aaron evans

Bill Ray of The Register writes that the iPhone will fail and fail badly. The device doesn’t even exist yet and we’re already trying to predict its failure. Let me try to break apart his argument.

First, Ray contends that a critical aspect of the mass adoption of the iPod was that it could hold all of your music. The argument is that people will not want an iPhone if it can only hold a portion of your music library. It is true that people hadn’t thought about portable music players as holding all of your music before the iPod. However, iPod sales are heavily biased toward the smaller, cheaper models that cannot hold your entire music collection. This has been true for as long as Apple has sold these smaller models. The iPod’s success is not predicated on holding your entire music collection. The iPod’s success can be attributed to its appearance, its ease of use, and its near perfect integration with iTunes that is still unmatched by other vendors. In other words, Apple’s success come from two things that it has always been better at than other companies: industrial design and hardware/software integration.

Next, Ray says:

The clever design of the iPod stretched into the software – the clean and simple interface is indeed easy to use, and users seem very comfortable with iTunes on their PC. But creating a simple interface for a single function is one thing. Replicating that experience to manage all the functions of a mobile phone is another thing entirely.

Mobile phones are not complex to use because of bad interface design, they are complex to use because they are complex devices with a myriad of features. The fiercely competitive mobile phone business has driven interface development at an astounding rate: it has become de rigueur for every new handset to feature a revolutionary new interface mechanism. Yes, that ‘clever’ Apple iPod interface that was copied into iTunes….. It was the other way around: the iTunes interface precedes the iPod interface. The clever aspect of the iPod interface is the click-wheel, not the hierarchical layout of music that is present in both iTunes and the iPod.

Why will Apple succeed where other phone manufacturers have failed? Why should we believe that Apple will be able to create a simple interface for these very complicated (sic) devices? Even if we accept that these devices are somehow unique in their complexity, has Ray ever compared the UI for Windows Media Center, which manages a vastly complex set of varying functions, with Apple’s FrontRow? Apple can make seemingly complex devices very simple.

Again, Apple’s advantage in the phone market arises from its great industrial design and its ability to integrate hardware with software. While phone manufacturers may be trying to ‘get’ industrial design they do not get hardware/software integration and they will not unless they start building Windows apps to sync with phones. Cell phone manufacturers choose to clutter their interfaces to allow for video downloads. Apple will allow iTunes to sync videos to your phone. Cell phone manufacturers have bizarre sequences of dialogs that allow you to enter contact and calendar info into your phone. Apple will simply remove this capability and allow iTunes to sync your calendars and contacts to your phone, just like it already can do with your iPod. Apple has such a clear advantage in leveraging iTunes to make their devices simple and clean that it’s hard to see how phone manufacturers could hope to compete with Apple in this respect.

Ray continues by explaining the economics of the cell phone and the relationship between cell phone manufacturer and network operators. He explains that network operators subsidize the cost of phones so that they can entice new customers and that in return, cell phone manufacturers go out of their way to please the network operators. The logic is that Apple will either have to succumb to the demands of the network operators or choose to sell its phone at a very high price.

Most analysts believe that Apple will become a mobile virtual network operator (MVNO). This means that Apple will pay some large operator like Cingular to use its service and then act as its own operator on top of Cingular’s network. Apple would be left to sell their phones at some very high cost (maybe $500-$600 ?). Ray dismisses this idea:

Some have suggested that Apple will simply set up their own Mobile Virtual Network Operator (MVNO) and just fund the subsidy; making the money back on calls and use of the iTunes service. However, iTunes has always existed to sell hardware, not subsidise its production. The service isn’t supposed to make money, and while it might or might not lose a great deal of money it certainly can’t be called upon to cover the cost of a stylish handset any more than it could cover the cost of handing out iPods for free.

First, he is under the assumption that Apple cannot sell a phone for over $500. I think they could. Second, how much does Apple make as an MVNO? This unknown quantity is critical to any analysis of how much they could discount their phones. Third, why do we assume that Apple wants a heavily discounted phone? Any attempt by Apple to directly compete in the low-cost phone market will only cannibalize iPod sales.

I’m not entirely sure how MVNO will work but its my assumption that customers would send Apple a monthly check for service and that some portion of that goes to Apple while the bulk of it would go to Cingular. So, if Apple can sell the phones at $500, they make money on the phone and the service. No network operator or phone manufacturer can say that. Moreover, if Apple provides a very compelling service, they can charge a premium for the service.

To understand why Apple will be able to sell a phone for $500, we need to understand the changing market of the high-end iPod. The high-end of Apple’s iPod lineup is currently stagnant as portable video is unlikely to drive more sales. With music as the major attraction to any iPod, there is little more demand for a 120GB iPod than there is for an 80GB iPod.

In addition, flash densities are increasing so quickly that 40GB flash iPods are probably only a few years away. The high-end, hard drive based iPod can only last so long in its current form. Without the high-end iPod, Apple becomes one of many vendors offering similarly small and inexpensive music players.

As a corollary of Moore’s law, the features in the high-end iPod slowly migrate toward the cheaper variants. Customers who may not spend money on an expensive iPod when it is released are likely to at least know the features of the expensive iPod and want one. When the features of the high-end migrate downward, the customers already understands the features and is a likely buyer.

It is for these reasons that it is essential for Apple to keep the high-end iPods as the most desirable product in the iPod portfolio. An Apple designed phone that could replace an aging iPod would be very desirable to many consumers.

Apple will succeed in the phone market but Apple’s success will not be defined by overall marketshare. Apple’s version of success in the phone market will be in the form of a successful replacement of the aging high-end video iPod whose functionality can slowly migrate to cheaper and smaller iPods. Apple is not interested in taking over the mobile phone market but rather in solidifying their leadership position in the market for portable, cool devices. Apple’s ultimate goal is still to use these devices and their seamless integration with a PC to drive Mac sales.

This entry was posted on Saturday, December 23rd, 2006 at 11:56 am and is filed under Apple. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.