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How Apple Inc. (Nasdaq: AAPL) Became the Vampire Squid of Tech

Apple Stock Price History
(Nasdaq: AAPL)

Business partnerships with Apple Inc. (Nasdaq: AAPL) produce abundant profits – but usually only for Apple.

Using its clout as a vendor of highly desirable consumer technology, Apple secures extremely favorable deals with suppliers, providers of goods and services, and retailers.

Such deals are a major reason behind Apple's extraordinary profits.

"Can Apple continue to roll through industry after industry, soak up all the profits, and leave everything it touches as a smoking wreckage?" Craig Moffett, an analyst at Sanford Bernstein & Co. told the Los Angeles Times.

Despite increases in business volume, many companies that deal with the Cupertino, CA-company discover it's usually a one-sided relationship when it comes to profits.

Apple has, in effect, become the technology world's "vampire squid" — a term coined by Rolling Stone Matt Taibbi in 2009 to describe Wall Street behemoth Goldman Sachs (NYSE: GS).

An Apple Deal Carriers Can't Refuse

Apple's relationship with the U.S. wireless carriers – namely AT&T Inc. (NYSE: T), Verizon Communications Inc. (NYSE: VZ) and Sprint Nextel Corporation (NYSE: S) — is Exhibit A.

In this case, each iPhone costs about $600. Yet each customer pays just $200, leaving the carrier to eat the entire $400 balance. Although the carriers have long subsidized the cost of most of their phones, few cost as much as the iPhone.

Such deals help explain how the iPhone eats up 75% of the global share of mobile phone profits despite having just 9% of the global market share for cell phones.

While each carrier has attracted new customers by selling the iPhone, the monthly revenue from their contracts has not been enough to make them as profitable as customers who buy less expensive phones made by non-Apple vendors.

AT&T, the first carrier to offer the iPhone, has been hit hardest.

The company's operating margins from the fourth quarter – a blockbuster quarter for the new iPhone 4s model – shrank to 15% from 22.9% year over year.

"The AT&T wireless model is broken," Kevin Smithen, a wireless analyst at Macquarie Securities, told the Los Angeles Times. "AT&T is basically subsidizing Apple's revenues and profit growth."

Apple Stock (Nasdaq: AAPL)
Verizon, which started to offer the iPhone last year, hasn't fared any better. Its EBITDA (earnings before interest, taxes, depreciation, and amortization) margin, a measure of operating profitability, fell from an average of 46.4% per quarter in 2009-2010 to 42.2% in the December quarter.

Sprint didn't start selling the iPhone until late last year with the launch of the iPhone 4s. After selling 2 million iPhones in the December quarter, Sprint's adjusted wireless margin dropped from 16% a year ago to 9.5%.

"A logical conclusion is that the iPhone is not good for wireless carriers," Mike McCormack, an analyst at Nomura Securities, told CNN Money. "When we look at the direct and indirect economics that Apple has managed to extract from the carriers, the carrier-level value destruction is quite evident."

And yet no carrier has any plans to stop selling the iPhone because they fear losing customers. The most recent convert, Sprint, had found the No. 1 reason it was losing customers was because it did not offer the iPhone.

"It comes down to, 'Do you want to be with them or bet against them?'" Sprint CEO Hesse told CNN Money.

Apple Takes a Bite From Retailers

Retailers such as Best Buy Co. Inc. (NYSE: BBY) and RadioShack Corp. (NYSE: RSH) have also struggled to make money selling Apple products.

Best Buy sells iPhones and iPads in its stores, but makes far less money on them than for rival products running Google Inc.'s (Nasdaq: GOOG) Android operating system.

For example, Best Buy will earn about $100 from each iPhone, but as much as $300 on a similar smartphone running Android. That translates to a profit margin of 100% on an Android phone versus only 17% on an iPhone.

"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," Anthony Chukumba, an analyst with BB&T Capital Markets, told Reuters.

The story is much the same at RadioShack; thinner margins on Apple products have pinched overall margins.

And of course the profit starved from the retailers is funneled back to Apple.

"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."

Apple Squeezes the Supply Chain

But Apple doesn't reserve its profit pressure just for resellers. Companies on the other end – Apple's suppliers – feel the pinch as well.

One of the uses for Apple's nearly $100 billion stash of cash is to lock up vast quantities of components to ensure there are no hiccups in the production of millions of iGadgets each quarter.

Suppliers find that sort of cash almost impossible to resist, even when one of the conditions is lowering the price per component. And Apple uses its cash clout throughout its vast supply chain.

