iPhone 2: More than meets the eye

There has been much writ­ten about Steve Jobs’ keynote on Mon­day, intro­duc­ing a new ver­sion of the iPhone, a rebranded ver­sion of .mac, and a new ver­sion of the OSX Oper­at­ing Sys­tem. How­ever, amid all the praises, there seems to have been a few items miss­ing from the discussion.

iPhone: 3G OK but not everywhere

As expected, Apple did intro­duce a ver­sion of the iPhone that will run on third gen­er­a­tion (3G) net­works. Steve Jobs made a big deal about the wide avail­abil­ity of this new device glob­ally, high­light­ing a large num­ber of coun­tries in which the prod­uct will soon be available.

Glossed over, how­ever, is whether it makes much of a dif­fer­ence. Let’s take a look at 3G cov­er­age offered by AT&T in the United States (I man­aged to get to this map from a list AT&T pro­vides):

On this pic­ture, the areas marked in blue are the areas where AT&T offers 3G ser­vices, as the fol­low­ing leg­end reminded me:

So while it is true that you will be able to buy a 3G iPhone in most of the US, it’s not nec­es­sar­ily a guar­an­tee that you will be able to use 3G ser­vice in areas out­side of major urban cen­ters. It was not men­tioned on Mon­day and I think I may have a good idea as to why: to say that you are offer­ing a tool which will be avail­able only to urban­ites would have stolen some of the magic.

How­ever, the truth of the mat­ter is that most of the cur­rent iPhone buy­ers appear to live in the tar­get areas. In my expe­ri­ence, while iPhone are fairly ubiq­ui­tous in the New York, Chicago, DC, and San Fran­cisco cir­cles I tend to run in, I haven’t seen as many of them when I go to other areas. It could be that the device is attrac­tive to peo­ple who live in cer­tain areas and may not be as attrac­tive to oth­ers. I don’t know why it is but it’s just an observation.

Cost

A pos­si­ble rea­son for the phone cur­rently being more pop­u­lar in large cities may have been price, an item that Steve Jobs also men­tioned as some­thing they needed to work on. When the iPhone was first intro­duced, its $599 price was seen as high com­pared to the rest of the mar­ket. Sub­se­quent price cut brought the price of the phone to $399, a price that was more or less in line with what other smart phones were retail­ing for.

When it was first intro­duced, Apple dic­tated that cus­tomers would pay full price for the device and, on top of it, AT&T would pay Apple an extra $18 per month for every iPhone sub­scriber (or $432 over the 2 year con­tract that a sub­scriber would be locked in for).

When the iPhone was intro­duced, plans were rang­ing from $59.99 (for 450 min­utes, 200 SMS, and 5000 night and week­end min­utes) to $99.99 (for 1350 min­utes, 200 SMS, and unlim­ited nights and week­ends min­utes) with no extra data charges for brows­ing, email etc…

So, assum­ing a low cost $59.99 indi­vid­ual plan, the 2 year out­lay for an iphone user would be $1440 for sub­scrip­tio. Tack on the $399 price of the iphone and that’s $1840 over a two year period.

That’s a lot of money and Steve Jobs announced that they had heard com­plaints about the price, which have now resulted in this new device being avail­able for prices rang­ing from $199 to $299.

The new plan, accord­ing to an AT&T press release, start at $39.99 was voice ser­vice only with an extra $30 for 3G. This means that the most basic plan is now $69.99. By the look of it, the extra $30 plan is sim­i­lar to the exist­ing PDA Per­sonal plan they are offer­ing (It’s unclear whether SMS is included in the plan but AT&T does not seem to pro­vide any infor­ma­tion as to SMS related charges).

So, over the two year life of the plan required by the con­tract, the cost would be $1680 for sub­scrip­tion. Tack on the $199 to that price and you end up with a total of $1879 over a two year period, roughly $40 more than the out­lay for first gen­er­a­tion devices.

The inter­est­ing thing here is that the price is roughly the same even though the entry point is low­ered by a third. This plays to the per­cep­tion that the price has been dras­ti­cally low­ered but the truth of the mat­ter is that it hasn’t changed much.

Rev­o­lu­tion­ary Model?

What has changed, it seems, is the rela­tion­ship between Apple and AT&T. A year and a half ago, when Steve Jobs intro­duced the iPhone, it looked like AT&T had bent over back­wards to ensure they would get the device. Apple was receiv­ing kick-backs; Apple was dic­tat­ing the price of the device; Apple was con­trol­ling the inter­face; Apple was con­trol­ling the acti­va­tion (which could be done from home); You could buy an iPhone at the Apple store, go home, use iTunes to acti­vate your phone and, apart from receiv­ing a bill from them every months for the fol­low­ing two years, you didn’t really have to deal with AT&T.

Fast for­ward to today.

The device is heav­ily sub­si­dized; AT&T keeps all the rev­enue from sub­scrip­tion; Apple still con­trols what’s on the phone deck; AT&T requires in-store activation.

Sud­denly, the busi­ness model doesn’t seem so rev­o­lu­tion­ary. In fact, it seems that Apple is now falling in line with every other phone device man­u­fac­turer. Yes, it still has con­trol of the inter­face but it seems that wire­less providers are more lenient when it comes to that these days.

What I sus­pect is that real­ity has largely set in. While lofty goals of sell­ing 10 mil­lion iPhones were men­tioned, 6 mil­lion units have shipped. 6 mil­lion is a very respectable num­ber. In fact, it’s an impres­sive num­ber when you con­sider the price the device sold at.

