Apple: Strategy Behind Retailers Discounting Apple Watch And iPad

Using a smartphone to calculate data

By Neil Cybart :

One noticeable trend evolving over the past few weeks in the U.S. has been significant sales on Apple ( AAPL ) products at some of the country's largest brick-and-mortar retailers. Best Buy ( BBY ) and Target ( TGT ) have offered sales on Apple products in the past, but this year feels different. While some have looked at these promotions, as signs of waning Apple product demand and a directive by Apple to push excess supply through the distribution channel, the reality is much different. Retailers are positioning Apple Watch and iPad as the top gifts of the year, betting discounts for those two products will drive foot traffic into stores and page views to online stores. The end goal for retailers offering Apple Watch and iPad discounts is to generate the needed buzz and revenue to better compete with one of the best-performing retailers: Amazon ( AMZN ).

Retailers Are Having a Difficult Year

Traditional brick-and-mortar retailers have now been embroiled in a tough fight against online retailers for years. The sheer competitiveness found throughout the retail segment is now turning traditional retailers against each other. The single-most important development for the retail landscape has been the smartphone and the exploding phenomenon of "showrooming." Consumers, armed with their smartphones, and in some cases tablets, head out to malls and shopping centers with the goal of trying on or testing products only to then use their smartphones to compare prices across various stores. This process often occurs right in the store and has become quite noticeable in data trends released by mobile app analytics companies. Showrooming is especially common for electronics and other big-ticket items available at a number of different retailers.

To make this year especially difficult for many U.S. retailers, weather patterns have led to unseasonably warm conditions through mid-December, especially in the U.S. Northeast. As a result, apparel sales, traditionally a key component of fourth quarter sales, have been hit hard. When looking at year-to-date sales trends, it quickly becomes clear that 2015 has been a difficult year for most traditional retailers. When comparing their revenue growth trends to those of Amazon, the mediocre results quickly stand out.

U.S. Retailer Revenue Growth (year-to-date)

New Retail Strategies and Tactics

Traditional retailers have begun to adapt to the new normal. Best Buy has embraced a number of new strategies to compete against Amazon and other e-commerce retailers. Phrases like "price matching" have become engrained in many consumers' minds. Instead of fighting against showrooming, price matching is all about brick-and-mortar retailers placing foot traffic and online page views above increased margins and profits. Instead of losing a sale to a different retailer online, retailers are willing to lose a bit of profit in order to keep that customer.

The best retailers have gone even further and begun to turn their physical stores into something more than just a location for showrooming. Best Buy has doubled down on the concept of stores within stores, including 500 mini Apple stores. In addition, customer service, like the Geek Squad, has been positioned as a much bigger reason to venture to a Best Buy store. The long-term strategy behind such a plan would be to make up lost margin related to price matching with high margin service items such as extended warranties and repair jobs.

Niche retailers, like outdoor lifestyle retailers Cabela's ( CAB ) and Bass Pro Shops, have been able to turn brick-and-mortar stores into a type of attraction or amusement where families can literally spend the day. Despite all of these various strategies, all retailers share the same goal: occupying customers' attention and dollars. This is where doorbuster sales and various other high-profile sales on Apple products enter the conversation as such sales are meant to grab buzz and interest.

December Retail Observations

A few trends become apparent when looking at these recent Apple product sales at brick-and-mortar retailers.

Apple Watch is positioned as a tech gift of the year. Looking at the tech landscape and the best-selling new devices in recent months, 2015 has been the year of the wrist wearables. Accordingly, Fitbit (FIT) and Apple are the two leaders of the very young market , taking an 82% adjusted market share. However, for retailers craving buzz, store traffic, and a revenue boost, Fitbit just does not compare with Apple Watch. Not only were Fitbit wearables available in 2014, but they cost approximately a third to a fourth the price of an Apple Watch. In addition, Fitbit does not offer much exclusivity as the devices are available in many retail locations. Meanwhile, this is the first holiday gifting season for Apple Watch, with the product remaining quite exclusive in terms of retailer availability (Best Buy, Target, Wal-Mart (WMT), and mobile carriers). The end result is retailers positioning Apple Watch as tech gift of the year.

Best Buy's Apple Watch sale includes $100 off all models, including both Sport and Watch collections. Meanwhile, Target's Apple Watch Sale includes $100 Target gift cards with the purchase of any Apple Watch.

While Apple Watch remains polarizing within tech circles, the
general population has shown to be much more receptive to the
product, preferring its simplicity and ability to perform a few
tasks, including receiving notifications. If going strictly by
Apple Watch reviews on Best Buy's website, shown below, people
think very highly of Apple's newest product category.

While Apple Watch remains polarizing within tech circles, the general population has shown to be much more receptive to the product, preferring its simplicity and ability to perform a few tasks, including receiving notifications. If going strictly by Apple Watch reviews on Best Buy's website, shown below, people think very highly of Apple's newest product category.

iPad is still one of the top tech sellers. Even though the iPad has suffered from slowing sales momentum in recent years, the device is still a very good seller in absolute terms, especially during the holiday season. In addition, the distribution dynamic seen with the product ends up giving brick and mortar retailers an outsized share of sales compared to products like the iPhone sold at mobile carriers. The end result is the iPad makes one of the most popular gifts, especially for children and teens. It is in retailers' best interest to have sales on iPads to appeal to customers and drive traffic into stores.

