The Top 3 iPad 3 Storylines: First, How Much Will It Cost?

This Wednesday at 12:45 Eastern/9:45 Pacific, The Motley Fool's top analysts will be hosting a live blog breaking down what Apple's iPad 3 press conference means for investors. The best part? They’ll also be taking any questions you have about the tablet and Apple as an investment as well. Make sure to set a reminder to come back to Fool.com this Wednesday for all your iPad 3 news and analysis!

The next iPad is being unveiled this Wednesday and like always, Apple (Nasdaq: AAPL  ) is doing its best to build excitement by keeping all details about the event close to the vest. However, thanks to Apple's massive supply chain, hints do leak out. Some of these seem legitimate; others are so ridiculous they make you fall out of your chair laughing.

Yet, with the next iPad being a device that will drive north of $30 billion in sales across the next year -- not much less than the entire yearly revenue of a company Google's size -- the details of how Apple is evolving the product are tremendously important. While typical areas of speculation focus on what kind of processor the iPad 3 will have or whether it has a retina display (it will), across the next few days we're going to instead look at some under-the-radar questions which focus on how the iPad will effect Apple as investment. The first question we'll look at is: how much will the iPad cost?

Storyline No. 1: Price, price, price

In front of the newest iPad's unveiling, the question of price is picking up steam. Varying reports hint that -- possibly due to increased costs from the retina display -- Apple could price the iPad 3 starting at $580, which is $80 more than previous entry level models.

Just to get this out of the way, I don't think Apple will raise the price on the iPad 3. The origin of this "report" largely stems from a single post on Chinese microblog Weibo, which is about as loose a source as you can find. However, I do think it's important to explore why people might think Apple would feel compelled to raise the iPad's price.

First off, displays are expensive. According to iSuppli's initial bill of materials estimate, the iPad 2's display was about 39% of total material costs. That's more than the memory, battery, and processor costs combined. It's natural to assume that a new iPad 3 which includes a screen that has two to three times the pixels per inch would cost significantly more than the iPad 2. But it's hard to figure  pricing factors like manufacturing capacity, and Apple's ability to get cheaper prices through guaranteed-high-volume component buys makes it difficult to know just how much more a 9.7" retina display would cost the company.

Here's why a more-expensive iPad could make sense

So, why could it make sense for Apple to bump up the pricing of the iPad now? For one, Apple has priced the iPad extremely aggressively since its introduction. While the iPad has still commanded a comfy profit margin, it was priced at a level that sacrificed margins for rolling up market share. We could be reaching a total component-cost level where Apple feels the iPad's positioning within the tablet industry is established to the point the company can bump up the pricing to maintain or increase margins.

And here's why the iPad 3 will cost the same as an iPad 2

There's a risk to that strategy, however. First of all, Tim Cook has hinted in numerous presentations that he feels Apple is still in the very early stages of a shift to tablets. Apple's long-term aims are served best by continuing a transition from PCs to iPads and keeping new threats at bay through continued aggressive pricing.

From a competitive standpoint, while Apple has firmly dominated the high end of tablet market, competitors abound, and pricing the next iPad starting at $580 would only widen the gap between the iPad and lower-priced tablets like Amazon's (Nasdaq: AMZN  ) Kindle Fire and Barnes & Noble's (NYSE: BKS  ) Nook.

A need to defend the low end?
That threat from the low end actually creates tomorrow's most-interesting pricing storyline: Will Apple keep producing an iPad 2 that's priced at a more budget-conscious level?

That would be a situation pretty similar to how Apple has handled lower-priced competition in the mobile phone market. Rather than caving to pressure to produce a cheaper “iPhone mini” to battle low-priced Android offerings, Apple has continually discounted older iPhone models. Today, the iPhone 3GS can be found on many carriers for free on contract. In this case, rather than caving to the pressure of producing a smaller "mini iPad" that's 7" or 8", Apple would discount older iPads.

How low could Apple go with iPad pricing? When the iPad 2 was first unveiled, its hardware costs were estimated anywhere from $270 for an entry level 16 gb Wi-Fi model to iSuppli's estimate of $326 for a 32 gb 3G model. Let's settle in the middle and say the iPad cost $300 to make.

A year later, a few factors actually bring the iPad's hardware below that $300 estimate:

  1. The research companies that tear down Apple products and estimate costs might not properly account for the savings Apple wrings out from suppliers through forward-purchase agreements and its massive scale. That can be a meaningful total.
  2. Apple could scale back the storage and possibly other components on a cheaper iPad 2. Cutting back storage to 8GB wouldn't provide huge cost savings (maybe $5 to $10) since flash memory is getting cheap, but it's an option on the table if Apple wants to achieve a few higher percentage points in gross margin.
  3. The general laws of technology are in order: The older technologies are, the cheaper they become to produce. The expensive 9.7" retina screens of today will be more affordable when the iPad 4 rolls around. Likewise, some of the iPad 2's older components cost less than they did a year ago.

Then there are further costs on top of hardware. Apple has to pay for manufacturing, shipping, warranties, and general administrative costs as well. My guess -- and I emphasize there's a good portion of guesswork here -- is that we're still looking at $200 to $250 in hardware costs for Apple to produce even a budget-friendly iPad 2 in the next year.

So where does that leave the price point if Apple continues selling the iPad 2 next year as their budget tablet? I'd be shocked if they came in at $299 and surprised if they hit the $349 price point; I expect the budget tablet price to be $399.

Bottom line
Selling a reduced-price iPad has its risks; for one, the lower-cost, older model could cannibalize iPad 3 sales. More importantly, if the iPad 2 goes for $399, it'll still be double the cost of the next tier of tablets (though still superior from a hardware and software perspective). If Apple prices it in the $299 to $349 range, it would be an unprecedented move from the company on conceding margins, and the cannibalization angle continues to widen. 

In the end, I'd look for Apple to introduce the iPad 3 starting at $499. With a pretty huge hardware update relative to what users got between when the iPad 2 was launched, that price point should lead to the iPad maintaining its torrid growth rate. Its competitive position only grows.

I'm intrigued by the idea of an iPad 2 at a lower price point as well. My best guesswork in whether it succeeds is based on how Apple has continued selling the 3GS (and now, the iPhone 4) after new phones have been released. Based on that history, my opinion is that a budget-friendly iPad 2 would be a net positive, but investors hoping for a very aggressively priced iPad 2 to kill the Kindle Fire could be disappointed come Wednesday.

One more idea for the road
One final point I'd like to make is that while I've recommended Apple to investors for years and purchased the company in the portfolio I manage on Fool.com, my greatest "iPhone and iPad winner" has actually been one of the components inside Apple products. If you're looking for a way to play Apple, you shouldn't limit yourself to buying just the company. We've prepared a free report, "3 Hidden Winners of the iPhone, iPad, and Android Revolution" which not only details that winner in my portfolio, but also two other great ideas which are riding Apple's growth. To get your own copy of the report, just click here now, it's free!

Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of Amazon.com and Apple. Motley Fool newsletter services have recommended buying shares of Amazon.com and Apple and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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