Apple's Pricing Flexibility

Yesterday Apple announced its second quarter earnings (Q2, 2014 fiscal year). A couple important strategic points came out of the earnings call transcript, which is available at seekingalpha.com:

1)        Apple prices a product based on its assessment of the product's value -- it doesn't get hung up on maintaining a particular price. During the earnings call Tim Cook explained it this way:

[A]s I said before, we price things at a level that is fair for the value that we are providing, and so we’re certainly not stuck on certain price points. We price at values that are fair for the value that we are delivering." (emphasis added).

2)        Apple likes making products affordable -- and continues offering older versions of products -- because it wants to pull new users into the ecosystem and ultimately sell them additional Apple products. Apple is never just selling a single piece of hardware; it's selling the ecosystem and future Apple purchases as well. Again, quoting Tim Cook's comments from the earnings call:

"We've seen our ability to attract new users to iPhone to be very significant in the emerging markets. We were seeing new to iPhone numbers on the iPhone 4s sales in the 80 percentages in certain large geos. So, this to us give us a great comfort that we can continue to grow and we may not be able to attract some of those buyers to our top phone because of the price point. But if we can get them in on the entry iPhone, it gives them a great product, at a great value and gets them into the ecosystem.

And as you know from following us for a while, our ability to keep customers is very good and our ability to show other products that Apple produces to a family that's buying Apple product is also very good. And so, at the macro level, I see the opportunity of the market and getting more people into the Apple ecosystem much larger than any of the noise around the different carrier plans . . . ." (emphasis added).

These two reasons make it easy for Apple to strategically justify/prioritize upmarket and downmarket moves, which is why Apple will probably never experience a low end or new market disruption. To Apple, hardware "cannibalization" from a downmarket move is completely worth it because it pulls more people into a "sticky," closed ecosystem of highly profitable hardware and makes future, additional hardware purchases likely.

Christensen says most companies aren't motivated to make downmarket moves because of the negative impact on margins and sales. The unwillingness to move downmarket ultimately leaves incumbents vulnerable to low end or new market disruption from a competitor with a superior cost structure. See Concepts page and discussion of Clayton Christensen. Apple avoids this low end dilemma because when Apple makes a product more affordable it pulls new users into a closed, proprietary ecosystem, which ultimately leads to additional hardware sales. In other words, Apple's strategic priorities and financial incentives (bring new users into Apple's closed ecosystem and sell more Apple products to these users over time) are aligned with downmarket pricing moves, which in turn prevents low end and new market disruption. 

Apple's pricing flexibility flows from its ability to combine the product innovation/improvement benefits of vertical integration with the low cost structure benefits of a more modular approach. Apple is vertically integrated, and keeps certain capabilities in-house -- industrial design, hardware and software engineering, chip design, ownership of specialized manufacturing equipment, and retail distribution -- when these capabilities facilitate new product innovation, meaningful product improvements, and meaningful product differentiation. See post titled “Why Apple Co-opts Adjacent Component Businesses."

Apple outsources work, and relies more on component suppliers, when the work, capability, or component involves an area that’s “good enough” and won’t differentiate the product, enhance its value, or contribute meaningfully to future product innovations/improvements. So Apple focuses on driving these types of costs down. Examples include outsourced manufacturing labor, chip fabrication, glass displays, and flash memory. 

By outsourcing commoditized work, capabilities, and components, and keeping key differentiating capabilities in-house, Apple gets the innovation benefits of an integrated approach and the low cost structure benefits of a modular approach. And Apple uses its scale, along with long term contracts/partnerships with its suppliers, to reduce costs further. 

That’s why it’s so easy for Apple to move upmarket and downmarket depending on the “fair value" of the product sold. Apple has a very flexible cost structure, so Tim Cook doesn't need to get hung up on a particular price point. And that’s another reason why low end and new market competitors haven’t been able to disrupt Apple, at least thus far.

The author owns stock shares of Apple.