Apple Inc.s Slowing iPad Business Is a Win For Shareholders

Source: Apple.

There's a transformation under way at Apple that you might or might not have noticed. Apple's de-emphasizing the iPad.

The iPad burst onto the scene in 2010 and quickly established itself as Apple's fastest-selling device ever. However, with the increasing size of Apple's iPhone screens, iPad shipments declined 5% in Apple's FY '14 and 18% in Q1 of FY '15.

What's largely absent from the discussion of the slowing iPad sales narrative is that it has been to some extent knowingly engineered by Apple itself. While it might sound counterintuitive at first, Apple investors should be glad that the tech giant is de-emphasizing the iPad. Here's why.

Margins matterThe economics of Apple's iPhone business simply trump those of the iPad, and the margin profiles and replacement cycles of the two respective iDevices loom large here. Let's run through some numbers to illustrate this.

For starters, let's try to find some approximately equal basis for comparison in the features and technology of the iPhone and iPad. Here, I'll use the lowest-cost 16 GB iPhone 6 and the 16 GB iPad Air 2 with cellular and Wi-Fi capability. While this isn't perfect, it should provide the best "apples-to-apples" (pun intended) equivalency to illustrate the devices' different profit profiles.

These numbers would change (mostly increase) as you moved to larger storage sizes of either device, so they won't perfectly reflect the average margin or average selling price but should hopefully still convey my point. Take a look.

Source: Apple and IHS iSuppli.

The least-expensive iPhone 6 produces roughly 40% more gross profit than the comparable-feature iPad. Now, this alone plainly demonstrates the iPhone is a better business from a pure profit perspective. However, when you consider the long-term effects the iPhone and iPad replacement cycles have on Apple's profit over time, the difference becomes even more dramatic.

Replacement cycles accentuate the differenceWhile there's little definitive data on the matter, it's generally agreed that the iPad has a longer upgrade cycle than the iPhone for a few reasons. In regions such as the U.S., wireless carriers commonly help subsidize smartphone upgrades every two years as part of their contract structure.

There's also the simple fact that consumers tend to use smartphones more throughout their daily routines than they do tablets. If there must be a primary device and a secondary device between the two, the smartphone would be the hands-down winner in owner preference.

Consumers carry and use their smartphones much more throughout the day, using them for a wide range of both professional and personal activities. In contrast, tablets tend to remain at home and are used as recreational devices. This makes the iPhone not only the more profitable device, but also the device that is commonly purchased on a more regular interval than the iPad.

Let's look at some numbers.

Since there is no perfect universal data on upgrade cycles, we'll have to rely on some assumptions here as well. Again, I want to be clear that the hard dollars-and-cents figures below aren't the point. The high-level intent is to show how the replacement cycle actually magnifies the profit differences between the iPhone and iPad over the course of, say, a decade. See for yourself.

Source: ISI iSuppli, author's calculations. Period is one decade.

I selected an average three-year life span for the iPhone. In doing so, I tried to balance the likely shorter average age in developed markets, thanks to carrier subsidies, with the lack of this same practice in many developing markets. I used an iPad replacement age of four years to try to place the iPad between the general life spans of smartphones and PCs.

The point here is that, between the iPhone's greater profitability and users' tendency to upgrade their iPhones more frequently, Apple's move to cannibalize the iPad to grow the iPhone ultimately will make much more money for shareholders over time.

Furthermore, this trend is likely to continue. Recently, research firm IDC ratcheted back its estimate for tablet market growth as a whole, specifically predicting iPad shipments would fall roughly 5% in 2015. The purported issues facing Apple's iPad business certainly don't make for encouraging headlines, and it's clear there are both marketwide and Apple-specific reasons for the device's recent decline. However, in knowing that a healthy portion of the slowing demand for Apple's iPads is because more consumers are buying larger iPhones, Apple's strategy is likely to result in greater profits for its investors over the long term.

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Andrew Tonner owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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