Recently, KGI Securities analyst and in-the-know Apple (NASDAQ: AAPL ) source Ming Chi Kuo sent Apple fans into hysteria with the announcement of the long-awaited smartwatch. Analysts? Well, not so much. Specifically, the announcement was regarded with skepticism – an all too familiar reaction for analysts covering the iPhone 5c. Many analysts were scratching their heads wondering how Apple plans to sell smartwatches at $1,000. In short, many fear Apple is pricing itself out of a lucrative and undefined market.
Is Apple too worried about margins?
Wall Street has a familiar refrain with Apple: A lack of innovation after Steve Jobs's passing has led to margin erosion. And, in a way, they are correct. Looking at Apple's gross margins over the last few years tells a not-too compelling story for the tech behemoth.
After an initial bump, you can see that the trend has dropped considerably, eventually rebounding to the 37% range. This is an obvious concern because the larger this percentage is the more profit from each unit sold flows down the income statement to shareholders. With that being said, being overly concerned with margins for margins' sake also presents a risk to investors.
Remember the iPhone 5c?
Forgive analysts if they are a typically cynical bunch; it's a requirement of the job. However, this exciting new announcement/product from Apple appears to be a repeat of the iPhone 5c. Rumors around the last huge product offering – the iPhone 5c – reached frenzied levels of debate: What did the "c" stand for? Was it cheap? China? The answer, so far, appears to be none of the above. Basically, it was the iPhone 5 with a plastic case rather than metal and a few minor tweaks. In short, it appears this was a pure margin play by decreasing the bill of goods.
However, fans, analysts, and prospective buyers were looking for a lower-cost phone to bring new audiences into Apple's sticky ecosystem. Yes, a lower-price phone would have probably affected margins, but also would have expanded Apple's reach into emerging markets like China. While the particular cost and price mix can be debated ad nauseam, it is pretty well established that the iPhone 5c is considered an underperforming product by Apple's high standards. Essentially a "tweener," a product without a market with developed country buyers opting for the more expensive iPhone 5s and emerging markets opting for lower cost manufacturers sporting Google's Android operating system.
Notice the similarities?
On the surface, these two launches appear to have nothing in common. What does releasing a new product have to do with releasing a lower-cost existing product? Well, it all has to do with appropriate pricing and consumer's perception of value. Right now, it appears Apple is pricing themselves out of this market with the obscene cost of this new product. Historically, Apple has been able to enjoy premium pricing with its products – although that has moderated in recent times – but asking Apple fans to pay nearly three times Samsung's MSRP of its Galaxy Gear smartwatch may be asking too much in an undefined market. In addition to comparative value, a consumer also looks at total value. When faced with the decision to spend $1,000, does a typical customer opt for the iWatch, a product with tremendous potential but still in the infancy stage, or does that consumer opt for an 11-inch MacBook Air?
Final Foolish thoughts
It's important not to get ahead of ourselves with rampant iWatch speculation. Although Ming Chi Kuo has been accurate in the past, this is all still speculation. In addition, we don't know how many models Apple will bring to market, or the individual value proposition each possesses. However, if the rumors are true it points toward Apple being more concerned with maintaining margins than bringing a new product to the masses. And for a company that generates such a large amount of revenue from one product – iPhones – perhaps diversifying their revenue stream should be a more important goal.
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