A Gross Margin Case Study (Apple)Sep 21, 2023
Last week I talked about 4 ways you can impact gross margins.
This week I deep dive into a case study about Apple.
I think you'll find directly applicable things for your business!
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A Gross Margin Case Study (APPLE)
Last week I talked about 4 ways to improve Gross Margins.
This week I wanted to dive a little bit deeper into the beast that is Gross Margins and give a real-life example.
I used Apple at the end of the last email, so I decided to go deep into their actual business and found some really interesting things.
June 29, 2007, when Apple released the iPhone. From that point forward, their business was forever changed. Today, the iPhone generates 52% of its total revenue.
For the first few years, all things were rosy. Revenue was booming and gross margins were good.
In 2006, they had revenue of $19.32 billion. By 2009, they had more than doubled ($42.91 billion). And by 2012 they had grown by 810% ($156.51 billion). That comes out to 135% ANNUAL growth rate!
Needless to say, the introduction of the iPhone changed both the industry and Apple itself.
But then, their Gross Margins started to shrink.
Their Gross Margins, which were steadily over 40%, began to drop. By 2012, they’d dropped all the way to 37.41%.
While still highly profitable, there was a real downward pressure on their profits.
To counteract this pressure, they did a few things:
- Reduced the cost of the product
- Expanded their core product offering
- Added ancillary (high-margin) products
- Introduced a new revenue stream
Let’s dig in.
Reduced the cost of the product
Between the 2020 and 2022 annual reports, revenue grew by 14.55% and cost only grew by 10.61%. Since they don’t break out specifics, I can’t be certain what drove it. But, iPhone cost had to go down since it’s such a big part of that number.
I can also say this: without a significant effort, this big of a difference wouldn’t have happened.
Expanded their core product offering
For years, Apply only offered one phone. In 2013 they slightly expanded the line, offering an iPhone 5s and 5c. The c had fewer features and was lower priced.
In 2014, they took a step up and created the “Plus” line. This was a larger screen with slightly better features and cost $100 more than the base model.
This allowed them to capture both the high and low end of the market.
Based on their margin struggles, I’d assume the high-end product also had higher margins.
But margins stayed the same. So they had to do more.
Added ancillary (high-margin) products
The next phase they entered was the “accessories” phase of the business where they introduced the Apple Watch (2015) and AirPods (2016).
Both items allowed them to sell more to CURRENT customers, whereas iPhone growth is based on current customers reupping and new customers coming into the ecosystem.
By adding these items, they likely increased the LTV (lifetime customer value) and margin, as lower-priced accessories are usually sold at higher margins.
This was the example I used last week, so I’ll include the visual below:
Introduced a new revenue stream
Despite all these changes, margins stayed steady. As the phone wars heated up, the pressure to keep the upgrades coming made it harder and harder to capture additional margin on their phones.
So, in 2019 they started offering Apple TV+, a new streaming service positioned to compete with the Netflix of the world.
At the same time they released even more services:
- Apple Arcade
- Apple News+
- Apple Card
They were entering a new era of services and it had the potential to change their business.
Today, services are almost 20% of total revenue. In the future, this number is likely to be bigger.
After 4 years of flat gross margins, Q1 of 2021 saw gross margins increase by over 1%.
In a business Apple’s size, that represents over $41 million in additional Gross Margins annually.
Since that point, Gross Margins have increased another 3.5%!
Gross Margins rose from an average of 38.5% between 2016 to 2020 to 43.45% in the Q2 of 2023.
And that, my friends, is how you transform the business.
In the last 5 years, by increasing margins from 38.5% to 43.45%, they’ve extracted $51.41 billion in additional gross profits.
And the next 5 might be even crazier…
If Apple’s services continue to grow and COGS continues to improve, by 2026 the overall margins will have increased from 43.45% to over 50%!
But say Cost of Goods cuts can’t continue.
Even steady margins by product/service could result in a huge overall Gross Margin increase.
With Services Gross Margins at 71.75% (compared to 36.28% for products), let’s assume the growth of Services accelerates and Product slightly slows:
- Service grows at 20%
- Product grows at 10%
In 5 years, Gross Margins are still up 2.17%, or 6.9% over their 2016-2020 average.
I suspect both will happen (decreased COGS and increased Service revenue), but we’ll have to wait and see.
I cannot speak about the ongoing nature of Apple’s business and I’ll leave that speculation up to the market experts.
All I can say is those Gross Margins and Gross Margin trends are looking pretty, pretty, pretty good.
If you’re a business owner, they put on a masterclass on how to increase your margins and as a result, your profits:
- Control costs of goods
- Create tiered offerings to serve more customers (new iPhone)
- Offer ancillary, higher margin, products (Watch & AirPods)
- Introduce new product or service offerings (Apple TV+)
This aligns well with the 4 pillars from last week:
- Price (increased iPhone price)
- Cost (controlled cost of goods)
- Revenue Mix (introduced new services and ancillary products)
- Operational Efficiencies (hard to know, but likely did this with the Service offering)
And, this chart shows these changes perfectly.
The iPhone and iPad increased revenue and margins at first. But then, despite accessories like the Apple Watch and AirPods, Gross Margins lagged. But then immediately following the introduction of their services, Revenue and Gross Margins rose significantly.
What a beautiful thing!
Hopefully, this breakdown helps you see how it works in the real world.
I’d love to hear: did this give you any ideas for your business? Share them with me! I’d love to hear.