Apple 2.0

Covering the business that Steve Jobs built

Why does Apple charge so much for its iPhones?

September 12, 2013: 8:23 AM ET

The key, Horace Dediu says, is to think of the iPhone as a data services salesperson.

5C priceFORTUNE -- The short answer for why Apple (AAPL) charges so much for its iPhones -- e.g. $549 for the new iPhone 5C that most analysts expected would sell for somewhere between $300 and $400 -- is that it can.

"Anybody would if they could," writes Horace Dediu on his Asmyco blog. "That's a poor question. So the right question should be: why does anybody pay this much?"

Dediu's answer reveals much about underlying workings of the mobile phone business -- and indeed, the whole Internet economy. His key points:

  • Consumers, by and large, aren't paying those high prices. It's the operators -- 270 mobile phone carriers -- who pay the full freight.
  • The decisions operators make on whether to carry the iPhone are driven not by fashion or fanboyism, but by hard economic realities: ARPU, churn, network costs, depreciation, ROI, etc.
  • For many operators -- about two thirds of them -- the iPhone doesn't fit their business model. Verizon held out for years. DoCoMo just came around. China Mobile may soon as well.
  • Following the money, Dediu concludes that the operators who pay Apple's steep prices do so because the iPhone helps move users to higher revenue data services.
  • "These are more profitable services for operators," he writes, "and the subsidy model creates more loyalty and thus reduces churn and creates a stable cash flow which can then be leveraged through debt to upgrade networks and attract yet more loyal iPhone users."
  • But that's not the end of the money trail. Consumers end up paying most of the iPhone premium in the form of higher monthly phone bills. It's not itemized in the invoice, but Dediu estimates that $10 to $15 of every monthly bill in a subsidized plan goes to paying for the phone.
  • "So in a way," Dediu writes, "Apple has managed to place itself on many people's monthly phone bills. It's a nice place to be."
  • Some consumers see that transfer of payment as a thinly veiled con. It smacks of misdirection. The value of the iPhone is apparent to the user, but the payment for that value is not.
  • "In fact the whole Internet and all business plans that are built on it depend on a subtle 'something for nothing' type of misdirection," Dediu writes. "The Internet runs on the arbitrage between a consumer service market where everybody consumes but nobody pays and a separate data market where nobody consumes and everybody pays."

His conclusion:

"The iPhone could thus be finally understood as a complex service business. It captures value through the phone bill but delivers value through a screen. A misdirection magic trick which many have tried to pull off. It's essentially tapping into the $1.3 trillion communications market, skimming profits by delivering the 'content' which lights up the wires.

"It's great except it does not work everywhere. Not yet at least. The complexity of services means that they are usually found in more advanced so-called service economies and rare in less developed so-called goods economies."

Now that's what I call smart analysis. Why don't we get more of it from the guys who are paid to do it on Wall Street?

Link: S is for Service at Asymco.com, where much of the value comes from the quality the conversation in the comment stream.

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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