Macopinion

The iPhone Pricing Conspiracy (Part 1 of 2)

by Marc Zeedar macopinion@designwrite.com

In my previous column I wrote that I am not disappointed by the iPhone price drop. Early adopters must have a thick skin about these things and I fully expected such a move. It came earlier than I thought, however, and the price drop was larger than I expected. But of course the issue of iPhone is now all the rage on the Internet with everyone wondering what happened, what's going on, and why Apple handled the situation the way it did.

Here is my theory on things. Please note that I have zero credentials. I don't work for Apple or have any inside information. I merely have a brain, a vivid imagination, and decades of Apple fanaticism.

Imagine with me the course of iPhone development. From what we know, several years ago Steve Jobs was shown some secret Mac touch-screen prototypes. It was some cool technology, but Steve saw that the form factor was all wrong: instead of making a laptop with a touch screen (like those dud "Tablet PCs") he envisioned a tiny handheld for iPods and cellular phones. Over the next two years, all the details of the device were developed: the mobile Mac OS X operating system, the Multi-Touch interface, Cover Flow, etc. Partners like AT&T and Google were courted and brought in. Everything was done under typical Steve Jobs "Seal of Silence."

Now during this development, Apple was already working on market research, pricing decisions, and other aspects of the roll-out. These may seem like afterthoughts to most of us, but Apple has to think of all these details years in advance. Imagine the many questions: Is there even a market for such a device? How large a market? How much would people be willing to pay? How much would it really cost Apple to build such a device? And so on.

Remember, we're talking about an extremely complicated, advanced device that by its nature requires cooperation with other companies (i.e. AT&T). Apple engineering was trying to finalize the hardware inside, securing the best possible pricing for components.

My feeling is that the original price of $599 was decided early on in the development. Perhaps there were other prices, but this at least was a key target. The only question was, could Apple build the device and make a profit at that price?

As development proceeded, the answer seemed to be yes. Remember, we're talking about at least a two-year development process. Electronic component costs vary dramatically over such a period: just look at the pricing of memory, hard drives, processing chips, and other items. Probably when Apple started building iPhone prototypes they -- even at bulk quantities -- were going to cost over a thousand dollars in parts. But Apple was projecting that the component prices would drop in the future and by the time iPhone was ready to ship, the parts would cost much less.

Now by last January, when iPhone was introduced, Apple had pretty much finalized the hardware design. Component pricing was probably still somewhat up in the air, but close to final. So at that point Steve probably knew the iPhone could be sold for less than $599 and still make Apple a decent profit. But why take that risk?

If you've ever worked in product pricing, you know that you can cut but you cannot increase. It would be much better for Apple to drop the iPhone price than to sell it at a razor thin margin and just hope that profits would come via component pricing drops.

The other unknown factor in all these calculations is the public's reception of the device. Would people be interested? Would they understand the truly revolutionary nature of the device? Would the pricing be intimidating or only attract Apple fanboys and fangirls?

Obviously Apple -- and Steve -- believed in the product. But that's not a guarantee of success. Once the iPhone was unveiled, I'm sure the hype shocked even the most ambitious at Apple. It took the world's imagination by storm and everyone was talking about it. Do you really think Apple expected such a reaction? I'm sure they wanted it, but I doubt they planned for it.

Reaction like that means something. I'm sure the internal market research numbers within Apple skyrocketed and continued to change through the spring as launch day approached. You and I might just see those numbers as theoretical and meaningless, but those numbers are hugely significant to a manufacturing company like Apple.

If you remember back in the dark days of the Performa Macs in the 1990s, Apple lost millions betting wrong on market demand. Apple bought too much RAM and when the price dropped, Apple was stuck trying to sell it at a much higher price than it was available elsewhere. At various times, Macs were thus much more expensive than comparable PCs. Apple had excess computer inventory as well, miscalculating how much they'd sell. It was a disastrous time for the company and one of the first things Steve Jobs did when taking over was to reduce inventory to days instead of months so that they company could take better advantage of component price drops (and today component pricing is a key source of Apple profits).

Obviously Apple had plans for a phoneless iPhone (the iPod Touch) from Way Back When. But the iPhone had to come first, for several reasons. For one, a cellular phone must get FCC approval which would publicize the secret device. For another, many of the iPhone's parts were initially rare (like the Multi-Touch sceen) and cost more. iPods, being a known comodity, must sell within a certain price range. If Apple had come out with a $600 iPod people would have been like, "What? That's outrageous!" So Apple's plan was to release the iPhone first to seed the market. Sometime later the iPod Touch, using many of the same components, would be released at a much more iPod-like price range.

Now perhaps Apple had planned for that to happen this fall all along. I have no idea. It seems early to me, considering the iPhone hype -- I had written a column a while back that predicted that Apple would wait for Christmas 2008 before they released a phoneless iPhone.

But Apple's got information we don't: the specifics of iPhone and iPod sales, for one, and private market research for another. Perhaps their research says that if the iPhone cost a little bit less or if there was a phoneless model the sales would be staggering this Christmas so Apple decided to bump up the rollout.

In Part 2: Marc argues against those who think the iPhone isn't selling well and analyzes the reasons behind the price cut.

macopinion@designwrite.com