# Apple Takes the High Road to Profitability

Frank Fox - 2008.11.06 - Tip Jar

Today we're going to review some basic math principals. To help with this lesson, we're going to use a story problem. Please follow along in your books.

We'll pick one company that sells for a higher margin, around 30%. We'll call that company A (for Apple). Next we'll pick another company that sells at a lower margin, around 10%. We'll call them company D.

Both of these companies have to sell enough products to return a nice profit to their shareholders. Based on their profit margin, what would be the best strategy for each company?

Since these are both computer companies, let's assume they can both sell at the current average price for a generic PC, \$550.

 Company A Company D Unit Price \$550 Unit Price \$550 Profit (30%) \$165.0 Profit (10%) \$55.0 Volume 333,334 Volume 1,000,000 Total Profit \$55,000,110 Total Profit \$55,000,000

Company A has to sell only 333,334 computers to make the same profits as company D makes from selling a million. Clearly company D has to focus on increasing the volume of computers sold. Company A has to focus on making a lower number of sales while at the same time it has to focus on not letting their profit margin become eroded.

Another approach that either company could use is to shift its product mix, i.e., shift away from the average priced computer to higher priced models. If either company can shift its computer price to a higher selling point, it can sell fewer computers for a greater profit.

 Company A Company D Unit Price \$1,543 Unit Price \$1,543 Profit (30%) \$462.9 Profit (10%) \$154.3 Volume 118,817 Volume 356,449 Total Profit \$55,000,389 Total Profit \$55,000,081

That shift looks to be very positive to both companies. Increasing the sales of fewer higher priced computers is just as profitable as selling lots of cheaper models.

Which of these two companies is more likely to shift its unit sales to the higher priced models.

• The company with higher margins, which has worked to maintain the value of its brand.
• The company with low margins, which has worked for years trimming off any extras in order to lower prices at the expense of its brand.

It is brand A that is most likely to have maintained its brand value so consumers recognize which product retains its value at the higher price. Brand D is mostly likely to be seen as low cost leader. Consumers who previously bought from them will look for a low price on subsequent purchases.

Is making 30% profit somehow evil or corrupt when others sell at a lower margin?

No, profits vary widely from company to company. Some companies, such as Microsoft, make much higher margins on software (Microsoft's business division made 66% profit, which is twice what Company A makes). You would think they, of all people, would understand that higher profits do not constitute a "tax" - different prices are simply more choices for consumers.

This lesson is meant for those analysts who claim that a company should lower prices in order to drive up sales. The bottom line is that while it may increase sales but it could come at the expense of profitability and/or brand value. Neither of these are things to throw away for a small gain in market share.

Obviously, it is much better for Apple to capture a large share of the market for computers that cost more that \$1,000, even if that market is smaller. The profits are better on those computers, even if the total volume of sales is less than one-third of the rest of the market.

These issues interfere with Apple's ability to sell an \$800 laptop or \$400 desktop. Apple either has to make a system to sell in record numbers at the risk of losing sales of their higher priced systems, or they have to severely restrict the specifications of their budget systems to avoid cannibalizing their more profitable systems. The first option is not practical from a business point of view. The second option limits the unit growth and therefore fails to capture the benefits of high volume.

In many ways the original iMac was an attempt by Apple to create a system that could sell in high numbers without taking sales away from its pro desktop models. Since then Apple has gradually increased the value and price position of the iMac so that it no longer sells for close to the price of a budget PC. (The first iMac retailed of US\$1,299. The least expensive iMac ever was the 350 MHz indigo model, which sold for US\$799. Today's iMac starts at US\$1,199.)

This is the opposite of the PC world - every year every PC maker struggles to drop the price on new models while Apple raises its value by introducing new designs and features. Without a doubt the iMacs of today are a leap ahead of the iMacs of the past. Can the same thing be said of the average PC?

As Apple gobbles up the market for computers that cost over \$1,000, it may eventually find itself in a position to seek growth through the budget computer market.

Apple has to continue to position itself as a premier brand. The introduction of the Mac mini, originally prices as low as US\$499, did this to a certain extent. The price was increased to \$599 when Apple moved to Intel processors in 2006. The mini's small size and use of laptop components helped position the Mac mini as a premium device, even if the specification of a generic desktop PC may have been greater. Even Dell didn't release its small Studio Hybrid for a lower price than its cheapest desktop.

Apple's continued growth in the \$1,000+ computer market leaves a growing population of users unsatisfied with Apple's computer line. These are people who already own a Mac Pro or MacBook Pro but need a second computer. The iMac is positioned well as a single consumer desktop, but it's priced high for a second desktop. The Mac mini was a nice stopgap for some, but Apple has intentionally limited the features of this device.

Will Apple abandon the sub-\$1,000 market, or is there a new system they can sell in the \$500 to \$1,000 range? As we wait for Apple to show its hand in this area, we are thinking about what alternatives remain - there are the increasingly out-of-date Mac mini (last updated in August 2007), the purchase of a used Mac, and, lastly, a Hackintosh.

I'll be patient for a while longer, but the Hackintosh option is sounding better every day.

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# Well this is somewhat embarrassing, isn’t it?

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