By John Gruber
Atoms: We are not selling shoes this time…
iSuppli is a “market intelligence” company which, every time Apple releases a major new product, rips one apart and generates an estimated “bill of materials” for the costs of its components. Their estimates always seem to conclude that Apple is generating extraordinarily high profit margins, often in excess of 50 percent. They issue press releases trumpeting their research, which are then parroted in “Look at Apple’s crazy high profit margins!” stories all over the press.
I’m calling bullshit.
Take, for example, their report on the iPhone, which claimed a $599 8 GB iPhone costs Apple just $280 to produce. One problem with this is that they released this report in January, based not on a tear-down of an actual iPhone, but simply based on what they guessed was inside one.
In early July, they took some actual iPhones apart, and, surprise surprise, concluded they were pretty much spot-on back in January, with Apple earning margins of 55 percent. Holy Kreskin!
With amazing margins like this, no wonder several dozen news sites picked up the story, often with the emphasis that the iPhone is overpriced. Take, for instance, this story by Martyn Warwick for TelecomTV:
And that uncomfortable “ripped-off” feeling could well be exacerbated by new estimates released by iSuppli.
Margins on the device are running at an astonishing 55 per cent compared to below 30 per cent for most other smartphones. An analysis of the $599 iPhone indicates a manufacturing cost of $265.83 per unit although the factoring in of royalty payments and delivery logistics would increase that figure.
Warwick shifts from citing the figures as an estimate in one sentence to stating them as fact in the next. But we do not know that iPhone margins are 55 percent; what we know is that iSuppli, a company with no relationship to Apple whatsoever, claims Apple’s iPhone margins are 55 percent.
Searching in Google News, I’ve found several dozen stories from the past month about Apple’s supposedly exorbitant iPhone margins, but not one citing a source other than iSuppli.
Reasons for calling bullshit on iSuppli’s numbers:
Apple, as required by law, states their gross margins in their financial statements each quarter. For the past few years, these numbers have typically ranged from about 25 to 30 percent. But iSuppli has been claiming margins in excess of 50 percent for Apple’s most popular products for years. E.g. their claim last September that the then-new $199 4 GB iPod Nanos cost just $72 to produce, generating 64 percent margins. It’s true that Apple, in its quarterly statements, does not break down its margins product-by-product. And yes, in the 2007 Q3 results Apple issued yesterday, gross margin increased to an impressive 36 percent. But iSuppli has been claiming higher-than-50-percent margins on iPods for years, and Apple’s financial statements simply don’t back this.
It’s also the case that margins tend to go up over time, as a product goes from new to old. 80 GB hard drives, for example, almost certainly cost Apple less today than they did when they were first released last September. But iSuppli does its tear-downs when these products are new, and Apple’s margins are at their lowest.
The total cost of a product’s physical components is not the total cost to produce the finished product. Build quality, packaging, shipping, warranty costs — none of these are taken into consideration by iSuppli.
Some of their numbers are simply pulled out of thin air. The most precious iPhone ingredient, for example, is its software. Give some other company all of the physical components of an iPhone for the exact prices iSuppli quotes and tell them to produce an iPhone. Where would the software come from? Yet in iSuppli’s preliminary iPhone report, there’s this delightful line item:
Operating System - OSX: $7.00
I don’t know much about accounting, but I presume the development of the iPhone’s OS and application software counts as R&D, which is expensed differently than per-unit physical components. But regardless, iSuppli’s $7 number is pure nonsense. Try calling Apple and telling them you’d like to license OS X for your upcoming new cell phone, for $7 per unit. It makes no sense, and yet completely obscures the iPhone’s single biggest competitive advantage.