Pricing a Tablet

Like many other people in the tech industry, I rushed out to pick up an HP Touchpad when the price dropped to $99 and, having played with it for a few days, I can say that it is a very enjoyable device. This led me to the question of tablet computer pricing.

The tablet market

Today, the clear leader in the tablet market is Apple, with its iPad. According to a study by iSuppli, the device costs Apple between $230 and $346 (depending on configuration) to manufacture and is sold between $499 and $829.

Meanwhile, HP came out with its touchpad and, thanks to another isuppli study, we learned that it costs between $306 and $328 (depending on configuration) to manufacture it. Currently, the company has put those device in fire-sale mode, retailing them for $99 and $149, leading many to highlight that the company is losing large amounts of money.

Comparing the two, based on roughly the same feature sets, we get the following (for the sake of comparison, I used the non-3G version of the iPad since HP has only sold WiFi enabled tablets and doesn’t have a 3G product out):

Apple HP
Model  16Gb  32Gb 16Gb 32Gb
 Materials cost  $219.35 $248.85 $296.15 $318.15
 Manufacturing cost  $10 $10 $10 $10
Total production cost  $229.35 $258.85 $306.15 $328.15
Retail Price  $499 $599  $99  $149
Profit (Loss)  $269.65  $340.15  ($207.15)  ($179.15)
Profit Margin  117.57%  131.41%  (32.33%)  (45.40%)

Looking at this chart, it is clear that Apple is substantially more efficient in its supply chain, being able to build a tablet for about a third less than HP. But what also becomes clear is that the Cupertino company has been pricing the device to maximize profit and there seems to be a lot of room for selling tablets at a lower price without losing one’s shirt.

But how much would people be willing to pay?

Listening to the market

One of the most fascinating things I’ve noticed recently is that the price of ebay auctions, on most goods, tends to be relatively consistent as the auction comes closer to its conclusion. Take any given good and you will find that there is relatively little difference in the bids on several auctions for the same thing ending within minutes of each other.

Another interesting artifact is that the price of a second hand device on craigslist tends to be close to the price of the same device at the end of an ebay auction.

Those two facts seem to point to a natural equilibrium when it comes to pricing goods, where a majority of sellers and buyers cluster around a price point that seems to be what the market is agreeing to as a price point.

Apple HP
Model 16Gb 32Gb 16Gb 32Gb
Ebay Average Price  $475-$525  $550-$575  $180-$250  $260-$300
Craigslist Average Price  $440-$520  $550-$650  $200-$250  $250-$290
Market Price  $490 $581 $220 $275
Market Premium (Discount)  ($9) ($18) $121  $126

On its face, it’s interesting to see that iPad2, as a product, does not seem to loose much value on the resell market, with second-hand versions reselling for roughly the same price as the retail one.

However, there is an interesting phenomenon here with the HP Touchpad selling for over $100 more in the after-market than the suggested retail price. While this is partly due to scarcity, it is interesting to see that the price ceiling has actually sustained itself for the last couple of weeks, even as more supply has been made available.

The evidence seems to point to customers being interested in buying a 16Gb tablet for between $200 and $250 and paying up to $50 more for double the space. The challenge still remains that HP actually would continue losing money at those price points.

16Gb 32Gb
Production Cost  $306 $328
Low end price  $200 $250
High end price  $250  $300
Lost on low end price  $106  $78
Loss on high end price  $56  $28

Looking at this, however, it seems the losses could get lower if HP priced the market closer to what the market currently seems to dictate. However, a loss is a loss and there would still be question as to how the company could actually make this a success.

Options for HP

Based on the above data, it looks like there could be a chance for HP to attack the marketplace and make WebOS the second most popular operating system in the tablet space, succeeding in establishing WebOS as an alternative to iOS and potentially besting Android in that arena. To do so, the company could look at a number of different approaches to subsidize the difference in price.

One of the first things HP might want to look at is the lifetime value of a customer. Is there a way they could recoup the $28 or $56 they are losing on that customers.

Could they, through the sales of apps, make that money back? Assuming a 30% cut, as most people seem to take these days, it would mean that they would need to sell $96 (for the 32Gb) or $186 (for the 16Gb) worth of app. Assuming apps are selling for $3 per app (which a cursory look at the recommended apps seem to point to as an average price point), they would need to sell an average of 32 apps per 32Gb Touchpad sold or 62 apps per 16Gb tablet sold.

