How Apple sets its prices

Comparison-shopping for new electronics can be fun and addictive. With a bit of patience, some luck, and an eye for good deals, you can find everything from TV sets to hard drives at a significant discount. In fact, in our economy, discounts are one of the primary mechanisms that retailers use to compete against each other.

But all bets are off if you happen to be in the market for a product made by Apple: Both iOS devices and Macs seem to be impervious to the discount game. In fact it's so rare to find a significant price variance between retailers that, when it does happen, the event usually draws considerable press coverage.

House advantage

With so many laws regulating competition among retailers, how does Apple pull off this amazing feat? It turns out that the company uses a fairly straightforward strategy, known as price maintenance, that takes advantage of the popularity of its products and exploits a quirk in the way retailers are allowed to advertise their merchandise.

Most products move from manufacturers to retailers through a network of distributors. Even though each product has a "manufacturer suggested retail price" (MSRP), each retailer is free to set its own sale price. Thus, a laptop with an MSRP of $500 might cost the retailer $250 to buy, and might carry a sticker price of $350, accompanied by a bold "30% Off!" announcement in the store's weekly flyer. A different retailer might offer an even lower price to attract more store traffic, or conversely it find itself in a weaker position due to lower sales volume and have to charge its customers more for the product.

All of this price variability is possible because of the large difference (commonly from 30 to 55 percent) between the wholesale price--what the retailer pays the distributor for each unit of the product--and the MSRP for each unit. That gap leaves enough room for each retailer to set its own policies and generate a sometimes significant range of market prices for a product.

Apple, however, extends only a tiny wholesale discount on its Macs and iPads to your retailer of choice. The actual numbers are a closely guarded secret, protected by confidentiality agreements between Cupertino and its resellers, but the difference probably amounts to only a few percentage points off the official price that you find at Apple's own stores. With such a narrow gap to tinker with, most retailers can't offer big discounts and still hope to turn a profit.

Carrot and stick

The price maintenance approach cuts both ways: Retailers have relatively little incentive to carry Apple products, or to dedicate precious retail and advertising space to them, if the potential profit from sales is so low. On the other hand, large chains not uncommonly turn a barely profitable product into a "loss leader," selling it below cost to increase customer traffic or to boost sales of ancillary goods, such as accessories and cables, that have a higher profit margin.

This is where the second part of Apple's retail strategy kicks in: The company supplements its tiny wholesale discounts to resellers with more substantial monetary incentives that are available only if those resellers advertise its products at or above a certain price, called the "minimum advertised price" (MAP).A This arrangement enables retailers to make more money per sale, but it prevents them from offering customers significant discounts, resulting in the nearly homogeneous Apple pricing we are used to.

The strategy benefits Apple in a number of ways. First, the company makes more money on direct sales and doesn't have to compete against marked-down prices offered by its own resellers. Since Apple's own retail operations are among the most profitable in the world, undercutting their prices for the sake of a wider distribution network would be counterproductive.

Most important, the narrow range of of price variability prevents any one retailer from establishing a strong enough market position to give it an advantage in future negotiations with Apple. Big-box store chains like Walmart are notorious for using their heft to extract higher and higher discounts from manufacturers--even to the point of forcing the latter out of business. By keeping its products' prices on an even keel, Apple reduces the potential for future conflict within its distribution channels, which also helps keep its own retail operations operating in the black.

When good discounts go bad

The situation with the iPhone is slightly different. Though the phone's retail price is in the hundreds of dollars, most consumers buy it alongside a two- or (in Canada) three-year cellular service plan. In exchange for the opportunity to charge their iPhone customers $70 or more a month, the carriers subsidize the cost of the device itself, which consequently carries a much lower price than it would if sold unlocked and contract-free.

For retailers, these phone-and-service-contract deals are profitable not because of the hardware's selling price, but because of a commission that carriers pay them, depending on the length and the cost of the mobile plan that each customer chooses. This helps explain why many stores will sell you an iPhone at the discounted price only if you buy it together with "in-store activation"; otherwise, they'd miss out on the bulk of their financial gain from the transaction.

This fact also helps explain why stores sometimes break rank and offer discounts on Apple handsets. Such was the case with certain Walmart locations during this past holiday season, which offered consumers an iPhone 5 for $127--a $70 discount from the normal $199 price. The retail giant probably set up this special deal without Apple's involvement, and it produced repercussions in the marketplace as competitors attempted to match Walmart's prices.

The end of the road

The pricing techniques that Apple uses aren't illegal, and most of them are commonplace in the industry. MAP, for example, is almost certainly at play when an online retailer requires you to add a product to your basket before revealing its price; and carriers offer kickbacks to resellers for most smartphones. Apple has simply distilled these standard tactics into a retail strategy that, so far, has worked out very well--aided, in no small part, by the public's seemingly insatiable lust for its products.

The cumulative effect of Apple's pricing policy on consumers is hard to nail down. On one hand, we're deprived of the positive effects that price competition normally produces in a free market. The familiar phenomenon that Apple products tend to be more expensive than their competitors in the same market space doesn't just happen: You can easily find an inexpensive laptop, but it's much harder to come across an inexpensive Apple laptop.

On the other hand, it's also hard to come across an inferior Apple laptop--and this is true of every other product that leaves the company's manufacturing facilities: Generous profit margins and a tight control over its distribution channels have enabled Cupertino to produce higher-quality goods at prices that only modestly exceed those of rival products. Thus, arguably, consumers enjoy a better overall experience, dollar for dollar, in the long term.

Either way, Apple's pricing strategy is a fascinating aspect of the company's notoriously controlling nature. If nothing else, knowing that the prices of its products are so stable makes shopping for them relatively stress-free: The only patience you need is the patience to wait for the delivery guy to show up at your door.

This story, "How Apple sets its prices" was originally published by Macworld .

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