How will Google's attempt to devalue hardware hurt Apple?

How will Google's attempt to devalue hardware hurt Apple?

With Google’s recent release of the updated Nexus 7 tablet at $229, a lot of comparisons have been made between it and other low priced tablets on the market. It sure seems like Google wants to put pressure on vendors to offer solid specs with affordable price tags for consumers. After all, this helps sell more devices, and that increases the potential market for Google services, which is where the search giant makes its profit. This isn't dissimilar to how the race-to-the-bottom in App Store pricing has commoditized software, which benefits Apple's hardware-centric revenue model. But it does prompt the question, will it force down prices, or catalyze a price war, such that nobody really makes any money on hardware? And if so, what will become of Apple's business model?

I’ll be the first to admit I can’t predict the future, but for right now, I’m mildly concerned that Google is making it hard for other to earn a buck. That said, I don’t see this destroying Apple. Instead, it could push the Cupertino computing giant towards gross margins on products that Wall Street thinks are more sustainable.

It is well understood that iPhone margins are closer to 60% while iPad margins are more in the 30% range. On a $499 full-sized tablet that works out to $150 of gross profit, and I think it’s quite reasonable to assume that a $329 iPad mini has gross margin dollars of $100 or less. Compare this to a $229 Nexus 7, which probably has gross profit dollars of zero. Or compare this to the Amazon Kindle Fire HD, priced at $199, which probably also has gross profit of about zero.

Jeff Bezos has been incredibly clear about his company’s goal to make money when people use the tablet instead of when they buy the tablet. Google’s strategy is pretty much the same. (Again, Apple has stated the same strategy when it comes to iTunes - to operate it at just above break-even.)

If Google and Amazon are selling tablets at close to break even, doesn’t this practically guarantee that Samsung’s Galaxy Tab 3 7.0 ($199 for 8 GB) isn’t very profitable either? The difference here is that Samsung needs to make money from selling hardware ... just like Apple.

Assuming I’m right in saying that all of the major Android tablet vendors are not making money on their 7-inch tablets, then Apple is the only tablet vendor that makes any significant profit. Even then, Apple’s gross profit contribution from iPad sales is down from the days prior to the existence of the iPad mini. I think we all realize Apple makes a decent profit on its low priced $329 tablet, but it pales in comparison to the full sized iPad.

Can Apple maintain it’s price differential on tablets? I think they can. It’s looking like the iPad is about $100 more than a similar-sized Nexus tablet ($229 vs. $329 and $399 vs. $499). The world is full of examples where people pay more based on perceived value, and user experience. I think Apple has created more compelling user experience for the average customer, and much more so for Mac customers. Please understand I’m not saying the iPad is better. I’m saying it’s a cleaner, easier experience for most consumers. The iPad also has a much better tablet-optimized app selection compared to the Google Play store, although Google’s store caught up with smartphone form factors, so it seems reasonable to assume they’ll catch up eventually on tablet form factor apps too.

Either way, I think Google has created a situation where Apple’s tablet margins are lower than they might otherwise be. But at the same time, I think these lower prices are causing enormous growth in the market. And that’s good for Apple, especially if they can achieve solid penetration into markets like education, healthcare, or other verticals where a tablet form factor helps automate processes, reduce error, eliminate paper, speed up business, etc.

So that’s tablets. But what about smartphones? Truth be told, that’s where I’m more worried. What’s stopping Google from causing the same damage to Apple’s smartphone margins? They already have the Nexus 4 at $349 (for 16 GB), which is much, much cheaper than an off-contract iPhone 5.

This hasn’t affected Apple’s pricing much yet, but I think that’s mainly because of carrier subsidies in developed markets (where the iPhone is so successful). The simple truth is that Apple’s carrier partners make awesome money attaching voice and data plans to smartphones. As long as customers are clamoring for the iPhone, and the current pricing lends itself for decent carrier profits, Apple can probably maintain its pricing.

