Rumors suggest that Apple’s next generation iPad could be smaller, less than 8” diagonally, and feature light in order to get the iPad under the critical $200 price point.
A Changing Strategy at Apple?
Apple’s recent movements in the tech space suggest the company is facing stronger competition. Last year, the company moved to keep its older iPhone 3GS product available for sale. The idea is that Apple can hit two types of consumers – those who want the best and newest iPhone at the $199 price point, and those who want an iPhone at a lower cost. The 3GS is currently free from AT&T with a 2-year contract;
The strategy seems to be working. Even my mother, a Microsoft loyalist, recently purchased her first smart phone – an iPhone 3GS – as part of a new 2-year contract. Apple believes that at a lower price point allows it to reach into a new market, while increasing its market share and improving its App Store revenues. The company takes a massive 30% cut from every app sold in the App Store.
But this new strategy may be problematic. For the first time in the company’s history, Apple has to compete on price. Never, ever has Apple been the low-cost leader in a particular space. Instead, it relied on a monopoly on its own operating systems, selling laptops, mp3 players, and smart phones at a price well above similar Microsoft and SanDisk devices.
Why Investors Should be Concerned
Apple’s foray into lower-cost products may mean that the company now has to compete on price. Nike is a perfect example of a company that does not – it’s shoes and clothing are consistently sold at much higher prices than competitors because of its brand.
Speaking of branding, cheapening a brand is something very few companies want to do. Take, for example, Ralph Lauren, a clothing company built on a premium brand. The company also owns the well-known “Chaps” brand, which targets a consumer with less disposable income than Ralph Lauren. Of course, Ralph Lauren could put its name on less expensive garments, but instead it chooses to operate under a different brand for a lower cost audience so as not to dilute its signature namesake.
Apple is very much a premium brand. In fact, the iPhone has become a status symbol in China, where millions of people own the iPhone 4s despite the fact that Siri cannot even comprehend spoken Chinese.
Amazon and Google may be delivering a kick to Apple’s bottom line. In the past few years, Apple’s margins have grown tremendously as it keeps more and more profits from the same dollar of sales.
Apple’s sales have also increased, as you can see from this chart grabbed from Google Finance:
Since 2007, margins for Apple have nearly doubled.
Watch Margin Compression like a Hawk
Investors hate with a passion any brand that experiences margin compression, especially if the firm is a so-called “growth” stock. As Apple launches a low-margin tablet product (one which may cannibalize sales of the pricier, fully featured iPad), and looks toward other low margin devices (the company is rumored to be entering the cable set-top box market), Apple’s margins may be under pressure for several quarters. If the brand is devalued, margins may permanently deteriorate.
If I were an Apple stock shareholder, I would be concerned about Apple’s position on the defensive. For years, Apple has maintained premium pricing and a near “luxury” position in consumer electronics. Should Apple spread itself too thin to target lower margin sources of growth, expect future multiple compression. A high profit margin is indicative of earnings quality and resiliency; declining profit margins imply the company is working too hard to grow its bottom line.
What do you think? Can Apple sustain itself as a signature brand in the consumer electronics space?
A value investor and blogger who enjoys discovering the hidden gems available on the public markets.