With Apple’s (NASDAQ:AAPL) media event for the expected launch of the iPhone 5 nearing, many believe that the company may also introduce or give insights into its plans of launching a smaller 7-inch iPad, the much rumored iPad mini. The case being made for a smaller iPad is the growing competition in the low-end of the tablet market from Amazon’s (NASDAQ:AMZN) recently upgraded Kindle Fire line and the mid-year launch of Google’s (NASDAQ:GOOG) Nexus 7 tablet. With the tablet market still in a very nascent stage, many believe that Apple needs to stamp its authority as the creator of the market by introducing an iPad mini that will drive other competitors out of the market and make the market its own. But, as with most business strategies, there is a flip side to this story that makes us skeptical about Apple adopting such a strategy right now.
Difference in business models
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Amazon and Google’s strategy around low-end tablets do not involve making a profit on the hardware itself, which is instead used as a front for driving their core businesses. Amazon makes money off selling content and wants to be the one-stop shop for all e-content purchases, which is why the Kindle Fire is positioned as an ideal way to access Amazon’s Appstore or buy books, music and magazines or rent movies. Google, on the other hand, is primarily an advertising company with almost 65% of the company’s value derived from search ads alone. Most of its business decisions therefore revolve around bolstering its ad business. The Android project in general and the Nexus 7 in particular have therefore been conceived as ways to get more people to use Google services and search on mobile devices, thereby enhancing the search giant’s ability to compile useful information about our online habits and serve relevant ads.
Apple’s business model, on the other hand, works in the exact opposite way. It uses content and apps to drive hardware sales. The iPhone and the iPad business contributes almost 70% of Apple’s value, while iTunes app and content sales account for a meager 3%. Apple’s margins on its content business are abysmally low as it runs this division at near break-even solely to drive hardware sales. This difference in how Apple treats its hardware business, as opposed to Amazon and Google, makes it difficult to presume that Apple would want to enter into a tablet price war with them.
iPad mini makes little sense now
The only reason why we believe Apple would even consider such a move would be to corner more market share. But going after market share isn’t really the biggest driver for Apple’s mobile business as the iPhone has shown. In the many businesses that contribute to Apple’s value, the company has mostly steered away from playing the volume game – preferring instead to have a niche market while cornering most of the industry profits. In the mobile phone business (which contributes more than half of Apple’s value), its global market share is in single digits, but it takes up at least 70% of the industry profits every quarter because of its high margins.
It is possible to argue that Apple doesn’t have to take a margin hit to introduce the iPad mini if it considers a $299/$349 price point but it already offers the older/refurbished versions of the iPad at similar price points. (See Debunking iPad Mini Rumors Part I and Debunking iPad Mini Rumors – Part II) If Apple does see a threat from the low-cost tablet categories, all it needs to do is market these models a little better to gain more mind share. Considering the nascent nature of the tablet market, however, it just doesn’t make sense to cannibalize the sales of the higher-end iPad models at this juncture with an iPad mini. While Kindle Fire’s launch last year saw a spike in interest in the low-cost tablet category during the holiday season, the drop-off in sales in the subsequent quarters showed that the iPad faced little near-term pressure from the low-cost category. (See Apple Doesn’t Need To Enter The Low-Cost Smaller Tablet Market).
Of course, as the tablet market matures, Apple may consider introducing an iPad mini as it slowly makes more business case to cannibalize the sales of its existing models than lose market share to rivals. In such a scenario, we believe the best way for Apple to extract any value would be to develop a low-end version of the iPad mini without the Retina display, price it around $299, and maintain respectable margins. This best case scenario would add only about 5% more value to Apple’s value, taking our price estimate to about $735. (see Debunking iPad Mini Rumors – Part III)