Early adopters of the iPhone were outraged when Apple announced last week that it was lowering the cost of the device by $200. So angry, in fact, that Apple offered iPhone users a $100 coupon for Apple products. Apple’s pricing decision makes good economic sense — start a new product out with a high price to maximize the profit you extract from those desperate to get their hands on the new gizmo, then gradually lower the price to attract consumers who are less rabid for the device. So why are customers so angry, and did Apple make a mistake?
Though some have argued that the whole incident was an orchestrated PR move, in the Freakonomics blog on NY Times.com economist Steven J. Levitt points out an often overlooked reality:
What economists (and Apple too, I guess) ignore is that consumers hate it when companies follow practices that look like they are designed to maximize profits. You won’t find it in economic models, but consumers care about the reason a firm chooses the price it chooses. If a firm raises prices because something happens to make it more expensive to supply the good (e.g. oil prices rise, so the price of airline tickets goes up), consumers are accepting…. But when prices are raised and lowered strictly with the goal of extracting the most possible from consumers, people get upset. Apple’s price cut looks like one driven purely by a desire to maximize profit, which is why everyone is so mad.
Still, Apple would have lost something in the neighborhood of $200 million if they had introduced the iPhone at $300, so how could Apple have handled the situation in such a way as to anger neither customers nor shareholders? Levitt suggests,
A $200 coupon to the early adopters. It wouldn’t have cost Apple that much more, and it would have made it much more difficult for early adopters to remain angry. Why go halfway? The company also could have waited until the new version was available and timed the price change to coincide with the introduction of the fancier version.
It’s an interesting case and one that points out that pricing a product is not entirely about maximizing profits and responding to fluctuations in supply and demand. It also contains an element of PR (as many “luxury” handbags demonstrate). It matters not only what your product costs but also that customers have a sense of why it’s priced as it is. If the price seems to suggest that your most enthusiastic customers are dupes (rather than sophisticates), then it’s unlikely they’ll take the insult with a smile, regardless of whether there is merit to the charge.
(Image of price tag by Rhymes with Nicole, CC 2.0)
