The economics behind the new iPad
Apple's new product is getting considerable hype. If we stop for a minute and look at the iPad from the perspective of behaviorual economics, then we can see behind the hype into Apple's real motivations for some slightly odd announcements. There are 3 insights from economics that really do help explain some of the quirkiest announcements today.
Marginal cost pricing
Lets be clear, in economic terms the hardware of the iPad is not a new product. It's an iPhone Maxi edition. That makes it a line extension. And there is one thing we know about line extensions. You don't need to sell many of them to make money. The reason is that the development costs are low. The R&D spend on the iPad can be made to seem significant and I do respect the care that has gone into the iPad. But the fact shines through, this is just a tweaked up iPhone. The savings on R&D from that decision will have been huge.
Even so, Apple still needs to defray the cost of software R&D on the iPad, and now it can now do that over the whole iPhone and Macbook ecosystem. This explains why the iWork announcement was so prominent. Any development R&D on iWork can be spread across a wider install base. Making the average total cost (which includes R&D) closer and closer to the marginal hardware cost of the additional units (which excludes R&D). In a different economy maybe we would have seen more unique development for the iPad. But Apple need to move units and to keep their cost of doing so down.
This low development cost becomes even clearer when we look at the pricing structure. What we see at play here is classic price discrimination based on self selection.
Price discrimination
Think that you're paying $829 instead of $499 because you want 3G and more features? You're not. You are paying almost twice the price because you are a certain type of consumer that feels good about having the best. And Steve Jobs has figured out how to let you pay to do so.
There are Cannon cameras with the same lens, same sensors and same photo outputs. The only difference between them is the model name and a couple of features turned on or off. The price range for these self selecting categories is also almost double from cheapest to most expensive. The iPhone explored that strategy and the iPad brings it to perfection.
Choosing which iPad model you want is like stopping at one of those honesty boxes on the side of the road for fresh fruit with a sign saying: "Pay however much you want."
This allows Apple to win new users in the middle market while still catering to their loyal, affluent and engaged customers. In fact, the iPad shows that they are actively focusing on their heavily engaged customers.
Pareto's Principle
Pareto is the Italian 18th Century economist credited with the first research on the 80/20 rule. Which suggests that in Apple's case, 80 precent of their revenue will come from 20 percent of their customers. Apple have built the fun parts of the iPad to focus on the best of their existing iTunes store customers. I have only just started buying applications for my iPod Touch but one of my colleagues started buying apps on the first day they got their iPhone. Apple wants the iPad in the hands of those customers that are already in the habit of using iTunes, the App Store and now the IBookstore.
The real reason for making the iPad an iPhone Maxi rather than a Macbook Mini is obvious. The app store is a closed ecosystem that allows Apple an ongoing revenue stream with almost zero marginal cost for growth. Beware though, the app store is not yet nirvana for developers and many have complained that even with large volume they can't extract sustainable value.
My area of interest is in the business impact of design, so I still love Apple and am looking forwards to seeing how the iPad evolves. But today will live in infamy as the day we all realised that Apple are human as well, and that base economic motivations can influence even the most purist design driven firms. From a behavioural economics perspective, today was really just a series of shrewd moves by Apple to maximise revenue while minimising risks. But we need to look behind the veil of the R&D hype to see them for the careful and measured steps that they really are.
