iPhone Platform Takes Over from the Mac

With over 45 million iPhones + iPod touches, 66,000 apps available, and 1.5 billion apps downloaded, Apple is busy building an unstoppable platform.

The Mobile Majority

With 5.2 million iPhones accounting for $2.9 billion (non GAAP) and sales of roughly 3 million iPod touches for another $600 million last quarter, the iPhone platform is already worth more to Apple than Macs ($3.329 billion).

As Year on Year (YOY) Mac revenue was down and the average selling price of Macs lower, Macs are unlikely to generate more revenue than the iPhone platform again, even though GAAP subscription accounting will hide this for a while.

At WWDC, Apple announced that there were 75 million OS X users, and at the end of the March quarter there were over 37 million iPhone/iPod touch users. Even after the successful June quarter for Mac sales, mobile users of OS X are now the majority.

In the September quarter a year ago, Apple sold 6.9 million iPhones when the 3G model was launched. A month into the quarter - 6 weeks after the launch of the iPhone 3GS - Apple still can't make enough to meet demand, which could easily exceed 7 million this quarter.

With the "back to school" promotion including a full rebate for the 8 GB iPod touch when you buy it with a qualifying Mac, quarterly platform sales should be over 10 million for the first time. This would be sequential quarterly growth of over 20%. The App Store tornado is blowing away the competition.

The decrease in iPod numbers in the June quarter is hiding the growth of the touch. In the conference call, Apple's CFO Peter Oppenheimer said that YOY growth was over 130%. After the annual refresh (in September?), sales numbers should really accelerate from buyers who want apps but are not prepared to change cellphone carriers or don't want to pay for the additional benefits of an iPhone. AdMob estimates that in the US there are already 13 million iPhones and 12 million iPod touches. In the longer term, as wireless becomes more pervasive and more use VoIP, I expect the iPod touch will outsell the iPhone.

Yet most analysts and market reports are locked in to the cellphone numbers. How Nokia compares to RIM and Apple, etc. in the smartphone market and how much each cellphone maker sells. Making better guesses than the others helps analysts sell their services.

The problem comes when a product or range doesn't neatly fit into their predefined markets. Microsoft solved this for the Zune by persuading analysts to look in more detail at the top end of the MP3 player market. For a while this made the Zune look more relevant. NPD, for US retail, also follows this approach with the $1,000+ computer market, where Macs dominated in June with 91%.

In the future we can hope for iPod touch retail numbers, which can then be combined with AT&T's iPhone activation figures for a more accurate view of the US mobile market.

Beyond AT&T

In the US, the exclusive deal with AT&T won't go on forever. Adding T-Mobile in the US would be straightforward but, given their patchy 3G coverage, of limited help in selling more iPhones and driving user costs down. A move to Verizon and/or Sprint would require Apple to design a CDMA iPhone which, due to network data/voice limitations, would not allow the use of a browser during a phone call. A CDMA iPhone would also need a bulkier form factor if it were to work worldwide.

As long as Apple designs for slim and light, this seems unlikely. Verizon announcing plans to have its own online App Store makes an agreement even less likely, at least until it fails. Undoubtedly Apple will take another look at a Verizon iPhone agreement in a couple of years, when their next generation network is widely available. In the meantime it would be a good launch partner for an iPod touch HD or ARM based netbook.

Nevertheless, the threat of a linkup with Verizon lets Apple drive a harder bargain with AT&T. As iPhone sales could be held back by the carrying capacity of the AT&T network, any extension to the current deal could require network improvements. Since, according to Om Malik's calculations, the average iPhone user pays $35 more per month, there should be enough money to pay for the improvements.

According to Tim Cook, "almost 20% of the Fortune 100 have purchased at least 10,000 units or more, and multiple corporations and government agencies have purchased in excess of 25,000 each." With the latest Forrester survey of 300 North American companies showing that nearly 1 in 4 support the iPhone, it is selling to companies in numbers that Macs have only reached in education deals.

Growing the Platform in Europe

In Europe, in many countries, the former national phone companies still dominate, and Apple already has agreements with major carriers like Orange (France), T-Mobile (Germany), and Telefónica in Spain/UK. As exclusives end, these carrier relationships can be extended into other countries. Orange has lost its exclusive through the French courts, because it was distorting competition, and all three of the carriers now sell iPhone packages.

