Categories

Visualizing Apple's Profitability

After the last earnings report, many noted that Apple’s gross margins dipped. Turley Muller noted in a letter to PED that the cause was probably the aggressive ramp in iPhone 4 production which broke new records at 14.1 million units.

That may be. My estimate of iPhone margin shows it dropping to about 49% from the more usual 55% (sometimes even higher).  We’ll never know exactly how much, but sometimes margins drop. RIM and Nokia are punished for drops in the GM percent so why shouldn’t Apple?

However, there are some other factors to consider: the overall margin is currently historically very high. As the high-margin iPhone makes up more of the total product mix, the overall margin should be growing. And it is. The chart below shows the trend since 2005. GM was in the high 20’s five years ago.

Note however the other margin: operating margin. After taking the fixed costs into consideration (which we saw to be shrinking as a percent of sales), Apple’s bottom line profitability has been rising slightly more rapidly than the GM. It has plateaued recently but not dipped significantly.

Also note that there have been dips in the past from which GM expansion resumed. One such dip was at the launch of the first iPhone in 2007, though we can’t be sure that was attributed to the iPhone itself or to other factors like that most cited by management: components costs.

However, the bottom line profitability is only part of the picture. It would be instructive to look at which product contribute how much. You won’t see this analysis often because the gross margin by product is not published by Apple and it takes quite a bit of guesswork to get there.

I maintain product-level gross margins and compute the overall GM bottom-up. The product-by-product line profitability is based on several assumptions which I won’t detail here, but those assumptions lead to the following contribution chart:

There are several takeaways here:

  1. The iPhone is huge (57% of gross profits). It is far more important than most people assume. Without it, the company would not have materially grown EPS since 2007.
  2. The “Music” which includes iTunes revenues is tiny. Many people assume that iTunes is a large contributor to Apple’s operating profitability but operating margins on the store are 10 percent. Peripherals add more to the bottom line than the iTMS/App Store. The benefit of the iTunes/App Stores is in the hardware sold.
  3. Software contributes more now than the iPod. This is completely under everyone’s radar but Apple’s software business has been growing and with 80% gross margins (assumed) it’s a big part of the profit picture.
  4. The iPad margins are lower than the iPhone. As it grows in volume, the profit share will grow, but it’s a long way from being the profit share leader.

This picture should also be a warning to Apple’s competitors. If they seek to grow shareholder value and shift profits away from Apple they need to see just how much of that profit is captured in hardware. At the same time, they need to realize that it’s the non-hardware businesses which make the hardware so desirable. Like it’s products, Apple’s income statement is very inter-dependent.

  • http://twitter.com/_ChrisHarris @_ChrisHarris

    Very interesting (as always). Is the profit from the App Store included in the 'Software' line? If so it's interesting that the introduction of the App Strore in Q3 2008 (I think?) hasn't changed the line much.

    • asymco

      iTunes is part of the thin purple line. Apple reports it with the unfortunate and anachronistic "Music".

  • http://www.mercuryintermedia.com Bill T.

    I suspect Apple's declining margin can be traced to their decision to set the iPad's entry level price ata low-margin $500 to make it difficult for others to field a profitable competitive product. Apple's vertical structure provides good margins and their immense component buying power strains supply, driving up the cost of entry for competitors, requiring them to buy market share. Samsung apparently doesn't want to, hence pricing the Galaxy so high it may be stillborn.

    With it's limited margin (my assumption) and aggressive moves to expand distribution, Apple seems to be saying "the tablet market is ours – competitors beware".

    • Rob Scott

      "I suspect Apple's declining margin can be traced to their decision to set the iPad's entry level price ata low-margin $500" – I agree.

    • asymco

      Partly. Even choosing a low margin for the iPad (around 30%) the iPhone margin had to go down. Management attributes this to component costs.

      • Joe_Winfield_IL

        Every smartphone was starting to look the same (a Jonathan Ives 2007 design to be exact), so Apple did what they do best. They left the UI unchanged but dramatically altered the hardware, inside and out. They didn't just add ports and improve the camera, they changed everything. Margin was sacrificed a bit as a tradeoff to radically higher sales.

