Not everyone needs to be Apple, or to do things the Apple way. Apple makes big margins on their $500 hardware. Why can't HP or some other company be profitable by making small margins on $200 hardware, moving a lot of units, and taking a cut of app sales?
I posted this in another thread, but it warrants repeating:
The key factor everyone's missing from a loss leader strategy is that the consumables must be a requirement to use the device. Consoles, razors and printers can all sell for a loss because they are worthless without games, blades and ink. You can get by on a tablet (and I bet a majority of non-tech savvy users do) by just using the built-in apps and/or free apps.
If HP went with this strategy with the TouchPad, it would require that a user spend $1000 on apps to make up for the $300 loss on each TouchPad. At an extremely generous $5/app, that's still 200 apps per user.
Margin is traditionally formulated as the difference between the selling price and the cost of goods sold (“COGS”), basically all of the variable costs required to manufacture the unit and ship it to the customer.
Cost of Good Sold does not include the infrastructure required to get the customer to buy it. So while shipping the unit to an Apple Store might be included in COGS, the rent Apple pays for the store and the salaries of the geniuses in the store are not part of COGS. Marketing expenses are not part of COGS. There’s another value, Cost of Sales or “COS,” that includes certain somewhat fixed but discretionary costs associated with selling the product. COS is always larger than COGS.
Anyways, “margin” is a useful thing to know when comparing products and companies, however we cannot assume that just because Apple has high margins, that there is a business opportunity for someone to have lower margins. It could be that the other business will be killed by their Cost of Sales. This is especially a problem when competing with an incumbent: Marketing and other costs are going to be very high while you try to compete with the juggernaut.
Imagine, for example, that Apple spends $1,000,000 a month marketing to a certain small segment of the market. If you want to sell to the same segment, you are going to need to spend serious coin to offset Apple’s million dollars a month plus all the goodwill Apple enjoys from making products people actually like.
But your sales are insignificant to begin with, so your COS will far exceed any margin you plan to extract, putting you in the red from day one. Meanwhile, Apple is spending that $1,000,000 a month out of their high margins. And worse, if you expect your price to do all the talking for you, what will you do when Apple launches the iPad Nano at a low price? Their COGS are lower than yours, so they can obliterate your price advantage with a single press release announcing a Black Thursday sale.
The hard truth is, competing on price is a difficult job. You need to have very deep pockets and some expectation of a big payoff down the road to make back the money you lose up front. You need to have a COGS edge. In other words, you need to innovate somewhere other than deciding to charge less. Dell did that back in the day with their supply chain optimization. Apple does that now. You need to do something more than simply cut margins: You need to disrupt the tablet business.
It is not impossible, but it is more than simply sharpening your pencil. Exempli gratia: Kindle, as noted by another commenter elsewhere.
HPQ's top line is $31Bn/quarter. Cuts on app sales are a rounding error. Meanwhile, they're selling tablets at cost, devaluing the space they're competing for, and they remain at a structural disadvantage to Apple and Samsung, both of whom are handheld supply chain giants.
How does this work out well for HP?
It's easy to see how it works out well for Hacker News: there's a third viable tablet platform! Yay! But HPQ can't make decisions to maximize hacker morale; they are legally obligated to serve HPQ's bottom line.
Incidentally, your comment addresses only half of Gruber's point; the other half is that a $500->$100 discount's success doesn't prove demand either for a $200 price point or for a product with a $200 BOM.
Spending $195 to deliver a $200 platform, and then making an additional $5-10 per customer on app sales, is not a terrible spot for a business to be in. It's not Apple territory, and maybe it's not worth the risk or opportunity cost for HP given their profitability in other spaces. But one need not be a "big dummy" to think there might be room for a profitable player to use that model.
Incidentally, I only addressed the part of Gruber's post I thought needed responding to. He's right that the fire sale doesn't prove anything about market viability for an at-cost device.
First, HP makes $3Bn/quarter in gross profit. The tablet business you propose is a major strategic initiative that, EVEN IF it pulled neck and neck with the prohibitive market leader, makes only $23mm/quarter†. That's a disaster.
Second, when you're making $15 per customer and the prohibitive market leader is making $200 per customer, your business exists at the pleasure of the market leader; they can cut their prices by 10% and put you out of business; the can plow an order of magnitude more money into marketing and product development and still beat you easily on the numbers.
