Saturday, June 30, 2007

Apple's iPod: Capturing Value in a Global Innovation System

Trade statistics can mislead as much as inform - For every $300 iPod sold in the US, the politically volatile US trade deficit with China increased by about $150 (the factory cost). Yet, the value added to the product through assembly in China is probably a few dollars at most.

US company Apple created the iPod music player and outsources the entire manufacture of the device to a number of Asian companies.

In a fascinating study published this month, researchers at the University of California, Irvine - Greg Linden, Kenneth L. Kraemer and Jason Dedrick - present a framework for analysis and use that framework to look at one member of Apple’s iPod family, part of a thriving ecosystem that has upended business models across the consumer electronics, computer, and entertainment industries.

The researchers say that the iPod is a perfect example of a globally innovated product, combining technologies from the US, Japan and a number of Asian countries.

Using a report from Portelligent Inc. that provided a breakdown of all the 451 parts that go into the 30-gigabyte video iPod, which retails in the US for $299, the Irvine researchers costed the components and the final assembly at plants in China.

The most expensive item was the hard drive, which was manufactured by Toshiba and costs about $73. The next most costly components were the display module (about $20), the video/multimedia processor chip ($8) and the controller chip ($5). They estimated that the final assembly cost only about $4 a unit.

Tracing the supply chain geography by attributing the cost of each component to the country of origin of its maker was viewed as presenting a partial picture because Toshiba makes its hard drives in the Philippines and China. The Broadcom chips are made by an American company but most of them are manufactured in Taiwan.

To distribute the costs of the iPod components across the countries where they are manufactured, the researchers looked at the production process as a sequence of steps, each possibly performed by a different company operating in a different country.

At each step, inputs like computer chips and a bare circuit board are converted into outputs like an assembled circuit board. The difference between the cost of the inputs and the value of the outputs is the “value added” at that step, which can then be attributed to the country where that value was added.

The researchers estimated that the $73 Toshiba hard drive in the iPod contains about $54 in parts and labour, meaning that the additional value that Toshiba added to the hard drive was $19 plus its own direct labour costs. This $19 is attributed to Japan since Toshiba is a Japanese company.

An estimated $163 of the iPod’s $299 retail value in the United States was captured by American companies and workers, breaking it down to $75 for distribution and retail costs, $80 to Apple, and $8 to various domestic component makers. Japan contributed about $26 to the value added (mainly via the Toshiba disk drive), while Korea contributed less than $1.

The unaccounted-for parts and labour costs involved in making the iPod came to about $110. The authors hope to assign those costs to the appropriate countries, but that’s not so easy to do.


The researchers set out the following conclusions from their initial analysis:

First, the biggest winner is Apple, an American company, with predominantly American employees and stockholders who reap the benefits. If the iPod had been made by Sony or Samsung, the value to the US would be considerably less.

Second, the producers of high value, critical components capture a large share of the value. For the 30GB Video iPod, the highest value components are the hard drive and the display, both supplied by Japanese companies. US suppliers provide the two most valuable microchips.

Third, trade statistics can mislead as much as inform. For every $300 iPod sold in the US, the politically volatile US trade deficit with China increased by about $150 (the factory cost). Yet, the value added to the product through assembly in China is probably a few dollars at most.

While Apple’s share of value capture is high for the industry, the iPod’s overall pattern of value capture is fairly representative.

Today, no single country is the source of all innovation and therefore US companies need to work with international partners to bring new products to market. These companies will capture profits commensurate with the extra value they bring to the table.

This is simply a fact of business in the 21st century, and the good news is that many American companies are winning this game and continuing to bring significant benefits to the US economy.

The researchers conclude that as long as the US market remains dynamic, with innovative firms and risk-taking entrepreneurs, global innovation should continue to create value for American investors and well-paid jobs for knowledge workers.

But if those companies get complacent or lose focus, there are plenty of foreign competitors ready to take their places. If this happens, the benefits from the global innovation system could quickly shift away from the US.

100 Million iPods Sold

Apple announced in April 2007 that the 100 millionth iPod has been sold, making the iPod the fastest selling music player in history. The first iPod was sold five and a half years ago, in November 2001, and since then Apple has introduced more than 10 new iPod models, including five generations of iPod, two generations of iPod mini, two generations of iPod nano and two generations of iPod shuffle. Along with iTunes and the iTunes online music store, the iPod has transformed how tens of millions of music lovers acquire, manage and listen to their music.

Apple launches the iPhone - Report and Video