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Wednesday, April 03, 2013, 06:44 pm PT (09:44 pm ET)

Apple's iPad pricing, distribution stronger than iPhone

Apple will have an easier time holding onto iOS market share in the tablet market than in smartphones, writes an analyst with an outperform rating on the company, thanks to more competitive pricing and better distribution.

"We see several differences between Apple’s approach to the smartphone and tablet markets," Toni Sacconaghi wrote for Bernstein Research in note covered by Barrons.

David Han shows off iPad purchase


iPhone subsidies and the pricing umbrella



"The iPhone left a price umbrella for other smartphone vendors to offer cheaper unsubsidized smartphones, even at the premium end," Sacconaghi wrote.

"The subsidy model allowed Apple to earn gross margins well above 50% on the iPhone, compared to ~30% on non-subsidized hardware products (Mac, iPad, iPod). Other smartphone vendors using free Android software were able to price below Apple for unsubsidized phones and still earn gross margins above 30%, especially on high-end smartphones."

Apple's iPhone carrier subsidies have previously been cited as a risk for the company, based on the reasoning that, were mobile providers to drop the program, users would be pushed toward cheaper phones and be more hesitant to pay the premium price of iPhone-class hardware.

Of course, the reason why carriers are paying Apple subsidies is because the attraction of the iPhone is selling their more lucrative data services. Attempts to replicate the iPhone's draw using Android alternatives, a strategy pursued by Verizon Wireless in its "Droid" campaign of 2010, haven't been nearly as successful.

The cost of market share: profitability



While Apple's competitors, including Android licensees, BlackBerry, Nokia and other Windows Phone partners, have all focused on market share by offering cheaper devices that can undercut the iPhone, Apple has intentionally focused on the much more lucrative, high end smartphone market.

That's resulted in Apple taking in the lion's share of the mobile industry's profits. If Apple were simply trying to win a trophy for market share, it could have simply produced 60 million iPhone 3GS units and distributed them at cost in developing countries during the winter quarter. Apple could simply have blown through much of its $13.1 billion quarterly profit to "beat" Samsung in market share, rather than allowing Samsung to do that while earning $4.8 billion less than Apple.

With a 2009 manufacturing cost of around $180 per phone (likely much less today), bragging rights to "shipping the most phones" in the quarter would have cost Apple less than $11 billion (likely much less, as dumping 60 million iPhones in any country would also have had a negative impact on competitors' sales).

Setting and maintaining such a "market share record," however, is not as important to Apple as producing higher quality devices and selling them at a profit unmatched by any other manufacturer.

Otherwise, Apple could simply have blown through much of its $13.1 billion quarterly profit to "beat" Samsung in market share, rather than allowing Samsung to do that while earning $4.8 billion less than Apple.

The iPad offers no room for competition



While Apple's smartphone market share has been held back by larger volumes of cheaper devices from its competitors, the same hasn't occured with the iPod touch and iPad, which have held onto majority market share longer.

"Apple did not leave a similar price umbrella [to the iPhone] under the iPad," Sacconaghi wrote. "In fact, the iPad was cheaper than tablets with inferior features when it was first released. Now there are competitive Android tablet offerings at lower price points, especially because competitors such as Amazon and Google are aggressively pricing hardware in as their businesses makes gross profit on content and search, respectively."

The difference between the iPhone and iPad pricing strategies means that while competitors could earn smaller profit margins of around 30 percent in competition with the far more profitable iPhone, in the iPad area they can only give away their devices in hopes that dumping a loss leader will create a much smaller market for selling content or pushing ads.

While Google and Amazon have a business model to distribute low profit tablets in the U.S., that same plan isn't working out globally because neither company has established content stores with the global reach of Apple's iTunes and App Store. That highlights a second strength of the iPad over its tablet challengers, one that isn't shared with the iPhone.

The iPad has better distribution



"Distribution for the iPhone, at ~240 carriers," Sacconaghi wrote, "is significantly lower than Samsung and Nokia, which have essentially global distribution, and Blackberry, which is distributed by >2x the number of carriers.

"By contrast, the iPad has stronger global distribution through Apple stores, carrier partners and network of resellers, including third-party retail outlets (e.g., Best Buy, Wal-Mart, carrier stores) and third-party websites (e.g., Amazon.com)."

The fact that Nokia, Samsung and Blackberry still have much greater global mobile phone distribution channels than Apple is a fact that's never mentioned when market share figures are bandied about.

Most users are aware, however, that Apple was exclusive to AT&T in the U.S. until 2011, when Verizon began carrying it. Sprint didn't pick up the iPhone until the end of that year, and a variety of other significant U.S. carriers, including T-Mobile and a variety of regional carriers, didn't get the iPhone until its fifth generation.

Apple is also still negotiating carrier agreements for the iPhone around the world, including China Mobile, the world's largest carrier by subscriber count, and NTT Docomo, Japan's largest, which is rapidly bleeding subscribers to its iPhone-bearing competitors.

The fact that Apple has the smartphone market share it currently has despite much weaker distribution (since the iPhone's inception) makes it no surprise why Apple maintains an even stronger share within the tablet market, where its distribution is superior to its loss leader tablet competitors.

Sacconaghi maintains a $725 price target for Apple, which closed today at $431.99, just $13 above its 52 week low and dramatically below its all time high of $705 reached last September.