The gutsy marketing and strategy behind Apple's iPhone price cut

The iPhone price cut appears to be the story that will never die. Leander Kahney at Wired News and I had a great discussion yesterday about the what and why behind the iPhone price cut. Some of what we discussed ended up in the Wired article here, titled, The Perils of Taking the IPhone Mainstream. But there was actually some background and analysis that Leander didn't use, so I thought I would fill in that back story here.

First, here's one of my quotes from the article:

According to Howe, Apple initially priced the 8-GB iPhone at $600 not to milk early adopters, but to purposely constrain demand. While production ramped up at its Asian factories, Apple wanted to restrict buyers to the relative few happy to pay $600 for the phone. Nonetheless, Apple went on to sell a million iPhones in the first two months –- a clear indication of the device's popularity.

Then, as it became clear there was enough factory capacity to produce millions of them in time for the crucial holiday season – when sales explode -- Apple dropped the price to take the gadget mainstream.
With Tuesday's launch of the iPhone in Europe, it's clear that Apple is confident it can satisfy demand in multiple countries.

"(Apple) said they'd like more time before dropping the price," says Howe, "but you can't move the holidays. Clearly, Apple's gearing up for a big holiday season."

Apple has good reason to be gearing up for this holiday season based upon its experience with the iPod. Steve Jobs made an incredibly gutsy call last year in the spring when he told manufacturing to gear up to make more than 20 million iPods to sell over the holidays. Why was it gutsy? Because Apple had never sold more than 14 million iPods in a quarter before. Yet the decision had to be made, and Jobs and his team made it. And it is sounding like Jobs has recently made that same decision with the iPhone by doubling iPhone production for this holiday season too.

But back to the price cut. One London analyst firm has asserted that next year's average selling price for the iPhone will be $200:

"In our projection, we believe there will be about 18 million iPhones sold next year at an average selling price of about $200, and that means a very sizable portion of total handset revenues will move from other manufacturers to Apple. (It) will be in the vicinity of 5 percent that Apple will steal from incumbents."

Not to be outdone, the New York Times asserts that the price might go to zero:

"The iPhone could have an overall impact on the economics of the phone industry. It has put a hardware manufacturer in a highly unusual position of strength relative to the carriers (Verizon, AT&T, etc.). They’re accustomed to calling the shots about what devices get access to their network; not so with the iPhone. It carries its own weight with consumers.

Mr. Saccanaghi, after discussing the issue with various players in the mobile phone ecosystem, estimates that AT&T could afford to pay Apple $15 a month over the lifetime of a two-year contract. That adds up to $360 in payments. And that’s considerably more than the $200 to $350 that AT&T pays other retailers (like Best Buy, Radio Shack) for customer sign ups, Saccanaghi writes.

What does it mean?

Apple could conceivably sell the iPhone hardware at a substantial loss while still generating greater profit per iPhone than it does from the highest-end iPod.

Sounds like a good deal for Apple, with a caveat. If Jobs decides to drop the price of the iPhone, he might consider offering a rebate to existing customers beforehand."

So with production ramped up for the holidays, is Apple going to follow Motorola into the downward price spiral of death?

Oh sure. And it will happen right after Steve Jobs attends an ice skating party in hell with bad Muzak.

What people don't get is that Apple is waging a marketing war to reshape the value chain for the mobile phone industry. Everyone is trying to figure out which trench Apple is occupying, when Jobs is flying in jet fighters for surgical strikes.

Consumers value what they pay for. They don't value things they perceive as free. And that's the marketing blunder the US mobile phone market has bought into over the last 10 to 15 years. By bundling "free" and generic phones with cell phone service, mobile carriers have devalued both the brand values of the handset makers and their own services. The handset makers are hurt because the low values that carriers will pay for free phones eliminates the incentive for those manufacturers to do anything but cut costs. The carriers are hurt because they have to pay subsidy fees to the handset makers of anywhere between $150 and $250 over a two-year contract to actually buy those free handsets. You've heard of a win-win deal? This is a lose-lose deal.

What Apple has done is inverted the value proposition. It has created a phone that consumers see as sexy and desirable, so desirable in fact that they will actually pay $400 to $600 for one (depending on geography). And because the device is desirable, Apple can demand exclusive deals with carriers, which creates valuable differentiation for those carriers that have iPhones and disadvantages for those that don't (yes, I'm talking about you, Verizon and Vodaphone). Because Apple is providing valuable carrier differentiation, Apple can then capture the subsidy revenue stream that the carrier would have normally paid to the handset manufacturers anyway for "free" (and undesirable) phones.

Now, if Apple were to cut the iPhone price to zero, would any of this be happening? Not a chance.

So Apple is going to use its iPod playbook all over again. The original 5 gigabyte iPod went on sale for $399 in 2001. Today, a 16 gigabyte iPod touch sells for -- you guessed it -- $399. Apple chose the price points based on consumer demand and interest. A constant set of features will move down the price scale to more value-oriented price points, but Apple will introduce new and even more desirable products at the old price points. And so long as it can keep that engine going, it will make money hand over fist. And the rest of the handset makers will bang their heads against the wall trying to figure out how they do it.

Don Reisinger at CNET's Crave recently recently asked the question, "Is Steve Jobs really smarter than anyone else?" in this way:

"In the United States, GSM carriers are not the only option, and more often than not, people are willing to go with Verizon Wireless or Sprint Nextel, regardless of the inability to easily switch between the aforementioned companies.

But in the U.K., the economical landscape is much different. In fact, most Britons are more than happy to change carriers and are keenly aware of the terms 'unlocking' and 'SIM cards.' In fact, many people in the U.K. have already purchased an iPhone in the States, brought it home, unlocked it and added it to their own carrier.

Steve Jobs knew that the U.K. is rife with unlocked phones and exclusively GSM coverage. And by looking like the best friend to O2, he's effectively pulling the same trick out of his bag: tell everyone they can only have an iPhone on one carrier, ignore unlocking, take the revenue from O2, and enjoy higher hardware sales due to simple unlocking procedures. Once completed, head to France and Germany, rinse and repeat.

It's amazing to me just how much control one device wields all over the world. Can you think of any other product that could command such respect from a massive cell phone carrier and create a whole new way of doing business in the cell phone industry? I certainly can't.

I can't either. That's because Apple combines award-winning designs with some of the best strategy and marketing in the world. And as long as the press and Apple's competitors keep focusing on the price cuts instead of the strategy and consumer desires, it will continue to reshape the mobile phone industry to its own advantage -- and in the process make its investors a lot more money than anyone wedded to the old mobile phone business expects.

Full disclosure: the author owns Apple stock.

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Apple, ATT, Brand, Customer experience, iPhone, iPod, iPod touch, Marketing, New York Times, Price cut