Battle Of The Tablet Business Models: Apple iPad

by John Kirk   |   September 25th, 2012

Introduction

Today there are 5 titans battling to win the tablet wars: Apple, Amazon, Google, Samsung and Microsoft. When it comes to evaluating tablets, we often focus on the differences between the competing companies’ various tablet offerings in the hope that we will detect the little things that make a big difference. However, sometimes it’s best to step back and look at the big things that seemingly make all the difference. A company’s business model is one of those big things.

A tablet business model can be quite intricate but, in essence, it can be broken down into three parts:
— Where does the tablet make its money?
— Where does the tablet provide value to its potential customers? (Why is the customer willing, even anxious, to pay for a company’s particular tablet product or services? What makes a tablet unique? Why does a potential customer choose one company’s tablet over that of another?)
— How well does a company’s business model work overall? How well does it work in comparison to the competition’s business models?

With the above in mind, over the next few days let’s take a look at the tablet business models for Apple, Amazon, Google, Samsung and Microsoft in order to see if we can find the patterns that will help us predict which tablet business models are going to be the winners and which tablet business models are destined to be the losers in the upcoming tablet wars.

1.0 Apple iPad

1.1 WHERE DOES THE APPLE IPAD MAKE ITS MONEY?

When introducing the new Amazon tablets, Jeff Bezos said:

“We want to make money when people use our devices, not when they buy our devices.”

Bezos was purposely contrasting Amazon’s tablet business model to that of Apple’s. But was his characterization of Apple’s tablet business model accurate?

Pretty much. But Bezos’ description of Apple’s tablet business model, while accurate, doesn’t quite tell the whole tale.

Apple makes their money when people buy their iPads. Many think that Apple also makes a great deal of money from the sale of content and by taking commissions from the sales of apps, but this is a misnomer. True, Apple makes literally billions from those sales but that still only represents a tiny fraction of the revenues made from the sale of the iPad itself.

Apple facilitates the sale of content and apps in order to make their iPads even more valuable and even more attractive in order to sell even more iPads in order to make even more money. Content and App sales are crucial to Apple but Apple makes its money from the sale of the iPad, not from the sale of content and apps.

1.2 WHERE DOES THE APPLE IPAD PROVIDE VALUE?

The Apple iPad provides good value in both its hardware and its software. Apple’s store is also excellent but it cannot match the prowess of the Amazon store which has far more content selection at equal or better prices.

The iPad’s real strength lies in its apps and its app ecosystem. No competitor can touch the iPad there. The iPad has more than 250,000 (and counting) tablet optimized apps. More importantly, the iPad has a thriving app platform. Developers develop for the iPad first, developers are well paid for their services and customers see more value in the available iPad apps and readily buy more apps and pay more for them.

However, in my opinion, an even greater strength of the iPad is how Apple makes all of the various elements — hardware, software, content, apps,iCloud, retail support, etc. — work together as one. Customers get (and are willing pay for) value from the seamless experience rather than from any one particular aspect of the iPad.

1.3 APPLE IPAD BUSINESS MODEL ADVANTAGES AND DISADVANTAGES

The Apple tablet business model is coherent and aligned. (Which is not the same as saying that their tablet business model is the only available business model or that it is always perfectly executed.) Their tablet hardware is the “ticket” that their customer’s buy in order to gain access to “Apple World”. Once customers enter Apple’s walled garden, they seldom want to leave.

Apple’s primary mission is not to provide their customers with the best of any one thing but, instead, to provide them with the best overall user experience. This gives Apple a tremendous advantage. They don’t always have to be number one in hardware, software, content, apps, etc. So long as their overall user experience is excellent, that is enough, and more than enough, to keep their customer’s satisfied.

This often baffles industry watchers, pundits and analysts alike. They look at the individual parts of Apple’s tablet offering, find them wanting, then wonder how Apple can continue to compete so very well against other devices that seem to offer more and better features.

What they fail to understand is that Apple shouldn’t even be trying to add a hardware or software feature to their tablets unless those features perfectly integrate with, and add to, the whole. In a seeming paradox, Apple is not trying to make the best iPad, the best operating system or the best content and app store. Instead, Apple is trying to integrate all the pieces into one coherent whole and provide their customers with the best overall user experience. In this – as reflected by the iPad’s superb customer satisfaction numbers – they have been entirely successful.

Summation

Apple’s tablet business model is a very good. The results speak for themselves. However, it’s not the perfect tablet business model and it’s not the only tablet business model. It is now being assaulted from all sides by the entirely different business models of Amazon, Google, Samsung and Microsoft. How does the Apple tablet business model compare and contrast with those competing business models? We’ll see as the week progresses.

