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The cognitive illusion that is iPhone n-1

How do you think about the iPhone 3GS after the iPhone 4 is out? I have a hypothesis that it’s not what it seems.

The standard logic is that the 3GS (which I will call the n-1 where n is the current phone version) is a lower-priced leftover that covers a lower price point and expands the market.

I think it’s designed to give the illusion that the iPhone 4 is actually more desirable steering more potential buyers to the new (nth) phone.

To illustrate I’m going to call upon the wonderful example given by behavioral economist Dan Ariely at the TED talks.

Imagine I give you a choice: Do you want

  • (a) “a weekend to Rome, all expenses paid” or
  • (b) “a weekend in Paris, all expenses paid”?

They are different but compelling choices. Perhaps a survey would find these two choices equally popular.

Now imagine I added a third option to these two that nobody wanted:

  • (c) having your car stolen.

It seems a strange choice, because how could having your car stolen in this set influence anything? Obviously (a) or (b) would be the only compelling options. But what if the option for having your car stolen was not exactly like this. What if the third option was

  • (a-) “a trip to Rome, all expenses paid but no free coffee with breakfast.”

Given that you can have Rome with coffee, why would you want Rome without coffee? It’s an inferior option just like having your car stolen.

But, the moment you add Rome without coffee as an option, Rome *with* coffee becomes more popular and people choose it much more often. Having Rome without coffee makes Rome with coffee seem superior, not just to Rome without coffee but even to Paris.

Adding (a-) to the set of choices (a) vs. (b) makes choosing (a) much more likely.

He goes on to describe a subscription offer from The Economist which, by inclusion of an inferior option, steered people to choose a more expensive option.

My point here is that I hypothesize that the iPhone n-1 (Rome without coffee) is an inferior option to the iPhone n (Rome with coffee) and that it steers more people to choose iPhone n not just over iPhone n-1 but over the competition (Paris). Of course the inferiority of iPhone n-1 is offset by its lower price, but I put it that the difference of $100 is not that great in the eye of most users when they see the difference with the new model. The price difference does not make the iPhone n-1 look all that great. It’s still Rome without coffee.

We don’t have precise stats to prove that iPhone n-1 is ignored as an option, but the ASP numbers never seem to drop. They seem to indicate that the overwhelming number of iPhones sold are the top of the line. Therefore the presence of an inferior option does not dilute the average selling price, but, in fact, increases overall volumes of the top product.

  • http://www.macobserver.com/tmo/forums/viewforum/7/ Roman

    I *just* watched this talk a week ago, and did not make the connection to the iPhone. Bravo Horace.

    That being said, there is a short-term price difference of $100 which, presumably, is the difference bettween the extra speed, FaceTime, retina display. It's like "Rome – coffee + $500 cashback (or some relative amount)". It's also not heavily advertised by Apple, and I've always wondered just how many people actually know about the option.

    Still the typical use case could be, "what's the cheapest 'good enough' smart phone?" –> "Aha, most Androids are $200 while iPhone n-1 is $100. I choose iPhone" –> "Wow, the $200 iPhone is SO much better. What's $100 in the large scale of things anyway, with contract" –> Buys iPhone.

  • http://twitter.com/lantinian @lantinian

    Very convincing argument. However there might be other son so clever and more practical reason.

    As Apple has sold many 3Gs in the past it needs to keep a cheap production line to cover replacements from its warranty program. After all, most iPhone are sold with 1 or 2 year contracts. Shutting down the 3GS line and switching over to iPhone 4s will mean costly replacement.

    I would be really interested to also know what is the difference in the manufacturing cost of the 3GS compared to the iPhone 4.

  • Joe_Winfield_IL

    Good point. Plus as an added benefit, Apple never has to purge inventory of the older product by discounting before the new iPhone is released. I imagine their supply chain prowess is a bigger deal than most would give the company credit for. It is another margin advantage over the field.