The prob­lem is that 6 mil­lion is still a long way from ensur­ing 10 mil­lion devices sold by then end of Decem­ber. So AT&T must have men­tioned that fact to Apple and told them that while it was all very nice and they still wanted exclu­siv­ity, they would have to rene­go­ti­ate terms. And the nego­ti­a­tion brought Apple “back in the fold.”

A funny thing is that while AT&T exec­u­tives were high-fiving them­selves over that suc­cess, Jobs was prob­a­bly look­ing at another por­tion of the mar­ket they had not dis­cussed: software.

See, hard­ware is all great and fun but ulti­mately, it’s a sucker’s bet: there’s only so much money you can wring out of a device and mar­gins never really increase. The pre­vi­ous iPhone was cost­ing about $220 to build. This one, with a 3G chip and a GPS will prob­a­bly cost a lit­tle more. Of course, it’s sub­si­dized by AT&T (i’d sus­pect that AT&T pays between $100–200 per iphone) so Apple still makes some money but that’s pretty con­sis­tent. Increas­ing mar­gins on such a device would be hard as it requires heavy nego­ti­a­tions with sup­pli­ers to get bet­ter costs for parts and recon­fig­u­ra­tion of pro­duc­tion lines to improve effi­cien­cies. Those are not easy areas and invest­ments need to be pretty heavy in order to see returns.

But then, there’s software.

Soft­ware is almost dia­met­ri­cally opposed in its scal­a­bil­ity of cost (for a good under­stand­ing of the advan­tage, see dic­tio­nary under Microsoft ). Yet soft­ware, in itself is still pretty expen­sive to pro­duce (the same is true of music or any other cre­ative endeavor where the prod­uct can be dig­i­tized). How­ever, imag­ine being able to build a mar­ket­place where one would sell soft­ware pro­duced by some­one else. It would look like the type of mar­ket­place one would use to sell things like music, or maybe movies, or TV shows.

Oh wait, I know, it would look like the lead­ing mar­ket­place for sell­ing music. You know, the one by Ama­zon… uh, no, not that one. Who makes that lead­ing mar­ket­place? Oh yeah, Apple with the iTunes store.

Con­trol

In the fourth quar­ter of fis­cal 2007, Apple report­edly made $808 mil­lion in the cat­e­gory that includes the iTunes online store. This, largely by pro­vid­ing infra­struc­ture to sell other people’s prod­uct to users of its iPod.

Now comes the iPhone as, essen­tially, the next gen­er­a­tion of the iPod… and it seems that, as Apple ini­tially strong-armed the music indus­try into giv­ing it a por­tion of rev­enue it didn’t need too, Apple is now work­ing on ensur­ing that it will get con­trol over what goes on their own next gen­er­a­tion iPhone.

Last year, when they first intro­duced the device, it was locked down and fully under Apple’s con­trol. But over the year, tools appeared to break that strong­hold and peo­ple started devel­op­ing appli­ca­tions that enhanced the device for any­one who was basi­cally will­ing to void warranty.

Apple saw what was hap­pen­ing and ini­tially tried to fight it but the com­pany even­tu­ally real­ized that attempt­ing to fight such a trend was essen­tially like a game of wack-a-mole. Fun for sure, but hardly prof­itable and/or poten­tially suc­cess­ful. So Apple relented by pro­vid­ing a soft­ware devel­op­ment kit, a move that it hopes would bring devel­op­ers back into the fold.

This plugged the issue of non-standard devel­op­ment and, thanks to the require­ment to agree to cer­tain terms and con­di­tions, Apple can now dic­tate what appli­ca­tions can and can’t be cre­ated for the iPhone and it’s not the first time that Apple uses its SDK agree­ment to limit what appli­ca­tions can and can’t be built using it.

At this point, though, it still OK as Apple gives its devel­op­ers ways to fill gaps that exist on the device by pro­vid­ing soft­ware that Apple did not provide.

And that’s where Apple’s Push Noti­fi­ca­tion Ser­vice comes in. At first blush, it looks like a nice idea: instead of run­ning all appli­ca­tions in the back­ground, you just have your cur­rent appli­ca­tion talk to that ser­vice and that ser­vice then relays infor­ma­tion to the Apple server before pass­ing it on to you. It “sim­pli­fies” things and saves bat­tery juice. That’s all great, until you start think­ing about the impli­ca­tion: Apple now knows what works and what doesn’t in terms of applications.

The com­pany will not only know which appli­ca­tions are being down­loaded to iPhones, since the only way to load an appli­ca­tion legally is through the iPhone store pro­vided by Apple, but it will now know whether the appli­ca­tions are actu­ally used and what kind of usage pat­tern they have.

Of course, one would assume that since Apple is such a great com­pany and so devel­op­ers friendly, it will share this infor­ma­tion in almost real time with the appli­ca­tion developers.

Except it won’t.

The other thing this does is that it pro­vides Apple with a cen­tral sys­tem that knows what users are doing with their iPhone. This is basi­cally focus groups on a global scale and it’s very impressive.

Apple has essen­tially cre­ated for itself a device that will keep infor­ma­tion on what appli­ca­tions are being used on it, how much they’re being used, and by how many users. From there, I sus­pect it won’t be too hard to build an inter­est­ing roadmap that seems to mag­i­cally mir­ror the best applications.

And the devel­op­ers of appli­ca­tions that were fill­ing the gap cre­ated by Apple at the time? Well, it will be a prob­lem for them to try to com­pete with Apple but I’m sure the com­pany will be happy to have them develop other appli­ca­tions after it plun­dered their pre­vi­ous suc­cess­ful one.

Related Terms

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