Should Apple Move Down-market?

A question I have pondered from time to time is whether Apple should be moving down-market with their devices, offering substantially cheaper versions of what they make. There is risk to this, since it can be viewed as cheapening the brand. But there is also merit, in that it might help Apple gain new marketshare, and protect marketshare it has.

Competitors, Entry Points and Margins

One of the elements in Clayton Christensen’s book The Innovators Dilemma is that competitors often enter a particular market from the low-end. As companies mature and grow, they continue to chase the “right side of the graph”, going for the higher-priced and higher-margin spaces, and abandon the low-end as they do so. This opens up room for new entrants into the market, and can give them a foothold that allows them to grow and eventually displace the incumbents.

Typically, the low-end of a market (as represented by low prices for product) is typically also the one with the smallest margin of profit. Since profitability is the name of the game for most businesses, there is always pressure to either squeeze more profit out of your current products, or move into a space where you can charge a higher price and gain a larger profit. For low-end products, the margins are razor thin, and you offset that with volume: I may only make $1 per unit in profit, but if I sell 100 million of them, that starts to look like real money.

Apple Typically Ignores The Bottom

If you look at most of Apple’s product line, you’ll find that they typically don’t bother with products in the low-end of the price scale. There are exceptions. Apple has tried to offer relatively inexpensive iPods, after years of ignoring that segment. Through subsidized prices, they have a cheap/free version of the iPhone, albeit a rather old model. The entry price of the MacMini and 11″ MacBook Air, while still higher than the truly low end, is still lower than traditional Apple prices.

Apple makes a lot of money, and they do so by selling largely high-profit margin products. Where a typical consumer product, like an entry-level PC, may only represent 1-5% profit margin (you don’t make much on a $500 PC), Apple rarely takes less than 30-40% in profit margin on their devices. When compared like-against-like, most Apple products aren’t all that far out of line in terms of pricing. But people naturally compare the “cheapest Apple” agains the “cheapest from the other guys”, and Apple comes up wanting. In some ways, it is like comparing the cheapest Audi in North America to the cheapest Kia: the Kia will win every time, even though the Audi is a more up-scale car (no knock against Kia, they have some amazing product out now). It isn’t  a reasonable comparison.

So naturally one could ask if ignoring the low-end of the market is a mistake. Going after this space has pros and cons, as the biggest car manufacturers can tell you. A full-line automaker like Ford, Toyota or Volkswagen can tell you the challenges of trying to have cars across the entire spectrum of price and functionality, but also the potential benefits.

Pitfalls For The Entry-level

Going after the bottom can sometimes drag down the top. It isn’t universally true, but it is a risk. There’s a reason why guys like GM don’t try to sell $18,000 Cadillacs: it makes it hard to justify the $80,000 top-end models. Contrast that to Mercedes-Benz: in Europe, there are cheap(er) Benzes not available in North America. It depends on the region and the mindset. In some markets, having a super-low-cost entry model cheapens the top end models, and puts pressure to bring those prices (and the profitability) down with it.

In some cases, companies will use profits from top-end models to subsidize the price of the entry-level, selling the cheaper product at cost (or even below-cost). This ultimately drags down the overall profitability, but allows a company to stay in the low-end of the market.

In the specific case for Apple, their shareholders like their current profit levels. They will like them more in light of the dividend that Apple is now offering. Anything that impacts the overall profitability, and ultimately the dividend, will be seen in a negative light (even if it makes sense in the long-term. A lot of investors are rather short-sighted). That negative view puts pressure on the stock price, causing it to go down, and that can in turn put pressure back on management to “remedy the situation”.

But There Are Benefits

There are benefits for having cheaper, entry-level product, particularly for one like Apple that engenders a surprising amount of brand loyalty. Going back to cars, the traditional view was that an entry-level car would get someone into the manufacturer’s product line, and brand loyalty would keep them there. GM was one that had an entire plan for their customers from the first to last car: you bought a Chevy, moved up to either Buick or Pontiac, and then ultimately to a Cadillac. The flaw for car manufacturers today is that brand loyalty is simply not there. Few car brands (or even most consumer products) inspire that kind of brand loyalty anymore.

But Apple is an odd beast. For the past few years, people who buy one Apple product tend to stick with it. This phenomenon isn’t limited to a small group of “fanbois” and loyalists. Hundreds of millions of people who started with something as mundane as an iPod have added iPhones, iPads, Macs and AppleTV’s to their technology inventory. These are everyday, average consumers who would happily switch from Tide to Cheer to save a couple of bucks at the till. Few consumers are all that loyal to a lot of brands. But when it comes to Apple, it is like Coke vs. Pepsi: you are either one or the other.

