Friday, 03 June 2011 12:43

Look & Listen Closely As The Solitary Margin Compression Theory Slowly Bears Fruit: Apple to Drop Flagship iPad Prices?

I have dedicated a decent amount of BoomBustBlog real estate warning of Apple's impending margin compression, most recently... “Is The Evidence For An Apple Margin Collapse Now Incontrovertible?“and “I Absolutely Dare Anyone To Read This And Still Not Consider The Probability (Not Possibility) Of Apple Suffering From Margin Compression“. Well, words is going around from Apple's S.E. Asian suppliers that market fundamentals are coming home to roost. As you read the snippets below, remember what both I and Steve told you months ago - Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof!...

From C|Net - Rumor: Apple already drumming up parts for iPad 3

Although the iPad 2 is only a few months old, Apple is already trying to gather up the necessary parts for the iPad 3, according to a report from DigiTimes yesterday. Citing industry sources, DigiTimes said that Apple has begun certifying components for the next-generation iPad, a process that's triggered quick responses from many Taiwan-based hardware manufacturers.

 

The sources said that Radiant Opto-Electronics has already won certification for its LED backlight units, while makers of backlight modules and light bars have received certification as well. One component still to be certified is the tablet's touch-screen panel itself. Companies such as Samsung and LG have typically supplied panels for Apple, but DigiTimes said that Apple is close to certifying panels made by Taiwan-based Chimei Innolux.

 

DigiTimes also mentioned rumors that Apple would use AMOLED (active-matrix organic light-emitting diode) panels made by Samsung for the next iPad, however, industry sources said they believe the tablet will still sport the same 9.7-inch LCD display used in the first two iPads. Apple and Samsung have also been embroiled in a couple of dicey lawsuits with each other, potentially making it difficult for the two companies to work together right now.

The AMOLED and Super AMOLED screen tech is vastly superior to what Apple is currently using in its iPads, and as such Apple's products will be lacking (relative to those that use said technologies) if they go with the more antiquated tech. This is a consequence and byproduct of Android's massive reach. Google has, in effect, turned Apple's largest suppliers (LG and Samsung) into its largest and most powerful direct hardware competitors - as clearly outlined last year in this blog. And back to Cnet...

 

To no surprise, component makers say the iPad 3 will launch in 2012. But some of the Taiwanese parts suppliers believe Apple will lower the price to compete with rival tablet makers.

And there you have it, logic and common sense. Lower prices will lead to lower margins. For those that are paying attention, it is evident that it is already happening. Let's reference the model behind the subscriber document File Icon Apple - Competition, Cost Structure and Forensic Valuation and go through the basic fundamentals, step by step for the iPad which is a very strategic segment for both Apple and the industry. First, the basic math:

Revenue per Unit - Cost per Unit = Margin

First of all, iPad sales have already dropped. There is now significant competition for parts and supplies now that Apple has to compete with about 440 other companies that are trying to sell similar devices. Next up, let's review the revenue per device, which as you can see has been trending down sharply over the last three quarters, including the quarter that launched the iPad 2.

At the same time that aggregate sales and revenue per unit have decreased, the cost per unit has increased over the same 3 quarters...

The natural consequence of the movement of the variables above - Revenue per Unit - Cost per Unit =

These numbers and charts are happening BEFORE the Android Honeycomb/Ice cream sandwich competition has set in. The first true Android tablet has just shipped 3 months ago, and the real competitors that offer demonstrably better features and value are just launching now (ex. Asus Transformer and Samsung Galaxy Tab 10.1/8.9) and selling out everywhere within hours). Even with the launch of these formidable products, we are only 1% or so (5 out of 440 manufacturers) into the introduction of what is essentially just the first iteration of Android tablets (next revision will be out before the end of the year with Android 3.2) and then their is Microsoft Windows 8 which will put a full computing system on a ARM powered tablet. What do you think will happen to the revenue, cost and margin numbers when competition truly heats up?

As the myriad and quite capable form factors, software GUIs and outright leaps in performance and capabilities manifest themselves in the form of Android over the next 12 months, Apple would be downright suicidal not to alter its path. In order for Apple to win this race, it has to be in it, and the entrance fee for running is margin compression. This was obvious over a year ago: “

I follow the comment sections of many prominent, and some not so prominent but nonetheless excellent blogs and new media sites, and misconception seems to reign above many others, and that is that Google will not make any money with Android other than (now sparse) mobile ad revenue. This is a total misunderstanding of the Google/Android Strategy. For those who cannot see the forest due to all of the tree bark getting in your way, I urge you to review Android Now Outselling iOS? Explaining the Game of Chess That Google Plays in the Smart Phone Space:

 

Many commenters are lamenting on the fact that Google is not making money on Android sales since the OS is given away for close to free while Apple is making $250 per handset sold. Those who are looking at it from this perspective are missing the forest due to that big fat tree that is in their way! Yes, Apple is making a killing on its iPhone sales, and it would be difficult to attempt to catch them with a fat margined product. They have managed to produce both margin and volume and have wrapped it up with extreme customer loyalty. What the armchair pundits are missing is the power of reach. Google is developing massive reach, and developing it ridiculously quickly. A byproduct of this reach is the commoditization of the smart phone platform which will probably cut the fat margined business model off at its knees. That is not to say that Apple will be cut off at the knees, but they will have to alter their business model for the competitor-less margin that they enjoyed for the last three years will no longer be a given. It also means that anyone else reaching for the crown (including Apple) will have to spend more upfront to gain less per unit sold. This actually benefits Google, for they are not in the hardware race, yet they benefit from each and every handset, tablet, desktop and automotive unit sold. Google is trying to become the new Microsoft!

