Apple takes risks in bid to shake up the mobile market

When Steve Jobs introduced the iPhone at Apple’s annual Macworld trade show in January, he set a high bar for measuring the success of the new mobile handset.

“In 1984 we introduced the Macintosh. It didn’t just change Apple, it changed the whole computer industry,” the technology group’s chief executive said to raucous applause. “In 2001, we introduced the first iPod and it didn’t just change the way we all listen to music, it changed the entire music industry.”

“Today,” he told the swooning crowd, ”we are going to reinvent the phone.”

It was classic Jobs bravado. But the excitement surrounding the iPhone is hardly limited to the Macintosh faithful. In the eyes of its boosters, the iPhone seems destined to change the world. Freed from the shackles of the “baby software” that cripples most phones, the argument goes, iPhone users will become the first consumers in the world to gain full and unfettered access to the internet while on the move, as well as enjoying a simpler way to manage contacts, listen to music and make traditional calls.

On Friday, more than two years of anticipation will come to a head when the iPhone goes on sale in US stores, in what is sure to be one of the most closely-watched product launches of all time. It is expected to make its debut in Europe later this year and in Asia in 2008.

But is the iPhone truly a breakthrough device? Or is the frenzy around the iPhone launch just that – hot air amplified by clever marketing? As with any new Apple product, it is difficult to separate the hype from reality.

“If the chief executive of Nokia had stood up and said he was launching a phone that was big and heavy, had no keyboard, was only 2G and not available for six months, he would have been crucified,” says Ben Wood, an analyst at CCS Insight. “It is unique that Apple have been able to get away with that.”

The fact that Apple has chosen to make the iPhone run on a slower 2.5G radio rather than a faster 3G connection is just one of the issues that could cause the iPhone to hit a snag, at least in its first incarnation.

“The two obvious areas for improvement in this version of the iPhone are adding the 3G network and adding more memory,” says Charles Golvin, an analyst at Forrester Research. The lowest-priced iPhone has just four gigabytes of storage – far less than most video iPods.

At $499 for a basic iPhone handset, Apple is entering at the top end of the smart phone market. The iPod was priced at a similar premium to other music players when it arrived on the scene in 2001, but Apple was soon able to segment its market and offer stripped-down versions of the player to more price-sensitive consumers. Today, an iPod shuffle can be bought for less than $80. It may be difficult to achieve similar price flexibility with the iPhone.

“If Apple wants to bring the price down like they did with the iPod, they have to re-engineer the entire operating system from scratch,” says Richard Windsor, an analyst at Nomura.

The excitement around the iPhone stems from a simple fact: in spite of their increasing importance in our day-to-day lives, most mobile phones remain clunky, crammed with hard-to-use features, second-rate software and awkward keypads.

When it launched in 1984, the Macintosh was the first personal computer to abandon clumsy text commands in favour of a visual interface controlled by a computer mouse. The move made the world of computers accessible to the mainstream, setting a new standard for ease of use in computers that is still copied today.

To improve the user interface of mobile phones, Apple has done away with a fixed keyboard in favour of a touch-screen that allows button configurations to change depending on whether a user is making a phone call, viewing a picture or composing an e-mail message.

One of Apple’s chief breakthroughs with the iPod was to tie the new gadget closely to its iTunes music software, a move that made it easy for iPod customers to store and organise entire libraries of music. With the iPhone, Apple has sought to replace the dumbed-down software found on most smart phones with a fully-fledged operating system capable of supporting graphics and web browsing usually found only on desktop computers.

“It’s really about taking experiences and capabilities that have been here for a long time in most mobile phones and making them much, much better,” says Barry Jaruzelski, a consultant at Booz Allen Hamilton. “It’s basic innovation. Having observed over two decades how people interact with technology, Apple understand how to solve problems people don’t even articulate they have.”

While it may be tempting to view Apple’s entry into the handset market as a calculated move designed to cement its position as the world’s leading lifestyle brand, the reality may be more complex. The truth is that, in contemplating its next move after the iPod, Apple may have had little choice but to enter the mobile phone business.

“Apple almost had to do the iPhone,” says Mr Jaruzelski. With a 70 per cent share of the digital music market, it was just a matter of time before iPod sales growth started to even out.

For at least a year leading up to the iPhone’s debut in January, Wall Street analysts had been arguing that Apple would need to come up with several new blockbuster products in the same class as the iPod in order to justify the huge growth premium attached to the company’s stock price.

“Every consumer electronics category goes through a boom and a flattening out,” Mr Jaruzelski explains. “Apple had to add a new category to sustain their growth.”