Tomorrow we look at Amazon and the Kindle Fire business model.

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John Kirk

John R. Kirk is a recovering attorney. He has also worked as a financial advisor and a business coach. His love affair with computing started with his purchase of the original Mac in 1985. His primary interest is the field of personal computing (which includes phones, tablets, notebooks and desktops) and his primary focus is on long-term business strategies: What makes a company unique; How do those unique qualities aid or inhibit the success of the company; and why don’t (or can’t) other companies adopt the successful attributes of their competitors?
  • http://www.facebook.com/msaleem Muhammad Saleem

    I think this statement you make is too broad.

    “Apple’s store is also excellent but it cannot match the prowess of the Amazon store which has far more content selection at equal or better prices.” — this is only true of books, movies, and television shows, specifically for the U.S. market. The international story is very different and the app ecosystem situation is the exact opposite as you say later.

  • steve_wildstrom

    I don’t think people realize just how little money Apple makes from app and content sales. Total revenues from the iTune Store (including the App Store) and the Mac App Store were at most $9.2 billion in fiscal 2011. I say “at most” because Apple’s reporting includes other software sales and internet services. That means these sales account for just under 9% of Apple’s revenues. But 70% (probably more in the case of some content) of the revenues are passed on to the vendors, leaving a gross profit of $2.8 billion. Apple doesn’t report profit by segments, but if we apply the same gross margin-to-net income ratio as for the rest of Apple’s business, we get a net of $1.7 billion. That’s nothing to sneeze at, but it is only 6% of Apple’s net income.

    • capnbob67

      I think it’s pretty well assumed that music and video content are run at little more than break even. I can’t find it definitively but the NY Times in 2008 had songs at 80% wholesale cost to Apple, leaving 20% for CC fees, creating/running the store and bandwidth. I doubt the variable pricing of songs has made that much more for Apple since the labels forced that move and they have probably taken most of any additional profit for themselves (if there is any). Video is about the same IIRC. Apps are better (70/30) but the 30% has to subsidize the 80% of downloads that are free which I would imagine eats into the gross margin on the paid apps pretty heavily. I would guess net margins are no better than 5%. It was said that the iTunes store cost $1Bn to run in 2009 and I would imagine it costs a lot more now on the vastly increased volumes being pushed.
      That said, it is still a better business than Amazon (but then corner lemonade stands make better margins than Amazon).

      • steve_wildstrom

        A 30% gross margin is not especially generous for retailing. (Amazon runs at about 22%, but that is exceptionally low and it shows in Amazon’s profit margins.) Basically, Apple runs the whole content and app business as a way to drive hardware sales, not as much of a profit center in its own right.

        • capnbob67

          Agreed. We know all this. I was just saying that your estimates for Apple’s profitability on its content operations were probably optimistic.

          • steve_wildstrom

            I absolutely agree. I was going out of my way to make the most generous assumptions and even then, content is a small piece of Apple’s net.

  • Greg Lomow

    I hate to be mean but this analysis seems a little simplistic. Here are some ideas to contemplate:a) Apple is a platform-vendor as much as it is a device-vendor. In this regard, Apple is looking to attract partners who will add value to the platform and in return they get something useful to their business. For example,- game platform – it takes a special combination of hardware, software, graphics, etc to support cutting edge games that benefit game makers and iPad buyers- education platform – Apple has invested in capabilities like iTunes U and iBook Author that set it apart from other tablet vendors as an education platform- business platform – great developer tools (eg Xcode) mean that it is easier for iPads to become business tools

    In contrast, someone like Amazon is not really creating a robust platform that makes it easy for others to add value (ie you see companies building home entertainment systems for the iPad ecosystem, but few of them do this for Amazon tablets).

    b) one advantage of Apple business model is that it generates huge amounts of revenue that can be aggressively plowed back into strengthening the platform and the devices (this is why Apple can provide the best developer tools, the best app store, can create custom CPU chips, etc.). Someone like Amazon who is making meager margins has very little money to plow back into the platform.

    c) part of Apple’s business model is being international – with app stores and media deals in 100+ countries – someone like Amazon is not following this business model
    d) part of Apple’s business model is partnering with other companies (and this seems to be a relatively recent development) such as Facebook, Twitter, Yelp, Baidu, Tudou, Sina Weibo, etc. and this doesn’t seem to be part of the business model being followed by companies like Amazon.