Wow, I have to admit that I was taken aback by the recent news that the iPhone 11 was now in short supply in New York due to the Coronavirus. This is starting to get real for those of us in the United States. We may not pay attention to world disasters, research on personal health, or politics. But if you try and take away Netflix or our iPhones, all hell breaks loose.
For those who think that this may not impact Apple much, think again. Part of what makes Apple the financial juggernaut that they are, is that they have a high fixed cost structure. This means that once they lay down their investment for plant and equipment, they simply have to deliver as many units as they can and everything above a certain unit number is gravy. I’m over-simplifying a bit, but not by much.
But a high fixed-cost structure is a two-edged sword. This means that if Apple fails to deliver as many units as they planned, they can’t reduce their cost structure on short notice. Once a company opens a plant, or hires a contractor to do it, there are a whole slew of costs that start piling up every month. Firing up a manufacturing plant and not being to deliver units for sale is kind of like buying a new car and then quitting your job. The auto loan holder doesn’t care about your job situation, you just need to send them their monthly check.
When it comes to high-tech manufacturing, costs are quite fixed. The cost of labor is variable and the cost of equipment is fixed. You can lay off employees if need be, but you can’t furlough robots. And all of that equipment on the manufacturing line is depreciated monthly. And those monthly depreciation costs are much higher than labor. That’s one of the nasty side effects of automating the modern manufacturing plant.
Thus far, Apple has done the right thing. They’ve lowered their guidance for the next quarter and prepared Wall Street. This does two things. First, it shows that management knows their business well. They have their finger on the pulse and are prepared to adjust guidance if need be. Second, it helps to prevent a panic sell when they finally release their earnings. Sure, their stock price may go down in the short-term, but a controlled descent is much preferred over a crash landing.
Apple has never really had to deal with this situation before. In recent history, when they didn’t have enough units to satisfy demand, it was because they didn’t have enough capacity. This means their fixed costs were in proportion to their sales. The current situation is much different. They have a fixed cost structure tailored to a sales level they may never achieve.
This current situation of having too much equipment and not enough sales is uncharted waters. It’ll give us a small glimpse into Apples fixed cost structure. If I had to guess, I’d say that Apple may be underestimating the negative impact on their earnings.
But a high fixed-cost structure is a two-edged sword. This means that if Apple fails to deliver as many units as they planned, they can’t reduce their cost structure on short notice. Once a company opens a plant, or hires a contractor to do it, there are a whole slew of costs that start piling up every month. Firing up a manufacturing plant and not being to deliver units for sale is kind of like buying a new car and then quitting your job. The auto loan holder doesn’t care about your job situation, you just need to send them their monthly check.
When it comes to high-tech manufacturing, costs are quite fixed. The cost of labor is variable and the cost of equipment is fixed. You can lay off employees if need be, but you can’t furlough robots. And all of that equipment on the manufacturing line is depreciated monthly. And those monthly depreciation costs are much higher than labor. That’s one of the nasty side effects of automating the modern manufacturing plant.
Thus far, Apple has done the right thing. They’ve lowered their guidance for the next quarter and prepared Wall Street. This does two things. First, it shows that management knows their business well. They have their finger on the pulse and are prepared to adjust guidance if need be. Second, it helps to prevent a panic sell when they finally release their earnings. Sure, their stock price may go down in the short-term, but a controlled descent is much preferred over a crash landing.
Apple has never really had to deal with this situation before. In recent history, when they didn’t have enough units to satisfy demand, it was because they didn’t have enough capacity. This means their fixed costs were in proportion to their sales. The current situation is much different. They have a fixed cost structure tailored to a sales level they may never achieve.
This current situation of having too much equipment and not enough sales is uncharted waters. It’ll give us a small glimpse into Apples fixed cost structure. If I had to guess, I’d say that Apple may be underestimating the negative impact on their earnings.
RSS Feed