Fixed Costs and Apple Case Study

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Apple's cost of production includes both the cost of goods sold and the fixed costs associated with running its operation. The company's business model is that it handles the design and marketing of its products, and then contracts a third party company to produce them, usually in China. Apple maintains a gross margin of 39%, and this up from 37% in 2013, which is a reflection of the company's pricing power in the market as much as anything else. Component costs for Apple's flagship phones have been broken down and one of the trends that stands out is that the larger phones carry with them higher margins. For example, the 7 Plus carries with it $84.50 more in gross profit for the company (Mayo & Mayo, 2017). The components are slightly more expensive, and the company charges significantly more for the device. This perhaps explains the upward creep in the company's gross margins, as larger phones have become increasingly popular in recent years due to the trend towards mobile browsing on phones over conventional browsing on computers.

Operating costs last year were 11.2% of revenues, compared with 8.9% in 2013, indicating an upward shift in operating expenses. The biggest factor there is actually R&D expense. The basic SGA expense for 2016 was 6.5% versus 6.3% in 2013. R&D, however, increased by $5.5 billion, 4.6% of revenues, versus 2.6% of revenue in 2013. This jump in R&D expenses is unrelated to iPhones or other core products, and is actually related to the company's efforts in developing self-driving cars. Apple is funding that effort from its massive cash pile, rather than its ongoing operations. Basically what this means is that the $5.5 billion that has increased the company's fixed costs so significantly relates to a different business entirely (Campbell, 2016), and the income statement has to be viewed with that in mind. The company's fixed costs have actually changed little.

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Fixed costs therefore have little to do with Apple's output decisions. The company makes money like no other, and has no problems paying whatever it costs on the fixed side. There is some evidence that the company takes variable costs into account in its production decisions, however. It makes more money on a large phone than a small phone, so it wants to guide consumers towards the larger phones. To do this, it makes the small phones quite small in terms of memory, discouraging consumers from purchasing them, roughly analogous to super sizing at a fast food restaurant. Apple focuses production and marketing on the larger, more expensive products because those come with the higher margins. It does this in order to maximize shareholder value from each of its products. It knows that if someone is going to buy one phone every three years or so, that it needs to maximize the return it gets on each transaction, and it can do that by producing more of the bigger phones and orienting its marketing towards them.

Apple's Market

The biggest product by far for Apple is the iPhone. In that market, Apple holds a 14.5% share, putting it in second place behind Samsung, which has 20.8% share. Apple's share is gaining, however. The 14.5% figure is for all of 2016, but in Q4 Apple held a 17.8%, good for market lead, largely because of the Note 7 scandal, which severely damaged Samsung's reputation as well as taking one of its major products off the market (Strategy Analytics, 2017). The industry is basically split into high end and low end. High end phones are the norm in developed countries and among wealthy consumers worldwide. In less developed countries, the massive middle classes own cheaper phones. Last year, 44.9% of the market was held by firms outside of the top.....

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