February 9, 2010

The iPad will compete on quality, not price

From Megan McArdle on the iPad dropping in price if sales are not hot:

The question, of course, is "how low can Apple go?" ...

One estimate is that the cheapest iPad costs $270 to manufacture. Throw in advertising, transportation, distribution, and so forth, and maybe they can cut the price $100 if they're willing to make a slim profit in order to establish a market. Of course, there's probably more room on the high-end models, and presumably costs will fall as they get more experience, and volume. But I don't see them getting within striking distance of a Kindle particularly soon.

I don't see them competing on price against the Kindle in the first place. No one wants the iPad for decoration. It is like a video game console -- not "a netbook without a keyboard" -- because consumers value it only to the extent that they value the games you can play on it. Or whatever it is that people are going to play around with on their iPads. Apple will try to deliver a cooler experience than what you get with a Kindle and charge a higher price for that. (Most people would pay a $10 premium just to avoid referring to their toy by the goofy name "Kindle.") That strategy seems to have worked for the iPod and iPhone.

It also worked for winners in the video game console industry. Nintendo had no real competition for its NES, and all three of the major 16-bit consoles were about $200. But from 1995 through 2005, prices varied; the cheaper consoles bombed and the winners were expensive. Sony's PlayStation cost $300 compared to the $200 Nintendo 64, and Sony's PlayStation 2 and Microsoft's Xbox both cost $300 compared to Nintendo's Gamecube or Sega's Dreamcast which cost $200. Only in the current generation has the cheapest console sold the best (Nintendo's Wii).

The reason that the PlayStation and PlayStation 2 could command such higher premiums over the Nintendo consoles is that consumers raved about the games for Sony's consoles and thought the N64 and Gamecube games were comparatively more forgettable. Expensive consoles that offered terrible games, however, obviously did not sell well, such as the $700 3DO or the $400 Sega Saturn. Video game consumers pick the console that offers them the best experience and figure that it's worth paying whatever the cost is, as long as it doesn't have a sticker price of over $500. So, there is no competition based on hardware price -- or software price, for that matter, since video games cost about the same from one system to another at a point in time. Competition here is based on the quality of the software that the console runs, so long as that wouldn't result in a $500 price tag (as with the ill-fated $650 Neo Geo, which had great games).

In fact, the iPad could get within striking distance of a Kindle right away simply by deciding to provide a crappier experience than originally planned, switching to cheaper parts, and so on. The supply side of "supply and demand" is just as subjective as the demand side -- Apple could take the money, etc., that it's now putting into whatever accounts for the $270 cost estimate, and reinvest that in cheaper parts, more limited capabilities, etc., in order to compete on price against the Kindle. In Apple's subjective evaluation, the current investment pattern is worth more to them than what they perceive as the next-best alternative use of that stuff. To put it simpler: price-based competition would have led Apple to design a much cheaper device in the first place.

Because no one knows quite what to make of this doo-hickey, it's like a movie, no two of which are alike -- you have to consume it in order to determine how you subjectively value it. (In Hollywood Economics, Arthur De Vany drives home this point and its implications for how the movie industry works.) Having used an iPod, iPhone, computer, ebook reader, etc., may give you the vaguest clue what the iPad experience will be like, just like watching Star Wars would give you a hint about what watching The Empire Strikes Back would be like. But there's so much noise in the guess about what a sequel will be like based on the first movie -- it could be a Nightmare on Elm Street 2 -- that you really do have to experience the sequel to figure out what it's worth to you.

So the planned-for price drops, if they happen, may be Apple's way of starting high and lowering it later just to feel out what the demand will be for this baffling sequel to the iPod and iPhone. It seems to have little to do with price competition.

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