A margin of error

Prior to Apple’s earnings report I read at least one article suggesting that the most important indicator to watch was Apple’s margin. I suppose this was due to a recent decline in margins from a peak gross margin of 47.4% in Q1 2012 to 36.7%.

As the graph below shows, margins began to recover by Q3 2013 and are nearly on par with year-ago levels.

Screen Shot 2014-02-12 at 10.32.50 AM

The guidance for the present quarter is a gross margin between 37% and 38%. This would imply a flat q/q GM line (blue line above.)

This is not quite catastrophic.

To better understand margins, it helps to compare them with other companies. When Apple reached that peak of near 50% gross margin I noted that such a level was higher than Microsoft’s and Google’s. The irony being that Apple was nominally an (implied) low-margin hardware company while Microsoft was an (implied) high-margin software company and Google was an (implied) high-margin internet services company.

Here is the picture with the last two years added:

Screen Shot 2014-02-12 at 10.02.17 AM

In the last two years Apple’s margins have declined but so have Google’s. And although Microsoft’s fell, they fell less than Apple’s and thus overtook it to remain slightly more profitable (32.5% vs. 30.3%) into Q4.

I also added Samsung Electronics’ operating margin.[1]

So although Apple stabilized, it did so at an extraordinarily high level, well out of band for a hardware company. Thus the question remains: Are Apple’s margins a fluke? Is the recent rise of margins to levels far above those of a comparable hardware company and into the realm of software and services sustainable?

The simple answer is to assume that the iPhone and iPad, which make the bulk of revenues and which explain much of the rise, enjoyed a temporary buzz which allowed them to be priced at a premium but as that buzz wore off, the pricing and margins would decline. This is common with fads and fashions.

But the situation is far more nuanced. If the margins were due to mere novelty, the effect should not have persisted over so many years. Pricing data shows that the iPhone remains exceptionally valuable and that the iPad, excluding line extensions, has also held the line on pricing.

The missing piece in the puzzle is that the iPhone and iPad and iPod touch and Apple TV are pieces of an inter-dependent network of assets. The iTunes stores, Apple’s services and Apple Retail are easily ignored because they are not “profit centers” but I believe they are a key component to the sustainment of these margins.

In other words, the iPhone and iPad enjoy margins not just because they are new and well designed. But also because they form part of a ecosystem. The key word is ‘system’. The user buys into a system not just what the device embodies.

This is why I’ve always said that the iOS product businesses should be thought of as “hardware as a service”. The inspiration comes from the notion of “software as a service” which posits the idea that software purchases should be thought of as services and thus recurring revenues.

iOS devices are part of a service matrix: the user experience in the stores, the after-sales support (including the easily ignored Applecare), the broadband supplied through operator service (which is part of a trillion dollars of value), the apps and content that can be purchased (which add up to a mountain of money), the network effects of iMessage and iCloud and now iRadio and Match and Siri.

These services attachments are well understood as great business models and underpin some of the most celebrated businesses to emerge in the last decade including Google, Amazon, Facebook, Box, Dropbox, Windows Live, etc.

It’s curious therefore that whereas these other businesses are highly valued as services, in the case when the service is a component within a larger system, the value is missed. In an integrated context the connection between services and high margins is not understood. The reason may be the absence of robust systems analysis and a preference for the facile explanation.

  1. As a large conglomerate, Samsung will have a lower blended average. Separating the Telecom group’s operating profit shows a 16.14% divisional operating margin. []
  • Daniel

    Outstanding. “Hardware as a service.” It’s tough to articulate why Apple’s robust margins are sustainable, but you’ve nailed it. Thanks for taking the time to write this evergreen piece.

  • Andrew F.

    Sorry if this is a completely naive question, but why is it so important to preserve margins as opposed to growing absolute revenue and profit (i.e., the argument people often make against a lower cost iPhone)?

    Also wanted to say thanks for yesterday’s podcast on TV. Amazing insights, even if you did a great job of walking around the question of whether you thought Apple TV could disrupt the cable box. Lol.

    • important

      Important to whom?

      • Andrew F.

        To investors and analysts, I suppose, since they’re the ones I always hear bitching about margins.

    • StevenDrost

      Its challenging from a brand perspective to target different price segments. Think of cars, The Toyota brand could not attract high end customers, so they created Lexus. To address the IPhone specifically (because it is the largest profit maker) it would be challenging to make a good enough product to beat out low-end competitors and still maintain differentiation from their high end products. The fact that the second tier phone (5C) switched to a plastic body tells use they are concerned about this.
      I do think the portfolio will expand to the 350 and then 250 segments. But, i would look for the 5C level of phone to be the worst they produce. Also i would look for features like metal bodies, finger print readers and what ever comes in the future to differentiate the products.

    • El Aura

      Movement on the margins front means there is competition on the price front (ie, they cannot sell all their products at their desired margin). Which means they don’t dominate the market such that they don’t have to care at what prices their competitions sells.
      This no-longer-domination (eg, compared to the iPod) is showing up in other areas. How dominant was the 30-pin dock connector on audio peripherals five years ago and how dominant is the Lightning (or Lightning + 30-pin connector) there now? I’d say there is a serious decrease which is weakening the value of the ecosystem. Where previously you bought an iPod (or an iPhone for the first years) and knew it would work out of the box almost everywhere, that is no longer the case.

      • obviously

        “Movement on the margins front means there is competition on the price front”

        This is obviously not necessarily true. Margins can decrease as costs increase, as they do temporarily at the introduction of new products, etc.

      • Stefan Popescu

        Who uses a connector these days anyway?
        Bluetooth and wifi take care of the connections – why do you need to plug it it except for charging? I would rather say that devices that don’t have BT are on the path to extinction. The connectors are prone to mechanical failures while BT and wifi are a breeze to setup nowadays, why get stuck in the past?

      • charly

        Connectors don’t have conflicts, are easy to secure and much cheaper. They also don’t use up bandwidth

      • Stefan Popescu

        You must be joking, right?

        BT and wifi bandwidth is really expensive and hard to get.
        People need absolute security locked in by wires and connectors otherwise their connections will get sniffed, devices will get hacked, data compromised and their identity stolen or stored on NSA’s servers.
        Also the connectors don’t take space in devices and are really easy to ignore when designing the devices to make them physically smaller and simpler.
        Plus, is so nice to have to carry around a whole bunch of cables and connectors, just in case…
        And last but not least – the connectors never break and they can be easily fixed or replaced without rendering the entire device useless.

