The iPhone price cut: just smart marketing

Based upon the press today about yesterday's Apple special event, you'd think that Steve Jobs was selling Zunes instead of cutting prices on Apple's highly popular iPhone.

Despite completely revamping Apple's iPod line for the holidays, the number one story today is about the $200 price cut on the Apple 8 GByte iPhone. There were more than 11,000 stories on Google News about the iphone over the past 24 hours, Apple stock dropped 5% yesterday, and pundits are claiming people who bought iPhones over the past few months are anywhere from "irked" (USA Today) to "angered" (The Boston Globe) to "screwed" (The Unofficial Apple Weblog, and it's their word not mine).

Get a grip, folks. This wasn't personal; Apple simply made a shrewd marketing move. It paid off too -- to the tune of about $150 million which will fall to the profit line over the next couple years.

Let's rewind a few months and review what actually happened. Apple went into its June 29 iPhone launch with a stock of about 300,000 iPhones and a manufacturing capacity of roughly 150,000 a month, give or take. It knew it wanted to price the phone at $399 for the holidays, because it expected to ramp up its production lines significantly by then. But until about September or so, Apple was looking at constrained production. Demand was going to exceed supply -- big time.

Now, if Apple had launched the iPhone at $399, what would have happened? The lines at the Apple stores would have been twice as long, but there would have been no more iPhones. That means twice as many prospective customers would have been disappointed and turned away as the product sold out. Everyone and their brother would have written articles about how Apple has misjudged the market and its production. It would have been a PR disaster.

Instead, Apple used the Force -- the force of marketing, that is. It signaled its constrained production by introducing the product at a relatively high price (although as we've noted previously, $499 was a price that was entirely within normal ranges for other cell phones such as the original Motorola RAZR and is still less than today's Nokia N95). In essence, it said with its price that this phone was for the cool, well-heeled person who had to have the best. And so Apple had the largest consumer product launch in history by dollar value and even so, it was often out of stock for a month.

Now Apple could have continued this approach going into the holiday season, but by this time, its manufacturing partners have figured out how to make the phones and boosted production. This was a requirement for Apple to meet its goal of selling 10 million iPhones by the end of 2008 -- it had to have two to three times the production capacity by then. So with greater supply (and lower manufacturing costs to boot), Apple cut prices for the holidays.

There's one other important point: Apple needed to rationalize its pricing of the iPhone against the iPod touch launch price. The iPhone couldn't carry a $200 premium over an iPod touch; too many people would have just said, "I already have a phone" and bought those products. But by bringing the iPhone price into line with the iPod touch, Apple ensured that consumers could choose whichever device met their needs best without pricing playing a major factor.

We can calculate what this little twist was worth to Apple. We know based upon Jobs' statements yesterday that Apple is on track to sell its millionth phone this month. So for safety's sake, let's say that 900,000 are already sold at the higher price. Of those, maybe 150,000 will get some sort of rebate or refund through their credit cards or price protection (I don't think it will be nearly that high, but let's just accept it for argument). That leaves 750,000 phones that earned an extra $200 premium over the targeted $399 selling price. Do the math, and you discover that Apple pulled in an extra $150 million for its trouble. Not a bad business decision at all, given that that $150 million is largely profit. And that's a nice profit cushion for the iPhone business unit to have while Apple ramps up its carrier subscription revenue numbers.

People in the technology and investing press need to realize that Apple is in the high-touch consumer products business. Even at its high price, an 8 GByte iPhone was still less than your average Fendi or Louis Vuitton handbag, and no one writes outraged articles when those go on sale every year. With a clever pricing strategy, Apple both garnered a $150 million premium to its normal sales, generated significant PR buzz with almost no advertising or other marketing, and now is getting even more attention from its new lower price. As Steve Jobs said today about falling iPhone prices in USA Today, "That's technology." But it's darn good marketing as well.

Full disclosure: the author owns Apple stock.

UPDATE: Apple announced it is providing $100 rebates to all 8GB iPhone customers who haven't received other rebates. That means it will collect only a $75 million premium on the first sixty days, not $150 million. Sounds like even better marketing since it retains both some of the premium and the goodwill of early adopters.

Technorati Tags: Apple, Economics, iPhone, iPod, Manufacturing, Marketing, Pricing, Public Relations