Pricing and Profit Consistency and the Halo Effect

Wednesday, 17 April 2013

Horace Dediu, “Escaping PCs”:

If this estimate is considered then the operating profits from PC operations imply that Apple generates more profit than all the top 5 PC vendors combined.

Assuming further that “other” vendors have the same profitability ratio as the top 5 combined yields a figure of 45% “profit capture of PC market” for Apple. This is not as good as its performance in the phone market, where Apple has about 72%, but it’s not bad.

And as with the phone handset industry, Apple’s profit share in PCs far outstrips its unit sale market share.

Matt Yglesias, after pondering Dediu’s numbers, suggests Apple should cut Mac prices to pursue market share:

One thing that pops out of this is that even though it’s the iPhone and the iPad that make Apple such a giant company, they’re pretty much killing it as a PC vendor too. That said, particularly in light of the PC sector’s decline in the face of quality improvements and a slowed consumer upgrade cycle, you have to wonder why Apple’s corporate strategy involves such high profit margins on Macs. It’s clear that profits from iPhone and iPad are more than sufficient to meet Tim Cook’s goals in terms of dividends and investments. According to Dediu, Apple earns an average 19 percent operating margin on its Mac sales compared to 4 percent for Dell and less than that for HP, Lenovo, and Acer. A question to ask is whether piling up extra cash in the Braeburn Capital account is a smarter strategic move for Apple than investing in larger market share via lower prices. You could cut Mac prices 15 percent across the board to match Dell’s margins.

If it were me, though, I’d take a good hard look at really shaking the industry up with a 20 percent price cut. That would reposition the Mac as a loss-leader whose function is to enhance the overall value of the Apple ecosystem.

It’s not within Apple’s character to pursue market share for the sake of market share. I’m not even sure that price is what’s holding back further Mac market share gains. A lot of people buy Windows PCs specifically because Windows is what they’re familiar with; they don’t want to even consider a Mac for the same reason many of them are rejecting Windows 8: too different.

And, even if cutting Mac prices did significantly grow Mac market share, the customers Apple would gain from this strike me as unlikely to then generate profit for Apple by subsequently buying iPhones and iPads. By definition, the new customers they’d gain from slashing the price of Mac hardware would be price-sensitive customers. Why would those customers buy iPhones and iPads unless the prices of iPhones and iPads were also similarly slashed?

The “halo effect” — the theory that Apple can get a new customer to buy one Apple product, that customer, if happy with their purchase, is likely to start buying other Apple products — strikes me as only likely to be effective if all those products are consistently priced and marketed. Industry observers break out PCs, tablets, smartphones, and media players into discrete product categories, but Apple, from a consumer branding perspective, does not. Macs, iPads, iPhones, and iPods are all just Apple products, and they’re all priced and designed the same way: seldom the cheapest, but usually the best.

It’s their consistency in that regard across all products that drives the halo effect, turning someone who never bought an Apple product in their life into someone with an iPhone, iPad, and MacBook.

The conventional wisdom is to pursue profits by maximizing market share. Apple pursues profits by specifically targeting only the high-margin segments of the overall market, and effectively forgoing market share in the low-margin segments, no matter how large those low-margin segments are.