      • charly

        BT & Wifi are really expensive compared with wires (dollars instead of cents)

        Sniffing a wire isn’t that much harder than BT or Wifi and it is not encrypted so that is not really the problem. What is is 0wnership. Any BT and Wifi chipset firmware has a a change of 1 that it will be broken within 10 years

        Designing antenna’s also cost efford

        I know your Apple so need a lot of different cables but out there in not-Apple land they have standardized on usb-mini. that is all you need (plus whatever that earphone plug is called)

      • Kizedek

        Movement on the margins front can also simply mean that they have a new mix of products that includes new products. They always warn that new products will decrease margin.

        Once a product has been on the market a year or so, the fixed costs of development have been paid off and the margin goes up. The longer the life of the product (as with the iPhone 4 or 4S), the lower the cost per unit when all units have been considered — regardless of component prices.

        The margin on Apple’s older products is higher. Ironically, lower gross margins across the board actually means new products are selling well.

        Other companies rarely see this. If a company makes half a dozen new models every six months and barely sells any of them in the single digits of millions, then they will never achieve such margins.

      • charly

        That assumes that those dozen new models are under the hood very different. In reality they are often more a different paintjobs

        ps. Apple’s 4s are under the hood also a few different models.

      • Kizedek

        Cool, Apple improves even the same model in subsequent periods; and somehow still manages to improve margins.

      • charly

        Make different is not necessary make better. They sometimes have different radios etc.

  • Usage and satisfaction statistics also imply that it is an effective system, the hardware devices are sold to people that really use them to access the ecosystem and are satisfied from what they get.
    Those too are key to maintain the margins and Apple focus rightly is on user experience.
    And satisfied users buy from itunes and that increase the ecosystem appeal for developer and that improve the ecosystem, a virtual circle.

    Android devices, used only as phones, are counted for market share but do not count as ecosystem extension metric, so ecosystems war is a very different story from market share war.

  • JohnDoey

    Wasn’t the margin drop simply a result of Apple turning over its whole product line all at once?

    They sell each product generation at a set price over the course of a year or so. Therefore when the product first ships, it has a low margin, but over the course of its sales life, that margin rises as component prices fall and production becomes streamlined.

    If they replace all their products at once, then that could cause a short-term margin crash. However, you come back 6 months later and the margins are way up again.

    • charly

      Sound production is always used as the reason why ios is better than android. Problem is that it is a very small market otherwise Amiga would still exist

      • Kizedek

        way to miss the point. John is saying that the hardware of the iPhone and iPad in combination with apps together provide solutions to any number of real world use cases — which previously would have required costly, specialized pieces of hardware.

        I would add that simply providing a USB port or an SD slot, or anything else that makes an Android phone “open” and “extensible” does anything to bring an Android device “up to par”. The point is that the whole system adds value. You have to have hardware and accessory makers, and app developers, all willing to take a chance on the system. Hence, you have solid, top-notch card readers, credit card swipers, diabetes blood sugar devices, pro camera lens mounts, midi interfaces, you name it, for the iPhone.

  • stefnagel

    The terms product and service are innately confusing. A service can be a product of an organization’s work. A product can be a service the organization renders to customers. I like the term “solution.” Products and services are solutions when they address the work to be done successfully. For that, Apple can charge a premium.

  • graphex

    The impact and benefits I experience from the Apple devices I use (maxed out iMac 27 at work, 17″ MacBookPro for traveling, iPhone in my pocket and iPad for the few other times) and the sync’d services across these devices (Mail, OmniFocus, Dropbox, Safari/Pages/Numbers through iCloud and VPN/screen sharing) is simply profound in both my professional + personal lives. If there were better tools to make me even more efficient, trust me, I’d buy them. The bottom line is Apple’s offerings of ‘hardware as a service’ allow me to be more and more productive every day.

  • Space Gorilla

    It does seem that many analysts, and regular folks, don’t understand that the iPhone or iPad is more than just the device. Perhaps because usage is so low in the Android world, that causes a bias to discount the importance of the ecosystem of content and services?

    • obarthelemy

      Or perhaps because the same content and services are available on Android, thus nullifying the issue ?

  • Rogelio Solis

    I agree with everything in this article, except for the following statement:
    “The irony being that Apple was nominally an (implied) low-margin hardware company while Microsoft was an (implied) high-margin software company and Google was an (implied) high-margin internet services company.”

    I believe Apple has always been an implied high-margin hardware company, even from yourself, am I wrong?

    • Kizedek

      Horace isn’t comparing Apple’s margins to other hardware companies, he is comparing hardware margins in general to software margins in general.

      Software should absolutely have the greatest margins: you provide a set of serial numbers to your OEMs, or at worst you copy optical media and stick them in a box.

      Now MS is making the shift in function to hardware, and consumer hardware at that. It should be shaking the world, but as usual the attention is on how much Apple needs to wow everyone with its next product before it dies.

      • Sacto_Joe

        One fascinating aspect of Apple’s disruption via mobile is that Apple has undercut the Microsoft hegemony. As a result, software’s margins are under attack for the first time in a very long time. Apple has thrown the gauntlet down for pure software companies, both with the generally lower price iOS sells for and with the free Apple software it is now offering.

        So ironically, we are seeing Apple maintaining high hardware margins both by its first-mover position and by its focus on high quality while its competitors are left with the hardware scraps and increasingly commoditized software.

      • Kizedek

        Yes. And MS has always been less able in software than most wanted to believe, while Apple has always been better at software than most wanted to believe…
        …the proof is in the hardware.

      • highr0llerr

        While I agree with Horace on a lot of points he’s making, I don’t think that any software business is necessarily a high margin one. In one of his earlier posts about iTunes, Horace made an assumption that Apple’s software business should have similar margins compared to Microsoft. The purpose of each company’s software is different. In Microsoft’s case it has been its primary revenue driver. Whereas for Apple, software is a product that sustains its hardware and the ecosystem in general. Thus, the pricing policy is driven by totally different considerations. Apple doesn’t price its software to hit a specific margin target, it does so to increase the attractiveness of its products, which in turn may lead to higher sales. They have been known to change the software pricing dramatically. E.g., when they dropped the OS X price from north of $100 to just $30 a few years ago. In September they started giving away some of its software for free. Again, the software margins likely took a big hit. I wouldn’t be surprised if all of Apple’s software goes free in a few years, implying negative margins. IMHO, it’s erroneous to assume that Apple maintains constant software margins and that they’re similar to Microsoft’s.

