iPad Down 20%: Investors Are Focused on the Wrong Thing

By Adam LevyFool.com

Source: Apple.

Another Apple earnings report, another quarter of declining iPad sales. iPad unit sales have declined for seven straight quarters, ever since the beginning of calendar 2014. It's important to note what changed in the market in the year or so leading up to the iPad's decline, so we can assess what exactly is going on and how Apple is doing in responding to the iPad's struggles.

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The biggest factor leading to declining iPad sales, in my opinion, is the increased sales of large-screen smartphones, or phablets. Samsung released its Galaxy Note at the end of 2011 and ushered in the era of phablets. With the option of spending a bit more on a smartphone and receiving the benefits of a small tablet, iPad sales were doomed to suffer. In Apple's most recent quarterly report it noted that iPad sales had decline nearly 20% year-over-year to 9.9 million units.

The rise of phabletsSamsung's first iteration of the Galaxy Note was released four years ago, and it went on to sell 10 million units within a year. By 2013, phablets accounted for 5.6% of global smartphone shipments. In 2014, phablet sales climbed even higher. Sales increased more than threefold, accounting for 14% of total smartphone sales.

While phablets started to take off, sales growth of tablets started to decline. The iPad saw a much more significant decline compared with other tablet makers because of its first-to-market position and premium pricing. As the tablet market slowed down, low-end devices started eating up iPad's market share, too.

The point is, phablets are cannibalizing tablet sales, and the outlook is that phablet sales growth will continue to outpace tablet sales growth for the foreseeable future. That's why Apple released the larger iPhone.

With that in mind, investors shouldn't be comparing iPad sales this year with iPad sales last year. They should include iPhone Plus sales in the comparison to see if Apple's strategy is paying off.

If you can't beat 'em, join 'emTim Cook has noted that 70% of iPhone users still haven't upgraded beyond the iPhone 5s. That leaves around 150 million people using an iPhone 6, iPhone 6s, iPhone 6 Plus, or iPhone 6s Plus. With the smaller models outselling the larger models by an average of 2.5-to-1, that means around 42 million people bought a phablet from Apple last year.

If you add those purchases to fiscal 2015's iPad sales of 55 million, Apple sold around 97 million mobile devices with screens of 5.5 inches or more. Compared with the previous year, when Apple sold 68 million iPads and about 3 million iPhone 6 Pluses in the week of its launch, that's a 37% increase.

It's worth noting, however, that doing the accounting by screen size, the smaller iPhone unit sales were still up about 11% for fiscal 2015.

But cannibalizing the iPad with the iPhone Plus has led to significant revenue growth. The entry-level iPhone Plus costs $750, and the average selling price is probably closer to $800. Comparatively, the average iPad selling price in the fourth quarter was just $432.66. The iPad Mini, which faces the biggest threat for cannibalization, sells for a bit less. So Apple is cannibalizing its own products for almost twice the price.

Apple is taking the same approach with one of its new products, the iPad Pro. It may cannibalize sales of the iPad Air, but it costs $250 to $300 more per unit. Additionally, Apple will sell compulsory accessories for the iPad Pro, including the Smart Keyboard and Apple Pencil, which will further increase the value of selling the Pro over the Air.

Overall, Apple may have entered the phablet market a bit late, but its decision to do so has certainly paid off despite the impact on iPad sales.

The article iPad Down 20%: Investors Are Focused on the Wrong Thing originally appeared on Fool.com.

Adam Levy owns shares of Apple. The Motley Fool owns shares of and recommends 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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