During the fourth quarter 2012 Apple’s margin fell to about 38%, a level not seen since two years earlier and down from a peak of 47% in Q1 2012. Does this lower margin foretell lower prices or a loss of competitiveness?

Obviously not.

Gross margin is a function of Sales (aka revenues) and Cost of Sales. Gross margin as a percent is calculated with the following formula: (Sales-Cost of Sales)/Sales. If dealing with a single product, Sales itself is the product of shipments and price/unit but since cost of sales is also a product of shipments and cost per unit, the shipments numbers cancel each other out and the gross margin reduces to the ratio of (Price-Cost)/Price.

So a margin drop can only be caused if one of three things happened:

- Prices dropped
- Costs increased
- Both prices dropped and costs increased.

We can easily find out which of these was the cause in the fourth quarter because we have volumes and prices for all of Apple’s products. We can also derive total costs based a total gross margin. These are illustrated in the following retina-friendly diagram.