I've always been a big fan of Apple, they make great computers, great software and great music players. I'm also a big fan of business and the entrepreneur. I find just about everything related to running a business fascinating. That's probably why I've had quite a few myself. But I'm not here to write about myself today..
Lately I've been giving some thought to Apple's decision to lower the price of their iPhone from $599 to $399 and give a $100 credit to people that originally bought the iPhone before the price drop. On the face of it, this seems like a crazy move. Apple has sold over 1 million iPhones. (just under 1 million prior to the price adjustment). Let's take a look at that.
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$599 x 1 million = $600,000,000 gross sales
$250 x 1 million = $250,000,000 rough cost of phone
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$350,000,000 NET PROFIT
Cost of rebate = $100,000,000
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= $250,000,000 REVISED NET PROFIT
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So Apple has just taken a 30% reduction in profits. That's pretty substantial. Plus at the new price of $399 Apple is only making $149 from each new phone sale. That means that in order to make the same hardware revenue that Apple made off the first 1 million in sales they would have to sell 2.34 million iphones.
When investors heard about the price drop (and later rebate) they were not happy. Clearly they ran the numbers and saw the same thing I did. But if we look at the longer term outlook maybe this isn't so bad... maybe it's downright GOOD. Let's look at the rebate first
$100 rebate is not a cash rebate, instead you get a credit at the apple store. With Christmas coming up this rebate should be huge for apple. Suddenly getting someone an iPod is a much cheaper gift, with ipod nano's going for $49 after the rebate is applied. Or the low end macintosh mini going for $499 after rebate. $499 for a mac computer.. WHOA! In a nutshell the rebate should really increase sales this holiday season.
But Tom.... doesn't that increase sales still result in decreased profit per item? Yes it does, and I'll get to that in minute. But first I want to discuss what the new lower iphone price means.
At $599 the iPhone was the most expensive phone by far on the market. By lowering the price to $399 not only will the phone become more affordable (and in line with other high end devices) to people in the USA, but should be very attractive to people in Europe where the euro is at an all time high against the dollar. Plans are for the iPhone to be release in Europe in the coming months and with some countries having wireless service as their primary phone service this market is huge. It should help Appple hit their published goal of 10 million iPhones sooner then expected.
That brings me to the decreased profit per item issue.... Sure Apple is making less on the hardware side of things, but Apple has a second revenue source, content and subscriptions. Each iPhone is locked into a 2 year contract and Apple gets revenue for each subscriber. I haven't been able to find actual numbers, but even if it's just $1 per month (and the general impression is that it's much higher) that's an extra $48 for apple over the course of a 2 year contract. And frankly probably an extra $100+ over the life of an average phone. More phones in use means higher licensing fees each month. Also more sales of ipods means more people buying music from iTunes also another generator of profit for apple.
In chess there's a little joke that a player can yell out.... "SACRIFICE THE QUEEN FOR POSITIONAL". In essence you're telling the guy to give away his most powerful piece now for a better setup going forward. It's almost never a good thing to do this in Chess, although once in a great while the sacrifice is worth it. Will the sacrifice of immediate profit for potential future profit and better market penetration be worth it for Apple. We'll know in the upcoming months..........Sacrificing the queen for positional? Tomland can't say just yet.
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