But what if Google were to offer something like the Nexus 4 through carriers? I’m not saying they will. But if they did, it would put pressure on Samsung and Apple to drop prices. I suspect some Apple premium would still hold, but it wouldn’t fetch Apple 60% gross margins. Maybe margins on the iPhone would drop to 30%.

Long term, there is nothing wrong with earning 30% on a decent chunk of the smartphone market. In fact, at lower prices, Apple could probably compete much more effectively in more countries. Maybe those are two of the factors that have Apple, according to rumors, considering a less-expensive "iPhone 5c".

I think Apple has to be planning for continued pressure on smartphones, and it makes perfect sense for them to launch a lower cost iPhone in the near term. The smartphone segment is really the only major product line Apple has where pricing options are a function of device generation rather than feature spectrum. I think we all know that has to change.

The big question - what happens to Apple’s profitability? Does it shrink? Stay the same? Can it actually grow based on higher potential sales volume around the world?

Chris Umiastowski

Chris was a sell side financial analyst covering the tech sector for over 10 years. He left the industry to enjoy a change in lifestyle as an entrepreneur, consultant, and technology writer.

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There are 36 comments. Add yours.

Premium1 says:

I feel it is going to shrink. Especially if they continue with the lower specs for many of their devices(for example, if no retina mini this year) there are a ton of options that are only getting better and which is why I think apples tablet market share is shrinking. They used to be the one and only tablet that could actually do anything. And that is no longer the case. Yeah I know they have more "apps" woohoo! Times are changing and I think apple will have to as well. They can't maintain their super high margins like they have been used to.

BB fan forever says:

Actually, google just announced 1 million apps and still going. They overtook Apple not to long ago. How many apps are on Apple?

dannejanne says:

I prefer quality over quantity. And in my experience the Android counterparts are not as functional in many cases. iOS apps seems to get a bit more of love from developers generally. I don't care about the numbers. It just means we have so so many totally crappy apps that functions as "fillers".

Fumetsu says:

This may have been true in the past, but Android app quality with the release of Jelly Bean and ICS combined with much more robust functionality and API availability on Android means that iOS no longer has a defacto advantage in terms of app quality. I'm not able to think of any app on iOS that didn't have an equal or superior option on Android. Fragmentation isn't as much of an issue either since the Android SDK makes it easy to develop for multiple form factors and developers can build API support packages into their apps to let older devices access newer features.

Murani Lewis says:

This is why I dislike Google being behind Android. They aren't a hardware centric company and can afford to drag down profit margins of OEMs. Strangely enough I think the strategy could backfire on Google. The race to the bottom would put tremendous pressure on OEMs and ultimately will cause several of them to go out of business.

If Apple is willing to make a lower percentage of gross profit on the iPhone they can serve more markets and snatch market share. Apple is getting very calculating in how they can limit Google's profitability off of iOS users and that would serious hurt Google's profitability moving forward. More than anything else I value Apple's supply chain management. That is a tremendous asset to have as Google tries to devalue hardware.

richard451 says:

"They aren't a hardware centric company and can afford to drag down profit margins of OEMs"
-an odd statement considering the OEMs, not Google, make the Nexus hardware. In this case it's Asus and they has stated they have made a healthy profit on the previous Nexus 7 and are probably doing the same with the new model.

Some Random Bloke says:

The OEMs make the Nexus for now. Motorola is waiting.

Murani Lewis says:

This doesn't refute my statement. Instead of selling the Nexus 7 at $300 it is $229. Isn't that dragging down the profit? Asus isn't making a sizable net profit off the unit. Plus Google Nexus devices are statements by Google to show what is possible. It isn't like ASUS decided to come out with a Nexus branded product line and it just happens to be running Android. Oh well, this the type of stuff is why manufacturing jobs will stay in underdeveloped economies and ridiculous work conditions for the workers will continue.

richard451 says:

"Asus isn't making a sizable net profit off the unit. ". According to the CEO of Asus they are. If you have evidence to refute that, I'd love to see it. Asus has stated multiple times that they are generating a good profit from the Nexus 7. It's why they jumped on board for the new N7 and It's also why OEMs are stumbling over each other to make Android tablets.

