Apple’s declining profitability: Structural or seasonal?

Philip Elmer-DeWitt wrote recently in Fortune about Apple’s declining gross margin. While I think Morgan Stanley’s Katy Huberty makes some great points about the potential of gross margin to increase this year I’d like to add a few additional thoughts.  Ultimately, Apple’s product mix will largely define its gross margin in the years to come.  I believe Apple’s recent introduction of the 128GB iPad was driven by a desire to increase company profitability in the current year and less about customers clamoring for more storage.

The big question for gross margin becomes – what is the product mix for Apple in 2013? And perhaps more importantly, what devices does Apple launch in 2013?  Entering the TV market would likely lower Apple’s gross margin while clearly increasing revenue for the year.  In fact, I question if Apple has yet to bring a TV product to market because they are waiting for the dynamics within the TV market to improve to a point where there is less pressure on margins generally within the segment.  Smart watches are hot right now and I believe Apple could be both successful in the segment as well as bring-to-market a product that enjoys the type of gross margins Apple is accustomed to.

Apple is still largely a hardware company.  With growth slowing for the company, I expect to see them enter into both new geographic markets as well as new hardware categories.  In the short-run entering into new geographic markets (especially China) will be rewarded by Wall Street outside of what happens to gross margins as a result.  But eventually in addition to growing revenue Apple will need to maintain gross margins and therefore must pick new hardware categories carefully.