Once the need to move beyond the iPod into new areas of revenue growth had been identified, mobile was an obvious choice. People around the world bought about 1bn mobile handsets last year, 10 times the number of iPods sold in the past six years combined.

The sheer size of the market means that if Apple hits its goal of capturing 1 per cent of the worldwide handset market next year, a number equivalent to about 10m handsets, it could result in billions of dollars in new sales.

Yet, in spite of its size, the mobile handset market is far from an ideal battleground. “It’s a much more brutal competitive set when you are taking on Motorola, Nokia and Samsung than when you compare it to the MP3 player folks Apple were competing with on the iPod,” says Mr Jaruzelski. “They’re going to focus intensely on a new entrant.”

Nokia’s N95 phone, the Upstage phone Samsung has created for Sprint, the HTC Touch phone launched only a few weeks ago and Sony Ericsson’s W960, launched earlier this month, are all potential iPhone competitors.

The mobile handset business is not only well established and stocked with big competitors, it also is driven largely by demands of network operators. “Here in the US, operators buy 90 per cent of the phones. As a result, they dictate what the experience is like. Mobile phone makers are really under the thumb of the operators,” says Mr Golvin.

This skewed power arrangement is at the heart of many consumers’ frustration with mobile phones, which are often tailored to meet the requirements of network operators rather than customers, according to Mr Golvin. In the past, with both the Macintosh and the iPod, Apple has tried to minimise technical glitches by managing every aspect of the user experience. That level of control will not be possible with the iPhone, which will rely on AT&T’s mobile network for service in the US.

“Their partnership with AT&T is a huge change for Apple,” Mr Golvin says. “To be so highly dependent on a partner is very different.” Still, he says: “I think consumers understand the difference between the handset and the network. It’s possible that because there is so much hope around the experience, if consumers get an inflated idea of the experience there’s some risk of disappointment.”

Although the details of the arrangement between Apple and AT&T remain unclear, many suspect that Apple has negotiated special concessions not granted to other handset makers, such as a share in the revenue from service fees and greater control over the iPhone’s feature set. “In this case, Apple is the one that’s calling the shots on the device,” says Hugues De La Vergne, an analyst at Gartner.

Apple’s special arrangement may signal an opportunity for other handset makers to try to secure more favourable terms from their network partners.

Mr Windsor at Nomura says AT&T’s willingness to cede control in order to do business with Apple could amount to a Pyrrhic victory. In other words, the balance of power between mobile operators and handset makers may have been irrevocably altered by the iPhone. “Nokia, Sony Ericsson and Samsung have been given carte blanche to continue pushing their brands through the user experience at the expense of the operator,” he says.

Others are not so sure. “There aren’t any other players out there who can exercise the kind of control and leverage in getting new products to market,” says Mr Golvin. “It’s not like this is a harbinger of changes that Motorola, Nokia and Samsung will be able to benefit from.”

For the network operators themselves, the iPhone could prove a double-edged sword, says Mr Wood of CCS Insight. Operators have been working for years to encourage more users to download ringtones, pictures and video over their mobile connections. But with the iPhone, users will be able to download all the content they want by synching their device with iTunes over a PC connection. “This will encourage side-loading of music content from the PC, rather than over the air. It is not as attractive to operators,” Mr Wood says.

Mr Wood says Nokia, which is understood to be planning to launch its own music service later this year, could pose the same challenge. “Manufacturers like Nokia and Apple are looking to get more revenues from services, but face a challenge in doing that without treading on operators’ toes,” he says.

For Apple, the potential benefits of capturing just 1 per cent of global handset sales are likely to outweigh the risks of entering a new and unfamiliar market.

Yet even if it were to carve out a 10 per cent share of the mobile phone market, the iPhone would remain a niche product more akin to the Macintosh than the iPod; significant, perhaps, to Apple and its shareholders, and a beautiful piece of technology, but far from the revolution in human affairs that some observers have made it out to be.

SILICON VALLEY REGAINS ITS FAITH IN THE SMALL-SCREEN WEB

Eric Schmidt, chief executive of Google, has taken to reciting the latest mantra of Silicon Valley. Asked recently what the next big opportunities would be for the search company, he echoed a word that seems suddenly to be on everyone’s lips: “Mobile, mobile, mobile,” Richard Waters reports from San Francisco.

The new enthusiasm of the Valley’s internet leaders echoes the hopes of media companies around the world, which are coming to see mobile handsets as vehicles for their own ambitions to grab the attention of more people, in more places and for more time.

