Apple, Business, Companies, Hardware

Price wars: Cheap Macs are Utopian dreaming

These days, everyone is pressuring Apple to slash Macs prices or else… While the promise of ultra-cheap Macs that can match commodity PC clones on price seems God-given, in reality such move wouldn’t necessarily translate into a justifiable market share gain. In addition, Apple’s entrance into the commodity segment would surely devalue the brand. As a result, Apple would effectively surrender the premium market segment to others. Yes, we need cheaper Macs – we just don’t need ultra-cheap Macs.

If you have been closely following Apple lately, your heart may have skipped a beat on this rumor about imminent price cuts across the Mac lineup. As usual the well-informed Apple Insider first broke the news, claiming that entry level MacBook and iMac computers are up for price cuts scheduled within next two months. "Determined to grow its share of the personal computer market during the worst economic climate in its corporate history, Apple is tailoring changes to a pair of its offerings that will help drive down prices of some of the most popular Mac," Apple Insider’s Kasper Jade claimed, citing "people familiar with the matter." Before you pull out that credit card, it’s worth mentioning that the site noted only modest price reductions in the range of no more $100 to $150. Applied to most current price points of entry level 13-inch white MacBook ($999) and 20-inch iMac ($1.199) models, this would bring the two systems down to $849 and $969, respectively.

While the prospect of a cheaper Mac notebook and a 20-inch 2.66 GHz iMac in the sub-$1000 range surely is a welcome change that might enable Apple to better weather the storm in this pressured economy, in reality – suggested modest price reductions are hardly a game-changer. In fact, mounting expectations that a crappy economy will force Apple to enter the cut-throat, low-margin market segment where most commodity PC makers are losing instead of making money is nothing more than Utopian dreaming. Before I plunge deeper into this, it’s worth mentioning what impact the depressed economy has so far had on the California-based maker of shiny, albeit pricey gadgets.

Mac sales shrink, but not as fast as the rest of the industry
NPD Group estimated that Mac sales throughout the U.S. retail channel fell six percent in January 2009 and a whopping 16 percent in February.  Previously, the research firm predicted flat Mac sales for the December quarter while Windows PCs recorded a seven percent growth. Apple’s latest quarterly earnings confirm NPD’s estimates. The company shipped 2.22 million Mac units in the quarter ended March 30, a three percent decline from the 2.29 million units shipped in the year-ago quarter.

Sales of Mac desktops fell four percent in units and 22 percent in revenue from the year-ago quarter, while Mac notebooks shrunk two percent in units and 12 percent in revenue in the same period. However, although Mac sales sunk three percent, the rest of the industry shrank seven percent. Despite clearly negative impacts of the depressed economy and shrinking consumer budgets on Mac sales, the recession didn’t take the shine off the Apple stock. 

The secret: 40 percent tax on the latest Mac gear
In fact, Apple’s March financial metrics file as the best March quarter revenue and earnings in the company’s history. Having reported a whopping $8.16 billion in the March revenue (over $650 million increase from the $7.51 billion in the year-ago revenue) and net quarterly profit of $1.21 billion ($1.33 per diluted share), up from $1.05 billion ($1.16 per diluted share) in the year-ago quarter, Apple remains the money-making machine. There’s a good reason behind Apple’s ability to squeeze more profit even while Mac sales are shrinking – Apple’s margins.

The company’s gross margin for the March quarter was 36.4 percent, up from 34.7 percent in the year-ago quarter. This is in line with my recent estimate that put Apple tax on the latest Mac gear at 40 percent, confirmed by a research done by our own Theo Valich who pinned down the Apple Tax on the Mac Pro at $1665.15 for the baseline model and a massive $3,092.66 for the high-end configuration. Unlike commodity PC vendors, Apple can clearly lower prices of Macs by cutting a bit into its meaty margins.

However, don’t expect Apple to sacrifice a substantial portion of its margin just to compete with cheap Windows PCs. Just like Windows PC world has its Alienware, BOXX Technologies, Smooth Creations, HP VoodooPC, Apple rules its premium market segment. For those that are not satisfied with a look on brushed anodized aluminum look, there are companies such as ColorWare that will even increase the price at around $800-1200 by offering additional levels of customization.  

Apple owns the premium segment
If you know Apple, then it must be clear to you that the company chooses to play in the sub-$1000 segment, where all the money is and several lucrative verticals like education and creative. Apple is also strong with consumers who don’t compromise on quality. Last year, of every three dollars spent in the U.S. retail on computers, one dollar went to Apple. If we just look at the premium market segment, Apple claimed two thirds of the market.

