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The IPad Mini Margin Myth

|Includes:Apple Inc. (AAPL)

It seems to be taken as fact sometimes that the Apple's (NASDAQ:AAPL) iPad Mini has lower margins than the iPad Retina.

Examples

Apple's Decline: Thanks, iPad Mini

Apple: Lower margins on iPad Mini, iPhone 5 to dampen profits

The only problem is it is not true.

There a couple reasons this idea of lower iPad Mini margins, has had so much traction.

Apple said the Mini has lower margins

Excerpts from the Q4 2012 conference call

Katy Huberty - Morgan Stanley & Co. LLC

"Peter if you can comment on what's driving the significant gross margin down-tick in December given you should have decent iPhone mix? Thank you."

Peter Oppenheimer - Senior Vice President and Chief Financial Officer

"The iPad Mini has the full iPad experience, and we priced it aggressively at $329, delivering incredible value to our customers. Its gross margin is significantly below the corporate average."

The response about gross margins is that it is below the cooperate average. Almost everything is below the cooperate average, because the iPhone margins are so high, it takes some more research to answer the question of which iPad generate a better gross margin.

Prices are not indicators of margin

People seem to draw a correlation between prices of products and the margins they have. The price alone tells people nothing about the margins of a product. Boeing sells the Dreamliner for over $200 million dollars each. That statement does not help to determine the margins.

Price is important but the cost to build the product relative to the price is what really needs to be looked at. Thanks to iSuppli we have good estimates for what the cost of the iPad Mini, iPad 2, and iPad Retina are.

  iPad Retina iPad 2 iPad Mini
Price $499 $399 $329
Build Cost $316 $245 $198
Markup 56% 62% 66%

Even if iSuppli is off a little bit in their estimates the iPad Mini margins would still be higher than the Retina.

It is also posited that the iPad Mini will cannibalize the iPad Retina, and so the total profits will be lower since the profit in dollars per Retina iPad is more than the Mini.

Apple Q4 Earnings Recap: Mixed Results; iPad Cannibalization A Key Concern

Major Cannibalization Concerns At Apple

This is true if all the Retinas that were going to be sold were instead replaced by Minis. However if instead of buying 1 Retina they purchase 1.4 or more Minis the actual profits made would be more. Assuming the person was willing to spend $499 that would be over 1.5 Minis per iPad Retina. Let's Look at a few scenarios of consumer choices with the iPad Mini vs iPad Retina.

Note: Each additional level of memory is estimated at $10 build cost, cellular is estimated at $40 build cost.

Example 1

Someone has $500 dollars to spend on a iPad.

Option A:

  • Buys an iPad Mini 16GB, $329-$198=$131 dollars for Apple
  • Keeps the remaining $171 dollars which might go towards accessories.

Option B:

  • Buys an iPad Retina 16GB, $499-$316=$183 dollars for Apple

Option C:

  • Buys an iPad Mini 16GB+Cellular, $459-$238=$221 dollars for Apple
  • Keeps the remaining $41 dollars which might go towards accessories.

Option D:

  • Buys an iPad Mini 32GB, $429-$208 = $221 dollars for Apple
  • Keeps the remaining $71 dollars which might go towards accessories.

In the above example Apple makes more on the Mini if any upgrades are chosen and the customer has more money left over. This example demonstrates how the iPad Mini may likely capture more upgrade dollars due to the lower base price. Capturing the upgrade spending further increases the iPad Mini's gross margins beyond its initial advantage over the Retina.

Example 2

The customer has 2 kids who want iPads for Christmas.

Option A: (Customer has a limit of about $350 to spend)

  • Buys an iPad Mini 16GB, $329-$198=$131 dollars for Apple
  • Kids share the iPad

Option B: (Customer has a limit of about $500 to spend)

  • See Example 1
  • Kids share the iPad

Option D: (Customer has a limit of about $650 to spend)

  • Buys an iPad Retina 32GB, $599-$326=$273 dollars for Apple
  • Or Buys an iPad Retina 16GB+Cellular, $629-$356=$273 dollars for Apple
  • Or Buys an iPad Mini 64GB, $529-$218 = $311 dollars for Apple
  • Or Buys an iPad Mini 32GB+Cellular, $559-$248=$311 dollars for Apple
  • Kids share the iPad
  • Buys 2 iPad Mini 16GB, $658-$396=$262 dollars for Apple
  • Each kid gets their own iPad

Without the Mini the person with $350 to spend would have purchased no apple iPads, this was a lost sale. The person with $500 to spend ends up with one iPad the kids still have to share, but with choices on size and price. If the person with $650 dollars goes over budget $8 dollars , the kids each get their own iPad. Without the mini the person with $650 would have to settle for a solution that wasn't best for them. In most of the cases above the iPad mini brings in more money than the Retina. Even more important than the money to Apple is that the Mini gives customers at more price points the solutions that are optimal for them.

Conclusion

The iPad Mini is not a lower gross margin product than the Retina. Since it has a lower base build cost, upgrades for things like cellular connectivity and added storage increase it's gross margins in comparison to the Retina.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Stocks: AAPL