      • charly

        Apple does not sell mainstream software with monopolistic qualities except OS X and in that case they get their money trough hardware. Software without monopolistic qualities does not have fantastic margins like Office and Windows.

        Selling updates for software that interacts with the internet doesn’t make sense.Without it you can take a much more aggressive end-of-life policy (even asking real money for extending that) and the rest of your user base is much more uniform. Every linux company works that way, now mac and chromeOS and my expectation is that Microsoft will follow after April.

      • Kizedek

        Hey, you seem to be half way there. Just waiting for the final penny to drop with you: the integration of software and hardware makes both better than they would be alone (or with any two different companies each providing one).

        What’s that quote? “Anyone serious about hardware will create their own software”? Well, the converse seems to be true as well. We’ll see if MS and Google are really serious about software.

        The whole is better than a sum of its parts, and that is why people are willing to pay more for an Apple product (in case you are still wondering).

      • charly

        Integrating software and hardware has advantages but it also has negatives. In the PC world all the integrated pc makers are death as i don’t think Apple makers their own chipsets anymore but just buys them in from Intel

      • Kizedek

        It does seem to have disadvantages: you have to be willing to forego some marketshare for profit, and for the freedom to make the product you believe in.

      • charly

        You seem to assume that Apple is an integrated PC maker,I have so my doubts about that as their hardware is relatively stock Intel.

        That statement forgo marketshare for profit is weird. It assume integrated in more profitable which if i look at history is simply incorrect otherwise Atari, BeOS Bebox, Amiga, Archimedes, Next, SGI, Sun and countless others would still exist. Also i doubt that the margin of Windows + Dell combined on a Dell PC was that much different from an Apple PC.

      • Kizedek

        Obviously, the context is Apple. I don’t think the advantages or disadvantages, one way or the other, are going to be always be the same for all players.

        I am not assuming integrated is more profitable. Obviously, it is Apple that is profitable, whatever they are doing. You are seeing all kinds of disadvantages, apparently, and not seeing any up sides. If there are disadvantages for Apple related to marketshare, for example (as critics always seem to want to point out) perhaps there are advantages that mitigate or make up for them.

        Your assumption (and of others like Obart) seems to be that Apple can’t possibly do both hardware and software well — that their success is down to some trickery and cool factor. I think it is becoming increasingly clear to more and more people that Apple does in fact do both extremely well. And when others try to follow, no amount of vapor, obfuscation, trickery, or billions spent on marketing will get them close to the goal of being like Apple.

      • charly

        I’m not seeing only all kind of disadvantages, i’m seeing advantages and disadvantages in being integrated and to be honest i think the disadvantages win in the end so an integrated company like Apple looses in the end to disintegrated companies like Qualcomm and Android (though to be clear i think Qualcomm will be replaced by either Samsung or Intel)

        Apple’s success is down to luck, but luck has to be forced with hard work and talent

      • Kizedek

        There you go again with the “Android is a company that Apple has to compete against” idea. It’s really hard to have a serious discussion with you. Apple is not competing against its suppliers, either. (However, both MS and Google are competing against their customers).

        I’ll leave you with this : 10% of the phones, 87% of the profit.

      • charly

        So what, i would play for Madrid for 1% of what Messi makes

      • Kizedek

        so, Samsung would love to sell 10% of their phones and make double the money they are making now. But they don’t know how to make the product that will sell strongly at a higher margin; and it is questionable whether they have a sustainable business at their current income, since a lot of their business is built on offers and 14B in marketing and channel payments — Samsung may yet succombe to the race to the bottom plaguing the other OEMs.

      • marcoselmalo

        Before the transition to Intel, they used “stock” CPUs from Motorola and IBM. I’m not sure what your point is, unless you are ignoring that designing a motherboard and selecting components have value in the integration equation.

        You seem to be implying that integration requires custom design of every component down to the smallest transistor.

      • charly

        “Stock” when your 99% of the market is not really vanilla

        You don’t have to do everything custom but if the “integrated” is almost the same as the not integrated than i don’t see the value of being integrated

      • marcoselmalo

        Has Apple ever used commodity motherboards? Do they use a wide variety of sources for any one component in any one model? (For example, how many different vendors provide the optical drives for the MacBook Pro? Repeat this for every subsystem you commonly find on a computer.)

      • charly

        Has Dell or HP ever used commodity motherboards?

        ps. I know how Dell started so lets say from 1990

      • marcoselmalo

        I’m afraid I am not getting your point. I know for a fact that Dell used rebadged motherboards and would use a number of different ones at different times for a single model of computer. I’ve seen it with my own eyes.

        But as I’ve said, what is your point? You seem to be implying that using off the shelf components equates with a lack of integration, but really you seem to be chasing your own tail.

      • integrated

        Going back to your actual original point:

        “You seem to assume that Apple is an integrated PC maker,I have so my doubts about that as their hardware is relatively stock Intel.”

        Have Dell or HP ever created their own operating system and application software?

      • charly

        HPUX? And what did you think Digital & Tandem are.

      • integrated

        I have no idea. They sure seem to ship a lot of windows computers, if they’re so integrated maybe they should solely ship HPUX.

      • Kizedek

        “I don’t think that any software business is necessarily a high margin one.”

        Then you get it. Most people don’t. Particularly the ones who have said that Apple should have licensed OS X and iOS.

      • link

        “In one of his earlier posts about iTunes, Horace made an assumption that Apple’s software business should have similar margins compared to Microsoft.”


      • highr0llerr

        “My estimate is that Apple’s own software generated $3.6 billion in
        Revenues in 2012. As you can imagine, this is a high margin business
        which grows at nearly 20%/yr. Although I estimate that the software
        business has been overtaken by the Apps and Music businesses in gross
        revenues, it keeps an operating margin similar to that of Microsoft or
        about 50%.”

      • link

        From context that was obviously just comparing the calculated margin at the time to that of Microsoft in order to validate the margin estimates, not a judgement that they should keep and maintain those margins, which is what you appear to be arguing against.

      • highr0llerr

        I don’t agree that Apple’s software margin could be estimated based on Microsoft’s margins alone. Not now, not a year ago. That’s my main

      • link

        I didn’t say that’s what happened. From the quoted sentence, it appears the margins were estimated and then compared to Microsoft.

    • outlier

      The sentence means that hardware companies are generally low-margin, so, being a hardware company, you would expect their margins to be low. The point of the article is to try to understand why they, as an outlier, have margins on par with software and service companies.

    • Rogelio Solis

      Response to ‘outlier’ and ‘Kizedek’:
      Horace Dediu analysis is already “implied” to be the best in his field so, no, this “irony” statement is completely out of the question and is simply a mistake that negates value to his otherwise excelent explanation of this article’s title.
      I have a deep respect for Mr. Dediu and for all of his well intentioned commenters of his posts, this glitch on his thinking must be nothing more than an outlier, no pun intended.

      • Kizedek

        No, you are not wrong about Apple being a “high-margin hardware company”. Your interpretation of Horace’s text is simply wrong.

      • Kizedek

        You are correct that Apple is a “high-margin hardware company”, no implication about it.

        You are simply wrong in your interpretation of Horace’s text. It’s not a glitch, it simply doesn’t mean what you think it means.

        If a company is in the hardware business, whoever they are, the implication is that they are in a low-margin business compared to software or services.

        The irony that Horace is suggesting: Apple is staying firmly and consistently where it has always been (despite Wallstreet’s tunnel vision on every little percent down or up); MS is moving away from its traditional function as a software company, and moving more and more into hardware (something it has notoriously found difficult); and Apple is better at software than anyone gives them credit for (the main reason, in fact, for Apple’s high margins in the first place).

    • Kizedek

      [edit, moved]

    • I’m citing “Conventional wisdom” which states that hardware has a tendency to become low margin.

      • charly

        Convention wisdom is hardware becomes low margin, software becomes no margin

      • Kizedek

        Yeah, now, thanks to Google. It wasn’t that way for 25 years. Hence, the predicament that MS is now in.

        But apparently, it’s Apple that better watch out –– not the company that is having to change its whole structure and ways of thinking in order to survive in a changing world.

      • charly

        Google did not exist in 1995 but Netscape was free or look at the whole GNU thing or *nix before it, or FreeBSD

        The software wants to be free thing has nothing to do with Google. It is just a trait software has because the only cost for making it are design cost

      • Kizedek

        Hey, if you saw through MS’ snake oil business back in the day, good on ya. We are citing the “conventional wisdom”, and apparently, once MS came along with their IBM deal, “everyone” thought that was the way software was and always should be “done”.

        And they still act like it — Apple critics even here go on and on about how MS isn’t in any serious trouble because it can always milk the “enterprise” for upgrade licenses for ever or some such. …but it’s Apple’s margins we have to worry about, though, isn’t it?

      • charly

        As if Apple is better. in fact it is worse

      • Kizedek

        Not sure how great support, customer satisfaction and free updates that not the only extend the life of a product but improve it as well, could be construed as “worse”. As compared to the requirements to pay yearly for connections to networks and servers, etc.

        …but, then, you don’t believe in TCO studies, so whatever helps you sleep at night. OK, Apple is in fact worse (just not sure in which universe).

      • marcoselmalo

        Netscape was free because its main competitor, Internet Explorer, was free. Which was a bit ironic, in retrospect.

      • charly

        Netscape was shareware IIRC

        Mosaic was free, Netscape had a Gold version. This was all before Internet Explorer even existed.

      • marcoselmalo

        You might be right, but the way I remember it was that Netscape had a plan to charge for the browser application that was destroyed by MS offering IE for free.

      • N8nnc

        Internet Explorer was not quite free, rather “bundled with (your purchased at high cost) Windows”

      • charly

        It was free on Mac os9 and SunOS

      • marcoselmalo

        The Mac version was free, iirc.

        But whatever. At the time, it was more common than not to pay for software. Monetizing via advertising wasn’t really an option. Netscape hit upon the idea of making money via server sales.

        Most people (not including YT) were buying windows or computers with windows preinstalled anyway, so IE was free as far as they were concerned.

        This was 20 years ago, so if any of my facts are off, or the timeline, forgive me and correct it. Thanks.

  • vincent_rice

    “hardware as a service” is today’s mantra. It’s going up on the wall in big letters…

  • Sacto_Joe

    Hi, Horace,

    About a year ago, you had this to say about iTunes margins: “This means that iTunes inclusive of Apple’s own Software generates as much as 15% operating margin on gross revenues. That’s over $2 billion a year.” ( ) In light of Apple’s decision to give much of its software away free, thus both removing revenue and increasing expenses for the iTunes division, can you give us a new estimate of the operating margin for iTunes?

    Also, since iTunes is growing revenue faster than Apple as a whole, hasn’t the presumed lower margin of the iTunes division negatively impacted Apple’s overall margins, and won’t it increasingly do so in the future? And do you have any thoughts on the degree that this has occurred, or, all things being equal (i.e., assuming no major disruptions in the near future), will occur?

    (I’m personally not concerned with decreasing margins so much as with EPS and P/E compression, but shrinking margins could eventually become a cudgel for anti-Apple forces to attack the stock price.)

    • GlennC777

      Very good questions. I’d like to know the answers as well.

      In other words: could iTunes still be considered something of a loss leader? (Semantic pedantry notwithstanding).

      Looking at the graph, Apple is the company about whose margins I’d be least concerned.

      • Sacto_Joe

        I just got nailed to the wall on Apple 2.0 for using the term “loss leader”! I found a definition that shut them up:

        “Loss leaders are goods or services offered at steep discounts (generally below cost) in order to attract new customers to a store.”

        I pointed out that it says “generally”, not “always”….

      • GlennC777

        So I noticed. Hence the “semantic pedantry” reference. Ignore such silliness. You were right on.

    • highr0llerr

      So far Apple hasn’t cited the growth of iTunes revenue in proportion to the overall company’s sales as one of the reasons for the gross margin declines over the previous year. Personally, I believe that the App Store, the key component of iTunes, is becoming increasingly more profitable and is (at least partially) offsetting the decline in margins for iTunes due to the changes in the software pricing policy. I’d like to see an analyst asking Apple’s management about that in a quarterly conference call, instead of wasting time asking pointless questions about future products that they know will not be answered. Apple likes to emphasize how much the App Store is profitable for developers, but they have no reason to boast about the App Store being profitable for them, so they are unlikely to offer any data on that, unless specifically asked.