† And even that assumes that the money from the app store is pure profit, which it isn't for Apple.
I don't understand where you're getting the $23mm/quarter number. The last quarterly numbers I saw for Apple were just under 10 million iPads sold; using the $200/tablet and $15 profit numbers I gave before, that'd be $150mm profit on $2Bn revenue. Those aren't "blow your socks off" numbers, but they're not "disaster" numbers either (whereas what actually happened with the TouchPad was a disaster.) Numbers like that are at least viable for a major strategic initiative for a company like HP, provided there's sufficient motivation for such an initiative.
With the market leader making $200/unit and you making $15/unit, they could put you out of business if they're at a comparable price point. But if the competition's $600 iPad cuts its price to $550 or even $500, it's not going to pull a lot of customers away from your $200 hPad; you're serving very different segments of the market. Similarly, a 10% price cut by Maserati wouldn't threaten Cooper Mini sales.
I'm not saying HP necessarily made the wrong move here. I'm just saying, I don't think you have to be a "big dummy" to think there's room for a low cost, low margin tablet that makes some profit from software.
You're forgetting that those 10 million iPads were sold over many quarters. Re-do your math.
There is absolutely room for a low-margin low-cost tablet. The Kindle is one of them. But there isn't room for the HP Touchpad at HP. I kind of doubt there's room for the HP Touchpad anywhere, because it's intrinsically positioned against a superior product sold by an extremely competent company.
There, I agree. The HP TouchPad is trying to be direct competition for the iPad, and that's why it was a total disaster.
If instead HP made the WeakerPad, with higher capability than the kindle but lower than the iPad, and targeted the $200 price point (where their main competition is a bunch of 7" Android 1.5 tablets with resistive touchscreens), they might find a sweet spot in the market.
Not all of company's products need to be profitable all at the same, especially for the beast like HP. Obviously they need to be in the tablet business as it's direct threat to almost everything else they've got (well, except servers).
So devaluing that space as long as they can thanks to their other businesses might just as well be the only viable tablet strategy for HP while it reinvents itself.
How does it help HP sell servers, printers, PCs, calculators, test instruments, or enterprise software when they burn billions of dollars in an attempt to trash the tablet market?
This just doesn't seem complicated to me: there is no clear path for HP to make money on these tablets at the price points we're talking about. Therefore: they shouldn't sell them.
You don't agree that it is existential for HP to be in tablet business, even if it generates negative or close to zero margin (much like their PC, printer etc. office equipment businesses do now)?
How long do you think will they be able to sell their printer ink (has to be their highest margin business) if they don't compete in tablet space?
edit: so yeah, turns out they're actually spinning off tablets together with PC division as low margin businesses. Doesn't mean that whoever ends up with it (Samsung?) will have to do both.
Profit is an almost perfect indicator of barriers to entry. If a company makes a lot of profit (35+% operating margin) doing something - Apple's HW, or Microsoft's OS - many observers inevitably think they can just come in with a lower margin version, thinking "hey, some margin on huge volumes is still great!" But they miss the point that large margins follow from barriers to entry. Large margins on revenues the size of Apples indicate huge barriers to entry.
Maybe you can clarify what point you're trying to make. A Kindle's main function is to read books, not sell them. Likewise, a tablet's main function is to run software/apps.
edit: The argument that apps are more durable (in the economic sense) is questionable in and of itself; but even accepting the premise, that doesn't necessarily affect customer LTV, since durability is built into the price- the way a refrigerator costs more than a cooler and bag of ice.
We are on the same page- it does ultimately come down to LTV, and my intention was to show examples where it could work (other obvious ones are mobile phones and gaming consoles). I don't honestly have a figure on LTV of app buyers and if there was one I'd love to see it.
Tablet apps are generally not consumable, books are. I use maybe 5 apps on my iPad that weren't free and I keep using them. If I only purchased 5 books on my Kindle it would have become worthless to me after about 2 months.
Sure, you could. But no-one's had much luck with it yet.
When you cut materials costs (and R&D corners) enough to be potentially profitable at $200, you're looking at 7" (or less), lower-res, weaker batteries, resistive touch technology, shoddy integration, little testing and almost no support.