 

In the meantime, Google ramps up the potential to push software as a cloud service, downloadable software and interactive, activity/context sensitive rich media ads and services to hundreds of millions of new users. This opens up a phenomenal opportunity for Google, and it appears as if many are missing the point because Google (wisely) decided not monetize it immediately, but to let it gestate and grow. Do you remember 15 years ago when many felt the same about search and the fact that Google wasn’t making any money providing search (pre-advertising)?

...

Now, Apple will not sit on its laurels while Android eats its lunch, but their are only three realistic ways in which Apple can compete.

    1. They can compete on price, which they now have the scale and volume to do, but is the antithesis of the “Premium Apple Brand” that they have worked so hard (and quite successfully so, may I add) to create over the last few years. More importantly, it will materially (and potentially drastically) impact margins.
    2. They can compete on features and technology. This will be very difficult to accomplish due to the sheer extent of competition they are facing. Apple will effectively have to out engineer Samsung, Motorola, HTC and about 70 other manufacturers on the hardware side and simultaneously outrun Google’s Android and its army of hundreds of thousands open source contributors on the software side. This is highly unlikely. Doable but improbable. More importantly, it will materially (and potentially drastically) impact margins.
    3. They can license their OS along with minimum hardware specs to third parties. This seems to be the most logical step to the possibility of longer term dominance, but also apparently flies in the face of both the company’s culture and the company’s history. More importantly, it will materially (and potentially drastically) impact margins. If you remember, this is how Apple lost the PC wars, by refusing to license the OS as the PC became commoditized and prices fell through the floor. Microsoft benefited immensely from this occurrence for it did not make hardware, but it did benefit from every piece of hardware sold. Does this sound even remotely familiar (hint: Google cloud services) to anyone???

So, what is the recurring theme in all of these decision branches? Let me help out those who are still not getting it: More importantly, it will materially (and potentially drastically) impact margins. So, as Apple’s margins dwindle due to competition from the Android, they will consistently beat expectations since the sell side analyst community continues to play this non-sense game. As for those who don’t believe it can happen so quickly, take a look at Apple’s margins for the last quarter…

For more on this topic, visit:

  1. Apple on the Margin!
  2. A Glimpse of the BoomBustBlog Internal Discussion Concerning the Fate of Apple
  3. Math and the Pace of Smart Phone Innovation May Take a Byte Out of Apple’s (Short-lived?) Dominance

 

Apple's share price and market share benefit from two of the most potent marketing forces in the world - 1) the Apple marketing team, and 2) Goldman Sachs retail and institutional sales force. Both are in high gear and revving right now!

Of course, that doesn't necessarily mean that there is any credibility in said proclamations, though. Reference this priceless nugget in light of the links above...

Goldman Sells Nearly Half $Billion Of Apple Stock Directly Into Their Client’s Conviction Buy Recommendation: Guess Who Really Agrees With Reggie Now! Friday, May 27th, 2011

Fear not, oh ye deprived consumers of the truth! Subscribers can access unfettered, unbiased analysis on Apple's situation and prospects, by the numbers: File Icon Apple – Competition and Cost Structure Forensic Analysis and accompanying Apple iPhone Profit Margin Scenario Analysis Model – suggested use with Apple Earnings Guidance Analysis

Of course, Apple isn't the only company facing margin compression from the technology commoditization rage that is Android (ironically, it will probably fare the best). We also have...

Margin Compression in Nokia

Nokia Is The Latest Company To Experience The Margin Compression I Promised Android Will Deliver To All In The Sector June 1st, 2011 by Reggie Middleton

Margin Compression in Research in Motion:

As excerpted from Research in Motion Drops 10% After Hours, Precisely As We Warned Two Months Ago – MARGIN COMPRESSION!!! Thursday, March 24th, 2011 (I also warned again in April - Blackberries Getting Blacked Out, Imitate Amateur Base Jumpers Sans Parachute! Friday, April 29th, 2011):

On January 20th, I posted "Blackberries Lost More Market Share Than We Bearishly Anticipated While RIMM’s Share Price Spikes: Is It Time To Revisit the Bear Thesis?". I turned bearish on RIM last summer and made some money on its dip back then. Shortly afterward, its shares did the QE thing, despite the fact Android started sucking up market share everywhere while simultaneously squeezing margins like orange juice. As excerpted from the aforementioned post:

We have updated our mobile OS and handset manufacturer market share model and will make it available to subscribers as an online app by next week. In the meantime, let’s review some of the findings – vendor by vendor. First up is Research in Motion. This was a profitable short in 2010, with the share price hitting our targets within 100 pennies. Since then, the stock has risen appreciably. Let’s take a look to see if the rise was justified.

Page 5 of our Research in Motion forensic analysis (released in the summer of 2010 - File Icon RIMM Forensic Analysis and Valuation – Professional & Institutional or File Icon RIMM Forensic Analysis and Valuation – Retail) clearly stated that while we expected RIMM’s handset shipments to rise as a result of a rapidly expanding smartphone market, it will lose considerable market share.... RIM Smart Phone Market Share, RIP?

What About Google? Margin Expansion?

I will review my views on Google next week. Stay tuned! In the meantime, subscribers should peruse the Apple valuation numbers in File Icon Apple - Competition, Cost Structure and Forensic Valuation.

Last modified on Monday, 11 July 2011 08:42

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