And yes, I agree these profits are generated off the backs of workers who can't demand any better.

Aenean144 says:

You know, you both could be right, sort of ;)

Asus may be making a "nice" profit, but it does not mean Google is. There's nothing special or unique about Asus' pricing on their "Asus" branded tablets. (Transformer Pad/Infinity/TF series or Vivi RT). They span the typical prices that other OEMs have.

The Nexus 7 however sports a rock bottom price not seen on other Asus tablets. For the Asus CEO's statement to be true, the only way I can see that happening is Google is paying Asus $300+ for every Nexus 7, then turning around and selling them to consumers for $199 or $229 or $249 depending on model year or storage config. Google is taking a "loss" on the hardware hoping to do whatever the Nexus 7 is meant to do.

Remember this price imparity also exists for the Nexus 4. LG does not sell the Optimus whatever for $300, but about $500. Right? So is Google taking a loss here or is LG?

(Same question goes to Amazon and Kindles and their ODM).

Both LG and Asus, are what's the saying, cutting off their nose to spite their face or something? They are digging their own graves if Google ends up setting the price expectations. They are making the bet that the Google brand will bleed into theirs, while the Nexus program is just a temporary Google strategy. If it is not, they poisoned the well for everyone else, so maybe it's not that bad of a strategy. Still.

At least with the Nexus 10 prices, Samsung has some breathing room.

richard451 says:

"For the Asus CEO's statement to be true, the only way I can see that happening is Google is paying Asus $300+ for every Nexus 7, then turning around and selling them to consumers for $199 or $229 or $249 depending on model year or storage config. Google is taking a "loss" on the hardware hoping to do whatever the Nexus 7 is meant to do." - you have bad data on how expensive these components are. For example; the last Nexus 7 was only estimated to cost $152 and Google sells it for $200.

"The Nexus 7 however sports a rock bottom price not seen on other Asus tablets"
-hmm. again, you have some bad data. The other Asus 7" Android tablet is the MeMo (what a horrible name), it sells for $99. Somehow Google is setting the price expectation as too low by selling a similar tablet for twice the price. Think about how crazy that sounds.

Aenean144 says:

Sure, I've seen the MeMo. It's a budget tablet that MSRPs for $150. It has a CPU capacity that is 2x to 3x less than the 2013 Nexus 7, the CPU is even slower than the 2012 Nexus 7, which everyone thinks isn't all that great in the first place; its GPU is almost 10x slower than the 2013 Nexus 7; it has a 1280x800 res display, half the pixels of the 2013 Nexus 7; it has half the RAM as the 2013 Nexus 7, and so on and so forth.

This tablet isn't event top of the line in 2012 let alone 2013. It's a budget tablet around 100 to $150 of which there are many many offerings on the market of this class. It's not even remotely similar to the 2013 Nexus 7.

Lastly, the difference between BOM ("estimated to cost $152") and what it is sold for ("Google sells it for $200") is not real "profit". The BOM/(market price) is a "gross margin" or the difference is the gross income. It costs money to sell something. It costs money to maintain stock. It costs money to sustain and support something. It costs money to have a business transaction.

So if it really costs only $150 to make, and Google pays $200 to Asus for each one, Asus gets a profit. Meanwhile, Google is eating the costs of selling and supporting the device. This is not a trivial cost and is on the order of 50% to 100% of the BOM.

Murani Lewis says:

Exactly the true cost is so much more than just BOM. Yes if Goohle has picked up.the tab for things like marketing and maintaining supply than this frees up profit margin for ASUS. Google is still eating that cost and my point is that Google doesn't mind because they want the users so they can sell ads. Imagine how Google would freak out if Microsoft and Apple gave away free ads.

richard451 says:

I think Google does all the marketing, but then again I've never seen an Asus ad for anything (perhaps oversees they shine). Google doesn't seem to freak out when AT&T/Sprint/Verizon does a free ad for the iPhone.

