How Amazon and Google are toppling the Apple fortress

Manufacturing tablets at cost are turning the tablet market on its head and dragging Apple down

Apple’s been having an odd year with lots of ups and downs.  And then there was yesterday’s earnings call.  Apple—once again—fell short of analysts’ expectations.  This would make the third quarter since Tim Cook became CEO that Apple failed to wow with larger-than-life sales and profits.  Worse—the company is offering very conservative guidance for next quarter—the holiday quarter—which is typically the quarter in which Apple shareholders do the money dance.

What gives?  Is the Apple fortress really coming down, and is it Tim Cook’s fault?  It would be very cathartic to assign the blame to some inherent character flaw in Cook, but that’s not the case.  Rather, Tim Cook’s ascension to the role of CEO happened to coincide with Amazon’s release of its own super-low-cost tablet, the Kindle Fire.

Apple’s been stalwart in insisting that low-priced Android tablets have not been eating into iPad sales, and for the most part, this actually seems to be true.  An August report from IDC reveals that some 25 million tablets were sold in the second quarter, of which iPad accounted for 68%.  Furthermore, as Tim Cook pointed out at this week’s unveiling event, fully 91% of all Web traffic from tablets is coming from iPads.

So, yes, Apple is still the biggest kid on the playground.  But Tim Cook made an interesting comment in yesterday’s call that’s worth noting. 

When the company delivered its low guidance for next quarter—diluted EPS of $11.75 on revenue of $52 billion, even though it made $13.87 on revenue of $46.33 billion in the last holiday quarter—one analyst pointed out that if Apple only makes $11.75, it will be the first time in years that the company has had a year-over-year decline in the holiday quarter.  Apple is counting on high iPad Mini sales, but CFO Peter Oppenheimer explained that at the low(ish) price point of $329, the margins are a lot lower than usual for Apple.

Tim Cook chimed in that the team is “managing the company for the long haul.”

In other words, Apple is having to sacrifice its high margins to keep pace with low-priced tablets from Amazon and Google—who are producing their tablets at breakeven costs, because they’re not hardware companies.  Their tablets are designed to further their real bottom line: content, in Amazon’s case, and ad sales, in Google’s case.

Amazon CEO Jeff Bezos reaffirmed that strategy in a statement on the company’s Q3 financials: “Sell devices near breakeven and you can pack a lot of sophisticated hardware into a very low price point.  And our approach is working – the $199 Kindle Fire HD is the #1 bestselling product across Amazon worldwide.”

Apple never enjoyed the kind of market domination with the iPhone that it did with the iPad.  The Blackberry was already in wide use before the iPhone debuted in 2007, and it continued to dominate the smartphone market until Google eclipsed RIM’s market share and RIM fell off a cliff.

When Apple debuted the original iPad in 2010, it was a big ass deal.  Not only had Apple essentially created a new form of communication and content consumption—it created an entirely new market.  So naturally it enjoyed an unprecedented monopoly over that market while others tried and failed to create tablet competitors.  Apple has the brand fanaticism notoriety and the reputation for making high quality products to put competitors to shame.

In essence, Apple was the tablet market.  Its stock rose and fell in the years between the first iPhone and the first iPad, but prior to 2010, it never rose above $200 a share.  Enter the first iPad.  Between 2010 and 2012, Apple’s stock rose some 250%, from $200 to $700.

Have Apple’s soaring stock prices been a direct result of the company’s ownership—more or less—of the tablet market and its high margins?

Since the Kindle Fire hit the scene, Apple’s sales and profits haven’t been doing as well as expected.  The Street actually lowered its estimates for the quarter after word got out on Tuesday that iPad sales last quarter were lighter than expected (Tim Cook announced that Apple had sold its 100 millionth iPad two weeks earlier).  While many were expecting 17-18 million units sold, Apple ended up only selling 14 million.  

Interestingly, while Amazon is sticking with its strategy of producing tablets with virtually no margin, the company didn’t have such a great quarter either.  The company posted its first quarterly net loss since 2003, with a loss of 60 cents a share, while analysts were expecting a loss of only 8 cents a share.  And that’s after Apple had a mixed second quarter.

Is Amazon undercutting Apple at its own expense?  Is the Apple fortress coming down?

Street consensus is expecting a better December quarter than Apple is projecting, with estimates of $15.46 in EPS.  Analysts are also insisting that the current state of affairs is all “temporal noise.”

“We are tweaking our iPad estimates slightly lower, but we think the iPad mini could restore significant upside potential down the road, as the product expands Apple tablet market coverage,” said JP Morgan analyst Mark Moskowitz in a research note on Thursday.

But the fact remains that tablets aren’t necessary the way phones are.  The iPhone 5 saw high sales this quarter because people need phones.  Tablets are uber convenient if you need to fire off a quick email or read the paper, but they’re not really necessary to have if your car breaks down.

So consumers aren’t going to buy tablets the same way that they buy smartphones—and $500 is a lot to spend on a luxury item.  The iPad mini is cheaper, but still—why spend $329 when you can spend $199 on something that functions pretty well and you plan to use recreationally?  

And just to be clear, we’re in the middle of a damn recession.  Of course people are going to flock to cheaper products where they can find them.  So while the Apple brand has a lot going for it, it seems as though the Kindle Fire and Nexus 7 have graver implications for the tablet market than Apple is letting on.

Image source: aprayertoourfather.com