How can you find the number of $399 iPads sold?

When Apple announced their new iPad, they kept their current iPad2 model and said that they will sell this at $399. The $399 iPad2 is targeted at two segments

  1. Leaning towards Kindle Fire: Those who are attracted to Amazon’s $199 Kindle Fire but  now see higher value for their money in a $399 iPad (but do not find value in $499 iPad)
  2. Waiting it out: Those who do not find value in both the Kindle Fire due to its size etc.  despite its price  and  the feature rich $499 iPad due to its price

There is a third segment they don’t want to target but cannot avoid – new customers who would have picked the new iPad but find the $100 price drop attractive and hence choose that instead.

Add them up, you have the number of $399 iPad2 Apple will sell.

Why this is important? Because it tells us the market share Apple is going to take from Kindle Fire.

But we don’t have the customer segmentation data (Apple does). Furthermore, Apple does not breakout numbers on individual iPad lines.

We are not going to find the answer until next earnings report. But here is how you can model that number:

  1. In its quarterly earnings report Apple tells us the number of iPad devices sold and the revenue from the line. From these two data points we can find the average selling price (ASP)
  2. Luckily for our analysis Apple just kept one $399 model and discontinued all other iPad2 models.
  3. Last quarter they sold 15.5 million iPad2 units. Analysts are predicting similar number for next quarter. Any increase we see is from selling $399 units (n1)  and from increase in new iPad numbers  (n2) due to retina display  its support for 4G.
    n1 + n2 = the increase in number of iPad units from previous quarter
  4. We have two unknowns and one equation. We need one more equation
    For this we use the revenue from iPad numbers from Apple’s report. The change in revenue between two quarters is due to revenues from n1 and n2. ASP of n1 units is $399 and for n2 units we can assume the same ASP as previous quarter when there was no $399 iPad.
    n1 X $399 + n2  X last quarter ASP = Increase in iPad revenue

The number n1 will also tell us the market share Apple took from Amazon’s Kindle Fire.

Now you can be the first to report this number when Apple reports its earnings next quarter.

What if the reported iPad numbers are lower than previous quarter (or the same)? Not that difficult to do similar math and is left as an exercise to the reader.

Will Apple introduce $299 iPad?

There  are rumors in Tech Blogs that Apple might introduce a cheaper iPad – could be a 8GB version or a 7-inch version, priced close to $299. The argument goes, Apple does not want to yield the lower priced tablet market to Amazon. If Amazon took the risk to invest in 7-inch tablet and uncover a market for it, there is likely no risk for Apple to take its share of the market.

So should or will they do it? (Let us not consider here what Mr. Jobs said about 7 inch tablets)
If three to five million people bought 7-inch tablets in the last two quarters, isn’t that an opportunity for Apple? Not to mention, those who are on the sidelines, because they did not like Kindle Fire and could not afford $499 price tag may enter the market, expanding the pie.

All highly likely scenarios. But there is a third scenario of similar likelihood that most ignore when making a case for introducing a new lower priced version of the product. It is those who currently buy their $499 version switching to the $299 version.

Without going into the details of Second Degree Price discrimination here is a brief description. When there is no $299 version of iPad, if the $499 version offers you enough consumer surplus you will buy it. When there is a $299 version as well, you will pick that instead if it delivers more consumer surplus than the $499 version.

The question Apple will ask (but not the Tech Blog savants who are often wrong but never doubt their claims) is,

Is the foregone profit from those trading down made up by profit from new customers we acquired?

You can see their track record of past product versions (iMac versions  and MacBook Air versions)  we can say with high degree of certainty that Apple will ask this question.

If we used the previously published numbers by iSuppli and others on cost of iPad, it costs Apple about $249 to make $499 iPad. Say their gross margin remains the same for $299 iPad (i.e., cost drops to $149). Then for every customer trading down from $499 to $299 version, Apple has to bring in 1.67 new customers.

That is just to break-even the trading down customers. In addition they need to find millions more  to justify their investment.

Can they do it?

Side Note 1: When you uncover a new market or spend your resources to develop a new market, it is not all yours. Others will swoop in and get their share.

Side Note 2: If you run a frozen yogurt chain and want to offer a lower priced plain yogurt version, this is the question you should ask – Am I losing profit from those trading down to plain yogurt because they get better consumer surplus at its price point?

Second Degree Price Discrimination Infographic

Could not resist the title.

Take a closer look at the two images. These show the prices and main features of the tablets at the two extremes. In fact there are only extremes in the tablet market. There is no middle yet.

What do these images say about price discrimination? Write your answers on the back of iPad3 and send it to me.

The first image lists prices of Wifi only and 3G versions of tablets.

Why the price difference is not the same?

The second image shows the price difference of the tablets based on their storage.

Why the price difference?

There are two kinds of companies – Price Setters and Price Takers

When Amazon introduced its Kindle Fire it positioned it as a direct competition to Apple’s expensive iPad. In a letter published in its landing page, Mr. Bezos drew a clear distinction between Apple’s pricing strategy and Amazon’s pricing strategy. Apple was not explicitly named in the letter, but not hard for all to see who Mr. Bezos was talking about.

The two kinds of companies, according to Mr. Bezos, are those that focus on charging more vs. those that focus on charging less. While that is a pricing distinction Mr. Bezos want to drive for Kindle Fire positioning, there is another way to classify companies – based on the level of control they have in pricing their products. In fact I should say, the level of control they are willing to exercise and follow through in pricing their products.

There are indeed two types of companies; those that work hard to set prices (Price Setters) and those that just tag along, take market prices and work hard to stay alive (Price Takers). Be it charging for perceived value to customers (Apple’s pricing) or charging to reach the mass market and keep out the competition (Amazon), they both have a well defined strategy and work hard to implement it.

When Mr. Jobs was Apple’s CEO he used to say (some version of it)

If we knew how to make cheaper products that we are not ashamed of putting it in your hands, we would have made it

When Mr. Bezos talks about pricing (as recently as last week in Times) he seems to be saying (paraphrased)

We are not thinking short term, we can keep our prices low for a long long time, longer than our competitors can stay solvent

The core strategy and their commitment to follow through on it come through clearly in such statements. Apple and Amazon are Price Setters. They are not going to let the market set their prices.

Apple and Amazon are not alone in this class, Wal Mart , Whole Foods, lulu lemon, Wall Street Journal, REI, and most luxury brands (across all categories) are also  Price Setters. But this is small class of companies.

Price Takers are a large class of companies. They have no pricing strategy or if they have one they lack the will and wherewithal to follow through. They react. They let the markets decide their prices. You can go back and look at recent price drops of many products and see for yourselves who belong to this class.

Price Setters-3

Mr. Bezos wrote in his letter, companies that charge more and those that charge less can both thrive. Unfortunately that is not the case when it comes to Price Setters and Price Takers.

Price Setters will thrive and go on to create significant value over long term.

Price Takers will be relegated to the footnotes of history.