Rafi Mohammed

Apple's iPhone Pricing Strategy: Good, Not Great

Posted on September 11th, 2013 (0 Comments)

Reprinted from the Harvard Business Review website.

With yesterday’s iPhone release, Apple changed things up by going to a “good-better-best” pricing strategy on its new devices. As it always does, the company showcased a new and improved iPhone model — the 5S — which provides faster processing, a better camera, and James Bond-like fingerprint security technology. Prices for the 5S in the U.S. start at $199 for customers who commit to a 24 month contract, and $649 for those who prefer not to be tied to a two-year financial obligation. Apple also released a lower priced iPhone, the 5C (many view the “C” as a moniker for “cheaper”), which in essence is old technology — similar to the current iPhone 5 — in a plastic backed case available with a variety of new colors. 5C prices in the U.S. start at $99 on contract and $549 off-contract.

But in my view the good-better-best pricing strategy (in this case “better-best”) makes sense for Apple for a couple key reasons:

Giving customers more choice will generate growth. I often use the analogy of early-bird, regular, and chef’s table options that are available at many gourmet restaurants. This strategy allows customers to choose the price that works best for them. Newly married couples on a budget, for instance, opt to arrive before 6:30 PM while dining high rollers willingly pay a hefty premium to hob nob with the chef. A similar type of self-selection will occur with these two iPhone options. By serving the price sensitive market, Apple will grow its business with new early-bird customers.

It will preserve the 5S’s margins. In my consulting work with companies, I’ve been in similar situations as Apple now faces. Often times a premium product with large market share encounters a new wave of competition that is winning customers via rock bottom prices. For proof of Apple’s woes in this area one need look no further than the recent Siri-bashing Windows 8 Tablet ads, whose punch-line is $250 cheaper price tag than the iPad. To combat this pricing pressure, I inevitably recommend introducing a lower priced version — a fighter brand — which competes with new entrants and serves price sensitive customers. With the 5C in place as a fighter brand, the 5S is now better positioned to customers who highly value the handset and can continue to command a premium.

The stock market reacted harshly to Apple’s new strategy primarily due to the 5C’s $549 off-contract price. But why does the high off-contract price matter? In emerging markets such as China, buying handsets off-contract is very popular and the 5C’s relatively high price isn’t going to generate long lines of “I must have it now” customers. Analysts had previously predicted the off-contract 5C price to be around $400 and when the actual price of $549 was announced yesterday, investors got skittish.

The analysts blew it and Apple is now a victim of unrealistically set expectations. For the right to offer iPhones to their customers, wireless carriers typically pledge to sell large volumes. Verizon, for instance, has reportedly committed to purchase over $23.5 billion in iPhones in 2013 alone. Because of these deals, there’s no way that Apple would have offered a cheap off-contract 5C price. This would induce customers to buy off-contract — which would hurt its wireless supply partners who are hustling to meet their commitments. In fact, it wouldn’t surprise me if these high volume deals with wireless suppliers such as Verizon prohibit Apple from selling cheap off-contract phones.

What’s interesting is the intended outcome of the 5C — attracting price sensitive iPhone customers who buy on-contract — could have also been accomplished with a new pricing strategy. Taking a page from the car leasing industry, carriers should offer customers a range of choices. If $199 upfront for the premium 5S on contract does not work for a customer, offer them $100 upfront plus an extra $5 per month for the 24 months of the contract, or no money down and an extra $10 monthly finance payment. Customers typically focus on what it’s going to cost them today and often gladly tradeoff a lower upfront payment for a few extra dollars a month obligation. And just like car leases, monthly payments can be further reduced if customers pledge to return the phone in 24 months (presumably to trade-up to a new iPhone).

While the off-contract 5C pricing won’t move the needle in emerging markets, the key to success in these markets is to push on-contract (in essence, financing) or lease pricing options. Apple needs to promote these pricing practices to help customers understand that leasing or financing over time via contract are time-honored strategies used by customers to buy luxury products. It’s estimated, for instance, that over 60% of BMW and Mercedes new car sales in the United States are leases.

The 5C will accomplish exactly what Apple intended in the on-contract market — provide an early-bird $99 option, which is good. But what prevents this strategy from being great is the lack of a viable pricing-related growth strategy in emerging markets, which I believe is easily solvable.

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