What would an iPad Mini mean to Apple’s profits?

The Apple rumor mill never stops. Lately, people have been chattering about the supposedly imminent iPad Mini. Speculating about Apple’s next product release may be fun, but analyzing the impact such a device would have on Apple’s bottom line is even more interesting. Let’s try to get into the minds of Apple’s strategy team, albeit without the advantage of data they have, to make a call on the iPad Mini.

There are three steps to this process: The whys, what and what-ifs, and the final decision.

Why would Apple even consider an iPad Mini? The simple answer is profit. The question is whether this is about incremental profits or a defensive strategy to retain current profits that are under threat. Based on Apple’s history in the past 10 years, it is more likely about adding yet another billion dollar product line. Reviews of Nexus 7 aside, it alone cannot warrant a defensive move by the 800-pound gorilla.

And yes, “billion dollar” is the key phrase here considering the multiple investment opportunities available to Apple and the impact of the product line on its earnings per share. Apple’s machinery is set up to make the most when it sells millions of units of a product. Anything less than that is not the best use of their investment and marketing resources. The opportunity cost is huge.

There are three “C”s at play here: customer, competition and cannibalization.

Customer

Apple would likely consider targeting the following three customer segments:

Low-end customers who never considered a tablet — even the Fire and new Nexus — because they do not see value in them. Even if this is a big enough segment, by definition these are the low-value customers, not the high-margin rabid fans that Apple is used to. Going after this means competing only on price, which is anathema to Apple’s strategy.
Fire and Nexus customers, since this group of consumers stood up and identified themselves as a target segment for a low-end tablet. A customer survey by 451 Research found that only eight percent of those who were surveyed stated a preference for Kindle. Even if Nexus 7 doubles this by bringing in new customers, Apple’s share cannot be more than 50 percent of this segment. Apple has 62 percent market share and 90 percent profit share of the tablet market. Is another seven percent share at a very low profit attractive?
Existing iPad customers. In this case, Apple would position the iPad Mini as yet another device these customers should buy, in addition to their iPhone and iPad. If you consider how its current products are positioned, this is not far-fetched. Products such as the MacBook Air, iPod Shuffle and Nano are positioned for different purposes so that the same customer buys them all. Although this is the hardest strategy to execute, this is also the most profitable thing to do, as it meets the company’s goal of driving new profits. The question is, can Apple’s marketing pull it off?

Competition

The competitors here are the low-end volume players who sell devices at or below cost in the hope of driving future revenue from content and other sales. If Apple is the price setter in the premium tablet category, Amazon is the price setter in the low end. Entering this segment would mean becoming the price taker or making an effort to become a price setter with a different price point.

By design, Apple has never been a price taker. In any market, the price setter gets to control its own profit while a price taker is at the mercy of market forces. Trying to become a price setter when there already is one requires Apple to either go low or just a bit higher. Either way, Amazon has set the price anchoring. The most likely scenario is a $ 299 price point for the iPad Mini.

Cannibalization

A $ 299 iPad is a threat to multiple product lines.

iPad: In my earlier post, I outlined the effect of the $ 399 iPad2 on Apple’s profits and how 18 percent of the sales were iPad2s, without any increase in the total number of units sold. The iPad Mini will have a far bigger impact on current customers. This is because the iPad Mini will pack considerable value, so customers will see a higher consumer surplus due to its lower price point. (See here for a discussion of price discrimination and consumer surplus.) The iPad has an average selling price of $ 590 and gross margin of 47 percent. Even if the iPad Mini makes the same margin, for every iPad customer who trades down, Apple must bring in one more iPad Mini customer.
iPod Touch: In the presence of an iPad Mini, the iPod Touch would become the asymmetrically dominated alternative (the decoy option like the MacBook Pro scenario). Granted, it is not truly dominated since it provides portability, but you could argue that its size is its weakness. Although the Kindle Fire has not threatened the iPod Touch yet, an iPad Mini definitely would. Maybe Apple is willing to cannibalize the iPod Touch, replacing it with the new smaller iPad. That would mean no real profit upside from the iPad Mini.
iPhone: The crown jewel. It is harder for most to see how a smaller tablet could threaten the iPhone. Consider this in the context of total cost of ownership of an iPhone over two years: At $ 100 per month for mobile service fees and at $ 199 for the device, it costs $ 2,500. Mobile service providers are moving towards just one bundle of voice and data at $ 100 per month. If there were a $ 299 4G iPad Mini, some may consider a regular phone for occasional talking and the iPad Mini with $ 40 data fee as an iPhone replacement. Although no one would consider such a swap with a Kindle Fire 3G or Nexus 3G, an iPad is a different situation. The loss to Apple is considerable since it gets the full device price from the service providers. For every iPhone customer who chooses this swap, Apple must add four iPad mini customers.

Cannibalizing your own products is better than competitors devouring them, but that is nothing more than a cliché. No cannibalization is good. And there is no need for Apple to cannibalize itself, as there is no competitive threat in the near term.

What is Apple’s final decision going to be? Anyway you look at it, the iPad Mini poses a significant risk to Apple’s profits while not adding new profits. Unless they have data that shows the demand for a third device between the iPhone and iPad, and Apple’s marketing can pull it off, it is highly unlikely that an iPad Mini would have a positive impact on Apple’s profits.

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.

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