Price discrimination and the Apple iPad

Price discrimination is a way of charging some people more money than others for more-or-less the same good.  For some goods or services, some people are willing to pay more than others.  Charging everyone a high price means that you’ll lose sales.  Charging everyone a lower price means you’ll miss out on some of the income that would be generated by people who are willing to pay more.  Typically, a firm will determine a price that it thinks will be high enough to catch those who are prepared to pay a high price, but not so high as to dissuade too many of those who aren’t.  The alternative is to vary the price based on willingness to pay.  This is price discrimination, and today I’m going to use the Apple iPad as an example.

Apple iPad

A typical example of price discrimination is student pricing to see a movie.  Cinemas aren’t giving a discount to students because of any sense of charity – they do so because it’s a crude way to identify people with lower incomes and sell them tickets they otherwise wouldn’t buy.

The iPad makes a great example for price discrimination because the models are so similar.  The hardware is identical, except for two options – storage capacity, and 3G data network capacity.  The pricing – in Australian dollars at the time of writing – is below.

This price model can be expressed another way – as the base price plus the price of the only two things that can change:

The price jumps are pretty much consistent.  You pay $130 to move from 16 GB to 32GB, and another $120 to move to 64GB.  And you always pay an extra $170 for 3G data network capability.  But these components cost nothing at all like these amounts for Apple (even once currency conversions are taken into account).  The 3G capacity costs Apple about US$25, and the three storage options cost about US$30, US$60 and US$118 respectively.   Price discrimination is a key reason why Apple’s pricing is so out of line with its costs[1]}.If a potential buyer doesn’t have a high disposable income, but wants[2] an iPad, she can settle for the cheapest model, and manage storage needs by swapping in and out the data she needs.  Books take up little space, after all, so with a little planning, 16GB is adequate for most uses to which an iPad would be put.  If this user wants to be able to access a 3G network, she’s going to have to pay for the privilege.  It’s assumed that she’s a little better off, as she will have data network charges to pay.  The reasoning would be that if she can pay for the network traffic, well, she can also afford to pay a little more for the iPad as well.  A similar argument holds for storage.  If you are the sort of person who wants 64 GB of storage on a portable device, you’re probably using it to store films which (in theory, at least) you paid for.  Given that a digital copy of a feature film weighs in at 1.5 to 2 GB, that’s a fair few films.  If you can pay for the films, then you can pay for the 64 GB iPad.

So the variable pricing is a neat way for Apple to identify its customers who are willing to give it more money, which is one of the key conditions that allows a firm to price discriminate[3].  It really serves little other purpose.  Apple could easily have released all iPads with 64 GB, and only varied between 3G and no 3G (or, given that the 3G capacity costs it US$25, just released all of them with 3G).  If they had, even at the price of the Wi-Fi + 3G 32 GB model ($928), they’d be losing sales from people who might have had $630, but not $930 (so generating zero revenue) and also not generating the extra revenue from people who were willing to pay at least $1,049.

A final note.  Apple probably could have charged more for the 3G versions, at least on release.  They’ve sold out very quickly, at least in Melbourne.  There’s significant unmet demand and a shortfall in supply, which is a pretty good indicator that the in short term at least, the equilibrium price is higher than Apple has charged.

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FOOTNOTES
1. Another key reason is to allow for rationing of components, which may be the subject of a later post one day.↑
2. No-one, anywhere, needs an iPad.↑
3. The others are that the firm needs some form of market power, which Apple has (if you want an iPad, you buy it from Apple), and either the capacity to vary the goods (like the different capabilities on the iPads) or the ability to prevent resales (like selling your student movie ticket to a person who would otherwise have to pay full price).↑