We’ve all heard the story of the Golden Goose, how the owners cut it open to find its source of gold and thereby destroyed its daily output. Apple, with its iPhone, has a veritable Golden Goose: its profit margins (around 50%) are unprecedented in the tech industry (where many products make their makers a mere 10%, if that).
Initially such a remarkable feat was explainable because Apple had tech that no one else had: an innovative new touchscreen device that was unique. As long as the iPhone is special, Apple is able to command high subsidies from carriers.
These days everyone has copied Apple, so the logic is that the iPhone is no longer unique and Apple’s subsidy Golden Goose must end.
But here’s the thing: the copies are selling, but Apple’s iPhone is also selling. In fact, Apple can barely keep up with demand! Thus Apple’s margins have remained high. Carriers are willing to pay a premium to carry the iPhone because the iPhone brings in customers that otherwise would flee to other networks.
So why would Apple kill the Golden Goose by releasing a cheaper iPhone of their own volition?
Making It Up in Volume
Analysts claim a cheaper phone is the thing to do because it will drive market share. Apple might make less profit on each phone, but they’ll lock millions more customers into the Apple ecosystem and over the long haul will make more money.
This is dubious, at best. How many extra phones would Apple sell for each ten percent price cut? If an iPhone sold for $500 instead of $600, would that mere $100 price difference really sell that many more phones? In order to sell enough phones for ecosystem sales (where Apple makes as much as 30% of each sale) to make a difference — let’s say double the number of phones — the price would have to be significantly lower. That means 50% less, or $300 instead of $600. If Apple were to do that, the phones would have to be of lesser quality and margins would be razor thin. Pretty much what everyone in the industry except for Apple is doing!
So go look at Android and see how that’s working out for them. Most of the manufacturers are losing money on the hardware (Samsung is only profitable because they also make many cell phone components), and Google makes very little post-sale. Basically, people who buy cheap phones don’t buy anything later!
Most Androids are used as a feature phones (dumbphones). Their owners never buy apps, barely use the web, and don’t buy media (they either don’t consume it or pirate). They don’t even tap on mobile ads (Google makes far more selling ads on iPhones than it does on Androids, even though there are more Androids out there).
Apple, therefore, has chosen to compete in the higher-end of the market. It will not make cheap phones. By owning the best customers, Apple makes money at both ends: at the initial sale and long afterward, when the customer buys apps, movies, books, and more. Apple is intentionally ceding the lower market, the cheap customers. Is that a mistake?
The argument against that strategy is that Apple is losing market share to a competitor. The idea is that Android will become the dominant platform and developers will stop making apps for Apple’s device and concentrate on the bigger market.
But this forgets two key points. One, that larger market isn’t making developers money. Developers want to make apps for iOS because that’s where they can actually profit.
Two, the smartphone market is not like the PC market of old. In PCs, Microsoft established an ecosystem — Windows — and locked customers into that platform. That lock-in is a key advantage of ecosystems. But where’s the lock-in when customers aren’t actually using apps or buying anything on that platform?
Even if customers do buy a few mobile apps, mobile apps don’t cost as much as traditional desktop apps. It’s quite a different thing to move from a Windows PC with possibly thousands of dollars of applications to a Mac where you have to buy all those programs again, versus mobile where you might have $50 of games and apps to buy on the new platform.
In other words, what makes a mobile platform “sticky” isn’t the same as on the desktop: it’s the user experience that keeps people on iPhone. That’s why vastly more people move from Android to iPhone than the other way around.
Another key difference with the PC market — where Microsoft ruled for two decades with an OS-based monopoly — is that desktops are long-term purchases. People don’t buy a new computer every few years any more. But in mobile, that’s not true. Mobile tech is changing so rapidly that everyone wants a new phone every year or two. That’s a huge opportunity for Apple, especially if customers aren’t happy with their cheap Androids.
In other words, Apple’s fine allowing Android to gain a little ground now. It’s temporary. In a couple of years, those frustrated and unhappy customers will be delighted to switch to Apple.
When Will the Golden Goose Die?
Clearly, no Golden Goose lasts forever. At some point, Apple will have to reduce their margins.
Or will they?
Look at what Apple did with iPods: over time, they introduced a variety of models with different capabilities and price points. They still made a nice profit on each one.
It doesn’t take a genius to see that Apple’s strategy with iPhone will be the same. However, until yesterday’s announcement of two new phones, the 5C and 5S, Apple had never produced multiple models of an iPhone. (In the past, Apple has just kept around older models to sell at discounted prices.) This is the beginning of Apple’s strategy, but many are impatient. They forget that Apple didn’t release all those iPods instantly: they evolved over time.
