Free iPhones Would Yield Rich Returns

Last month, Apple CEO Tim Cook announced the long-anticipated iPhone 5S, and also a second product, the iPhone 5C, with a suggested retail price starting at $99. While Cook later argued that the 5C was not intended to be an entry-level device, it is clear that the less expensive device—Wal-Mart is currently selling it for $49—could enable less affluent customers to join the Apple family.

Basic economics strongly support this reasoning: demand for a product or service goes up as the price goes down. Keep prices low; encourage high demand. But oftentimes, lower prices have a paradoxical effect. In fact, lower cost is often equated with cheap, and nothing could be worse for Apple than having that association. It is one of the reasons that Steve Jobs always priced his products higher than others, even at the risk of losing market share.

The alternative to reducing prices is to eliminate them entirely. For many products and services, it’s not acceptable for the price to be low: it must be free. Apple may have been better served by giving the iPhone 5c away for free.

Unlike a low price, $0.00 is a very special number. Economists have shown that people do not behave rationally when things are offered for free. Duke University’s Dan Ariely demonstrated that the difference between free and a penny is psychologically greater than the difference between $.99 and $1.00, and that affects purchasing behavior. A 2012 Cambridge University study found that free apps are 100 times more likely than paid apps to be downloaded more than 10,000 times, despite the fact that the average price of a paid app is only $.99. When something is free, consumers are willing to try it more often and be far less critical. They are also more willing to upgrade over time. There is optic value in offering something for free, both in terms of functionality and quality.Low prices are considered cheap; free is not. Free is simply considered no cost – the absence of money – without an accompanying value judgment. This is a subtle psychological difference that can make a big difference to a company’s products and brand.

How can Apple make money if it gives away its iPhones?

Every iPhone user knows that the cost of the device is only a fraction of the price you pay for the privilege of actually using it. Apple receives revenue from wireless carriers, which can be more profitable than the one time sale of a device. While Apple sells hardware, its customers make up a network of customers who pay for usage.

These same customers also buy content. Embedded in every iPhone is iTunes, Safari, iCloud, AppleRadio, AppStore, iBooks and more. Each of these applications is another opportunity for Apple to make money, but only if people are using Apple’s hardware. A free iPhone would onboard more customers without risking undercutting Apple’s other devices.

Unlike many of its competitors, Apple enjoys a high degree of brand loyalty: once a customer has one device, they’re more likely to buy other Apple products like computers and tablets. A customer with a free version of the iPhone may well get “hooked” and eventually graduate to a higher priced phone, particularly if it adds superior value.

It is in Apple’s best interest to build its customer network both broadly and deeply. To that end, Apple must also consider where it could sell a good portion of its next 100 million devices: China and other emerging nations. But the iPhone 5C currently costs $733 in China without provider subsidies, and Apple hasn’t yet been able to strike a deal with the country’s largest providers. Offering the phone for free would be a boon to carriers, who would then be far more likely to share usage revenues with Apple. As an added bonus, free iPhones in China would be the death knell for black market “shanzhai” phone manufacturers, who can produce fake iPhones for $40 and sell them for around $100. In more developed economies, free iPhones would take market share away from competitors, and could even put some of them permanently out of business.

While free isn’t feasible for every product – Porsche wouldn’t last very long if it gave away Boxsters – it can be invaluable in building a strong, loyal network. Apple is uniquely poised to offer free products because the fraction of the $49 purchase price the company receives is much less than the potential gains of adding one additional user to the network. And the $49 price risks devaluing the brand in a way that free product would not.

Many companies use a “freemium” model, which simply means offering pared-down versions of expensive products and services at no charge. My own company offers several free products which have actually improved our bottom line. But free pricing models are often overlooked, especially by industry leaders. That leaves open an opportunity for the rest of us.

(Photo Credit: wicker_man, Flickr)