It would be remiss of us not to make note of the iSuppli data that has whizzed its way around the internet this past week regarding just what it costs to build an iPhone, with the world up in arms over the idea that Apple is getting a 50% plus margin for its iPhone at its currently announced price.
What we’re shocked at, is that anyone is shocked by this.
Apple has both a design and market leader premium in its music and video devices, and iSuppli acknowledges that Apple operates some models of the iPod at similar margins, citing around 45%. Or does it? In fact it may be considerably more.
We remain convinced that iSuppli, which has specialized in this process of tracking down components and pricing them, is good at what it does and has component relationships that mean that it can get its hands on a lot of competitive pricing information. But we’re not so sure about some devices.
We don’t yet know which company is supplying the applications processor or what CPU technology is behind it in the Apple iPhone,and we won’t know until a device can be bought in June and torn apart. So we don’t know what volumes already exist and what potential discounts Apple might achieve. The general gist of what iSuppli is saying is correct, which is that Apple is setting its pricing for the long haul and knows that as it is attacked it needs to be in a position to drive down pricing and retain a margin on these devices.
But the manner that Apple has done this over the years is different from other companies. It will usually commit to exceptionally high volumes, offering cash up front, to secure big discounts and in some cases component exclusivity. This radically changes its economics, and if anything it makes it increase margins, at the expense of cash flow.
For instance in November 2005 Apple paid $1.25 billion up front to land long-term supply agreements with Hynix, Intel, Micron, Samsung and Toshiba for NAND flash memory through 2010.
Within this move it sponsored a new relationship between Intel and Micron to jointly produce NAND flash, whereas Intel has in the past only made NOR flash. This takes the pain away from Intel to enter a new $18 billion market and it was likely to be extremely grateful. Its partner Micron went on to secure the core assets of advanced Flash controller designer Lexar on the
back of that deal.
So let’s just suppose that iSuppli allocated $100 or so for the 8GB of flash that the Apple iPhone has in it, then perhaps it has allocated too much.
The same goes for its teardown of other devices which offer unknown costs. The pre-Christmas effort it made on the gaming market, concluded that Xbox 360 was making a small margin, possibly $75 to share with retailers, while the PS3 was losing $300 per device.
This is impossible to quantify without placing a notional value on the Cell chip that has been co-developed over the past 6 years with IBM and Toshiba. Sony may have spent $2 billion on manufacturing facilities for it, and an un-quantified amount in engineering time, but the number of chips it will make, what they will be used for and over what time, are all unknowns. Is the Cell chip costing it $1,000 each, in the iSuppli methodology, or $100? It doesn’t give much detail, but what it does say is that it allocated 11% of the $805 cost to the Cell chip, so around $90.
At that price Sony will have to sell around 100 million Cell chips to break even. Well we know that Sony will sell at least 100 million if it repeats the success of the last two generations of games consoles, and that the chip will also be used in development workstations, graphics supercomputers, set tops, HDTVs and potentially evening cellphones ‘ so it MAY sell as many as 500 million in the next 7 or 8 years. It’s a moveable feast, and we understand iSuppli’s dilemma and it has to start somewhere.
The point is that these devices do have large margins, they always do. IBM mainframes used to have an 80% margin shipped from the factory, but they still didn’t make much in the way of profit. And in the case of both of these devices there is the potential for some subsidy, in that Sony could pick up the $300 shortfall that iSuppli claims exists on the PS 3, by selling around 8 to 10 games for the device over its lifetime (usually it will sell more like 5 games a year, so this would take two years). Apple can conceivably make some additional revenue from iTunes and also it may well be taking a percentage of Cingular new client revenues that it churns from other cellcos.
So the Apple device may have far MORE margin in it than even iSuppli imagines, and that’s still not a surprise, because Nokia, Sony-Ericsson, Motorola and Samsung HAVE to come after Apple with designs similar to the iPhone because they do not want another seat at the global handset table, and Apple needs to be able to defend itself with future price cuts.
Already LG Electronics has a design (see pics from Engadget below) that look remarkably like the iPhone, called the KE 850, which will be out by March or April.
It is supposed to come with animated menus, quality video player, touch screens and is ready for 3G, not just GSM.
Faultline sniffs around the market all the time and we hear the same issues about cost, components, margins and how this or that product cannot make it because it costs too much. But these are often put together by companies that are rivals, and that only know what it would cost them to build something, not what it might cost if they could change shoes with larger companies.
Sony is almost certain to only charge a write down charge of R&D plus minimal manufacturing costs, for the components it makes itself such as the Cell chip, and share this across shipments in any give financial year. It will also have taken a leaf out of Apple’s book regarding strategy to drive down Flash memory pricing, as its devices use so much of it. In the end it is likely to report profits in the PS3 manufacturing line in its first full year.
And Apple is likely to have negotiating headroom with Asia Pacific and European cellular operators to ensure that it can put the iPhone into those markets though a cellco subsidy, which will make it sell far more.