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Apple's growing problem: Shrinking profit margins

(MoneyWatch) Investors were generally happy with Apple's (AAPL) earnings on Tuesday. The company beat analyst expectations, not a given for the consumer electronics giant of in recent quarters.

Although the financial results came as something of a relief for Apple, they are hardly stellar. Total revenue was up only 1 percent from a year ago, while profits were down 22.6 percent even with what Apple said were record iPhone sales in the third quarter.

The company also has a growing problem with shrinking margins. The continuing drop suggests that, absent the release of innovative new products, Apple's brand could lose the cachet that once guaranteed huge sales and profits.That could seriously undermine the company's traditional business model of driving profits with popular, but high-priced, products.

Although the number of iPhones sold was up by 20 percent year over year, revenue from the devices was up only 15 percent. Why? The average sales price for an iPhone has been dropping -- from $641 at the end of 2012 to $581 six months later.

That price drop suggests that the mix of iPhone models has changed significantly, with the latest and most expensive starting to lose popularity as more people buy older, less pricey iPhones. Apple CEO Time Cook acknowledged as much in highlighting the strong sales of the iPhone 4S, which the company rolled out in 2011:

What we've seen is that the number of first-time smartphone buyers that the iPhone 4S is attracting is very, very impressive. We want to attract as many of these buyers as we can. We saw that beginning to happen toward the end of the (fiscal second quarter ending in March) timeframe, as I referenced on last quarter's call.

Cook did say that the iPhone 5 is still the most popular model "by far." Yet the decrease in iPhone prices suggests that many consumers are content with older iPhones and aren't willing to spring for pricier newer models.

That is bad enough, with the iPhone driving Apple's earnings. But it isn't the only place where the company's margins are being squeezed. In the last calendar quarter of 2012, the introduction of the iPad mini contributed to a drop in the average sale price of all iPads from $536 to $466, or more than 13 percent. The iPad's average price in the most recent quarter fell even further, to $436.

Apple is forecasting gross margins next quarter of 36 percent to 37 percent, compared with 36.9 percent in the latest period. Will margins eventually rebound? Perhaps, if Apple comes up with some winning new products.

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