Submitted by Charles Hugh-Smith of OfTwoMinds blog,
The math of netting $1 billion is daunting.
The mainstream financial media nearly wet its collective pants with excitement in reporting that the planet’s corporations paid $1 trillion in dividends in 2013. What they didn’t report is that clearing billions in profit is about to get much harder.
As a refresher, let’s look at what it takes to net $1 billion in net profit.
You sell 10 products or services that each yield $100 million in net profit. There aren’t too many such products or services. Aircraft carriers come to mind, but there are fewer than 40 active-duty carriers in the world. A semiconductor fabrication plant that costs $1+ billion might yield $100 million in net profit for its vendors, but there aren’t many $1+ billion fabs around.
You sell 100 products or services that each yield $10 million in net profit. Examples include large airliners, power plants, etc.
You sell 1,000 products or services that each yield $1 million in net profit.
You sell 10,000 products or services that each yield $100,000 in net profit.
You sell 100,000 products or services that each yield $10,000 in net profit.
You sell 1,000,000 products or services that each yield $1,000 in net profit.
You sell 10,000,000 products or services that each yield $100 in net profit.
You sell 100,000,000 products or services that each yield $10 in net profit.
You sell 1,000,000,000 products or services that each yield $1 in net profit.
Let’s consider a well-known example of a highly profitable company: Apple. Back in the good old days, when Macintosh computers were scarce and highly desirable, Apple famously netted $1,000 per computer in profit. (Please adjust for inflation to dial in the time-frame.)
So Apple had to sell 1 million Macs to net $1 billion.
Margins have dropped considerably as competition increased and the cost of components dropped. Can any company net $1,000 nowadays on a personal computer? It seems unlikely, as technology works to lower costs and increase supply, reducing margins.
Let’s say Apple nets $100 per iPhone and iPad. If so, Apple has to sell 10,000,000 of these devices to net $1 billion.
But since low-cost Android phones and tablets can be had in China for $50 each wholesale, manufacturers without the cache of the Apple brand and features have to sell 100,000,000 such low-cost phones and tablets at $10 net profit each to net $1 billion.
At the consumer-products level, companies selling shampoo, diapers, etc. have to sell 1 billion items that each net $1 to reap $1 billion in net profit.
As the costs of production and the demand both decline, profits plummet along with prices and sales. Apple looks ahead and sees a market for smart phones and tablets that is increasingly saturated in advanced economies (i.e. everyone who wanted one has already bought one, and the market for replacements is not a high-growth scenario) and increasingly competitive in emerging markets (i.e. consumers might desire an Apple product but are unable to afford one, so they buy a $50 device instead).
Thus it is not entirely surprising that Apple is looking far afield for new opportunities to reap high margins and profits: Apple exploring cars, medical devices to reignite growth (S.F. Chronicle, subscription required)
Such a buying spree has ignited fierce speculation in tech circles and on Wall Street about Apple’s future ambitions, especially as smartphone and tablet sales start to slow. Most of that speculation has centered on wearable technology or perhaps a souped-up upgrade of Apple TV.But Apple is thinking bigger. Much bigger.
A source tells The Chronicle that Perica met with Tesla CEO Elon Musk in Cupertino last spring around the same time analysts suggested Apple acquire the electric car giant.
The newspaper has also learned that Apple is heavily exploring medical devices, specifically sensor technology that can help predict heart attacks. Led by Tomlinson Holman, a renowned audio engineer who invented THX and 10.2 surround sound, Apple is exploring ways to predict heart attacks by studying the sound blood makes at it flows through arteries.
Taken together, Apple’s potential forays into automobiles and medical devices, two industries worlds away from consumer electronics, underscore the company’s deep desire to move away from iPhones and iPads and take big risks.
Allow me to state the obvious: Apple is grasping at straws in its search for new ways to net $1 billion. Electric autos are a small but growing market, but Mr. Musk appears to be doing quite well on his own at Tesla and has little incentive to cut anyone else into the deal.
High-cost medical devices depend on the tottering sickcare system for payment, and if the Affordable Care Act (ACA) has indeed provided the final destabilizing push over the cliff, counting on the gummit to pay full price for millions of costly devices/tests may not be a sure bet any more.
The math of netting $1 billion is daunting. You have to sell a million products or services that net $1,000 each to clear $1 billion. Say the battery pack on an electric car costs $12,000 now. It’s certainly possible to net $1,000 on each pack at that price. But you have to sell 1 million packs a year to net $1 billion. Since electric autos are selling in the thousands, not millions, it will be a long time before anyone can sell 1 million battery packs a year.
As the price of batteries declines, it will become more difficult to net $1,000 per pack. By the time the price has declined to the point that someone can sell 1 million packs a year, the net profit per pack might be $100 rather than $1,000.
Here’s the macro picture: China and the emerging markets are slowing as various credit bubbles pop, meaning the profits from moving commodities to Asia will plummet. The developed world is also depending on credit bubbles and the one-time consumption of seed corn (capital/equity) for its anemic expansion. Eating Our Seed Corn: How Much of our “Growth” Is From One-Time Cashouts? (February 25, 2014)
The point is this: technology lowers margins, and credit bubbles inevitably pop. Any company or nation that depends on maintaining high margins in credit-bubble-based “growth” is about to find that it’s much harder to net $1 billion, much less $1 trillion.