Pricing the IPad

When Steve Jobs first announced the IPad the biggest gasp came when he gave the price. Everyone knew that he was going to announce a tablet and that it would be pretty much an oversized IPhone. Industry analysts expected it to go for upwards of $800. Instead the starting price was $500. Since then, most of the competition has either been in that ball park for a smaller tablet or in the $800 range for a similar tablet. Granted, the model of IPad most comparable with these more expensive tablets have similar price tags. That does not make up for the lack of a lower-price alternative. The Galaxy Tablet costs less but requires a two-year data plan.

Traditionally, Apple has some of the highest margins in the industry. How can they sell these tablets for so little?

There have been many suggestions - their low-cost Chinese production facilities, their vertical integration, their Apple Stores. Some of these suggestions have more merit than others.

First, it is possible to produce a tablet with similar specs for less. Viewsonic has a 10" tablet for less than $400.00. According to reviews, it runs Android 2.2 and has great battery life. It also has a slow, clunky interface that is so bad Staples stopped carrying it. Even if the implementation was bad, this proves that it can be done.

So why can Apple do it and no one else can?

I'm going to start by eliminating some of the factors others have given. Yes, Apple has extensive production facilities in China. So do others.

They operate their own retail stores. That means that they could run the stores on a break-even basis in order to keep the price down on the end product. They could but I don't think that they do. If they were cutting margins on the IPad then you would expect them to do the same on other products. They don't. Their computers are expensive.

 They have a tightly integrated product stack. They design everything in-house down to the CPU in their tablets. They do not have to pay licensing fees for the operating system. Again, I don't thing that this is what keeps down the IPad price. The argument still applies about everything else they make and why the rest of it is so expensive. They may not have to pay a licensing fee to Microsoft for the operating system but that does not make it free. They have to develop it themselves. That takes money.

So what is the answer? I think it is a two-part answer. First, the cost of making a device breaks down into three parts. There is the cost of the materials, the cost of the labor it takes to assemble it, and the cost of developing the device. This last is important.

Designing a new product is expensive. It is also a fixed cost. In order to make a profit, you project the minimum number of units you expect to sell then divide that into the development cost and add the resulting figure to the per-unit cost. That gives you your minimum price. You can play with this figure several different ways but the basics are still the same. This is also known as the break-even point - how many units do you have to sell at a particular price before breaking even?

Let's say that it costs $50 million to develop a new tablet. Apple is sure that they will sell more than 10 million units so they can add $5 to the unit price to pay for development. But a competitor does not have the Apple magic. They might only sell a half million units. That means that they have to add $50 to the unit price.

We saw this happen when the IPhone was first introduced. Apple was not sure how popular it would be so they really jacked up the price. It was immediately obvious that they had a hit so they dropped the price by $200 just a few weeks after the phone's introduction.

When Apple introduced the IPad they were sure that they would sell millions so they divided the development costs accordingly. The Galacy Tab has been a surprise hit and has sold over a million (the last I heard) but it could just as easily have flopped. That means that a much higher portion of the development costs went into each one.

That is probably a big factor in the tablet prices. Once a few successful competitors come out we will see prices drop.

There is another factor that is unique to Apple. For most manufacturers, the finished unit itself is the top of the chain. Once you sell it your revenue stream is finished. This is not true for the IPad.

The IPad is meant as a "media consumption device" and Apple set things up so that you pay for most of the media and they get a big cut. If you want to buy music or a video or a book, they are there to sell it to you. If you are paying a service like Rhapsody, then they also want a cut. If you use your IPad the way Apple wants then you are constantly paying for content and they are getting 30%. That means that they do not need their normal margins. They could sell it to you at cost and still make money.

That is a revenue stream that no one is able to match at present.