An entry-level version of the iPhone, Mac and iPad could allow Apple to capture customers sooner. Let’s face it, a lot of consumers are cost-conscious. The Android manufacturers know this, and have gained considerable ground in the smartphone space by offering products across the entire price spectrum. They went from “none” to about half the market in just a few years. Apple has done well in smartphones, but how much better could they have done if there had been a cheap/free iPhone when Android first came out?

New Product, Not Just Lower Prices

So what could Apple do? It depends on the product line. For Macs, I would say that Apple could drop the prices on the current “Air” line when it introduces a new “Pro” line. And I mean drop the prices a lot. Having a $599 MacBook Air and a $399 MacMini would get them much closer to the sweet-spot for entry-level product. They could continue to charge a premium for the Macbook Pro and the iMac, because those could still be positioned as a premium level.

For the iPhone, they will presumably keep the iPhone 4 going, and it will become the “free with contract” phone after the next iPhone is released. But the unlocked price of the device should also be brought down, and by a lot, to something like $199 or $299. Sell it at a hair above cost. People are still going to buy the top-level iPhone in large volumes. But a low-priced iPhone that feels like a premium phone opens up the potential to capture cost-conscious customers and “bring them into the fold”.

The iPad is a trickier one. I think Apple made a mistake by not making the latest iPad an “iPad 2S” or something like that, and keeping a continuum with the iPad 2. The price drop on the iPad 2 wasn’t exactly substantial, and I think it should have been bigger, countering the Kindle Fire, which has been the only real threat to the iPad so far. I wouldn’t say go down as far as the Fire in price, although Apple probably could. It would just be selling at cost. But it would potentially allow Apple to keep a toehold in the entry-level space of the market. One option is for Apple to offer a smaller form-factor iPad, in between the iPod Touch and the current iPad, at a substantially lower price.

Apple Has Been Here Before

While Apple was the scrappy underdog fighting for it’s place in the world, taking the premium-product route was a good idea. It was off-the-wall. It was different. It brought them brand recognition and it gave them a leadership position that their sales volume didn’t always justify. Apple isn’t the scrappy underdog anymore. Sure, there are still more Windows machines than Macs out there, and the iPhone is still the number 2 smartphone platform. But Apple is gaining ground rapidly in personal computers, owns the tablet market, is one of the biggest players in the content market, and isn’t that far off from having the number 1 smartphone platform.

Apple has been down this road before, in some ways, with the original Macintosh. It was initially perceived as something of a leader, for a little while anyways. It facilitated the rise of the GUI and software that the average person could use. It lead in design and usability. Yes, Apple made an ill-considered foray into the low-end of the market by allowing clones, but the clones didn’t bring lower prices, they just competed with Apple for the same market segments. Why would the clone makers want to try for the 1-2% profit margin segment and ignore the 20-30% profit market Apple was going after? All they did was try to carve up a small slice of the pie, rather than increasing size of the slice. By insisting they stick with premium prices and high margins, Apple put themselves in a position where their products were marginalized, almost to non-existence. No real product leadership, and focus on numbers (and keeping that precious high margin) almost killed the company.

Apple now has a chance to broaden their base, and bring some long-term stability to their company and their products. By remaining focused on the higher-end of the product foodchain, they are vulnerable. Their hold on the tablet market is strong, for the moment, and it appears unlikely that Android is going to be the platform that unseats it. But Windows 8 is still a potential threat, and it will come with low-priced tablets and a substantial suite of software (even though most of it won’t be touch-enabled or readily usable on a tablet, at least not initially). Apple has also started to make in-roads in the enterprise market, but when the security issues with Android are addressed (and they will be), Apple will find themselves under pressure there too.

The shareholders like the nice, fat profit margins and the total profit now, but they also like the substantial revenue that comes with it. Apple shareholders weren’t happy with the results before 1997. Sure, Apple still had a healthy percentage of profit. But the total numbers were rather paltry, and they were declining. So, would the shareholders prefer a company with 30-40% profit, but declining in absolute dollars over time as revenue drops? Or would they be happier with smaller profit margins, but continued growth in absolute profit and total revenue? And would they be happier if their investment had a larger share of their various markets to sustain this? Apple is a leader now. They will likely be a leader for a little while. But they may not be there forever, and making an effort to increase share a bit, and stabilize themselves by broadening their appeal a little, isn’t the worst idea in the world.

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