Apple has long been hailing its rock solid Mac OS X operating system, iLife suite of integrated digital lifestyle applications preloaded on every Mac sold, virtual lack of viruses, the design and general trouble-free computing for an average consumers as key advantages that justify the premium. The company argues that these intangible advantages make Macs less expensive, and even comparable with Windows PCs, in the long run. The reasoning struck a chord with consumers from the upper market segment who are on the hunt for value and functionality and who are ready to pay the premium for a quality product.

Damage that cheaper Macs can do to the Mac brand
Yes, if Apple were to suddenly slash down Macs to $500 in order to compete with Dell, HP and a plethora of knock-off vendors from Far East, this could help boost the company’s share of the market into two-digit range. But Apple’s entrance into the commodity market would alienate its premium customers with whom the Mac brand would lose its appeal. If you play in the premium market, there’s nothing worse than devaluing your brand.

Just remember how early iPhone customers reacted when Apple slashed the handset by $200, prompting Steve Jobs to apology and introduce a $100 rebate for the affected consumers. Imagine how you’d feel if the $1.199 20-inch iMac you buy today suddenly goes as low as $699 in a two months time. Wouldn’t you feel cheated or at least angry? Of course, Apple might always roll another rebate program to ease the pain of customers affected by such sudden price drop but this wouldn’t change the fact that a premium consumer wouldn’t deem Macs as valuable as they are now, when they’re pricier.

Consumers don’t care for cheap BMWs, why would they care for cheap Macs
Blame it on the psychology or just side-effects of Apple’s decades-old marketing, but the fact is that premium brands like BMW, Apple or Ferrari owe much of their power to premium pricing which attaches certain feel of worthiness to a product. Now, I’m not suggesting that premium pricing can push otherwise ordinary product, not at all. But if the majority of industry players battle each other in the commodity space, those vendors who address premium market with high-quality products that stands out from the crop can often do so at premium prices – that’s why they call it the "premium market."

People know that high-quality yields high price and they expect this. When you take that out of the equation, premium customers lose interest. We’ve seen it happening before, with Sony and BMW. Both companies tried growing market share in the past by bringing prices down to cater for lower-income consumers. The move almost sent Sony into the bankruptcy and damaged its brand heavily, up to the point that it is no longer identified with top quality.

Once Apple’s brand is devalued, there’s no going back
Ultra-cheap Macs wouldn’t necessarily grow Apple’s market share enough to justify such risky move. The vast majority of PC sales are enterprise purchases, the segment with too many barriers for noteworthy Mac penetration. The majority of the remaining consumer purchases are often guided by inertia, habit, brand attachment and other factors that even Apple’s reality-distortion field would have trouble reverting.
In fact, only a smaller portion of the commodity market would pay notice to cheap Macs. If Apple moves into the commodity market only to realize the move didn’t exactly worked out, it can always retreat to the premium segment but there will be no guarantees that premium consumers will dig the brand "polluted" with side-effects of the price-war.
Apple’s answer: a Mac tablet that is the Mac netbook you’ve been waiting for
Of course, I’m not suggesting that cheaper Macs are wrong – on the contrary. Price drops across the Mac lineup are a welcome change that will make Mac systems more affordable to the general public, enabling Apple to grow its share of the market and better weather the storm. It’s exactly this expectation that Apple is obliged to enter the commodity market that’s bothering me. Apple is the premium brand and has no obligation to cater for the masses, just like Prada, BMW or Swarovski. This isn’t to say that Apple should address lower-income consumers with a new breed of product. After all, there is plenty of space between 3-inch iPhone and a 13-inch white MacBook for a new form-factor device.
It is my opinion that we may see a 10-inch Mac notebook, like the now discontinued 10-inch Titanium PowerBook model, which should sell for around $800. I don’t think there will be a Mac netbook in a traditional sense and Apple on its part keeps criticizing netbooks per se for their compromises and limited functionality, as we already addressed it in our series of Netbook analysis [Netbook Analysis Part I, Part II, Part III, Part IV].
What people expect as a Mac netbook may actually turn out to be the Mac tablet, a sleek ultra-thin multi-touch gadget with up to 7-inch display that might sell between $400 and $700. It will do everything a regular netbook does, just with more style. And yes, it will have the App Store with loads of additional programs that will extend built-in functionality, just with the iPhone. Make sense now?