Macopinion

The iPhone Pricing Conspiracy (Part 2 of 2)

by Marc Zeedar macopinion@designwrite.com

Some have speculated that iPhone sales have cooled or were never that hot to begin with, and that this price cut is evidence of that, but I don't agree with such thinking. Hype does not necessarily translate into sales, but it does show interest, and interest and awareness are huge in business. Just in raw public relations the iPhone has been a monster hit for Apple, even if they didn't sell as many as they or others expected. There isn't a company on the planet that wouldn't want to be in Apple's shoes right now.

As to actual sales numbers, until this week we didn't know how many iPhones have been sold (Apple hit the millionth mark in 74 days), and we don't even know how many Apple expected to sell, so it's impossible for those outside Apple to gauge whether sales are good or poor. The only numbers Apple has stated is a goal to sell 10 million iPhones by the end of 2008 and that they would sell one million by the end of September 2007 (a goal already reached).

The one truth we do know about quantities is that Apple never expected to sell ten million iPhones at $600 each. From the beginning the plan was to set the initial price at $600 and lower it as component costs dropped.

We don't know how many Apple expected to sell at the high price -- perhaps it was a million. Perhaps that happened earlier than Apple had anticipated and now Apple's lowering the price as component costs have gone down. For all we know, Apple had an internal goal of selling a million by the end of the year.

Remember, it does not matter what the public or "analysts" or others think or projected about Apple's sales. The only thing that matters is what Apple thought, because Apple made decisions based on those numbers.

What we do know is that the sudden price drop of the iPhone feels unplanned and unexpected. If it had happened in November, I don't think anyone would have complained. But just two months after release? Anyone with any sense at all would know that would create waves.

So this was not scheduled like this. Something happened to change things. Either Apple's sales numbers were dramatically higher or lower than expected, component prices took an unexpected dip, or Apple obtained some new information (like a survey that showed 90% of all teenagers would buy an iPhone if cost $400 instead of $600).

My theory is that the reality is a complex mix of all these factors. The iPhone price was initially high, ready to drop if needed to spur sales or if certain sales targets were reached. The iPod Touch was planned, but waiting in the wings to see how the iPhone test project went. Component prices were based on certain sales estimates, which were either missed or exceeded.

Whatever the reasoning, you can look at the current pricing of Apple's media player line and see how elegant it fits together. At the high end we've got the 8GB iPhone, which sells for $399. For the same price you can get a phoneless iPod Touch with 16GB, or save $100 and get the 8GB model and not have to pay for the phone components. If you need more storage than is available on a flash memory-based player, you've got the hard drive-based iPod Classic which hold either 80GB or 160GB of media and sells for $249 and $349, right in the middle of the low-end iPod Touch pricing. Then in the smaller devices category, you've got the $149-$199 iPod Nano or the screenless iPod Shuffle for $79. Basically, every price point is covered, and you make your decision not on price but on form factor and capacity. It's really brilliant.

Now Apple probably could have priced the iPhone $100 more. It seems that the phone aspects would be worth a bit of a premium. But there is an 8GB difference in memory to distinguish the two, which presumably covers the cost of additional phone components. But by dropping the iPhone's price to match the similar iPod Touch, Apple is encouraging buyers to see the iPhone as merely an iPod variation. There's also something about the $399 price point: $500 is a major purchase, but under that it could merely be an expensive splurge. In the past we've seen people buying $300-$400 iPods for Christmas, so I've no doubt that's Apple's goal.

Finally, there's one more thing we need to remember. Back at last quarter's press conference when Apple projected earnings for this quarter, they indicated that earnings would take a hit due several things including, to quote Apple CFO Peter Oppenheimer, a "product transition I can't get into."

No one knew exactly what this meant and it wasn't explained, but usually this means that a new product is released with an initially lower profit margin. In light of the recent products introduced, I suspect that both the iPod Touch and the iPhone have tighter margins than Apple usually has. Apple expects to make up the difference in volume and marketshare gains, and over time, as component pricing goes down, Apple's normal margins will return.

If true, this means Apple is setting price points based on what will sell, not on profit margins, which is intriguing. It tells me that either iPod is weak and Apple is desperate to revive the line (extremely unlikely given steady sales of iPods), or that Apple sees Christmas as a big opportunity to sell a boatload of product if the pricing is correct. I suspect the latter, and Steve Jobs himself as much as said so in his Open Letter to iPhone Customers:

"iPhone is a breakthrough product, and we have the chance to 'go for it' this holiday season. iPhone is so far ahead of the competition, and now it will be affordable by even more customers. It benefits both Apple and every iPhone user to get as many new customers as possible in the iPhone 'tent.' We strongly believe the $399 price will help us do just that this holiday season."

Doesn't that sound like a company trying to take advantage of the extraordinary publicity surrounding the iPhone to build some terrific marketshare?

Think of this from Apple's perspective: they planned and released the iPhone on schedule this summer, but possibly moved their iPod Touch plans forward to take advantage of the iPhone hype. I can imagine that last spring Steve said, "Man, this iPhone is so hot, we've just got to jump on it and get that iPod Touch out for Christmas!"

Of course doing that meant adjusting the planned iPhone pricing because the iPhone couldn't be too much more expensive than the iPod Touch as they are such similar devices (dramatic differences in price cause sales cannibalization). But this was decided just a few months ago in the spring -- it was "too late" to change the well-publicized iPhone's pricing. So the iPhone launch went off as scheduled and now, in the fall, Apple introduces the iPod Touch and drops the iPhone price.

Now Steve was awfully quick with the $100 Apple Store credit idea, wasn't he? No doubt that was planned as a contingency. As all this was being figured out, there was concern about how early buyers would react. Steve's answer was the Apple Store credit and I like how quickly he pulled it out when he heard the negative publicity. It was a brilliant strategy, turning a negative into a positive and garnering even more publicity in the process. Apple could have just dropped the price of the iPhone prior to introduction, but doing it this way generated Apple more revenue and more publicity: they are now the company that "listens" rather than a merely greedy corporation.

That brings up another point: if Apple was really all about the profits, or if iPhone sales have been so disappointing Apple needs to drop the price already, would the company be so eager to give out $100 store credits? Come on, that's the action of a company rolling in dough with a huge hit product on their hands. Apple wants to keep the ball rolling and not allow any negative publicity to spoil the atmosphere.

The bottom line is that on the issue of the iPhone pricing fiasco, there really are only two possible scenarios. In Scenario One, Apple and Steve Jobs really were out to gouge the early adopter market for an extra $200 profit. If so, dropping the price by the full $200 two months later seems like a silly and obvious way to reveal your greed. Surely the geniuses at the company could have come up with a better plan to disguise their evil plot!

In Scenario Two, other factors were involved in cause this particular sequence of events. In other words, this was not planned.

Obviously I favor the latter explanation. I have no confirmation of what really happened, but I think that things just happened at a faster pace than Apple expected. Either the iPhone was a bigger hit than Apple had thought, or component and manufacturing costs dropped earlier than Apple planned and that gave them a chance to move forward sooner with the iPod Touch.

Either way, what's done is done. Steve has spun the negatives into a positive story and gotten even more publicity out of the controversy. iPhones are now $200 cheaper, making them an incredible value -- and the new iPods are all awesome. It's genius!

macopinion@designwrite.com