Apple addiction drives sales, hits retail margins

For U.S. consumer electronics chains, Best Buy and RadioShack, selling Apple products is at best a bittersweet experience. Every new Apple gadget, such as the 4G iPad unveiled on Wednesday, helps bring more people into stores of the two chains. At the same time, they are making less money with every Apple iPad, iPhone or iPod they sell than they would selling a comparable device. “At a very basic level, Apple gives less retailer margin” because Apple creates the demand, said Andy Hargreaves, an analyst with Pacific Crest Securities. Analysts have estimated that Best Buy buys the 16GB iPhone 4S from Apple for about $600 then sells it for $300 to consumers who sign up for a new two-year wireless contract. Best Buy does not actually take a loss on the sale because wireless providers like AT&T give it a $400 commission for signing up the subscriber, but it makes only a $100 profit.

Some Apple magic! 

On a comparable Android device such as a Droid RAZR, Best Buy pays Motorola $300 for the phone, sells it for $200, and still gets the $400 commission, making $300 on that sale. Best Buy’s profit margin on the iPhone sale is about 17 percent compared with a profit margin of about 100 percent on a comparable Android phone. “Clearly, the profit margins on Apple products are thinner than other products, whether you are talking about an iPod versus another mp3 player, whether you are talking about an iPhone versus Android or BlackBerry handsets,” said Anthony Chukumba, an analyst with BB&T Capital Markets.

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He said that is also true of profit margins on an iPad versus an Android tablet. Many iPads are wi-fi only, so retailers do not get paid by a wireless carrier on many iPad sales. Regardless of how much retailers make on electronics sales, they must stock hot products. “There is just not a whole heck of a lot that a Best Buy or a RadioShack can do about it,” Chukumba said. “They have to carry Apple products from a sales perspective, a relevance perspective, and a customer traffic generation perspective.” The new iPad “will be a great upgrade product which will drive traffic and excitement at Best Buy, RadioShack, Staples Canada, Wal-Mart and Target,” Janney Capital Markets analyst David Strasser wrote in a note on Thursday. Chains like Best Buy and RadioShack have been struggling with narrowing margins, partly due to Apple products.

“When I have talked to Best Buy, they have told me the one exception is the Macs,” Chukumba said, adding that Best Buy has better profit margins on Mac computers than on Windows-based personal computers. Best Buy and Apple declined to comment for this story. Unlike last year when only AT&T had the iPhone, all of RadioShack’s major wireless partners, including Sprint and Verizon, are now pushing the iPhone. RadioShack Chief Executive Jim Gooch said last month that increased sales at RadioShack stores open at least a year but hurt margins.

Weak margins have driven away some investors. Anthony Abbate, a portfolio manager at Granite Value Capital, said taking a short-term hit to margins to increase sales is not a smart strategy for any company.

“I can’t really say an example of when it would be good to do that,” Abbate said. “Overall, I think it’s a really poor strategy because all you are doing basically is selling more units, but you are selling them at a lower price. So, at the end of the day, I don’t think your profits are going to be any higher.”

Abbate sold Best Buy’s stock last fall citing poor business fundamentals.

In addition to the lower margin on many Apple products, Apple’s clout in the industry is another factor working against retailers. For example, if a non-Apple device did not sell well and had to be discounted, Best Buy could force some compensation from the manufacturer for the sales miss. But, Chukumba said, “It wouldn’t surprise me if Apple is not writing that check at all. Once again, it has to do with leverage. Apple has much more leverage over Best Buy than Samsung, LG, Sony, Motorola Mobility, HTC. There is just no comparison.”

Accessories and services can help boost margins for retailers selling Apple products.

“When somebody comes into Best Buy and buys an iPhone, make sure they don’t just leave with an iPhone. Make sure they also buy a protective case, a bluetooth headset and maybe a warranty plan,” Chukumba said. Also, the high-end model of the new iPad can operate on a high-speed 4G Long-Term Evolution (LTE) network, presenting an opportunity for better margins if retailers sell more connections to people wanting faster service, Strasser said.

Best Buy should also encourage manufacturers to create products that can compete with Apple and carry higher margins. “Best Buy would love nothing more than there to be competitive Android tablets,” said Chukumba.

Reuters