While I am no fan of ultra-high P/E stocks, I have to say that I have a soft spot for Amazon (AMZN). From a consumer perspective, I love the company and make the overwhelming majority of my purchases from the site. As an investment, however, it's hard to stomach the shrinking margins and lack of profitability. That being said, as I went on Amazon.com today to make a purchase, the front page caught my attention:
This inferiority in the low end of the tablet market as far as technical specifications go is actually quite a new thing for Apple (AAPL), whose iPad line generally has strong hardware across the board relative to its peers. However, in the new "shrunken" tablet space, Apple is necessarily taking a more muted approach to its hardware.
It's Out Of Necessity
In contrast to Amazon, whose goal seems to be "market dominance now, profits later," Apple is in business to make money today. It has gotten away with selling what are essentially commodity products at an extremely high premiums by establishing a strong brand that has embedded in the general population the image of superiority.
However, in the mini-tablet space (7" - 8"), Apple not only has competitors who can produce quality products, but competitors who were there first and are willing to break even or lose on the tablet hardware in order to make money off of the software ecosystem. Amazon with its Kindle Fire HD and Google (GOOG) with its Nexus 7 are the prime threats here.
So what was Apple to do? There is a very real threat that these "mini" tablets will supplant the traditional tablet as the media consumption computing gadget, so Apple has been very smart to make sure to release a product to address this need. This will unfortunately hit gross margins. But what is even more disconcerting is that Apple is pricing its apparently inferior product on the hardware side at a significant premium to the competition.
The Ecosystem - Is It Worth The Premium?
The thing that could very well save the iPad Mini and its future iterations is the fairly strong iOS software ecosystem. While the Android ecosystem has the majority of the smartphone market share and is quickly closing in on that of iOS on tablets, the iOS application ecosystem is currently richer.
I believe, however, this is currently changing and that as Android devices become even more ubiquitous, the software ecosystem will not only catch up, but in fact will become richer. Bright young programmers with cheap Android devices will bring their creativity to bear on these devices, especially as Android devices become affordable in developing countries.
In short, while the Apple software ecosystem is closed and very rich today, Android will reach parity and even surpass the richness of the iOS world going forward, eliminating the software ecosystem advantage that Apple can use to justify its higher prices for inferior hardware.
Apple Executives Constantly Bashing Competitors
One thing that is typically the sign of a company running scared is when the executives are actively bashing the competition. At the iPad Mini launch, the iPad Mini was introduced almost immediately in side-by-side comparison with the Nexus 7. Phil Schiller introduced the iPad Mini by trying to slam the Nexus 7 in every way possible. There was no mention, of course, that the iPad Mini is a full 65% more expensive than the Google device (and the Amazon Kindle Fire HD).
Clearly Apple feels threatened. The release of the smaller device is the first clue, and the aggressive bashing of the much more attractively priced competition is yet another sign of this. Apple was not the first on the scene with a 7"-class tablet, and even its more expensive entry is subjectively better at best.
Apple is no doubt threatened. For the first time in a while, it wasn't first to market with a "new" popular form factor. Further, even as Apple's new release indicated that it was "caving in" after dismissing the notion of a 7" tablet, its stance is arrogant and defensive as it claims that it would never release a 7" tablet and that a 7.9" one is fundamentally a different thing.
Look, the number doesn't matter - if the Nexus 7 or the Kindle Fire had actually been 8" devices, it would have met the same resistance from Apple management. These smaller devices are lower margin and posed a significant threat to Apple's top and bottom lines, but they also proved to be popular.
As Apple struggles to maintain its gross margin profile with these new iPads, it is unclear as to how successful they will be - the 7" Android tablets are still cheaper and are quite good at what they do. And in an economic recession, the last thing the middle class is going to do is buy a 10" tablet, a 7" tablet, and a notebook all at once.
Apple has every reason to be afraid of the 7" Android tablets, especially when its competitors do not care about turning a profit on the devices themselves. Look for continued margin erosion in Apple's results as its first-mover advantage fades. And while I cautiously draw the comparison to Research In Motion (RIMM), the gross margin story is starting to look awfully familiar: