Costs of Next Generation iPads - Case Study Example

Costs of Next Generation iPads In the production of any product, there are costs that are incurred so as to make sure the whole process is a success. All these costs then determine the price of the created good or service through a process explained under the theory known as the cost of production theory of value. This simply states that the factors of production (which include labor, capital and taxes etc.) make up the cost. This theory basically explains that the long run price of a commodity is just equal to the sum of the cost of the inputs that are used to make the commodity including all the additional interest charges. In this context we will look at the costs incurred in the production of Apple’s new generation iPads. The company has basically two models of the new generation iPad models; one that is equipped with 32 GB on NAND flash memory and the other that is equipped with 64 GB NAND flash memory and both with a 4G long term evolution (LTE) wireless capability. These are just but the major brands of the new generation iPads. What stands out is the difference in the price of production of the two different models. Looking at the bill of materials of these two, we find that the new iPad 32 GB carries a total of $364.65 and an additional cost of about $10.75 which covers the cost of manufacturing one unit so that the total bill of materials for this iPad to be at $375.10. The 64 GB one’s bill of materials is just $22.85 more than that of the 32 GB model. Looking at these new models, it is simply the prices of their parts that make them so expensive. “For instance the NAND flash memory prices range from $16 to $67 and are one of the key profit generating components for Apple in the new iPad line” A. Rassweiler (2012) noted. The iPads display and touch screen are also expensive at $120 according to Andrew Rassweiler (2012) too. Some other parts include the $23 A5X processor manufactured by Samsung and which makes up 6.3% of the total BOM, a $41.50 camera similar to the one installed in the iPhone 4 modules, and an improved capacity lithium polymer battery that cost $32.00per piece. This new battery can support 42.5 watt hours which is about 75% from the previous 25 watt hours in the iPad 2. This new battery costs only about 40% more than the old model which costs about $22.75. All in all, basically the 2nd generation iPads cost about$271.00 to produce, about 9 percent cheaper than the 3rd generation ones. According to IHS iSuppli’s Fred Straker (2012). Apple has chosen to leave the price difference at only $71 in order to make it difficult for any other company to beat the price of the iPad 3 given how expensive its production cost is. The average variable cost of producing these new model iPads is just about $360 which is a very high price per unit produced. This however means that on the other hand Apple won’t be able to make quite the profit margin that it was evidently used to with the sale of every iPhone unit, although they will not be too much at loss as most of their profits will be from the 64 GB versions of the new iPads, that is if they sell. The cost of making a 64 GB version just beats that of making the 16 GB one by about $50, with the retail price difference being over $200 due to the added 4G LTE networking technology. This is basically an upgrade that pushes up the retail price of the 64 GB version way beyond the cost of the actual upgrade. This actually means that the more expensive iPads if sold will comfortably cover for the not so much profits earned by the company through the selling of the slightly affordable ones. Specifically the 64 GB8with no 4G and the 16 GB9 up to the 64GB11 are Apple’s most expensive iPads and if sold will earn the highest of profits. These are the models that can earn the company the profit margins they are looking forward to. Also the retail price of the iPad 3 is about $629 and that gives Apple a marginal profit of about 51% which is slightly less than that of the 3G iPad2 which is 56%. Anyway experts see this as a huge gamble taken by Apple and might backfire and choke up on them. This is because the sales of these new generation iPads may not be as profitable as expected. Earlier we saw that the only difference in the retail price between the 3rd generation iPad (that have no 4G in addition to the Wi-Fi technology) and the ones that have this technology installed is way over $360. This is not proportional to the difference in manufacturing costs which is just about $60. According to Andres Bylund (2012) this increase in price may not earn Apple as much profit as they would expect since they (the customers) are already enjoying better deals on the lower end models that don’t fetch a lot of profits as the higher end models. Apple’s strategy of increasing the memory 4 times from 16GB to 64GB will only add about $50 to the bill of materials but a whooping $200 to the retail price tag. The memory increase is not the only thing that does not make that much sense considering the huge gap between the production cost and the retail price. We have an improved graphics engine in the new processor doubles the price of the new A5X Quad core graphical processor to about $23 which is not that necessary since it will only be used in the packing of the screen with pixels nothing else. Looking at the new power saving battery that costs