This post was originally published on this site
For years, Apple has been expanding the number of products it sells by offering “Pro” versions with additional features and higher price tags. But what’s driving Apple’s decision-making, profit-padding dollars or consumer-centric sense?
On Monday, Apple made the newest addition to its ‘Pro’ product line, unveiling AirPods Pro, a higher-end version of the wireless earbuds the iPhone-maker debuted in 2016. With noise-canceling to drown out ambient noise and a slightly modified design that includes rubber eartips, AirPods Pro offers more features than the original AirPods, but are otherwise quite similar. Their most noticeable difference, however, comes at the check-out counter. AirPods Pro have a $249 price tag that’s $90, or 51%, more expensive than the original $159 model.
Earlier this year, Wedbush analyst Dan Ives told Fortune that Apple’s AirPods manufacturing cost is $59 per pair. Given the AirPods’ similarities to the AirPods Pro, it’s unlikely—if not impossible—that Apple is adding $90 in further costs to manufacture its new wireless earbuds. In other words, each AirPods Pro sale generates even heftier margins than the $100 Ives previously estimated that every pair of AirPods nets for Apple.
The decision to deliver a pricier (and more profitable) option with a feature consumers want isn’t a surprise. This is the same tack that Apple has taken with its iPad Pro, which until recently, was the only model to use Apple’s stylus-like Pencil. In the company’s smartphone business, the iPhone 11 has the same processor as the iPhone 11 Pro, but customers pay extra for a better camera in the Pro model. Compared to the MacBook Air, Apple’s MacBook Pro models offer more storage and power—as well as the flashy touch bar—but choosing the Pro model costs customers hundreds of dollars more.
Apple has used these premium devices to drive more revenue and profits—an especially important factor in Apple’s business, given the declines in its iPhone business over the past year. In the fiscal year ended Sept. 28, Apple’s iPhone revenue reached $142.4 billion, a far cry from the $164.9 billion it generated in the prior year.
But analysts say Apple’s bifurcated device strategy, with high-end models sitting alongside cheaper options, is also a response to consumer demand.
“The Pro models always add more functionality and richer features and use better components,” Creative Strategies analyst Tim Bajarin says. “Many users have asked for their devices to have more capabilities and they make their buying choices based on their actual needs.”
According to IHS Markit’s Wayne Lam, Apple generates significantly more profits on the sale of higher-priced devices. Lam says with iPhones, specifically, Apple has historically generated 40% of gross profit—a measure of the selling price less the cost of manufacturing and selling the device. Using that assumption, Apple is making about $280 in gross profit on the sale of each $700 iPhone 11. But for the $1,000 iPhone 11 Pro, the company’s per-unit profit is $400.
Apple, however, doesn’t spend all of its $120 in incremental profit margin on components. In September, researcher TechInsights said Apple pays $73.50 for the triple-lens camera in its iPhone 11 Pro and iPhone 11 Pro Max. The company didn’t say how much Apple pays for the iPhone 11’s dual-lens camera, but the price difference is likely negligible.
Regardless, Apple’s 40% profit margin on each iPhone sale is the industry leader. According to several third-party studies, other smartphone companies can only muster half Apple’s margin on the sale of their devices.
Still, choice matters, Lam says. “Apple isn’t necessarily using Pro to create more margins—Apple is offering more options.”
A diverse portfolio?
In recent years, Apple has indeed diversified its product offering. While the company still discontinues older models with seeming commercial appeal, like it did last year with the iPhone X, it’s also expanded the number of products it sells to reach consumers at different price points, like its $350 iPhone SE.
Expanding its product line to include hardware at various price points is a potentially important visual for a company that still faces criticism for charging an “Apple Tax,” a term used to describe the premium consumers pay to get an Apple device instead of a comparably equipped (and often cheaper) alternative from another company. Apple doesn’t divulge individual product profit margins, but considering many of the components it bundles in its hardware are the same other companies use in cheaper alternatives, there’s a good chance that Apple Tax is driving its healthy margins.
Take, for example, the price difference between Apple’s 12.9-inch iPad Pro, which features stylus support and 64GB of storage to start, and Microsoft’s Surface Pro 6, which has a full-fledged Windows operating system, stylus support, and 128GB of storage. Apple’s option starts at $999—$300 more expensive than the $699 Surface Pro 6.
Forrester analyst Frank Gillett says Apple’s Pro branding is a signal to customers that they’re buying a “premium” experience. He says Apple is broadening “its product lines to offer more mainstream price options, and not just premium priced products.”
A new tack for tech
In addition to increasing the number of products it sells, Apple has also changed the method by which it unveils its Pro products.
Traditionally, tech companies, including Apple, Google, and others, have released the full-featured product customers want first. Take, for example, Amazon’s Echo smart speaker. They then follow up with a more budget-friendly alternative, like Amazon’s Echo Dot.
But as the AirPods Pro release illustrate, Apple has flipped the script on this kind of product development. The company starts with the standard model with some—but not all—of the features that consumers want, and follows it up later with a feature-packed alternative that customers really wanted all along.
“They always start with a more mass market approach and add upper-end features once they become available,” Bajarin says. “In some cases, Apple even had to create the new technology features themselves to meet high-end customer needs.”
Ultimately, whenever Apple uses its Pro branding, it’s telling customers that it’s willing to listen to what they want—as long as they’re willing to pay for it.
“I bet lots of people will pay extra for the AirPods Pro,” Gillett predicts. “They want the extra features.”
More must-read stories from Fortune:
—AT&T’s CEO appeased activist investor Elliott Management
—The wireless industry needs more airwaves, but it’s going to be costly
—Spotify’s way to convert free users to paying customers: even more freebies
—Apple looks ahead to augmented reality
—Lyft tries again with monthly memberships. Here’s how much it costs
Catch up with Data Sheet, Fortune’s daily digest on the business of tech.
