March 20, 2012
Apple Margin Falls To Drive Marketshare
Peter Suciu for RedOrbit.com
In the world of business there is often cited “giving away razors to sell razorblades.” This formula exists with many high-tech products, everything from printers, where the replacement toner costs one-third or more the cost of a new printer to video game consoles, where the companies sell the hardware at a loss and make up the money in license fees.
Now when spending several hundred dollars on a new video game console it might seem hard to believe that the companies are losing money, but they are. This was certainly the case with Sony´s PlayStation 3, which reportedly cost at least $100 more for every unit sold to produce than the sticker price. That doesn´t even include the R&D costs.
So why did Sony do it? And more importantly why is Apple basically doing the same thing now with the new iPad? It comes back to the razorblade scenario and also marketshare. While Apple already makes a lot of money from its apps, it doesn´t need to give away the tablet to make the money up in apps. This just a small part of the bigger picture.
First, let´s consider the new costs for the new iPad, as well as the new pricing for the iPad 2. The 16GB model with Wi-Fi only is $499, while the Wi-Fi plus 4G model is $629. That´s actually only $100 more than the iPad 2, which is $399 and $529 respectively for the Wi-Fi or Wi-Fi/4G version.
Now the iPad price does steadily go up, $599 and $729 for the 32GB version with respective Wi-Fi or Wi-Fi/4G version, and $699 and $829 for the 64GB respective Wi-Fi or Wi-Fi/4G version.
But here is where it gets interesting. Unlike Sony or many companies, Apple has never actually embraced the “giveaway the razor to sell razorblades” way of doing business. The company has always maintained a decent profit margin, although to some this has meant notoriously higher prices in categories where there has been fierce competition. Despite this fact, Apple followers have paid more.
This was certainly true when the iPod took down Creative Labs and most of the other competitors in the digital music player arena, and propelled Apple towards being a major player in mobile phones.
However, according to IHS iSuppli and reported by Apple the third-generation (new) iPad cost at least $316 to produce, more than the previous iPad 2. IHS iSuppli noted that the new iPad (32GB Wi-Fi/4G version) costs Apple $364.35 for parts, plus about $11 for assembling, with a total of $375.10, roughly half the $729 of the sticker price. But this is also doesn´t include the software, licensing, royalties or other expenditures.
This results in lower margins for apple.
Part of the reason is that material costs have actually spiked in price. Apple, which maintains a static pricing strategy when new versions are introduced, will thus see a drop in profit margin.
Lower Price for Greater Market Share
However, there could be another reason for why Apple isn´t raising the price. This is because it needs to remain cost competitive in the very tightly contested tablet arena. When the iPad was released in 2010 it wasn´t exactly the only tablet on the market.
But thanks to robust marketing and an innovative design it changed the tablet market almost overnight. And unlike with the iPod, the rivals weren´t about to roll over and let Apple own this category.
As CNET noted earlier this month, “Apple should be blowing us away with the iPad 3, but it probably won´t.”
The company has seen much success with the iPad and iPad 2, and sold 15.4 million units in the fourth quarter of 2011. However, there are factors working against the new iPad — not the least of which is diminishing returns. How many times can the same customer return to buy a new version of last year´s latest and greatest, especially when the company is also continuing to offer latest and greatest versions of other products — notably the iPhone.
The iPad also has serious competition. At this year´s Consumer Electronics Show in Las Vegas there was no shortage of tablets with almost a dozen companies, from HP to Samsung to Toshiba in the tablet game, while Amazon offers an eReader with tablet functionality.
Companies such as Asus are introducing low-cost alternatives, and then there is another threat — the Ultrabooks, which are super slim laptops, some with the ability to transform from a traditional clamshell to a tablet. These offer greatly options for content creations, one of the greatest shortcomings of tablets.
So Apple is no doubt trying to keep the competition at bay by offering low prices. The question is whether consumers will go with the proven iPad, or consider a slightly cheaper alternative?
And in the post-Steve Jobs era will be interesting to see if Apple will embrace making less the sell more.