Few economic concepts have captivated my mind as much as the price elasticity of demand. I first stumbled upon this idea in the university, while I was studying Economics. It’s been almost ten years now and I still find it fascinating.
The price elasticity of the iPhone demand helps understand many of the particularities of the smartphone market. It also depicts Apple’s ASP resilience in an apparently commoditized market.
Let’s have a look at it.
Price Elasticity of Demand
We tend to believe that when the price of a good increases, demand decreases. And we are right. But there is more to it than that.
How much is demand changed when the price changes? Is the price of this good very sensitive or, perhaps, less sensitive? If I double the price, does demand collapses in half too?
This sensitivity of the demand of a good to its price is called price elasticity of demand. And in economics, we study this phenomena under ceteris paribus, meaning, when we change price or demand we assume all other things remain equal.
Let’s see how this price elasticity of demand looks like for a normal good:
This is a traditional demand curve. In this graph you can clearly see why when the price of a normal good goes down, demand goes up:
- When P1 moves to P2, then Q1 shifts to Q2.
The opposite is also true: when price of a normal good increases, demand decreases. Makes sense. But of course as it usually happens with these things, there is much more to the price elasticity of demand than this. And the price elasticity of the iPhone demand goes right through it.
Necessity and Substitute Goods
In order to understand some economic concepts it is very useful to study the extremes. Price elasticity of demand is one of those concepts.
As you might have guessed by now, not all goods have the same price elasticity of the demand. Let’s plot the demand curve for two types of goods: necessities and substitutes.
An essential good is one you cannot live without. It is a necessity for whatever reason. It is easy to understand how, under these circumstances, you would pay whatever the company selling this good wants you to pay. You’re a hostage.
That is why, looking at the graph in the left side, the demand curve is a vertical line. It is called perfectly inelastic demand curve. This means the market will take all the produced quantity regardless of the price at which it is offered.
A typical example of perfectly inelastic demand good would be a drug capable of curing cancer. Cancer patients would take whatever the company producing this drug is able to produce, no matter the price.
On the other hand, in a perfectly elastic demand curve the company is unable to charge a higher price than P1. At P1 or below, the market will take whatever quantity is produced.
An example of perfectly elastic demand is a commodity market such as wheat. There is a given price that acts as a ceiling. If wheat producers try to charge a higher price, demand for their wheat is zero.
These extremes are very interesting. In the perfectly inelastic demand curve, the producer of the good has all the pricing power and consumers are at its expense. But in the perfectly elastic demand curve, consumers are the ones holding all the power.
Basically, it all goes down to the singularity of a product. If a company is able to embed enough reasons for consumers to appreciate its product, the demand curve of that product will become somewhat inelastic. But if a competitor is able to provide a similar product to the consumer’s eyes, then its pricing power shifts away from the manufacturer to the client.
This should already ring some bells. The price elasticity of the iPhone demand, as we are about to see, is quite inelastic compared to its competitors.
The Price Elasticity of the iPhone Demand
As we have seen time and again, the demand for the iPhone is inelastic. Not completely, no. But quite inelastic compared to other platforms.
The price elasticity of the iPhone demand tends to be more vertical. This means that whenever Apple increases the price, demand is not affected that much. You can see this by comparing the distance between P1 and P2 vs Q1 and Q2.
Apple’s iPhone demand is almost that of a necessity good. A good that some people cannot literally live without. The reasons for this are subject to debate, but we can mention just a few:
- Proprietary operating system, software and services.
- Ecosystem effect, where owning more products of the company adds value.
- Great customer service.
- Excellent design and materials.
- Worldwide reach and distribution.
In other words, if you want an iOS smartphone, you have only one option: Apple.
In contrast, the demand for an Android smartphone differs greatly from that of the iPhone:
This is self-explanatory. The demand for Android smartphones is much more elastic, meaning that a small change in price has a huge impact on demand.
Price sensitivity goes hand in hand with the budget conscious mindset of the average Android user. The reasons for this are an old adage:
- Android is a commodity operating system, with commodity software and services.
- There is little difference among Android OEMs besides price.
- Customer support tends to suffer from manufacturers unwilling to sustain development of current and past smartphones.
- OEMs brand loyalty is very low.
A user can switch from one Android manufacturer to another with ease, taking all the apps and subscriptions along to a familiar system.
What this all means
The price elasticity of the iPhone demand has another upside for Apple: all it has to do is manage supply and avoid any serious screw up. Even if a new model ends up underdelivering its yearly innovation promise, a whole bunch of customers will buy the new (or previous) generation.
Simply put: they have nowhere else to go if they want an iOS smartphone. Their only option is to wait another year, in which case, demand builds up.
One can argue that Samsung is another example of inelastic demand, since they are able to sell Android devices at a premium. Despite this being true, Samsung’s ASP of $225 in 2016 is nowhere close to the iPhone’s:
That is because Samsung’s bulk smartphone revenue comes from budget phones instead of the premium range.
Let us get straight to the point: Samsung is competing against other Android OEMs for new customers; Apple is competing against the previous year iPhone.
Before wrapping it up, one final word on Apple’s iPhone pricing strategy. Apple is perfectly aware of the price elasticity of the iPhone demand. But instead of just upping prices, it has positioned different models in several price ranges:
Apple is taking advantage of its pricing power within the smartphone market. The company is protecting both ends of its premium position, the higher end with the Plus model and the lower end with the iPhone SE.
This is an implicit recognition of the heterogeneous iPhone user base. This base is no longer well served with just one model.
Apple is actively working towards strengthening the price elasticity of the iPhone demand. Making this demand curve steeper with every iteration. Adding hardware features, new software and compelling services.
This is another way of seeing the strategic importance of Apple Music. Another attempt to make the demand curve of the iPhone as vertical as possible.