up to 40% more will not be as effective in power saving since all the power backed up will be used to power the high pixel screen. Indirectly we find that the extra money was just spent on the screen and the most important question will now be; “will customers overwhelmingly choose high speed data and significant increase in the size of the iPad memory or will they be sensible enough to opt for the lower end versions that would not be as profitable?” Andres Bylund (2012). This is a situation that might not play that well with the Apple Company and might eventually influence the profit margin considerably. Also what is not quoted in these estimates are the costs of marketing the product and the research and development that was put into the creation of the new products. All these advancements in Apple’s technology and increase in the retail prices of the new line of iPad have however not translated into a significant increase in the manufacturing cost per unit produced and in turn into the pay earned by their workers. The manufacturing cost for producing an iPad 2 is around $8.15 while that of producing one unit of the new iPad3 64 GB11(which costs about $397.95 to produce and $829.00 to sell) is just $10.75. The difference in the manufacturing cost is just about $2.60 whereas if you look at the retail price difference between the 2nd generation iPad and the 3rd generation it stands at a figure that is way above $450. This simply translates into one thing; the workers at Apple are under paid considering the company’s huge profit margins. Ross Eisenbrey (2012) did some research and found out that Apple and a its key manufacturer in China, Foxconn are justifiably criticized for their bad labor practices like overtime hours that are illegal, forced and oppressive, hazardous working conditions and sometimes forced labor of minors (student interns). This is just proof of what we have seen above. There are some claims from the most of the workers that the wages they receive can’t even cater for their basic needs which shouldn’t be the case for anyone working for such a big company. The current cost of manufacturing an iPad unit is not the best offer Apple can come up with in all aspects as it is about 30 times the total profit made per iPad. Am quite sure that Apple can afford a deal much better than what they are currently offering. They can ensure better treatment of the production workforce since a close examination of the iPad cost structure leaves no doubt. “Apple as a company has double standards when it comes to treating of customers and its workers which is not only a violation of industry practices but also its own voluntary self imposed code of conduct” S. Prakashi (2012). Otherwise for Apple as a company, they will lose about $100 in pure profit for every customer who opts to buy the old iPad 2instead of the new iPad 3. This might mean that the total loss will turn out to be more than the profit from the sale of the old iPad 2 models. The cost of producing these new iPad models is so high that Apple might need to cut the production of iPad2 since the higher the number of its units sold the lower its contribution onto the total revenue. In average the variable costs incurred when producing a new generation iPad is high such that the Apple Company would not be able handle losses that high. On the other hand the variable fixed costs will remain constant even as the company expands the operations as the fixed costs always remain constant even as production increases. These fixed costs may be in the form of the cost of the most important parts of the new iPad whose prices are determined by other companies supplying Apple with the parts e.g. Samsung who supply the screens. Some of these fixed costs of production will have to be adjusted to accommodate the expansion of Apple in future. As more and more units are produced more and more parts would be required. There are many other things though that Apple would have to deal with whilst expanding and that will have to include the expenses to be incurred while marketing the increased volume of iPads produced. In short the high cost of the new iPad 3 components basically drives down the profit margins of the Apple Company. According to the research conceded by iSuppli which shows that the $316 cost for building one unit will substantially cost. This company maintains a static pricing strategy when they introduce new versions of existing line of products according to M. Campbell (2012). References Anders Bylund (TMF Zahrim), March 22, 2012, Will Apple Choke on These Expensive iPad Parts; http://www.fool.com/investing/general/2012/03/22/will-apple-choke-on-these-expensive-ipad-parts.aspx Fred Straker, Sun, 03/18/2012, iPad 3 Teardown Reveals Higher Production Costs; Eisenbrey, R. (n.d.). Apple’s iPhone profits dwarf its labor costs | Economic Policy Institute. Economic Policy Institute | Research and Ideas for Shared Prosperity. Retrieved December 13, 2012, from http://www.epi.org/blog/apple-iphone-profits-dwarf-labor-costs/ Mickey Campbell (2012), High cost of new iPad components drives down profit margins; Ross Eisenbrey, April 18, 2012 at 1:10 pm, Apple’s iPhone profits dwarf its labor costs; http://www.epi.org/blog/apple-iphone-profits-dwarf-labor-costs/S. Prakash Sethi, April, 2012; Two Faces of Apple; http://www.carnegiecouncil.org/publications/ethics_online/0068.html Read More