"Operations expertise is as big an asset for Apple as product innovation or marketing," Mike Fawkes, a former supply-chain chief atHewlett-Packard Co. (Nasdaq: HPQ)and now a venture capitalist with VantagePoint Capital Partners, told Bloomberg Businessweek. "They've taken operational excellence to a level never seen before."

Perhaps the best illustration of how Apple extracts profit from its suppliers is in NAND flash memory. Flash memory is used in virtually every Apple product, from Macs to iPods to iPads.

That's a lot of memory; in fact, Apple purchases 23% of the world's flash memory every year. With that kind of volume, it gets great deals. But the company can turn around and sell its hardware at a premium.

More importantly, the pricing grids for its mobile computing products are based on upgraded memory. You can bet that Apple pays far less for that 16 gigabyte upgrade than the $100 it charges customers.

"Apple earns nearly twice as much from reselling NAND than all the NAND suppliers combined, with NAND resale responsible for 20% of Apple's total operating profits last quarter," wrote Sanford Bernstein analyst Toni Sacconaghi in a recent note to clients.

Doing the math, NAND memory resales accounted for more than $3.4 billion of Apple's $17.4 billion of operating profit last quarter.

And what Apple does to suppliers and retailers isn't even the whole story.

For instance, Apple takes a 30% cut of every digital product sold from the iTunes Store, which includes songs, videos and books.

Even Google isn't immune from the Apple vampire squid.

Macquarie Capital analyst Ben Schachter estimates that of the $1.335 billion in revenue Google earns from searches on Apple devices, it keeps just $335 million. The rest — $1 billion — goes to Apple.

"They've done it with music and handsets, and now they're doing it to the carriers," Sanford Bernstein's Moffett told the Los Angeles Times. "The hard part is trying to figure out exactly what's going to stop it."

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Join the conversation. Click here to jump to comments…

  1. chano | March 14, 2012

    You sound like a jealous dweeb, crying into his milk.
    You try to make Apple sound shabby and grasping for being super-efficient and ultra-profitable.
    And yet everyone, competitors especially, knows that they would do the same in an eye blink – if only they could.
    The key is that everyone wants Apple's products because they are such good value given their absolute quality.
    As for profit margins on NA~ND memory, have you bothered to see what Starbucks margins are on coffee beans, what every car-maker's margins are on parts and many other everyday examples. ~Hw do you think supermarkets can do BOGOF offers if they were not making eye-watering margins on full-price products in the first place.
    Keep on sobbing into your milk.
    Steve jobs had a word that precisely describes people like you.
    Just one word.

    • NumbersDontLie | March 14, 2012

      You sound like an Apple junkie, injecting the fix.
      I don't think he was making Apple sound shabby at all. He pointed out how they generate their profits on both sides of the equation. Yes, their competitors would do the same in an eye blink if (rather when) then could. They will destroy some part of Apple's profit machine at some point. I assume you recall Apple's previous departure with Jobs? The meltdown was not overnight, but it happened. It will happen again.

      I have one word to describe people like Steve Jobs. Dead. Just one word.

      For the record, I own AAPL. I just want off the ride before it crashes, and I am looking to pick my spot.

    • Dexter | March 14, 2012

      One word to describe you Chano- Blind

  2. nihal bhat | March 14, 2012

    what will stop this?

  3. Yacko | March 14, 2012

    A lot of peripheral makers and their suppliers do well at least on a short term basis. As with most things nowadays, you go with the changes and come up with good aftermarket accessory ideas, you can swim with Apple.

  4. Shock Me | March 14, 2012

    Yeah. Not seeing the problem. When these other parties offer more value they will make more money.

  5. Ted T. | March 14, 2012

    So if the iPhone is so bad for carriers T-Mobile USA should be in the best shape, since they don't carry the iPhone. Yet they in the worst shape, and keep making public statements begging for the iPhone…

    Care to explain why? This has to be the dumbest article I've read all week. Apple is more successful than anyone because consumers want to buy their products and not the competitors products. If retailers weren't carrying Apple products, consumers would simply go to the Apple Store or buy online from Best Buy would go from low margins to no margins. Circuit City didn't carry Apple products, where are they now?

  6. Brian | March 14, 2012

    The haters just keep on hating. Apple was the underdog not so long ago. No other company has been ripped off as much as Apple. When the first iMac came out, practically every other product in sight adopted some of it's design elements. The laptops you use today, with the keyboard up by the screen? That looked really weird at first. In the old days, they all had keys back away from the screen. Within a few years, literally ALL the laptops look like this. Now, this is a relatively TRIVIAL example, but there are 1000's of them.

