Customer Acquisition and the Entry Level iPhone

by Ben Bajarin   |   August 13th, 2013

From an industry and market standpoint, a lower-cost iPhone certainly has the potential to shake up the market. In what ways we can only speculate but there are a few points about an entry level iPhone that are worth discussing.

The Cost to Acquire a Customer

This is basically how I view any product Apple prices below a premium price point. Any move Apple makes to go downstream is a strategic move to acquire customers who seek value but not at premium price points and get them into Apple’s ecosystem.

If Apple was just a hardware company and that is all, then it would make sense to have a discussion about how fast they can go downstream in order to compete globally. But Apple is not JUST a hardware company. They are a hardware + software + services company and each part plays a critical part to the whole experience.

To analyze Apple correctly we need to understand how the hardware plays into the software which plays into the services. Therefore we look at an entry level iPhone as a way to acquire new customers Apple finds valuable. I make this point specifically because I don’t believe a customer who just wants a “cheap” product is the kind of customer Apple wants or one that adds any value to a computing ecosystem. I say this because these customers don’t spend much if anything in app stores. These customers just want the cheapest data plans possible. These customers are unlikely to spend money on additional services, etc.

The fallacy those who think price is all that matters fall into is believing that all consumers value the same thing.

This is why Apple will never compete with anyone in a race to the bottom. Those customers are simply not valuable in the grand scheme of things and arguably not worth competing for. And luckily those who just want cheap are only a percentage of the overall consumer segment. The fallacy those who think price is all that matters fall into is believing that all consumers value the same thing. It is incorrect to believe that its hard to compete with free. It is easy, all you do is create a better product, experience, or solution, and market it to those who will value it.

So the philosophy of an entry level iPhone pricing is as such: the lowest price Apple believes is necessary to capture the type of entry level consumer who is still valuable to their ecosystem.

Horace Deidu, posted on his site Asymco in May, that iTunes customers spend at a rate of $40 per year as an average. Certainly in some cases, like mine, people spend more than $40 per year, and certainly in some cases people spend less. A person who just wants cheap would not spend nearly as much if anything in Apple’s ecosystem. But the key point for Apple and an entry level priced iPhone is how low does it need to be to still acquire a customer who will spend money and add value to the ecosystem. Apple could take a margin hit in order to acquire said customer and still make up that margin hit on the hardware and then some over the lifetime value of that customer. This is why the services (iTunes, iCloud, and future services) are so important to Apple’s long term strategy.

Redefining Engagement

Some additional necessary thinking was shared by Benedict Evans today with is post Defending iOS with Cheaper iPhone. Lots of good thoughts in this post as usual from Ben but one in particular is worth fleshing out.

“If total Android engagement moves decisively above iOS, the fact that iOS will remain big will be beside the point – it will move from first to first-equal and then perhaps second place on the roadmap. And given the sales trajectories, that could start to happen in 2014. If you have 5-6x the users and a quarter of the engagement, you’re still a more attractive market.”

This is a very interesting point and worthy of thinking and discussion. Engagement is an important metric but we must first back up and ask whether all engagement is equal? For example are even the most “engaged” people on iOS and Android doing the same things? In some cases, like in working professionals or premium customers, the answer may be yes but I’m sure there are also many cases where the answer is no. The other challenge with using the engagement statistics most promote publicly is that they all exclude important metrics. For example we don’t know how much extra time iPhone (or iOS) consumers spend on the device browsing the App store or shopping for music. The same is true on Android. This would be some key stats that would shed more light on engagement and said users value to an ecosystem. 1

If we just measure engagement by things like talking on the phone, texting, browsing the web, doing email, playing games, etc., then on the surface we can make an observation that at some point this these will be equal by sheer volume of Android. Simply because these are common tasks. What needs to be added additionally for a holistic ecosystem analysis is how much time is spent additionally where things (and all regions) may not be equal.

Regardless, even if the level of engagement does become equal taking Android 5-6x (or more) the customers to reach the same engagement, both platforms will remain and will be a focus for developers.

