Friday, 26 October 2012

iPhone: Supply and Demand

iPhone: Supply and Demand

Based on the link 5 hit the market on September 21, 2012. On its first day of pre-ordering, Apple managed to get over 2 million purchase, which is 1.4 million more than the first pre-ordering of iPhone 4 which was released in October 2010. Meanwhile, 4 million iPhone 4S was sold in the first three days after its launching. These figures clearly show that there is a robust demand for iPhone.

Unpleasantly, the opening-weekend sale of iPhone 5 has tarnished the image of Apple. It is not due to the lack of upgraded features of iPhone 5 - it is because of its supply and demand. Apple was deprecated by analysts who downgraded Apple because of the shortage of iPhone supply. The analysts expected that more than 10 million iPhone 5 would be sold. However, it only reached 5 million units of sales. In regard to this issue, Apple’s CEO Tim Cook explained that the small figure was not due to the declining demand from customers but due to the insufficient supply of iPhone. Apple also insisted that the demand for iPhone 5 was actually exceeded its supply, otherwise Apple could have generated more sales volume.

Graph 1: Demand and supply for iPhone 5 during its launching

Based on Graph 1, the quantity demanded for iPhone 5 exceeds the quantity supplied by Apple; therefore there is a shortage of supply. Apple could actually make more sales because the quantity demanded is expected to be 10 million units. If Apple managed to supply 10 million units of iPhone 5 to meet the future demand from consumers, Apple can maximize its profit at the equilibrium point where efficiency takes place; neither overproduction nor underproduction.

Not more than a month after iPhone 5 was launched, Apple confronted with another issue relating its outsourced assembly operation in China. Foxconn is an electronic firm that outsources work for Apple and manufactured the iPhone 5 for Apple. It is reported that thousands of the factory workers involved in a dispute over the strict quality control and being forced to work on a holiday. They went on strike because the new quality demands imposed on iPhone was difficult to be met and they were under pressure. As to this matter, Foxconn claimed that this strike has not led to halted production of iPhone 5 and has nothing to do with the recent shortage of supply of iPhone 5. Whatever controversy points to Apple, would it affect Apple tremendously?

In my opinion, the issue on the workers strike is not a big matter to Apple because iPhone has become a leading smartphone in the market, especially in the U.S market. Why do many people choose iPhone over other smartphones? The main attributions to this are the product quality, price and brand. iPhone is featured with widescreen format that enables its users to watch videos and touch the screen comfortably. iPhone also runs on the iOS; an operating system that provides thousands of applications. While many Android phones emerge into the market, still many phone users believe that iOS applications be the best. Given the iPhone 5’s sales expectation, it is clear that consumers are willing to pay high price for iPhone. It is a worth buying phone because of its high quality. Because of this, Apple can charge a higher price for its iPhone and thus makes greater profit margin. iPhone also has been a powerful brand in the global market. People buy iPhone as a status symbol. For example, iPhone users are acknowledged as a rich people or maybe a ‘tech geek’. All these area have differentiated iPhone from its close substitute, but not a perfect substitute. iPhone fans, for instance, are willing to pay more for iPhone. So, when its price increase, the quantity demanded for iPhone decreases but it does not necessarily decrease to zero unless the price rises by a large enough amounts. When consumers switch to its substitutes, the demand curve for iPhone will shift to the left, but not very significant i.e. decrease in demand. Based on Graph 2, as consumers turn to alternative smartphones, the demand curve D1 shift to D2.

Graph 2: Substitution effect

As iPhone has the product differentiation over its rivals who run on Android systems for their smartphones, Apple can generate high sales. Since iPhone is in monopolistic competition, iPhone makes a short-run output and price decision just like a monopoly firm does. 

Graph 3: Short run: Economic profit

Apple maximizes profit by producing the quantity at which marginal revenue equals marginal cost, millions of iPhone a month and charging the price of $250 per unit. This price exceeds the average total cost of $100 per unit. The blue rectangle illustrates economic profit of $750 million per month. (Refer to Graph 3)

Graph 4: Long-run: Zero economic profit

However, iPhone is not going to gain economic profit for long. Eventually, its competitors as well as new firms enter the smartphone market as iPhone makes an economic profit. As consequence, the demand for iPhone decreases as more firms join the market. The demand curve and marginal revenue shift leftward. Thus, the profit maximizing quantity and price fall. At the profit maximization the price change equals average total cost, so economic profit is zero. In order for iPhone to regain profit in short run, Apple has to launch new phone to start the cycle again. This means that Apple would have to invent new phone that even better differentiated so that Apple can compete in the market with greater sales volume. This situation can be seen when Apple launched iPhone 5 after iPhone 4S has been in the market for a year in response to other smartphones like Samsung Galaxy enters the market. (Refer to Graph 4)

Last but not least, I believe that everyone knows that iPhone has been phenomenal to the global market. Demand for iPhone is mushrooming for every model launched. The success of Apple iPhone in the phone market is following its power to influence the market for smartphones. Any potential threats and negative speculations seem not to hurt Apple badly. Apple indeed is a market leading for smartphones.

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