        My guess is that the iPhone 5 will be more evolutionary in its hardware specs. 4G will be enough of a headline that leaving pretty much everything else the same will be acceptable. Perhaps the next version of the A4 chip will be out, but it's not like anyone is complaining about the speed performance on today's models. Also, the accessories makers are just catching up to iPhone 4. Apple would be wise to let the market catch up, because 3rd party accessories are a big competitive advantage of the iPhone and iPod lines. If I'm right and they don't change much, would you agree that the margins will tick back up?

      • Iphoned

        "but it's not like anyone is complaining about the speed performance on today's models."

        Well, iPhone seems underpowered when it comes to intensive web browsing. Rendering HTML and associated page code is very processor intensive. Many websites would just hang for minutes at a time before opening. I am sure the same is the case for all current Arm- based devices. So clearly the next version screams for a more powerful processor, which luckily Arm is making available. Who knows, these maybe powerful enough to run Flash normally, thus exposing (what I believe) the fallacy of SJ's argument re. Flash and forcing Apple to rethink is Flash stance.

      • asymco

        Flash may render on devices if you throw enough horsepower at it, but that does not make SJ's argument false. Flash as part of Macromedia was the industry pariah for years, even Adobe condemned it and suggested SVG as a better alternative before giving up and buying them.

      • timnash

        Another issue with iPad this quarter was building inventory. Exiting Q3 Apple had next to no inventory, at the end of Q4 3-4 weeks, say 1.1 million units.

  • techMonkeyBoy

    @Bill T
    "the tablet market is ours – competitors beware".
    This is my read on the iPad as well.

    And the following quote from Steve Jobs from the last conference-call seems to support this contention as well:
    "And sixth and last, our potential competitors are having a tough time
    coming close to iPad's pricing, even with their far smaller, far less
    expensive screens. The iPad incorporates everything we have learnt
    about building high value products from iPhones, iPods and Macs. We
    create our own A4 chip, our own software, our own battery chemistry,
    our own enclosure, our own everything. And this results in an
    incredible product at a great price. The proof of this will be in the
    pricing of our competitor's products which will likely offer less for
    more."

    • David Chu

      It's also about all the custom software that apple builds for the iPad and iPhone.

      Take iMovie for the iPhone. Considering it took 18 months to build, there is no 3rd party developer that could have come close to making an app as impressive. They can't stomache the risk that Apple can. The app also highlights why web apps are not the answer to every problem.

      These apps really differentiate Apple from it's competitos and I would only expect more to come out.

  • r.d

    iPad is low margin for now but I think
    when IPS-LED display prices fall next
    year when new production comes online.

    Otherwise iPad shares the same chips with ipod touch, iphone and
    even TV.

    • Kristian

      TV Will be marvelous thing when the game center opens for the TV. They already sold 250 000 last quarter and they will sell much much more during the Xmas season.

  • Iphoned

    For the purpose of valuation Apple is effectively a one product company. (macs, for example, are now only 16% of profit by my estimate)

    • r.d

      ya it is fashionable gadget maker based on ARM processor, Flash Memory,
      Wifi, 3G chips, LIthium Battery, Touch Screen, AppStore, with little music distribution monopoly.
      That is all.

      You can say that for every company in this world.

      • Joe_Winfield_IL

        If that is the case, why is Apple making all the profits? That is like saying that 3M is a one-trick pony relying on coatings and adhesives. Like 3M, Apple is incredibly successful at combining incremental innovation with generic components. They know when to add a proprietary layer to all the commoditized parts you listed. It is this proprietary part that sets Apple apart from Sony, LG, Motorola, Dell, HP, etc. It is what drives customer satisfaction, and in turn, market share and profits.

  • Pingback: Monday links: fixing the dinosaur Abnormal Returns()

  • pk de cville

    Horace,

    Can you expand the chart with the Q410 data? Much appreciated.

    • asymco

      Those are calendar quarters, so it's up to date.

