Apple, Inc.'s iPad Business Is Struggling for 3 Reasons

Apple's iPad business continues to disappoint investors.

Apr 27, 2014 at 11:00AM

Apple (NASDAQ:AAPL) reported a strong quarter on Wednesday, with profits exceeding analysts' expectations. Revenue was a beat; iPhone and Mac sales came in much better than expected. Gross margin, which had been trending down, bounced back.

Yet, there was one glaring weakness in the report: iPad sales (16.35 million) fell far short of estimates (19.7 million) -- Apple's tablet business declined 16% on a year-over-year basis. This isn't just a one-off instance, but a troubling trend. With the exception of the holiday shopping season, the iPad has fallen short of expectations in nearly every quarter for the last year. But why?

Longer replacement cycles
While smartphones are typically replaced on a biennial basis, tablets are kept for a longer period of time. Research firms, including IDC, have noted that a maturing tablet market poses a challenge to manufacturers, as consumers see little reason to upgrade from their existing devices.

Consumer Intelligence Research Partners, in a survey of some 2,000 consumers, noted that iPads tend to be used in ways much more comparable to devices with longer replacement cycles (PCs, TVs) rather than shorter ones (smartphones). iPad owners take their time replacing a lost or broken unit, and are much more likely to hand their iPad down to a friend or family member.

In short, while Apple can rely on its loyal customers to buy a new iPhone every two years or so, the same can't be said for iPad buyers.

No carrier support
That regular, two-year replacement cycle is largely the byproduct of a wireless industry willing to subsidize the cost of a new handset every two years. When a wireless contract expires, iPhone owners upgrade to a new model -- and Apple gets another sale.

iPads, in contrast, are overwhelmingly separate from the carrier complex. Sure, you can buy one of Apple's tablets through a major carrier, but very people few do. Last year, analyst Craig Moffett estimated that 80% of tablets sold in the U.S. do not sport wireless chips and only 5% are actually connected to wireless networks at any given time. Analyst Chetan Sharma came to a similar conclusion in 2012, noting that only 10% of U.S. tablets relied on wireless networks.

The separation of device and network has another component -- it allows Apple to be more easily undercut in price. Apple remains the single largest manufacturer of tablets, but its overall market share has slipped, surpassed by Android-powered tablets last year. Android tablets are available for a fraction of the price of iPads, and many of them are just as capable. Admittedly, this is no different from the phone market -- many Android handsets are available at a fraction of the cost of iPhones, and so far, that hasn't had much of an impact on the iPhone business.

But there's a crucial distinction between the two -- whereas iPhones are subsidized by the carriers or financed over 24 months, iPads have no such advantage. Consumers purchasing a new tablet have to pay the entire purchase price up front -- making a cheaper Android alternative far more enticing.

A weakening tablet market
Finally, one trend affecting both Apple and its Android-powered competitors is a tablet market that, overall, is showing signs of weakness. Last month, IDC cut its estimates for tablet sales, projecting the market to grow less than 20% in 2014. If that's the case, it will a sharp drop from last year, when the tablet market grew by more than 50%.

The growing popularity of smartphones with larger screens may be having some effect on tablet demand, particularly in emerging markets. Last year, IDC reported that phablets outsold both tablets and PCs in most Asian markets during the second quarter. These phones boast screen sizes between five and seven inches, calling into question the need to own a separate tablet.

The iPad company
During its first two years on the market, the iPad experienced rapid growth, selling faster than any of the products that had preceded it. Some projected that, one day, Apple would become the "iPad company" -- its tablet business looked on track to eventually overtake the iPhone.

At this point, that notion looks to be thoroughly shattered. Barring drastic changes to its tablet strategy, Apple's tablet business should continue to disappoint.

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Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends and owns shares of 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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