Computers

Apple Cuts Prices Strategically


Throughout the recession, Apple (AAPL) watchers have wondered whether the consumer electronics giant would release cheaper products to appeal to today's thrifty consumers. With sales of many products from other companies in the doldrums, the conventional wisdom goes, Apple could walk off with huge slices of market share for everything from Macs to iPods to iPhones if it would just lower their prices.

Apple ended the suspense at a company event for software developers on June 8, cutting the price on the most recent version of its iPhone and some versions of its MacBook Pro line of laptops. But far from slashing prices willy nilly, Apple made targeted cuts likely to help it win share without sacrificing the earnings gains that have powered an 80% increase in the stock price since mid-January, to 140.

The most dramatic move was to cut by half the price of today's iPhone 3G, to $99. Piper Jaffray (PJC) analyst Gene Munster speculates this cut will double demand for the phone—as occurred after Apple cut the price on the original device to $199 from $399 in June 2008. Apple's most recent reduction came two days after rival Palm (PALM) introduced its much-hyped Pre smartphone for $199. "I figured Apple would come in at closer to $149," Munster says. "They're clearly hungry for market share, and they don't want to give the Palm Pre room to breathe."

Even as it gains share, Apple is unlikely to sacrifice much margin. Analysts believe the profit margin on the $99 device will be roughly as cushy as in the past. Apple is benefiting from falling component prices as demand for displays, memory chips, hard drives, and other components dries up.

And given Apple's confidence in its ability to create hit products, the company has a penchant for convincing suppliers to give it even better prices in exchange for agreeing to buy up lots of units well into the future. Says one partner who asked not to be identified, "They got a very sweet deal from us, because we want to be in their future products." The huge increase in iPhones shipped will let the company better spread some fixed costs, such as for software development and advertising, over more revenue. Analysts figure that AT&T (T), the exclusive partner for the iPhone in the U.S., will pay for some of that $100 price drop, so as to lock customers in to the lucrative two-year sales contract. AT&T spokesman Mark Siegel says "the impact [of the subsidy on AT&T's bottom line] will be minimal," though he declined to elaborate.

Little if Any Impact on Gross Margins

No doubt, there are fewer dollars of profit on a $99 product compared to one that sells for twice that amount. But Apple also announced a faster, pricier new model that could help make up the difference. Called the iPhone 3G S—"the S is for speed," Apple marketing chief Phil Schiller told the crowd at San Francisco's Moscone Center—the device will cost $199 for a model with 16 gigabytes of storage and $299 for a 32GB model. Given that the additional 16GB cost only $24 or so, Apple is clearly keeping plenty of profit by charging $100 more, says David Carey, an analyst at tech consultancy Portelligent.

Apple can also expect a rising tide of profits from software. The company takes 30% of the sales from programs sold in its App Store. Once it unveils an upgrade to the iPhone software on June 16, developers will also be able to charge customers not only for the program, but also for upgrades or extras—say, new levels to keep gamers hooked on their favorite iPhone title. Many developers say this new capability will help them bring in far more money per customer. Apple's overall gross margins were at 34% in fiscal 2007 and 2008 and are likely to remain close to 35% in 2009, Munster says. "I would be shocked if these price cuts cause their margins to go down," he adds. Apple has forecast margins of 33% in the current quarter and 30% in the next.

The company also lowered prices on laptops, though less dramatically. Despite the rise of inexpensive netbooks based on Microsoft's (MSFT) Windows software costing as little as $200, Apple didn't bring out a cheaper entry-level model. Instead, it lowered the price of various versions of its higher-end MacBook Pro laptops by $300. At the same time, it beefed up the capabilities of one of its more affordable offerings, the MacBook Pro with a 13-inch screen. Now tricked out with more memory, a better screen, and a longer-life battery, the device has been repositioned at the low end of the top-shelf MacBook Pro line. "Yesterday, it cost $2,000 to own a MacBook Pro," says Gartner (IT) analyst Van Baker. "Today, it costs $1,199. This is Apple doing what it's always done: It goes after the higher-end customer."

New iPhone Boasts Speech Advances

Ordinarily a company's refusal to match competitors' price cuts on certain devices might cost it market share. But Apple continues to bring out new innovations that analysts think will continue to entice consumers. The new iPhone 3G S includes a higher-resolution camera, with software tricks such as the ability to focus on your subject by simply tapping on the screen. And it's the first iPhone that can be used to record video.

With the new iPhone, Apple pulls into the lead when it comes to using speech as a way to operate a phone. While other phones let you dial a friend by simply saying their name, iPhone users can now also ask their phone to play all the songs by a given artist in their iTunes library, or even ask it to create a playlist of songs like the one playing at any given moment. "That's fantastic," says Steve Chambers, an executive with speech recognition company Nuance (NUAN). "Apple may be late with some basic features, but it is clearly pioneering the use of speech in other ways." Chambers won't say whether Nuance's technology is used in the new iPhone, but says that Apple has "licensed a broad portfolio of our speech technologies for use in their products."

For the most part, investors seemed comfortable with the announcements of the day. Shares lost less than 1% despite Apple Chief Executive Steve Jobs not making the appearance that some blogs speculated he might make. On medical leave since January due to complications from pancreatic cancer, rumor sites and investors debated whether he would show. Even here, it seems Apple may reject such black-and-white alternatives. "The company is going to take a phased approach" to Jobs' return to work, which the company has said will occur by the end of June, says Tim Bajarin, president of consulting firm Creative Strategies. "There's no reason he would come right back to a 40-hour workweek."

Burrows is a senior writer for BusinessWeek, based in Silicon Valley. With Olga Kharif in Portland, Ore.

Burrows is a senior writer for Bloomberg Businessweek, based in San Francisco.

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