Apple Inc. says its latest iPhones defy the limits of technology. They also defy a long-held principle of economics.
Products – especially in the world of personal tech – usually become cheaper as time passes. Technological advances and supply-chain efficiencies lead to a reduction in costs, which allows manufacturers to cut prices. That hasn't been the case with high-end smartphones.
According to data collected by tech blog Android Authority, the average price of flagship smartphones made by Sony Corp., LG Electronics Inc., HTC Corp. and Samsung Electronics Co. Ltd. has crept up every year over the past five years – from about $600 (U.S.) in 2012, to more than $750 today (even as sales-challenged LG has kept prices relatively flat).
Apple's latest offerings push the boundaries much further. The two new models of the iPhone X (pronounced "iPhone ten" in a nod to their release 10 years after former chief executive Steve Jobs unveiled the original iPhone) will sell in Canada for $1,319 (Canadian) and $1,529, respectively – the kind of price tag previously reserved for laptop or desktop computers, not fragile pocket-sized rectangles of glass.
"Folks are of course choking at the price, but it doesn't matter: iPhone X wasn't designed to appeal to those folks that are economically rational," says supply-chain expert Wayne Lam, who is an associate director and principal analyst with IHS Markit Ltd.
"Smartphones and this type of device don't behave like a normal good. If you have a product that's always evolving, that kind of defies what we expect from economics."
Component costs on the rise
The iPhone X is fully $300-more expensive than the next best phone in Apple's lineup, the iPhone 8 Plus. Part of the explanation for the rising prices comes from an obvious place: the increasing cost of components (silicon chips, screens and camera sensors) – as well as the research and legal expenses (manufacturing, licensing and IP) behind putting them all together.
By comparison, IHS analysis of the iPhone 7 Plus suggests that device's parts cost between $250 and $270, with the touch-screen unit running about $50. The new X has a new AMOLED screen that likely costs twice as much, according to Mr. Lam, in part because Apple has a single-source of supply for that component: No. 1 rival Samsung. The new camera parts and the depth-sensor that enables facial-recognition capabilities will likely also add to the X's production cost.
As costs have risen, Apple has not been willing to compromise on its margin. Mr. Lam says the Cupertino, Calif.-based giant has maintained an average profit margin of 33 per cent in its iPhone business over the years, in part thanks to one smart trick: generating as much as an 80-per-cent margin on NAND memory.
NAND memory stores the data on your phone, so when Apple sells the 64 GB model of the iPhone 8 for $929 in Canada and then sells the 256 GB edition of the same phone for $110 more ($1,139) the only difference is the NAND chip, which typically costs only about $20.
"They were able to do that because they were such big buyers of NAND memory, they were able to use that to really crank up their margin," Mr. Lam says.
"Good, better, best"
Apple has another secret weapon to unleash on buyers: the psychology of pricing.
One of the less-noticed elements of Apple's new lineup is that the other two new devices – the iPhone 8 and 8 Plus – are not much different from the iPhone 7 and 7 Plus, but they also got a price hike: $50 (U.S.) for the 8 and $30 for the 8 Plus.
Rafi Mohammed, pricing strategy consultant, and author of The 1% Windfall, says the lineup of new devices – the iPhone 8, 8 Plus and X – fits perfectly into a pricing strategy he calls "good, better, best," which allows customers to consider a product line's prices incrementally in ways that can end up boosting their overall willingness to spend.
"People often start at the top, and they'll start thinking 'Gee, is it worth the trade-off to go down?' Having a very expensive product at the high end tends to pull people upwards in what they end up spending," Mr. Mohammed says.
This kind of pricing is used in everything from auto makers with luxury, standard and economy brands, to Netflix's streaming tiers, but it has the effect of making the middle "better" category (the high-margin 8 Plus in this scenario) typically end up as the best-selling segment.
"It allows you to serve customers in a wide variety of valuations and it really reduces your risk: If you happen to misprice one, they will pick another one," Mr. Mohammed says.
So while some analysts have suggested that Apple is experimenting with premium pricing, as it did with the high-end Apple Watch Edition, Mr. O'Donnell and Mr. Mohammed agree, Apple has more certainty about this new high-priced frontier than consumers might expect.
"This is too big and too important for them, this is two-thirds of their revenue," Mr. O'Donnell says. "They can't afford to do an experiment."
The rise of financing
Consumer's willingness to spend more on phones has been driven by a proliferation in the ability to spread out the cost of a new phone. In the United States, that's thanks to the widespread availability of no-interest smartphone financing by the country's large wireless firms, which turn that $1,000 price tag into a more manageable monthly payment plan of $50 or so.
In most markets, including Canada's, carriers may offer purchase subsidies but expensive phones often require buyers to put down a hefty payment up front.
Since 2014, approximately 75 per cent of U.S. smartphone customers have converted to monthly payment plans, according to Bob O'Donnell, CEO of TECHnalysis Research. This has kicked off a booming new multibillion-dollar market in new debt vehicles and bonds the telecoms are selling to investors to get this form of subsidy off their books.
"It's a dual-edged sword: On the one hand it means people will be more willing to buy higher-end phones; it's only a few extra bucks a month," Mr. O'Donnell says. "It presents a dilemma for Apple in that it's easier for people to just skip over the iPhone 8 and say I only want a X."