  • ericgen

    I saw this video a month or so ago. It's quite good, as are most of the TED talks that I've watched so far. I don't remember how I got there and I vaguely remember hearing that the idea that the (n-1)iPhone was for this role.

    Perhaps you made this statement with the associated link in a comment on an older post?

    • asymco

      This article is an expansion on an earlier comment I made, which I am struggling to find.

      • arjun

        I remember it, thought it was under theory but was under market, actually : http://www.asymco.com/2010/06/16/iphone-4-asp-is-

        I'm a heavy promoter of your blog btw, interesting reading, even though I cannot comment on anything.

      • asymco

        arjun,
        Thank you very much for finding this. It would have saved me a lot of time re-typing the example. Now I need to find a way to search comments…

  • Stu

    Any thoughts on how this will apply to iPad 2 vs iPad 1? Especially if Android 3 & decent harware isn't around yet. (Coming real soon now!)

    And if so, what that means to next years iPad numbers, assuming Apple doesn't have much lag from announcement to shipping.

    • r.d

      iPad 2 is going to be minimal upgrade with just facetime camera.

      It can't have retina display – too taxing to the GPU. change in resolution
      also messes up RAM, developer support, more battery drainage.
      A9 is not yet ready. A4 at hight megahertz is not going to make that much difference.
      Battery has to be the same size.

      real change is software and only thing is needed is Full Textbook support.

      • Stu

        Can't? Let's see, retina display on the iPad would be 2526×1080@326ppi given the same size as now. That doesn't seem like a stretch for *any* modern gpu. Not sure how a change in resolution 'messes up RAM'. Apple already has some developer support in the current SDK for retina display on the iPad; at worst they could double the resolution like they did for the initial iPad app support. And the battery doesn't have to be the same size – as the iFixit guys noted, there's lots of empty space in the current iPad.

        So, they could add lots of things, especially if they're competing with the current vaporware devices being announced. There's no telling what they'll actually put in it. But I'm willing to bet a dollar that they'll do more than add a camera. Getting back to my original question, how much does the iPad v2 need to improve to make the same leap that the original article talks about?

  • http://twitter.com/ThembeK @ThembeK

    I can confirm that this is actually 100% true. It is exactly what we are picking up from the data. I was explaining a similar concept to a consultant (based on my retail experience) two or three weeks back. And he completely disagreed. Will send him the link.

  • famousringo

    I agree that it doesn't make much sense for people to choose the n-1 over the iPhone n. But at the same time, when I go to Apple's online store, I see that the 3GS actually has a longer shipping time than the iPhone 4, which suggests even tighter supply constraints for the 3GS than for the iPhone 4 right now.

    Obviously if Foxconn can only churn out so many iPhones a day, Apple would rather make an extra $100 on iPhone 4s, but somebody must be choosing Rome without coffee.

    • Gandhi

      3GS has longer shipping time probably because it is manufactured in lower numbers, not because it has greater demand.

  • Gavin Costello

    This article has arrived at a fortuitous moment for me as I struggle to decide how to offer some new services. Separate to my existing service or as an Add on.
    I'll swing back here in a couple of months to let you know how I went with getting Rome + coffee to become a more effective seller than just 'Rome' is against my 'Paris"

  • http://twitter.com/_ChrisHarris @_ChrisHarris

    I wonder if Android has the reverse effect? An undesirable (n+1) element perhaps?

    We know that the pace of Android development is so great that many companies are trying to one up each other by announcing / leaking details of newer handsets many weeks before release. If you're due to buy a handset and another company announces the n+1 model to be released in 3 months time, it could make you avoid purchasing the current model.

    • asymco

      Good question. There probably is an element of confusion that discourages purchase when the options available are too large. Imagine looking for an unfamiliar product like ice skates. If you go to a shop that has 300 versions in stock you'll be frustrated. If you go to a shop with only 2 or 3, the purchase is much more likely. For the expert in the area, 300 options is a benefit, for the non-expert it's a detriment.

