Why Apple must target the $230B luxury car market

If Apple is going to make a success of its car project, it has to target the $230 billion global luxury automobile market. Doing so may be the only way to keep investors happy. But displacing incumbents such as Mercedes-Benz will not be be straightforward.

The iPhone maker has reignited efforts to build its own vehicle, Reuters reported last month, though it's at least five years away from production, Bloomberg reported on Thursday.

Since the project started in 2014, Apple has undergone numerous false starts, laying off hundreds of staff in both 2016 and 2019, as costs ballooned and the focus shifted from electric vehicles to self-driving technology and back again. If CEO Officer Tim Cook proceeds, he faces tough choices on how to enter a market with famously meager profitability.

For all its recent stock market success, Tesla has demonstrated the pitfalls that come from a lack of automotive experience, repeatedly enduring manufacturing problems and missing production goals. So, there is little doubt Apple would contract the manufacturing out to a third party, such as Magna, as Bloomberg has already written.

At one point about five years ago, the Canadian company had close to 100 employees working with Apple, helping steer the tech company through the engineering process. But the work with Magna never graduated to working out how or where to build a car.

This time around, Magna is not the only option. Foxconn Technology Group, which makes iPhones under contract for Apple, is also stepping into the automotive industry -- it established a joint venture last year with Fiat Chrysler Automobiles, the automaker merging with PSA Group. And perhaps more pertinently, established automakers are now very serious candidates.

Indeed, Hyundai seemed to confirm a local report it was in discussions with Apple, before walking the statement back. Such a tie-up could help resolve some of the earlier problems Apple faced with components.

In consumer electronics, the Californian company is used to getting first access to the best tech. After all, it's the biggest player around when it comes to generating profit for suppliers. If Apple wants exclusivity on the latest cutting-edge 3-D sensor technology, say, suppliers fall over themselves to contribute to the more than 200 million iPhones the company is expected to sell this year.

That is different when it comes to cars, as Apple learned in 2016. With little visibility into how many vehicles it expected to ship in its first year, or when that might happen, there was little incentive for a supplier to provide any components exclusively when a customer such as Volkswagen Group would sell some 10 million vehicles that year.

It therefore makes sense for Apple to team up with an established player, and five stand out: VW, the Renault-Nissan-Mitsubishi Alliance, Volvo and its Chinese parent Geely Automobile Holdings, General Motors and, of course, Hyundai's partnership with fellow Korean manufacturer Kia. All have developed electric vehicle platforms with enough scale to prompt suppliers to scramble for contracts. Some have expressed a willingness to build vehicles for other brands -- VW's already working with Ford, and GM with Honda.

Nonetheless, while teaming up keeps your fixed costs low, it poses a challenge when it comes to profitability. A contract manufacturer usually costs about 10 percent more than making the vehicle yourself, according to Eric Noble, president of automotive consultancy the Car Lab.

And profit margins in automaking are already slimmer than they are for the iPhone. Tesla likely enjoys a gross profit margin of about 30 percent on the Model 3, Bloomberg News reported in 2018. Apple's gross margin on the iPhone is almost double that.

The single biggest outlay in electric vehicles is for the battery, which does not benefit from economies of scale due to the fixed cost of raw materials.

In the Tesla Model 3, the battery is more than a third of the total manufacturing cost, at about $13,000. If, as Reuters suggests, Apple is able to find a way of reducing that cost with new battery technology, automaking becomes a more attractive proposition.

But even a 50 percent cheaper battery would likely leave a car short of Apple's iPhone profitability if the price point is similar to Tesla's.

Price is the obvious way to bridge the gap. Apple is not going to make a mass market car. It has to be a luxury vehicle and likely needs to be priced north of $100,000, particularly if it has self-driving capabilities that use sophisticated lidar technology.

In theory that would be a similar pricing strategy to the iPhone, but in practice it would target a completely different spending bracket, which would not be easy.

Vacuum-maker Dyson ditched its own vehicle efforts after realizing it would need to charge 150,000 pounds ($200,000) for a car.

Apple has a better chance of becoming a serious automaker. It has an edge over incumbents when it comes to software and design, and may even have a jump on battery technology, though such advantages would not last forever. The best way forward would be with a price point closer to a Ferrari than a Fiat.

The race is on again.