4 things Apple did to transform their gross margins (and you can too)
Listen, you're not Apple.
But the story below is a wild one.
It's a story of how Apple has transformed their gross margins.
And don't miss the lead: you can do it to.
We talk about the four ways they did it and how it can help you.
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4 things Apple did to transform their gross margins (and you can too)
June 29, 2007, when Apple released the iPhone. Today, the iPhone generates 52% of its total revenue. It’s hard to overstate the impact the iPhone had on the business and technology industry.
This transformational product resulted in transformational results from Apple. Revenue was booming and gross margins were good.
In 2006, they had revenue of $19.32 billion. By 2009, they had more than doubled ($42.91 billion). And by 2012 they had grown by 810% ($156.51 billion). That comes out to 135% ANNUAL growth rate!
But then, their Gross Margins started to shrink.
Their Gross Margins, which were steadily over 40%, began to drop. By 2012, they’d dropped all the way to 37.41%.
While still highly profitable, there was a real downward pressure on their profits.
Over the next 8 years, Apple saw a temporary increase on gross margins, then a gradual dip over time. Next thing you know, they’re languishing significantly below the gross margin’s they enjoyed at launch.
Last week we did a gross margin deep dive, so I thought this week we’d follow it up and walk through step-by-step how Apple overcame the negative pressure on gross margins and starting capturing a higher margin that even at launch of the iPhone.
They did four specific things, each of which we’ll discuss:
- Expanded core product offerings
- Reduced the cost of the product
- Added ancillary (high-margin) products
- Introduced a new revenue stream
Let’s dig in.
Expanded core product offerings
For years, Apply only offered one phone. In 2013 they slightly expanded the line, offering an iPhone 5s and 5c. The c had less features and was lower priced.
In 2014, they took a step up and created the “Plus” line. This was a larger screen with slightly better features and cost $100 more than the base model.
This allowed them to capture both the high and low end of the market.
Based on their margin struggles, I’d assume the high-end product also had higher margins.
But margins stayed the same. It was clear it didn’t have the impact they were hoping, likely because those other products weren’t as successful as hoped.
So, they had to do more.
Reduced the cost of the product
Between the 2020 and 2022 annual reports, revenue grew by 14.55% and cost only grew by 10.61%. Unfortunately, most public annual reports don’t break down the specifics behind those numbers, so we can’t say for certain what drive costs to grow at a slower rate than revenue.
But for you, the small business, think in terms of two things:
- Increase prices as cost stays the same
- Drive down cost of product
Driving down costs can come in many different ways. Sometimes it’s seeking out a new supplier, sometimes new (cheaper) materials. Other times it’s volume discounts.
There are almost an endless number of ways to manipulate costs. The swing is so large that it’s unlikely it was just one product or service the change was captured on.
It was likely a significant effort, across many products, vendors, and internal teams.
This highlights that these changes are not easy. They’ll take sacrifice and significant investment. But, when given the attention needed, they can fundamentally change a business.
Added ancillary (high-margin) products
The next phase they entered was the “accessories” phase. In 2015 and 2016, they introduced the Apple Watch and AirPods.
iPhone growth was based on new customers coming into the ecosystem and current customers upgrading devices and around this time the rate of upgrade slowed. These items allowed them to sell more to current customer, increasing the amount of money each customer spent.
This is commonly measured with LTV (lifetime customer value), but because accessories tend to be higher margins, likely created upward pressure on margins.
As we showed last week, if customers who were previously buying accessories elsewhere, start buying from Apple, it could have a substantial impact on margins. In this (fake) scenario, it increased them by almost 30%!
Introduced a new revenue stream
As the phone wars heated up, the pressure to keep the upgrades coming made it harder and harder to capture additional margin on their phones.
So, in 2019 they started offering Apple TV+, a new streaming service positioned to compete with the Netflix of the world.
At the same time they released even more services:
• Apple Arcade • Apple News+ • Apple Card
Apple was entering a new era of services and it had the potential to change their business.
Today, services are almost 20% of total revenue. In the future, this number is likely to be bigger.
After 4 years of flat gross margins, Q1 of 2021 saw gross margins increase by over 1%.
In a business Apple’s size, that represents over $41 million in additional Gross Margins each year.
Since then, Gross Margins have increased another 3.5%!
Gross Margins rose from an average of 38.5% between 2016 to 2020 to 44.14% in 2023.
And that, my friends, is how you transform the business.
In the last 5 years, by increasing margins from 38.5% to 44.13%, they’ve extracted over $50 billion in additional gross profits.
Looking forward
As you look forward, the future is bright.
If Apple’s services continue to grow and COGS continues to improve, by 2026 the overall margins will have increased from 44.13% to 48.11%!
In the most recent quarter, their gross margins were outpacing expectations at 46.2%, which could mean 2026 and beyond will bring gross margins of over 50%.
I cannot speak about the ongoing nature of Apple’s business and I’ll leave that speculation up to the market experts.
All I can say is those Gross Margins and Gross Margin trends are looking pretty, pretty, pretty good.
If you’re a business owner, they put on a masterclass on how to increase your margins and as a result, your profits:
- Control costs of goods
- Create tiered offerings to serve more customers (new iPhone)
- Offer ancillary, higher margin, products (Watch & AirPods)
- Introduce new product or service offerings (Apple TV+)
This aligns well with the 4 drivers from last week:
- Price (increased iPhone price)
- Cost (controlled cost of goods)
- Revenue Mix (introduced new services and ancillary products)
- Operational Efficiencies (hard to know, but likely did this with the Service offering)
And, this chart shows these changes perfectly.
The iPhone and iPad increased revenue and margins at first. But then, despite accessories like the Apple Watch and AirPods, Gross Margins lagged. But then immediately following the introduction of their services, Revenue and Gross Margins rose significantly.
What a beautiful thing!
Hopefully, this breakdown helps you see how it works in the real world.
I’d love to hear: did this give you any ideas for your business? Share them with me! I’d love to hear.
