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Unpeeling Apple's Nano

By Arik Hesseldahl Rumors swirled for weeks that Apple Computer CEO Steve Jobs had a product up his sleeve that would upstage the long-awaited ROKR music-playing phone. The speculation was confirmed on Sept. 7, when Apple (AAPL) unveiled with fanfare the iPod Nano. The ultra-thin digital music player has been met with mostly rave reviews, and it stole the limelight from the ROKR, developed with Motorola (MOT) (see BW, 9/19/05, "Apple's Phone Isn't Ringing Any Chimes").

Now that the Nano is on the market, attention has turned to more practical questions. Among them: How fat are Apple's margins on it?

Market research firm iSuppli set out to satisfy the curiosity by buying the $199 2-gigabyte version of the Nano and tearing it apart. The verdict? It costs Apple $90.18 in materials to build the unit and $8 to assemble it, leaving a profit margin before marketing and distribution costs of about 50%. That's consistent with the margins on earlier iPod versions and serves as a reminder of what a profit machine the iPod family of products has become for Apple since it was introduced in 2001.

Margins on the computer-maker's other products tend to be slimmer. An iSuppli teardown of the Mac Mini found the cost of material and manufacturing on that computer to be about $283, leaving a gross margin of 44% before marketing and distribution costs.

WINNERS AND LOSERS. "Historically, Steve [Jobs] won't accept anything less than 20% gross margin on any product," says Creative Strategies analyst Tim Bajarin. "In the rare cases when the gross margins have dropped below that, it has been a fluke." Apple has sold some 16 million iPods in the first nine months of fiscal 2005, and 21 million since its inception. Thus far in fiscal 2005, the iPod has brought in $2.6 billion in revenue, accounting for about 25% of Apple's total.

Another set of questions answered by iSupply's exercise: Who supplies Nano's components -- and who got cut out of the pie? The analysis found San Jose (Calif.)-based Cypress Semiconductor (CY) to be a big winner, at the expense of Synaptics (SYNA). Synaptics specializes in touch-sensitive technology that forms the basis of the click wheel used to navigate between songs on previous iPods.

But Santa Clara (Calif.)-based Synaptics lost out to an Apple-designed click wheel that has contains a 55-cent chip from Cypress, says iSuppli analyst Chris Crotty. The Cypress chip appears to save Apple about 45 cents on a comparable Synaptics chip, which costs about $1, says David Carey, president of Portelligent, a research firm that has analyzed other iPod models.

CHIP LEADERS. Snagging the chip inside the Nano is important for Cypress, says Crotty. The coup is likely to boost interest in the company's programmable system-on-a-chip family of components that are used widely in products ranging from lamps to exercise equipment, he notes.

The Nano also marks the return of longtime iPod audio-chip supplier PortalPlayer (PLAY) in Santa Clara, Calif., which has supplied the audio chips for most of Apple's iPods over the years but missed out on the iPod Shuffle, released in January. For that product Apple used a chip from SigmaTel (SGTL), based in Austin, Tex.

Crotty says SigmaTel's chips have often been the favorite of companies building MP3 players that store music on flash memory chips, which consume less power, while PortalPlayer has been favored by companies whose players use hard drives. Before the Shuffle and Nano, all iPods used hard drives for storage, so PortalPlayer was a natural fit.

MEMORY HOG. Now, Apple's decision to use PortalPlayer for the Nano shows it's making inroads with customers whose devices rely on flash memory. "PortalPlayer ruled with hard-drive players, and Sigmatel ruled flash players," Crotty says. "Now, we're seeing them invade each other's turf."

Apple's choice of memory supplier is making perhaps the biggest waves. Having tied up 40% of the so-called NAND flash memory output of South Korean chipmaker Samsung (see BW Online, 8/26/05, "A Memorable Deal for Apple and Samsung?"), Crotty estimates that Apple is paying $54 for 2 gigabytes worth of memory. That would cost any other manufacturer $90, giving Apple a discount of about 40%.

The arrangement not only makes it tough for other manufacturers to compete on price but will also cause them huge supply headaches, since Samsung is the world's biggest flash memory vendor. "How do you compete if you can't get the memory you need?" Crotty says. "And even if you can get it, you're not able to sell the volume needed to negotiate a better price."

NARROWING THE FIELD. Giving Apple a break -- and in the process squeezing other MP3 player manufacturers -- also benefits Samsung's own MP3 player business, Crotty says. "The market is heading toward consolidation, with its own big three, Apple, Samsung, and Sony," he says.

As of 2004, the top three manufacturers of flash-based players were iRiver, Creative Technologies (CREAF) and Samsung, according to IDC analyst Susan Kevorkian, with Sony (SNE) lagging far behind the pack. Other companies in the business include Dell (DELL) and Matsushita (MC), which sells players under its Panasonic brand. Still, some are feeling heat. D&M Holdings, owner of the Rio brand, recently announced it was getting out of the business.

All in all, it looks like the Nano may have extended the iPod's reign -- and given a major boon to select suppliers.

Hessaldahl is a reporter for BusinessWeek Online in New York

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