Understanding Apple – iPhone 5, A Note on Supply Constraints
Jaan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
By now, Apple’s (NASDAQ: AAPL) press conference of Sept. 12 is history. And now the speculation is “How many will be sold in the first weekend and by the end off the month?”
In an Apple 2.0 article, a reader comments:
I would like to posit a few points on this.
1 – Every year they DO expand supply. It is just that the demand exceeds even their expectations.
2 – Frequently, the limitations are on not only the capacity to build the product, but also the ability to get supplies. For many supplies, this is just a matter of ordering sufficiently in advance and financially helping the suppliers to increase capacity to meet your demand. But for hot new items of the latest technology, there may be no possibility of increasing supply sufficient to meet your demand. The ability to expand production for complex new items such as hi-res screens, cannot be done overnight. The machines to make them need to be produced, not just adding people to a production line.
3 – and most important...
Additionally, the cost of under-estimating is that customers need to wait. You may lose some customers due to this, or you may gain due to the perceived value of a scarce item. But in the end, it is probably not significant since most people will probably just wait the few days or few weeks.
The cost of over-estimating is very hard. To begin with, you lose that value of having a scarce commodity.
More important, however, is the fact that the cost of producing X million iPhones is affected by how much you increase capacity. That is, if you have capacity for R units per month, then it will cost you more money to expand that capacity to S units per month than it would to just produce at that R capacity. It costs to build facilities and to hire workers. If that new capacity continues to be utilized for a significant amount of time, then these costs become minimal. Certainly, the profits from selling so many more units far outweighs the costs of start up.
If, however, you do not sell out all your added capacity, then the start up costs will basically become added costs to your overall production, production that you would have been able to meet at the old rate. You may even incur costs for shutting down some of this capacity. You have basically wasted your investment in expanding.
4 - finally...
If you grossly overestimate your needed capacity, you will have over-supply and pressure to lower your price. Just look at the HP (NYSE: HPQ) TouchPad . They overestimated demand and had to sell out at $99, just one-fifth the original price. RIM also (NASDAQ: BBRY) saw the perils with their Playbook. from Wikipedia:
Following several months of poor sales RIM started discounting the price of Playbook from its original $499 retail price to $300 at many outlets in late September 2011.
This cuts not only profits, but image as well.
This last two points in particular explains the phenomenon. The cost of not meeting demand is minimal, but the cost of overestimating demand can be much more painful.
==== Understanding Apple series
You may love Apple and their products, or hate them to the core, but you cannot deny that Apple now has the highest market cap of any company, their products are trend setters, and currently they are trading at rather low multiples, especially regarding forward earnings.
Warren Buffet has the maxim: “Invest in what you know!” So, for those who want a unique perspective on Apple’s success, I have a series of articles Understanding Apple. I hope you will find them helpful and provocative.
Let me know what you think.
The Foolish Bottom Line
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Malcolm Manness has a Masters degree in Computer Science, and has worked for 14 years in development, technical publications and software quality assurance. He has been investing for 20 years. Currently, he does writing, and FileMaker Pro programming on contract. His short fiction can be found (under pseudonym J. Seunnasepp) at http://50centflash.com/. He owns shares of Apple.
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