Beware thin margins for smart devices

Before you and your partners launch a new company to compete with the iPad, iPhone, Nexus One, Droid, or similar smart  networked devices, be sure you understand the cost structure underlying this marketplace. Margins appear to be slim today and promise to be slimmer tomorrow.

Companies keep these figures secret, very secret, declining thereby to provide a road map for competitors. Thus a small industry has developed, teardowns, whereby specialized firms rip devices apart, analyze their design, identify their components, and calculate how much they cost to manufacture.

Last week The Economist published the parts cost for four well known phones.

Note that the iPhone 3GS with 16MB of memory has a parts cost of $170.07 and an assembly cost of $6.60. Neither ATT nor Apple quotes online a price for the phone without a wireless plan, but while I was writing this post a 3GS with 16MB sold on eBay for $550. ATT sells the same phone for $199, but requires a two-year service contract.

Like all chip-based devices, component prices, particularly memory, tend to fall in accordance with Moore’s Law. Components for the original iPhone cost $218, a full 28% higher than today. Absent competition, falling prices would mean larger margins, but smart phone competition this year should be fierce.

A better target might be the iPad. Until one of the teardown companies acquires and analyses a production model, we will just have to guess at cost. Based on the figures above, the parts cost of current iPhone is about 30 per cent of list price. Assuming the same for the iPad, a $499 model would have a parts cost of $150.

Still want to compete? Do what David Dell did for PCs and discover a dramatically more efficient sales and distribution channel.

Today’s Economist (9/30) calls the new device “The book of Jobs” and predicts great competition from many sources.”Different industries are already converging on this market: mobile-phone makers are launching small laptops, known as netbooks, and computer makers are moving into smart-phones. Newcomers such as Google, which is moving into mobile phones and laptops, and Amazon, with the Kindle, are also entering the fray: Amazon has just announced plans for an iPhone-style ‘app store’ for the Kindle, which will enable it to be more than just an e-reader.”

The soft spot for entrepreneurs: apps and content, where there are already multitudes of competitors, none yet dominant. And if you use a spell checker, add “iPad” to your dictionary.