A Gadget Is More Than the Sum of Its Parts
As a teenager growing up in the Cleveland suburbs, my first real job was at a Chick-fil-A restaurant in a local mall. I did everything: manned the cash register, made sandwiches and cleaned up.
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It’d be fun to report that that job taught me important skills and precepts that followed me for the rest of my life, but that’d be pushing it.
That job did teach me, however, one important thing about the business world. My best friend, John, worked next door at a watch shop. He told me he could get incredible discounts on the watches — all I had to do was ask. I needed a watch, in fact, so I picked out a $200 model and asked what I’d have to pay. He said $60.
I was appalled. “You mean to tell me that your shop pays $60 for that watch, and then jacks up the price to $200 for the consumer? That’s outrageous! That’s practically robbery! You should be ashamed to work there!”
John was amused, and he proceeded to teach me a lesson. “Oh, really? That’s a big ripoff, huh? Well, let me ask you this: How much do you think Chick-fil-A pays for each of the chicken breasts?”
I calculated that in the massive quantities this chain purchased, it was maybe 40 cents.
“And the bun?” Maybe 4 cents. “The pickle?” One-tenth of a cent. “O.K., and how much do you sell the sandwich for?” $2.40.
Now, it’s been 30 years. All of the numbers in this story are vague recollections — I don’t need e-mail from chicken-farm vendors setting me straight. But I’m quite sure of the result: By the time I’d done the math, John had made me realize that my sandwich shop was marking up its product more than his watch shop. I was the one who should be ashamed.
I think of this transaction every time somebody does a “teardown analysis” of an iPhone, a Kindle Fire or some other hot new product. These companies buy a unit, take it apart, photograph the components and then calculate the price of each. Then they tally those component costs and try to make you outraged that you’ve paid so much markup.
IHS iSuppli’s breakdown of the iPhone 4S component cost, for the $400 model, is $245.
(Here’s iFixit’s teardown, which is more about photographic evidence of the teardown and less about the prices of the pieces.)
And here’s the iSuppli analysis of the Kindle Fire, which concludes that Amazon is deliberately selling the Fire at a loss — with the intent of making it up in sales of movies, e-books and music. (It costs Amazon $201 to make one, which it sells at $200.)
These are fascinating studies, of course, just as my Chick-fil-A anecdote has its charms. But all of them ignore the elephant in the room: there’s a heck of a lot more expense to bringing a product to market than component costs.
For example, they completely ignore the cost of developing the software. It doesn’t write itself, you know.
What about the cost of the packaging? Would you like them to send your new iPhone in a Ziploc bag?
What about the shipping from China? The royalties, licensing, taxes and insurance? What about the marketing and PR that let you know the product exists? The tech-support department? The factory workers? The sales and accounting teams? The graphic design? The prototypes, field testing and beta testing?
Big companies can’t work out of a rusty van. They need office and lab space somewhere, and that means rent, facilities management, electricity, heating and cooling, water and taxes.
Every time I read about one of those teardowns — whether it’s an i-gadget or a chicken sandwich — I cringe at the fallacy of the entire exercise. If you think that Amazon’s real cost to make that Kindle Fire is $201, then by all means, go to China and cobble one together yourself.
And if the purpose of the analysis isn’t to get you outraged at the markup, then the premise is suddenly a lot less interesting. What, in the end, makes the component costs any more important than all of the manufacturer’s other expenses? Why aren’t people publishing similar exposés about the company’s shipping costs, or real-estate taxes or licensing fees?
It’s actually amazing that the electronics companies have found a way to make their powerful, beautiful machines available to the masses at prices that millions can afford, even after paying all of those expenses (of which the components are just one component). Once you have the facts, the proper reaction isn’t outrage — it’s awe.