Pricing a Tablet

Like many other people in the tech industry, I rushed out to pick up an HP Touchpad when the price dropped to $99 and, having played with it for a few days, I can say that it is a very enjoyable device. This led me to the question of tablet computer pricing.

The tablet market

Today, the clear leader in the tablet market is Apple, with its iPad. According to a study by iSuppli, the device costs Apple between $230 and $346 (depending on configuration) to manufacture and is sold between $499 and $829.

Meanwhile, HP came out with its touchpad and, thanks to another isuppli study, we learned that it costs between $306 and $328 (depending on configuration) to manufacture it. Currently, the company has put those device in fire-sale mode, retailing them for $99 and $149, leading many to highlight that the company is losing large amounts of money.

Comparing the two, based on roughly the same feature sets, we get the following (for the sake of comparison, I used the non-3G version of the iPad since HP has only sold WiFi enabled tablets and doesn’t have a 3G product out):

Apple HP
Model  16Gb  32Gb 16Gb 32Gb
 Materials cost  $219.35 $248.85 $296.15 $318.15
 Manufacturing cost  $10 $10 $10 $10
Total production cost  $229.35 $258.85 $306.15 $328.15
Retail Price  $499 $599  $99  $149
Profit (Loss)  $269.65  $340.15  ($207.15)  ($179.15)
Profit Margin  117.57%  131.41%  (32.33%)  (45.40%)

Looking at this chart, it is clear that Apple is substantially more efficient in its supply chain, being able to build a tablet for about a third less than HP. But what also becomes clear is that the Cupertino company has been pricing the device to maximize profit and there seems to be a lot of room for selling tablets at a lower price without losing one’s shirt.

But how much would people be willing to pay?

Listening to the market

One of the most fascinating things I’ve noticed recently is that the price of ebay auctions, on most goods, tends to be relatively consistent as the auction comes closer to its conclusion. Take any given good and you will find that there is relatively little difference in the bids on several auctions for the same thing ending within minutes of each other.

Another interesting artifact is that the price of a second hand device on craigslist tends to be close to the price of the same device at the end of an ebay auction.

Those two facts seem to point to a natural equilibrium when it comes to pricing goods, where a majority of sellers and buyers cluster around a price point that seems to be what the market is agreeing to as a price point.

Apple HP
Model 16Gb 32Gb 16Gb 32Gb
Ebay Average Price  $475-$525  $550-$575  $180-$250  $260-$300
Craigslist Average Price  $440-$520  $550-$650  $200-$250  $250-$290
Market Price  $490 $581 $220 $275
Market Premium (Discount)  ($9) ($18) $121  $126

On its face, it’s interesting to see that iPad2, as a product, does not seem to loose much value on the resell market, with second-hand versions reselling for roughly the same price as the retail one.

However, there is an interesting phenomenon here with the HP Touchpad selling for over $100 more in the after-market than the suggested retail price. While this is partly due to scarcity, it is interesting to see that the price ceiling has actually sustained itself for the last couple of weeks, even as more supply has been made available.

The evidence seems to point to customers being interested in buying a 16Gb tablet for between $200 and $250 and paying up to $50 more for double the space. The challenge still remains that HP actually would continue losing money at those price points.

16Gb 32Gb
Production Cost  $306 $328
Low end price  $200 $250
High end price  $250  $300
Lost on low end price  $106  $78
Loss on high end price  $56  $28

Looking at this, however, it seems the losses could get lower if HP priced the market closer to what the market currently seems to dictate. However, a loss is a loss and there would still be question as to how the company could actually make this a success.

Options for HP

Based on the above data, it looks like there could be a chance for HP to attack the marketplace and make WebOS the second most popular operating system in the tablet space, succeeding in establishing WebOS as an alternative to iOS and potentially besting Android in that arena. To do so, the company could look at a number of different approaches to subsidize the difference in price.

One of the first things HP might want to look at is the lifetime value of a customer. Is there a way they could recoup the $28 or $56 they are losing on that customers.

Could they, through the sales of apps, make that money back? Assuming a 30% cut, as most people seem to take these days, it would mean that they would need to sell $96 (for the 32Gb) or $186 (for the 16Gb) worth of app. Assuming apps are selling for $3 per app (which a cursory look at the recommended apps seem to point to as an average price point), they would need to sell an average of 32 apps per 32Gb Touchpad sold or 62 apps per 16Gb tablet sold.

What about movies? A downloadable app on the Touchpad is called the HP movie store. It appears movies rent for $3.99 and sell for $20. Assuming the same 30% split, they would make $6 on every movie sold or $1.20 on every movie rented. To recoup their cost, they would need to either sell 10 movies per 16Gb tablet or 5 movies for the 32Gb model. Alternately, they would need to rent 47 movies for the 16Gb model or 24 on the 32Gb one.

Assuming a two year life on the devices and its associated customers, it seems that recovery of cost could be realized.

But let’s not forget some of the other (potentially more lucrative options). As a successful alternative to iOS, the company could develop an ecosystem of components (keyboards, cases, etc…) that work with the device. They could charge a small fee for certification as “Made for HP Touchpad” and receive revenue from that source. Furthermore, with a strong position in the market for their offering, they could then potentially license out the operating system itself (as more and more devices enter the market, the chances that more developers will be attracted to the platform increase), generating enough revenue to more than subsidize the cost of the initial production run.

Looking at the production costs of Apple’s iPad, it also seems clear that there is much that can be done to optimize the supply chain and manufacturing of the Touchpad. HP could initially target their own internal efforts with a goal to get the Touchpad produced at a rate that was low enough that they could first offer them at cost and eventually make a small profit on the hardware itself.

As a long term play, though, it looks like the main goal of this slew of HP touchpad would be to establish WebOS (and thus HP) as a leader in the tablet market. To do so may allow the company to build some strong margins on OS licensing at some point in the future. However, it would require a willingness to take some short term losses (under 12 months) to establish a strong position in the market in the long term.

Options for tablet manufacturers

It seems the HP touchpad has given the industry an idea of what the market is willing to pay for a tablet not produced by Apple. While it is true that the WebOS operating system is very polished, I think that factored less in people’s interest in the device. The market wants an inexpensive tablet that works relatively decently and they’re willing to spend $250-300 for it.

There are now rumors that Amazon is considering entering the market with its own Android-flavored tablet, priced in that range. To do so, considering the fact that Amazon will generate revenue from alternate sources like the Kindle store, the app store, and streaming movies and TV shows, seems to be a natural evolution and it appears that a pricing strategy that would be the tablet in the sub-$300 range makes sense. If they do so, it will be interesting to see how their offering fares. A failure to take off could translate in trouble for Android as a lower price point Android offering ought to be successful and failure would mean a problem with the OS. If it takes off, Amazon could reignite the tablet market and cut off HP’s chances to establish their operating system as a strong contender in the tablet space.

Because technology costs continuously go down, it is clear that we will see a sub-$250 tablet within the next 24 months from someone other than Apple (Apple has a tendency to price rigidity and may drop some older generation iPad models to the $299 range but I doubt they would go much lower than that). Efficiencies in production and supply lines make that not just a possibility but pretty much a sure thing.

As to who will control the second most popular operating system (assuming Apple retains its lead) in the tablet business, it’s really up to HP to decide how it wants to play. It has a unique opportunity to take that spot right now but the window of opportunity may be closing extremely fast for them.

As a final note, realize that the observations I’m making above are only relating to the tablet market and do not affect the smartphone marketplace at this time: that ship has mostly sailed and it’s a two-player game at this time: iOS and Android.

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