This week’s launch of Apple’s iPhone has become a lightning rod for this latest burst of interest in mobile media consumption and internet access. Even if it remains a niche product sold in only small quantities, such is the power of Apple’s brand and presumed prowess in consumer technology that some see the iPhone as a catalyst for an entire industry.

“I am 100 per cent convinced it will be the change agent” for the mobile internet, says Marco Boerries, the executive in charge of Yahoo’s efforts to go mobile. Just as the Macintosh computer pioneered a new user interface that brought personal computing to the masses, so the iPhone will trigger a breakthrough in mobile computing, he adds.

The early history of the mobile internet, however, suggests that it would pay to be cautious. Eight years after NTT DoCoMo’s low-speed i-mode service first demonstrated there was a market for mobile internet access, and seven years after the auctions of “3G” spectrum touched off investment mania in Europe, more fortunes have been lost than made.

“The whole [mobile] industry in the last eight years has spent hundreds of billions of dollars to buy bandwidth, upgrade networks and subsidise handsets,” says Mr Boerries. “And what do people do? The same things they did eight years ago.”

That may be an exaggeration, but it is true that years of hype about the mobile internet have yielded little. Hopes that the habits of avid Japanese and South Korean mobile consumers would spill over to the rest of the world have not been fulfilled, and few services have turned into mass-market hits.

Ringtones provided a brief, but not lasting, flurry. Mobile games bring in €1.6bn (£1.1bn, $2.1bn) but that market is slowing and will reach only €2bn globally by 2011, according to Screen Digest, a research firm. Consumers never took to e-mailing pictures around from their cameraphones, something that mobile operators hoped would generate strong demand for mobile data services.

Other new services may face a similar fate. Downloading music direct to mobile handsets is likely to become only a €1.5bn market by 2011, predicts Screen Digest, as consumers take the cheaper route of “side-loading” songs onto mobiles from PCs.

Aside from SMS messaging (or “texting”), this has left an anaemic mobile data industry. In Europe, most carriers earn just $1-$2 a month per subscriber from these data services, according to Analysys Research (they earn another $3-$12 a month from texting). This is a mirror image of Japan, where carriers charge according to the amount of data they ship rather than by the message (text messages use little bandwidth).

What is worse, growth in wireless data revenues has largely evaporated. “Things have looked fairly flat for a lot of operators over the last couple of years,” including in the advanced markets of Japan and South Korea, says Alastair Brydon, at Analysys.

The arrival of the iPhone may be one catalyst, but it will take far more to transform today’s feeble mobile internet industry. Top of the list are services that work well enough on a small handset to draw a mass audience and new business models and forms of advertising capable of sustaining a substantial industry.

To some extent, the fortunes of the mobile industry are likely to continue to rest heavily on communication services. Just as texting has been the bright spot in recent years, mobile e-mail looks set to become a big new market. Beyond this, hopes rest broadly on two things.

One is that browsing from small handsets will finally become a worthwhile experience. Starting with WAP and continuing with the slow browsers and the unappealing “walled gardens” of services created by mobile operators, the technologies and services have been far from easy to use.

The big internet companies have contributed to this record. Early services, such as mobile search, were nothing more than copies of PC applications, admits Mr Boerries. Companies such as Yahoo and Google are racing to design services that are better suited to mobile phones, where space is at a premium and keyboards hard to use.

A partial change in strategy by mobile operators may help to stimulate this drive to create more suitable services. Starting in Europe, mobile operators are moving away from their walled gardens, giving users greater access to other internet services (though, fearful of being reduced to the position of nothing more than low-margin data carriers, most are treading carefully). They are also dropping their pay-by-the-bit pricing plans and applying flat-rate monthly charges for data, something that could encourage users to browse the mobile web more freely.

The other big hope is that the handset is about to become a form of portable television. Mobile television emerged in South Korea, but in recent months the first services in Europe to broadcast to handsets have attracted considerable interest. It is too early, though, to say whether such services will become big money-earners.

Current hopes rest heavily on the emergence of a mobile advertising business. Just as the early wired internet moved from being a subscription-based business to one relying largely on advertising, the same is now set to happen in the mobile world, says Jonathan Bulkeley, a former head of AOL in the UK and now head of mobile commerce company Scanbuy.

With the mobile advertising market worth less than $1bn last year, it may seem a stretch to think that this can become the foundation for a thriving industry. Yet the same might have been said of internet advertising in the mid-1990s.

AOL earned only $1 a year for each of its users in 1994, says Mr Bulkeley; by 2000, that had risen to $40. “In mobile, it’s like 1995 on the internet,” he says.

Additional reporting by Maija Palmer