Lastly…

This is a point I have not seen made yet that I think is very interesting. As much as Apple will benefit from getting new customers with an entry level iPhone that benefits their ecosystem so will Google. We know Google makes more on iOS than Android and interestingly an entry level iPhone will likely help Google’s bottom line as well. When you dig through the numbers on how profitable iOS is to Google’s search revenue, Google may be the biggest cheer leader for a lower-cost iPhone.

The questions around this are interesting. If a lower-cost iPhone does shake up the market in Apple’s favor globally would Google put even more emphasis on iOS? Would Apple even let them? Will Apple do more strategically with Siri to usurp search or other value from Google?

Services are a critical part of the end game for many industry players. Google was always fascinating to me because they are a services company first who worked their way backwards into software, and now hardware with Motorola. Apple came from it the other direction starting with hardware and software and now investing heavily in services.

Strategically, so much is going on in the market that will define the next decade or more of computing.

  1. of course, engagement on tablets is so disproportionate on iOS vs. Android. And on this point, it may never be equal. []
Tags: , , ,

Ben Bajarin

Ben Bajarin is a Principal Analyst at Creative Strategies, Inc - An industry analysis, market intelligence and research firm located in Silicon Valley. His primary focus is consumer technology and market trend research. He is a husband, father, gadget enthusiast, trend spotter, early adopter and hobby farmer. Full Bio
  • Lars F. Jørgensen

    I would venture that it’s not the Apple eco-system that get iOS users to spend more money, but the type of customer that have been buying the iPhone that was willing to spend more.

    Now Apple is inviting a more average mobile customer into their premium world and I believe that we will see the new iPhone customer spend less in the Apple eco-system than the existing customers do.

    By creating, an inexpensive way to get the iOS experience Apple might just end up losing twice. They will make less money on the phone and the new customers will spend less after they enter into the Apple eco-system.

    The question is if there will be enough new customers flowing in to make up for the money less spend?

    • Jurassic

      Unlike its competitors, Apple has a history of not introducing new products that won’t generate healthy margins.

      Apple is in an excellent position to introduce a low-cost iPhone that will bring in the dough. All that you need to do is look at the iPod Touch. The iPod Touch is an iPhone that is missing 4g and GPS. Those are very inexpensive to add.

      The 32GB iPod Touch sells for $299, and it has a high margin. It is easy to see replacing the aluminum body with a less expensive plastic one, and reducing the storage to 8GB or 16GB.

      With the addition of 4g and GPS, this new low-cost iPhone could easily be sold at the same $299, and bring in the same margins as the 32GB iPod Touch. In fact, these low-cost iPhones will probably EOL the iPod Touch all together.

      Apple’s competitors have very low margins on their low-end phones, but Apple has the ability to generate huge profits selling low-cost iPhones in countries where phones are purchased outright, and where the high-end iPhone is too expensive for most people.

      • r00fus

        Given phones require carrier support (at least their frequencies/tech), I don’t see the iPod touch ever going away (for folks who just don’t want/need a phone, just want iOS).

        Will the 5C be a “world phone” – very unlikely. This will allow Apple to price-discriminate very easily – that alone would provide all the product differentiation that’s needed – lock into certain GSM frequencies or CDMA, and you can buy in India (for example) and not be able to use in USA. Want a world phone running iOS? Get an iPhone5 or 5S.

        With this assumption in place, the 5C could be sold for very small margins in emerging markets and not cannibalize other markets.

        • qka

          In my case, a cheap prepaid phone and a wireless network iPad (or mini) are ideal.

          I don’t talk or text much, so the unlimited plans that are forced on iPhone users are not for me. To me, they seem like AOL all over again!

          Likewise, the two year replacement treadmill for phones is excessively conspicuous consumption. I replace my Mac every three or four years, so will go my iOS devices.

          Most of the time I am within WiFi coverage, so i don’t need a data plan. With their data limits, they would not give me enough under usual cases. Having an iPad with the pay as you go data plan, I can buy data for only when I need it (traveling). Also, those iPads have GPS.