      • Sacto_Joe

        I can’t disagree, except to say that I HOPE the iTunes earnings aren’t dragging down Apple’s overall earnings. Unfortunately, I also agree that Apple is not likely to “boast” about revenue from a income stream that they once declared was operated at approximately break-even.

        If iTunes were going to be separated out in the comparisons to other companies, then I’d say tell all. But we don’t see, say, Microsoft’s margins being concatenated with the margins of PC manufacturers, and I don’t expect we ever will.

        So is it better for Apple to just not give the information? I don’t know. There are pros and cons on both sides. But I guess if it is in fact dragging down margins, I’d rather have it out in the open. It would then be up to bloggers like Horace to point out the unfairness of comparisons that don’t concatenate hardware and software revenue and margins.

      • NostraThomas

        Mr. Joe, Good questions and observations. One thing: Apple definitely doesn’t want to declare much profit from media sales– music, movies, books, etc. Apple pays to license those things and if the content owners get the idea that Apple is more than breaking even, those licensing fees will be raised at renewal time. Netflix had that problem and has dropped/lost a lot of content because of it. Expect Apple to keep those numbers close to the vest and rely instead on terms like “break even”.

      • charly

        The healthiness of a margin is not something absolute but depends also on risks incurred by selling a product. The risk for Apple in selling other peoples software and content is much lower than in selling their own hardware (Apple doesn’t have to pay for an unsold app but it does for an unsold iphone)

      • Kizedek

        Indeed. Seems to be something MS forgot with the Surface, something Samsung forgets as it gives away its products, and something Motorola and others forgot when they made products they couldn’t give away.

        Amazing how adept you are at finding lessons that only Apple has learned.

      • charly

        Explain. I don’t follow you?

      • Kizedek

        Well, the risk you are concerned about is really rather more of a risk for others, don’t you think? Apple seems to be handling their end rather well.

        As I understand it:
        a) Apple sells pretty much every product they can make. There entire stock turns over in a matter of days apparently (Something that even the perishable food industry would find enviable). And Apple keeps their price points on item they sell; so, Apple must be getting something right.
        b) MS took a write-down on Surface; and they don’t really have a handle on hardware, manufacturing and supply chain like Apple does. They are going to find hardware difficult in any volume.
        c) Motorola was failing on its own; Google didn’t turn it around; and now someone else is giving it a go.
        d) Samsung promotes its products in all kinds of ways. They sell comparatively few premium products for full price.

      • charly

        No, If i was you i would say that Apple not selling their iphones is about 1 in a million so the risk is tiny but with apps etc. it is zero so risk for the itunes store is smaller than for iphones and should have lower margins to be health.

        ps. How is the 5c selling? They may sell any 5c that is made but that is because they canceled a lot of orders. Canceling cost money.

      • Sacto_Joe

        Re: Part the first: I agree. I just think the market isn’t smart enough or well informed enough to get that.

        Re: Part the second: I don’t know how well the 5C is selling. But recall that it’s main intent was to lower the cost for a “year old phone”, so the real comparison is between it and the year earlier year old phone.

      • charly

        It is selling less well than expected otherwise the wouldn’t have canceled contracts.

      • Kizedek

        How is the 5c selling? Probably fine. But we won’t know much detail until the quarterly call, I guess…

        As ever, the “issue” is predicting mix to have on hand before a new launch. Someone always has something to complain about.

        Apple wonders if 8M iPhones on hand is enough for a launch weekend. Apple doesn’t want to overdo it… after all, MS could only sell about 200k of their 2M Surfaces.

        So Apple goes with, let’s say, 5M 5c’s and 3M 5s’. But Apple, lot and behold, gets orders for, let’s say, 3M 5c’s and 6M 5s’ on launch weekend! What a problem… Sell remainder of 5c’s throughout the rest of the month, and frantically increase production of 5s’ to 500K PER DAY, never having dreamed that the 5s would be so popular.

        Lower the anticipated production rate of 5c’s and raise the rate of 5s production. It’s called fine-tuning production.

      • charly

        Selling fine is not selling much lower than expected.5c sells below expectation. That is bad news for Apple

      • Kizedek

        The point is, as many have commented, Wall Street “rewards” for short-term gain, not sound strategy. Apple simply refuses to play the game, and refuses to chase marketshare for its own sake.

        So, if sales are less than expected, they adjust production, and move move to correct the next iteration of the product. They neither sit on a warehouse of unsold goods, nor give away the products.

      • Sacto_Joe

        I know that. You know that. Does the market know that? They sure don’t reward AAPL like they do….

      • charly

        A company shouldn’t let the market decide what is good for them.

      • Sacto_Joe

        “A company shouldn’t let the market decide what is good for them.”

        That’s a logical disconnect. I never inferred in any way that Apple let the market decide what is good for them. I mean, it’s a true statement, but so is “The sky is often blue”.

    • I will write about iTunes margins at some point in the future. I estimate that the margins have indeed come down.

      • Sacto_Joe

        Thanks, Horace!

  • peto1

    “a preference for the facile explanation.”

    Horace, ignorance is a passion on par with love and hate …

  • Neohedonist

    “In other words, the iPhone and iPad enjoy margins not just because they are new and well designed. But also because they form part of a ecosystem. The key word is ‘system’. The user buys into a system not just what the device embodies.” To me this extract is the nub of the issue and explains how Apple has managed to maintain margins and customer loyalty. Personally i find the 5S a bit too small for my ageing eyes and would prefer something Note-sized but my investment in the Apple ecosystem is such that its not worth doing that apart from the build quality of the iPhone

  • Gene Grush

    Excellent comparison of the margins for Apple, Microsoft and Google. Another key ability for Apple to maintain there margins is there ability to vertically engineer and control all aspects of their manufacturing. This seems to have resulted in a lower cost of goods or lower manufacturing cost. This prevents Samsung from greatly undercutting Apples prices for small functional tablet unless they want to take a significant hit on their margins. In the case of tablets, Samsung is only matching on price.

    The Eco system is a huge driver in customers to continue to buy Apple products, but if there is an enough of a price difference for the same functionality people would switch.

  • 程肯

    “and a preference for the facile explanation.”
    LOL, I think you got it!

  • Shoulda been an Ibanker

    How to improve Apple’s gross margin:

    What if Apple bought Comcast?

    We used to toy with the idea that Apple should buy Sprint to
    control its own network (as it likes to control everything), but this seems
    much better.

