A few of our friends over at TUAW are engaged in a pretty interesting debate about the future of Apple’s iPod touch model Line. Apparently, there are several people in the tech community who believe the class-leading device is being phased out by the strategists in Cupertino. Chris Rawson explains:

A reader wrote in to us surmising that the iPod touch is on its way out, to be replaced by a lower-cost iPhone 5. It sounded ridiculous at first, but the evidence he gave sounds pretty compelling when it’s all put together.

Basically, the circumstances prompting this line of thought are threefold. First, Apple’s 2011 “Back to School” computer promotion replaced the usual free iPod touch with a $100 iTunes gift card. The second point concerns Apple’s releasing its new iPhone in September, the same time it traditionally starts selling revamped iPods. Lastly, there doesn’t yet seem to be any specific mention of new iPod touch hardware in the recently-released iOS 5 developer preview, and Apple has removed the “iPod” moniker from the music player app in iOS.

All this led to the aforesaid Rawson opening up a speculative for-and-against with colleague Richard Gaywood on

whether Apple is likely to lower costs on the iPhone 5 enough to make it a viable replacement for the current iPod touch lineup.

Rawson, who seems a bit more ready to believe that iPods are on the way out, begins his case strongly, saying that, should Apple reduce the price of the baseline unlocked iPhone to $299, “the iPod touch would pretty much have no further reason to exist.”

Gaywood counters that that’s not likely to happen, as Apple would have to essentially cut the price of its most economical current handset in half. Furthermore, the profit margin on iPod touches has been cleverly bumped up in recent years by its receipt of both a cheaper housing and less expensive internals (aside from the actual A-series processor itself):

Note that the parts Apple skimps on — the baseband, the display, the DRAM, the flash, the rear-facing autofocus camera — are some of the most expensive parts in the iPhone 4 to start with.

Rawson then makes a series of arguments about the current costs of production (including BOM, or “bill of materials”) and how, since the new iPhone is expected to differ only slightly from the iPhone 4, the unlocked prices of said iPhones are more or less unsustainable and must come down. He notes that, while Apple makes a profit of about 25% on the sale of each 16 GB Wi-Fi iPad 2, the cheapest iPhone 4′s margins are between 50 and 60 percent. Also, Rawson notes that discontinuing the iPod touch product line would not only lighten Apple’s manufactory burden but also give potential iPod touch buyers all the more reason to opt for a cheaper contract-free iPhone, which, he claims, “would go a loooong [sic] way to making up for the reduced per-device margins.”

Gaywood responds thus:

A common rule of thumb for a R&D-heavy devices like the iPhone is 1/3 materials, 1/3 cost, 1/3 profit. If you just compare how much it costs to assemble with how much Apple sell it for, it looks like a huge margin — but all those smart guys in Cupertino don’t come cheap, nor do their swanky digs…

Bottom line for me is this: replacing the iPod touch with an iPhone at the same selling price would inevitably require Apple to sacrifice considerable profit margin, would face carrier hostility (which might be so severe as to make them refuse to issue data plans for it), would be of marginal benefit to many consumers (customers who cared about having cell data for an iPod touch already own iPhones, I’d wager), and would cannibalize sales of the more lucrative iPhone (particularly the pre-pay models, which America might get now it has unlocked iPhones).

Since the debate was probably via email (or some other piece-by-piece vehicle), Rawson had enough time to do further research on the iPhone’s profit margins. He discovered that,

[a]fter running through the numbers a bit more closely, selling the iPhone 5 for $299 looks like a net loss for Apple (which ain’t gonna happen), but selling it at $399 would yield a profit of about 17 percent. That’s far lower than the margins Apple currently enjoys on the iPhone, but Apple’s financial guidance for the past couple quarters has warned investors to expect overall profit margins to decline.

So, it turns out the move might not make much financial sense, after all. And, oftentimes, financial sense is the only kind of sense big consumer technology companies consider. However, Apple’s not wholly preoccupied with dollar signs and could conceivably go the course suggested by Rawson (and other proponents of the iPod touch ouster), favoring long-term production and model streamlining over short-term, higher-yield margins.

However, I’m inclined to agree with Gaywood in all this. Most new iPod touch owners, in my personal experience, are children or teenagers already on some family cellular plan. There’s no compelling reason for these folks — if they’ve already got other phones or plans without the requisite data packages — to shell out an extra $100 or so (should Apple significantly drop the unlocked iPhone’s price at all) instead of buying a cheaper, fully-app-supported device. Also, even though the iPod touch is slowing its breakneck sales pace a small amount, the line is still an enormous seller, estimated to move 30-35 million units by year’s end.

As for why no new iPod touch has yet been announced, there could be a very good reason: Perhaps a new model is coming out in winter to anchor the holiday shopping season. Apple is known for staggering hardware refreshes and revisions, and it would make sense to reposition the iPod touch launch since the new iPhone has been delayed and reset for a fall release.

I’d be extremely surprised if the iPod touch indeed turns out to be on its last legs. I think there’s a definite and sustainable place for the device in Apple’s mobile lineup, and I’ll share my reasoning in a future post.

Meanwhile, feel free to explain your own position on the matter in the comments below.