Our Apple addiction is sending its profits sky high

Apple has hit on a brilliant business model that exploits the willingness of customers to pay a premium for its products.

The Conversation

Apple has reported the largest quarterly profit ever made by a public company. This is largely thanks to record iPhone sales of 74.5 million units over the Christmas period. With prices starting at $US649 for the iPhone 6 in the US and costing more than $US1,000 in many other parts of the world, it’s no surprise.

Apple products cost varying amounts the world over. The company has justified these price differences by citing different taxes in different countries, as well as additional costs associated with supply chain, logistics and other, non-specific business costs. As a result, customers outside of the US can pay up to 25 per cent more for products. But even in the US, the margins the company makes on its products are huge.

And there’s little we consumers can do to circumvent this pricing. Apple imposes strict controls on how and where its products are sold -- it is virtually unknown for Apple products to be available outside Apple certified sellers and, as such, there are very few opportunities to buy Apple products at discounted prices.

Key to Apple’s strategy is its price maintenance approach, which means retailers receive only a small wholesale discount margin and cannot therefore afford to engage in significant price reductions. Retailers have an incentive to sell Apple products at the company’s recommended price which enables them to maximise their returns on every product sold.

Why we buy

So, why are we prepared to buy Apple products at seemingly inflated prices? Why can’t we as consumers do as we normally do -- search the internet for lower prices and then buy from the cheapest retailer? Economic theory indicates that something called price elasticity of demand is a key factor when pricing products -- the greater the PED, the more likely that demand will not fall if price increases.

PED is often used to predict buyer behaviour for products that could be regarded as addictive, such as cigarettes and alcohol. However, one could argue that despite the apparent inflation in Apple product prices outside of the US, we as consumers are still willing to buy Apple products at relatively high prices. Apple products could therefore be regarded as addictive, with consumers embracing the benefits associated with them and, more importantly, coming back to buy newer versions.

Apple’s strategy is now well established and consists of four pillars:

  1. Offer a small number of products. This reduces operations and supply chain complexity and gives Apple greater power when negotiating contracts with suppliers of parts or materials.

  2. Focus on the high end. Premium products yield premium profits. Focusing on customers who have a high PED ratio, are not too concerned about selling price and are more interested design, capability and, of course, the brand.

  3. Give priority to profits over market share. Apple actually sells fewer phones than Samsung, but with higher margins.

  4. Create a brand that makes people starve for new Apple products. This kind of approach is reflected in the high demand for Apple products in most parts of the world.

With the increasing level of competition in all its key markets, the future for Apple is uncertain and it would appear that its products will need to offer increasing value if they are to command premium prices.

Overall, Apple is in a unique position due to the addiction of people to its products. The firm can afford a supply chain strategy that focuses on minimising its costs, combined with a pricing strategy that creates significant price premiums that even are, to a small extent, shared with the supply base, even though most of the production is outsourced.

Altogether, we see a brilliant business model that exploits the willingness of customers to pay a premium for its products. The high prices -- bearing in mind that Apple has excellent supply chains -- depend to some extent on the costs in the countries they are sold in. But, ultimately, it is us, the consumers, who are willing to accept these prices.

This article was originally published on The Conversation. Read the original article.

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