The iPhone is far trickier than an iPod. An iPod is relatively simple: it just plays music. It needs a way to sync music to it, to charge it, an interface to control song selection and playback, and perhaps a few other bells and whistles (such as Nike fitness tracking, a camera, or a radio). Within those requirements, Apple was able to produce a range from high-end iPods that featured large amounts of storage and bigger screens to the diminutive iPod Shuffle with no screen at all.
How in the world do you produce an iPhone without a screen? It is feasible: Apple already has voice control, so I can imagine a tiny device that you control with a voice interface. But the tech to do that in a way that meets Apple’s standards of quality isn’t here yet and probably won’t be for a few years.
Apple is in a precarious position regarding its Golden Goose: if it produces something cheaper that’s “good enough,” most people won’t buy the higher-end product. Finding just the right mix of features while still being an “iPhone” is extremely difficult. If Apple trims out too much for a cheaper product, it risks damaging its brand. With a pocket computer like an iPhone, removing hardware features can ruin the whole purpose of why someone would buy it in the first place.
That’s why Apple must move carefully in how it adds new products to the iPhone lineup. Too cheap hurts the brand and cannibalizes higher-profit sales. Too low-functioning and the product is no longer an “iPhone.”
What Apple has done with the 5C and 5S is fascinating. The 5C is not much different from the iPhone 5 in terms of internal hardware. It’s year-old tech in a new plastic case. But the colored phones are plenty functional and fun and slightly cheaper. That means big margins for Apple, but still plenty of appeal to buyers. I predict the 5C will be a huge seller.
The 5S is definitely aspirational. The fingerprint sensor is awesome: everyone will want it, but it’s not critical. The new camera features are desirable, but not critical. The unique M7 chip that tracks your motion without battery drain is cool, but not critical. If someone is pinching pennies, they’ll drool over the 5S and buy the 5C. Some will sell a kidney and buy the 5S just because it’s aspirational.
Apple has successfully separated the two models. The two are close enough it’s like deciding between a smaller, slightly cheaper iPod nano with less storage and a bigger iPod with room for all your songs. It’s genius.
Apple’s Sleight of Hand
Many are critical the 5C isn’t cheap enough, but they’re missing the point: the second model wasn’t about price. It’s about differentiation.
This is just the beginning of Apple’s long-term plans for having multiple iPhone models. I believe that eventually Apple will have a whole slew of different models at different price points, just like they did with iPods. It just will take more time with iPhones, both because of the nature of the device — it’s more complicated and mobile tech was progressing far too rapidly (that pace of change is slowing) — and because Apple has to be extremely careful it doesn’t kill the Golden Goose. Its products need to be perceived as high-end for it to command a high price. It would ruin the brand to suddenly introduce something cheap.
In fact, I believe that Apple has fooled everyone with the 5C. People are seeing it as the cheap phone and the 5S as the “real” iPhone. That’s the opposite of what Apple has done.
In reality, the 5C is the “real” iPhone. That’s the iPhone for the masses. The 5S is the red herring. Apple has made it to move the high-end upward. In effect, Apple has actually lowered the price of its main product. Yet it did this in a way that has fooled everyone. By making the case plastic and the manufacturing process simpler, and using year-old parts, Apple’s profits are the same even with the lower price. Yet now an iPhone costs $100 less!
This trick is brilliant because it keeps the perception that Apple is expensive. It doesn’t hurt the brand at all. Apple is still aspirational, and even the “low-end” 5C is so well-made and designed that people will desire it. Teens, especially, will love the 5C, while the 5S will appeal to well-heeled adults and security conscious IT people.
This trick also sets Apple up for the future: who doesn’t believe that next year’s iPhone 5C-equivalent won’t have a fingerprint sensor or other features that are standard today on the “high-end” 5S?
Apple has set the standard for the top, and it can, as needed, ease those features down the line, producing a slew of different iPhone models. Each would have the basic capability of being an “iPhone” — running apps, making calls, taking pictures — but some models will have more features for a little bit more money.
By doing this, Apple is preserving its Golden Goose. It may eventually even have a cheap phone — perhaps a $200 cellphone watch without a screen — but because the Apple brand will still be so coveted, carriers will essentially be forced into carrying Apple’s products and paying Apple a hefty premium.
At that point, Apple will have products all over the price spectrum, yet still be generating margins in the 50% range!