Economics of Apple iPhone: Price Discrimination or Pricing Error?

CASE BODYApple Inc. (NASDAQ: AAPL) is engaged in designing, manufacturing and marketing mobile communication and media devices, personal computers, and portable digital music players. It also sells a range of related software, services, peripherals, networking solutions, and third-party digital content and applications. The Company's products and services include iPhone, iPad, Mac, iPod, Apple TV, a portfolio of consumer and professional software applications, the iOS and Mac OS X operating systems, iCloud, and a range of accessory, service and support offerings. It also sells and delivers digital content and applications through the iTunes Store, App Store, iBookstore, and Mac App Store (Reuters, 2012).Apple has been a leader in the consumer electronics market for much of the 21st century. Such Apple products as the iPod, iPhone and iPad have become household names and set industry standards. The company typically maintains tight control over the distribution and pricing of its products.Apple is known to rely on early adopters. By 2007, it has built a loyal customer base with such ground-breaking products as the Macintosh computer and the iPod music player. The iPhone that was introduced in June 2007 was expected to continue in the same fold.At the time of the iPhone release its competition existed mainly in the form of RIM's Blackberry devices that had features similar to those of iPhone. The BlackBerry Pearl smartphone equipped with a camera and a media player existed since September 2006. On May 3, 2007, RIM introduced their next line of devices, the BlackBerry Curve (Research in Motion, 2007). More competition was on its way. At the end of August 2007, Nokia unveiled several new cellphones and an integrated music, maps, and games service (Nokia, 2007). In November 2007, Google released its open-source Android operating system designed specifically for mobile phones (Johnson, 2007).Nevertheless, the iPhone was highly anticipated. Over the eleven-week run-up to the introduction date, Apple's stock price went up 35%, as seen in Figure 1. The iPhone was expected to tap into a massive new market for Apple. Apple's CEO Steve Jobs said in the 2007 MacWorld keynote address: One percent market share equals 10 million units. This is a giant market. If you [sell] just 1% market share, you are going to sell 10 million phones-this is exactly what we are going to try and do in 2008, our first full year in the market - grab 1% market share and go from there... We think we are going to have the best product in the world, and we are going to go for it, see if we can get 1% market share - 10 million units in 2008 (Farris and Spekman, 2009).The introduction itself, however, was far from smooth. On the opening day, June 30, 2007, the iPhone was introduced in two versions - a 4 GB version sold at $499, and an 8 GB version at $599 (see Table 1). Many people stood in lines to get their hands on an iPhone. Apple reported that 270,000 iPhones were sold in the first 30 hours of the sale.A little over two months later, on September 6, 2007, Apple abruptly cut the price of the 8 GB iPhone by $200 to $399. The 4 GB model was discontinued altogether.The price cut was unexpected and led to negative reports from industry analysts. A Wall Street Journal article (Wingfield, 2007a) quoted Toni Sacconaghi, an industry analyst at Sanford Bernstein, as saying it was unheard of for Apple to cut prices so quickly after the introduction of one of its new products, and questioning whether Apple could meet its sales goals in the absence of a price cut. It can't be a bullish signal about iPhone volumes, Mr. Sacconaghi said.Apple's stock price fell $7.40 on the news to $136.76, and had a further decline of $1.75, to $135.01 the following day. In just two days the shares lost over 6 percent of their preannouncement value. See Figure 1.Apple customers were taken aback by the price cut. While technology companies often reduce prices on their products, Apple historically introduced replacement models with changes in design and improved features instead of discounting existing models. …