SockRolid says:

Consumer electronics hardware prices always drop over time. Period.
Apple knows this. That's why they're moving into iCloud and why they're
ready with iAd. To prepare for their future service- and ad-revenue business model.
(Especially when they roll out their "real" television strategy.)

Oh, and as for Google's tactics, they're hurting themselves more than Apple.
They're reinforcing the consumer mindset of "there's the authentic Apple product,
and there are crappy copies."

crazygonzo says:

Money matters, with advancements in Android it's hard to believe an iPad is better. Either Apple adjusts and sacrifices some profits or they'll return to the Mac era when they were nothing more than a blimp on map, a small footnote in PC space. I believe that asking a premium price for hardware that's not premium in 2013 is crazy, e.g. forget about 16GB capacity or slash the prices (and asking for additional $100 to jump from 16GB to 32GB is disgusting when you look at the sd cards). It was Apple's choice to skip on a sd card port, now they need to live with it and offer more storage at an even cheaper price than the competition does and pray it's enough to sell their product (again). More available technology means customers win so Google did a nice job with their device.

Jim Gramze says:

Never once have I wished I had extra portable storage for my iPad. The cloud and WiFi work for what I use between devices. I don't get it.

Trappiste says:

Considering that Apple products offer value only in select regions and for speakers of a very limited set of languages -- for others, iOS 6 is still basically iOS 4 or 3 -- pricing may not really matter much at all in the future. Google is relevant locally, everywhere, and that gives Android products inherently-superior value. Google is an ad company, so they know this stuff. Appe does not. Apple designs products in America for Americans to be used in America. That model can drive initial penetration (out of sheer novelty of the product), but is not a globally-sustainable approach in a maturing, increasingly-competitive market.

Aenean144 says:

"Either way, I think Google has created a situation where Apple’s tablet margins are lower than they might otherwise be. But at the same time, I think these lower prices are causing enormous growth in the market."

You are thinking too tactically here I think. The tablet and phone markets are maturing and being commoditized. To me, this means the needs of the vast majority of the market is being met by low price tier hardware and software features have gotten good enough. Ie, a product from a commodity maker is good enough. This drives the margins down for the companies who made all the money during the market segment's growth period.

So, if wasn't Google, it was going to be someone else. Google's already done the job, not through Nexus devices, but by getting Android 4.x to a point where it meets most everyone's needs. The rest will be done by OEMs eating everyone from the bottom up. Samsung is in the same boat as Apple here.

Apple goes where it went in the computer market. They go premium and sustain there at low growth until the next market busting product cycle arrives. Their demarcation line for PC laptops is $1000 and for desktops is $600. They then design devices or products that justify those prices. For the phone market, I think you can already see where that line is: around $300. I don't think they'll produce a tablet or phone below that price. The iPod touch is neutered to get below that.

Now, the race is on to see if Apple can design a product line to justify a $300 to $800 price tag to sustain their bottom line.

MooseMonkey says:

Best reply thus far, and I wholeheartedly agree. A lot of folks in the tech arena forget that even when Apple's desktops were a tiny fraction of the overall PC scene, they were the only OEM making any bloody money. Technophiles also seem to have forgotten the years that passed between major, game-changing innovations, and have subsequently confused minor feature additions ("Look! I can wave at my phone now!!") and out-there geeky items (hello, Glass) that'll unlikely take off. Apple has always released a 'wow' product then improved it incrementally, and at whatever pace suited their needs and to complete their vision - not ours. Whether or not the tech writers like it, Apple will likely always be Apple - independent of whether they are mega-brand or boutique.

dannejanne says:

Google Glass lol. Even for a tech-geek like me that is far too geeky.

Jeff Kibuule says:

Especially for people who know that it doesn't cost $100 for Apple to put in 32GB of flash memory instead of 16GB, I think they are starting to see what real competition looks like this fall. This is not a walk in the park anymore.

Some Random Bloke says:

They've always known what real competition looks like. When they tried to compete on the competition's terms, in the 90's, they almost went under. When they said, 'Screw you, we're going to do what we want,' essentially premium priced products, they've done well. Remember, marketshare only counts if you're making money.

