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Is the iPad 2 cannibalizing the new iPad’s profits?

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In about four weeks, Apple will announce its fiscal 2012 Q3 earnings. Its accountants are busy tallying the numbers, including the number of iPads sold and revenue from the iPad product line. These two numbers hold the key for the longevity of the iPad 2.

Are the days numbered for the $399 iPad 2?

When Apple announced the new iPads in March, it dropped the cost of the lowest-priced iPad 2 (the 16GB Wifi only version) by $100 and continued to sell it side by side with the third-generation iPad. This is not in the usual mold of clearing out previous generation products at a reduced price.

Analysts speculated that Apple kept the iPad 2 around to counter the threat from cheaper tablets, specifically Kindle Fire. Despite being a year old, the iPad 2 is packed with power and features that other tablets do not come close to matching. Offering it at $399 helped bring in new customers who didn’t consider buying it at $499 and snag some who would have bought a Kindle Fire.

It is a win-win for Apple — almost. The $399 price point is also attractive to those who otherwise would have bought the new iPad at higher price points. This is what economists call second degree price discrimination. When offered multiple options at different prices, customers pick the one that gives them the most value (consumer surplus). In the absence of the $399 iPad 2, customers would have picked the pricier new iPad. But when offered side by side, some see higher consumer surplus from the iPad 2 than the new iPad. That is exactly why Apple kept just the 16GB Wifi model of the iPad 2 and not the entire product line.

For every customer who chooses to buy the iPad 2 instead of the new iPad, Apple loses $100-plus in pure profit (the cost difference between the models are marginal). If that total loss turns out to be more than the profit from selling the iPad 2 to new customers, Apple will quickly pull the plug on the iPad 2.

We will not get a breakdown from Apple on the number of iPad 2s and new iPads sold. But we can figure out these numbers by doing simple math on Apple’s earnings statement.  Last quarter, when it had the $399 iPad 2 for only a month, Apple sold about 2.1 million $399 iPad 2 units. That was 18 percent of the total number of iPads sold, which did not increase much from the previous quarter. This translates to just 10 percent of total iPad revenue. The higher the number of iPad 2 units sold, the lower its contribution to revenue.

This is the first full quarter when iPad 2 and the new iPad are sold side by side. Apple would prefer to keep the iPad 2 proportion at 18 percent or lower. If that number goes up, it signals significant erosion of Apple’s iPad profits by its own product.  The worst case scenario is that Apple sells three times as many iPad 2s as the previous quarter without a net increase in total number of iPads sold.

When the earnings report comes in next month, pay close attention to the iPad numbers. If you have been waiting to buy one, you might want to grab one now before they’re gone.

Rags Srinivasan is a management professional who specializes in product strategy and strategic marketing. He is currently working on big data products. He blogs at Iterative Path and tweets at @rags.

26 Responses to “Is the iPad 2 cannibalizing the new iPad’s profits?”

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  2. Kreig Zimmerman

    yep. i debated the #kindlefire for months before i chose a post-intro refurb #ipad2 for $349.

    but underlying that reasoning was a) the piss-poor profile of the fire and 2) the seeming inability of the new ipad to do more than be more graphically svelte.

  3. Mike Hathaway

    iPad 2 is my goto ipad for the schools. We order them 30 at a time. There is almost no benefit to the ipad 3 in the Education world. The only real difference in the units is the screen. And you get 20% more ipads for the buck, the 2 is a screaming deal.

    Personally I think the $399 price point is now a permanent fixture apple would not kill just to up profits. It gets people in the door and makes it real hard for anyone else building a tablet to attempt a price war (at least unsubsidized. Apple has that 85% repurchase rate from customers down the road making the need for a profit on any initial product purchase not as important.

  4. Stewart Tan

    if people really compare the specs betwen the new ipad and the ipad 2, i would say the specs difference is only about 10% of the upgrade made on the ipad 2. the new ipad has a brighter screen, upgraded camera and faster network speed (4G). so, will this actually change the thoughts of customers on the apple tablet? First of all the 5 megapixel camera on the new ipad brings less interest in customers thought as people rarely use a tablet for snapping photos so the camera upgrade isnt a much big deal on why customers should head on for the new one instead. secondly, a brighter screen on the new ipad isnt changing the minds of people about their ipad 2. the ipad 2 already posseses a great screen resolution which perfect for reading. but this time apple seemed to think the other way round. the only good thing about the retina graphics in the new ipad is just by zooming into pictures and photos we can see the detail which is clear. this is what apple thinks but in my opinion people dont really care about zooming in to see great detail. another thing will be the 4g network. the new ipad comes with ultrafast 4g network where as the ipad 2 is 3g. you know internet speed is also affected by weather conditions so sometimes 4g is not neccessarily ultrafast if compared to 3g. when ipad 2 connects to 4g network it is also seemingly fast. like i said the difference between the new ipad and the ipad 2 is just a minor upgrade on speed and performance. this is how customers think when buying a product whether its a year old resulting the ipad 2 still sells greatly in market. so if apple is planning on cutting down the sales of the ipad 2, it would bring great dissapointment to apple users as well as fans just to pursuade customers to buy the new ipad.

