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Apple employees prepare the newly released iPhone 6 for sale
Hannibal Hanschke—Reuters

Why Apple Can't Sell Cars Like iPhones

Feb 25, 2015

The Apple car! It's Cupertino's latest nonexistent product to drive the tech world into a frenzy. Ever since the Wall Street Journal reported that Apple has "several hundred employees" working on the production of a Tesla competitor (by 2020, no less, according to Bloomberg), pundits have been fighting over the viability of an Apple-branded automobile.

On Monday, Vox's Matt Yglesias jumped into the fray, taking on what he saw as the prevailing argument against the Apple car: namely, that the car industry is a low margin business, and Apple needs high margins to keep making its usual hefty profits. Here's Yglesias:

The misperception here is that Apple earns high margins because Apple operates in high margin industries. The truth is precisely the opposite. Apple earns high margins because it is efficient at manufacturing and firmly committed to a business strategy of sacrificing market share to maintain pricing power.

If Apple makes a car, it will be a high margin car because Apple only makes high margin products. If it succeeds it will succeed for the same reason iPhones and iPads and Macs succeed — people like them and are willing to buy them, even though you could get similar specs for less.

That's sort of true, but it's not the whole picture. To understand Apple's business model, we need to take a step back. Apple earns high profits because it goes into high-volume industries dominated by low-margin players who sell relatively affordable products. Apple then makes a premium product, one where you can't get similar specs for less—there is no other computer or smartphone with the software or build quality of an iPhone 6 or Macbook Air—and prices its offering a few hundred dollars more than the competition. Then it earns billions off this relatively small price increase by selling high quantities of units.

In other words, Apple makes premium versions of things everybody needs at prices most people can still afford. To quote a 2010 review of the iPad, by Daring Fireball's John Gruber, " 'Affordable luxury' is the sweet spot for mass market success today, and Apple keeps shooting bulls eyes." A similar strategy for an Apple car then, would be to sell a premium-quality car with higher margins (Apple's gross margin in 2014 was close to 40%) at a still-affordable price.

The problem for Apple is that it's a lot easier to increase margins in a low-cost industry than a high-cost one. Even if an iPhone 6 costs 100% more than a cheap LG smartphone, it's only $200. Same thing with the Macbook Air, which is twice the price of a low-end Windows laptop but still affordable at $1,000.

But trying to get similar margins in the automobile market means a price increase of thousands of dollars, not hundreds. Double the price of a $22,970 Toyota Camry, or ask for even a 50% premium, and you're in BMW territory. (That company's cheapest sedan costs $32,000.)

The typical Apple customer has enough disposable income to double their phone budget and buy an iPhone 6. Buy one fewer latte a week, and you're pretty much there. Asking someone to double their car budget is a very different story. That's not affordable luxury, that's luxury—period.

This isn't to say Apple won't make an expensive high-margin car, just like BMW. The premium car market isn't nearly as profitable as the cell phone market, but it's not nothing. It's also possible Apple will make a low-margin car while charging a slight premium over the likes of GM and Ford. The entire global automobile market in 2014 was about half the size of the iPhone market alone, meaning such an endeavor would be a lot of work for not much growth, but anything is possible.

But for Apple to do either of these things would be to abandon the affordable luxury strategy that has made it the most valuable company in the world. That's worth thinking about when considering an Apple car's chances.

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