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The strategic tension inherent in the iPhone franchise

I don’t write product reviews and I don’t pass judgement on individual products but I do own and test various products. For example I have the Android powered Samsung Galaxy 5 (GT-I5500) and the experience is, in my opinion, better than for recent Symbian phones but not as smooth as for Apple’s products.

But that’s not what this article is about.

It’s about the price. The price for the Samsung is one third that of the iPhone 4 (both devices unlocked and sold in Europe with a 23% VAT). It was also purchased in a department store with as much hassle as buying a pair of gloves.

When it comes to the product, it may be a fair trade-off: one third the price for one third the product. The specs are not only worse but the whole experience is rougher and cruder. But that “one third the product” may be just good enough for a large population of users who are now satisfied even with “one tenth the product”. The price point should be evaluated as a valid threat.

But Apple can respond. It’s not like this is asymmetric competition. As the iPod shows, Apple can make money with low end products. Easily. Is this entry price point (€200 unlocked) something Apple should cover? My answer would be an unqualified yes.

For operator distribution, the subsidized price combined with a high-end offering is by far the best marketing mix (price, promotion, positioning, etc.) However, for non-operator distribution, a lower spec unlocked device sold through tens of thousands of points of purchase (like the iPod, and soon, iPad) makes a lot of sense from a platform point of view.

These two channels are often in conflict due to subsidy and exclusivity clauses. This conflict makes the decision to ignore the non-operator channel compelling. The economics for the operator channel are always going to trump the non-operator channel. But as the platform expands across geographies and income segments not covered by the operator-subsidized channel, these populations will need to be addressed.

So this is the inherent strategic tension for the iPhone franchise: Whether to use the iPhone brand to enable ubiquitous mobile computing outside operator channels, or use iPod/iPad as a complementary but separate brand to engage in an orthogonal attack.

I suspect the decision has been made. We will observe the consequences next year.

  • Vikram

    I expect that as with the various iPods, Apple has a strategy in place ready to go if they feel that they can effectively differentiate a mobile phone lineup outside of simply price.

    Jobs has talked about Apple's strategic mistakes in the mid-80'to mid-90's where he felt that Apple should have gone for marketshare but simply chose to rest on their laurels and it caught up with them. The iPod strategy is certainly proof that he is acting on that belief.

    I think that they will do different phones with different value-ads: Retina display vs.non, better camera vs. lesser etc…

    I think as well that the success of the Android phones has more to do with the fact that it is really the success of the smartphone that is the issue. People are starting to jump on the value of smartphone technology and for those that came from a "dumbphone" – which is the vast majority of phones – smartphones are a brand new world and most people won't know the difference in value or performance of Apple vs non-Apple phones. They are happy with a "good enough" experience and Android certainly provides that.

    That is why Motorola and HTC and Samsung are thriving on Android for the time being – the market is growing for everyone including RIM and even Nokia, once they get a few better smartphones out there will do well and "good enough" works compared to the dumb feature phone experience – even if the software is not as good as iOS. I work a lot in India and there are several brand new new non-Android touch-screen "smartphones" with some basic apps that people are buying like crazy because it is a better experience than the feature phones that they had and they can get them for less than $200.

    I expect that once the smartphone market gets saturated ( a long runway still) that then Apple's innovation and quality will stand out. The market is big enough for everyone right now.

    Having said that, I think that Jobs is loathe to let opportunities slide by if he can get an "Apple quality" product out there at different price points and the various iPods are a testament to his understanding of this.

    I agree with Horace in that i think that different priced phones are a move that Apple should do, and I suspect, will do.

  • Gavin Costello

    Horace

    I previously wondered when the iPad was released whether Apple would end up cannibalising itself. (http://wp.me/p1XYS-3U)

    In the end I decided:

    "…Apple believe the Mobile Device is more essential and, more importantly, more profitable. Perhaps they have factored that into their business cases. After all, Apple believe in leaving the past behind.

    Either that or they release an iPhone Nano But that's just a commodity, Apple don't do commodities"

    I still wonder the same thing, but I've seen nothing to date which says their Business Cases are under threat.

  • Iosweekly

    Apple won't enter a price war, but of course they aren't against creating a product specific for the low to middel end of the market.