    Comcast is big: enterprise value $187bn, but Apple, if
    anyone, could do it as it has more than $150bn in cash on its balance sheet and
    AA+ rating. Some combo of cash, stock, debt, could get the deal done.

    It would boost Apple’s gross margin from around 38% today to
    more than 46% — GM is probably the most important measure for Apple analysts.

    Both companies are cash flow machines.

    It would solve Apple’s longstanding problem of getting
    content for its “hobby” Apple TV with NBCUniversal and Comcast’s existing content deals – and likely force Disney (with ESPN, ABC,
    etc.) to the bargaining table – Jobs’ widow is also the largest shareholder in

    It would instantly give Apple a massive broadband network
    and bolster the value to its Cloud offerings.

    Since net-neutrality was just struck down in US, the value of
    owning a network just went up a lot.

    US telcos are starting to push back on iPhone subsidies,
    this deal would give Apple a lot more bargaining power.

    It would have no impact on international iPhone/iPad
    business partners, but add a lot to domestic business and overall cash flow and
    GM, current return on $150bn in cash and investments is negligible.

    Idea is not so far fetched as Microsoft used to be a big
    cable investor with its holdings of ATT Cable and then Comcast. Apple seems to love to do things that Microsoft fumbled (tablets, smartphones…)

    Apple has recently been rumored to be spending a lot to
    boost its internet throughput –pressuring suppliers like Akamai, why?

    Apple had also apparently been in talks with TWC to partner
    over Apple TV. Comcast deal obviously changes that dynamic.

    When asked about the company’s cash and buybacks reecntly,
    Apple CEO Tim Cook suggested that they may need the cash for a big
    transformative deal – they’ve never really talked like that before.

    • charly

      You haven’t named wifi network as a reason to own Comcast but building out your own glass network is probably cheaper than buying Comcast. I can also be done sequential so possible losses are smaller

      • Shoulda been an Ibanker

        What about customer acquisition costs? Comcast already has 20mm paying customers, and will have another 8mm when TWC deal closes. Comcast also has content, something Apple desperately desires. It’s a lot more than just fiber.

    • StevenDrost

      Almost all that cash is overseas and would need to be repatriated at a steep cost. Never going to happen.

      • charly

        How can all the cash be oversea when Apple makes most of its money in the US

      • StevenDrost

        They make a lot of money in the US, but not most. Besides, the dividend and buybacks are all from domestic cash. But that was not my opinion check the numbers.

  • obarthelemy

    Several questions:

    1- “The user buys into a system not just what the device embodies.” How certain are we of that ? A quick – and statistically invalid- survey of 3 iPhones around me show the ecosytem to be irrelevant: all aps installed are either also available on Android (I can’t speak for WPhone), or can be substituted. No peripherals have been bought, and neither has much media content. Hard to gauge the importance of the OS itself, but neither of the three use Siri (neither do Androiders around me use whatever voice stuff is in Android nowadays) . Also, the underperformance of the plastic 5C, which does enjoy the same “system”, seems to point at the actual device being the purchase trigger (for its camera, design, looks and brand). No Apple Stores in my neck of the woods, so that’s out of the equation.

    2- Are there any models for margins vs market share ? Apple’s market share has been falling rather fast both in smartphones and in tablets, as conventional wisdom predicts (I guess I’m the “facile explanation” posterboy). In that context, what’s interesting is not so much that Apple have maintained margins, but whether they’ve paid a higher price for it (in market share) than would be expected.

    3- I’m wondering whether Apple shouldn’t be benchmarked also vs luxury companies, say Burberry and Yves Saint-Laurent.

    • just

      Did you read the word “just” in the sentence you quote in 1?

    • Flexxer

      1 – Please stop sharing your anecdotal “evidence”. It proves absolutely nothing whatsoever.

      2 – You may have missed a few days of news lately. Two data points you might find interesting: Apples share of worldwide mobile phone sales went *up* from 7,5% in 2012 to 8,3% in 2013. Apple collected over 87% of all profits made in the global handset market in the December quarter. Quite a price they pay for concentrating on the high end, right?

      3 – I’m wondering how many Android vendors will have to lose money quarter after quarter unril you realize that it’s *them* who are in deep sh*t.

      • obarthelemy

        1- Anecdotal evidence is not very valid, but *is* better than no evidence and tautological assertions. Quantitative or qualitative research would be much better, but I’ve never seen any about that subject. Don’t forget that the opposite of “facile thinker” is “convoluted believer” ^^

        2- I don’t accept the validity of “smartphone market share should include dumbphones”, unless you also include at least landlines, MP3 players and radios, and a dash of TVs, books, and PCs.

        3- Sorry, not about scorekeeping but about trying to understand Apple’s margins

      • You accept “smartphones” like the Galaxy Y as smart phone when they are basic feature phones. What counts is the overall share of all phones. Markets hate like Androids will collapse just as fast as Symbian’s did.

      • charly

        Have you ever used a Galaxy Y? It’s a smartphone (crappy, but good for its price)

      • Flexxer

        1 – Your own example shows that yes, actually, anecdotal “evidence” *is* worse than no evidence as it distorts your perception and you obviously are unable to look beyond it.

        2 – Share of the total mobile phone market is the only market share metric that matters. You must be the last person on the internet to not understand this.

        3 – Sorry, but no, you show time and time again that you are all about scorekeeping, as long as Apple’s score is negative. Which it always is, at least for you.

      • charly

        2. An emergency Samsung C270 is in a different use market from a smartphone so no, the total mobile phone market is not important otherwise you should also count ipods & landlines

      • Kizedek

        Read the article on Ben-Evans about “smartphone” as a metric. You can’t get any more phones than “all phones”. “Smartphone” is growing from zero a few years ago, to rapidly subsuming the whole phone market, by definition. Horace talks a lot about this.

        Again, you can’t get more phones, than all phones. Apple was shooting for 1 percent. They have been moving from 8 or so, to 12 or so. Maybe they have a shot at 20%, who knows?

        Their share of “smartphone” goes “down” because that arbitrary category is growing faster than iPhone is growing, but as a category, “smartphones” cannot grow beyond the set of all phones of which it is a subset, by definition. That should be obvious.

        Now, of course “Android” (of some flavor) is on most phones already, “smart” and “dumb” phone alike…. Because it is the new default, free, lowest common denominator OS for all phone OEMs, whoopee!

      • Mark Jones

        The smartphone share metric is flawed because a larger and larger percentage of smartphones are being used as if they were just featurephones (primarily voice and SMS/MMS on the move).