  5. First of all, as an owner of a Gen 1 iPad and a New iPad, I can tell you there is a huge difference in the display quality, especially for tasks like reading and writing. As for hardly an upgrade, better screen, better graphics processor, better camera (yes it does come in handy sometimeus), better Bluetooth and more RAM makes it a very good upgrade, especially when coming from a Gen 1 iPad, or no iPad at all. That said, if you don’t want the extra features, iPad 2 is still a great device and an excellent buy.

  6. john frankel

    I doubt the cost difference is marginal between the two, and think that the iPad2 might even have a higher $ profit contribution to $AAPL. Screen, chipset and end of run benefits.

    • The bigger point here is, presence of the lower priced version adversely affects the sale of new iPad. The cost savings, if any, are not enough to justify loss of $100 profit for each customer who otherwise would’ve chosen new iPad but decided to choose iPad2.

      • eldernorm

        Rags, while I generally agree with you, you keep talking like Apple is a Target store… Is Market share a big winner for you or does profit make a difference.
        The key here is that people are buying Apple. Apple buyers stay with Apple. They do not jump to Kindle just to save $ 100. And yes, Apple may not make an extra 300 million $ in a quarter, they will have to live with 5.1 BILLION…
        Just saying… the bigger picture is where Apple is at. Many of us see that, even if we cannot clearly describe it.

        Just a thought. en

  7. immovableobject

    Apple make not make as much profit on the iPad 2, but Apple’s unparalleled customer loyalty (voluntary lock-in) will pay off when people inevitably get the itch to upgrade to an iPad with greater memory capacity, features and performance.

    It is better to cannibalize your own product line than let a competitor do it.

    • In general it is better strategy to cannibalize your own product than let a competitor do it. But not a preferred approach to let your past cannibalize your future.
      In this case the issue is iPad2 is still far ahead of the competition and delivers high value to customers, especially at a price $100 less than the new iPad.

  8. Like someone said, the “new” iPad was hardly an upgrade. In fact I can’t even see the difference that the supposed “retina” display is supposed to be. Many others can’t see the difference either. And yes, I compared them side by side.

  9. ipad2 is for Eduction. It is not going anywhere.

    you Q2F12 number is completely wrong. ASP of ipad
    fell by $100 in that quarter. Apple built ipad3 from January-March
    in order to sell 3 million on the first weekend. So you believe
    that another 6 million were produced in 3 weeks left in the quarter.

  10. Sandman619

    If enough sales if the iPad2 off-set the sales of the New iPad, then revenue could be down marginally. But that would take a huge sales of the iPad2. As far as profitability ? The iPad2 R&D have been fully paid off. So even at a lower price, the iPad2 is making at least as much profit as the New iPad. The media always neglect to include the non-hardware costs into the products. Granted, Apple doesn’t provide a transparent way of adding this in, but it’s always ignored by any cost reports… as well as software, OS, etc

    Cheers !

      • Nam Seunghan

        You are only talking about variable cost here. All the fixed costs are allocated to the unit, in any manufacturer. What sandman argues is that if R&D cost for iPad2 and any other fixed cost doesn’t incur any more and fully allocated, then iPad2 could be more profitable than new iPad, which may be still be allocated into new iPad, per unit basis and unit cost of goods manufactured.

        Your argument should be, since we are talking about earnings (and more directly, product margin), this cost is all incurred, and doesn’t make difference in calculation. Your reply is confusing.

        But, Sandman could be still right, if Apple has to incur more fixed cost (R&D or other) for new iPad. It’s not that far fetched, since new iPad will get more features in coming iOS6.

        Now coming to your post, I don’t think Apple is naive not to notice your point. After all, they are the one who has all the information and control over inventory. You calculated all based on $399 for ipad2 and $499 for new iPad. But they could easily control the flow of inventory and make ipad2 available at mostly 32gb, so that either way, they are maximizing.

        Also, all of this is, I should say with no offense, with no hard evidence. You could have surveyed, say, just around manhattan, so that you can minimize the cost in your side, to find out what’s really happening. Are the customers getting ipad2 or new ipad? Is ipad2 in short leash?

  11. cookingjobs

    So why not mimic strategy on iPhones? In this case, keep iPad2 with 16GB, and have new iPad for $100 more, but with 32GB. Continue with 64GB and 128GB versions, but no 16GB version in the newest model.

  12. Rhonin

    The availability of the iPad2 likely has an impact.
    A second impact; the new iPad was not a “step up” for a lot of us who elected to stick with the current model instead of buying the new model. I suspect that hurt as much as if not more…..

  13. Gregg Alley

    I fInd it hard to believe that the new iPad costs little more to manufacture than the iPad 2, considering the screen, battery and camera components.

    • Technology is very extreme with pricing, so while iPad was expensive when it first started its price will go down naturally, but since they have the blueprints from the first one. Making the second one is halfway done allowing it to be cheaper or the same price.