AppleTV, iTV and content pricing

The Apple rumor mill is in full swing again. This time is it about a (supposedly) soon-to-be-announced upgrade to the AppleTV, which is slated to be called iTV. Thus far, AppleTV has repeatedly been described by Apple execs as a “hobby”. But if we believe the rumors, soon, it may be turned into a real business.

The AppleTV, for those who do not know, is a small dedicated computer that allows the user to browse, download and play standard definition and high definition video and audio content from the iTunes store, YouTube and local computers with iTunes. And the entire system is controlled with a thumb sized remote control.

Here is one journalist’s take on the matter:

“Currently, TV downloads from iTunes cost an average of $1.99 per show—just high enough to annoy many customers who are used to getting TV for free, but low enough that people pay it. A 99¢ TV rental would obviously be a little closer to free and, if the shows remain commercial-free like the rest of iTunes, would be an upgrade from watching them on the boob tube or Hulu.”*

While the pricing strategy is a mystery to this particular journalist, for us in the pricing industry it is not. Apple, being the Pricing Champion they are, priced content on iTunes to maximize profit instead of demand. They know that early adopters are a smaller group, but they are not price sensitive. They buy because they want to be first. They want to know they are on the leading edge. Likewise, the AppleTV is not cheap at $229. You could almost afford a “real” computer at that price. But again, early adopters are not price sensitive.

So if the rumors are true, and Apple will introduce the $99 iTV and the cost of downloads does reduce to 99¢ it really just means that Apple now believes their little device is ready for prime time and expects it to be widely adopted. Some people call this strategy a skimming pricing strategy but I think it is just common sense. Think about this for a second. You develop a new product, created a whole new business segment, and you want to recoup your product and infrastructure development cost as soon as you can - so you price relatively high because you know the early adopters and not price sensitive. But as the product reaches the mainstream, volume goes up and price sensitivity goes up - so you lower the price. But this time the sunken research and development costs are already paid by the early adopters, so you can lower the cost and maintain profit margins. More often than not, just like in Apple’s case (if the rumors are true) a new version of the product is developed that is cheaper to manufacture and, because it is now a “different” product, it does not alienate those early adopters that are sooooo important for future product development.

The lesson to learn hear (no matter if Apple introduces this new product or not) is that what is a pricing mystery to some is common pricing sense for the rest of us. And that anybody who prices new groundbreaking products and/or services should not price low but should be aware that their marketplace’s early adopters are not price sensitive. In this context I could expand this article into a rant about the stupidity some people call penetration pricing, but I’ll save that for another time….

With warm August regards,

Per Sjofors

*The full article can be found at http://arstechnica.com/apple/news/2010/08/-more-evidence-for-99-itunes-tv-rentals-apple-tv-makeover.ars

Stirring the music download pricing pot

The music industry has been stirred up once again this week. After years of pressure from the labels, Apple finally gave up on its one-price-fits-all strategy for iTunes and introduced a three tier pricing model -- with downloads now available for $.69, $.99 and $1,29.

So among the three largest sellers of downloadable music, it creates an interesting competitive environment:

• Apple, the clear market leader with a premium product, with the highest priced downloads, a claim to better sound quality, and complete integration with iTunes and iPods
• Amazon.com, with a single price of $.99, “standard” high bit-rate MP3 files and an application that can integrate with iTunes and therefore iPods
• WalMart.com, with a $.05 lower price per song than Apple’s pricing scheme ($.64, $.94 and $1.24) and “standard” high bit-rate MP3 files.

So it will be interesting to follow:

• Will Apple lose some of its market share to Amazon - thus proving that a lower one-price-fits-all approach is the preferred consumer way to buy downloads.
• Or, will Amazon follow Apple and WalMart with three-tiered pricing?
• Will WalMart’s strategy to copy Apple’s tiered approach (but at a lower price) pan out? Will they gain market share?

What will the three-tiered pricing strategy do for the business results of Apple and the big music labels they’ve partnered with? Will it drive more revenue and profits or will consumers migrate back to the illegal file sharing sites that created the digital music market in the first place?

I will keep an eye on these developments and be sure to report back to you soon.

>>Update at 2pm 4/9/09: It did not take long. Amazon just introduced some songs at $1.29

With singing regards,

Per Sjofors
Founder/CEO
Atenga Inc
818 887 4970
per@atenga.com

The AppStore, a microcosmos for understanding price elasticity

On a number of technology blogs, a bit of grumbling has started over the price of software bought from Apple’s AppStore. So let me just explain what this is.

I’m sure you are aware of the iPhone, one of the hottest consumer electronics products in the last 12 months. About a month and a half ago, Apple introduced an updated version of the product, the iPhone 3G. As the phone is basically a small portable computer, Apple also introduced what they call the AppStore, a section of iTunes where iPhone users can download small software applications. The AppStore has been a huge success, with hundreds of these iPhone applications available, selling more then $30m worth of software in the first month despite the fact that a majority of the apps are available for free.

