Can rising iPod sales hurt Apple’s profitability over long haul?

“Apple Computer Inc. has a runaway hit with its market-leading iPod digital music player, but could the device’s success actually hurt the company’s profitability over the longer haul? ‘It’s an excellent question,’ said Shaw Wu, an analyst at American Technology Research, who estimates the gross margin average of all iPod models is about 22 percent, narrower than the margin earned on its higher-end Macintosh computers. ‘You look at last quarter, their gross margin went down a bit sequentially,'” Duncan Martell reports for Reuters.

“Gross margin, or the percentage of revenue left after subtracting product costs for Apple in its September-ended quarter was 28.1 percent, narrower than the 29.7 percent in the June-ended quarter. Gross margin is one common metric analysts and investors track to gauge the health of a business and how much to pay for a company’s stock,” Martell reports. “As Apple’s business shifts more to consumer electronics items like its iPod — sales of iPods now account for nearly a third of total Apple sales — that means the sales of its more profitable Mac computers make up less of the total. ‘As music and iPods continue to outpace computer hardware sales we expect that shift to drive lower profit margins,’ said Deutsche Bank analyst Chris Whitmore. ‘But that will continue to translate into pretty strong operating-income dollars and earnings per share.'”

Martell reports, “But even as Apple’s gross margin declined in the fourth quarter from the third and year-over-year, there are other things Apple is doing in its business that may hearten investors: it’s spending less on research and development, sales and marketing and other costs as a percentage of revenue. Operating income as a percentage of revenue in its most recent fourth quarter was 11.4 percent, more than double the 5.5 percent in the year-ago quarter, although down from 12.1 percent in the third quarter. ‘Apple has offset the gross margin pressure by managing its business better,’ Wu said.”

Full article here.

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24 Comments

  1. Surely this would only become a problem if their mac sales started to fall? As is mac sales are up so surely iPod sales are a bonus on top of growth in their traditional markets? Admittedly I haven’t read the whole article.

  2. MXNT – exactly! And the opposite is happening.. Mac shipments are growing some 43% a year! Once MacIntels come out, this is likely to increase. Shaw “Wong Way Wu” gets his knickers in a twist again…

  3. So more sales = lower gross margin, and this right on the heels of record quarterly sales and profits = stock price drop. OK, I give up. This is bizarro-world.

    Left is right! Up is down! Right is wrong! Good is evil! Say goodbye when you arrive and hello when you leave!

    I’m outta here…

  4. This is why having nothing but MBAs in a small room is dangerous.

    Profit is profit – if you’re making more money than your expenditures take away, you’re in good shape. Since, literally, any positive margin can be considered a good one, 28% is certainly nothing to be concerned about. What other investment makes that kind of coin reliably?

    If you’re margins are good AND your’re expanding your market in absolute numbers (as Apple is), AND even expanding your share of that market as a percentage (as Apple is), then …

    I’m sorry. What exactly is the problem again?

  5. Wow. Computer sales on on the increase, iPod sales are increasing at a faster clip so gross margins go down.

    They need to use common sense. If a company sells widgets only and gross margins go down, yes, it’s bad. Apple is expanding in different directions right now. They have no debt and a huge cash reserve.

    These analists are overreacting.

    /yes I spelled analists wrong

  6. This story is brought to you by Reuters. They have something of a track record for spinning stories to put Apple in a bad light.

    They’ve run many stories that attempt to diminish Apple or the iPod.

    Come to think of it, they have something of a track record for distorting other stories for no apparent reason.

    Truth is flexible for Reuters.

    Ironically, the Magic Word is ‘fact’

  7. Well, that Wu person seems to frequently comment with very peculiar cautionary possibilities when considering Apple, with only an occassional burst of enthusiasm. Looks like an agenda to me, but even if it’s not .. in regard to Apple anyway, it’s certainly a pattern, and one that seems to often be at odds with prevailing reported market activity, imho.

  8. The only way increased iPod sales would be a problem is if Apple couldn’t produce as many computers because they were instead producing iPods. Like if they produced Macs and iPods on the same assembly liine. Obviously, they aren’t even produced in the same factory, much less the same line. There is no constraint between the two.

    The only constraint seems to be the availability of CPUs from IBM and Freescale. Apple is working on solving this problem with the introduction of the Intel based Macs. The constraint on iPods is that they are so popular that Apple can’t keep them in stock.

    What was the problem again?

  9. I doubt Mr. Wu has his MBA. And if he does, he should be ashamed of himself.

    If Apple decides tomorrow to sell purses and can sell them for a dollar more than they make them, without adversely affecting their other product lines, then investors should applaud such a move.

  10. > there are other things Apple is doing in its business that may
    > hearten investors: it’s spending less on research and development

    That depends on whether you are a short or long term investor.

  11. In other news adding water to cola creates a “wattered down taste”

    If you think of AAPL as a holding company for the Mac Business Unit and the iPod Business Unit, then this article is pointless. The MBU gross margins are UNAFFECTED by the iBU gross Margins and vice versa.

    What the article should be pointing out is that Mac mini price points are bringing down MBU gross margins. But when you sell entry level boxes for $499 and quad core pro systems for $4,999 then the product mix is MUCH more important than the average gross margin of all that stuff.

    Bottom line is that to look at any one stat for AAPL is a massive mistake. They sell $999 software packages at 80%+ gross margin. They sell lower end iPods at <30% margin. They sell lowend desktops, high end workstations, OS software, Server software, home applications like iLife and Pro stuff like StudioPro. And digital music. And iPods. And accessories. And extended warranties. And web email/file storage.

    MDN word: social

  12. These guys are complete MORONS. This article must have the highest proportion of stupid statements relative to total statements of any article I’ve seen this year. Your average convenience store owner has more business sense, and it’s NOT just the silly point about margins going down (which would you rather have, margins going down and total profits going way up, or the reverse?). The R&D point is even more unbelievably dopey; R&D is going down as a PERCENTAGE because Apple is selling more of the same type of products while R&D is staying pretty much the same. Only if Apple were to develop more types of NEW products/services would the R&D percentage have to increase. Since Apple has proven it can be very innovative at this level of R&D over the last few years, there’s no reason to increase R&D, so it will decline as a percentage of total costs/revenues. More R&D is NOT always good since every company hits a point of diminishing returns beyond which R&D dollars are wasted or simply less efficient in generating innovations.

  13. Another spin to these statistics is that as a market matures and more and more competitors enter the market, gross profit margins decline. This is normal occurrence. If the dominant market player plays it cards right then the extra competition can force it to innovate to stay ahead of the pack,

    Sound familiar? Video as a free option differentiates Apple from its competitors. And if there’s one thing Apple is renowned for is it innovation.

    However, other companies mature differently, they stop innovating and begin to lose focus. Does that sound familiar…Microsoft ? I agree with the figures I just interpret them in a different way.

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