    I think something may happen with the iPhone before it's normal June refresh, in particular with the gimped low end model (currently the 8gb 3GS) being replaced by a A4 powered model , a slightly smaller form factor, perhaps with only slightly lessor specs (like a weaker camera, no gyro, 256mb ram, smaller battery, max 8gb storage) – keep the $99 subsidised USD price point and $399 unlocked.

    Kind of like the MacBook is to the MacBook pro, or the 21 inch iMac is to the 27 inch models.

  • http://twitter.com/_ChrisHarris @_ChrisHarris

    It's an interesting point, and one that's been echoed by the recent resurgence of iPhone Mini rumours. I agree it's clear that Apple needs to offer a lower cost solution, but I'm not sure how well the iPhone form factor will scale.

    With my developer hat on, I would say that a key reason developers love the App store, lies in the maintaining of the 320 x 480 display size (the iPhone4 supports double resolution but you simply add an extra hi-res graphic to the resources). This means that any change in the form factor would necessitate a new product to build for. Or the smallest reduction in the screen size would make existing Apps more difficult to use simply by the reduced size of the finger targets. We can already see some evidence of this when trying to use the new iPod Nanos.

    So I'm not sure Apple could produce an iPhone mini without sacrificing the all the Apps in the App Store like they did with the iPad. Which doesn't sound like a smart move. That would only leave them with the option of reducing profits / specs to compete.

    • Iosweekly

      I think the iPhone has room to shrink without needing to make the screen smaller, the top of the bezel could definitely slim down. And it could be possible to even reduce the screen size by just a fraction, say 5%, and keep the same resolution at a slightly higher pixel density, so as not to destroy the UI elements.

      • http://twitter.com/_ChrisHarris @_ChrisHarris

        You're right it *is* possible to reduce, but battery and camera space would be lost. Both are key components in their differentiation from Android. At the moment Apple do have a low cost iPhone, and it's called the 3GS. I think that if they really want to capture market share they just need to lower their margins for the 3GS and start doing some deals.

      • ericgen

        I don't know. Apple often picks a model of something to try out new stuff. The new iPod Nano may actually be the testbed for a reduced size touchscreen for a smaller, cheaper iPhone. They did something similar with the MacBook Air. It's size and strength were its amazing thing. No one really noticed that it was a testbed for the unibody construction that would soon be in all MacBooks.

  • Duane

    I couldn't agree more, so many people can't seem to get over the historical symmetry of this iOS vs Android thing with the Mac vs PC war, and while Horace has written extensively as to why this isn't the case surely the biggest question has to be what is Apple going to do differently this time, and when are they going to do it?

    As mentioned above the iPod gives us many clues, as does their current distribution strategy for iPods and iPhones (well outside the states at least)

    Thanks for another great post

  • MattF

    I think a lower spec and cheaper version of the iPad is more likely in the immediate future than a lower spec iPhone– the iPad and the iPod touch will be two ends of a general-purpose WiFi iOS family, the iPhone will be a somewhat nich-ey device (analogous to the position of the iPod classic) that does everything the WiFi devices do, and also makes phone calls.

  • http://twitter.com/netgarden @netgarden

    Some of this comes down to whether Apple's goal is to try and stay relatively homogeneous across device form-factors, so as to avoid fragmenting their developer base; or, embracing fragmentation and developing a greater "verticals" orientation.

    Mark

  • parv

    i reckon they will follow the ipod strategy. The 'iphone nano' will have a smaller screen', preinstalled with the following apps:
    facebook, twitter, youtube, mail (email), address book, ical

    Don't think it will have safari.

  • Richard

    I think bypassing the operator channel with a low end product will be very risky and won't make their operator patrners happy at all. Retailing a low end mobile phone on the high street is very different to selling MP3 players, for a start Apple invented this market yet the market for low end mobile phones is very much Nokia's and increasingly Samsung's domain. Very different dynamics at play with this strategy so why risk the continued success of the current model?? They do not need to do it since they are on course with virtually every modern household having an Apple device of some sort, all using a common platform for connectivity, service and content. If the strategy allows more services to be sold or consumed differently then maybe it's worth it.. but cannot see the rational of what will be a pissing contest with Nokia over the volume of hardware units sold which could undermine their excellent service propositions.

