How Apple Will Handle Price Erosion with iPhone 7?

Apple is set to announce on September 7th  the next generation of its flagship iPhone. There are several rumors about the new model which no doubt will be called iPhone 7. I am not interested in the specific design changes, lack of headphone jack or any of the myriad subtleties that will get Apple fans excited. I am more interested in the most important part of the product – its price points. What are the different price points will its models be offered at to maximize Apple’s profit?

IKEA, which operates in a different domain and at the opposite end of price spectrum than Apple, says,

At IKEA we design the price tag first and then develop the product to suit that price.

Apple is no different because like IKEA, Amazon and Starbucks Apple is a Price Setter. With that let me make some predictions for iPhone 7 models and price points.

First prediction is a certainty at 100% confidence level. There will be two major models based on screen sizes – iPhone 7 and iPhone 7 Plus.

Second  prediction has more than 90% confidence level. Apple will announce 3 models under each screen size. The rule of 3 has been seen consistently throughout iPhone lifetime and we can safely say the same now.

Third  prediction has close to 90% confidence level. The price points of 3 models will be exactly same as the previous generation iPhone 6s as seen below.

iphone6s

Fourth prediction has higher than 90% confidence level.  The lowest capacity point will be 32 GB. There has been significant heartache among Apple fans and users on the capacity of lowest model. The 16GB has not been enough to store all the bloated OS, Apps, photos and music.

But that had served Apple well in delivering significant ASP (Average Selling Price) upside and profit. The table below is from opening weekend sales of iPhone 6, the first time Apple made the capacity points as 16GB, 64GB and 128GB.

iphone6-sales-forecast

As my previous analysis showed, Apple made about $4 billion additional profit per year by not offering more than 16GB for the lowest priced model. With iPhone sales slowing, Apple cannot allow for ASP erosion and profit drop because of 32GB model.  Which leads us to final prediction.

This final prediction has just 60% confidence level. There will be another feature that separates the iPhone models than just capacity. If Apple succeeded in the past by getting more to choose the 64GB version at higher price point by crippling the lowest priced version with 16GB capacity, it needs another way to make the lowest priced model unattractive to those who are tempted by the thinking 32GB is good enough at $100 less than next model.

The implied assertion here is the models won’t be simply 32GB, 128GB and 256GB but 32GB, 64GB and 128GB with a tweak to 32GB model.  The reasoning is based on Apple’s philosophy of giving customers just enough and nothing more. That is changing 16GB to 32GB does not mean the other too capacities double as well.

So expect the lowest priced 32GB model to lack a vanity feature that will prevent those who can afford to pay the additional $100 from choosing it, thereby help Apple keep its higher ASP and current profit levels.

If this prediction turns out to be false then you must start worrying about drop in profits the following quarter.

Product Positioning Comes to iPad Pro

Apple is running a new Ad telling us how great an iPad Pro is as a computer. The 30 second Ad is titled, “What is a computer?”

What is really going on here? This is a simple case of product positioning. To remind you, product positioning is telling (targeting) specific customers (segments) what job you want them to hire the product for. Remember, if you do not position your product they will do it themselves or if they don’t your competitors will do it for you.

You have seen the tablet sales and ASP go down quarter after quarter.

ipad-sales

Consumers are holding on to their older generation iPads as long as possible and with no revolutionary features there is no reason to buy new or upgrade. With iPhone, Apple Watch, and MacBook lines  Apple is already maxing out our wallet share.

So it decided to target a segment that has budget to pay (business customers) and telling them what specific job it wants them to hire an iPad Pro for.

Is that all net new revenue however? When customers hire one product for a job to be done they may have to fire another. In this case they could be firing Apple’s own MacBook Air. Apple is known for letting its new products cannibalize its past. In the case of MacBook Air it packs incredible amount of value at a very low price point. It does not generate any add-on sales to recoup lower gross margin. On the other hand the MacBook Air drives sales of $129 pencil,  $160 keyboard and app sales.