  • Todd Rowekamp

    I think the n-1 has benefited from the $15 data plan. As a parent I can spend $100 less on the phone, max out text messages, and save $15 per month for a total savings of $560 before these changes. The limited memory also limits the music / apps they can buy.

    I think 7 " iPad will be huge for kids especially if there is an option in the 300's as my 1,4, and 6 hear old fight over it constantly

    • Martin

      Get a Google Voice account. The Google Voice apps for iOS should have push notifications soon and you can text for free through Google Voice, only for the cost of data (which is insignificant).

  • bud

    Is iPhone n-1 a loss leader?

    • asymco

      For a tour operator, Rome without coffee is just as profitable as Rome with coffee. It's just a signal.

  • http://twitter.com/TektonikShift @TektonikShift

    Such pricing schemes have long been in use by Apple, they are the master.
    These price decoys have be documented many times; http://www.msnbc.msn.com/id/38980367/

    -Tek

  • J Ives

    Every Android manufacturer plays this card every other month. Not unique to Apple.

  • Mr E

    The iPhone 4 is clearly better from a hardware angle, the only downside is price (natch). The 3GS is around to serve 2 main purposes:

    1) Reduce supply pressure of the iPhone 4. Even as iPhone 4 production ramps up and almost 6 months after its launch, there is still widespread shortage worldwide. Whereas a potential customer might be sitting on the fence with regards to a purchase decision, the existence of a 3GS provides a low-cost "gateway drug" to get into the iOS ecosystem of App Store, excellent web browsing experience etc.

    2) Preserve value of the iPhone brand. Many new iPhone 4 owners have upgraded from n-1 (3G or 3GS) and the continued sale of n-1 by Apple itself means the depreciation cost of n-1 phones are minimized. What this means is that owners with carrier contracts can upgrade to the next n+1 device at minimal outlay of cash with the proviso of extended carrier contracts (24 months in this part of the world), which is not necessarily onerous outside of the US.

  • Sandeep

    Horace,

    Cost framing is widely used by most product companies and retailers. The effect even works in the reverse.

    Consider a High Street retailer that sells watches. They typically carry a couple of very expensive watches that no one in their right mind would ever buy. But they serve a purpose. You enter the showroom, the salesperson shows you these watches priced at $80k but are awful and tasteless to look at. Then they show you better looking watches at $30k. You like some of them, the salesman praises your taste, you decide not to look like a cheapskate and go for a lower $15k watch range and settle for the $30k watch.

    This is the reason some companies produce extremely high end versions of their products that are impractical. Think Porsche 911 GT2, compared to which the 911 looks like a steal.

    • asymco

      This is not quite the same thing as price framing. To use your watch analogy the iPhone n-1 illusion is like a company selling red watches vs. a company selling blue watches. Each prices their products at $30k. But the red watch company also offers a version for $29k except it has no strap. The hypothesis is that the having the second, inferior red watch next to the regular red watch would compel more buyers to buy the $30k red watch at the expense of the blue watch. Note that this is not a portfolio question since the red watch company only has one product.

  • AlleyGator

    Horace, what's odd to me is that I know people are still buying the 3GS. A waitress just a week ago saw my iPhone 4, asked me about it, and mentioned that she'd just gotten a 3GS and loved it.

    And let's be honest, the 3GS is still pretty good. In a year when iOS 5 comes out, maybe not so much. But for now it's not too shabby. You get multitasking and it plays Angry Birds just fine.

  • timnash

    There are other large potential iPod markets which Apple barely addresses – like making the Nano into a completely customizable watch see http://lowendmac.com/nash/10tn/6g-ipod-nano-marke… or as a hearing aid http://lowendmac.com/nash/09tn/ipod-hearing-aids….

  • asymco

    Of course the 3GS is a decent product. I don't mean to imply it's like getting your car stolen. And it probably is an attractive option to many. There will be many for whom a $100 difference is nothing to sneeze at. But I suggest that it has an effect of re-enforcing the value of iPhone 4 and making the purchase of iPhone 4 over competitor products more compelling.

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