What about movies? A downloadable app on the Touchpad is called the HP movie store. It appears movies rent for $3.99 and sell for $20. Assuming the same 30% split, they would make $6 on every movie sold or $1.20 on every movie rented. To recoup their cost, they would need to either sell 10 movies per 16Gb tablet or 5 movies for the 32Gb model. Alternately, they would need to rent 47 movies for the 16Gb model or 24 on the 32Gb one.

Assuming a two year life on the devices and its associated customers, it seems that recovery of cost could be realized.

But let’s not forget some of the other (potentially more lucrative options). As a successful alternative to iOS, the company could develop an ecosystem of components (keyboards, cases, etc…) that work with the device. They could charge a small fee for certification as “Made for HP Touchpad” and receive revenue from that source. Furthermore, with a strong position in the market for their offering, they could then potentially license out the operating system itself (as more and more devices enter the market, the chances that more developers will be attracted to the platform increase), generating enough revenue to more than subsidize the cost of the initial production run.

Looking at the production costs of Apple’s iPad, it also seems clear that there is much that can be done to optimize the supply chain and manufacturing of the Touchpad. HP could initially target their own internal efforts with a goal to get the Touchpad produced at a rate that was low enough that they could first offer them at cost and eventually make a small profit on the hardware itself.

As a long term play, though, it looks like the main goal of this slew of HP touchpad would be to establish WebOS (and thus HP) as a leader in the tablet market. To do so may allow the company to build some strong margins on OS licensing at some point in the future. However, it would require a willingness to take some short term losses (under 12 months) to establish a strong position in the market in the long term.

Options for tablet manufacturers

It seems the HP touchpad has given the industry an idea of what the market is willing to pay for a tablet not produced by Apple. While it is true that the WebOS operating system is very polished, I think that factored less in people’s interest in the device. The market wants an inexpensive tablet that works relatively decently and they’re willing to spend $250-300 for it.

There are now rumors that Amazon is considering entering the market with its own Android-flavored tablet, priced in that range. To do so, considering the fact that Amazon will generate revenue from alternate sources like the Kindle store, the app store, and streaming movies and TV shows, seems to be a natural evolution and it appears that a pricing strategy that would be the tablet in the sub-$300 range makes sense. If they do so, it will be interesting to see how their offering fares. A failure to take off could translate in trouble for Android as a lower price point Android offering ought to be successful and failure would mean a problem with the OS. If it takes off, Amazon could reignite the tablet market and cut off HP’s chances to establish their operating system as a strong contender in the tablet space.

Because technology costs continuously go down, it is clear that we will see a sub-$250 tablet within the next 24 months from someone other than Apple (Apple has a tendency to price rigidity and may drop some older generation iPad models to the $299 range but I doubt they would go much lower than that). Efficiencies in production and supply lines make that not just a possibility but pretty much a sure thing.

As to who will control the second most popular operating system (assuming Apple retains its lead) in the tablet business, it’s really up to HP to decide how it wants to play. It has a unique opportunity to take that spot right now but the window of opportunity may be closing extremely fast for them.

As a final note, realize that the observations I’m making above are only relating to the tablet market and do not affect the smartphone marketplace at this time: that ship has mostly sailed and it’s a two-player game at this time: iOS and Android.

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10 Comments. Leave new

Your economic model is off. You are making a common error about profits in downloads, and how they could offset losses in tablet sales.

While it’s true that Apple takes a 30% cut on content and apps, you are seemingly making the assumption that the 30% is profit. It is not. Most of that 30% goes to run the store, pay for bandwidth, programming, maintenance, advertising, and other miscellaneous costs involved in the sales, including transaction fees. In addition, most app downloads are free, and Apple makes nothing off those, but still needs to pay for all of the costs incurred.

In reality, it’s agreed that Apple receives between 3-5% profit on each dollar sold in its iTunes and App Stores. Therefor, you will have to extensively re-work your numbers to reflect this fact. And while doing so, remember that Apple and other companies still want to make at least a small profit on those download sales. So you need to figure that in as well.

What this does is to entirely change your model. The amount of content that needs to be sold is now far larger than before. Indeed, it rises to an unsustainable, and unreasonable amount. This is why I’ve insisted that Amazon won’t have a tablet they need to subsidize, as they would have the same difficulty. It needs to be understood that these are not phones, and so the customers are not bound by a two year agreement. How would HP, Amazon, or any other company ensure that enough downloads would be bought so as to offset these losses and make a profit on both the downloads and the tablet sale? I don’t see any way to do so.

