Retaining Pricing Power – iCloud Case Study

When rumors about Apple’s iCloud started appearing I was surprised that they were getting ready to give up the biggest pricing lever they have – Flash Capacity. If files were stored in the cloud and streamed to the device then does it matter whether you have a 16GB iPad or 32Gb iPad? Will customers bother to pay more just to get additional capacity?

In the past I wrote at length on how Apple practices effective price discrimination with its pricing for Flash capacity in its iDevices.  Here is the chart I used that shows the price curves for different iDevices.

How Apple prices Flash capacity has nothing to do with what it costs them. iSuppli breakdown showed that price difference between 16GB and 32GB iPad is only  $15 while the price jump is much more than that.

Another noteworthy aspect of this Flash pricing is the price jump is not the same for all iDevices. As you can see from the chart, the curves get steeper as the screen size and functionality of the device increase. Clearly, the value from additional 16GB flash to an iPad customer is lot more than that for iPod or iPhone customer.

So the same capacity is priced differently based on the value to the customer.

The final and crucial piece of price discrimination puzzle is the absence of arbitrage. Apple completes its power to practice price discrimination by eliminating arbitrage (in this case alternatives). A simple way for customers to add more capacity is through extension slots but none of the iDevices provide that feature. So if we want more capacity we better be ready to pay more, lot more.

With iCloud is Apple likely to lose this pricing power by creating arbitrage?  It would have if the files were really streamed from the cloud like Amazon and Google. But true to their pricing mantra of capturing all customer surplus upfront the iCloud solution does not permit any arbitrage opportunity for the customers. The Journal sheds more light on the iCloud implementation that is very different from that of  Amazon and Google

Apple’s strategy, on the other hand, rests on consumers storing their content locally on their devices. Its new iCloud service allows consumers to easily sync their music collections to any of their Apple devices. Aside from the initial sync, a Web connection isn’t necessary.

In other words, the need for bigger capacity on iDevices still exists. Customers cannot trade iCloud capacity and streaming to offset the higher price premium they pay for bigger flash capacity. We will continue to pay $100 for our perceived need for higher capacity.

Apple will continue to capture value from commodity components.

Despite the competitions and the disruptions, Apple continues to retain its pricing power – built into their product DNA is the need to maintain pricing power. What we see is an example of perfect alignment of product and pricing strategy that helps them with the real business goal – profit.

Is your product strategy aligned with your pricing strategy?

A Neat Execution of Multi-Version Pricing By AT&T

When was the last time you looked at your AT&T bill, paper or electronic? If you are a smart phone customer with unlimited data plan you will be surprised to find page after page of itemized data usage.  If the data plan is all you can eat, why bother with this data? It was  about signaling value and protecting reference price, preparing us for the future of tiered pricing.

Future is here as AT&T announced that it is moving away from unlimited pricing to three tiers of pricing. It is very similar to a pricing plan I wrote about almost an year ago. A crippled 200MB version for $15, a mid tier 2GB version  for $25 and a higher priced version that scales linearly with each GB.

AT&T says 65% of their customers use less than 200MB and 98% use less than 2GB. On the surface this would look like a price cut to a majority of the customers. Which is what makes this price change all the more effective, positioning it as price cut to majority of the current customers.

Their $15 version will find only a few takers despite the 65% claim. It is crippled so that those with high willingness to pay will not be tempted by it.

A $25 price for 98% of their customer base may look like un-captured consumer surplus. But they are not skating to where the puck is now but are skating to where the puck will be. What AT&T is looking at is how this customer mix and usage behavior is changing with our always connected iPad world and how much value we will get from a fat data pipe spewing media into our devices.

The net is they are practicing effective price management, targeting each segment with a version at a price point they are willing to pay.

If one price is good, two are better!

Aligining Price With Value – Metering Vs. Versioning

In any  all you can eat pricing model, be it a lunch buffet or at&t iPhone subscription pricing, as long as the  total revenue  exceeds total costs, the business will make a profit  regardless of whether they lose money on any one customer.  There will always be a distribution of customers based on value they receive and price they pay

  1. Some customers get more value than what they pay
  2. Some don’t get as much value as they paid for

The problem occurs  when  the first segment uses a higher proportion of the service and risk completely starving the second segment.

AT&T says,

the heaviest data users, saying that 40 percent of AT&T’s data traffic came from just 3 percent of its smartphone customers

To provide appropriate level of service to the second segment AT&T needs to size their services so the big appetite of the first segment is served. Facing customer backlash from slowness, AT&T is trying to reduce data usage by the heavy iPhone users – this implies they are either working on introducing metered pricing or a multi-version pricing.

Either of these plans require that their subscribers understand the value they get from the current unlimited plan. If the customers do not know  how much value they have been receiving they will balk at any changes to current pricing. AT&T has a leg up on this, they have been itemizing  data plan usage minutes (page after page if you received paper bill) even though the plan is supposed to be unlimited. It is arguable how many customers look at paper bill but the auditing does provide a way for AT&T to make a case with its customers when they introduce new pricing plan.

For example,

“Dear customer, do you know, on the average, you used 100 minutes of data service for 1GBytes download in the past 12 months. That’s $50 in value per month and $30 more than what other customers like you receive. To better serve your needs and those of all our customers like yourself we are introducing a new pricing plan …”

Which one will it be? Will it be metering, charging per minute or megabyte of download of data usage? Will it be a set of new data plan versions offering a combination of minutes and download? Which has better chances of succeeding?

