Ever since rumors began swirling a few weeks ago that Apple (NASDAQ:AAPL) was planning a move into the car market, a vocal group of Apple bulls have been talking up this supposed new market opportunity. The car rumors helped drive Apple stock to a new all-time high last week.
A few brave souls -- including Business Insider CEO Henry Blodget -- have dared to question the possibility that building cars will be Apple's next huge growth market. They have been promptly shouted down by the Apple bulls. But Apple investors shouldn't count on an Apple Car becoming "the next iPhone", if such a product makes it to market at all.
A tough business
I don't often find myself agreeing with Henry Blodget and his frequent bouts of skepticism about Apple. However, his intervention into the Apple car flights of fancy was quite appropriate.
While bulls threw around numbers like "$40 billion revenue, $20 billion profit" for Apple's car -- without offering any evidence -- Blodget pointed to the financial statements of a variety of major automakers. It should come as no surprise that mass automakers have fairly low margins, but the same is true for luxury automakers.
Blodget points out that even Porsche has a net margin of less than 15%. Porsche is one of the most profitable automakers due to its ultra-luxury focus: it brings in about $100,000 in revenue per vehicle sold. However, because of its high price point, Porsche sells fewer than 200,000 vehicles per year.
Moving a little down-market from Porsche, BMW has struck a nice balance between volume and profit margin. Including both the BMW and Mini brands, the company sells about 2 million vehicles per year at an operating margin of around 10%. BMW is projected to earn about $11 billion for 2014.
Even best-in-class automakers are doing less sales volume than Apple's iPhone -- which surpassed $100 billion in revenue last year and will likely grow 40%-50% in FY15 -- and at significantly lower margins. This implies that building cars isn't likely to produce an iPhone-like profit stream.
But Apple revolutionizes markets!
While no automaker today produces Apple-like earnings, plenty of optimistic Apple bulls think that the company can somehow turn the auto market on its head to drive industry-leading unit volume and profit margin.
One common refrain among this crowd is that nobody thought Apple would build the iPhone into the profit machine it is today. Hedge fund manager and Forbes contributor Eric Jackson claims that Apple will be far more efficient than today's automakers and thereby earn higher margins.
Let's take a closer look at these claims. How did Apple turn the handset business into a $50 billion-plus annual profit stream in less than a decade? Was it by being more efficient than its competitors?
Absolutely not! The iPhone became a massive success story because Apple got people to spend more -- a lot more -- on their phones. Before Apple showed up, the average selling price of mass-market cell phones was in the $100-$200 range. High-end smartphone makers of that era (like BlackBerry) had ASPs around $350. By contrast, Apple has been able to charge $600 or more for the iPhone.
Applying these lessons to the auto industry, Apple would probably need an average selling price of at least $100,000 to produce a car at an iPhone-like 50% profit margin. Even if it were willing to accept a more modest Mac-like margin of 20%, the average price would still need to be upwards of $60,000.
It's extraordinary that Apple convinced hundreds of millions of people to spend hundreds of dollars extra -- perhaps subsidized by a wireless carrier -- to buy an iPhone rather than another handset. But it's still not very plausible that Apple will convince millions of people to pay a $20,000 or $30,000 premium for their next cars.
Apple in the car
At a high level, Apple's competitive advantage revolves around user experience. The strangest thing about the "Apple Car" debate is that so many people think Apple would enter a capital-intensive, low-margin business, when it could play to its strengths by working with existing automakers on user experience add-ons, something it's already doing with CarPlay.
Apple observers might retort that the company likes to create "walled gardens" where it has control over everything from hardware to software. But this isn't such a hard-and-fast rule.
Thus, Apple recently created a connected home platform -- HomeKit -- but it didn't start making its own refrigerators, thermostats, or dimmer switches to go along with it. Apple created HealthKit to provide a unified health experience on iOS, but it didn't start opening its own clinics or hospitals.
By working with existing automakers on CarPlay and other initiatives, Apple can improve the utility of the iPhone and deepen its long-term competitive advantage in the smartphone market. There's no need to chase flights of fancy in the auto market: the iPhone is still the No. 1 key to Apple's future.