Best Buy's iPad sale includes $100 or $125 off all models, except for iPad Pro. Meanwhile, Target's iPad sale includes $50 or $80 Target gift cards with the purchase of select iPad models.

No sales uniformity. Even though more than one retailer is having sizable discounts on Apple Watch and iPad, each retailer has slightly different promotions. Other retailers, like Wal-Mart, don't have any Apple product sales. This tells me that these promotions are not necessarily directed by a third party, but rather settled upon by each individual retailer.

What about other tech products? Other than Apple Watch and iPad, there are very few tech products that will sell in the same ballpark in terms of quantity and revenue. The only exception would be Fitbit, which unveiled a very extensive marketing campaign for its range of wearables with the company expecting to sell upwards of eight millions device this current quarter. While Microsoft was able to generate some much needed buzz with the Surface line of tablets, sales are still quite a bit lower than iPad-like revenues. Meanwhile, Amazon Kindles lack the growth and excitement of previous years.

The Strategy Behind Big Apple Sales

Best Buy and Target are discounting Apple Watches and iPads because they are confident those two products will be able to garner interest and buzz to generate increased foot traffic and page views. Only 2% of Target's sales originate from its website, with Best Buy seeing a bit larger percentage (10%). Accordingly, it is conceivable that these Apple product sales will drive traffic to stores. Given the competitive trends, being able to get a consumer to a store is becoming more difficult and expensive. Once in a store, Target can then do its job and sell additional product. It is a version of the milk and bread strategy where grocers place the milk and bread in the back corner of the store in order to get you to walk through all of the other aisles and items.

Retailers have long relied on this strategy to boost revenues, but it has taken on greater importance in recent years as competition intensifies. Electronics retailing in the hundreds of dollars represent the keystone of this strategy, especially in the November and December timeframe as people are willing to spend hundreds of dollars buying gifts for loved ones in addition to splurging on gifts for themselves.

Apple's Involvement with Sales

Similar to any consumer goods company, Apple has working relationships with its third-party retail partners. Unfortunately, when it comes to analysis, these relationships are cast in mystery as the details surrounding contracts are confidential. In addition, the information found in these contracts is often not known by many people and is rather bland, limiting the odds of leaks reaching the press since there is little interest in such details. Traditionally, companies compensate third-party retailers for selling their product by offering lower wholesale prices with a varying degree of built-in margin available to the retailer. This margin is dependent on a number of factors, including the amount of power each party holds in the relationship. Wal-Mart, for example, is well known for its ruthlessness when it comes to its suppliers, demanding low prices in return for significant purchase orders. There are also stipulations where companies can dictate how low a retailer can sell a product for with various incentives in place to have retailers follow such clauses.

When it comes to Apple's direct involvement with these Apple Watch and iPad sales at Best Buy and Target, the most likely scenario is that Apple is aware of and has signed off on such sales although much of the financial impact is carried by the third-party retailer. Why does Apple allow massive discounts on its products? Temporary discounts during peak shopping seasons of the year have little to no long-term negative consequences on branding. In fact, by embracing third-party sales while maintaining its own "no discount" policy at Apple Retail, Apple is further able to maintain its brand image. If Apple was providing significant kickbacks or compensation to these third-party retailers, such trends would appear in financial trends through the average selling price ((ASP)). This explains why Fitbit's ASP is well below the actual retail sales prices of its products. Fitbit provides retailers much better margins than compared to Apple.

Financial Implications

From Apple's perspective, what may end up being the most valuable long-term financial takeaway from these Apple product sales is increased brand relevance for Apple Watch. Apple has sold seven million Apple Watches to date, and I currently estimate Apple will sell another five million Apple Watches during the current quarter. This would suggest that Target and Best Buy have the potential to move upwards of one million Apple Watches this quarter, or $400-$500 million of Apple Watch revenue. This is not a trivial amount for Target and Best Buy and would certainly help offset weakness in other areas such as winter apparel. A very successful holiday quarter will help cap off a successful launch calendar year for Apple Watch with unit sales nearing 11 million. The product category would be well positioned for Apple Watch 2 in the first half of 2016.

For iPad, the iPad mini experiences strong sales each fourth quarter followed by a steady and dramatic drop-off in sales in subsequent quarters. I estimate Apple selling 17 million iPads during the current quarter which means Target and Best Buy could sell up to three or four million iPads, or another $1.3 to $1.7 billion dollars. Combining Apple Watch and iPad sales, these Best Buy and Target sales are likely worth at least $1.5 billion of revenue. When considering the additional product sales resulting from customers visiting stores in search of these Apple products, Best Buy and Target will likely bring in more than $2 billion of revenue this quarter related to Apple promotions. In the competitive retail landscape, discounting Apple products ends up being a worthwhile bet.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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