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The technology margins

There’s no question that the successful high-tech companies of the world can make a lot of money. Last quarter Apple posted a billion dollar profit, while the big telecommunications companies are reporting profits in the hundreds of millions.
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There’s no question that the successful high-tech companies of the world can make a lot of money. Last quarter Apple posted a billion dollar profit, while the big telecommunications companies are reporting profits in the hundreds of millions. Even Sony managed to make a small profit of $14 million U.S. this year in the same quarter they lost an estimated $429 million U.S. due to the recall of 9.6 million laptop batteries.

Microsoft has the largest cash reserves of any company on the planet at $49 billion, which often earns more in interest than the company’s mainstay operations. Still, would you believe Microsoft has spent over $9 billion developing Vista up to this point? Kind of takes the sting out of the $250 price tag for the home version available this week.

Every business model is slightly different. Some companies operate with small margins and make huge profits due to their volume of sales, while others are more inclined to make a guaranteed profit with every sale. Other companies are willing to take a loss on new technology in order to attract a built-in customer or subscriber base — standard practice for most printer and cell phone companies these days. Still other companies start out with small or negative margins for some products, knowing they will make money down the road when economies of scale kick in and their products become cheaper to produce.

To that end, customers usually have no idea what a product is actually worth — how much an items costs to manufacture, how much of the price tag is dedicated to research and development and the support of said item, and how much the company stands to profit. However, a handful of consumer technology websites have made a point of stripping down new technologies and pricing their components separately to give people an idea of what the actual costs might be.

For example, a market research company called iSuppli recently broke down the cost of materials going into Apple’s new iPhone, and found that the parts for the four gigabyte version will cost about $229.85 (all figures in American dollars), with another $15 for manufacturing costs. Given the reported $499 price tag, that gives Apple a profit margin in the range of 50 per cent.

The iSuppli figure doesn’t include expenses like research and development, the ongoing costs of supporting and marketing the product, the warranty losses, and the various percentages charged at each level of distribution, but it’s helpful when deciding whether to buy early or later when the price comes down.

Similarily, Merill Lynch of Japan estimated that the manufacturing cost of a Playstation 3 was over $800 U.S. per console at launch, resulting in a $300 loss to Sony for each unit sold. When economies of scale kick in, and manufacturing of specialty items like the Core Processor is optimized, the manufacturing costs are expected to go down to about $320 after three years.

Comparatively, the Xbox 360 cost more than $525 to manufacture at launch in 2005, and manufacturing costs have already dropped by about 40 per cent. Where once Microsoft was taking a minimum of $125 loss per unit at the beginning — not counting the thousands that were likely replaced due to overheating issues — the company is now making a manufacturing profit of about $75.

The Wii was profitable from the beginning because of the decision to use older processors and graphics technology to reduce the manufacturing cost per unit to about $158. Each unit will make about $80 profit for Nintendo.

It’s unknown whether Sony or Microsoft will ever turn a profit on console sales, given all the expenses that go into their video game systems above and beyond actual manufacturing costs. For example, it’s been estimated that the first Xbox lost Microsoft over $4 billion in manufacturing, and that’s after selling over 30 million units. It really doesn’t matter, because the console manufacturers make most of their money on licensing fees from game companies.

Which brings us to why video games themselves — mass produced on automated assembly lines — cost about $60 to purchase.

According to a recent article in Forbes ( www.forbes.com ), the average game now costs about $20 million to develop. To get into the black, companies estimate that they have to sell anywhere from 500,000 to a million copies of a game. Once they surpass a certain mark game companies can greatly increase their profits, but most companies are hard-pressed to have that kind of success with every single title.

Art and Design expenses account for about 25 per cent of the cost up to the break-even point, or $15 per game. Programming and engineering is about 20 per cent, or $12 per game, while the retailers get about 20 per cent or $12 of the sticker price — of which maybe a dollar is profit for the company after their own expenses are figured in. The console manufacturers (Sony, Microsoft and Nintendo) usually get about $7 per game on average in licensing fees, or 11.5 per cent of a $60 sticker price.

Marketing is about 12 per cent of the cost, or $7 per game on average although actual costs depend on the game and the campaign.

Manufacturing costs are low, about $3 per game or five per cent of the cost although that could increase if Sony and Microsoft go to Blu-ray or HD-DVD formats respectively.

The remainder is usually eaten up by licensing, administrative costs, distributor margins, and hardware development cost.

Some sites to visit to find out how much technology products actually cost include Engadget ( www.engadget.com ), ZDnet ( www.zdnet.com ), and C/net ( www.cnet.com ).