  • Alan

    I've been wondering if Apple would use the high margin iPhone to allow them to lower the margin on Macs in order to increase sales. It's a tightrope walk – if they are too successful selling macs at a reduced margin then the cumulative gross margin comes down. But if they can walk up the mac sales with iPhone sales they could keep the overall GM where the analysts want it AND broaden the Mac sales base by lowering sales price. Perhaps the aggressive pricing on the new Airs is the proof of this.

    • asymco

      I can assure you that what the analysts want does not enter into any of the planning at Apple. Or, at least, I hope not.

      • Alan

        LOL! Good point. Perhaps "where management wants it" is a better phrase.

  • Pingback: Looking Closer at the Apple numbers « Velocha()

  • yet another steve

    I suspect that, given its history, Apple is actually uncomfortable with how high its iphone margins are. Seriously. I think Apple would lower them in a heartbeat if they thought there was significant volume that was there to be picked up. But that's obviously not the case when you're supply constrained. And here in the US, AT&T is shielding users from the higher price vis a vis other smart phones. And no matter how you slice it, the carrier charges dwarf the phone price, so accepting lower margins wouldn't really affect the total price to the consumer much.

    Apple certainly shows no real concern over their short term share price, and a few whiny analysts are not going to distract them from thinking long term.

  • Pingback: Monday links: fixing the dinosaur | Total Trader()

  • Pingback: Korta klipp – 26 Oktober 2010()

  • Iphoned

    @

    “Flash may render on devices if you throw enough horsepower at it, but that does not make SJ’s argument false.”

    Of course, it is not technically faulse. That’s what makes the argument a particularly skillful marketing sleigh of hand. If you can’t deliver a tablet that would handle the web as it is, you just ban the par of it that you can’t handle, call it old and obsolete and ship anyways. Bingo. Problem solved. But I suspect this one would come back to bite. Because Flash is not going away and the next gen of devices will have archore powerful processor. And then why would one want to buy a device effectively crippled for practical web browsing?

    • Alan

      Flash on the desktop shows no signs of going away, but on mobile devices it is different.

      Flash has 3 primary uses: a container for video, banner/animated ads, and games/apps.

      For mobile video a lot of it is now handled either by using html5/h.264.
      The games don't usually work because of the interactions needed: hover over, click and drag, etc.
      Ads would work as is, BUT the most common mobile implementations of flash enable "click to view" by default. So that means the flash doesn't show up unless the user specifically requests it.

      So in that scenario the ads are almost never going to show, who clicks on a blank flash box in order to see an ad?

      So the play for flash on mobile is:
      Video that hasn't yet been re-encoded and uses more cpu/battery to play
      New games/apps that have been re-coded to use touch interaction

      Not a big draw in my opinion.

      • Iphoned

        Yes, we al know the theory, but in practice it makes for very frustrating web browsing. Users are not going to put up with this once faster mobile devices become available that run flash without performance issues.

  • Chris

    Since getting the first iPhone, and later upgrading to a 3Gs, I do maybe 85% of my web browsing in mobile safari. The only time I intentionally switch to my mac to view a site is when a page has detail that can't be seen when it's zoomed out, e.g. when you need to see the big picture plus the details. This isn't often but it happens.

    I have noticed the lack of flash maybe a dozen times, usually for reasons that would be as well served by alternatives to flash. Basically, I don't miss it, and very rarely realize that I'm browsing without it. It's irrelevant for me.

    I recently added Click To Flash to my desktop, expecting a wonderful release from all that dang Flash that was gumming up my surfing. Except for the spots where ads used to be, I rarely see the Click To Flash graphic that would load the embargoed Flash file.

    As for users not putting up with flash's absence, whether or not faster processors make it more practical on mobile devices, it's not just the horsepower/battery drain that makes flash a pain in the ass. It's buggy as hell even on devices with sufficient CPU cycles and RAM, will hog both obscenely. Also, some 130 million people in the last 3 years have decided it's not such a problem.

    As a poster said above, the use case is legacy-encoded video and some basic games. What on earth is the great attraction that it has for people who bemoan it's absence? Maybe just that Apple says they can't have it?