    Microsoft got to where it is today with a deal from IBM and by FOLLOWING Apple's technology lead.

    This has been the case since the 70's. Apple was STRUGGLING badly until Steve Jobs made a deal with Bill Gates. Jobs had an open an shut case against MSFT as they got caught red handed stealing the Quicktime Code (they just blithely pasted it right into "Windoze Media Player" without much of a care). Jobs made a deal where Softie had to pledge support for Mac. It worked for MSFT as they were being found guilty of being the world's biggest monopoly (but never received punishment).

    All Jobs needed was to restore confidence in the employees, green light the CORRECT projects, and get MSFT's foot off it's throat for 5 years.

    Apple is and always has been full of very talented people.

  7. Tripod | March 14, 2012

    There are no tears shed here for the wireless carriers. They are victims of their own business model – subsidize the hardware and lock the customer into a two year contract. They gave Apple the advantage.

  8. Michael | March 14, 2012

    "Back in the day" Microsoft used their enormous clout to swallow up smaller companies and secure license deals that favored them to the exclusion of other technology companies. Not too many people seemed to care back then. Microsoft was the dominant player (like Colossus) and folks seemed happy about it. Now Apple is using its leverage in the marketplace to secure favorable contracts for itself and everyone cries foul. Why would people accept Microsoft doing this, but not Apple?

  9. Jay Knight | March 14, 2012

    Dumb article with no research, just immediate knee-jerk reactions to numbers. While some points are salient, take, for instance:
    "In this case, each iPhone costs about $600. Yet each customer pays just $200, leaving the carrier to eat the entire $400 balance. Although the carriers have long subsidized the cost of most of their phones, few cost as much as the iPhone."
    I had the sense to walk into a phone store and look at the price of other high end phones without a contract – $400-$700, or, amazingly enough, same as the iPhone. I also see phone providers going out of business left , right, and center
    "For instance, Apple takes a 30% cut of every digital product sold from the iTunes Store, which includes songs, videos and books. ".
    And most book manufacturers take about 85% or more.
    And most music distributors ("record manufacturers") take about 95%. Did you bother to ask a band or singer what percent of each album they get?

  10. AdamChew | March 14, 2012

    Can never understand this subsidising thing, this writer sounds as if the telcos would be making the money back from the subscribers.

    Just one question Mr Zeiler will the telcos make back the amount of money they spend on subsidising the iPhones? If yes then why the whine?

  11. etype | March 14, 2012

    This is the stupidest thing I've ever heard! What will you think of next! Apple spilled your milk?

  12. etype | March 14, 2012

    Apple stole my cheese!

  13. Juan Carlos de Burbon | March 14, 2012

    Why is this news? Doesn't every company strive to be leaders in their industry with incredible clout over their supply chain? Hasn't WalMart already achieved similar success in the retail world?

    While we give Steve Jobs a lot of credit for building Apple, this is the true genius of Tim Cook.

  14. tom fane | March 17, 2012

    I am happy to see Apple sussesful and chances are they will continue for what-ever the reasons. The thing I don't like about it is that they are using child labor in China while they could be hiring Americans and helping the economy of our country. Don't tell me that with the billions they are worth and huge profits they make that they can not afford to pay a minimum wage to Americans and still have money left over to make them rich. Does it make sense to become the riches company in the US and still not hire our citizens to do work for them? It is just greed to make their (AAPL) bottom line more impressive.

  15. E Goff | March 18, 2012

    This is not a foolish article, simply a jealous display of gobbly-goop! To my knowledge, no other company has ever accomplished what Apple has. They are the ultimate epitome of entreaprenureal beginning, innovation, and life-changing intellectual property. As a retired 15 year Apple exec. I lived through the Jobs/Sculley fiasco, the early days of the Mac launch and the "death" struggle against IBM & Microsoft. There has never been a turnaround such as Steve Jobs pulled off upon his return to Apple. Now that Apple has become the world's most valuable & innovative company they have a target on their back. Everybody wants a "bite" out of the Apple! Fortunately, for us shareholders and avid Apple supporters, Steve not only left his legacy, but a talented bench strength as well. Apple is dripping with unprecedented talent at all levels. Today, Apple is a case study at many of our Higher Ed. Institutions. I had the ride of my life during my Apple tenure and am able to continue that ride through their exciting products and bottom-line success. Thank God for Steve & "Woz" who started this journey back in the late 70's! Thus, be jealous, be critical – just be thankful you are not in one of those long lines outside of an Apple store waiting for your new iPad. That way you have more time to write articles like this or play with your Amazon "kindle".

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