Apple And Its Decoy Pricing For iPhone X – Apple Inc. (NASDAQ:AAPL)

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The Harvard Business Review hypothesized that the four digit pricing of the iPhone X was a consequence of Apple’s (AAPL) wish list to bring more exclusivity within its product portfolio. There’s probably an element of that, yes. But more so, I think this is a case of decoy pricing (or asymmetric dominance effect as it is called in Decision theory) than exclusivity.

What is decoy pricing?

Consider a company trying to sell two air conditioners. They are equal in every facet except the tonnage. “Cool” is a 1.2 ton air-conditioner at $500 whereas “Frigid”, at $800 has a tonnage capacity of 2 tons. A consumer looking for a cheaper AC would buy Cool and those looking for better tonnage would buy Frigid.

The asymmetric dominance effect says that by introducing a third decoy, the company can influence consumer buying pattern towards either one of its products without changing the product in any manner. Let us assume that the company wants to increase the sales of Frigid, on which it earns higher margins. And here, to use the cliche, there is a method to the madness. For this to work the new option must be worse in all aspects to exactly one of the two products (Frigid in this case), and partially worse than the other (by extension, Cool). A third product – “Snow”, a 1.8 ton AC priced at $900 is introduced. Snow is worse compared to the Frigid when we look at the price and tonnage. Compared to Cool, Snow has a better tonnage but a higher price.

The company does not want consumers to know it is exploiting their cognitive weaknesses to fill company coffers. So it adds a feature which is known to be relatively irrelevant in purchasing decisions. Assume that the new product is available in a stylish red and black design, which Cool and Frigid are not. According to the theory, looking at the pricing on Snow, consumers perceive Frigid as a deal and the Frigid would sell more compared to the time when only two products were present.

The Economist magazine tried to exploit this theory to the extreme in 2011. In this Ted talk, Dan Ariely, who wrote the paper on this topic in 1995, hilariously explains the seemingly vulgar exhibition of how the magazine tried to exploit consumer psychology to increase demand for its costlier product.

As you can see in the picture above both the Print subscription, and the Print + Web subscription were priced at the same rate. Dan Ariely took this to a class of MIT students and asked them what they would select. 84% selected the combo subscription and the rest went for the web subscription. But when he eliminated the print only option, voila, 68% of the students selected the web only subscription. Only 32% opted for the combo deal.

Now let’s look at the case of how Apple might be using this theory in a seemingly more nuanced way.

Guess Apple’s decoy

In its launch event, Apple introduced the iPhone 8, iPhone 8 plus and the iPhone X. Which one among them is the decoy? I think there are two decoys here – the iPhone 8 and the iPhone 8 plus. The two products that the company is really trying to sell is the iPhone 7 and the iPhone X. Why do I say that? The 8 and 8 plus are only marginal upgrades on the 7 version. If I were an Apple acolyte (I am not, I own a Pixel) using an iPhone 7 plus, I would be dejected as a wet hen on getting such a minuscule raise for $799. The iPhone X is the only alternative I’d prefer as an Apple acolyte who wants to switch. Among these loyal Apple fans, I think the company also wanted to test how they would react to the psychological barrier of a $1000 phone. Therefore, the iPhone X was probably the only new product launch last month.

And since the 8 series is only marginally better, the iPhone 7 series suddenly seems like a steal to price sensitive customers on lower versions of Apple or Android platforms. This makes the iPhone 7 the second, albeit an old product in this decoy strategy.

Conclusions

Basing my conclusions from the above theory, I would say that sales of the iPhone 8 series unlikely to be noteworthy compared to the new launches we saw in the past. There are conflicting reports about production delays on the iPhone X. If there are no production delays I think we could see better days for the stock. If not, the best hope for Apple investors is that the excitement doesn’t fizzle out by the time iPhone X reaches the consumer’s hands. Else, the company would be bracing for one of the worst years in its recent history.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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