I remember way back, Eco 101, being told that it was never a good idea to sell one product in the hope that sales of another related product would offset those losses to give a profit. In my business over the years, I adhered to that concept. Apple also does, which is why it’s so successful. This suggestion would not be successful.

    A good point on the running cost not being captured but remember that part of my premise is that a tablet could, if priced properly, establish a strong competitor to iOS. I believe HP may be finding itself in an interesting position where WebOS now has a chance to establish itself as a strong player if they are willing to look at the current spate of touchpad as a loss leader.

    In terms of your econ101 class, it is based on physical goods thinking. Remember that the cost of production of digital goods goes drastically down as network effects take hold. Producing a piece of software make the first copy expensive but subsequent ones are substantially lower. For that reason, there may be a need for HP

      We are talking about physical and downloadable goods. In addition, the premise is the same. It doesn’t matter whether these are physical goods or not. Costs are costs whatever the medium the product or service is delivered in. The point is that it would be a very bad idea to sell a physical good at a big loss, and that is what it would have to be, on the premise that you woukd make up those losses on the *possibility* of making them back somewhere else. That’s a very big risk.

      There’s an error in your new assumption about cost of digital goods as well. I don’t see Apple paying content companies anything different when they sell more of a song, movie, Tv show, etc. Than if they just sell one copy. They don’t. Same thing with books and apps. You are wrong here. The content companies make more money per download as more get “sold”. But the stores selling that content pay the same. Neither Apple nor Amazon produce their own content, therefor they continue to pay the same 70 cents or so per song, no matter how many they sell. They still get 30% of that sale. Nothing changes. The same thing for every other bit of digital goods they sell.

      Even if you were right, they would still get 30% of that lowered cost, so they would make even less.

      We also have to see what really happened here. HP dropped the price to $450, at which most all, if not all of their profit was wiped out. No sale. Then they dropped the price to $400, and were losing some money, but still no sale. One website dropped it to $369, and still no sale. $369 is at, or below the actual cost of the tablet. Don’t go by parts and assembly costs, they are only a part of the cost. I was an electronics manufacturer, and I always shake my head at these so called estimates.

      It sold out at $99. I’m willing to bet you that it cost HP about $300 per tablet to do that. Figure out a way that HP, or anyone could make up a $300 loss, much make a decent profit by selling downloads of any kind, while still making money on those downloads. It can’t be done.

      Now, we read of Amazon’s so called tablet. It seems as though it’s more of a fancy reader as a challenge to the Color Nook than it is to the iPad. That makes sense. There is no way Amazon can challenge the iPad. But they can attempt to lock up the 7″ color reader content business.

        I probably should have broken out the story into 2 parts:
        1. What are people willing to pay for a tablet
        2. How HP may be able to recoup some of their cost.

        On the first point, I think the touchpad is an interesting case because it shows there is a potential market for a $250-300 tablet.

        On the second, it’s true that my model is incomplete and not fully thought out and probably would need more fleshing out. The point is that there may be ways to subsidize costs on tablets that could allow for a tablet to sell for less than its manufacturing price (eg. the kind of subsidies that exist on phones).

        On the Amazon tablet, I beg to differ with you. The content part will potentially make that tablet successful, which is what my hunch was when I initially thought of software and content as a way to subsidize HP’s effort.

Am I right that there is something of a sea change here in terms of assumptions, from most of our lives when Windows faced competitors such as MacOS and OS/2? Specifically, that an operating system is a lot like an auction site, realtor, or dating site. The winner has a large barrier to losing, through a significant feedback effect. In the example of auction sites, everyone wants to be where the most other buyers and sellers are, period. For operating systems, it was the presence of the most applications, users, and developers. Have we now reached a point where the main few applications people use are becoming either commoditized into the platform, or available via an (increasingly ubiquitous, mature and sophisticated)  web?

As for HP, if you want my take – not that you asked  🙂 – and it is unfortunately driven by base instinct rather than such admirably objective analysis… I have no idea what they were smoking. I pity their shareholders. WebOS was a dead letter when they bought it, and it’s twice as dead now. Palm’s multi-year failure to execute took them from being years ahead of everyone to years behind. Their management should live in infamy. The result for HP is an inexplicable multi-billion dollar boondoggle with no hope of surviving against the onslaught of both Apple (at the high end) and an entire Android industry (at the low end), capable of ruthlessly optimizing their costs and delivering enormous variety all over the retail landscape. Even if this burst of tablet-subsidy were to buy WebOS some window of interest, how many cheap Android tablets will be trampling over it in months? I doubt HP will change course. 

