Apple Does Not Need A New Tablet, It Needs A New Tablet Strategy

| About: Apple Inc. (AAPL)

Summary

On Monday, rumor has it a new iPad model will replace the iPad Air 2. Reports suggest Apple will abandon the Air concept and create a slightly smaller Pro.

Shifting from an Air to Pro philosophy is probably not the worst idea, but it won't reverse the nearly 40% decline in iPad unit sales.

Apple's continued fidelity to Steve Jobs's insistence that tablets not become mere consumption devices is undermining Apple's second most important product line.

Lower cost iPads will be necessary to compete with Amazon and Samsung, but Apple can preserve margin on these devices and boost profits by expanding digital sales on the platform.

Apple needs to embrace iPad as a content consumption device that could potentially revolutionize television the way iPod revolutionized music.

Introduction

Although it has been delayed a week from its original launch, rumors continue to buzz that Apple (NASDAQ:AAPL) will debut a new iPad Monday. Usually reliable sources suggest the new iPad will shift the product line away from the Air philosophy of the last two iterations and towards the Pro model, which was debuted in larger-screen form last year.

Apple's (presumed) move actually keeps with the prediction of Seeking Alpha's own Mark Hibben. However, it may not be the correct move. Typical of the "consumers don't know what they want" company, Apple appears to have decided to go against the prevailing trend in the tablet market. This time, it may hurt them. The thesis of this article is that the company that created the tablet market may be misreading where it is going next.

Cook's Strategy

I am not accusing Apple of being idle. To his credit, Apple CEO Tim Cook has not tried to hide anything. When iPod sales got small enough and Apple Watch sales disappointed, Apple simply folded them into larger categories to hide the gory details. Despite some suggestions he might do the same with iPad as sales went into freefall, Cook has taken the open and honest route.

He is also hard at work trying to reverse the trend. Despite being in the shadow of perhaps America's greatest CEO in history, Cook has not been afraid to reverse Jobs-era policies when he feels they are hurting the company.

One such move: enterprise, which Jobs famously shunned, but Cook has made a full-court press to woo. The recent release of the oversized iPad Pro was the latest step, and the biggest. Cook already had Apple working with his former employer, IBM (NYSE:IBM), to push Apple hardware to enterprise customers and collaborate on vertically integrated software for specific businesses. Now he has a piece of hardware to match Apple's new ambitions, with a number of features built into the iPad Pro that suggest it might be the first tablet actually built with businesses, not consumers, in mind.

Apple is also tackling the software side. In addition to creating new apps with IBM for enterprise, Apple is also working on Classroom, to help make iOS more appealing to schools. Marketing is getting a refresh too, with not just Cook, but the entire senior leadership of Apple dispatched to give interviews and showcases about Apple products, especially iPad, to enterprise customers. The strategy is bearing some fruit, as Apple continues to expand its enterprise partnerships.

But it was not enough. Apple's recent sales figures showed another decline in tablet sales, down almost 40% in unit sales from the 2013 peak and down 25% from even last year's depressed number. It's possible iPad Pro simply was too new and not available in sufficient quantities. Maybe it hasn't been given enough time to move the needle. That's certainly Apple's preferred take on it. Cook says drawing enterprises into the iPad ecosystem will take time. Given Apple's twelve-figure cash hoard, Apple can certainly afford to be patient with a new strategy, but what it can't afford to do is ignore evidence it may be on the wrong track, especially when that evidence comes in the form of a competitor in hot pursuit to supplant it.

Fire Rises From The Ashes

Certainly, there is no immediate danger of that, but Amazon (NASDAQ:AMZN) is going to try. It's $50 Fire tablet vaulted it all the way back to third place for tablet sales over the holiday period last year, a 175% increase in a single year. If Samsung (OTC:SSNLF) falls victim to the same sales decline as Apple, and Amazon posts another strong year of growth, it may take over second place this holiday season. Amazon's tablets have long been mocked as "fruitcake tablets," things people buy for children or loved ones as gifts, but don't want for themselves.

They are smaller, less powerful, and have lower resolutions. But they are much, much cheaper. Amazon has long since made its philosophy, and strategy, clear. It sees tablets as mere gateways to customers. Fire is sold more or less at cost to encourage the purchase of both digital content, and more importantly, Prime memberships, which spur sales of Amazon's physical goods in the general retail sector.

This is anathema to Apple, which not only considers itself exclusively a purveyor of premium products, but also inherited from its late founder a visceral distaste for any suggestion a tablet should settle for such a small role in the human condition. When Steve Jobs released the first iPad in 2010, he had only one regret, as documented in his official biography. He had set the bar too low. More than one reviewer said they loved using their tablet to consume content, but it lacked the necessary tools to really be a creator of content. Jobs, who usually didn't have much use for outside criticism of his ideas, took the reviews hard because he thought they were right. When he designed the iPad 2, one of the last products before his death, he pushed to incorporate content creation tools like a second camera and more powerful software.

Artistry Or Decadence?

This attitude, that tablets are for content creation as well as consumption, has outlived its creator at Apple to the present day. Tim Cook himself made explicit reference to it when launching the iPhone 5s in September 2013. Apple was just starting to get some early evidence that iPad's growth was levelling, and he spent a considerable amount of time at the keynote pushing the theme. Apple devices, he said, were "great for consuming content," but they were "incredible for creating content."

To make sure everyone got the message that tablets were for creating things, he took Apple's five best content creation apps, which usually cost $20 apiece, and announced that henceforth they would all be free, an unusually generous giveaway by the unapologetically stingy Apple. Less than a month after the event, Cook called all reporters back for another product launch where he unveiled iPad Air, priced at the same $499 despite the proliferation of lower-cost alternatives, and with more tools than ever for artists. You could almost hear Apple's engineers and management shouting "create, dammit, create!"