Derrick4Real says:

competition is good. A price war is great. The consumer get's more for cheaper. I've no problem with it. I welcome it. Maybe because of it the next iPad mini may have to get a price drop to $229. There's that's great for me.

sting7k says:

The "iPhone 5C" will be low cost for Apple to manufacture. Probably not all that low cost for the end user. They just have to repackage the A5 SoC (maybe even an A6) into something less expensive to manufacture than the iPhone 4/4S. Apple is making this iPhone to save their profit margins, not for us.

Wake me when the iPhone 5S or 6 get real.

Some Random Bloke says:

As a non-investor (and I recognise this is an investor column), the only reason I care about Apple profit margins is the sustainability and direction of the business.

Jim Gramze says:

I like the look and feel of Apple products better. Price and meaningless specs don't affect that. It's about the experience you want and can afford. I don't settle for a lesser experience unless I can't afford better. My iPhone is an extension of my iPad and Mac Pro, not merely an end unto itself. If you like Android better then good for you, same with Windows. I don't care about who is gaming stats or on top of whatever mountain the writers claim matters so long as I can get the experience I want for myself.

Harry Wild says:

It will be interest to see what Apple's answer is to the Nexus 7 - 2! Will they just do a minor refresh like upgrade the CPU to an A5X and double the RAM to 1GB or will they breakdown and be competitive and add the retina screen in the second generation iPad Mini?

We will know in September!

oscarcanada says:

I think that in the long run, a number of things could happen. Remember a lot of the OEMs abandoned their legacy systems for the open Handset Alliance at at time when smartphones were still virgins and tablets almost non-existent......and then Google were offering them open source
I think you will see more and more OEM's develop their own OS or indeed look to get deeper in bed with Microsoft. Today that's not feasible but imagine in 24 months time.....when windows has a much later installed base and track record, that will be pretty alluring to an OEM. As well, what is Samsun takes Tizen seriously and makes that their platform of choice? That's a big chunk if the android market gone.
As good as android is, I think most people buy a Samsung cos they make awesome products, not necessarily cos they want an android device.

Joe Belkin says:

On the surface, it might seem so but consumers are smart - other than contrarians, the majority of consumers recognize that Apple is worth about 60% more - that Android OS is not worth anything unless it's "free." So, Android subsidized or cheap phones sell fine but not android tablets unless they are discount to about 40% of the price of an Apple product ... just as google Tv has failed at $199 or a Nexus phone priced the same as an iphone ... in this sense android is windows (same with windows, they'll put up malware when it's a cheap device) name is the devauled/the low price option ... the obvious example is MS selling surface at or slightly lower than an ipad - disaster ... the win brand name is devalued - as long as a laptop is 40% the price of an Apple one, like win laptop at $399 sell fine to Apple's $999 comparison ... but look at ultrabook sales - poor - while the hardware is still not quite as good as an MB Air, it's close - in theory at $899 or $799, it should sell but nope. Unless there is a 60% pricing difference, Apple wins. So, surea Google tablet will sell some units but the reality is it affects Apple to a very low degree unless they are budget hunters or contrarians who refuse to buy Apple anything and would rather suffer than admit Apple/IOS/OSX is a superior experience ... Google is a great ad search monetize company but is really a one trick pony. They have failed in EVERY attempt to create a second business unit. While Apple has created a $40 BILLION dollar business unit in just 3 years with the ipad, in that same time, Google has sold a few hundred Google glasses after soending how many billions to create the SEgway of the 21st century?

Fumetsu says:

This is incredibly arrogant.

The iPhone is heavily subsidized and in some cases free in the US, and in countries where it isn't Android phones both high end and mid range still outsell Apple equivalents. Android tablet share has surpassed iOS even with the iPad Mini competing in the same price range. Just because Apple prices itself higher doesn't mean they are inherently better. Not everyone sees the value in paying more for less functionality, and doing so doesn't make them "contrarians" or budget hunters.

