Apple iPad maintains price advantage

NEW YORK -- The new iPad model hitting stores today comes with several improvements over the original version but the same price tag, hobbling efforts by rivals at breaking Apple Inc.'s hold on the emerging market for tablet computers.

Competitors such as Motorola Mobility Holdings Inc. can't seem to match the iPad's starting price of $499. Tablets that are comparable to the iPad in features cost hundreds of dollars more, while cheaper tablets are inferior to the iPad in quality.

This is highly unusual in the gadget business, where early products, such as the first Blu-ray players or digital cameras, are expensive. Competition then gradually brings prices down. With the iPad, the reverse is happening.

It looks as if this is a result of Apple's strategy. The company appears to have chosen, right from the start, to make less of a profit from its iPads than it does from iPods and iPhones. The move is particularly odd for a company that isn't known for cheap products.

Apple's profit margin on the $499 entry-level iPad model is about 25 percent, according to an estimate by Toni Sacconaghi at Bernstein Research.

By contrast, the company's profit margin for all products, before corporate overhead, was 38.5 percent in the most recent quarter. Sacconaghi and other analysts estimate the margin for the iPhone 4 is 50 percent to 60 percent. (Apple charges about $600 for it, though it's cheaper in stores because wireless carriers subsidize it.)

Apple is telling investors to expect overall margins to keep declining, meaning competitors can't expect much of a reprieve.

The competition

There are cheaper tablet computers available, but they don't perform as well. They have poor screens, poor touch sensitivity and poor software, and they are slow. For example, Archos sells a tablet that's roughly iPad-sized for $370. Reviewers at CNET and Laptop Magazine say its screen washes out unless you're right in front of it, and it has problems sensing touch.

A tablet that can match the iPad 2 in quality and features costs much more. For example, Motorola's Xoom sells for $800, or $600 if the buyer agrees to a two-year data service contract with Verizon Wireless. The iPad 2 with the same amount of memory -- 32 gigabytes -- and cellular data capability on AT&T's or Verizon's network costs $729, no contract required.

The Galaxy Tab from Samsung Electronics Co. is half the size of the iPad, yet costs $500. And that price is only available if the buyer pays an activation fee and signs up for at least one month of data service from Verizon, at a minimum total cost of $55. The tablet can be had for as little as $300, but that requires two years of data service, or hundreds of dollars in fees.

Some 100 models of tablet computers have already gone on sale or are on the way. Gartner Inc. project that 65 million tablets will be sold worldwide this year, and analysts expect the bulk of them will be iPads. Apple sold 15 million of the original iPad in its first nine months on sale. Research firm IDC says three-quarters of all tablets sold in the last three months of 2010 were iPads.

J.P. Morgan analyst Mark Moskowitz believes there's a "bubble" building in tablets, with supply potentially outstripping demand by 36 percent this year. That could put additional pressure on tablet prices, though Moskowitz believes manufacturers will be hurt less than suppliers of components, which are able to command higher prices now because tablet makers are eager to secure displays and other parts.

Samsung, Motorola and other tablet makers will have to rely on other products they have to cushion the blow.

Apple advantages

Analysts say Apple has a couple of advantages that let it sell an iPad profitably at a price that would put another manufacturer at break-even, or at a loss.

Apple sells about a third of iPads in its own stores and from its website. By cutting out the middleman, Apple is able to keep more of the slim profit margin for itself.

Also, the iPad uses many of the same chips as iPhone and iPods. That means Apple is able to buy them in huge quantities, bringing down costs. Wayne Lam at research firm IHS iSuppli estimates that Apple alone buys 20 percent to 25 percent of the world's production of flash memory chips, which go into phones, iPods, memory cards and the iPad.

Lam also speculates that Apple is using its clout and its cash to ensure supplies of another crucial component: touch-screen displays, which make up a large share of the tablet's cost.

Apple said in January that it had spent $3.9 billion on long-term contracts to secure supplies for the next two years of a "very strategic" component it wouldn't name. If Apple is indeed tying up a lot of the production capacity, competitors could have difficulties getting screens at a reasonable price. Apple did not return messages to comment on that or its overall pricing strategy. Motorola had no comment.

Apple also designs its own processing chips to run iPad and the iPhone, based on blueprints it licenses from ARM Holdings Inc. For the Xoom, Motorola buys its main processing chip from Nvidia Corp., meaning there's one more vendor to pay.

One other factor is the software powering the tablet. The Xoom and other rivals generally use Google Inc.'s Android system, which Lam says demands more memory, raising the cost of the product. Apple's iPad software isn't as ambitious about "multitasking," or the ability to run more than one application at the same time, so it doesn't need as much memory.

In short, using Android forces iPad competitors to produce more expensive machines, Lam said. They might be able to bring component costs down by working closely with Google to optimize the software, but meeting the needs of a range of devices and companies is difficult. Because Apple controls its own software, it's a better position to tailor it to its own devices.

That adds up to very difficult math for competitors.