The Tale of Apple ASPs

Yesterday Apple announced its Q3 FY-2013 earnings. The product line unit numbers and revenues reveal something rest of the earnings statement do not.

Here are those numbers,

apple-q3-13

ASP is the Average Selling Price. You can compute that by dividing revenue by units sold. While average usually hides details a change in average is interesting. Because change in ASP points to change in product mix they are selling or change in prices. When a business has products that cover the entire price spectrum, ASP shifts are something to pay attention to.

For example a larger drop in ASP  with only minor drop in unit numbers will point to people not seeing value in their premium products and are happy with the low-end products. Good enough beats better. Since premium products bring more gross profit – you don’t think it costs Apple  $200 or even $100 (at 50% gross margin) to go from 128GB MBA to 256MBA do you?

With that background let us look at iPhone, Mac and iPad ASPs.

First iPhone ASP.

iphone-asp-q3-13

iPhone ASP held stead till last quarter (Q2-FY12). But since then it took a drop. The reason it held stead in the past quarter was iPhone 5. But after all those seeking new and great buy their iPhone 5, the market is left with only the price conscious customers and they are buying iPhone 4 or iPhone 4S leading to this drop in Q3. Another factor for slowing iPhone 5 sales is some of those who want new and great are waiting for imminent iPhone 5S.

Next the Mac ASP. Previously Apple used to break down desktop and portables. Unfortunately we do not have that data anymore. So the ASP comparisons do not tell full story.

mac-q3-13

Last year I wrote in GigaOm how the new Retina display would help Apple increase ASP. That is happening. More people prefer the SSD and Retina components in their MacBook Pros. It is also likely more 15″ models than 13″ are selling as the former offers more value than the 13″ models.

But the slight drop in last quarter could be explained by the MacBook Air refresh and those waiting for MacBook Pro refresh. The new MacBook Air pack lot more value for the price and the absence of Retina display is not a concern as you can see in that linked article.

Finally iPad ASP. Apple said customers use other tablets as expensive paperweights. But its tablet ASPs are dropping like paperweight.

ipad-asp-q3-13

I wrote (in GigaOm) before how keeping the iPad2 and introducing iPad mini will affect ASP and profits. You can see those models are not that far off from what we are seeing now. iPad minis are definitely more popular. But I believe there is another factor at play here – fewer customers are willing to pay high price premium for 32GB and 64GB versions of iPad. Most realize they do not need that much storage or rely on Cloud storage that obviates need for $100 SSD upgrade on their iPads.

There are rumors about Apple testing bigger tablets. As they realize they cannot price discriminate just based on commodity SSD capacity they are opting for other product dimensions as a way to up the ASP.

Bottom line, iPhone is relatively safe. With iPhone 5S the ASP will stay steady or improve. MacBook series ASPs are a worry, as people have more options to add external flash drives Apple will find hard to justify the price premium on those. iPads are a definite concern, watch for significant product changes in this area.

 

Markup is just plain gross, not Gross Margin

An anonymous commenter on my previous post wrote,

maybe you need a refresher in the most basic tenets of finance and accounting because gross margin is a percentage, not an absolute dollar figure. you’re referring to GROSS PROFIT, but calling it gross margin.

First correction on this comment is – Gross Margin can be expressed as either absolute dollar value or as percentage. In most situations it is understood by context – especially by the practitioners. Gross Profit and Gross Margin are used interchangeably as well. See for example Apple’s earnings release

apple-gross-marginBut when Google Finance shows Apple’s financials they refer to it as Gross Profit.

Sometimes we see Gross Margin Percentage explicitly used to indicate percentage margin. Again practitioners are not confused by any of the terms even when two of them are used interchangeably.

What is Gross Margin? (or Gross Profit)

Expressed as dollar value it  revenue less cost of goods sold. Expressed as a percentage it is this difference divided by revenue.

The anonymous commenter (who seem to have inexplicably routed his IP traffic through Fool.com, because I know MotleyFool is not afraid of making comments) added,

gross margin is the percentage that a company nets on the sale of a good after dividing it by its cost of goods sold.

That is not true. What this person is confusing with is  Markup. While Gross Margin (etc.) are financial accounting terms Markup is not. Its origins are in cost based pricing. You compute the cost to make a widget, add your preset margin you want to extract and call it the price.

Which you, my right tail readers, know is simply gross way to set prices. It would serve us all well if we banish the  “Mark Brothers” – Mark Up and Mark Down.

Another note on Gross Margin – it is a financial accounting term used for financial reporting purposes. The intended audience are investors and regulators. Since competitors can also see this companies do not want to signal their exact cost structure. So they  confound this number with a share of fixed cost allocation from manufacturing.

If you as a product manager or marketer going to worry about margin, worry about customer margin.

The Lego Pricing Puzzle

In a recent Wired blog post, physicist Rhett Allain asks

Why Are LEGO Sets Expensive?

and answers his own question by stating,

I’m not sure I would say LEGO blocks are that expensive, but the statement is that they are expensive because they are so well made.

