The Business of the iPhone

There has been a lot of press and commentary on Apple’s iPhone. Deservedly so. From what has been presented thus far the iPhone is a sleek piece of hardware and software engineering as only Apple can produce it. Whether the iPhone is revolutionary, expected or somewhere in between, the discussion has focused primarily on the device’s features and interface. Much less has been said about the implications of Apple’s iPhone business strategy. Since the iPhone was announced on January 9, my thoughts have turned to the decisions that Apple has had to make in order to enter the wireless market and what may come in the wake of the iPhone’s June 2007 launch.

Why iPhone?
Apple’s decision to get into the wireless device business is not surprising. Since the launch of the iPod 5 years ago, Steve Jobs has touted the connected experience where all Apple devices and services work and play seamlessly with one another in one glorious digital ecosystem. Since the mobile phone has become the one device that no one is ever without, despite the fact that nothing about the wireless experience is very good, it was only a matter of time before Apple got into the game. “Everybody hates their phone,” Time magazine quotes Jobs as saying, “and that’s not a good thing. And there’s an opportunity there.”

Uncharted Territory
Having decided to get in the game, Apple’s most significant decision is to be a manufacturer only rather than a manufacturer + MVNO. This is curious since Apple’s brand is largely based on its control of the end-to-end consumer experience. The MVNO route would have allowed Apple to maintain the most control over the end-to-end iPhone experience, clearly important after the ROKR fiasco. However, it would also have taken Apple into uncharted territory as a wireless operator. With iPhone v.1 Steve Jobs has decided to take the path with the fewest risks and stick with what he knows Apple does best.

Strange Bedfellows
Making the choice to be the iPhone’s manufacturer rather than an MVNO necessitated a greater reliance on a national U.S. wireless operator. The big tradeoff is that the iPhone experience will be greatly impacted by the operator’s call quality, customer care, and billing - typically wireless subscribers’ biggest gripes about any operator. Apple may be relying on the iPhone’s target base to be sophisticated enough to distinguish between Apple’s product and the operator’s service, but I have my doubts. In the end it’s no use having the coolest phone in the country if you have poor reception where you live, or if the quality of your support leaves much to be desired.

Apple’s choice to partner with Cingular does not surprise me if only because Cingular has the largest subscriber base in the country and that increases the likelihood that the iPhone will meet its initial sales projections. What are Cingular’s motives for entering into the iPhone partnership with Apple? It has been widely reported that Cingular entered into a long-term agreement with Apple two years ago without so much as a sketch on a napkin and that the operator also agreed to give Apple free reign in development of the iPhone’s features. Needless to say, this is not typical of the relationship between wireless operators and handset manufacturers. Clearly, Apple is no ordinary handset manufacturer.

The Payoff
What does Cingular gain in exchange for its partially financing the development of the iPhone? At a minimum, exclusivity and some payback for its investment. Cingular is counting on the excitement and novelty of the iPhone to generate significant sales and new customers during its unspecified “multi-year” contract with Apple. It is also likely that iPhone users may be required to purchase Cingular’s pricey monthly data plan as part of their contract with the operator. Finally, Cingular will almost certainly receive upwards of $70-90 on every handset sold, standard practice in the industry when an operator helps finance a new device. While Cingular may refrain from inserting its proprietary features such as MEdia Mall on the iPhone, I suspect that Apple’s choice to ship the device with a closed operating system (eg. not open to third-party developer features) is the price Jobs had to pay in exchange for retaining total control over the device’s software.

The Future of the iPhone
Will the iPhone be a winning proposition for Cingular and Apple? If the iPhone meets its target of 1% of the market (or 10 million units), yes. Some analysts feel that’s an ambitious goal however, and that the sales are more likely to be in the 2-5 million unit range. Either way, the future of the iPhone may be very different down the road. Some idle speculation:

• Over the course of its multi-year agreement with Cingular, Apple continues to refine the iPhone’s hardware and features, notably 3G support, better battery life and more memory. WiFi support will only expand after the Cingular agreement is up. Removable battery and expandable memory will never happen.
• After the agreement with Cingular is over, Apple becomes an MVNO. Having gained the experience of working hand-in-hand with Cingular, Jobs may feel Apple has the knowledge and insight to really transform wireless service in the US. With last year’s purchase of a state-of-the-art 107,000-square-foot data center in Newark, CA, Apple may be anticipating just such a move. With this move, Apple provides limited third-party developer support to encourage development and adoption of novel features and mashed-up services.

I sincerely hope Apple takes back the end-to-end iPhone experience after its exclusive agreement with Cingular comes to an end. If there is one company that could transform the business of wireless in the U.S. it is Apple, but it can only do that if it isn’t shackled to any players already in the field.