          To me, the lack of GPS is the biggest differentiator between the iPod touch and the iPhone.

      • SSShu

        Is it possible that Apple will tweak the 5C prices to take into account the market that they are aiming for then? Just to cover the predicted drop in customer spending on those devices?

      • Space Gorilla

        Yes, I’ve been waiting for this for two years now. The iPod Touch with the ‘phone part’ added. I have four teenagers, this would be a perfect device for them. Crossing my fingers.

    • https://twitter.com/#!/azulum azulum

      Willing to spend more or able to spend more? In your comment is the implication that people who do not have money do not have taste, or at the very least, are unable to recognize value. This is false. And the resale value of the iPhone (and Apple products in general) proves that pretty well — after all, who would buy a used iPhone?

    • aardman

      I think based on the sales figures (and customer profile) of 4 and 4S, Apple has a pretty good idea of how to position the 5C and they will not be getting the kind of surprises that you worry about.

      We fret a lot about Apple’s seemingly puzzling moves, forgetting that we don’t see the kind of sales and market info that Apple has. Based on previous performance, I tend to trust that a) Apple knows what they’re doing and b) they’re nimble enough to make midcourse corrections as needed.

    • r00fus

      I disagree with your sentiment. I think there isn’t one dimension to customer “quality”. For example, I’m very interested in migrating my dad to an iPhone for his daily driver (he currently uses a basic phone), and with t-mobile it’s not costly to add a line, but my old VZ iPhone4S won’t work (jailbreak impossible for now) on t-mobile. I don’t want to shell out $300 for a used iPhone4 / AT&T, so I’m really interested in what Apple offers for the 5C. He doesn’t need Siri, and hates Google for some reason so Android is out of the picture, and an iPhone5 would be way too expensive.

    • orthorim

      This argument makes no sense to me.

      Apple is keeping its high value customers. It’s just acquiring low value customers as well. A low value customer is better than a Samsung customer to Apple.

  • peter

    Worrying about canabilizing your own sales is something you should do when you have a 50%+ market share; this is a luxury problem that Apple does not have.

    Their first worry should be the health of their platform. Given the Microsoft Windows winner-takes-all experience, it ought to be clear to Apple that there is not necessarily a niche for them as a very profitable number 2.

    It should be fairly simple for Apple to find sufficient differentiators in the hardware + software + services chain, to maintain high margins on the ‘heavy’ users, while still being able to attract ‘lighter’ users and make a buck (and lock out other platforms).

    That gets me back to the main point; currently Apple is under-utilising the price discrimination tool in their iPhone line up. Hal Varian, currently at Google, wrote an interesting book that covered the topic 15 years ago. High tech industries can be quite unforgiving to those that leave money on the table (that sustains competitors), so introducing much more price discrimination is not an option but rather a necessity for Apple (even if those marginal customers are not nearly as profitable as the current ‘golden’ crop).

    • benbajarin

      Which book? I’ve seen some of his stuff but not all.

      And yes I agree, this is clearly why Apple will do this. My overall point is that Apple does not just want to sell hardware. So they want to acquire customers who value more than just the hardware and will spend money in the ecosystem. For someone who just wants cheap, meaning their needs are met with really any average device as well, they don’t do much else with the devices, these are the ones I’m not sure Apple will go to length’s to acquire.

      • peter

        Hal Varian: Information Rules… 1998. Particularly interesting is the notion of spending money to create ‘inferior’ products solely with the purpose of enabling price discrimination.

        I take your point that a ‘cheap’ customer who will never spend more than $10/month on mobile computing is outside Apple’s reach, but there in enough in the below $50/month market to be of interest to them (and others).

      • Hosni

        Apple should set a comparatively low price for the iPhone 5c not so much to attract users to the ecosystem, but to “hook” them on Apple’s iDevices (hardware) for their future purchases. This is a far more valuable consideration than profits from sales of software and electronic media. iTunes Store sales themselves don’t generate huge profits for Apple (30%x$40 per year), but owners of iTunes media are more loyal to the brand — a far more profitable consideration.

