The Economics of the iPod

Hal Varian writes:

An iPod Has Global Value. Ask the (Many) Countries That Make It: Who makes the Apple iPod?... [A] number of Asian enterprises, among them Asustek, Inventec Appliances and Foxconn... do final assembly.... Greg Linden, Kenneth L. Kraemer and Jason Dedrick... applied some investigative cost accounting to this question....

The retail value of the 30-gigabyte video iPod that the authors examined was $299. The most expensive component in it was the hard drive, which was manufactured by Toshiba and costs about $73. The next most costly components were the display module (about $20), the video/multimedia processor chip ($8) and the controller chip ($5). They estimated that the final assembly, done in China, cost only about $4 a unit....

At each step, inputs like computer chips and a bare circuit board are converted into outputs like an assembled circuit board. The difference between the cost of the inputs and the value of the outputs is the “value added” at that step.... The profit margin on generic parts like nuts and bolts is very low, since these items are produced in intensely competitive industries and can be manufactured anywhere. Hence, they add little to the final value.... [H]ard drives and controller chips have much higher value added....

[T]he $73 Toshiba hard drive in the iPod contains about $54 in parts and labor. So the value that Toshiba added to the hard drive was $19 plus its own direct labor costs. This $19 is attributed to Japan....

The researchers estimated that $163 of the iPod’s $299 retail value in the United States was captured by American companies and workers, breaking it down to $75 for distribution and retail costs, $80 to Apple, and $8 to various domestic component makers. Japan contributed about $26 to the value added (mostly via the Toshiba disk drive), while Korea contributed less than $1.... [U]naccounted-for parts and labor costs involved in making the iPod came to about $110. The authors hope to assign those labor costs to the appropriate countries....

The real value of the iPod doesn’t lie in its parts or even in putting those parts together. The bulk of the iPod’s value is in the conception and design of the iPod. That is why Apple gets $80 for each of these video iPods it sells, which is by far the largest piece of value added in the entire supply chain.

Those clever folks at Apple figured out how to combine 451 mostly generic parts into a valuable product. They may not make the iPod, but they created it. In the end, that’s what really matters.

Comments

[lagarita]

"The bulk of the iPod’s value is in the conception and design of the iPod. That is why Apple gets $80 for each of these video iPods it sells"

Isn't part of that $80 for the marketing that creates demand for the iPod?

It's interesting that the mark-up on the iPod appears to be about half of that on the first iMac (which cost about $400 to make and sold for $2500 IIRC).

[Rod Hoffman]

This is the Reader's Digest version of James Fallows' article on the benefit of trade with China in the current Atlantic Monthly.

[Bruce Wilder]

The profit margin on generic parts like nuts and bolts is very low, since these items are produced in intensely competitive industries and can be manufactured anywhere. Hence, they add little to the final value."

Notice the reasoning above focuses on market structure, while the reasoning below is about virtue.

"The real value of the iPod doesn’t lie in its parts or even in putting those parts together. The bulk of the iPod’s value is in the conception and design of the iPod. That is why Apple gets $80 for each of these video iPods it sells, which is by far the largest piece of value added in the entire supply chain.

Those clever folks at Apple figured out how to combine 451 mostly generic parts into a valuable product. They may not make the iPod, but they created it. In the end, that’s what really matters."

The tendency of economic theory to confirm the virtue of the winners only serves to obscure the truth. It is the economic equivalent of the watchmaker hypothesis and the "perfection" of nature.

Apple sunk cost investments in product development, reputation, advertising and marketing are quite substantial, and can only be recovered in circumstances in which it exercises considerable market power.

Apple did a nice job with the iPod series, but far from a perfect job. They stole significant intellectual property from Creative Labs, which also developed some great players, but was not as successful in the marketplace of trendy. And, the iPod had some significant downsides to its design, like a battery that could not be replaced, and a proprietary music format that tied the device to the iTunes store.

[elliottg]

Who knew that the i-brand was created for free? In 3 - 12 months there will be functionally equivalent or better iphones available for significantly less price. How will these authors explain the difference in price?

[D-Slam]

"..and a proprietary music format that tied the device to the iTunes store."

Not true. The iPod also plays the ubiquitous mp3 format... which is widely available from a number of legit sources. (You can also freely rip your own CDs to the device). I have 4,000 songs on mine and I have not spent a nickel at the iTunes store.

And to be honest, I took a look at the competing players beforehand.... none offered a noticable price/performance improvement... Creative's player was the same price as an iPod. Sony tried to enter the market and did an absolutely terrible job.

[Jon H]

"It's interesting that the mark-up on the iPod appears to be about half of that on the first iMac (which cost about $400 to make and sold for $2500 IIRC)."

The first iMac sold for $1299.

In 1999 the price was cut to $999.

[Jon H]

"and a proprietary music format that tied the device to the iTunes store.'

That's a neat trick, considering that the iPod was being sold for a few years before the iTunes store opened.

Actually, it plays mp3 and AAC. AAC is not proprietary and also works in other players like the Zune.

What's specific to Apple is the DRM on DRM-protected AAC songs sold on the iTunes store. The non-DRM-protected EMI songs for sale on the iTunes store are just AAC and should play on any AAC-compatible player.

[Maynard Handley]

"They stole significant intellectual property from Creative Labs, which also developed some great players, but was not as successful in the marketplace of trendy. "

Really? STOLE? As in broke in Creative Labs and nabbed some pieces of equipment and prototypes?

Or perhaps you agree (strange since you are making a legal claim) that you used the incorrect word, that they engaged in copyright infringement? If so, please give us details.
Or is it patent infringement? Again, details please.
Or are you claiming that they are using a trademark owned by Creative?

Or are you just talking out your ass?