Those tablets exist. They're also crap and almost no-one buys them and is happy.
Apple makes the biggest margins, moves the most units, and has the most app sales of anyone on their platform. It will be tough to compete on any of those fronts.
I also disagree with Arrington on the Touchpad, but Gruber and other Apple acolytes' disregard for high-volume low-margin markets seems misplaced. Yes, Apple makes a lot of money by tailoring devices for high profit margin markets. That's clearly a lucrative way to do things, if you can pull it off. But, obviously, not everyone can. Surely there's room in the market at large for both models? And surely it's good for everyone to see competition at all levels?
There is no room in the market for selling products at a loss, and without a clearly lucrative business model behind it, there's also no room in the market for selling products at cost. Those aren't pundit opinions; they're laws of physics.
There's a back and forth to be had about the value of the app market for HP, but the best available evidence suggests that by itself it is nowhere nearly large enough to justify a strategic investment in tablets.
So if you want to make the point that there are other strategies besides Apple's, sure. Nobody can argue with that; it's not falsifiable. To make your comment useful, propose a way for HP to make real money on those tablets.
The Xbox is sold at a loss but overall is a profitable division for Microsoft. There is room in the market for loss-leaders, it's just a question of where to build a revenue model from.
Unlike Android, HP could have run an end-to-end product, controlling the hardware, software, and app ecosystem, but could have tried doing it at a lower price. There's no guarantee the market would have supported it, but seeing how eagerly people snatched up the fire-sale tablets, it's kind of disappointing not to even see them try.
The Xbox is only useful in tandem with its consumable $30 games. It's a prime candidate for a razor/blades strategy.
In comparison:
(a) Tablets are useful without buying a single app.
(b) The price point on apps is far lower than on Xbox games.
(c) Apps are on the whole less consumable than games, most of which lose much of their value after just a week or two of use.
(d) The sole use case of the Xbox is to facilitate games, which means that everyone who owns an Xbox buys them. The key value propositions of a table are "watch video, browse web, read books", and in each of these three categories the apps to facilitate them are either built in or free.
I share your disappointment, but don't believe my disappointment rebuts economic reality.
Don't forget the vast quantities of accessories for consoles. Extra controllers, Xbox Live, downloadable content, are huge profit centers for the Xbox division.
The difference here is that Apple has such a good supply chain that it's practically impossible for anyone else to undercut Apple without selling at a loss. It's quite likely that an inferior competing device has a higher manufacturing cost than the iPad.
Don't conflate Apple's high-margin & (relatively) low-marketshare/volume computer business with their high-margin & high-volume iPad/iPhone business.
In order for someone else to win on price, they are also going to have to beat Apple on cost. If a Dell laptop and an Apple laptop cost the same, who would ever buy a Dell? And the prices aren't even close, sometimes Apple is 2x the price of a Windows machine (and yet people still choose to buy Apple). But in the tablet & phone space, Apple prices are not much higher than Android/WebOS/Wp7/Blackberry. And Apple's costs are clearly lower.
There are a lot of reasons why this is so. Right now Apple has their own distribution network, the other guys generally don't. Apple has better brand value and has negotiated killer deals with the phone carriers. But at the end of the day the most important factors are the volume & the narrow choice of parts.
Apple has more volume than anyone else, by an order of magnitude. That means they get better prices from suppliers and they can spread their fixed manufacturing costs across more units. Higher unit numbers always leads to lower unit costs for a lot of reasons.
So if you want to compete on a device that is close to the iPad, you are going to be really hard pressed to beat the manufacturing cost unless you ramp up to build the same number (which is super risky if they don't sell).
The only way to get a lower manufacturing cost is to buy components that are lower level than the iPad. This is what happens in the computer business. Going back to Dell v Apple, how many people really would argue a $700 Dell is better than a $1200 Apple in the quality? Maybe in value, but not in quality. In the tablet & phone space, there are not as many corners to be cut. You can fill a computer with a cheap motherboard, hard drive, etc. You can stamp out a crappy sheetmetal case or mold some plastic rather than machine the case like Apple does. Most people won't notice the difference becasue you interact with the computer through peripherals.
On the mobile device the big cost drivers are hard to skimp on. A smaller battery makes a functionally inferior device. A crappy case or screen impacts the look & feel of the device in the way a case on a desktop doesn't. There are few options for CPUs and we don't have the same extraneous CPU cycles like in the computer world so a crappier one is very noticeable.