    • asymco

      I agree except for the question of "need". It's a race to a billion users and although it's not winner take all, it's important to place on the podium.

      See: http://www.asymco.com/2010/09/02/the-race-to-a-bi

      • Joe_Winfield_IL

        Why is it important? Apple's primary responsibility as a public company is to maximize shareholder return. If we are in agreement that chasing the lower end will be dilutive, is there really enough strategic incentive to pursue the lowest common denominator? Keep in mind that somewhere near half of existing iPhone revenue comes from carrier subsidies; these friends could become very powerful foes if Apple chose to poke them.

        Also, large businesses would likely be among the large-volume low end buyers. If Apple is truly making inroads today at current price points, they would sacrifice tremendous margin by letting businesses buy watered down product. Apple runs the risk of pushing many high profit customers to the low end. This would likely offset much of the gain of grabbing new customers upgrading from older feature phones.

        I live in the US, so my perspective is probably flawed. We have no choice but carrier subsidies. The Android products being marketed are often offered as buy one get one free by mobile carriers, so pricing is a bit difficult to compare. However, the standard market price for a current model smartphone is $199 subsidized. This price point seems to work tremendously even for inferior products, so there is less upside in my US market than the rest of the world.

        Also, Apple has never chased ubiquity except for the iPod. This was, to me, an exception due to the fact that the mp3 market was inconsequential at the time of iPod's release. There was no market leader being backed into a corner by Apple's presence. Even today, they are by far the most profitable PC manufacturer with single digit market share. They would like to grow share, but they are determined to keep prices and specs on the higher end of the range rather than compete with the commoditized manufacturers who have everything to lose by Apple's presence in their domain.

    • Gandhi

      You could have made the same argument when the original iPhone was introduced and Apple was facing entrenched competition. Apple did bypass the operators to a much greater extent than anyone had done previously. And they do retail a low-end phone today, the 3GS.

  • CndnRschr

    Don't forget that a cheaper device is already being sold by Apple to try to cater to the lower end (it is available locked or unlocked and therefore can be sold anywhere). The problem with this approach is the once a year June launch which generates amazing buzz for the new iPhone. People know that the cheaper product is last years model and thus the buzz around the new iPhone undermines the desire to buy the cheaper product. A better strategy may be to introduce a tier 1.5 device in January that borrows some components from the current iPhone but is lower specced that previously available (memory limit, cheaper materials). This bridge product would allow sales to the more price conscious without cannibalizing the "must-have the latest device" buyers in the earlier cycle. Apple's product releases for handheld devices are entirely predictable (iPod, iPhone and likely iPad) and this causes demand spikes and availability delays. The trick will be to provide a refresh without undermining the flagship products.

  • OpenMind

    I believe Apple has made its decision: it needs a healthy market share, but not lowering the user experience of iPhone. Apple is going to release a CDMA iPhone based on the controlled leak from WSJ. Half of US mobile users is on CDMA (Verizon/Sprint), and so is one third of China mobile users. That would put iPhone on the equal footing of Android, operator technology wise. Right now iPhone is handicap by network technology it supports.

  • http://twitter.com/ThembeK @ThembeK

    I want to agree with you Horace (and other contributors), I really do. But the operator channel, at least from where I’m from is nothing short of shocking. The subsidies apply to both postpaid and prepaid and they can be very aggressive. But it’s not only subsidies that are a problem, it is the entire model. The markup on devices is extremely tight or negative. Price erosion is a weekly occurrence. No one makes money from selling devices except OEMs. Partners make money from commissions/revenue share. That is the only way to make money.

    How do you compete with a business with no mark-up? If a device cost you ZAR200.00 in retail, that is probably its landed cost.

    If Apple insist on selling iPad/other iOS devices through its channels and partner channels with everyone adding his own markup on the devices, I am telling you right now that they have already lost.

    I am a retailer and I have never seen something like this before.

    It is impossible to compete with the carriers channels unless you sell knock-offs.

    Coming back to the article, I would also like to see an entry priced iPhone/iPad, but if they are to move tens/hundreds of millions of units then they need to go via the carrier channels in additions to their channels.

