Retailers like Holt Renfrew and Neiman Marcus are successful because of their focus on the unique needs of upscale customers.
They stock innovative high quality products, provide terrific customer service and work tirelessly to delight their customers. In exchange for the product and service level they offer they’re able to charge high prices and earn high margins.
On the other hand, low cost retailer Walmart is the largest retailer (and largest company) in the world. In 2010 Walmart had over $421 Billion USD revenues and $13.4 Billion USD profits. “Save Money, Live Better” isn’t just a mantra for Walmart’s customers; it’s also the retailers’ core strategy.
Although the luxury market is a terrific one the low cost market is almost always bigger. Walmart is operationally excellent, buys in high volume, charges minimal mark-up and makes money -- lots of it --on volume.
The question is … in these tough economic times will price be enough to dislodge Apple from their dominant market share position? Will Amazon (or someone else) become the Walmart of the tablet world?
Harvard Professor Michael Porter and others have written extensively about how companies can compete on price or they can compete at the high end (with innovative new products and/or great customer experiences) but they can’t compete on both. Porter has shown that this reality applies to every industry - not just to the retailers described above
In addition to the everyday difference of these two models there can also be different performance at different stages of the business cycle. Today for instance we are living through a historically soft economy with expectations of anaemic growth at best. In tough economic times like this consumers are often squeezed on many fronts and choose to cut back expenditures or to choose lest costly alternatives. "That's good news for low cost businesses."
It’s was no surprise then when Canadian value priced restaurant leader Tim Hortons Inc. announced yesterday that in the quarter just completed profits soared 40 per cent on high sales. Clearly some consumers were trading down from an expensive lunch out to a more cost efficient alternative. Similarly, McDonalds has posted fabulous financial performance recently based upon the same phenomena.
What does all this have to do with the tablet computer business you might wonder?
Apple launched the mainstream tablet marketplace when it brought its iPad to market in April 2010 and shipped almost 15 million devices before the end of the year. The second generation iPad2 was launched in April 2011 and by most estimates iPad shipments to date in 2011 exceed 30 million units. Wow!
Apple is clearly in the business of providing innovative products that customers love and based upon this and other innovations they’ve created one of the most valuable brands (and companies) in the world.
In exchange for that innovation Apple has been able to command premium prices. For example market intelligence firm iSuppli says that the $729 32 GB iPad2 cost $333.25 to manufacture. That’s $395.75 of margin per unit or roughly 54%! In addition to the hardware margin Apple makes a lot of profit on apps and content sold through their App Store. Just like Holt Renfrew and Neiman Marcus, Apple makes products for upscale customers.
What about alternatives to the iPad? Firms such as RIM with their Playbook and HP with their Touchpad have tried launching similar products at similar price points with virtually no success. The one hint at an opportunity came when HP exited the market and sold off remaining Touchpad inventory at massive discounts. Customer lined up to buy the product pointing to an opportunity for low priced alternatives to the iPad.
Fast forward to this week when Amazon’s new Kindle Fire tablet computer will ship in the US market from the Amazon site and over 16,000 retail locations in the U.S. including Walmart! It may be the first legitimate competitor to the iPad.
What kind of margins will Amazon make on Kindles? It’s hard to tell for sure but best estimates are that the $199 Kindle Fire costs over $209 to build. That’s right … they lose about $10 on every one they sell. At the other end of the lineup the new Kindle sells for just $79 and costs $84 to make. They’ll only lose $5 on each one of these they sell! Now that’s a low cost strategy!
If they’re losing money on every unit, how will they stay in business? Amazon’s is betting on a traditional “razors and blades” approach where they hope to move large quantities of Kindles at or below cost and earn profits by selling the content (books, music, movies, apps) that will run on them.
Amazon is acutely aware of what they’re doing. At the Kindle Fire’s launch, CEO Jeff Bezos said that “there are two types of companies: those that work hard to charge customers more and those that work hard to charge customers less. Both approaches can work. We are firmly in the second camp.”
Of course Apple and Amazon are not the only two players in the tablet market. Competitors such as the Nook from Barnes and Noble and many alternatives based upon the upcoming Windows 8 from Microsoft will also compete and get some share.
For now though, it seems like Apple has established and will maintain the leading position at the high end of the tablet marketplace and that Amazon and other competitors will compete on price.
The question is … in these tough economic times will price be enough to dislodge Apple from their dominant market share position? Will Amazon (or someone else) become the Walmart of the tablet world?