I do not believe it will be usage based pricing. It does not align with the current minutes plan and the  problem it introduces with customers constantly worrying about using the data service.  AT&T already has a track record in executing a successful multi version pricing plan for its wireline high speed service (see figure left). Modeled after this we should expect to see three to six different data plans at different price points, each offering a combination of minutes and download (GBytes).

Versioning is about offering multiple versions at different price points so the customers self select- in this case it also helps to better align the value customers have been receiving with the price they pay.

Market Share Or Profit Share?

Would you prefer to get 50% of the market share (in whatever market you play in?) Almost all businesses would like half the market.  The focus on market share is built into every marketing campaign, sales and pricing decision made. Is market share the right metric to measure a business’ success? One other metric that was popularized by BCG was the Relative Market Share (RMS). It tries to add more relevance by measuring success of the business relative to others.

Relative Market Share (I) = Brand’s Market Share ($,#)/Largest Competitor’s Market Share ($,#) (source link)

For the market share leader, the largest competitor is the second largest competitor. For everyone else it is the market share leader. So for the business with 50% market share in a market where the next biggest competitor has 20% market share, the leader’s RMS is 2.5.

RMS does add more relevance over the simple market share metric. RMS, combined with market growth rate, is used to position the business in the BCG 2X2 (Star, Cash cow, ???, Dog). But does this still tell anything about the profits the business is making or what it takes to bring in the profit? Is the market share leader with 2.5 RMS in a growing market better off than its competitors?

Let us look at the cellphone market share and profit share metrics reported by The Wall Street Journal.  The chart “Ringing Up Profits” comes from the WSJ article. Looking at the simple market share numbers, Nokia is clearly the leader with 45% revenue share and Apple is no where to be seen on the revenue share.  The next biggest competitor to Nokia is Samsung that has a market share of 31%. So the RMS for Nokia is close to 1.5.

Next let us look at the profit share. Again Nokia is the leader with close to 59%. The next biggest competitor with most profit is not any Samsung, it is Apple with 20% share of the toal market profit.

If we used a metric “Relative Market Share Profit – RMSP” which is similar to RMS except computed using profit numbers, Nokia has a RMSP of close to 3.

Yet if you looked at Nokia’s latest earnings its not doing great. Barrons magazine wrote “sell” after the earnings report. Today Apple announced blow out numbers, 15% increase in net profit. Apple stock has been on a tear. So why Nokia with a high RMS number doing financially poorly and Apple with extremely low RMS is doing extremely well even in the down market?

The answer lies in what it takes to deliver the profit and RMS does not capture this data. Apple and RIM with a total of less than 3% market share have 35% of the total profit in the cellphone market. That clearly point to the high variation in the operating margin between  Apple+ RIM and the rest of the cellphone makers. The variation comes form the product mix – Apple and RIM sell just the high margin smartphones. The smartphone revenues  are still a very small fraction of the overall cellphone market but have a disproportionately higher share of the market profit.

The simplicity of using one metric like RMS to describe the market dynamics, while attractive, is far from useful in defining it meaningfully. Yet I am compelled to do just that with a different single metric,  “Relative Profit-Revenue Share Ratio “. This is defined as follows

Profit-Revenue Share ratio  =      Profit share %/Revenue Share%   ( let us call this  PR Ratio)

Relative  Profit-Revenue Share ratio =   PR Ratio/(PR Ratio of  largest competitor)

If we use the numbers from the WSJ article and computed the ratios, the results will look like this

rp-ratioNow we can see which market player is most effective in wringing out profits out of those revenues.

Will att offer a $20 iPhone subscription plan

As predicted by the Financial Times story Apple announced a 50% price cut on its entry level iPhone. It kept is price levels at $199 and $299 for the newer versions that not only have more capacity but also have better features, most important of which is shooting and editing videos. In the 2X2 map of price sensitivity of phones vs. plans, Apple’s move addresses the segment that has high price sensitivity for phones  but leaves out the segments that have high price sensitivity to plan price.

I previously talked about at&t’s reported plan to either cut its cost for data plan or introduce a new plan for $20. It does not make business sense to cut the price of existing plan. So the right option is to introduce a new data plan for $20 but with restricted bandwidth.

at&t should design its versioning and pricing such that those with higher data needs will self select themselves for the higher rate plan. Another factor in all you can subscription pricing is that an average user should consume less than their allocated bandwidth and anyone who exceeds the limit must be penalized such that they are nudged to upgrade to the next higher plan.

Since the new iPhone 3G-S introduced yesterday have features that consume higher bandwidth it is expected that the average data usage on the newer iPhones are bound to be higher than what it is with current iPhones. If at&t were to introduce a lower priced data plan it should limit it to the low-end iPhone. This is also in sync with the positioning by Apple to target the price sensitive segment – the lower left corner of the matrix.

Together, the $99 iPhone and a $20 data plan (if introduced) capture three of the four segments identified and nudge the fourth (bottom right) to move to upper right and hence lead to profit maximization for at&t.

iPhone Multi-Version Pricing Will Increase Its Market Share

Financial Times reported the possibility of Apple introducing new versions of iPhone priced at $99 (or a $149 or both). Previously at&t was reported to be considering a restricted data plan at $20.  Combined, the two plans will work to address the price sensitive customer segments. This move is not surprising given the strategic trackrecord of Apple and at&t in the past. As the saying goes, if one price is good, two are better.