  • kevin

    Horace, your excellent post hits directly at a key strategic choice that Apple has to make. Outside US, in countries where phones are not subsidized, Apple needs a cheaper phone (around $200-300) to compete. Even in US, Apple could sell an unsubsidized no-contract $299 phone via Virgin Mobile or prepaid carrier. I've also heard from Asian friends that using last year's model creates a "leftover perception". Though sales of that model seem to be decent, as Apple has repeated this many times. A simple fix is to launch a slightly different new phone, with cosmetic changes, but internally, mostly the same. (continued in next post)

  • kevin

    So what functionally is needed for such a phone to still be an iPhone – so as not to dilute the iPhone brand; what is CORE? One poster said no browser, but isn't an Internet Communicator core to "iPhone" brand? Are Apps core, and if so, is it a subset of Apps? Yet Apple needs watch fragmentation. Is wi-fi core? Probably. Is Facetime core? If so, need the front-facing phone. Not knowing Apple's future plans, I'd say the retina display, 5MP+ camera, and GPS are not core, though a camera is essential to any phone. Compare to iPod; music player is core. Click-wheel, video, photos are not core. So shuffle, new nano, classic and touch all fulfill core aspects of "iPod" brand. Added features of iPod touch are not core to the iPod brand. (continued in next post)

  • kevin

    And when does Apple need to release, to make a difference strategically or even tactically? The first-strike window is closing as "good enough" touch-based smartphones are on the market. In these early days, people compare touch-based smartphone against featurephone, and decide on data plan or not. If Apple waits beyond summer 2011, it would largely be convincing smartphone owners that iPhone is better than their phone – seemingly a much harder upsell, though easier in that they already have a data plan.

  • ChuckO

    Doesn't Apple already do this with the previous version iPhone for $99?

    • kevin

      Yes but no. In the US, it is $99, which isn't that much more than free. But in unsubsidized countries, it's still around $499, which is expensive when compared to touch-based smartphones now arriving on the market at around $200-300.

  • yet another steve

    So many of us are in the US that we forget how expensive the iphone is. And, of course, a US bias magnifies Android's share.

    Clearly the last decade shows that Apple has learned its lessons from the Mac/PC wars. It has also showsn that the lessons Steve Jobs has learned are not the conventional wisdom. The lesson is not, be Microsoft. The lesson is be a better Apple. For most of a decade in the ipod market, the conventional wisdom was "Apple is going to blow the ipod just like they blew the mac" (by being "closed".)

    It turned out that the only thing that successfully threatened the ipod was the smartphone. And guess who saw this, and got in front to own this trend?

    I agree that the decision has been made. I have also learned that if you have to bet on Steve Jobs or conventional wisdom, bet the house on Steve Jobs.

    to its credit, it is not in Apple's DNA to lose money on a product. But it is in their DNA to sell strategic things at break even. And Apple's only resource constraint is its ability to recruit and adequately deploy talent… that is management.

    In the end though, it'll really come down to whether Apple thinks it can deliver a compelling lower end experience. And engineering execution.

    ====

    Separately, I wonder if the leaks of both VZ iphone and a "range of models" are the first airstrikes in Apple's counterattack against Android. This is not the 1980s or 1990s Apple.

    There's also a point I always come back to. The printing-money-faster-than-they-can-ever-spend-it Apple is unlike Google and Microsoft in that these outsized profits are not monopoly-generated. Only the ipod hand iTunes download have market dominance. Macs and iphones–the source of most of Apple's profits–sell into fiercely competitive markets. Apple has gotten rich by knowing how to fight.

    And profitability is firepower. Yes the handset makers with their slim profits can keep making new models. But they'll never be able to change the game the way Apple keeps doing.

    • nate

      "There's also a point I always come back to. The printing-money-faster-than-they-can-ever-spend-it Apple is unlike Google and Microsoft in that these outsized profits are not monopoly-generated. Only the ipod hand iTunes download have market dominance. Macs and iphones–the source of most of Apple's profits–sell into fiercely competitive markets. Apple has gotten rich by knowing how to fight."

      Well said! It's almost shocking.