Apple's new iPhone 6s lineup stays at $199/$650 for 16 GB, goes up to $299/$750 for 64GB, and tops out at $399/$850 for 128 GB, on- and off-contract. That's how Apple segments for low, middle, and high-end. It has nothing really to do with storage size or price though—Apple can and has done the same thing with screen sizes, processor speeds, or even product colors—it's just something most people look at in a store and understand. More costs more.
The segmentation game
Segmenting by low, middle, and high-end is standard business practice for consumer goods. Low end or budget pricing get people in the door and make products more accessible to those who truly can't afford anything more. Middle pricing is what most people end up buying. High end, or premium pricing exist for people who either aren't concerned about money or who need a premium feature enough that they're willing to pay for it no matter what it costs. Appliances, cars, food— almost everything—has examples of low, middle, and high pricing segmentation.
"Starting at $199" is also psychologically important. Just like having $199 instead of $200 is important, the lower the number we see, the less panic we feel. It's not the model that makes Apple or any manufacturer the most margin, nor is it the model that offers any consumer the most value, but it lowers stress and gets the buying process begun. From there, both the up-sell and the bargain hunting begin.
It's tempting to think those who buy the highest end subsidize those who buy the lowest end, or that capacity-based segmentation subsidizes all the rest of the technology that's consistent throughout the platform, or even that it subsidizes the operating system and software like iLife, iWork, etc., all of which are now given away "for free". (Apple currently chooses not to monetize customer attention or data to subsidize prices.)
Perhaps a better way to look at it is that Apple, as a vertically integrated provider, has the luxury of thinking in terms of the overall device, including hardware, software, and services. The goal for a company like Apple is then, when you combine all models together, to get to a certain average sale price (ASP). Some pay more, some pay less, some pay in the middle, and depending on how the product mix works out, Apple either hits or misses that target. And then Wall Street rewards or punishes them for it accordingly.
Capacity—how many gigabytes of data storage an iPhone, iPad, or iPod has—is just an easy way for Apple to market low, middle, and high-end versions of their iOS devices. It's easy because everyone understands 128 is bigger than 64 is way bigger than 16. More money for more capacity is easy for Apple to do and for us to buy. Check out refrigerators, microwaves, television sets, cars, pasta—almost any consumer product. You'll quickly see similar patterns.
Apple could segment based on screen size instead, and theoretically charge $100 more for every additional inch. They're essentially doing that with the iPhone 6 Plus right now. They could segment based on processor speed, down clock the low end and ratchet it up $100 for every upwards bump. The PC industry traditionally does that with laptops and desktops. They could segment based on color and make gold or rose gold $100 model. Remember the Black MacBook? They could segment based on design and materials. The iPhone 5c did that. Most of us, I imagine, would really prefer they never differentiate based on build quality.
The component cost for the atoms of the differentiator is meaningless. It's the price we're willing to pay for it that matters.
But, 16 GB?
So, why make the low-end start at 16 GB instead of 32 GB? First, the MLC (multi level cell) NAND Flash RAM that Apple uses for the lower capacity devices is more expensive than the TLC (triple level cell) NAND Flash RAM that Apple uses for the middle and higher capacity devices, at least historically. Doubling its density to 32 GB would be even more expensive, relatively speaking, and that affects margin.
Second, the appeal of 64 GB compared to 16GB is considerable. Compared to 32 GB, not so much. If too many people go for the lower priced model it changes the ASP of the iPhone, and pushes Wall Street back into DOOMED mode.
Third, in enterprise, education, emerging markets, and first-time buyers price of entry is still critically important. For some organizations and use-cases, storage size isn't as important as the lower price possible. So, instead of skimping on things like build quality or materials for those markets, Apple skimps on storage. Since they're primarily used for B2B apps, web portals, streaming, IM, and other lightweight tasks, higher capacity isn't an issue.
Fourth, by leaving 16 GB at $199 and lowering 64 GB and 128 GB by $100 each, it makes the middle and high end more affordable and even more attractive as up-sells, and that raises ASP.
The future of segmentation
To make lower capacity devices more livable, Apple introduced iCloud Photo Library and iCloud Music Library so they could store less locally, and will soon be introducing even more technologies like asset slicing, on-demand resources, and a new type of compression to thin the operating system and apps alike, and to take up less space to begin with. They're an interesting investment in time and resources just to maintain lower capacity product segmentation.
Note, this isn't a defense of the 16 GB strategy, it's simply an explanation of it. Apple is a business and decades of being in business has shown that $100 increments based on storage capacity is a model the market not only understands but rewards with astronomical amounts of money. That doesn't make it right or wrong, comforting or maddening. It just makes it what it is.
And Apple likely won't change it unless and until they can find something better.
This article was originally published in June of 2014 but has been updated to reflect iPhone 6 and potential iPhone 6s marketing segmentation strategies.