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Apple, Amazon and IBM Show Possible Pitfalls of Beloved High Profit Margins

by Chris Gaun  |  February 12, 2013  |  Comments Off on Apple, Amazon and IBM Show Possible Pitfalls of Beloved High Profit Margins

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Last Tuesday, IBM cut the price of some of its POWER line to under $6,000. Steve Lohr of the New York Times observed that this move is designed to entice customers interested in analytic workloads and “notably Hadoop.” One of the better introductions to Hadoop that I’ve seen is Robert Scoble’s interview with the CEO of Cloudera, Mike Olson (video below).  Olson reiterates that relational databases will always be important but he also notes that open source Hadoop was designed with clustered commodity servers in mind. In comparison, the huge shared memory servers that power traditional big databases often sell for high margins. Some of these boxes need to compete against commodity to win customers in the Hadoop space, and the price drop is indicative of that.

There are various reasons high margins can exist. Higher margins may appear when there are large barrier to entry or if customers are “vendor locked” into a single product line.

When Apple and Amazon released their financial results over the past few weeks many were puzzled at the equity market’s response. Apple was wildly profitable while Amazon lost money, yet the former was punished while the latter rose in the stock market. Eugene Wei writes that low margins may answer part of the mystery:

An incumbent with high margins, especially in technology, is like a deer that wears a bullseye on its flank. Assuming a company doesn’t have a monopoly, its high margin structure screams for a competitor to come in and compete on price, if nothing else, and it also hints at potential complacency. If the company is public, how willing will they be to lower their own margins and take a beating on their public valuation?

Hat-tip to Derek Thompson at The Atlantic for finding the above quote.

Now, Apple has patents, which grant a limited time monopoly. There also may be cost in switching smartphone operating systems. That said, many companies saw Apple’s high profits per good sold and the competition is now fierce. On the other end, Amazon is competing with the brick-and-mortar low margin retail business, but has a lead in the online realm where huge data centers, fulfillment centers, and other high cost expenditures are needed for entry. The outcome: Apple is often priced at single digit multiples of its earnings while the market is ok with Amazon having hundreds of times the stock price of its profits.  According to Wei, that’s because the market believes Apple is more easily assailable than Amazon.

It seems then that technology and the market may abhor precious high margins at times.

Note: This is an individual analyst’s blog and not a piece of peer reviewed, actionable, Gartner research.

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Chris Gaun
Research Analyst
4 years at Gartner
7 years IT industry

Chris Gaun is an Analyst with Ideas Research. ...Read Full Bio

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