Apple Pricing Strategy

I’m a big Apple fan. I also have a degree in economics which makes rationalizing the former interesting.

I’ve read a lot about Apple’s pricing decisions and it’s generally wrong. I don’t mean to seem arrogant but companies like Apple generally act rationally. During the period between the announcement of the Apple Watch and its release in the following Spring, I heard many different theories as to Apple’s practice and motivations. In reality, however, the truth is much more simple.

There’s a principle in economics known as the inverse price elasticity rule. It’s basically the following:

Set the Mark up (i.e. Price – Marginal Cost/ Marginal Cost) equal to the inverse elasticity to maximize profit.

(P-MC)/P = -1/E

This bit of math is the crux of many economic and business decision making processes. What’s elasticity you ask? That’s a bit more complicated.

Elasticity is essentially a way to measure the response in demand for a product for a given price increase. You can measure it as the percentage change in demand over the percentage change in price. The resulting ratio explains a lot about the product.

An elasticity greater than 1 indicates a higher response to a change in price. Luxuries such as eating out, purchasing expensive clothes, and other less “necessary” goods are often in this category. Inelastic products (with elasticities less than 1) are typically more required (i.e. gasoline, cigarettes, electricity, heating oil, etc.)

Apple maximizes profitability by ensuring this equation is satisfied.

The very nature of marketing is to manipulate elasticities. Apple does its best to ensure that the utility and desirability of their products is as high as possible. But they can’t deny economic truths. Apple doesn’t set their prices because of their cost of goods sold or by their margin. Apple sets their prices to maximize their profit. Samsung, LG, Google all follow the same process. Apple just does it better.