How Apple's iPhone Could Flop

Could the Apple (AAPL) iPhone flop? You wouldn’t think so, judging from the reaction to the device on the Street and elsewhere. But I tend to think that there are great risks for Apple and the approach it has taken that may not come into focus until the phone gets closer to launch later this year.

At CES this week, reaction to the device was decidedly mixed. There were several consistent concerns. One, price. Two, the appeal of typing on a touch screen may be limited. And three, the decision not to choose a 3G network, which means data speeds will be fairly slow. And four…did I mention the price?

In a report issued yesterday, Toni Sacconanghi, hardware analyst at Bernstein Research, lays out the issues.

For starters, let me note that Sacconaghi is quite impressed with the phone itself. He says it “offers superior functionality to our expectations, mitigating some of our cannibalization concerns.” But a trade off for the functionality is the high price point: $499 and $599, depending on how much memory it has.

“Apples goal of 10 million units in FY 08 appears predicated on securing widespread global distribution, but more importantly, on convincing consumers to spend dramatically more on an enhanced handheld computing experience,” he wrote. “We do no think this is a slam dunk.”

Sacconaghi walks through some interesting numbers on the current phone market, which I have compiled into a Harper’s Index-style list:

• Number of phones from the four major U.S. wireless carriers which are now priced above $400: none.
• Percentage of phones in 2006 which sold for more than $300 at wholesale: 5%.
• Estimated number of phones Cingular sold last year that cost more than $300 at retail: about 500,000.
• Estimated number of such phones that sold globally last year: “perhaps 10 million units.”
• Number of iPhones Apple thinks it can sell in fiscal 2008: 10 million.
• Estimated number of Blackberry handhelds that Research in Motion sold over the last 12 months: about 5.5 million.
• Likely reaction on the Street if Apple sold 5.5 million iPhones in fiscal 2008: huge disappointment.
• Estimated monthly cost of operating an iPhone, given likely requirement of data plan in addition to a voice plan: $80.
• Total estimated cost of operating an iPhone for the first two years: $2,500.
• Percentage of global cellular users in the U.S.: about 10%.
• Percentage of total handheld sales represented by the U.S.: about 15%.

• Number of Cingular wireless customers:about 60 million.
• Number of handsets Cingular sells a year: about 40 million.
• Cost to buy the LG Chocolate music phone: about $100 through Verizon.
• Cost for the Sony Ericsson w810i music phone: about $79 from Cingular.

Sacconaghi says there is also a risk that the decision to base the phone on EDGE technology, rather than faster 3G networks, could result in a disappointing user experience in terms of connectivity. He also thinks the touch screen could prove frustrating for heavy e-mail users.

Motorola’s (MOT) RAZR was offered at $500 at launch; but as Sacconaghi notes, it only hit mass adoption when it dropped to $100, which took only 10 months. “It is unclear how aggressively Apple can afford to price the phone, and it appears unlikely that carriers will provide the Apple phone with unique subsidies,” he writes. One issue that other phone makers do not have is that a price that drops too low will cause cannibalization issues. “If the iPhone drops below $250, we suspect Apple margins would suffer, and provide little to no incentive for consumers to purchase stand-alone iPods. Carriers appear unlikely to give Apple any special treatment or extra subsidization, given that most will likely resent the iPhone’s wi-fi capability and Apple’s tie to iTunes.”

Sacconaghi also notes that it is highly unlikely that companies are going to buy iPhones for their executives rather than Blackberries - this will be a consumer purchase. “Would you pay $2,500 to use the iPhone for two years? Or would you rather stick with your company-issued Blackberry/PDA/phone and carry a seperate $250 iPod Video?”

Apple today is down 88 cents at $96.12.

Comments

[Tom B]

This WILL be a business product, because you can write off the cost that way. And you get way more raw functionality than any competing product delivers.

From a consumer POV, I am not willing to "bite", but I would if 1) I was already on Cingular 2) I didn't already have an iPod. It replaces four devices: an iPod; a cell phone; a crude GPS; and a crude "ultramobile PC".

From Roughlydrafted.com:

Shuffle $79 Ultra small and simple
Nano $149-$249 Very small and thin
5G iPod $249-$349 Hard drive based, with large capacity
iPhone $499-$599 Phone and Internet features

[Macbth]

Eric read the comments from this S/Alpha
It says it all:
ce.seekingalpha.com/ar...
You are as bad as Herb.

[Alpha24Seven]

C'mon Eric... You know damned well this thing will explode. Be real.

One thing. 3G is dead and Apple was smart to do an end run on it because Wi-Max will bury 3G. Smart move. BTW take a look at the roll out smoothness of 3G and then re-ask yourself why you even asked the question in the first place.

One more thing. The quality of analysts these days is suspect at best. All the *best* people have been hoovered straight in to hedge funds and -- no disrespect intended -- are the ones not invited to the hedgies party.

Price? everybody I know is lining up to get one and price is of no concern -- none whatsoever. Business user's will be deluged (in short order) with all kinds of new apps so don't worry about business users. It is NOT a closed system as some have speculated.

[Stustanton]

At CES? That's the competition. You are reporting what you didn't see? $499 and $599 are unsubsidized prices. You are comparing them to subsidized prices, aren't you? $80/mo plus $499, unsubsidized, isn't $2500/yr, so where did that cost come from? 3G phones can still be coming, yes? Did you merely overlook that? This iPhone works on household wireless for its internet connection; it's primary a data connection is not over cellular. It's not 3G, remember. The S Ericsson w810i cell phone sells for $299 with free shipping, or free with Cingular contract, so isn't Cingular's subsidy $300? (Took 3 minutes to check that.) That would make the 4GB version $200 plus an $80/mo service plan. So what's your problem with that? This was a well written, poorly authored article. The facts don't add up as presented. It muddies the water, lacks substance. rewrites someone elses article without verification, draws false or unsupported conclusions. My opinion: Grade: F+. (the plus is for the picture - good pix.)

[PatrickEvans]

No Stewart, those $499 and $599 prices are what you pay with the contract. The phones won't be available without a contract from Cingular.

I agree with Eric's assessment that the market for phones in that price range is probably not large enough to get Apple to 10 million units. It won't be easy for Apple to grow that market as much as will be needed to hit those goals, especially when they have already sliced the overall market in half by signing a multi year exclusive agreement with Cingular.

The overall cost to the consumer numbers are somewhat exagerated. In your analysis you neglected to back out the money that the customer is going to spend regardless of whether they purchase the iPhone. Most cell phone plans are probably on average at least $50? I think that may be conservative, but I'll use it as an estimate for this argument's sake. If you are correct that the iPhone's plan will cost around $80 a month, that leaves the differential cost at $30. This yields a total cost for two years of iPhone joy at roughly $1750. Still steep, but 30% lower than your estimate. The additional cost of using the iPhone could be less if your current plan is more than my estimate.

As to the concern about the user experience with data applications being less than adaquate: this device has wifi built into it. That means that when you are at home, at the coffee shop, at work, or anywhere else with wireless internet service you will be using that much faster connection to browse the web, use google maps, or send emails. This will also reduce the data usage on your cell phone plan.

Hopefully the lack of tactile feedback will make it hard for those heavy email users to compose and send emails while they should be focused on driving their cars. Other than that I don't think its a big deal, I've always felt the touchscreen typing on the ticketing kiosks at the airport works great.

Overall I agree with you, this is a high risk move for Apple that is most certainly not a slam dunk.