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Analyst digs into iPhone story

updated 11:25 am EST, Tue January 30, 2007

Digging into the iPhone

Apple's iPhone is slated for shipment in June, but the device raises several important questions because it represents a new market segment for the Cupertino-based company. Research firm Piper Jaffray's senior analyst Gene Munster mulls over these questions which range from the economics of the Cingular/Apple partnership to the addressable market of the iPhone, addressing each while examining the Apple/iPhone story. Piper Jaffray maintains its 'outperform' rating on Apple shares with a price target of $124.

What are the economics between Apple and Cingular?

Each iPhone customer will need to sign a two-year contract with Cingular, regardless of which store they purchase the handset from, and another Piper Jaffray analyst for the Mobile space believes Cingular will not subsidize the iPhone. Additionally, Apple will likely avoid the tarnished image Motorola recently endured due to dropping RAZR prices by maintaining a high price point for its new cellular phone.

"Apple cannot allow Cingular to subsidize handsets sold only through Cingular stores, which would cannibalize Apple Retail Store sales," Munster wrote in a research note obtained by MacNN. "However, it is possible for Cingular to reduce overall iPhone costs by reducing service fees and offering discounts to iPhone customers, whether they purchase the phone at an Apple Store or a Cingular Store."

Cingular will benefit from added subscribers attracted to the new phone, while Apple utilizes the largest U.S. carrier as an initial market for the iPhone.

"We believe [that] Cingular will be aggressively attracting new subscribers during the launch of the iPhone by reducing service fees and announcing discounts to iPhone customers," Munster said. "Of note also is the fact that by partnering with Cingular, Apple does not need to be involved with any billing or subscriptions for wireless users."

Cingular has confirmed that no revenue sharing plan exists from added iTunes Music Store users as a result of the iPhone, and that there will be no Cingular branding on the iPhone other than the provider's name in the corner of the screen next to the signal strength indicator.

"The key takeaway for Cingular in the relationship is the addition of customers who will likely be significant users of margin-enhancing value-added services for the operator," the analyst said.

How much does it cost to switch carriers?

Apple's iPhone will be sold exclusively to Cingular wireless customers, meaning that would-be iPhone customers with other U.S. providers will need to switch to Cingular before using Apple's latest device. The average cellular contract length is two years, suggesting that roughly 25 percent of other wireless customers' contracts will expire between now and six months when the iPhone launches in June.

"Unless consumers wait until their contract expires, they will need to cancel their contract for between $175-$200," said Munster, who points to contract cancellation fees for major U.S. providers ranging from $175 (Verizon) to $200 (Sprint, T-Mobile). "In addition to canceling a subscription, potential iPhone users may have to subscribe to an EDGE data plan (between $19.99-$44.99) and pay Cingular's activation fee ($36)," the analyst wrote, adding that Cingular will likely try to mitigate the cumbersome barrier to adoption by offering a lower priced iPhone service package.

"In a worst-case scenario, the switch could cost as much as $236 plus the cost of the iPhone ($499 or $599) plus monthly voice and data service (as low as $78 together)." Munster believes that in such a case, the total added cost of switching from a similar device on another provider before the contract expires would total roughly $736 for the 4GB iPhone and $836 for the 8GB model.

"While we see this as a very high price point, we feel this is indeed a worst-case scenario and that Cingular will offer discounts on service to iPhone customers."

Will there be widespread enterprise adoption of the iPhone?

Companies already under contract with Cingular's Business Division can easily add Apple's new iPhone to the list of handsets available to employees, but Apple's latest device is significantly more expensive than the cheapest BlackBerry handsets.

"We don't believe businesses will pay a premium for the added media features," Munster wrote. "So while we do not anticipate widespread enterprise adoption of the iPhone, we also believe that most employees carry a personal mobile phone as well as their company email device (as well as an iPod) and these users will be candidates to simplify from three devices to two by switching to the iPhone."

Will the iPhone be available through other carriers?

