Apple's Pricing Decoys

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?

http://www.msnbc.msn.com/id/38973101/ns/business-bloomberg_businessweek/

Why Economists Love to Study Cellphone Pricing

By SAUL HANSELL

Have I tragically underestimated the ability of foreign cellphone companies to come up with devilishly complex pricing plans and the skill of economists to convert those schemes into pat theories that can be illustrated with neat charts and graphs?

The many people who have written me over the last two days about my Sunday article on the method behind the madness of cellphone pricing say I have.

The article began quoting Barry Nalebuff, a Yale economist, saying cellphone pricing plans were “weird.” Alex Kaufman, a doctoral candidate in economics at Harvard, wrote to chastise me for my “characterization of economists as throwing up their hands in confusion over this problem.”

Indeed, he pointed me to the work of Michael Grubb, now a professor at M.I.T.’s Sloan School of Business. I had spoken to Mr. Grubb for the article, in fact, on the recommendation of Mr. Nalebuff. His research seemed interesting, but a bit too involved to describe in the article, given how many other topics I had to cover.

Mr. Grubb told me that as a grad student he too was perplexed by pricing plans with big bundles of included minutes and high charges for extra minutes, what economists call three-part tariffs. After investigation, he wrote a paper arguing that phone companies were exploiting overconfidence by consumers about their ability to predict how many minutes they would use.He summarized this in an e-mail message to me:

Three-part tariffs optimally exploit overconfident consumers because overconfident consumers both underestimate the likelihood of very high usage, and the need to pay high overage charges, and underestimate the likelihood of very low usage, and the likelihood of not getting a refund for included “free” minutes.

Consumers certainly do make bad predictions about their own behavior. Studies show that people buy gym memberships, rather than paying per gym use, because they believe they will work out more than they really do. And when I wrote about the credit card industry, I saw studies that showed people thought they paid off their bills in full, and thus avoided interest charges, far more often than they actually did.

That’s not the only factor here, though. Andrew M. Odlyzko, a mathematics professor at the University of Minnesota, wrote me with a very interestingpaper he co-wrote in 1979 which argued that consumers often preferred flat-rate pricing to paying by usage even if it would save money. It cited data from phone companies that showed half the people who chose local phone plans with unlimited calling would have saved money choosing a pay-per-call plan. The paper listed three reasons:

(i) Insurance: It provides protection against sudden large bills. (What happens if my son comes back from college,and starts talking to his girlfriend around the clock?)
(ii) Overestimate of usage: Customers typically overestimate how much they use a service, with the ratio of their estimate to actual usage following a log-normal distribution.
(iii) Hassle factor: In a per-use situation, consumers keep worrying whether each call is worth the money it costs, and it has been observed that their usage goes down. A flat-rate plan allows them not to worry as to whether that call to their in-laws is really worth $0.05 per minute.

The second factor there matches up with Mr. Grubb’s idea that consumers are overconfident of their ability to predict how to save money. The cellphone executives I spoke to believed that the desire for stable prices, encouraged by their pain-inducing overage charges, was a better explanation for consumer behavior.

On another topic, several readers outside of the United States chastised me for oversimplifying cellphone pricing structures in the rest of the developed world. (And I didn’t even talk about emerging economies like India, where wireless service is much cheaper, mainly because of lower costs.)

One important difference is that in most other countries, the person who calls a cellphone pays the bill. Receiving wireless calls is free. This seems very attractive to consumers, especially when rates are high, and it helped explain the rapid deployment of cellphones in Europe and Asia.

But as it has developed, the caller-pays system has inhibited the use of cellphones. The rate to call a cellphone in many countries can be quite high and can vary depending on the carrier of the person you are calling (which you may not know). That means that calling one cellphone from another can lead to nasty charges. This, some say, explains why people in caller-pays countries talk on cellphones far less than people in the United States.

The article also didn’t make it clear that carriers in many countries offer subsidized handsets for people willing to commit to a service contract. Indeed, such plans are becoming more common in many countries as people try to afford expensive smartphones. But it is also true that it is far, far more common in many countries for people to buy phones at retail stores and then to buy prepaid blocks of minutes from carriers as they need them.

Spend a minute looking at the various options available in Britain, and you wouldn’t say that things are any less complicated there. Here is the page, from Carphone Warehouse, a large retailer, for the iPhone 3GS and for theBlackBerry Curve 8520.

One footnote I left out: A few people asked for citations for the effective average price of 5 cents a minute and 1 cent a text message I cited. The voice statistic came from the CTIA, a wireless industry trade group. The text figure came from a study of monthly cellphone bills conducted by Nielsen.

http://bits.blogs.nytimes.com/2009/11/17/why-economists-love-to-study-cellphone-pricing/?partner=rss&emc=rss