Meanwhile, "The Everything Store" was positively embracing the ideal of consumption. Fifty dollars is a breakthrough price, but it also means consumers know they aren't getting everything they would get with a $500 iPad. Amazon has to make trade-offs to hit that price target, and their success hinges on if they can identify correctly which aspects of a tablet's functions, specs and capabilities customers value most and which ones they are willing to go without to achieve savings.

This is sort of the mirror image of Apple's problem, which is to keep coming up with new capabilities that persuade people to keep paying up for their top-of-the-line model. Amazon has come to focus almost exclusively on content consumption as a tablet's reason for being. Its cameras are mediocre, its screens just big enough to enjoy a movie but not really big enough to work on. But it gives literally thousands of free apps to every Fire owner, and free trials of its Prime Music and Prime Video services. And it keeps cutting prices.

The fact that Amazon tablet sales rose while Apple sales fell suggests Amazon may be on to something. At the very least, Amazon seems to have a better finger than Apple does on the pulse of what consumers want to see as incremental improvements in their tablets. Lower costs for hardware and content seems to trump stronger processor power, bigger screens or better cameras. Even Cook's ambition to put iPads in every school may fall short, as schools on tight government budgets will certainly consider cost as one of the prime factors in determining whose tablets they purchase.

The refresh rate on tablets is further evidence of the trend. Confounding predictions that they would be replaced every two years or so like smartphones, people are holding onto their tablets for three, four years, sometimes even longer. And when they finally do replace them, they often pass down their current model to a family member who finds its adequate to their needs. This behavior is consistent with people finding that older equipment with older processors is more than enough for the tasks they actually use the tablet for, namely content consumption. They simply aren't motivated to constantly shell out $500 more to get the latest content creation tools.

A Different Revolution

Rather than continuing to fight this trend, Apple should learn to embrace it. The fact that most iPads are being used as mini-TVs, not mini art boards, is no reason to be disappointed. TV is as desperately in need of a revolution today as just about any other industry. Apple is more than capable of beating Amazon at its own game. While Amazon Prime Video has become considerably more compelling content-wise over the last few years, it is still essentially little more than a poor man's Netflix. It has no news, no sports, and even the scripted fare is not as good as Netflix. Amazon does not have the cash flow or profits to make its tablets the center of an entertainment revolution. But Apple does. It's cash hoard is more than sufficient to bring TV kicking and screaming into the 21st century.

Sports would be an excellent place to start. Fifteen years after MLB began offering out-of-market games on computers, professional sports TV rights are still remarkably balkanized and quaint. In-market transmissions are only allowed on home TVs and usually cannot be streamed to phones or tablets, even if the user has an authenticated cable subscription. Meanwhile the out-of-market packages continue to suffer from blackout rules and technical difficulties that drive even the most devoted fans to angrily cancel the service.

Imagine Apple bringing its "it just works" engineering expertise and a wad of cash to bear on this problem. It can afford to buy the rights to any content it wishes, even uber-expensive NFL fare. As a new entrant unbound by any legacy systems from old 20th century technology, it could simply abolish the in-market/out-of-market dichotomy by buying the rights to both and running one common stream over its own servers to prevent technical problems. The iPad makes a natural platform for this revolution, a TV screen large enough to enjoy both movies and sports and small enough to carry around in a handbag or a backpack, or curl up on the sofa with.

This does not have to mean a reduction in Apple's financial ambitions for iPad. Americans alone spend almost $120 billion a year on TV. Europe, Japan, and Asia take the figure far higher. Accepting the iPad's natural role at the forefront of a content consumption revolution could be exceedingly profitable for Apple. And as the profits from selling content through the device went up, Apple could afford to let the hardware profits go down, finally beginning to match Amazon and other competitors' sub-$200 offerings.

iPads Like iPods

I know that many will object that Apple does not do cheap products. Of course, Apple does not do anything cheap, but that is not to say it insists everything be expensive. Apple does not object to low-cost products. Its iPods eventually bottomed out at a mere $49 for the Shuffle, which has no screen and small memory and so is very cheap to build. But no one would call it a cheap product.

What Apple objects to are low-margin products, which they feel don't properly reward the people who develop them. Whatever a device costs to make, Apple insists on a healthy mark-up. But if the costs of the device are cheap enough, that can still result in a more affordable offering. The iPad 2, which started at $499 back in 2011, was cut to $399 in January 2012, but then stayed at the same price for two more years, despite the fact that its costs almost certainly kept dropping rapidly. Had Apple continued cutting $100 a year off the price, as it does with its iPhones, it would have been at $199 by the time they retired it. And many older iPads are still in use, since again, they are more than adequate for the content consumption that most people use them for.

It is perfectly feasible for Apple to offer a $199-$299 full-sized iPad without giving up margin per device. Yes, absolute profit would go down, but if it was enough to revive iPad sales it might still take total hardware profits higher, to say nothing of all the extra content sales those tablets would produce.

Conclusion

Apple is far from vanquished. It is still the company which sets the bar every other tablet vendor measures themselves against, and it has a strong and loyal customer base. But a 40% decline in sales can never simply be shrugged off, even though it might have been tempting to when everyone else's sales were falling right along with theirs. But now that a competitor seems to have actually found a winning formula for tablet sales, even in a declining market, it is time for Apple to confront the questions it has too long ignored. Most customers simply don't need to create content, they just want to consume it. Tim Cook needs to be brave in the face of the Steve Jobs legacy again, and admit that sometimes, customers do know exactly what they want.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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