        When iPods and landlines provide voice comm and SMS/MMS on the move, then one should include them too.

      • charly

        A larger share buy them as feature phones but they soon use them as smartphones. Who doesn’t want Whatsapp.

        A C270 does not provide MMS and adding SMS to a landline isn’t hard.

      • charly

        With a fritz! you can have landline smartphone

    • Jeff g

      That post was the best example of mental masturbation I’ve seen in a long time.

  • Liuliulemon

    From my perspective, I believe there’s another reason why Apple has such high margins, or why Apple charges such margins. Apple strives to promote its product as a luxury – as an unique experience. To create such an image among consumer’s minds (especially Chinese consumers) charging a high price is part of the value proposition. This is partly evidenced by Vertu charging thousands of dollars for its outdated phones from the 80’s that rich consumers still buy.

    • Sacto_Joe

      I can’t agree. Apple isn’t in the “luxury” business, it’s in the “quality” business. Huge difference.

  • Kenton Douglas

    Looking at the second chart the valid comparison is between MS and Samsung, ie an (almost) pure software business vs an (almost) pure hardware business. In that regard conventional wisdom stands true. Both Apple and Google are somewhere in-between as evidenced by the chart. Google is largely a web services company, and in that regard a roughly 25% margin isn’t inappropriate. Similarly, the margins returned by Apple aren’t exceptional for a fully integrated operation.

    • benchmark

      “Similarly, the margins returned by Apple aren’t exceptional for a fully integrated operation.”

      What’s your benchmark here?

      • Kenton Douglas

        Simply MS. I don’t know where this perception of Apple as hardware company comes from actually. They have two OS’s, development languages, a browser, productivity suites, content creation apps, a fully integrated cloud service, etc … just like MS. Therefore a using MS as a benchmark is valid to me. I think they key is their operational scale on hardware, and, as mentioned being fully integrated where we can talk about HaaS.

      • benchmark

        Seems like a terrible benchmark for a “fully integrated operation” considering their money is solely made from selling software for other people to integrate.

      • Kenton Douglas

        Maybe, but it depends on how you look at it. For me “fully integrated” simply means Apple make their own hardware. I would look at the second chart and say the difference between MS and Apple averages at maybe 5% (+/- 2%)? That is about your average Windows PC OEM margin. There’s nothing ‘magical’ about making hardware. You could make a case that being fully integrated results in a better user experience though.

      • benchmark

        The value of an integrated computer company is in both hardware and software.

    • Sacto_Joe

      “Google is largely a web services company, and in that regard a roughly 25% margin isn’t inappropriate.”

      Google, however, has competition (principally Bing and Yahoo), although the competition hasn’t yet challenged Google’s margins, being content to enjoy higher margins themselves. Still, in theory, an adequately funded competitor could drive Google’s margins down. That is exactly what Apple is doing to Microsoft. Basically, it has created low margin software, funded by its high margin hardware arm. If Google becomes too much of a nuisance, Apple will do the same to them that they’re in the process of doing to Microsoft. (How? Apple buying up Yahoo comes to mind. And why not? After all, Microsoft has Bing.)

      Of course, Google has the advantage of seeing Apple slowly disassemble Microsoft, and also of seeing how Microsoft doomed itself by moving too slowly towards an integrated solution like Apple’s. Perhaps Google can build out a complete hardware ecosystem before Apple lowers the boom on their margins (Chrome, I presume). Good luck with that….

      • charly

        Search engines can be money printers so i doubt that Apple wouldn’t try it if they thought they could succeed.

        Apple software is low margin because of the way the books are kept. Add $100 to the price of an Iphone for IOS and their software becomes high margin and hardware not so high margin

      • Sacto_Joe

        “Search engines can be money printers so i doubt that Apple wouldn’t try it if they thought they could succeed.”

        You missed my point. You infer the answer is Apple couldn’t succeed with a search engine, even with a turnkey system like Yahoo. I’m suggesting that they will try it, and succeed, if they feel Google is more trouble than they’re worth. Apple Maps comes to mind….

        “Apple software is low margin because of the way the books are kept. Add $100 to the price of an Iphone for IOS and their software becomes high margin and hardware not so high margin.”

        Exactly. Apple won’t “add $100 to the price” because they gain more by offering it free. It’s a kind of “loss leader”.

        (Definiton of loss leader: “Loss leaders are goods or services offered at steep discounts (generally below cost) in order to attract new customers to a store.”)

      • charly

        I wasn’t clear. Not $100 on top of the price but $100 on the BOM

        Loss leaders aren’t bundled.

      • StevenDrost

        I agree with what you are saying about software margins.
        But with regards to a search engine, it’s not about the potential for success, its about supporting the core objectives of the company. Apple executives have been saying for a long time that their object is to “build great products”. The way they make those products great is through software and services.
        Basically if you think of a service and it does not help sell hardware then they won’t do it.

      • Mark Jones

        I think Google can become a problem for Apple in two ways:
        1) Google removes all of its services from Apple platforms. IOW, it stops being a services company (using Ben Thompson’s – – grid).
        2) Google passes much more of its advertising/search revenue on to device makers so the device makers can make a profit while also being competitive with Apple’s devices.

        To a degree, Microsoft tried option 2 with Nokia, but Nokia with Windows Phone was not competitive on the high-end. It looks to be competitive in the mid- and low tiers where the ecosystem matters less, but at the cost of generating no profit (even when adding in the Microsoft subsidies).

      • Sacto_Joe

        Re: 1): Google already tried that. It lagged development of its iOS maps program. Apple made their own, and it has cost Google dearly. As Br’er Rabbit said: “Please don’t throw me in the briar patch!”.

        Re: 2) Google’s stock would drop like a rock. They could do it, because three people have a majority share interest. But woe to Google if it failed! And don’t forget that Apple has far more cash than Google. In that kind of a shootout, Google could easily lose.

      • Mark Jones

        Good points. Remember when Apple blocked Google Voice from the App Store. At the time, critics said Apple was afraid that its users would choose Google instead of Apple services (though Apple explained that it didn’t want its users to be confused). Regardless, as the Maps switch has clearly shown, Apple has nothing to fear from third-party services. Rather, iOS users have the best of both worlds, Apple services/software and the best third-party services (including Google’s). Just like on the Mac (OS X and Windows and Linux).