Apple and Cingular have signed a multi-year exclusive contract for the iPhone, but Munster says it is still unclear whether the deal applies to all iPhone models released throughout the duration of the contract. Cingular's president of national distribution Glenn Lurie in mid-January, however, said that Apple's contract with the cellular carrier covers 'all models' of the iPhone including several other devices in the works that could debut in the near future.

"We believe Apple will release new iPhone models quickly (as the company has with the iPod) and these devices will eventually be open to other wireless carriers, possibly even before the Cingular contract expires."

Any expansion to other carriers will broaden Apple's addressable market beyond Cingular's 58 million subscribers, and Apple is almost guaranteed to use other carriers outside the U.S. Rogers Wireless late last week confirmed that it would serve as the sole provider for the iPhone in Canada, and that it is actively working with Apple to speed the launch. The Cupertino-based company has already revealed plans to expand its iPhone distribution to Europe in the fourth quarter of 2007, and to Asia in 2008.

"Apple will need to develop other versions of the iPhone for these markets (CDMA, etc.), which the company will likely also sell to other U.S. wireless carriers just after or even before the exclusive deal with Cingular ends."

How quickly will the price of the iPhone decrease?

While industry trends reveal that handset prices generally decrease quickly, Munster believes that the iPhone will approach the $399 mark and future models will address more price-sensitive markets.

"At launch the Motorola RAZR retailed for about $500 and one year later the price had decreased 50 percent to $250," the analyst noted. "While we feel the price will decrease with time and with future models (as Apple has indicated), we don't feel the price decline curve of the RAZR is an accurate measurement."

What are the gross margins of the iPhone?

Apple likely timed its entrance into the handset market with precision, according to Munster: "While iPod margins are decreasing, our analysis of Palm's Treo devices indicates about a 30 percent margin, which we also believe is an accurate estimation for the first iPhone models longer term, bu likely the initial iPhone model has a greater than 30 percent gross margin."

What is the addressable market for the iPhone?

Apple's broadest addressable market for the iPhone is Cingular's 58 million subscribers, but only about 10 percent of those (5.8 million) have phones that cost more than $300.

"We estimate that nearly 30 percent (14 million) of Cingular's subscribers have iPods," Munster said. "Assuming 30 percent of Cingular's subscribers own an iPod, then we estimate that of those 14 million iPod owners, about 60 percent (8.4 million) are likely candidates for the iPhone."

Piper Jaffray's estimation of likely iPhone customers falls roughly in line with Apple's own hopes to sell 10 million units in the first year, and Apple's addressable market will grow significantly as more models are released through more carriers in the future. Of IDC's estimated 201.4 million wireless subscribers in the U.S., Munster estimates that about 20 million use phones that cost more than $300 and roughly 50 million own iPods.

Broken down by provider, Verizon Wireless holds 57 million subscribers, Sprint PCS 53.7 million, and T-Mobile 27.5 million representing an additional 138.2 million. The analyst notes however that Apple will need to develop a CDMA version of the iPhone to address those markets.

Why doesn't the iPhone support the 3G wireless standard?

"The only glaring shortcoming of the iPhone is its over-the-air wireless standard (EDGE) rather than the faster 3G technology," said Munster. "But because of the iPhone's other functionality (including WiFi), we believe Apple was forced to decide not to use the 3G standard in order to keep the price down."

The analyst estimates that a 3G-based iPhone would cost an additional $100, but that Apple will eventually reap the benefits of economies of scale and favorable component markets, ultimately releasing a 3G model. Despite the current lack of 3G support, Apple's iPhone offers WiFi support as part of its broad feature set.

"While WiFi phones are common in Europe, they are less common in the U.S. The European mobile market is controlled primarily by the retail channels, which drives handset feature innovation and competition. In the U.S., however, the carriers control the market, which leads to handset makers including over-the-air wireless radios (like 3G and EDGE, which require data plans from the carriers) rather than WiFi radios, which enable users to access the internet via pre-existing WiFi hotspots," Munster explained. "Moreover, U.S. carriers try to limit WiFi features in handsets due to the threat of cheaper Skype and other VoIP (Voice Over IP) communications solutions."

