Who's Xoom-ing who? Why don't new tablets match Apple's price?

So tablets are the hottest thing in tech right now. Apple has just announced the second coming of the iPad while every other tech firm is trying to get in on the game. The recurring theme in reviews of these tables is that in comparison to the iPad, they seem pricey. It’s a weird world when Apple seems like a bargain.

One possibility is that competitors simply put more into their tablets. A recent Wall Street Journal article reported on a tear down comparing the Motorola Xoom with the most comparable iPad (‘Xooming’ In: Researchers Say Cameras, Display Add to Costs of Motorola Xoom, Mar 1). Here are the findings in graphical form:

And here’s a discussion of what they mean:

So the Xoom (by the way, doesn’t Xoom sound a lot like Zune? who thought that was a good idea?) is a little more expensive in terms of components. As the Journal notes, Motorola claims not to be aiming for the current iPad but the new one. Thus this gap may close some when Apple adds cameras and faster processors. But Apple still plans to charge just under $500 for its base model while the Xoom is basically $800. What gives?

An article on TechRepublic (The one big reason why iPad rivals can’t compete on price, Feb 18) provides an interesting answer: The Apple Store.

More specifically, the combination of Apple’s 300+ retail stores and its online Apple Store means that the company sells a huge chunk of its iPads directly to its customers. While Apple has cut distribution deals with Best Buy, Target, Wal-Mart, Amazon, and a few others, those are mostly market-share grabs and ways to help spread the iPad’s marketing message.

Apple appears to carefully control the inventory it sends to these retail partners. Even during the holidays, there weren’t typically huge stacks of iPads on a pallet in the aisle at Best Buy or Wal-Mart like other popular consumer electronics such as the Nintendo Wii or the Xbox 360. The iPads seemed to be sprinkled among the various retailers throughout the holidays. Meanwhile, the Apple retail stores were loaded with an almost unlimited supply of iPads, so if you wanted to make sure you got one your best bet was to go there (or order one from Apple’s Web store). One estimate was that Apple sold 8.8 iPads per hour per retail store on Black Friday.

While Apple hasn’t released statistics on the percentage of iPads that it sells directly to customers versus the number it sells through its retail partners, I wouldn’t be surprised if the number of direct sales was as high as 50%.

That means that Apple can set the retail price of the iPad at a precipitously low number. The company can swallow the bitter pill of hardly making any money from iPad sales through its retail partners because it can feast off the fat profits it makes when customers buy directly through its retail outlets and the Web store. However, companies like Motorola, HP, and Samsung have to make all of their profit by selling their tablets wholesale to retailer partners.

This is an intriguing suggestion although at face value, fairly obvious. However, there is a little more to it. Lot’s of firms sell their own wares on the web in ostensible competition with independent retailers. But it is unusual for the manufacturer to undercut retailers. More often, the manufacturer sells at the suggest retail price while retailers are free to charge less. The retailers then get the majority of sales and the manufacturer has to make sure they stay happy and remain willing to carry the product. Not so Apple. It’s not that Apple is undercutting retailers. Rather the unusual point is that they are taking the majority of sale so the likes of Best Buy are an afterthought when it comes to iPad sales.

This relates to work on supply chain contracting and particular to a phenomenon called “double marginalization.” (I basically owe my academic career to this stuff.) The usual story is that decentralized supply chains with multiple profit maximizing firms are less efficient than integrated ones with a single decision maker. Basically, the decentralized firms take actions without realizing how their actions distort those of others. Thus a manufacturer sells its goods above its marginal cost which causes the retailer to price too high so the whole supply chain ends up selling too little. The interesting thing is these basic models don’t fit this story. Apple seems to be restricting the supply of iPads to retailers so Apple continues to call the shots and gets the retail price it wants while getting broader distribution.

I can see that Apple gets something out of this deal. If someone lives in, say, Manchester, NH, without a local Apple Store, they can see iPads first hand at a local retailer. If that is what they need to be convinced to buy the product, Apple gains a sale without having to build out its network. What I don’t necessarily see is what Best Buy and the like get out of this. They have fixed costs to taking a product (e.g., training staff) but are never going to have huge sales for these products. Yes, more traffic is always good and they make a little more on add on products like cases and such. Still that doesn’t seem like a great business.