Regarding Analyst Speculation on iPod Pricing

Monday, 18 September 2006

Dan Nystedt, reporting for IDG News Service, in an article whose title, “Apple’s New iPods Priced for Profits, Not Market Share”, gives away its thesis:

The top sign Apple is going for the green is its lack of aggressive pricing, according to Gartner analysts Joseph Unsworth and Jon Erensen in a Monday report. The second-generation iPod Shuffle, for example, could have been priced closer to US$49 to stimulate demand from users, since the cost of materials going into it amounts to only $30, the analysts said. Instead, the shuffle is priced at $79.

The company could have also priced the new 8 GB product lower than $249, since its materials only cost $130, Gartner said, the same with its 4 GB, which at $199 is far higher than the $90 worth of materials inside, and the 2 GB version, which is $149 and is made from materials costing only $70.

Leave aside for now the assumption that these cost-of-materials estimations don’t include Apple’s manufacturing or marketing costs — let’s just assume for the sake of argument that these estimates are correct and fair.

These analysts’ explanation for the high-margin pricing — that Apple is going for profits at the expense of market share — is certainly possible. But I offer another explanation: that Apple can only manufacture these new iPods so quickly, and that they expect to sell them as fast as they can make them, or nearly so, from now until Christmas at these prices.

For example, in December 2004, there were widespread shortages of iPod Minis and 20 GB iPods; simple economics dictates that when demand outstrips supply, the price is too low. If you assume Apple was making as many iPods as it could (i.e. that they weren’t capable of increasing supply), that means they left money on the table by not having priced them higher. They likely could have sold the same number of iPods at higher prices.

Perhaps these guys are just dense, and don’t even get it. Nystedt’s article continues:

The two Gartner researchers even lamented Apple’s decision to discontinue the 1 GB nano, which they say could have been a nice mass-market item for around $99.

Why not sell a 512 MB version, too? And what about 3 GB and 6 GB? And what about more colors?¹

Why not? Because the relative simplicity of their product lines is a key part of the Apple experience (both with iPods and Macs). You want a new Nano? It’s $149. You want colors or more storage? $199. You want the really cool 8 GB black one? $249. And if you really do want an iPod for less than $100, get a Shuffle.

Even if it’s not a matter of supply constraints, the prices Apple sets affect more than just margins. The article continues:

“Apple is in a secure position atop the portable media player market and has decided to strategically focus on its margin this time,” the analysts said.

But margin is just one component of profit — the other is unit sales. If Apple simply wanted to “strategically focus on its margin”, they could have kept the prices exactly the same as last year’s (per GB). Or, taken to its logical extreme, they could have raised prices.

The goal isn’t to maximize margin or unit sales, the goal is to maximize the product of margin and unit sales — the profit. The really tricky part is that when it comes to “market share”, you might want to make less profit in the short term in order to grow your market share and make more profit in the long term from repeat customers.

Now, maybe these Gartner guys are right — maybe Apple’s overall market share is going to dip this holiday season because they’ve increased their profit margins. But Nystedt presents this as fact, as though it’s not even possible that Apple has chosen these price points with the goal of maximizing both profits and market share at the same time.

To the victor go the spoils; when you’ve got a smash hit and a strong brand on your hands, you can sell for higher margins and increase (or at least maintain) your market share.

And why should Apple’s prices be judged by the cost of their component materials, anyway? Shouldn’t they be judged against the rest of the market? SanDisk is the number-two seller of MP3 players in the U.S., with 10 percent of the market (vs. Apple’s 76 percent). Their 8 GB e280 is an iPod Nano competitor (flash memory, color screen) and costs $250 at Amazon — the exact same price as Apple’s new 8 GB Nano.

At the low end, the e250 is SanDisk’s 2 GB player, and costs $110;² Apple’s new 2 GB Nano costs $150. That’s a significant difference, to be sure. But given Apple’s long-standing “increments of $50 for everything other than the Shuffle” iPod pricing model — which model is part of the iPod brand — the only way Apple could have gone lower would have been to charge $100. I.e. for Apple, the premium brand, to undercut SanDisk, the discount brand, on price. That’s not necessarily a bad idea, but a 33 percent price reduction is not a small cut, and it would throw off their nice, even 2/4/8 GB for $150/200/250 pricing scheme. And that’s not even to mention that the Nano is thinner, weighs less, looks better, has a better user interface, and offers better desktop software.

I wouldn’t say “no” to cheaper iPods, but these guys seem to be asking Apple to flush money down the toilet. If Gartner analysts Joseph Unsworth and Jon Erensen disagree, I suggest they head to a nearby high school and ask a few students whether an iPod Nano is easily worth $40 more than a SanDisk e250.

What I think is going on is that these analysts, along with tech reporters like Dan Nystedt, are still reading from the old script where Apple products get written off as overpriced and their customers branded as mindless cultists / zealots / fanatics / fools who are willing to pay exorbitant markups. The idea is to paint Apple as a company that milks its own loyal customers. What other company gets held to a standard like this?

Don’t be fooled that this story is part of a trend (at least not yet). Like Dan Goodin’s story for the Associated Press on Macs as virus targets back in May, Nystedt’s story for “IDG News Service” is syndicated, and so this one story is showing up everywhere from here to here to here, creating the impression among headline-watchers that there are a bunch of stories about Apple’s exorbitant iPod margins.