Is the iPad 2 cannibalizing the new iPad’s profits?

In about four weeks, Apple will announce its fiscal 2012 Q3 earnings. Its accountants are busy tallying the numbers, including the number of iPads sold and revenue from the iPad product line. These two numbers hold the key for the longevity of the iPad 2.

Are the days numbered for the $399 iPad 2?

When Apple announced the new iPads in March, it dropped the cost of the lowest-priced iPad 2 (the 16GB Wifi only version) by $100 and continued to sell it side by side with the third-generation iPad. This is not in the usual mold of clearing out previous generation products at a reduced price.

Analysts speculated that Apple kept the iPad 2 around to counter the threat from cheaper tablets, specifically Kindle Fire. Despite being a year old, the iPad 2 is packed with power and features that other tablets do not come close to matching. Offering it at $399 helped bring in new customers who didn’t consider buying it at $499 and snag some who would have bought a Kindle Fire.
It is a win-win for Apple — almost. The $399 price point is also attractive to those who otherwise would have bought the new iPad at higher price points. This is what economists call second degree price discrimination. When offered multiple options at different prices, customers pick the one that gives them the most value (consumer surplus). In the absence of the $399 iPad 2, customers would have picked the pricier new iPad. But when offered side by side, some see higher consumer surplus from the iPad 2 than the new iPad. That is exactly why Apple kept just the 16GB Wifi model of the iPad 2 and not the entire product line.

For every customer who chooses to buy the iPad 2 instead of the new iPad, Apple loses $100-plus in pure profit (the cost difference between the models are marginal). If that total loss turns out to be more than the profit from selling the iPad 2 to new customers, Apple will quickly pull the plug on the iPad 2.
We will not get a breakdown from Apple on the number of iPad 2s and new iPads sold. But we can figure out these numbers by doing simple math on Apple’s earnings statement.  Last quarter, when it had the $399 iPad 2 for only a month, Apple sold about 2.1 million $399 iPad 2 units. That was 18 percent of the total number of iPads sold, which did not increase much from the previous quarter. This translates to just 10 percent of total iPad revenue. The higher the number of iPad 2 units sold, the lower its contribution to revenue.

This is the first full quarter when iPad 2 and the new iPad are sold side by side. Apple would prefer to keep the iPad 2 proportion at 18 percent or lower. If that number goes up, it signals significant erosion of Apple’s iPad profits by its own product.  The worst case scenario is that Apple sells three times as many iPad 2s as the previous quarter without a net increase in total number of iPads sold.
When the earnings report comes in next month, pay close attention to the iPad numbers. If you have been waiting to buy one, you might want to grab one now before they’re gone.
Rags Srinivasan is a management professional who specializes in product strategy and strategic marketing. He is currently working on big data products. He blogs at Iterative Path and tweets at @rags.