    The analogy to a site and network effects is an interesting one that probably ought to be pursued further as a line of thought. I believe you’re on to something there but the main question is really whether this is different from what it was in the past (Windows, after all, did succeed because it had more applications than the other OSes)

    Palm is really a tragedy, when you think about it. They were the precursor of a lot of the world we know today (I still remember the oddity of my Treo 80 about 10 years ago as a phone that could surf the internet as well as provide calendaring and contact functions) and the WebOS is a beautiful implementation that may have entered the market a little too late. However, because it is so good, the WebOS does represent the potential of a cloud-centric operating system and it would be nice for it to have a chance. It has the polish of iOS and the internet-centricity of Android and with standard HTML+CSS+Javascript as the development tools to create apps, it has a potentially large development community. But then again, as you point out, HP will probably fail in reviving it.

      Yes, I completely agree – there is no other word but tragedy. The industry was theirs to lose by years. It’s incredible to me that it’s ended this way. In some parallel universe, everyone is using some BeOS-inspired, Garnet-successor in their mobile devices. I wish I could see it. 🙁

      And, interesting, right? It feels like the notion of “what is an operating system or a platform?” really is changing. In years past, you just had to have a way to launch apps and provide them with a set of basic services. Now you don’t have a system if you don’t have a first class web browsing experience. And it would seem foolhardy not to include a way to manage media, to play MP3 and a well-known set of video codecs. To send email and use a calendar. Probably even Office-compatible word processing and spreadsheet capabilities. And as the “first class web browsing experience” continues to evolve, we’re converging on a point where that first requirement can increasingly supply all the others. 
      My concern is that, to do that, HTML+CSS+Javascript will have to be enhanced to the point where it is a true rich client platform. And compared to its peers, it is an inferior basis for one. Yes, HTML5 is a well-intended attempt; even more decisively so was WebOS. But Javascript has always been a poor language, and the web stack as a whole has been messily and contentiously evolved, rather than cleanly and elegantly designed. Another hunch I have – again, unsupported by anything but intuition – is that the purpose-designed rich client platforms, such as iOS and Android, will carry the day. 

        There an is amusing aside that Microsoft fought for the right to put a browser in their OS (and eventually got taken to court on monopoly grounds for it): they were aware of what the market would bring.

        As far as the messyness of Javascript, remember that Linux started out as a messy OS so it is possible that Javascript would follow the same course. Google has already proposed extensions to it that would allow it to address part of devices (like the camera or the GPS built into many devices) so I think it’s not too far that HTML5 could become a strong contender to specific OSes. In the end, the openness of the web (and the internet as a whole) is at hand here so it’s a question of do we want HTML5 to improve or do we want other people to tell us what we can and cannot do with the internet.

You seem to disregard the fact that, if HP had offered a tablet 80% as good as an iPad, with some differential advantages, they could easily have sold them for 80% of the iPad’s pricing.
Once such a tablet platform is established, they could then add the secondary revenue feeds you speak of.
But it was not to be and, once again, the bozos in the boardroom screwed their product before it even launched and then pulled it because it failed to launch.
Apple has too many factors in its favour to be easily challenged. CPU design, battery design, making the whole widget, hundreds of appealing slick clevernesses built in to the OS; apps to die for like Garageband and hundreds more strengths.
There is no money to be made by aiming low in any such market. Apple has proved that time and time again. It angers every competitor that Apple is so very profitable, but those same competitors are signally unwilling to change their thinking and their MO to buy or build their own capabilities, or even to club together to try and match the bulk pricing that Apple achieves as a matter of course.
Silly really/ the answers are simple enough but for most players, they cannot turn the clock back 10 years and built their vertical infrastructures they way Apple has.
No contest.
Let the competitors eat the crumbs that fall from the Apple table. For now and for a few years more at least, Apple is munching on cake.
They deserve it as they have earned and invested their way to such profitability and success.

    You are correct in your assessment that Apple will continue to lead the market but there is ample room for the #2 right now. Today, most people are betting that Android will win that spot but what I’m highlighting here is that it’s not in matching Apple that one will win but in doing something different. A lower-priced strategy MAY be the way to go as the market has indicated that it’s willing to pay about $250-300 for a tablet not from Apple (so let’s assume that Apple will continue selling on the high end here). If HP wants to recoup its investment in WebOS, it ought to think about going after that #2 spot and it looks like there are ways in which it could achieve this.