Apple’s iPad sales are not so magical after all

Apple’s tablet shipments fell short of expectations -- and it’s likely not going to be the last time.

Apple's iPad Air.
Apple introduced the iPad Air in late 2013. Josh Miller/CNET

Apple's iPad may be losing some of its magic.

The second quarter, ended in March, was a great one for Apple in nearly every respect. The company posted better-than-expected profits, revenue, and margins, and the 43.7 million iPhones it sold outpaced the 38 million anticipated by analysts. Apple reported a 5 percent rise in Mac unit sales at a time when the overall PC market struggled. Apple CEO Tim Cook also boosted the amount of cash returned to shareholders by $30 billion to $130 billion and said the company would split its stock 7-for-1 to attract more investors. Apple's shares jumped 8 percent on the news.

But there was one noticeable red mark on Apple's balance sheet -- iPad sales. Apple sold 16.4 million iPads in its fiscal second quarter, less than the 19 million expected by analysts and the 19.5 million it sold in the year-earlier period. The iPad is Apple's second biggest money maker after the iPhone and accounts for about about a fifth of sales.

Most tablet makers would be thrilled with those kinds of sales, but it's not enough for Apple, the company that revolutionized the category and set off a frenzy of me-too products. When the iPad was introduced in 2010, then CEO Steve Jobs called it a "magical" device, and it lived up to that name, essentially inventing the market for tablets.

But the magic isn't as strong as it once was. iPad sales have been erratic over the past several quarters amid tougher competition and market saturation. Apple posted its biggest period ever in the holiday quarter ended December 28, with sales of 26 million iPads. However, that's one of only two quarters (out of the past five) that iPad demand rose. Shipments of the tablet, including the larger-screen iPad and the iPad mini, have averaged a quarterly decline of 4 percent year-over-year since the June 2013 quarter, Piper Jaffray analyst Gene Munster noted. It's clear that the blockbuster days of 50-percent-plus growth are over, but what's troubling is whether growth will cease all together.

"The iPad business is somewhat questionable right now," said Brian Marshall, an analyst with ISI Group. "It grew slower than the Mac business, and that's not the kind of trend you want to see."

Cook, speaking to analysts on the earnings call this week, attributed the shortfall to changes in the number of devices held in channel inventory (which means it's either sitting in stores or on trucks) and said Apple met its internal estimates for iPad sales. He added that Apple has sold more than 210 million iPads since launching the first model and that the availability of Microsoft Office on the iPad should help boost sales.

And Cook said high customer satisfaction levels, high numbers of people planning to buy an iPad, and substantial usage levels among iPad owners make him confident in the tablet's prospects.

"When I back up from all of these, I feel great," he said Wednesday during the call. "That doesn't mean that every quarter, every 90 days is going to be a number that everybody is thrilled with. But what it means to me is that the trend over the arc of time that things look very, very good, that iPad has a great future."

But even after adjusting for inventory differences, iPad sales still declined by more than 3 percent. And analysts say that's alarming.

So what's going on? A few things. First, the iPad's replacement cycle is more like a PC than a smartphone. People don't have the two-year upgrade incentive that comes from wireless carriers, and Apple hasn't made big enough changes to the iPad to compel even their most ardent fans to immediately buy the newest model.

It's also much easier for people to pass older iPads to relatives or friends when they upgrade, unlike phones. Most people who crave a tablet likely already have one.

At the same time, Apple is going up against dozens of new, inexpensive devices that run Google's rival Android mobile operating system. Along with Amazon's Kindle Fire, there are many dirt-cheap products created by companies such as British grocery chain Tesco. The grocer sold 400,000 of the £119 Hudl tablet ($200) in the first few months after it hit the market in September.

Android was the OS on 62 percent of the tablets sold in 2013, according to Gartner. Apple, while selling the most tablets of any single vendor, controlled only 36 percent of the market, down from 53 percent in 2012, the tech research firm said.

iPad Mini with Retina Display
Apple updated the iPad Mini with a retina display. Sarah Tew/CNET

Android devices retail for much less than traditional PCs and often cost less even than the iPad, which is priced starting at $299 for the iPad Mini from 2012. The 7-inch, 8GB Kindle Fire HD, by comparison, starts at $139.

Then there's the phablet factor. The large-screen devices, hybrids between smartphones and tablets, are removing the need for people to carry multiple devices, particularly in Asia and other regions where they're most popular.

"That definitely impacts [tablet sales], especially in places like China," said Brian White, an analyst with Cantor Fitzgerald.

If Apple releases an iPhone 6 this year, with a screen that's larger than the current 4-inch iPhone, that could dampen iPad sales. People may find they don't need both devices, or they may wait even longer to buy new iPads.

What can Apple do? For starters, it could add even more functionality -- making the tablet almost on par with a full-blown computer. It's still too difficult to do intensive tasks on an iPad, and people still tend to use tablets more for entertainment than for work.

Many analysts believe the company is working on a larger screen "iPad Pro" for release later this year or next year. That could help attract users of Apple's Macintosh computers. And while Apple has long panned hybrid devices that can convert between tablets and laptops -- Cook two years ago famously compared it to combining a toaster and a refrigerator -- the company may change its mind and create a hybrid of its own.

"Apple needs to offer a converged device," says Sanford Bernstein analyst Toni Sacconaghi. That would be a "larger iPad screen with greater peripheral integration, that would allow Apple to capture a greater share of the [approximate] 300 million PCs sold annually."

None of this means the iPad is kaput. Apple will continue to sell millions of models, and it will continue tweaking the device to make each generation better than the last. But slower iPad sales put even more pressure on Apple and Cook, who celebrates his third anniversary as CEO in August, to release that "next great thing."

 

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