How Apple sets its prices

Comparison-shopping for new electronics can be fun and addictive. With a bit of patience, some luck, and an eye for good deals, you can find everything from TV sets to hard drives at a significant discount. In fact, in our economy, discounts are one of the primary mechanisms that retailers use to compete against each other.

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But all bets are off if you happen to be in the market for a product made by Apple: Both iOS devices and Macs seem to be impervious to the discount game. In fact it's so rare to find a significant price variance between retailers that, when it does happen, the event usually draws considerable press coverage.

House advantage

With so many laws regulating competition among retailers, how does Apple pull off this amazing feat? It turns out that the company uses a fairly straightforward strategy, known as price maintenance, that takes advantage of the popularity of its products and exploits a quirk in the way retailers are allowed to advertise their merchandise.

Most products move from manufacturers to retailers through a network of distributors. Even though each product has a "manufacturer suggested retail price" (MSRP), each retailer is free to set its own sale price. Thus, a laptop with an MSRP of $500 might cost the retailer $250 to buy, and might carry a sticker price of $350, accompanied by a bold "30% Off!" announcement in the store's weekly flyer. A different retailer might offer an even lower price to attract more store traffic, or conversely it find itself in a weaker position due to lower sales volume and have to charge its customers more for the product.

All of this price variability is possible because of the large difference (commonly from 30 to 55 percent) between the wholesale price--what the retailer pays the distributor for each unit of the product--and the MSRP for each unit. That gap leaves enough room for each retailer to set its own policies and generate a sometimes significant range of market prices for a product.

Apple, however, extends only a tiny wholesale discount on its Macs and iPads to your retailer of choice. The actual numbers are a closely guarded secret, protected by confidentiality agreements between Cupertino and its resellers, but the difference probably amounts to only a few percentage points off the official price that you find at Apple's own stores. With such a narrow gap to tinker with, most retailers can't offer big discounts and still hope to turn a profit.

Carrot and stick

The price maintenance approach cuts both ways: Retailers have relatively little incentive to carry Apple products, or to dedicate precious retail and advertising space to them, if the potential profit from sales is so low. On the other hand, large chains not uncommonly turn a barely profitable product into a "loss leader," selling it below cost to increase customer traffic or to boost sales of ancillary goods, such as accessories and cables, that have a higher profit margin.

This is where the second part of Apple's retail strategy kicks in: The company supplements its tiny wholesale discounts to resellers with more substantial monetary incentives that are available only if those resellers advertise its products at or above a certain price, called the "minimum advertised price" (MAP). This arrangement enables retailers to make more money per sale, but it prevents them from offering customers significant discounts, resulting in the nearly homogeneous Apple pricing we are used to.

The strategy benefits Apple in a number of ways. First, the company makes more money on direct sales and doesn't have to compete against marked-down prices offered by its own resellers. Since Apple's own retail operations are among the most profitable in the world, undercutting their prices for the sake of a wider distribution network would be counterproductive.

Most important, the narrow range of of price variability prevents any one retailer from establishing a strong enough market position to give it an advantage in future negotiations with Apple. Big-box store chains like Walmart are notorious for using their heft to extract higher and higher discounts from manufacturers--even to the point of forcing the latter out of business. By keeping its products' prices on an even keel, Apple reduces the potential for future conflict within its distribution channels, which also helps keep its own retail operations operating in the black.

When good discounts go bad

The situation with the iPhone is slightly different. Though the phone's retail price is in the hundreds of dollars, most consumers buy it alongside a two- or (in Canada) three-year cellular service plan. In exchange for the opportunity to charge their iPhone customers $70 or more a month, the carriers subsidize the cost of the device itself, which consequently carries a much lower price than it would if sold unlocked and contract-free.

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