What happens when the iPad outsells the Mac

The iPad, we can all agree by now, has been a hearty addition to Apple's product stable.

Many who closely watch Apple figured sales would be pretty good, but no one predicted Apple would sell a whopping 7.33 million of the touch-screen tablets during the last three months of 2010,as the company announced last week. That's close to doubling the number of Macs the company sold during the same time, a fairly amazing feat when you consider the time both have been on the market. The iPad landed in April, while Apple's been making Macs for more than 25 years.

But even though it sells more iPads, Apple still rakes in more money overall on Macs than the touch-screen tablets: $5.4 billion in revenue on desktops and laptops, $4.6 billion from iPads. But at the rate things are going--and with a second iPad coming out in the next few months--it's not difficult to imagine that very soon Apple will be make more money on iPads than Macs.

Now here's a pesky question: Is that a good thing for Apple if iPad sales somehow eat into Mac sales?

For your average consumer electronics hardware company, this situation could be fairly unnerving. That's because the Mac, like many higher-end PC competitors, is a much more profitable product than the iPad. Apple keeps more of the overall price they charge on a Mac ($999 and up) than they do on an iPad right now ($499 to $829).

Piper Jaffray analyst Gene Munster estimates that Apple gets a 25 percent gross margin on an iPad compared to a 40 percent gross margin on a Mac. (That is to say, the difference between what Apple charges for a device and what it costs them to actually make it, divided by how much they charge for it.) It's not a perfect calculation for showing profit on a product, because it doesn't account for hidden costs beyond hardware--like research and development, marketing, overhead, and more. But it's a good indication of how profitable a device is.

Investors and financial analysts can get a little nervous when this happens to a company they're interested in too. Especially when the function of the less profitable product, like an iPad, can mimic some of the same functions (e-mail, Web browsing, checking Twitter, Facebook, and so on) of the far more profitable product, a MacBook. It inspires questions of how much the iPad is "cannibalizing" the Mac--or are people buying an iPad instead of a Mac because it has close enough features to what they want.

But that's what sets the folks in Cupertino apart from your average device maker. Apple isn't just a hardware company. And the iPad (and iPhone and iPod) have been designed to bring in even more revenue in a way the Mac, for now, does not.

"The iPad is not just a product that Apple makes and throws out there in the market. It's a platform," said Michael Cusumano, professor of management and engineering systems at the Massachusetts Institute of Technology's Sloan School of Management. "So there's alternative ways of making money."

That alternative being iTunes. And of course, that very popular App Store, the iBooks Store, and potentially newspaper and magazine subscriptions, whenever that eventually gets off the ground.

And on digital content like you find in iTunes, the margins "are extremely high," noted Cusumano. "Because these are pure digital goods. So you can't just look at the gross margin of the product to understand the whole business model that Apple has gotten itself into."

So while the Mac might make the company more money per unit, it can't be counted on for customers to spend as much on other items the way the iPad can. The Mac has iTunes, of course, but doesn't inspire multiple app purchases and e-books the way the iPad and iPhone do. Or at least not yet.

The Mac App Store, introduced several weeks ago, is clearly designed to do the same thing: be a platform for Mac users to spend more money on digital goods.

Not losing sleep
While financial analysts may be concerned about what happens if people buy an iPad instead of a Mac, Apple is apparently not. In response to questions from analysts during its earnings call this week, Apple COO and acting CEO Tim Cook insisted he's not "spending one minute thinking about cannibalization."

It's something many PC makers that are also producing full-size media tablets may have to worry about. According to Mika Katagawa at Gartner, as much as 10 percent of the PC market "will be eaten up by the media tablet" by 2014.

While they won't overtake traditional PCs completely, they will sell well, she says. Tablets made by other manufacturers may not come with a complementary digital platform that drives content sales the way the iPad does. Sure, some tablets will have the Android Market, but those profits go to Google and developers.

Further, Cook says he's counting on the iPad (and the iPhone) having the same effect that the early iPod did on Mac sales: it drove them up. People who probably had never used a Mac went into an Apple Store to buy an iPod and gave a Mac a spin.

iTunes is the key
But how long can Apple keep up high margins on products that slowly get commoditized is a valid question. As time goes on, the margins on selling hardware itself are going to get lower and lower, and competitors will be able to cheaply reproduce similar stuff--see MacBook Pro lookalikes from HP and Dell, or almost any MP3 player today.

It's possible that iTunes and its associated content stores will be where Apple makes a very significant chunk of its money someday, at least according to MIT professor Cusumano, who researched the issue for his book. iTunes brought in $1.1 billion last quarter. It's sold 10 billion apps so far, and the Mac App Store is just getting started. That number is only going to rise, and it's conceivable that someday Apple could change tactics on hardware, argues Cusumano.

"In many cases, they may end up giving away these devices and making all their money in iTunes," he said.

It's possible, of course, but not everyone agrees, particularly because hardware and its design at Apple is very resource-intensive--lots of time and energy is placed on producing hardware of a certain quality.

Arvind Bhambri, who teaches competitive strategy at USC's Marshall School of Business, thinks tightly integrated hardware and software is always gong to be Apple's plan for growth because it's what sets the company apart.

"Because it's their hardware that's driving a lot of their software revenues. It's a very symbiotic relationship," he said. "It's having one of the richest application platforms that makes their hardware attractive. And attractively designed hardware is what brings people to their App Store to start with."

Apple's increasing reliance on the iPad, in other words, shouldn't be a cause for concern. The iPhone, after all, has been its most popular and profitable product for several years. What it does symbolize is just how prescient it was four years ago to drop "Computer" from Apple Inc.

Correction 6:32 a.m. PT: This story initially erred on revenue figures for Macs and iPads. For the quarter ended December 25, 2010, Apple recorded $5.4 billion in revenue from Mac desktops and laptops, and $4.6 billion from iPads.