By Poornima Gupta and Noel Randewich
SAN JOSE (Reuters) - Apple Inc will begin to sell an 8-inch version of the iPad on Friday to compete with smaller tablets including Amazon.com Inc's Kindle, but set a higher-than-expected price tag of $329 that Wall Street fears could curb demand.
The 7.9 inch "iPad mini" marks the iPhone-maker's first foray into the smaller-tablet segment. Apple hopes to beat back incursions onto its home turf of consumer electronics hardware, while safeguarding its lead in a larger tablet space that even deep-pocketed rivals like Samsung Electronics have found tough to penetrate.
Apple Chief Executive Tim Cook and marketing chief Phil Schiller took the wraps off the new tablet, which essentially has most of the functions and features of the full-size iPad but in a smaller package.
Priced at $329 for a wi-fi only model, the iPad mini is a little costlier than some predicted, but some analysts see that as a bid to retain premium pricing levels. Others fear the gadget will lure buyers away from the $499 flagship 10-inch iPad, while proving ineffective in combating the threat of Amazon's $199 Kindle Fire and Google's Nexus 7, both of which are sold at or near cost.
"Apple has always been a premium hardware manufacturer. It's basically a hardware company and they don't have Google advertising or Amazon's online store to fall back on," said Destination Wealth Management CEO Michael Yoshikami.
"But people are happy to pay a premium because it's quality hardware, and the ecosystem (of content and apps) cannot be underestimated."
The focus on growing competition was evident as Schiller -- at a launch event held in San Jose's California Theatre -- compared the iPad mini with Google's popular 7-inch Nexus 7 tablet, citing feature by feature why the new Apple device was superior. It is unusual for Apple to single out a specific competitor in its product launches.
"Theirs is made of plastic," Schiller said, referring to the Android tablet. "The entire Android product is thicker and heavier."
In a surprise move, Apple also announced a fourth-generation full-sized iPad just six months after unveiling a third generation device to much fanfare. The latest tablet, which again goes for $499, is faster and slimmer and comes just days before Microsoft is due to show off its own "Surface" tablet.
Wall Street analysts have said for months Apple was planning a less expensive version of the iPad to squash cheaper rival devices, a move they say might hurt its margins but prevent its rivals from dominating an increasingly important segment.
"It's coming in the range that most were grumbling about and that, quite frankly, we're a little bit concerned about," said JMP Securities analyst Alex Gauna. "It's a little confusing at this juncture to try and figure out how it fits into the line-up. Is it going to cannibalize the more expensive iPad?"
"It is worth noting that there are zero-margin products out there competing with them now ..., and that is presenting some challenges to Apple."
Apple's shares ended regular trading down 3.2 percent at $613.36, after gaining 4 percent on Monday in the run-up to the event.
SIGHTS ON AMAZON
The original iPad was launched in 2010 by late Apple visionary Steve Jobs and went on to take a big chunk out of PC sales, upending the industry and reinventing mobile computing with its apps-based model, often called an ecosystem.
A smaller tablet is the first device to be added to Apple's compact portfolio under Cook, who took over from Jobs just before his death a year ago.
"It's very cool," Cook said of the iPad mini. "We told you earlier this year you would see some incredible innovation from Apple across the year. We think we kept our promise."
In a rarity for a company that tightly controls events, Apple live-streamed its invitation-only presentation to Apple devices such as the iPad and Macintosh computers.
Amazon's Kindle and the Nexus 7 have grabbed a chunk of the lower end of the tablet market and proved demand for a pocket-sized slate exists. That has forced Apple into a space it has avoided and at times derided, analysts say.
Apple's chief rival in the smaller-tablet arena is Amazon, which proved a 7-inch tablet at around $200 has consumer appeal. The Kindle Fire, released last year for $199, was one of the hottest-selling holiday gadgets. It pressured Amazon's margins but gave it potentially millions of new high-spending customers.
Amazon sold more than a million Kindles a week during December, paving the way for others like Google with its Nexus 7 to try and beat Apple in a market the company created.
The Internet retailer has now put its second-generation Kindle Fire HD on the market, which it says is the "best-selling product across all of Amazon worldwide," based on undisclosed U.S. sales figures and international preorders.
Google's Nexus 7 tablet, built by Asian manufacturer Asustek, quickly ran out of stock after its July launch.
All three companies will be vying to get their devices on shopping lists during the U.S. holiday season, which traditionally starts next month.
Surveys conducted ahead of Tuesday's news suggested some consumers had hoped for a more affordable mini tablet.
The "starting sweet spot" for the tablet would be in the $249-$299 range, according to a survey of more than a thousand consumers by Baird Equity Research.
"When asked what the most they would pay for a smaller iPad was, our respondents on average said that they would pay $242 for a 7-inch iPad and $268 for an 8-inch iPad," said William Power, Baird Equity Research analyst.
PRICE IS KEY
Jobs famously derided the 7-inch screen, saying such a device should come with sandpaper so users can file down their fingers. But an internal email revealed during a patent trial showed he turned more favorable to the idea by early 2011.
Apple has sold 100 million iPads so far, with the device accounting for 26 percent of Apple's fiscal third-quarter revenue.
But analysts are concerned now about erosion of Apple's industry leading margins as it takes on the Kindle Fire. It earned gross margins of 23 percent to 32 percent on U.S. iPad sales between October 2010 and the end of March 2012, according to a July court filing by Apple.
Rivals haven't fared as well. Amazon's first Kindle Fire just about breaks even, according to IHS iSuppli estimates, and Google has said its Nexus 7 is being sold at cost.
"The pricing may limit sales. From a profitability perspective though, I think at $330 Apple is still getting adequate gross margins on the sales," said Morningstar analyst Brian Colello. "But at that price point it may limit adoption and unit volumes."
(Additional reporting by Alistair Barr and Alexei Oreskovic, Editing by Edwin Chan, Richard Pullin, Andrew Hay and Steve Orlofsky)