Apple Goes Slumming to Fight Google (and Microsoft)

(Originally published here.)

For years, Apple has earned higher profit margins than its competitors by convincing customers that it sold products that were exclusive and cool. Those who pay up for the privilege of owning an Apple product feel like they are part of an elite organization that, somehow, anyone can join.

That has been the secret sauce that allows Apple to charge premiums of as much as 50 percent over the prices of comparable computers and phones sold by competitors, which in turn has let it earn outsized profits despite selling a relatively small number of devices.

Now, however, executives in Cupertino, California, are betting that it’s time to abandon this strategy. Competitive pressure from Google has pushed Apple to dilute its brand by offering a cheaper iPhone, known as the 5c, which will cost about half as much as the new 5s. This gambit may work, but it will not be without some long-term drawbacks. Apple has introduced a hierarchy of quality and price within the community of iPhone owners.

Apple’s mobile market share has already peaked in rich countries as consumers are now warming to the high-end smartphones and tablets made by Samsung and powered by Google’s Android operating system. In the rest of the world, Apple has aspirational appeal among the upper-middle class but is too expensive for most people. Nokia’s “dumb phones” and, to a lesser extent, cheaper Android phones made by Samsung, HTC, LG and others are all vastly more popular in India, Africa, and Latin America.

Unlike Apple’s premium phones and tablets, those products are barely profitable. However, there is some evidence that people who like their lower-end devices will upgrade to high-margin ones made by the same company. This is one explanation for why Microsoft was willing to purchase Nokia’s money-losing handset division, which was announced last week. A few billion euros is a small price to pay for what could be more than a billion potential Windows phone customers.

This also explains why companies like Samsung are willing to live with profit margins just half of what Apple earns in exchange for relentless growth in market share. They sell cheaper phones that get consumers up the ladder toward higher-end products.

Apple has long resisted this strategy, but the 30 percent decline in its market value over the past 12 months and the pressure from activists like Carl Icahn may have gotten it to change its tune. That could be good for the company’s long-term growth, but it will come with a cost that the executives in Cupertino may not fully appreciate.

(Matthew C. Klein is a writer for Bloomberg View, and owns an iPhone. Follow him on Twitter.)


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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