Rumor says a small, 7-inch iPad is coming. It's a ploy to help Apple defend margins
Next time you're sitting at an airport bar and hear two businesspeople debate whether Apple (AAPL) is a technology or design company, chime in: "Nope. What Steve Jobs sells is pricing." Pricing? You bet. Jobs is a master of using pricing decoys, reference prices, bundling, and obscurity to make you think his shiny aluminum toys are a good deal. Apple's Sept. 1 announcement of new products was a classic example. The popular iPod Touch media player has been revamped at three price points, $229, $299, and $399—all costing more than the iPhone, which does everything the Touch can plus make phone calls. What gives? Watch Apple, and you can learn pricing tricks for your own business. First, understand that pricing games are vital for Apple, because competition is fierce in the tech world and product hits just don't last. The current iPad costs $499 in its lowest-powered configuration, vs. the Archos 7 Home Tablet ($189) or the Dell Streak ($299 with a two-year AT&T contract). And competitors are rushing to offer more functionality for hundreds of dollars less—the Streak tablet throws in a videocam and phone, which iPads don't yet match. Apple's touchscreen buzz window is closing fast, and even though it will inevitably add features—I predict the iPad will sport a camera, videocam, and phone within two years—today's tech wonders, like the much-copied iPhone, become tomorrow's commodity. So let's count the ways Apple defends itself with pricing: 1. Price decoys. The Economic Daily News of Taiwan reported in August that Apple has started to build smaller, 7-inch versions of its iPad tablet, timed to hit U.S. shelves before Christmas. If you wonder why in the world Apple would add yet another potentially cannibalizing product to its lineup of iPods, iPod Touches, iPads, laptops, and computers, realize that this gadget is likely a decoy. Decoys, in marketing, are products, services, or price points that a business doesn't really want you to take, but rather use as a reference to make another product look better. Economist Dan Ariely, author of Predictably Irrational, gives the classic example of a Realtor who shows you a home that needs a new roof, right before taking you to a higher-priced house she really wants to sell. It's hard to tell if a $400,000 colonial is a good deal—but compared with a $380,000 home that needs work, it looks damn good. Now consider, $499 for an iPad? Well, compared with a smaller one with fewer features, it suddenly looks great. Decoys explain why Apple often sells each gadget in a pricing series, such as the new iPod Touch's $229, $299, and $399 price points for different storage capacities. You may gladly spend $229 to get a hot media player, thinking it's a deal vs. the highest-priced version … and not blink that you could instead buy an iPhone 4 at the lower price of $199 with more features. The $399 "decoy" has clouded your judgment. Apple wins the best of both worlds—stoking demand for products that look like bargains and for all the decoys it sells at much higher prices. Yes, some people will spend $399 for a music player with slightly better technology—and Apple makes even fatter margins. 2. Establish a high reference price. Behaviorial economist Richard Thaler has noted that consumers are really bad at making decisions about value, so constantly need "reference prices" for comparison. A dress costs $80. Is that too much? Not if it's marked down 50 percent from $160. Trick is, that artificial $160 reference price may not really exist. Apple has played this game with itself by launching products such as the iPhone at artificially high reference prices—the iPhone cost $599 when it first hit the streets—and then rapidly lowering that price. Today, a $199 iPhone seems a steal; Apple in essence is using its first-iteration pricing as a reference to make its current products feel affordable. You may be on the fence for a $499 iPad, but if it drops to $399 by Christmas, won't you feel better?
3. Obscure the reference price. Ah, this is a more clever Apple marketing trick—instead of giving consumers a reference price, hide the pricing altogether. Mail order business Omaha Steaks does this by selling complex bundles of meat and side dishes for about $100; the assortment of items obscures any comparison with prices at your grocery store. Candy in movie theaters is another classic example of price obscurity, because it comes in unusual, large boxes that are shaped nothing like what you see at other stores—so $5 candy seems cool. Apple also obscures references by making its products look like nothing else, from the first iPod with a unique scroll wheel to the current iterations wrapped in gleaming aluminum. Apple seems wondrously unique, until you consider aluminum is the same material you wrap leftover fish in … and then it hits you: Apple is disguising itself so you can't compare prices. Is the new $99 Apple TV box a good deal? Who knows? It looks like nothing else on the planet. 4. Bundle price components to hide what you can. Buy an Apple product, and you'll spend more downstream. For every iPad or iPhone sold, Apple likely counts on your future song purchases, video rentals, and soon iAd clicks on app advertising. That sexy new Apple TV thing doesn't store anything, so you'll pay to play. Apple is not unusual here; almost every mobile handset, for instance, has some of its costs buried in future monthly data fees over a two-year phone contract. All of this "bundling" means the price over time is much more than what you think picking up the Apple gadget. The pricing strategy is brilliant. By staging a series of perceived technology innovations and then adding price decoys, reference prices, obscurity, and bundling, Apple makes us willing to pay more to do the same stuff we did 30 years ago: Read magazines, type messages, watch shows, make phone calls. The communication breakthroughs are mostly an illusion, but with shiny aluminum in our hands, who cares what it costs?