iPhones and behavioral economics

Over at Thought Gadgets, Ben Kunz sees behavioral economics in iPhone pricing. He says the phone’s “reference price,” (ie. it’s original retail price of $599) and customers’ perceived “transaction utility” (ie. whether or not customers think they are getting a good or fair deal), which are concepts popularized by Thaler, can explain Apple’s marketing strategy over the past year. Kunz seems to be going against conventional wisdom since he applauds the massive price cuts on the iPhone, including a $200 cut just a few months after its initial release, as part of a shrewd strategic campaign. So much for Apple customer backlash? Memories are short when the product is great.

How has Apple played this pricing game?

1. First, optimize margins based on (margin per product x total sales). In simple terms, you can either sell a few products with huge margins, or sell many products with lower margins. Apple in effect did both, by launching the original iPhone with a $599 price tag, taxing early adopters, then sliding the scale down to $399 and now $199 to reach more of the masses.

2. Then, if possible, obscure the reference price altogether. Thaler noted that most people buy a car, or a suit, or candy in a movie theater by comparing it to what they think “a fair price” is. Sometimes a clever marketer can obscure this reference price. Candy in movie theaters comes in really strange, large boxes — boxes that you won’t find anywhere else. The reason? You can’t really calculate whether $4 for an oversized box of candy is a good deal.

Steve Jobs obscured the reference price with an iPhone design that didn’t look like anything else.

3: Third, work to increase the reference price. By comparing the new $199 iPhone to the $599 original phone, Steve Jobs is in essence competing with his prior self — and winning. The $400 in savings is fiction, but it feels like a good deal.

4: Bundle price components to mask what you can. The iPhone generates revenue for Apple not just from the $199 sales price, but from hundreds of dollars in hidden data fees paid to AT&T (and then to Apple) and all the iTunes songs you download. Data fees are bundled with the AT&T separate bill. ITunes fees are grouped into your personal music account. The total is again obscured, because each bundle is treated separately in the consumer’s mind.

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One Response to “iPhones and behavioral economics”

  1. Steve Laniel Says:

    I disagree with point 3. $200 is, I think you’d find, a fairly standard price point for high-end phones. Wasn’t the RAZR priced around there? My suspicion is that $200 is at the middle or high end of the range that people consider reasonable for a phone. Now when people are deciding which phone to buy when theirs bites the dust (as all phones will), they’ll consider the iPhone, where before they might have considered it a frivolous toy.

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