A rather lengthy economic analysis of the cannibilization of iphone sales
In my last post, I focused on the portable electronics market and how the new ipod could fit into that as a Portable Media Player (
https://forums.macrumors.com/showthread.php?p=4114327#post4114327) , as well as on Apples long-term opportunities. Right now, everyones focus seems to be on how the ipod could cannibalize the iphone, so I thought Id shoot out an economic analysis of the gains and losses associated with a WI-FI ipod.
REMEMBER: THIS IS AN ECONOMIC MODEL, THAT, LIKE ALL ECONOMIC MODELS, IS SIMPLIFIED TO CAPTURE THE CENTRAL POINTS. IT IS MEANT TO BE A STARTING POINT, NOT AN ALL ENCOMPASING ANALYSIS.
First, its good to set the parameters. If the Ipod only has a full-screen and multi-touch, it will cannibalize a relatively insignificant part of the iphone market (compared to the huge sales it will generate). Those who will buy it over the iphone (those who would not buy the iphone otherwise are irrelevant to cannibalizing the iphone market) value the video and storage of video features as the paramount upgrade, and one that would mean shelling out $500 (probably $600 if they like storage so much) for a device whose other features they find relatively insignificant (otherwise they would stick with the iphone regardless). If they didnt value the video so much, then they would just buy/keep a high-storage ipod. On the other side, anything more than WI-FI would be either a) a cell phone (which they already have) or b) a much expanded Portable Music Device, which would leapfrog the ipod (they probably arent there yet, but it would cost a lot and generate plenty of revenue to offset lost iphone sales).
So, it is the WI-FI that is the central issue of cannibalization. What we have to do is imagine two worlds, one with WI-FI ipod and one without, comparing the difference between the two. One of the categories of differences is long-term strategy, which I touched on in my last post. The other is cannibalization of sales which is important not in terms of total sales (that Could fall under grabbing market share and the strategy category) but in terms of profit.
(Summaries of the math will be in bold)
For Apple to add WI-FI to generate more profit, its additional sales of iPods times the profit per iPod (plus change in profit margins total) compared to the world without WI-FI would have to be greater than the lost number of iPhone sales times their profit PLUS the profit that Apple gets from AT&T (which could get the raw end of the deal because Apple doesnt care about their AT&Ts profit beyond how it effects their strategy). Summarized (taking non-touch ipods out of the model for simplicity and because there is less overlap. A substantial increase in ipod touch with WI-FI price over without WI-FI could push people to cheaper players, but thats really too complex for now):
World WITHOUT WI-FI iPod (World A):
Total iPod profit = (new iPods sold) X (profit per iPod)
Total iPhone profit = (new iPhones sold) X (profit per iPhone + profit per AT&T contract)
Total profit = (total iPhone profit) + (Total iPod profit)
For them to (profit-wise) add Wi-Fi, then the increase in (Total iPod profit) would have to be greater than the decrease in (Total iPhone profit) so (Total profit) would be greater (duh, I guess).
Difference in world WITH WI-FI iPod (World A):
---note, prices would likely change, profit per iPod could increase (likely) or decrease
(Total iPod Profit of World B) = (Total iPod profit of World A) + (increase in iPod sales) X (new profit per ipod) + (original total ipod sales) X (difference in profit per ipod)
Basicallythe profit from selling more ipods plus the additional (or perhaps less) profit per ipod would be the increase in total iPod profit by adding a touch-iPod.
(Total iPhones Profit of World B) = (Total iPhone profit of World A) + (decrease in iPhone sales) X ((profit per ipod) + (profit per AT&T contract))
Basicallythe loss of profit from selling fewer iPhones would be the decrease in total iPhone profit by adding a touch-iphone (sort of obvious, but just following the math).
So, for World B to be better:
(increase in iPod sales) X (new profit per ipod)
+ (original total ipod sales) X (difference in profit per ipod)
>(absolute value) of
(decrease in iPhone sales) X ((profit per ipod) + (profit per AT&T contract))
BasicallyApple must sell more iPods at the new price plus the additional margin of the new iPod price to MORE THAN MAKE UP FOR the lost profit from both iPhone hardware sales and AT&T contracts.
Markets usually are efficient, so why shouldnt Apple release many products and let people choose? A) iPhones, as a new device, have huge profit margins that people may not be willing to accept for music players with much stronger competitors that are no longer so much less hip and B) the AT&T contracts are like extra money.
