As a potential Apple (NASDAQ: AAPL ) smartwatch continues to drive buzz in the rumor mill, it's worth asking: Would an iWatch really have a meaningful impact on Apple's bottom line? Chances are, it probably wouldn't. But that doesn't mean the iWatch wouldn't indirectly benefit Apple shareholders over the long haul.
A paltry sum
In Apple's fiscal 2013, the company's annual revenue hit $170.9 billion. Moving this number higher won't be an easy task for Apple management. To put this revenue in perspective, consider that it is greater than the sum of Amazon, Intel, and McDonald's annual sales combined. Making matters even more difficult for management, Apple's enviable profit margins send a huge chunk of this revenue to the bottom line. In 2013, Apple reported net income of more than $37 billion. Budging $37 billion in net income would be difficult or even impossible for many publicly traded companies.
Since a potential iWatch would likely sell at a lower cost than the iPhone (Apple's largest business segment), it may be difficult for the iWatch to move the needle on Apple's massive bottom line even if it is a blockbuster success. Fortunately, we can get a closer look at whether or not this is true with Piper Jaffray's Gene Munster's recent estimates of the potential impact of an iWatch.
The estimate is based on a survey of 799 U.S. iPhone customers; in the survey, Munster sought to put a figure on Apple's addressable market for a potential iWatch. Assuming an average selling price of $350, 12% of the surveyed customers said they would buy an iWatch that connected to their iPhone. Extrapolating a conservative global figure from this study, Munster came up with his estimate: 5 to 15 million smartwatches in the first year.
Millions of devices at $350 for Apple, however, aren't always enough to have a big impact on Apple's business -- at least in the short run (more on this idea later). Munster estimates sales of 7.5 million units would only boost both revenue and gross profit by 1%.
Is the iWatch out of the question?
Obviously these estimates are just one analyst's projections and not a perfect what-if scenario with crystal ball-like accuracy. But assuming Munster's conservative projections are somewhat close to reality, does this mean Apple shouldn't pursue an iWatch? Not at all.
Apple CEO Tim Cook has, on several occasions, referred to Apple's well-known "halo effect" as one of its key marketing strategies. In the 2012 Goldman Sachs Technology Conference, for instance, Cook said that the iPhone is creating a halo for both Macs and iPads. In other words, iPhone sales often serve as a way to solidify customers' connection within the sticky Apple ecosystem, leading to purchases of both Macs and iPads. The iPhone is Apple's "gateway product," Cook has said.
Again, in Apple's second-quarter earnings call, Cook mentioned the halo effect in a different light. During the quarter, iPhone ASPs declined as a result of more aggressive pricing on Apple's iPhone 4. Cook expressed his satisfaction with the aggressive pricing by explaining that the aggressive pricing of the iPhone 4 is getting customers into Apple's ecosystem.
"[W]e believe that the ... price point that we are offering is an incredible value for people, that allows them to get into the ecosystem with a really, really, phenomenal product," Cook explained.
With Apple's halo effect and its sticky ecosystem in mind, an iWatch could make sense -- despite the potentially small impact on Apple's bottom line it could have in the short run. If an iWatch offered a unique Apple experience and served as a method to convince many on-the-fence customers to buy an Apple product, an iWatch could lead to an incrementally larger number of valuable lifelong customers.
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