So Apple is happy to let iPad Pro take Macbook Air’s job and stop refreshing the latter line.

Marketing is nothing more than Segmentation, Targeting and Positioning.

How do you increase prices? The AT&T way

As a consumer I am like everyone else, I do not like prices going up. As a practitioner I appreciate well executed price increases. Starbucks and Apple continue to be shining examples of well executed price increases. Starbucks scores big for its repeated success and Apple for the high profit impact of its methods. While not quite in their league, I want to call out AT&T for its recent price increase rollout.

We have seen the quiet dance of price signaling between AT&T and Verizon before, this price increase is definitely in that template. If you have not seen the news, AT&T recently changed its wireless pricing plans:

  1. Got rid of its lowest priced option
  2. Got rid of data overages
  3. Lowered price of higher priced plans

Here is the before and after wireless pricing plan.

att-wireless-plans

If you look closer you will notice the finer points of this well executed price increase.

  1. Branding: The branded the entire spectrum of options differently, from Mobile Share Value to Mobile Share Advantage. The latter supposedly convey better value than just the word ‘value’.
  2. Eliminate the lowest priced option: In most cases, from a car wash to mobile service plan, you can execute a successful price increase simply by eliminating the lowest priced option. The reason is that it tempts too many people to self select.
  3. Increase price on lower end: Will the customers not complain or switch? Some likely would but AT&T incurs higher cost to support these low value customers and there really is no where else these customers could go glen similar low end strategy from other providers.
  4. Manage reference price effect: Reference price is what the customer is used to paying for and expects to pay in future. Customers are sensitive to that and react to that. One way to manage reference price effect is to avoid apples to apples comparison, remove old versions and replace them with newer different versions. In this case you can see except for two data levels most levels are new.
  5. Give more of what costs you less and what customers value more: Wireless service is a fixed cost business. After the infrastructure is laid out there is no additional marginal cost to serve you 3GB or 20GB. So AT&T packed more GB on higher end and lowered the price points. This will nudge more to move from lower band to higher price points compensating for any lost revenue from lower prices at this end. In any case they have enough data to show number of customers in each price band and how much data they use.

That is not bad for a backend infrastructure company.

 

The New York Times Fixing Pricing Errors

The New York Times subscription pricing was a mess. For a long time their pricing suffered  from three major errors

  1. No branding for versions – Let alone branding, there was no names for the multiple different versions they offered. It was simply a mix of features and a price point thrown in. It is very important to define your version and create positioning in the minds of customers. At the very least this helps create shortcut for customers to know what they are buying and at best makes them feel good about what they are buying.
  2. Too many choices – Is there really a right number of versions to offer? The right answer is there isn’t but more often in practice 3 has become the Goldilocks number. The Times had four with the fourth one a forced one.
  3. Wrong Value Allocation Among Versions: For versioning to be effective it must clearly show value differences among them. More precisely, the customers must perceive the value difference, see them as fair and be able to self-select to the right one. The Times had drawn value boundaries wrong – it created versions at different price points based on type of digital access. It tried to charge add-on for smartphone and tablet access over web access. So its pricing for Web+Smartphone+Tablet came to $8.75 vs. just Web+Smartphone at $3.75 and Web+Tablet at $5.
    Customers do not see access to same content through their multiple devices as additional value and do not want to pay for it. If you are creating 3 versions the customers must see clear value differences among them.

I am glad to see Times finally fixed their pricing errors. Here is their new pricing page:

nytimes-subscription

The versions all have a name.

No more contrived versions at multiple price points.

They don’t charge extra for smartphone or tablet access and created versions based on newer benefits, “Times Insider Access”.

That is fixing past pricing mistakes.

You are welcome The New York Times.

3 Charts Flash Warning Signs for Fitbit

In the past I wrote extensively about Fitbit’s Product-Market fit or lack there of.  Despite overly aggressive predictions from analyst firms on adoption of fitness devices, abandonment rates cautions us to take careful view of Fitbit growth.  Since  I last wrote my take on Fitbit it had made three earnings announcement. While Fitbit posted units and revenue growth in all three reports its stock took severe beatings after two of the three earnings reports.