To his credit he immediately qualifies his claim by adding

Really, this has to at least be partially true.

Then professor Allain goes on to make his case based on size variances in Lego pieces and compares it with variances in other blocks used for “play constructions”. Finding no statistically significant difference with other plastic blocks he adds,

but the LEGO blocks appear to be created from harder plastic. Maybe this would lead them to maintain their size over a long period of time. (but no data)

Finally he builds a regression model of price of Lego sets  to number of pieces in each set.

In essence, Allain made up his mind that Lego is expensive because of the intricacies in manufacturing, its cost of materials and number of pieces. He then collects data that would support his claim but quickly discards them with alternative explanation when data doesn’t fit his claim.

But lost in all this are some published hard numbers from Lego. They have 70% gross margin and 30% operating margin. Note that I am using gross margin reported in financial statements that usually include other fixed cost allocations to confound the numbers. That is Lego’s real contribution margin (price less true marginal cost) could be higher than 70%.

Even if Lego were to cut is price in half they would make as much gross margin as MegaBloks that makes Lego compatible pieces. Intricacies in manufacturing and cost of hard plastic do not contribute to Lego’s costs (or prices as Allain claims). That is Lego does not incur any additional costs because, “they are so very well made”.

Lego is priced thusly because they identified customers who value its offering and are willing to pay the price premium despite the presence of cheaper alternatives. All the reasons about details of pieces and their size variance are post purchase rationalizations we tell ourselves to justify the price we paid.

Your costs are just that, your costs. Costs are not something you pass on to your customers (unless you use that as ploy to pass on price increases).

Procter and Gamble Chasing Market Share

All last year, the common theme among the CPG companies was higher profit despite decreasing sales because they had better price realization. CPGs delivered higher profits by increasing prices, reducing promotions and with creative packaging. But that trend is coming to an end for at least one of the companies – P&G. In the recent investor conference call they announced plan to cut prices, add promotions – all in efforts to regain market share. P&G was losing sales for the past two quarters and they are now determined to turn this around, especially in the  fabric care sector. As  some of its customers turned to cheaper store brands, P&G tried to hold on to them with multi-version pricing. They not only introduced Tide Basic to appeal to price sensitive customers but also introduced high margin super-premium Tide Total Care to keep the customers within the brand family.

The tide has turned now, as they so no cheer in continuing drop in market share, especially in fabric care segment. P&G announced a 13% price cut on its Cheer brand detergent. Is that a move that will  help with market share? Probably. But in the key and the only relevant metric of profit they may be giving away too much with a 13% price cut.

P&G’s 10-K states their average gross margin is 50%. With a 13% price cut their margins will drop and the sales have to increase 36% to make up for the lost margin. That is an extremely tall order in the highly competitive and saturated fabric care market. As a comparison, their historical sales growth was in the region of 3% to 8% per year.

Unless they are looking at the total customer margin and not just gross margin on one product. Customer margin is the total margin from many different P&G brands a customer buys. This will reduce the required increase in sales but not near the 8% number (you can do the math on required customer margin for that). There is one more risk with lowering prices, lowering customer reference price and thereby reducing chances of future price increases.

The net is P&G, the inventor of marketing research and customer driven product strategy, is going to trade profits for market share. I  will be watching next quarter sales numbers with great interest.

Safeway Moving Up The Value Chain

In February, CEO of Safeway Mr.Steve Burd expressed his dissatisfaction with the CPG brands over their price increases. Almost all major CPG companies increased their prices since last fall when the commodities and fuel prices shot up. Since then their costs have come down but prices stayed up.

As I wrote before, the price increases enabled companies like Cadburys, Nestle, Unilever, Del Monte  and others to deliver 10-14% increase in their quarterly income despite  very small growth and in some cases even fall in their revenues. The brands were able to grow their profits because of the change in customer mix. As more and more of their price sensitive consumers switch to cheaper and private labels all they are left with are the price insensitive and brand conscious loyal customers.

Safeway is a distribution channel with high fixed costs and low single digit operating margin (around 3%). It saw its gross margins fall over the past five years. It was not happy with price increases because for two main reasons, it further cuts into its gross margin as Safeway and relies on these brands to draw in customers to the stores that help drive its revenues. The single metric of retail is monthly same store sales growth. Any stagnation or fall in this number sends bad signal to the stock market.

Safeway then said that it “will chew up the brands” if they did not reduce prices. I questioned this claim then but I admit  Safeway has followed through with its claim by aggressively developing its private label brands.  CPG companies had not had much to worry about a single retailer pushing its private label as the labels are, until now, limited to just that retailer. Now Safeway is moving up the value chain by becoming a CPG company. As a clear competition to major CPG brands, Safeway has signed deals to distribute its O organics brand and Eating Right brand at other regional retailers and at Albertsons.

The additional channels are not much compared to the rest of the market but Safeway has clearly established that it has a clear strategy and can execute on the strategy. The next round of price negotiations between Safeway and CPG brands is going to be much different from the previous rounds.