Research Paper: Economic Analysis the First Apple iPhone

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Economic Analysis

The first Apple iPhone was launched in June, 2007, and the product became an instant hit. The smartphone industry had evolved out of the PDA industry, and the current trend in cell phones to add different features such as cameras and mp3 players to enhance the phone experience. The iPhone represented something of a quantum leap in technology. To that point, only Blackberry and Palm were in the industry and their technology was substantially inferior to that of Apple. Apple quickly began to make inroads into Blackberry's market share as Palm fell by the wayside. In the fall of 2008, however, the first smartphones were launched using Google's Android system. This operation system was open source, which meant that OEM smartphone manufacturers could enter the industry freely using this platform, for which Google would receive little payment if any. This changed the industry dynamics for Apple. Over time, even the once-mighty Blackberry would struggle in the industry. One key industry dynamic is the number of applications -- or apps -- that are available for a given operating system. Consumers have demonstrated significant preference for the number of apps, and this presents a significant barrier to entry. The smartphone operation system industry has moved from oligopoly to monopolistic competition but is now headed back to an oligopoly state. This case study will examine the smartphone industry from the perspective of Apple, with particular reference to the strategies that Apple has used to win profits in the industry.

The Problem

The basic problem in the smartphone industry is how align the phones along the key dimensions of consumer preference. These are believed to be price and features. There is a high level of correlation to the amount of features a phone has and its cost, because of the fixed real estate of a smartphone and the fact that smaller components, or higher-quality components, cost more. Thus, consumers almost always face the trade-off between the utility of a feature-rich phone and price. Complicating the matter is that the price of the phone is sometimes obscured -- the phone is basically "paid for" by the telecommunications service provider, whose data rates just happen to be dependent on the quality of the phone it is selling, among other factors (Thierer, 2011). Assume, however, that in general consumers pay less for a lower-quality phone overall.

Apple has always positioned itself as a differentiated provider. It bases this on a few different dimensions. The company long ago realized that the money in technology was with the software, whereas the hardware for any product would eventually become commoditized. Therefore, Apple focuses on software development, design and marketing -- three creative tasks -- in order to generate its profits. The company has high margins, however, which gives it some flexibility in setting prices. The rapid maturation of the smartphone industry, however, has shifted from rapid growth and market share building to an approach built on leveraging an installed base as something of a cash cow -- selling apps, music and other services to existing customers, and having them update their phones periodically.

The problem for Apple is, having forged a dominant position in an oligopoly that allowed it to earn near-monopoly rents, how it should adjust its strategy and especially its pricing strategy in response to the new entrant in Android.

Economic Dimension of the Problem

Initially, Apple was competing almost entirely against the Blackberry. The latter was positioned as a business product, while Apple positioned its product as being for the average consumer. This approach, combine with Blackberry's slow embrace of the consumer market, allowed Apple to enjoy near-monopoly rents for the first 15 months of the iPhone's existence. No other smartphone could compare on quality and availability of apps and software, so Apple was free to charge monopoly prices, and did so. The company earned margins in the range of 75% and was able to retained substantial cash flow as a result.

However, the entrance of Android, along with the threatened entrance of Windows and a renewed effort by Palm to make a splash in the market, threatens to significantly divide the market, taking it to a state of monopolistic competition. For Apple, this represents a significant change. In a monopoly, or a duopoly where there is only limited overlap between the target markets of the two firms, Apple has tremendous pricing power. To the extent that it can convince consumers that they want a smartphone, Apple could capture that business and the consumer was unlikely to be price sensitive. However, with many competitors in the market, price sensitivity was likely to increase.

Typically, in monopolistic competition, firms can only earn profits where they enjoy short-lived monopoly, often created by effective branding, innovation or new product introductions. Apple could therefore maintain its prices if it was able to sufficiently differentiate its product. The company would still have a monopoly over its operating system, but most consumers exhibited no specific operating system preference. Consider the normal graph for monopolistic competition:

A price searching firm should produce at MC=MR (Investopedia, 2013). Doing this, however, represents a trade-off. Apple can set the price higher, but this will reduce demand. The lower price creates an opportunity cost, because consumers who are not price sensitive will also pay the lower price when they would have been willing to pay the higher price. Apple resolves this issue by finding ways to convince as many consumers as possible to pay the higher price, while accepting a lower market share as a result of this approach.

Instead, most consumers derived utility mostly for what they could use their phones for. This means the combination of features and software applications that could operate on the phone. Apple had an absolute advantage in this initially, because of its 15-month head start on Android (Beggs, 2013). However, Android's open platform was more developer-friendly, and it was a reasonable assumption that even if Android did not catch up, it would be able to deliver a competitive number of apps.

More important, Android was open license, so dozens of manufacturers were using the system, making devices at a wide variety of price points. This allowed the supply of smartphones to increase rapidly in the market, further driving down the price. A basic smartphone with basic features was rapidly becoming a commodity subject to low pricing that was just above the marginal cost of production in some cases. Buyers who truly needed the features not covered in a basic smartphone would still be willing to purchase a high-end model like an iPhone, but most consumers would have no need, and the availability of cheap ones would make them more price sensitive.

Analysis and Evaluation

Apple's response was to remain in the high end of the market. It sought to create monopoly by maintaining monopoly on its operating system but also on its software and on its designs. The name itself carried cachet due to exceptional marketing efforts. The company recognized that the market was growing so rapidly that even the high end of the market would deliver a high volume of sales. Apple also knew from its experience in personal computers that the company had high brand loyalty, something that would erode price sensitivity in a given percentage of consumers, anywhere from 5-20%. The company also realized that margins on lower-end models would continue to shrink, especially once the pace of innovation slowed. Apple's response, therefore, was to continue the rapid pace of innovation but also to maintain its pricing.

The market responded by punishing Apple in market share -- Android has now stolen most of it. However, Apple still has exceptional sales and profits because it was able to maintain sufficient innovation to keep its product differentiated. The company also has utilized its marketing goodwill, though there is… [END OF PREVIEW]

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Economic Analysis the First Apple iPhone.  (2013, April 22).  Retrieved March 24, 2019, from https://www.essaytown.com/subjects/paper/economic-analysis-first-apple-iphone/3225745

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"Economic Analysis the First Apple iPhone."  Essaytown.com.  April 22, 2013.  Accessed March 24, 2019.
https://www.essaytown.com/subjects/paper/economic-analysis-first-apple-iphone/3225745.