Wednesday, April 21, 2010

iPad economics

Last year, I wrote about how I dislike Apple products, yet still like the fact that Apple exists as a competitor to Windows. Now, that post is only half true (OK maybe 1/4 true). In our search for a new laptop and desktop, we actually considered purchasing a Mac. I even touched the MacBook Pro's intelligently designed multi-touch touchpad. I liked it, but I have concluded that -- although the Mac technology is nice -- it's not worth paying a premium (for me).

On another dimension of Apple, I am intrigued by the iPod Touch. The handheld technology is really interesting, and if I won one in some contest, I would be happy about it. I like the idea of internet in my pocket, and of course, I am a fan of the "there's an App for that" commercials. At some point in the not-too-distant future, I might consider buying one. On the other hand, I am not on the verge of buying the iPad, which is like a giant iPod Touch.

The fact that people of my type are not very interested in buying an iPad speaks volumes about the economics of the iPad. Apple faces an intriguing problem, and by studying it, we can learn some interesting economics.

Product differentiation and market power

In many respects, Apple made a lot of things better by developing the iPad. It has a bigger screen, better graphics, interesting book-reading features, and some artist sketch programs. In economic lingo, these changes to the product relative to others already on the market are called product differentiation.

Differentiating your product is one way to enhance market power. If your product is the only one that has such-and-such feature and consumers value that feature, your company can charge a premium. This is what Apple is trying to do with its iPad. They're marketing it as everything that is in the iPod Touch, but better and more.

Where else are you going to get a giant iPod Touch? There's a price for that.

Pricing over time

Now, you might wonder why Apple bothers to introduce a product that is a blown-up version of one of its other successful products. Aren't many of the sales of iPads going to be lost sales from iPods? I don't think so. This has to do with two features of the iMarket: durability of the product and impatience of some consumers.

Apple designed its customer base to be "eager at the beginning" by introducing the iPod at a high price, and then slowly bringing the price down to expand the customer base. The most eager, most impatient consumers are the ones who line up on the first day. As the price drops, less eager and more patient consumers become the new iPod customers. Now, consumers like me (who are on the fringe of Apple's market) are the only ones left without an iPod Touch.

The fact that we consumers sort over time based on how much we value the product implies that Apple can charge different types of consumers different prices (indeed, that's why they start high, and predictably lower their price). An important constraint on this exploitation of consumers is that every type of consumer has the option to wait. Apple has to price to ensure that waiting isn't the best option. Otherwise, they won't make any sales.*

iProduct durability: a Problem?

Another consideration is the vibrant resale market for iTechnology. Apple faces a tradeoff: Greater durability is valued by the consumer (and can lead to a higher price), but greater durability means that the resale market is likely to be a stronger check on the company's pricing. The company can control this problem in one of three ways:

(1) They can make a less durable product to sabotage the resale market. For iTechnology, it would be a bad idea because less durability means poor quality. As Apple is branded on high quality, this isn't a good option.

(2) Apple can control the total number of iPods on the market in their pricing over time (as above). So, that high initial price reflects that a strong resale market would result if there were more used iPods available.

(3) At regular intervals, Apple can introduce new, slightly better products that supersede the old ones. If you want the new features, you'll have to buy the new iProduct. This is a big reason why textbook companies introduce new editions of textbooks. If you want the new exercises (which might be assigned for your class), you'll have to buy the new book.

Of these options, Apple appears to use (2) and (3) in conjunction with one another. The introduction of the iPad is like a dramatic version of (3).

Back to Different Types: The iPad

The economics of Apple tells us that the type of consumer who is excited about the iPad is someone who bought an iPod years ago. By now, they are thirsty for a new technology from Apple, and the iPad is just good enough to draw this type of consumer into the market. Is this new product going to steal current iPod Touch consumers away? That's not likely.

Based on the start-high-go-low pricing strategy, the same kind of sorting over time that took place for the iPod will take place for the iPad. For the most part, current consumers who are contemplating an iPod are the type who were turned off by the high iPod price. Given this, they're not likely to be in the market for an iPad for a while -- at least until the price drops.

A final comment is that the iPad is not better on all dimensions. In fact, it is too big to put in your pocket, which takes away one of the best features of the iPod (portability). Only consumers who value the new features or the novelty of the new iProduct will come to the market. On this dimension, the reaction of consumer reviews is muted, as this CNET video demonstrates.

The name is funny, too. Jokes aside, the iPad is another interesting product from Apple that I probably never will buy. Then again, one of these days I'll have to find out what all the fuss is about Apple products. Maybe I'll start with the iPod Touch.

*This is a simple idea, but sometimes simple ideas are powerful. There is an entire literature on durable goods pricing that establishes this fact, and studies other elements of monopoly pricing of durable goods. It was started by one of my favorite economists, Ronald Coase.

1 comment:

Please feel free to share your ideas about this post in the open forum. Be mindful that comments in this blog are moderated. Please keep your comments respectful and on point.