At $269, Apple Watch Series 1 is one of lowest-priced smartwatches worth buying in the marketplace. Attractive pricing was one key factor driving record Apple Watch sales this past holiday quarter. In fact, even the Apple Watch Series 2, at $349, is one of the lowest-priced smartwatches in its class:

Fossil Fenix 5: $599

Garmin Forerunner 630: $399

Michael Kors Access: $350

Samsung Gear S3: $349

Fossil Q Founder: $275

Apple's aggressive pricing strategy has also gone a long way in shrinking the price gap between Apple Watch and dedicated health and fitness trackers. There is now only a $70 difference between an Apple Watch Series 1 and Fitbit Blaze.

Three Pricing Theories

There are three theories to explain Apple's AirPods and Apple Watch pricing strategy.

A) iPhone as Hub. Instead of making a profit on Apple Watch and AirPods, Apple is underpricing the devices in an effort to boost iPhone sales. The logic is that since Apple Watch and AirPods are being positioned as iPhone accessories, Apple views the devices as tools to keep consumers attached to their iPhones. Apple compensates for the lack of Apple Watch and AirPods profit by selling high-margin iPhones and Services.

B) Manufacturing Scale. This is the most straightforward theory. Apple has simply gotten better at making products at a lower cost. With a sizable production ramp (millions of units), Apple management can use scale and its existing supply chain to quickly bring down component and manufacturing costs for a new breed of personal tech gadgets.

C) Consumer Segmentation. Management is using product pricing to grow Apple's user base. On one end, management cuts entry-level pricing in an effort to make products more accessible. However, management then pushes at the other end of the pricing spectrum with premium SKUs targeting a different part of the user base. The higher-priced SKUs help boost Apple's overall margin profile.

History

On the surface, each of the three preceding theories seem to contain some logic. The iPhone is not only Apple's best-selling product, but also the most effective tool for growing the user base. At the same time, Apple has seen much progress in keeping component costs contained across its product line.

However, upon further examination, there is a serious flaw found with Theory A (besides the fact that Apple is moving beyond the iPhone as Hub product strategy). AirPods and Apple Watch pricing doesn't reflect a new strategy designed to juice iPhone sales. Instead, Apple has actually been traveling down this pricing path for years. Apple's decision to unveil the initial iPad at $499 in 2010, and then come out with a $329 iPad mini just two years later, marked a sea change in the way Apple approached product pricing.

In the mid-1990s, Apple made a series of strategic mistakes related to the Mac. Instead of trying to grow market share, management chased profit. Apple introduced a variety of high-priced Macs targeting existing Mac users. Apple was having difficulty targeting new users in the face of the strengthening Windows empire. Apple was doubling down on niche instead of chasing mass market.

Apple took a completely different strategy with iPad. With iPad, Apple cared much more about grabbing market share. This attitude was born from motivation to not repeat Apple's dark days from the 1990s. Up until last year, there was thought to be one major caveat to Apple's market share ambition. Apple was interested in initially grabbing share in the premium segment of the market and then gradually working its way down market. There is evidence to suggest this attitude is now changing a bit as Apple is selling wearables.

Apple's Pricing Strategy

AirPods and Apple Watch pricing demonstrate how Apple is looking to own not only the premium segment of the wearables market, but rather the entire market. As Apple runs deeper into luxury, the company is reducing entry-level pricing. This is a curious development as one assumes the opposite would have occurred - Apple would keep prices high to maintain a certain level of exclusivity or scarcity. Instead, Apple is redefining the concept of luxury in order to sell mass-market products.

Consider Apple's approach to Apple Watch pricing. With $269 and $369 Apple Watch options, Apple is very competitive with nearly every smartwatch. However, at the other end of the product line with Apple Watch Hermès and Edition starting at $1,149 and $1,249 respectively, Apple is selling different materials, and a different kind of experience, at much higher prices. Apple is segmenting the product line to appeal to a wider variety of users.