      • Kenton Douglas

        I would tend to agree overall. The market for advertising will become commoditized. Thereafter it’ll become a debate about (chargeable) subscription services, ie. iCloud vs Drive vs OneDrive. I think that will shape the future. You’ll probably see packages including Cloud storage, music catalogues, streaming games services, etc. for $x per month.
        In the end you’ll probably see a few large operations (MS, Google, Apple, and possibly Facebook and Amazon) that largely mirror each other with specific strengths in certain verticals, but where they all offer a similar value proposition to a user overall.
        In terms of your comments specifically, Yahoo is currently powered by MS. Apple buying Yahoo would actually assist MS. Also, Siri is now powered MS. So, I don’t see a case where Apple is going after MS by giving away, or charging very little for software. I think they are defending their PC operation in a declining market. Their PCs are too expensive to take significant share from Windows in general terms. It’s the iPad that’s causing the damage.
        It’s much more likely (and probable) that Bing will replace Google as the default search engine on Apple devices. It’s possible Apple might build their own search engine from scratch in the long term – they certainly have the cash. However, they’ve already covered the most important search component in mobile – maps.
        As for Google on hardware, I would think that we’ll see the Nexus program scale up. They already have significant leverage over LG and Asus (Nexus 5 and 7) in terms of those companies maintaining a reasonably healthy business. Now that they’ve had their amicable divorce from Samsung, I would expect to see some very competitively priced bottom end devices from Motorola/Lenovo (Nexus 3?) to compete with Samsung and MS for the ‘next billion’ in the emerging markets. They’ll also diversify into home automation (Nest Labs) and wearables through the ATAP bit of Motorola they kept.
        ChromeOS looks like it’s currently targeted at the business and education markets, where it’ll probably stay. Once mobile hardware minimum specs. move on a bit we’ll see a full Chrome run-time environment on Andriod where you’ll be able to mimic a full ChromeOS instance just like you can on Windows now. NB. One to watch for is a Chromecast enabled version(s) of Google Drive and Gmail to provide something like the old Motorola “Webtop” for content creation using your phone to initiate a streamed instance of those apps, and control a Bluetooth (or USB) keyboard and mouse. It should be an interesting year.

      • StevenDrost

        The problem with cracking into the search business is that Google owns it. Consumers when they think search, think Google, like when people think facial tissue they think kleenex. For a competitor to steal a significant market share, they would have to be an order of magnitude better. For that to happen would take boat loads of cash and time. Even with both, I still don’t think they could make a better product, let alone dethrone Google. That does not sound like a business Apple would consider.
        Then there is the question of “why would they do it?”. They’ve done services (Itunes, App Store, ICloud, Maps), but all those services were designed to help sell high margin hardware. Good search programs already available on their devices, why create another one?

      • mjtomlin

        Based off their purchase of the analytics firm, Topsy, I strongly believe that Apple will in fact release their own search engine, but keep it within their platforms; iOS, Mac OS X, and iCloud. Only Apple has a firm grasp on what interests their users and as such could build an engine that serves up more relevant results.

        Google search is a mess. (Although I will admit, the depth of their information goes far deeper than any other search platform.) They have their hands in so much information and data that their results are rarely relevant to what I’m looking for. Furthermore, there are way too many ads and they allow payments to be made to make sure your “hit” is at the top.

        After developing their own mapping solution, this would put another nice dent in Google’s core ad-driven business. The more “eyeballs” you can take away from Google, the more the value of their ad space drops. Especially if you’re removing the top-tier “eyeballs” who are able and willing to make purchases.

        Google doesn’t develop iOS software because they want the best for their customers, they do it because they know THOSE users are worth more to companies selling goods. Even with all of Google’s grandstanding about Android’s marketshare, their revenue share tells a different story – iOS accounts for more mobile advertising revenue.

      • StevenDrost

        If anything i would think that the privacy issues of creating a search engine would hurt Apple. I agree with you that Apple has access to information that could be used to make an excellent add platform. Where i disagree is how it helps sell high margin devices.
        Your right that it could hurt Google, but even with Maps, that was not their objective. Maps were created because Google refused to allow turn by turn navigation. Apple by creating it forced Googles hand and took away a key advantage of Android.
        See its all about selling high margin hardware. Creating a search program is not inline with their core strategy.

  • “iOS devices are part of a service matrix… the after-sales support”

    Right there. The importance – the powerful nature – of the Apple customer service experience has not, by in large, been recognized by Apple’s critics, bears, and Apple’s competitors.

    There’s tremendous reoccurring value for Apple once a customer is brought under the roof and that customer stays an Apple customer. I could go on about this topic, but I’ll spare you.

    • Mark Jones

      The concept of exceptional after-sales customer support is a staple of luxury or premium brands – whether cars, hotels, jewelry, etc.

      Apple still needs more Retail Stores, especially outside of the US, to fully achieve this service matrix, as its online support is generally slightly above average and not exceptional.

      I agree that Apple’s competitors don’t seem to fully understand this, as the competitor stores (i.e., Samsung, Sony) seem to be more focused on branding than support. Microsoft seems to have a good grasp of this service concept for its Stores, but lacks great consumer products to sell (except for Xbox).

      • Sacto_Joe

        As I said elsewhere on this thread, Apple isn’t in the “luxury” business, it’s in the “quality” business. Huge difference.

      • “Apple still needs more Retail Stores”

        Herein lies another common frustration with Apple. Not enough soon enough. Not enough Apple Retail Stores, not enough “growth”, too many supply constraints, product rollouts that are too narrow in scope, etc. What Apple doesn’t do is on par with what it does do that drives critics mad.

        Apple has been successful, in part, because it addresses its areas of weaknesses in a thoughtful and deliberate fashion.

        It benefits no one to carpet bomb solutions to these and other issues. The competition has littered the playing field with examples of how haste makes waste.

      • Mark Jones

        Critics also stupidly complained that Apple didn’t increase R&D quickly enough. As I’ve repeatedly said, Apple is not in a rush. They forego the quick buck for sustainable long-term growth. Which makes AAPL a difficult stock because the stock market tends to reward those companies that optimize for the next quarterly earnings report.

      • Sacto_Joe

        I totally agree. Apple is methodical. The modern market is interested in short term gain. That same market has jiggered Apple’s volatility in order to create some short term gain, but even there Apple is shutting them down, as with its recent buyback of its own stock when that volatility dropped the price down to $500/share.