Small S1 chip module may be the key to big Apple Watch profits

A common chip and memory configuration inside the Apple Watch lets Apple seek high profit margins, pegged at 60 percent or more, from the cases on the outside.

Regardless of which Apple Watch you consider buying, they all have one key common element: Apple's S1 module. That's the small processor, memory and sensors -- a system on a chip -- that powers every single Apple Watch ranging from $349 to $17,000 and up. That commonality means Apple's profits for its watch will hinge upon what's on the outside, with one analyst suggesting margins exeeding 60 percent for the entire product line.

This is vastly different from how Apple makes money from iPhone sales, the profits of which vary mostly on the amount of memory inside the handset you choose. Research firm IHS estimates the bill of materials for a 16GB iPhone 6 to be $196.10, for example. The cost for Apple to add 64 or 128GB of storage is figured to be between $17 and $46 by Forbes, yet these phones cost $100 or $200 more, respectively, to purchase; a healthy boost to the profit margin for Apple.

There is no memory choice for the Apple Watch though: All models have the same 8GB of flash storage inside, 2GB of which is available to save music files for wireless streaming. The difference is in the cases, and to a lesser extent, the watch bands.

For that reason, analyst Carl Howe, figures it really doesn't matter if nearly two-thirds of the Apple Watch pre-orders were for the less expensive Sport model. Howe suggests that there is plenty of profit margin built into the pricing for the steel and precious metal cases that will more than make up for this possible product mix:

"[M]y belief is that the Apple Watch product line will become Apple's most profitable product line ever, with gross margins exceeding 60 percent. Why? Because the core electronics modules in the expensive models are the same ones used in the Sport models, and they just don't cost that much. And while adding Gold cases and designer bands add cost to the bill of materials, the costs are small compared to the price premiums paid for these products."

Aside from noting the profit margin shift from something inside to something outside on the product, Howe also thinks that Apple has implemented a type of made-to-order approach for the Apple Watch.

Instead of building inventory of watches with various case materials, sizes and band combinations, Howe suggests that a limited initial inventory was produced. Once it was accounted for through pre-orders, he thinks Apple is building watches based on specific customer orders, similar to how Motorola does with its custom MotoMaker program.

That makes sense for the time being and could have much to do with the long lead times you'll see if you try to order an Apple Watch today: You'll likely have to wait 6 to 10 weeks to get your watch. As Apple better understands the product demand mix, it could shift away from made-to-order production though.

That won't change the potentially high profit margins though: Most of the money is built in to those more expensive Apple Watch cases as the internals stay the same thanks to that S1 chip, which gives Apple a known, fixed cost for the watch's innards.

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