Dark Matter and iPod
Hal Varian treats us to a paper by Greg Linden, Kenneth L. Kraemer and Jason Dedrick of UC-Irvine, who strive to figure out where the value-added from the iPod is created. Varian notes:
Who makes the Apple iPod Here’s a hint: It is not Apple. The company outsources the entire manufacture of the device to a number of Asian enterprises, among them Asustek, Inventec Appliances and Foxconn. But this list of companies isn’t a satisfactory answer either: They only do final assembly. What about the 451 parts that go into the iPod? Where are they made and by whom?
What is really interesting is that only $144 of the value-added goes to the manufacturers so when you paid $299, $155 of the value-added went either to the distributors who sold the iPods for Apple or to Apple itself for the designer of this device. The authors estimate that about 25% of the retail price was captured by the distributors with Apple getting $80 per iPod:
Based on these values, Apple’s gross profit on those units would be $80, which is 36% of the $224 estimated wholesale price. This $80 profit is greater than the price of any single input, so it is definitely greater than the value added for any of its partners.
The Dark Matter types should love this paper. Others who might find it interesting are transfer pricing geeks as well as accountants.
Update: This iPod accounting got me thinking about that old rule of thumb popularized by Robert Goldscheider. IP Updates explains what it is and where it came from:
Robert Goldscheider arrived at this now-famous calculation in 1959 when one of his clients, Philco Corporation, had about 18 European licensees for its radio and phonograph patents. Goldscheider calculated that Philco’s licensees assumed the major risk of commercializing their products, about 75 percent. That left 25 percent of the risk to licensor Philco, reflected in a 25/75 percent split of pretax profits.
My understanding is that in these particular deals, system profits were about 20% of sales with the royalty rate being about 5% of sales. Many IP economists have criticized the use of this rule of thumb especially for sectors where profit margins were very high. If one thinks about the $80 per iPod that Apple gets as a percentage of either wholesale prices or even retail prices, it exceeds 25% of revenues. The authors of this paper note that much of the value-added for the manufacturers and distributors is likely captured by wages rather than profits. So as a percent of system profits, Apple’s take is much higher than 25%.