So, lets look at some numbers:
iPhone sales:
800,000 sales this quarter. 10 million target by end of 2008.
http://ca.today.reuters.com/news/ne...1_N21387623_RTRIDST_0_TECH-IPHONE-UBS-COL.XML
iPhone profit:
$335 for 8g model (for parts and labor, other costs similar to ipod)
http://www.computerworld.com/action...leBasic&articleId=9026178&intsrc=news_ts_head
AT&T contract for Apple: Estimates range from
$3 (for old AT&T customers) per month to
$11 (for new customers). Total of $72 to $264 for 24 month contract (Yikes, thats just pure profit).
Total estimated iPhone profit: $268 million this quarter for phone plus $57.6-$211.2 for contract gained over life of deal (assuming most are 8g models (95% of first weekend models were) and costs vs price stays relatively stable. Remember, its a rough estimate).
If Apple were to meet its 10 million mark (well see), than that rises to $3.35 billion in hardware and $720 million to $2.64 billion in contract profits (THATS why they went exclusive). By comparison, General electric makes roughly $3-6 billion TOTAL per quarter, and Wal-Mart $3 billion per quarter. The iPhone profit is a perfect example of the power of a monopoly (in this case, on the only popular and well functioning cell phone/mp3 & video player). iPods have less of an advantage because there are many similar devices that can bring the price down (even if no one has a touch-ipod, if a $200 60 gb video player is on the market, it makes it harder to sell a $500 touch ipod with widescreen just for the added advantages).
The ipod is harder to handicap, mostly because no one has seen it. One estimate of the release of the 5g ipod puts its cost at $151 and price as $299 (
http://www.ahorre.com/business/real_estate/business_news/ipod_profit_margins_50_percent/) , and while the price is $50 less, the parts have certainly gone down as well. For a touch ipod, one could remove the cost of cell-phone compatibility from the iPhone ($20-$40 has been mentioned on this board), but might need to add back in a large hard drive if it costs more than the iPhones flash memory.
So a ipod touch with WI-FI could cost between $200 (iPhone minus cell) to $250 or even more with hard-drive costs. IF Apple kept its ipod profit margin at 50%, then we could see a $400-$500 hard drive, but there are a few reasons that might suggest against this. 1) iPods have many closer competitors, even if the iPod touch would be unique. 2) Lower prices and margins for lower capacity devices 3) Back in 2005, the ipod had far fewer competitors 4) People may just not be willing to pay upwards of $500 for a portable music player like when the ipod was released. A range of $300-$450 could encompass the new ipods while giving Apple a decent profit in an already saturated market.
Comparing the two, and without the price or cost of the new iPod touch, what we can do is look at HOW many iPods Apple could have to sell at what profitability to make up for lost iphone sales (remember, other factors such as cost of distribution and margin to outside sellers are roughly similar or small as to not disrupt the full picture, but can be added after constructing the model, thats what economics is).:
iPhone profit per model: $400-$600.
iPod profit per model: $100-$250 ($200 cost plus $250 profit or $250 and $250 for 50/50)
Example: If WI-FI adds $75 (assume charging $100 over similar device without (even if they dont make it) minus $25 component cost) profit AND many more sales (this is hard to predict) could, as one example, have 1 million more sales at $200 profit and 2 million sales with an additional $75 profit which would mean $350 in additional profit. If half of those 1 million sales came from CANNIBILIZING the iPhone, that would still only mean $250 in lost iPhone profit, and a NET gain of $100 million dollars, plus a new market niche.
What the above example shows, however, is that it could go either way, depending on cost, price, and total sales of the new iPod. Apple has experts probably working on those very models, and of course they know how much it costs them (and then will set the price). While iPhones make a ton of profit, iPods make a good amount too, sell more, and will not cannibalize iPhones at a 1 to 1 ratio. Apple can probably predict sales at different prices and components pretty well, and adjust what they build and sell to make selling profitable regardless (WI-FI would have a leg up, because they would be able to sell more).
Assuming the technology is no problem, then what may really shape this debate over WI-FI isnt the profits shown above, but the strategy (
https://forums.macrumors.com/showthread.php?p=4114327#post4114327) that they may consider for the long-run and how an advanced iPod (aPod?) would fit in.
Well, that was fun, and while I could have (perhaps) just waited until Wednesday, it sure helped me get a better handle on the iPod/iPhone market (and no, it didnt take hours to write this, I just type fast). Congratulations and thanks to anyone who has read all of the way to the bottom of this, and I apologize for the many mistakes that I am sure that I have made above, and I really hope that I haven't made any big enough to make the entire analysis invalid.
P.S. think of how many socks are sold each year. iSocks could TAP into a huge market, and would only cannibalize the iSandal, leaving the iPhone alone. What a perfect alternative.