Making dollars and sense of Apple’s enormous share of mobile computing profits

For the last few years, industry pundits have been reporting on the surprising gap between Apple’s share of shipments compared to its share of profits. Investors care more about profits than market share.

On Monday of this week, John Paczkowski of AllThingsD wrote another one of these stories, quoting a report from analyst Tavis McCourt of Raymond James. Tavis is a sell-side analyst, and we’ve met many times at various trade shows and analyst events. I think he’s a smart guy, so I am happy to pay attention to stuff that he writes.

Here is a snippet of Paczkowski’s story:

Though it shipped only about 6 percent of the industry’s smartphones and tablets in the second quarter, Apple captured about 43 percent of the industry’s revenue, according to Raymond James analyst Tavis McCourt. And it generated an astonishing 77 percent of the industry’s operating profits. This, even in a seasonally weak period for iPhone sales.

When I saw this, I knew something was amiss. There is no way Apple has only 6% of the industry’s smartphone and tablet volume. No disrespect to the author intended, but my guess is AllThingsD misquoted McCourt’s research report, or is mixing and matching smartphone and overall phone share numbers (but I’m guessing here, having not seen the full report).

Smartphone and tablet market share numbers

So what are the real numbers? The most recent quarter to have ended is Q2 of calendar 2012. Let’s have a look at some of what the industry analysts have published, shall we?

First up is the smartphone segment. Data from Canalys shows that 158 million smartphones were shipped in Q2. Over 100 million of these were Android phones, and Apple shipped about 26 million phones, for a market share of 16.4%

Oh, and just in case you don’t trust the Canalys report, IDC issued a press release that says Apple’s smartphone market share stands at 16.9% for the same period. Pretty close to Canalys’ estimate.

It is really interesting to see that Android controls about 2/3 of the smartphone market, and I’ll come back to this in a moment.

But next up, let’s look at the tablet market. Again, we turn to IDC for a nice summary of Q2 tablet sales. In the tablet market, Apple still dominates with a whopping 68.2% global market share. But that’s on a base of only 25 million units (versus 158 million smartphones). Still, it pushes up Apple’s aggregate tablet + smartphone market share to about 23%, which is significantly higher than 6%.

Why Apple earns 77% of the profit

Now let’s get back to the key question:

How does Apple earn more than 3-fold the percentage of industry profits than it has in market share?

According to the Raymond James report, Apple has 77% EBIT share, which is accounting speak for “operating profits”. It stands for “earnings before interest and taxes”, if you care.

77% of profits with only 23% of shipments? Is this crazy talk? No. I don’t think it’s crazy at all.

That said, I will say that the Raymond James analyst had to make his best guess on many pieces of non-public information. Specifically, a lot of Android volume comes from domestic Chinese vendors. Canalys estimates that 27% of smartphone shipments go to Chinese buyers. In China, the top 4 smartphone vendors are Samsung, ZTE, Lenovo and Huawei. Keep in mind that none of these companies break down their profitability in smartphones. Hence the (educated) guesswork by any analyst trying to report on this.

Notice another trend among smartphone vendors in China? It’s called Android. Apple is growing in China. It’s just that Android is growing faster. And this massive growth of Android in China is a perfect example of why Apple’s profits are disproportionately higher than its global market share.

It’s all about pricing power.

Apple’s average selling price for the iPhone is above $600. The off-contract price starts at $649. Compare that to the newer, and certainly more expensive-to-manufacture Samsung Galaxy S3 varies by carrier by AT&T starts at $549 and Verizon at $599.

Apple dominates at the high end of the market. And even without the highest-end phone around, they make more money per phone than Samsung.

But the big Android volumes are not coming from high end devices. Much of it comes from low cost phones made by Samsung and other leading OEMs (original equipment manufacturers).

Apple controls its entire platform. And for those who enjoy Apple’s walled-garden ways, it makes for a simple and beautiful user experience. Apple excels at selling more expensive products by making them useful, simple, and gorgeous. Android vendors tweak the UI, but largely compete on hardware. It’s more of a commodity fight.

Some studies show that Android market share has peaked in the US market. Yet it continues to explode in low cost markets such as China and India. This suggests Apple’s disproportionate share of profits will continue.

But there’s another interesting point to consider. Let’s look back to China. Right now Apple is the #5 smartphone vendor in the country. But what about for tablets? Digitimes recently reported on research firm Analysys International’s study showing the iPad holds 72.7% market share for tablets in China.

Tablets are a much newer product than smartphones. They tend to be secondary devices as well. I’m guessing most folks who do not own a smartphone would rather buy one before considering a tablet. This makes tablets more suitable to richer people. Again, this plays to Apple’s advantage.

In time, as smartphone adoption peaks, and as tablet prices continue to drop, I’m convinced Apple won’t dominate quite so much on shipments. And they may not control nearly as high of a perctantage of the industry’s total profits. But until Apple shifts away from selling into the high end of the market (if it ever happens), Apple will likely hang onto its disproportionate share of profits, relative to shipments.

For vendors who sell lower cost hardware, perhaps we’ll see a lot of inivation around alternative revenue strategies. We’ve started to see this with the Kindle Fire. My guess is there is a lot more to happen here. But that’s a topic for a future column.