Market analysts with IHS Markit recently published a cost analysis of Apple's (AAPL 1.62%) new iPhone X. The iPhone X with 64 GB of storage is priced at $999, but IHS Markit claims that the device costs just $370 to manufacture.
Previous IHS Markit reports estimated the cost of the iPhone 8 and iPhone 8 Plus -- two lower-cost iPhones announced alongside the premium iPhone X -- at $247.51 and $277.66, respectively. These reports seem to confirm what's intuitively obvious: The iPhone X is more expensive to build, so Apple charges more for it.
Apple executive Phil Schiller. Image source: Apple.
If the iPhone X really costs $370 to build, then you might be tempted to think that Apple generates at least $629 in gross profit per iPhone X sold, for a gross profit margin of approximately 63%. Running the math for iPhone 8 and iPhone 8 Plus we get gross profit margins of 64.6% and 65.2%, respectively.
However, we know for a fact that there's no way that Apple's pocketing gross profit margins of between 63% and 65% on its new iPhones. Most of the quarter-over-quarter sales increase that Apple is expected to enjoy in going from its most recently reported quarter to the current quarter will come from the ramp-up in shipments of iPhone 8, iPhone 8 Plus, and the reportedly tough-to-build iPhone X. If Apple's new iPhones really generated gross profit margins of over 60%, then Apple wouldn't be guiding to gross profit margins of between 38% and 38.5% for the current quarter; it'd be much higher.
So, what explains this disconnect?
Missing costs
The first thing that could be driving this disconnect between the implied margins that IHS Markit published and the financial reality suggested by Apple's guidance is that IHS Markit's numbers are just plain wrong.
In fact, Apple CEO Tim Cook once famously said that the third-party cost breakdowns that are published estimating the cost-to-build of Apple's devices "are much different than the reality" and that he's "never seen one that is anywhere close to being accurate."
If we assume, though, that the component cost estimates published by IHS are at least in the ballpark, it's not hard to see where the mismatch between Apple's estimated margins and the implied margins from the teardown comes from.
What I think is going on here is that there are manufacturing costs -- costs that directly impact gross profit margin -- that the third-party estimates miss.
For example, one cost that doesn't seem to be accounted for is yield loss, which refers to components or phones that just don't make it to sale. Even if the costs for each component listed in this report are correct, the reality is that the assembly process for these phones isn't perfect.
Image source: Apple.
For example, there will be finished phones that ultimately don't pass muster (even if all the components that went into it were perfectly good), or there will be completed logic boards that ultimately prove defective. Apple may be able to salvage some of the components or materials in such cases, but mistakes in subsystem and overall device assembly could lead to parts getting tossed out, increasing the effective costs of the salable devices.
Beyond that, there are numerous intellectual property licensing costs associated with selling cellular-capable devices. In fact, Apple is currently in a bitter legal battle with Qualcomm (QCOM 2.55%) -- one of the companies that cellular device makers like Apple are legally obligated to pay per-device royalties to -- because Apple thinks it's paying Qualcomm too much.
Qualcomm isn't the only company that asks for a cut of the selling prices of cellular-capable devices, either, though Qualcomm charges the most (by far).
There's more. Apple's devices don't just wind up at Apple stores, carrier stores, and on customers' doorsteps by themselves. Apple's contract manufacturers need to ship these devices worldwide, and shipping is far from free. Apple itself offers free two-day shipping on items sold through the Apple online store. The customer doesn't explicitly pay for shipping, but Apple does, which further impacts the amount of gross profit Apple sees from each device sale.
There's simply a lot of costs that these component cost estimates miss, which I think is why those estimates seem to imply wildly higher gross profit margins for Apple than what Apple's financials suggest.