        To some degree, then, Apple should emulate Amazon with respect to Kindle sales: Accept a smaller profit on the iPhone 5c in order to “recruit” new customers, then two years later 80% of them will purchase an iPhone 6 or 7, iPad 5 or 6, iWatch, etc. Two years later, 80% of those who do will purchase iPhone 7 or 8, iPad 6 or 7, etc.

        Regarding the earlier point (from Peter) regarding the need to practice price discrimination: Apple is already practicing quite a bit of price discrimination: negotiated institutional sales, price discounts late in the model year (iPhone 5 was discounted about one month ago by several stores and carriers), discounted sales to employees, sales of used/refurbished devices (a new area of interest for Apple), discounts in overseas markets, etc. However, price discrimination is more profitable for a seller when it isn’t obvious, so that’s why we aren’t particularly aware of it. Because China Mobile’s 4G network will use a slightly different technology than most other 4G networks, it would also be possible for Apple to offer 5c models to China Mobile’s customers at a different price than 5c models sell for in other markets.

        The above notwithstanding, I believe that Tim Cook should rely more on economic analysis for key decisions than it appears he has heretofore.

    • aardman

      There is one constraint for Apple if it widens its price spread. How low can they go and still be able to offer full customer service esp. Genius Bar access? The level of customer service that Apple offers doesn’t come cheap. What if the Genius Bars get inundated by a deluge of service requests for cheaper phones that don’t carry their weight w.r.t. customer service costs? Or is Apple willing to practice customer service apartheid and damage its brand? I’m not saying more differentiation across their product line can’t be done, it’s just that we don’t know how much can still be done.

      I’m not sure either that winner-takes-all is the inevitable rule in smart phones. It wasn’t that way before iOS, why should it be such now?

      • qka

        Genius Bar support is available for a $49 iPod shuffle.

    • orthorim

      +1. Apple needs to make a cheaper iPhone as soon as the hardware is cheap enough to create a great experience. It’s as simple as that.

      As for the OP I don’t think anyone at Apple worries too much about how much value customers add, as if Apple was really picky. They’re not – they want to sell devices. That’s all. More of them, to more people.

      And it’s a fact that there are more people out there spending $300 on a phone than there are people spending $600.

      Having 30% or even up to a ridiculous 45% profit margins is not a law of nature for Apple. They like ‘em margins, but obviously selling devices is more important.

      As for differentiators: iOS 7 is full of them – that is it’s chock-full of features that Android just can’t copy at this point in time.

  • EpaL

    Perhaps another reason now is the right time for low-cost iPhone: iBeacon. If Apple are able to monetise it, those previously ‘lower-value’ users would not be so low-value anymore…

    • benbajarin

      This is a great point and one I’ve thought about for a long time but obviously have no way to quantify yet. I’ve long asked whether the willingness to spend at the low-end was a result of the OS. Since iOS is a more holistic ecosystem than Android, I’ve long wondered if when these lower end customers get in if they will be enticed to spend. I suppose we will see.

    • orthorim

      Possibilities are staggering for iBeacon but so far this is all speculation. I have my doubts that Apple is in the best position to roll this out – they’re focused on hardware sales first and foremost.

      • benbajarin

        Yes Apple wants to sell hardware but it is all inter-related and tied together as a part of the ecosystem. So I would argue that Apple has oriented their experience in a way to not only sell you hardware. In fact, I would even argue they do not JUST want to sell you hardware. Few companies are oriented like this.

        I also find this very interesting philosophically in that Apple wants to sell us stuff and Google and Amazon want to sell US! Take your pick.

  • hannahjs

    A few little things may subtract from your final point. iPhones sold in China would benefit Baidu rather than Google. Siri 2.0 will come with Bing integration, benefiting Microsoft. Apple’s default Maps app, greatly improved, may radically displace Google’s as a user favourite. Finally, and crucially, Safari’s default search engine in iOS 7 may be someone other than Google.

