Will the iPad Mini Be Bad Business for Apple?

Now that it’s almost certain that Apple (NASDAQ:AAPL) is showing off its much-rumored and much-discussed iPad Mini to the world next week, one of the biggest questions left to be answered is about the device’s price range. Where on the pricing chart will Apple fit in its bigger-than-the-iPod and scantier-than-the-iPad product? And though one of the reasons the company was said to have conceptualized the Mini was to take on the increasing rivalry in the tablet market from Google (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN) , can Apple dare to go as low as its competitors?

Amazon admitted recently that it was making absolutely no profit on its tablet line, which starts at $199 for the Kindle Fire HD. Google has also said that its $199 Nexus 7 is being sold at a cost and has no profit margin. That is not easy to do, as Microsoft (NASDAQ:MSFT) proved this week by announcing that its Surface will start at a high $499. And it is absolutely no secret that when it comes to margins, Apple likes it big. The company spends generously on its coveted products, but it also expects similarly high levels of returns.

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Apple devices are usually believed to generate a healthy profit for the company and details from the recent Apple v. Samsung court case in California, which showed that the iPad had a profit margin of between 23 percent and 32 percent, made it even clearer. Margins on the iPhone are even higher and predicted to average between 49 percent and 58 percent.

The third-generation iPad, which is sold for $499, is said to have a bill of materials of close to $315 for each unit. Even with the smaller 7-.85-inch screen of the Mini and a non-Retina display, as is expected, the cost of manufacturing one unit will not be much less than $300. Pricing the tablet much below that price point will simply force Apple to compromise on its business model.

But if Apple were to take the plunge and get aggressive with the price, analysts are worried that the device will start proving to be a worthy competitor to the full-sized iPad. Piper Jaffray analyst Gene Munster told investors in a note this week that the iPad Mini was likely to have a 20 percent cannibalization rate on regular iPad sales.

“We believe that the smaller iPad could cannibalize one million regular iPad units in December or a rate of cannibalization at 20 percent. For every five million smaller iPads, you lose one million standard iPads,” Munster said.

Although Munster expects the company to sell a total of 25 million iPads in December with five million of those iPad Minis, he shaved off a million from his previous estimate to account for consumers picking the cheaper Apple product. While the Mini may numerically help Apple maintain its very high levels of tablet market dominance, the additional buyers will not bring in as much revenue.

Of course, the solution is simply in balancing the margins. As long as Apple can figure out an optimally high margin for the new device and profits eventually soar, the lost sales will be offset. It is a delicate balancing game that Apple will have to get right.

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