So how do the other companies get to a lower cost? I just don't see it happening without making a drastically inferior tablet, and I don't think people are saying that tablets are unnecessarily powerful right now.
I see Amazon and B&N taking a big chunk out of the low-cost tablet market, and it will be hard for anyone else to compete.
They can sell direct to consumers and capture more revenue. They have a vested interest in locking customers into their ecosystem, so they can sell at cost. Finally, they are trusted brands and can use their online stores to promote product.
A company like HP and Samsung would make most of their profits on the sale of the device. $200 tablets will never be profitable on their own, so unless you have another revenue stream, it's not worth doing.
That leaves cheap clone systems probably running Android with crappy build quality and nonexistent engineering.
You can be sure that Amazon noticed the frenzy over $99 Touchpads and the strong sales of the Nook color.
I tried briefly to find actual numbers on the manufacturing run(s) of the Touchpad. I wonder how many of these are really out there. Is this just a blip on the chart compared to iPad numbers?
I'm a bit concerned about what this will do to the real Android tablet market numbers. How many Touchpad buyers would have otherwise bought a low-end Android tablet? That market is already fragile enough without HP blowing out tablets well below cost. (It's not that different than the Borders liquidations hurting Barnes and Noble's numbers when they're already struggling.)
Oh, and when does the RIM Playbook fire sale start?
This all goes back to the Jack Welch theory: either be number one or two in your industry, or find something else to do. What the heck did HP hope to gain by building a crappy version of the iPad and charging the same price for it? The lack of innovation at these companies is truly confounding. If I had any HP stock I would be dumping it with both hands.
While I agree with Gruber on HW sales being very profitable must he really resort to "dummy"? Its one thing to see Jersey Shore say things like this, but Gruber?
Apple has suggested the App Store is just above break even [1]. I personally find this believable. I download at least 15 free apps for every paid app. It might even be worse. Approving, hosting, and marketing all those free apps comes at a cost that adds up.
By contrast Apple likes to mark up hardware at 100% over bill of materials. That is to say if $300 worth of components goes into an iPhone, Apples wants to sell it for at least $600. The major exception to this is the iPad which Apple takes less to keep pressure on the competition.
Regarding iAds, I believe iAds was suppose to have sold around $65 million worth of ads for the initial launch. The revenue from that being split between Apple and the app maker. This is a tiny drop in the bucket. And there are reports Apple is having a hard time getting advertisers to renew. [2]
I think of it this way: the majority of iPad users probably spend less than $10 on apps, ever, and the same for media. And a big proportion of them spend $0, only using the iPad for Web, email, Facebook, etc. So on this group, Apple makes a couple bucks on apps and media, tops. Compared to the ~$100 they make selling the iPad.
I would disagree and say that the majority probably spends significantly over $10 on the apps. Remember, the "normals" who don't have the time to jailbreak their devices and such, those people actually pay money for games/apps ...etc. For somebody who was willing to pay ~$1,000 for an iPad, paying $10 for an app is not a terrible option, so I'd guess those people spend _significantly_ more than $10.
On top of that, there's probably a smaller segment of users who spend _ridiculously_ more than $10 on applications, and then even more on in-app purchases.
Keep in mind those cite revenue; of which Apple retains only 30% on apps. In short: if the app store loses to HTML5 in the long run, but people continue to prefer iPads and iPhones at current rates, you'd need a microscope to see the effect on Apple's bottom line.
How much did Apple make from your iPhone(s)? Let's say $300 every 2 years. How many apps have you purchased in that time? It's going to be less than $300 for most people, and Apple only gets 30% of that total, and has their own costs on top of it.
I have spent a decent amount on apps... but I spend to put on about 6 devices (iPhones, iPads, iPod touches for family members), and any new iDevices we buy.
That Apple recognizes and allows this behavior really tells me that they don't care about profit from apps.
Apps, for Apple, are features of the real product, the hardware. Hundreds of thousands of features where the competing hardware platforms don't compare as favorably.
It was the same with AAC DRM music on the iPod (when few other players at the time supported AAC, and none supported FairPlay DRM)... these were little land mines in a music library that prevented users from switching or even considering it.