    • r00fus

      Which are all reasons why Google has a bunch of interconnected iOS apps to keep their users locked into their services even on iOS.

      What this will mean is that as Apple distances itself from Google services (for iOS7 at least) as a dependency, in the future, I see Facebook and Google having their own “app ecosystem” within each mobile OS (see: Facebook Home).

      For now Google is stiff-arming Microsoft for WindowsPhone8 support for Google services, even going so far as to issue takedown requests for MS apps that utilize “private Google APIs”, but I see Google eventually (assuming WP exists as a viable mobile platform) creating another suite of apps for WP devices.

  • normm

    It’s worth pointing out that iPhone installed base is projected to pass Android in the US next year, and that’s ignoring all other iOS devices. That will certainly affect US developer perceptions. A cheaper iPhone could extend that reach to the rest of the world.

    It’s also worth pointing out that Evans’ numbers somewhat exaggerate the current global situation, since 400 million is just the number of iOS devices sold in the past two years, but another 200 million were sold before that, and most of those are probably still in use, passed on or sold until they fall apart. This isn’t true of the mostly cheaper Android devices.

    • r00fus

      Good point, even older iOS devices like the first iPhone still have access to iOS 3.0 and many supported apps even at that version and are still good front ends for AppleTV (Remote). Plus they still play music quite well.

  • Meaux

    “Those customers are simply not valuable in the grand scheme of things and arguably not worth competing for.”

    This assumes that the value of network effects is zero or close to it. My sister stayed on the Blackberry platform far longer than any right thinking person would, for one reason and one reason only, BBM. All of her friends in far flung countries had BBM and so they all stayed on because no one else blinked. Eventually she got an iPhone and regrets not moving over sooner. Getting low usage, low value people gets people locked into the ecosystem and also allows their friends that are higher up locked in. If a significant percentage of my friends left iOS for Android, iOS would become less valuable for me because all of the sudden iMessage becomes less valuable.

    This also ignores that today’s low value customer can be tomorrow’s high end customer.

    • peter

      I agree. I think the most important category of low value customers are teenagers. They move in fairly short time from pocket money to young adults without significant fixed expenses (house, family, etc). Traditionally the music and movie industries had a near monopoly on content sales to free-spending 18-25 year olds; obviously this is an extremely interesting group of customers for the Apples and Samsungs of the world.

  • orthorim

    These are interesting thoughts. But I think something much simpler is going on here: Apple is merely doing what it did with the iPod.

    They make the best device. Then once the hardware is cheap enough, they expand into the lower price categories. They can move themselves into a position where they (1) cover all price points (2) have the best user experience and (3) have the best margins of anyone in the industry. Then, they win.

    Apple already has the best experience, even though Android is catching up [Note that Android is not actually catching up in the lower price segments where devices run Android 2.3... ].
    Apple also has the best margins – though Samsung is in a brilliant position to compete in this regard.
    Now all they need to do is cover all price points. Low(er) cost iPhone is only logical.

    “Binding” people into the Apple ecosystem is something that Apple does on the side, like Apple TV. The lock-in really is not very strong. An iPhone user can relatively painlessly switch to Android. Services is something that Google does well but Apple doesn’t need to compete with that – they need to be good enough and that is a challenge; After maps Google knows that it is in its own best interest to *not* force Apple to compete. Google does *not* want Apple to suddenly have to re-invent search and email – why would they build up a competitor. They already shot themselves in the foot with maps.

    It’s important to remember: Services is not Apple’s main business. Its main business is hardware, and everything else that they do they do to fuel hardware sales.

  • Alfiejr

    once again this discussion commits the fundamental error of conflating all products running on a android OS into an imagined single “platform” that is counterposed against iOS products – which ARE a genuine single platform.

    as has been noted before, the massive numbers of android OS products in China, India, and the developing world having little or nothing to do with Google’s Android platform. with their own highly localized app stores, apps, and locked-in telco services, for all practical purposes they may as well be running on some other OS.

    the existence of “Android” as a single global platform, as Evans presumes, is simply a myth.