Why you can't get iPods at a discount.

The latest gadgets and tech toys.
Dec. 22 2006 1:54 PM

Gadgets for Sale … or Not

Why you can't get iPods at a discount.

iPod Nano. Click image to expand.

Last week, USA Today reported that online sales in November increased 25 percent over those from 2005. If you've shopped for gadgets online this holiday season, you almost certainly found that the camcorder or DVD player you wanted was selling at a wide range of prices. Why is there so much price variation for the same product? And how come some gadgets, like the iPod, cost the same no matter where you shop?

For one thing, e-shoppers aren't all alike. Some are obsessed with finding bargains and will fill their shopping carts at whichever online store offers the lowest price. Others care more about brand loyalty, delivery options, or ease of returns—things they'll pay a premium for. E-commerce sites differ, too, with brick-and-mortar chains jacking up prices to cover overhead, and garage operations exploiting low operating costs by diving far below the manufacturers' suggested retail price.

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But there's a more interesting explanation for price variation online. Hal Varian, an economist at U.C. Berkeley and co-author of Information Rules: A Strategic Guide to the Network Economy, argues that sellers offer the same products at vastly different prices as an intentional marketing strategy. (This phenomenon is what economists call price dispersion.) Imagine that everybody sold 42-inch Philips plasma-screen TVs for the same price. There would be no reason to comparison shop, consumers would always buy from the same places, and e-tailers' profits would stagnate. According to Varian, retailers who vary their prices over time—increasing them one week, then discounting the next—create the kind of price instability that encourages consumers to shop around. The end result is that shoppers visit several sites before making a purchase, which is exactly what retailers want us to do.

Research supports Varian's view. In 2003, a group of economists led by Michael Baye of Indiana University compared prices for 36 consumer electronics products purchased online. Another study by the same team analyzed millions of price points for hundreds of products over an eight-month period. Both studies found significant price variation, regardless of how many retailers sold the product in question. What's more, they found that the site offering the lowest price for any given product was in constant flux, meaning that e-tailers were raising and lowering their prices at will. As a result, Baye's team came to the conclusion that price dispersion on the Internet is an "equilibrium phenomenon"—the natural state of a competitive market.

All of this leads to a natural follow-up question: If price variation is the natural state of the Internet, then how come the 8GB iPod nano, for example, always sells for $250 (give or take a few cents)? No, the answer isn't that Apple illegally manages prices. In reality, Steve Jobs and Co. use an accepted, if controversial, tactic, a retail strategy called minimum advertised price, to discourage resellers from discounting.

The minimum advertised price, or MAP, is the absolute lowest price retailers are allowed to advertise a product for. (If you've ever shopped at a site that won't reveal a product's price until you add it to your shopping cart, MAP is the reason.) MAP is usually enforced through marketing subsidies offered by a manufacturer to its resellers. If a retailer keeps prices at or above the minimum advertised price, then a manufacturer like Apple will give them money to help advertise. If a store's price dips too low, on the other hand, the manufacturer can withdraw these advertising subsidies.

MAP helps smaller retailers compete, since it aids in reducing the kind of cutthroat price competition from big-box stores that can put them out of business. But what's in it for a company like Apple? Stable prices are important to the company, because it's a manufacturer and a retailer (both online and through its chain of Apple Stores). If Apple resellers dropped prices on iPods and iMacs—selling at or below cost to get customers in the door, or as a way to cross-sell stuff like software or iPod skins—they could squeeze the Apple Stores out of their own markets.

There is a downside to all that stability, however. By limiting how low sellers can go, MAP keeps prices artificially high (or at least higher than they might otherwise be with unfettered price competition). In 2000, the Federal Trade Commission forced the five major record labels to suspend MAP policies that it deemed excessively restrictive. MAP benefits manufacturers and, to a lesser extent, retailers, but not necessarily consumers.

Use of MAP in some form is fairly common in the gadget world, though few companies seem to pursue it with the rigor of Apple or Sony (both of whom operate retail stores). Shawn DuBravac of the Consumer Electronics Association believes most gadget manufacturers prefer to let the market determine price, and the dispersion described by Varian and Baye suggests he's probably right. (None of the companies I contacted for this story would discuss their pricing strategies with me.) That means good deals for shoppers willing to search them out.

As for Apple, part of what you pay for when you buy an iPod or a MacBook Pro is the coolness factor. Digital cameras, LCD TVs, and DVD players tend to be so similar from brand to brand and model to model that low prices play a larger role in determining which of them we ultimately buy. When you purchase an iPod, however, it's understood you're getting something unique. And you can be sure Apple knows that—and sets its prices accordingly.

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