14
Nov
2019

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Apple’s new pricing strategy

With the launch of the iPhone 11 hardware cycle, Apple has done something it has never done before – it lowered the starting price of the most popular iPhone model. The company, known for selling premium hardware at a very premium price, appears to be taking a more elastic approach to pricing as the global smartphone market reaches maturity. Rather than view this as a concession to competitive realities, we believe this new pricing strategy will lead to an even stronger ecosystem for Apple.

The entry-level iPhone 11, the successor of the iPhone XR, is $50 cheaper than its predecessor, despite two major upgrades over the XR – the addition of a second rear camera, and an OLED screen. It is also powered by the A13 Bionic chip, the same processor in the iPhone 11 Pro series. One would expect these upgrades to justify a price increase over the XR, but the fact that the price came down suggests that Apple’s component cost curve has fallen sufficiently over the higher-priced iPhone X and XS cycles that it can now pass cost savings on to customers without adversely affecting margins (more on this later).

From a competitive point of view, this price reduction makes a lot of sense. The incremental iPhone switcher is likely more price elastic than the previous iPhone switcher, and a lower entry price makes it more compelling to switch to Apple. More importantly, the iPhone has always been the price bellwether in the high-end smartphone market – Apple raises prices, and the other manufacturers follow. Apple’s sudden reversal may catch competitors off-guard, as they are now competing with Apple not only on experience but also on price. This is likely a losing proposition, because Apple’s custom silicon means the iPhone 11 performs better than most other phones in similar or even higher price ranges, and competitors don’t have a massive high-margin services business to help pad their low hardware margins.

This pricing change is also the most pronounced strategic shift yet from hardware to ecosystem. Historically, Apple has used the iOS platform, App Store and other services to support the premium pricing of its hardware. Now, Apple looks to be using hardware to support the growth of its services business, which is underpinned by the total active installed base of iPhones, iPads and Macs. A cheaper entry-level iPhone certainly goes to expanding the installed base of iOS products, which in turn drives not only greater services adoption but also sales of wearables such as Airpods and the Watch. The high services gross margin helps offset any downward pressure on hardware margins due to a lower iPhone average selling price.

Apple is in an enviable position among smartphone peers for having a (relatively) high hardware margin and an even higher-margin services business. The flexibility offered by this setup allows Apple to pull hardware and services levers as required to maintain growth and margin in ways the competition simply cannot. Apple’s new pricing strategy uniquely leverages both the company’s hardware scale and its services ecosystem, and is already starting to reward faithful long-term shareholders.

The Montgomery Global Fund and Montaka own shares in Apple. This article was prepared 13 November with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Apple you should seek financial advice.

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