Aggressive pricing on the iPad is going to result in lower gross margins for Apple during the June quarter, according to company executives. Apple CFO Peter Oppenheimer told analysts in a conference call Tuesday that he expects gross margins to fall from 41.7% in the just-completed March quarter to 36% in the June quarter, and that some of this decline is due to aggressive pricing for the iPad.
Gross margins are a measure of the cost of production/the cost of sales when measured against total sales, and that number is closely watched by analysts. Apple runs a tight ship in terms of overhead, research and development (R&D), and other such expenses, meaning that even a few tenths of a point difference in gross margins can have a significant impact on profits.
Other factors cited by Mr. Oppenheimer as leading to the sharp decline in gross margins include US$36 million in stock-based compensation expense, “a stronger US dollar, our Mac portable transition, the beginning of the education buying season, and a future product transition.”
Apple typically guides conservatively for revenues, profits, and gross margins. For instance, the company had guided analysts to expect gross margins for the March quarter to be 39%, but Apple turned in gross margins of 41.7%.
Mr. Oppenheimer attributed that difference in March quarter results to such factors as lower component costs, higher-than-expected sales (remember that conservative guidance on what is “expected”), and a stronger product mix of higher-profit products like the iPhone and accessories.
It’s the iPad, though, that stood out for Apple’s forward guidance. Apple typically prices its hardware products at a point that leads to overall gross margins in the high-30s (or slightly higher). Software, for instance, has very high gross margins in the 70-90% range for most companies, due to the very low cost-of-production compared to the street price.
This has been the way in which Apple has differentiated itself from its PC competitors. While Dell and the other low-price competitors have competed on price, Apple has competed on lifestyle, design, and quality, and priced its products at a point that allows the company to make significant investments in research and development, design, its own processor design, etc.
Mr. Oppenheimer made it clear to analysts that when it comes to the iPad, however, the company is being more aggressive with its pricing than usual, and that it intends to make the initial iPad market as big as it can, rather than focusing solely on margins.
“As we said in January when we an announced the iPad,” Mr. Oppenheimer said in his opening statement, “we [are being] very aggressive with pricing and are delivering tremendous value to customers.”
He iterated this point when asked for clarification, saying, “We’ve been very aggressive, and [we plan to] take advantage of our first mover opportunity here.”
Apple COO Tim Cook further emphasized the point, but added that the company expected to increase its profits on the device as time progressed and manufacturing costs decreased on the device.
“We think the market size for the iPad is very large, and we want to capitalize on our first mover advantage,” said Mr. Cook, further emphasizing Peter Oppenheimer’s earlier comment.
He added, “So as we’ve done in other products, although I’m not forecasting it, you can see that we have a good track record of writing down the cost curve with value engineering and volume manufacturing. At least, that’s been our experience with other product.”
For those not afraid to read between the line - and that includes us - Apple is saying that it is pricing the iPad at a point the competition will find difficult to match, and that this is more important in the short term than focusing just on the gross margins.
In addition, Apple is likely to keep the iPad at its current price points even while component pricing and manufacturing costs decrease in order to move the iPad into the gross margin range that Apple typically shoots for in its products.
*In the interest of full disclosure, the author holds a small share in AAPL stock that was not an influence in the creation of this article.