iPhone 2: More than meets the eye

Sometimes, the devil is in the details

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):

The full map of AT&T 3G coverage

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

AT&T legend

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.

About the Author

Tristan Louis

Writing and working on the internet since 1993, I've launched six companies, of which two went public and three were sold. This is my personal site and all opinions here are mine.

  • Steve W

    Why did you swag the iPhone subsidy so low? What conclusions would you draw if the subsidy equals $400 (bring the full price of the phone back up to $599)?

  • http://www.tnl.net/blog/ Tristan Louis

    Steve,

    At $200, that would be a 50% subsidy and, if you assume that the price is pretty consistent, then the following assumption would be that the cost stays pretty close to where it was most recently.

    So assuming a device that would retail (without subsidy) for $399 to $599 (the previous price range for the first generation iphone) and knowing that it will sell for $299 and $399, it looks like subsidies would cover somewhere in the $100 to $200 price difference. This is also based on the fact that AT&T will probably calculate the subsidy based on some form of volume discount.

    Those are the assumptions I’m making when trying to figure the value of the subsidy.

  • Al

    What makes you think Apple will turn on it’s developers? Just because Microsoft does this with great regularity does not mean every other player in the game will play by Microsoft’s rules.

    One other thing. Most apps coming out of Apple’s App Store will be free. Where is the profit in that? The iTunes Music Store doesn’t do much more than break even. It’s only there to make the iPod easier to sell. The App Store is all about selling iPhones not making money selling software. Apple Inc. is a hardware company, not a software company. The software, once again, is there to sell the hardware.

  • http://www.tnl.net/blog/ Tristan Louis

    Al,

    What makes me think that Apple will turn on its developers is the consistency with which they have done so in the past: it was the case with the iTunes SDK, it was also the case with the Quicktime 3 SDK, and if you can remember far enough, Apple once momentarily allowed external companies to manufacture macs, only to shutter the door on them when it didn’t please it. So one can be naturally cautious when dealing with Apple.

    The second part of your argument is that Microsoft does this regularly. It’s possible (though, in my experience, Microsoft has generally been more developer (developer! developer! developer!) friendly than Apple) but even if it were developer unfriendly, that would not make it right for Apple to follow suit: two wrongs do not make a right.

    On your item about apps being free: I’m sure that will be the case initially but some people will want to charge, I’m sure. And this serves as a warning to those people. Producing software for free is a good thing but not a way to earn a living :)
    As far as the iTunes music store not doing more than breaking even, I’d beg to differ. According to Apple’s latest quarterly report, it’s adding hundreds of millions of dollars in profit to the bottom line. I don’t know about you but, to me, 9 figures profits are hardly breaking even.

    Last but not least, you mention that Apple is a hardware company and not a software company. I think that dichotomy is wrong: Apple is in both business and they support each other (actually, it’s in 3 businesses: software, hardware, service, each reinforcing the other two). Of course, I could be wrong, and the page of “Apple Software” in the Apple store must be a figment of my imagination. The next time I go to the Apple store, I’ll ask them to give me a free copy of Final Cut Studio 2 because they’re in the hardware business and therefore the software must be free.

  • http://www.tnl.net/blog/ Tristan Louis

    A correction to the numbers above.

    Someone told me, via email, that SMS is actually an extra $5 per month. So, over the life of the plan, we need to add an extra $120, which brings the service price to $1900 and the total 2-years cost of ownership for of a 3G iPhone to $2099 or $220 more than the first generation iPhone.