone models that some analysts have begun to wonder whether Apple has lost its ability to create new versions that have enough dazzle to justify their high prices.

Not only has the shift toward cheaper phones nibbled away at Apple's profit margins, it's been dramatic enough for some analysts to view the iPhone 5 as a disappointment.

"I think it's no surprise then that the iPhone 5 is selling worse than expected," said Brian Colello, an analyst at Morningstar.

When Macchiavello went shopping recently for a new phone, she wasn't thinking about the bigger screen size of the iPhone 5, its faster processor, or the fact it could come with 32 gigabytes of memory. What she did think about was its price, ranging from $199 to $399.

So instead, she gravitated to the iPhone 4, which to some may border on heresy in the gadget-obsessed San Francisco Bay Area. Macchiavello got the iPhone with a mere 8 gigabytes of memory practically for free from AT&T in exchange for signing a two-year service contract.

"I'm not one who feels like I need to get the coolest things right away," Macchiavello said. "After a short period of time, the coolest thing isn't that cool anymore, and then it gets a lot cheaper."

Apple would argue that it's happy to have customers like Macchiavello. The company has found that once people buy Apple products, they tend to keeping buying more Apple products over time. Customer satisfaction is so high, and loyalty so strong, that a customer that starts small today is likely to grow into a bigger one down the road.

"Apple's 'black hole' ecosystem captures subscribers who never leave," Yankee Group analyst Carl Howe wrote in a recent report that argues these factors will give Apple a long-term advantage over rivals that run on operating platforms such as Google's Android.

Many analysts are not entirely convinced.

That's because Apple has built its reputation and much of its business in recent years on the ability to consistently deliver new versions of its products, especially the iPhone, that consumers were more than happy to buy in ever greater numbers at premium prices.

That was true at first of the iPhone 5 that went on sale last September. Apple said it sold 5 million units in the first three days, compared with 4 million of the iPhone 4S in 2011 and 1.7 million of the iPhone 4 in 2010.

But sales growth has slowed. In January, Apple executives said the company could have sold more iPhones if had the ability to make more older models.

After the Apple earnings conference call last week, several analysts noted that the average selling price of iPhones had fallen to $613 from $641 in the previous quarter, the result of what William Power, a Baird analyst, said in a report was "greater focus on the lower-priced iPhone 4."

Although Apple did not give specific breakdowns between versions, a recent report by Chicago-based Consumer Intelligence Research Partners found that for the first three months of 2013, 53 percent of those surveyed bought an iPhone 5, compared with 73 percent for the iPhone 4S for the same period after its launch.

Ben Reitzes, an analyst at Barclays, wrote in a note to clients last week that "the reception of the iPhone 5 and execution of late has tested our patience."

Beyond just profit margins in the short term, analysts also worry that people like Macchiavello who buy older phones with less memory are also less likely to buy other things like music and applications. Indeed, Macchiavello said she had downloaded only 11 apps for her phone so far.

And going forward, Wall Street wonders whether there will really be enough new features on the next iPhone, thought to be coming this fall, to generate the kind of enthusiasm to cause fans to set new sales records and return the company to the faster growth investors crave.

"It begs the question: Can Apple bounce back with an iPhone 5S?" said Colello of Morningstar. "Can they add enough that's new to make enough people believe it's worth it to buy a premium phone again?"

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