How Did Wal-Mart's IPhone Discount Defeat Apple's Price Controls?

Wal-Mart Stores (WMT) plans to sell the newest iterations of iPhones at a discount, a pricing strategy that Apple (AAPL) has managed to squash for years. The cheaper iPhone 5c will be sold at the world’s largest retailer for $79 along with a standard two-year service contract, 20 percent less than anywhere else in the U.S. The higher-end iPhone 5s will sell for $189, $10 cheaper than its typical sticker price with a service contract.

In the world of smartphone retail, this marks something of a breakthrough. Apple for decades has excelled at making sure the prices for its gadgets were as simple and as stripped down as the products themselves—a level of control achieved through a fairly aggressive combination of carrot and stick known as “price maintenance.”

Apple typically sets a minimum advertised price with retailers that isn’t a requirement but is a strong suggestion. The tech giant then promises to kick in a tidy financial incentive in the form of marketing dollars if the retailer keeps its gadget prices at that level or above. There have even been reports of Apple cutting off supplies to stores that strayed below the sticker-price threshold. The system ensures that small retailers won’t be undercut by big-box stores willing to squeeze margins or even take a loss. It also helps make sure every retailer is on a par with the prices in Apple’s own retail stores. VIDEO: AT&T, T-Mobile Offer iPhone 5C No Money Down Deals

One other trick to keep retailers honest: Apple apparently never gives them much margin to play with. Stores that buy Apple gadgets for only, say, 5 percent less than the suggested retail price aren’t going to be keen on discounting them further.

So how is Wal-Mart able to mark down the new iPhones despite Apple’s typically Jobsian efforts at price control? It’s possible that it got more iPhone money out of cellphone-service providers, who heavily subsidize handset sales in exchange for long service contracts. But mobile carrier are increasingly reticent about those deals, which leaves two plausible theories here (although neither company would comment directly on the arrangement):

1. Wal-Mart Twisted Apple’s Arm 

This was finally the iPhone iteration in which Apple needed to win lower-income consumers, which is why Apple made an unprecedented effort to roll out a plastic-case version of its new smartphone to fit smaller budgets. The deep-pocketed consumers in the smartphone market have by now already been saturated with products, and Samsung Electronics (005930:KS) has been coming on strong with alternative high-end products. In fact, Apple is getting plenty of criticism for not making the low-end iPhone cheaper still.

Wal-Mart essentially might have said: Look, you need low-income buyers, and we have plenty of those. Knock $20 off each phone for us, and you can lock in the bottom of the buying pyramid while maintaining some of your brand’s luxurious luster.

2) Wal-Mart Just Ignored Apple’s Rules 

Wal-Mart may have simply decided to forfeit any financial price-setting sweeteners from Apple. It runs on pretty lean margins to begin with and might not mind sacrificing iPhone profit if it is confident it can also sell a case or a screen cover at a 40 percent markup. The giant retailer has a long history of selling hot products below cost to get shoppers in the door. Back in the day, it was discounted CDs and DVDs—now maybe it’s underpriced handsets. And as the No. 1 cellphone seller in the U.S., Wal-Mart probably doesn’t have much reason to worry about Apple cutting off its supply.

Neither company is saying much about how discussions played out. Apple is handling inquiries by referring to its press release. A Wal-Mart spokeswoman, Sarah McKinney, said she was unfamiliar with Apple’s incentives to retailers to keep prices high. Wal-Mart’s lower iPhone price tags, she said, are strictly a Wal-Mart decision. 

“Honestly, it’s just our business model,” added McKinney. “We leverage our expenses so we can invest in price.” That seems to suggest Wal-Mart simply ignored Apple’s pricing preferences. Still, McKinney insisted Wal-Mart will make a profit on each iPhone, even at the lower prices.

Source: businessweek.com