Apple CEO Steve Jobs recently revealed that the iPhone does not feature an open development platform, preventing third-party software developers from creating and distributing software for the iPhone which could bypass Cingular's communication plans. Jobs pointed to the possibility of a poorly-designed iPhone application bringing down Cingular's west-coast network during a recent interview with Newsweek as he defended Apple's choice for a closed iPhone platform.




by MacNN Staff

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Comments

  1. TranceMist

    Joined: Dec 1969

    0

    SIM locked?

    There are two questions I'd like to see answered.

    1. Will the iPhone be SIM-locked. Since it is not being subsidized by Cingular, I see no rationale for this.

    2. Will it be possible to purchase the iPhone from Apple and NOT be forced to activate it with Cingular. (i.e. You walk out and must call to activate, but nothing happens if you don't)

    Again, both of these are typical tactics in the US based on subsidies, which apparently don't exist.

    If this is indeed the case, then there should be nothing stopping me from purchasing an iPhone from Apple and putting my T-Mobile SIM in it and being able to use it (sure, visual VM won't work, but that's not so bad).

  1. climacs

    Joined: Dec 1969

    0

    good questions

    I hate Cingular. So long as I would be forced to use Cingular, I won't be buying an iPhone.

    I travel frequently to Europe, so the matter of the SIM lock is crucial to me. I won't buy an iPhone if I can't swap out the SIM cards and use it over there. I don't particularly care if the advanced features don't work over in Europe so long as I can use it as a phone.

    The matter of EDGE vs 3G is important too... I think I'll be waiting for the next gen before I consider an iPhone. I don't believe in riding the bleeding edge any longer ;-)

  1. Timothy Flint

    Joined: Dec 1969

    0

    Cingular

    I doubt that this article has up-to-date information, since there is no longer a company called Cingular. AT&T discontinued the Cingular name the day after Jobs introduced the iPhone, or Apple Phone as it is likely to be called when it is introduced.

  1. jonbwfc1

    Joined: Dec 1969

    0

    what?

    "While WiFi phones are common in Europe"

    They absolutely are not. The only wifi phones you get are the very top end smartphones. 99%+ of phones sold are either 2G (GSM/GPRS) or 3G (UTMS & etc.). Even if we did have the phones, coverage of available wifi to use them with is pretty patchy even in the big cities and negligible outside them.

    In a market of millions of devices, you're probably talking about thousands of wifi enabled phones being sold a year i.e it's an utterly insignificant proportion. If this is the kind of background research this analysis is built upon, it's not worth the proverbial paper it's written on.

    Jon

  1. reboylin

    Joined: Dec 1969

    0

    iPhone Analysis

    I would recommend reading a series of articles that attempt to debunk the analysis of other websites as well as provide his own. Basically, I feel it's too soon, with too little information to generate such detailed speculation and "analysis". It does generate site hits and the back and forth prolongs it. Who has definitive information ... nobody! read: roughlydrafted.com articles.

  1. palane

    Joined: Dec 1969

    0

    Tarnished Image Motorola?

    Anyone care to explain that comment in the article? RAZRs are extremely popular and have powered Moto back into the forefront of phone makers. The original RAZR was designed by a separate group (no focus groups) and assumed to be a boutique product. As a mass market product, of course the pricing is lower. It's called Economies of Scale.

    I wonder if Apple's image has been tarnished by the dropping iPod prices? $499 for a 5GB iPod down to $299 for a 30GB iPod. Shocking!

    BB

  1. bluenote1

    Joined: Dec 1969

    0

    like the ipod rollout?

    I don't remember the original iPod getting the same kind of fervent praise/flak in society, but when it was released, it was available to Macs only. Most people thought it was a good product, but because of this limitation, it would never take off. I think that when it became Windows-compatible was when the numbers really started climbing for the iPod. I think that as long as the period of Cingular-exclusivity is not too long (say 2 years), and iPhones become compatible with a wide array of cellular service providers, the iPhone may follow a similar path.

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