Arnold Kling  

Pricing the Apple iPad

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Megan McArdle writes,

One estimate is that the cheapest iPad costs $270 to manufacture. Throw in advertising, transportation, distribution, and so forth, and maybe they can cut the price $100 if they're willing to make a slim profit in order to establish a market. Of course, there's probably more room on the high-end models, and presumably costs will fall as they get more experience, and volume. But I don't see them getting within striking distance of a Kindle particularly soon.

The revenue model is not selling iPads. The revenue model is getting people to pay for all the books, tunes, and apps that they download to iPads. Not to mention the cost of the "data plan" from AT&T.

The iPad, like the Kindle, is a portable cash register. With a Kindle, wherever you are, you are in a bookstore, with your credit card handy. There's nothing wrong with that. I own a Kindle, and I'm happy with it. But it's really not necessary to have to pay for one. I've shelled out much more for books on my Kindle than I did for the Kindle itself. The only reason not to give the Kindle away for free is that you would wind up putting it in the hands of consumers who are not all that interested in books.

Regardless of the price at which the iPad is sold, it is going to generate plenty of revenue. For Steve Jobs, getting people to pay for it is a bit like Tom Sawyer getting his friends to pay for the privilege of doing his whitewashing work for him.

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CATEGORIES: Business Economics

COMMENTS (11 to date)
Thorfinn writes:

?? The iPod was known as a device on which Apple made a killing, even as the company made little on digital sales on the iTunes store. The iPad will probably behave similarly.

The price of digital media approaches the marginal cost, which is zero. However, Apple can use its brand to mark up consumer electronic hardware. Even Amazon makes a killing on their Kindles while losing money on most eBooks sold. This is the opposite of the gilette model.

Adam writes:

Actually the fact that you've paid more for books than for the Kindle itself doesn't mean that Amazon could afford to give them away for free--in fact Amazon loses money every time you buy a Kindle book for 9.99, because they're actually paying publishers more for the rights to that book.

Al Chang writes:

Except that's not actually true, because in the real and ideal world, hardware manufacturers want cheap content (sold by someone else) to subsidize expensive hardware (sold by them) when each incremental unit throws off ~$250 in gross profit.

iTunes store revenue is estimated at $1b/qtr.
Apple claims to run the store at breakeven. In any case, the whole take of the 70/30 publisher/Apple split is $300m/qtr gross. The store serves all previously sold iPhones, iPods, PC/Macs.

Sales of iPhones *alone* last quarter were $5.5B with average gross margins near 60%, contributing $3.3B in gross profit.

Apple reports that App revenue is not significant enough to break out.

Don't go handing out those free devices yet.

(Watch for a race to the bottom in commodity eReaders as the economics work as you describe for hardware manufacturers without the leverage of a proprietary OS, as content publishers prefer cheap hardware to help sell their "expensive" books).

Ferruccio writes:

The business model "give away the razor, sell the blades dear" (which you appear to assert would work here) might theoretically work for a basically single-use device like the Kindle, or one which necessarily comes with a monthly payment to AT&T like the iPhone, but it wouldn't suit the iPad -- the iPad's just too flexible.

The iPad can be bought without paying any monthly sum (the base model is in fact Wifi-only), and it can be used as-is to surf the web quite nicely (unless you're desperately fond of Flash ads, I guess;-). In other words, if the razor is perfectly useful for other purposes on its own, without add-on blades or other sources of revenue to you, you'd better sell it for a positive profit margin -- so I think McArdle's right here.

Marcus writes:

This is related to the recent spat between MacMillan and Amazon. MacMillan wants to use the agency model which will in effect protect Apple from Amazon.

During an interview with Jobs after the iPad announcement but before the above spat, Jobs was asked how Apple was going to respond to Amazon's $9.99 new release price. Jobs said only that the prices would be the same. Ask directly if that meant Apple was going to sell new releases at $9.99 he again replied that the prices would be the same.

Then the spat between Amazon and MacMillan happened and now we know that what Jobs meant was that Amazon would no longer be allowed to sell new releases for $9.99.

Greg Ransom writes:

My understanding is that most of the ebooks Amazon is selling cost Amazon money -- e.g. they take a significant loss on each bestseller ebook sold.

Ross Williams writes:

If you listened to the most recent earning call from Apple in the third week of January you would have hear them state that Apple basically breaks even on the app store. Other media isn't much more, and brings down margins at Apple, which typically run in the 33-40% range.

The Apple strategy is to tie software to a hardware platform to offer an experience that cannot be match by others because of software patents. This is where they gain a premium that other computer makers haven't been able to match.

The app store's purpose (and using Objective C) is to tie software to the hardware in order to sell the hardware at a premium.

Matthew Gunn writes:

I see this is a classic example of learning by doing. By lowering the price, Apple sells more units and therefore learns more about producing iPads.

In a learning by doing model, the more a firm has produced in the past, the lower its marginal cost of production. This could even be extended to say the more it has produced, the larger the marginal revenue is from various tie-ins (book sales etc...) The more iPads Apple can get out there, the more Apple can learn what works, preparing itself to cash in with the next generation model.

If there is learning by doing, a firm will produce more than it otherwise would because every time the firm produces and sells a unit, it also learns!

In order to sell more, a price setter will therefore set a low price, especially if learning is rapid.

Marcus writes:

Greg Ransom,

Amazon sells New York Times bestsellers for $9.99 for which they take a loss. I don't believe they take losses for other e-books.

However, the big publishers are switching to the 'agency model' in which they set the price Amazon can sell books for. If you haven't heard about this then Google on MacMillan and Amazon to read all about their recent spat.

Under this model, Amazon won't be able to set their own price which in effect protects Apple. It appears the publishers have been waiting for somebody like Apple to come along to give them the leverage they needed against Amazon.

Lo Statuz writes:

Arnold Kling says

The only reason not to give the Kindle away for free is that you would wind up putting it in the hands of consumers who are not all that interested in books.

So true. Remember Audrey? If Kindles were cheap enough, hackers would find a way to use them as general-purpose computers.

floccina writes:

Have you all seen eh news about QualComm's Mirasol?

It will allow a color Kindle.

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