Google Glass isn't even commercially available to the public yet, and they just today announced their first phone since the Motorola purchase. YouTube, which isn't part of their core search business, brings in billions in revenue. Keep in mind Apple has been in business since 1976 and Google was formed in 1998, and Google has managed to surpass Microsoft in size and is 3/4s the size of Apple, with dozens of potential avenues for growth whereas Apple is largely dependent on iOS sales, which are slowing.

Im not trying to turn this into a fanboy flame war, but maybe you should take a step back before preaching about how superior you are because of the type of devices you have. You give Apple users a poor image. While Apple devices are high quality and do offer a good user experience, Google's products and its development of Android now are on equal footing and not the bargain bin junk youre portraying them to be. Even most Apple fans admit that its more difficult now to justify the price difference when all things considered the user experience and quality are equal. The old iOS arguments about lag and malware simply aren't representative of the actual experience.

Dark_Blu says:

I think Apple's answer on the Smartphone front is the iPhone 5C. If Apple makes this available everywhere (not just China), the profit margin will be lower than the iPhone 5S, but they will make that up on volume, as I think the plastic iPhone will sell like crazy. As for the iPad mini, I don't think Apple will give it a Retina display because people would buy the mini over the full size iPad in order to get a retina display mini at a lower price. Then again, that could be Apple's plan if they did give the mini a Retina display. As with the iPhone 5S, Apple would rather one of it's products steal sales from it's other products rather than allow a competitor to steal sales from any Apple product.

Apple will be fine. The perception is that Apple produces premium products that offer a superior user experience and as much as some of us may disagree with that thinking, I'm sure that Microsoft in the wake of a $900 million loss on RT and Surface Tablets that were priced higher than Apple's iPads but weren't perceived by the public to offer a more premium product with a better user experience, I'm sure Microsoft learned that hard lesson. Google can go the cheap route all it wants (Samsung too), but their products will never be considered "premium" in the way that Apple's are, without copying some premium experience method of Apple's.

geoadm says:

I have absolute zero respect for Google and their business practices. Anyone who thinks googles race to the bottoms is good for anyone but Google is fooling them self. Googles android "partners" are making a next to nothing. Samsung appears to be doing ok but they don't reveal accurate/real profits. How much of their profits are from phone/tablets and how much is from dishwashers?
Google is an advertising company and that is the sole purpose for everything they do. It will be a sad day when the only choice we have is to get google products covered with advertisements cause no other company can compete with googles prices

Fumetsu says:

Samsung very clearly separates its mobile unit from its other units. The mobile unit accounts for 60% of its revenues. Look up any of their earnings reports and you'll see it.

And to say that Advertising is the reason behind anything Google does reveals how little you know about Google or its founders. Google has always been about increasing access to and organizing information, and to enhance a users experience on the internet by making it faster and easier. When Google first started, it was common for results to be displayed based on how much an advertiser paid, and for ads to be embedded in results instead of separate from results. In fact, Google will only display an ad if it is relevant to the user and the search. If they feel an ad wont enhance a user's experience, they won't display one at all. There was a time that Google didn't have any ads at all, and they only began doing so once they could do so in a way that enhanced rather than detracted from the results.

Its easy to let the smartphone OS wars color your opinion of Google, but your characterization of them is incorrect.

The "race to the bottom" may mean that Apple's profit margins aren't as high, but it also means that smart phones and tablets and internet access are available to millions who otherwise couldn't justify the higher cost of an iPhone or iPad. Nothing is stopping you or anyone else from paying more if you choose, but "Apple makes less money" is a poor rationalization for justifying higher prices and lack of choice.

dannejanne says:

Well if I would buy a tablet I sure as heck would not buy a Android tablet no matter how cheap it is. I could not stand the occasional choppiness of the animations on a big screen like that. On a phone alright but not on a tablet. My father has a Galaxy Tab 2 10.1 and it's TERRIBLE. Like 10 frames per second. Horrible. It needs project butter at least need to fix that for him so it is tolerable at least.