After the recent July report the stock has been on upward swing.  It appears its Alta and Blaze models are selling briskly. According to  MarketRealist, Fitbit made 56% of its revenue from these two new devices. There are rumors about newer models of its Flex and Charge models.

Yet warnings signs aplenty if you look closely at Fitbit numbers. Here are three charts that flash warning signs for Fitbit. I compare only those metrics that are not affected by seasonalities – Gross margin and Average Selling Price (ASP).

Gross Margin Decline

alta-blaze-gm

Since the introduction of its new models Alta and Blaze the gross margin has taken a turn for worse. It appears Fitbit was able to make more per unit from its Flex and Charge bands than it is from flashy newer models. The chart shows combined gross margin drop. This tells us Fitbit’s pocket price is likely much lower than the list price for these units and/or its inability to control the bill of materials cost for these devices.

ASP Trend

alta-blaze-asp

The ASP (across all bands) improved from $88 to $105 in the quarter it introduced the devices. The list prices of $130 and $200 for Alta and Blaze respectively helped with this ASP improvement. But when we look at the most recent quarter we see a drop in ASP. This is especially a big concern given this was the first full quarter the devices were available compare to the previous quarter when the the devices were available only in the last month of the quarter.

Teasing out ASP of just Alta and Blaze

The previous ASP number was the blended ASP across all its bands. Given the numbers from MarketRealist that Fitbit made 47% and 56% of its revenue from just these two devices we can compute the blended ASP of just these two bands.

alta-blaze-alone-asp

This should give you a pause. The new models did well when they were new but then their sales seem to be driven more by promotions than by customer demand. It is a pretty steep drop within one quarter. Doing a quick channel check shows there are several promotions of $20 or more available on these devices. Blaze should be a bigger driver on increasing ASP from its $199 list price but its influence will wane when the rumored Charge 2 comes around in Fall.  As the Charge 2 gets more features it will make Blaze look less attractive with more customers picking either Charge 2 or splurging to buy a real smartwatch from Apple.

 

 

How is this still a business?

wineMarketPlace radio show tried to answer a reader question on wine pricing. A reader asked them to investigate,

How do wineries set the price of a bottle of wine?

The reporter answered this by calling on many different wineries. The answer from all of those interviewed is exactly the same – based on costs. And worse, with fixed cost allocation for each bottle of wine.

Adding up Costs -“… the price depends on three big costs. It would be vineyard, then production, then sales,”

Marketing Costs allocated to each bottle of wine – “80 percent of the cost of a $30 bottle of wine, distributed nationally, can be advertising”

Expecting customers to pay more for operations  – “And we’re pulling out any bugs, any leaves, any stems”   (To this the reporter replies, “I am willing to pay for wine without bugs”.)

Don’t forget to add packaging costs – “The grapes are going to be about 15 percent. The package might be 10 percent. The production is the vast majority of the cost for me.”

2012 NYTimes article on winery business points to dismal state of profitability in wine business. It is the only business where success is measured by ability to break even rather than ability to turn a profit. Once again we can see this cost driven thinking,

He said the costs of making a high-quality but small-production wine make it difficult to turn a profit. There are the salaries of the vineyard manager and the winemaker and also the costs of the bottles, labels and corks, which, he said, are $2 each.

The old saying in the wine business, “How to make $1 million in wine business? Start with $10 millions”,  seems to be explained by this pricing philosophy. If you look at this closely winery is one of the least customer driven of all businesses. There is no understanding of customer segment, why they buy wine to what wine to make. If they understand there is lot of factors affect the final product that are not under the maker’s control.

So you wonder how is this still a business? Only explanation is what one of the winemakers said,

“This wine business, we don’t make any money,” Mr. Ross said. “I do it for love. I sell shower doors for money.”