The UK has the most competitive market, and the agreement with Telefónica subsidiary O2 is up for renewal. As this market is already fragmented, Apple has much to gain from selling through several carriers, and Orange, T-Mobile, and Vodaphone are apparently interested. Since these have their own High Street shops, more and more people will see the iPhone as the recommended smartphone - and with 21 Apple retail stores, good support is in place.

Green is an important part of the European market, especially in Germany, the Netherlands, and the Nordic region, so Apple should promote iPhone's green credentials much more: iPhone. Not a throw away phone.

This approach could help Apple grab serious market share in Finland, Nokia's home base.

The iPhone is strongest in the postpay market, where carriers subsidise handset prices. Sales took off after Apple/AT&T switched to that model, cutting the initial payment for users. From conference call remarks, Apple is still sorting out the best way to sell in prepay markets. Tim Cook said "not that there are zero (smart)phones being sold in prepay; there are some, but it's much lower".

The iPod touch could help in markets where iPods have strong sales. Build an advertising campaign around the App Store and the touch, and then sell the iPhone as the iPod touch Plus - adds a phone, connects to the Internet wherever you can get a cellphone signal, more apps, more games, GPS, adds a camera (for a while at least), etc. Effectively this is an update of the way Steve Jobs launched the iPhone at Macworld, and a well executed campaign will get more people to choose between the iPhone and the iPod touch - and to try out the iPod touch when they like using another phone.

The Rest of the World

Outside of North America and the European Union, there is still much to be done. Sales figures in Russia and India are disappointing. In China and South Korea, both potentially large markets, there are no announced carrier partners. Many of the markets are prepay, and for many of the potential buyers, $500 to $800 for an iPhone is a lot of money.

If Apple wants to take over the top end and grow the iPhone market, it could use some of its large cash balance creatively to provide the financing for iPhone installment plans (the successful postpay contracts are effectively installment plans too, but financed by the carriers). Apple could partner with a local bank that wants to build this kind of credit business, and because Apple would be providing the capital in the form of iPhones, it would be attractive for a bank even in a recession.

Apple could reward buyers for prompt payments with credits on the App Store or iTunes. As Apple uses subscription accounting over two years, the installment payments could be structured so there is no impact or a positive impact on GAAP earnings. While this would impact free cash flow, as Apple invests for capital preservation it is currently receiving a minimal return on its $31 billion cash and short term balances.

If the agreement with China Unicom is as outlined on iPhonAsia for a minimum of 1 million iPhones a year for three years, it will be a good way to launch the iPhone, but history is littered with western companies spending money to launch in the great untapped China market and failing. Apple is, however, used to being a niche player, so it can keep expectations under control.

China Unicom, even though it is much smaller than China Mobile, has more customers than AT&T or Verizon. The big question is, when will the 3 year agreement start? Possible reasons for delay include:

• Logistics: As it covers a cheaper iPhone without WiFi (because of WAPI/WiFi issues), Apple won't want to launch before there is enough spare capacity on the production lines.
• Politics: China Mobile is moving over to a homegrown TD-SCDMA network, and many of the carriers want to establish Android handsets,, so the mandatory testing and licensing process may be stretched out.

Still Tim Cook said "it continues to be a priority project, and we hope to be there within a year".

The Customer's Relationship with Apple

Generally in markets where the iPhone is established, the real gains are from moving the customer relationship more and more towards Apple and away from the carrier. This is why the App Store is so important. Every time someone downloads an app, they reinforce the connection with Apple. Every time they enjoy using an app, it is more difficult to move to another phone. This is also why Apple has resisted sharing the App Store with carriers.

One number to watch is the number of active iTunes Store accounts. Growth shows an underlying gain in the Apple customer base.

Most, if not all, of the OS X increase in market share will come from increased sales of the iPhone and iPod touch (and any OS X ARM-based netbook or tablet). These are all handheld computers built around ARM chip designs.

Intel hopes to start getting smartphone wins with future x86 designs. Until it has a good solution for computing power per watt compared to ARM, so batteries in Intel smartphones last long enough, take up will be in niche markets where use of x86 software is the main requirement. Microsoft and Windows won't be a serious competitor in the short term, if at all.