Each developer set his or her own application price, or decides to give the app away for free, though most chargeable apps sell for $2.99 – $9.99. And on various technology blogs, I'm starting to hear about one of the world’s most common pricing mistakes. Developers are complaining, to whomever wants to listen, saying things like “I used my gut feel to price my app at $9.99 and it did not sell very well, so I dropped the price to $2.99 and sure I’m selling more but I’m getting less revenue”. This is a classic example of the perils of price elasticity. Price elasticity is a fancy name for how the demand of a product or service changes with the price. If the demand changes little with the price, then the price elasticity is low (or inelastic); if it changes a lot, price elasticity is high (elastic).

Once the elasticity curve is known, it is easy to generate a revenue curve. The revenue curve points out the best or optimum price, where the combination of price and demand generates the maximum revenue. If your market is elastic, and most markets are, selling your product at the optimum price point is crucial for the business results of your company, and can easily mean the difference between market leadership and marginalization.

These AppStore developers have a very unique advantage in the way they can discover the price elasticity curve for their product by simple trial and error. An advantage virtually no other company has. They sell software, so revenue max is also profitability max, they promote their product to a “closed” marketplace as they only compete with other software companies in the AppStore, and they can change the price as often as they wish.

So an AppStore developer can start with a price of, say, $9.99, wait a month, note the demand, change the price to $6,99, wait a month, note the demand, change the price to $4.99, wait a month note the demand and so forth. After plotting 5 to 6 demand points, all with prices taken out of thin air, it will be easy to set the optimum price, the price that will give the developer maximum revenue and profits. Of course, during this process, the company is losing revenue; leaving money on the table to define the lower-than-optimum demand points and forsaking sales volume to define the higher-than-optimum demand points.

Any company can do the same. Whether you are selling farm equipment, data storage, shovels, or boxed software the process is identical, but, because you don’t have the advantages of easily changing your prices on a platform like the AppStore, the process will be longer – probably a few years. And chances are that by the time you are done, your marketplace will have changed so much it will be time to start the process all over again. Not to mention that in the process, you will give up millions in lost revenues and margin.

So when you priced your product, did you use some combination of “gut feel”, “I know exactly what the market will bear”, or the all-too-frequent “our cost plus x % markup”? If you did, what are the chances that by sheer luck you will hit the optimum price point? If you were one of the very few who found that price point by luck, you probably have revenues beyond your wildest dreams. But if not, chances are much higher you are struggling to meet the numbers. If your company is like 99% of companies out there, you can easily gain 10% – 20% in revenue, double your growth rate, and double profitability by knowing the price elasticity of your product, and optimizing your price accordingly. Think about it. What would price optimization mean for your company?

And if experimenting with different price levels and seeing how they affect demand is not a realistic possibility at your company, as the cost in lost business is too high, how will you be able to define the optimum price?

With warm summer regards,

Per Sjofors
Founder & Managing Partner
Atenga Inc
www.atenga.com

Drop your margin 3% and lose $14b!

Apple Inc. (NASDAQ:APPL) is a price champion. It provides products that, while really being commodities, command higher margins and higher prices than any other computer maker. Apple never sells on "low price" and never discounts. Instead, Apple relentlessly works with its marketing and messaging to increase the perception of value of its customers, and in sales, to capture that higher perceived of value. With higher perception of value comes higher prices and higher margins.

Yesterday, however, Apple announced an unspecified product transition for the next quarter, indicating that its average margin will drop as low as 30%. Compare this with 33% in last quarter. As a result, shares dropped around 10%, shaving $14b of its market cap, but are now recovering slowly.

Then consider Dell (NASDAQ:DELL), who focuses all its marketing on the "low price, value for money" value. Dell operates at a 5.4% margin.

The consequence of these vastly different strategies is that Dell has revenues 2 1/2 times that of Apple, yet, the company has a market cap roughly one third of Apple’s! ($47b for Dell vs $134b for Apple).

Nearly every business faces these same choices. The company can be a value brand (Dell) or be a premium brand (Apple). The premium brand always has a higher valuation, but it take a concerted corporate effort to get there; to know and leverage customers value perceptions, to know how to build value in marketing as well as design, development and sales, to make the effort to learn their customers’ willingness to pay, and to optimize prices accordingly. Apple is doing a spectacular job of this - even after the coming slight margin decline.

Think about it - even if you are in a different industry you must choose your mindset and execute it relentlessly. Do you have the Apple or Dell mindset? What will it mean for your shareholders?

With warm summer regards,

Per Sjofors
Founder, Managing Partner
Atenga Inc
www.atenga.com