The Relevance of 10 M - awaiting the final numbers for the iPhone

The Apple iPhone was big news a year ago and a recurring theme at this blog from long before it had a name, and related to the iPod vs musicphone debates we had here for two years before the iPhone was launched. The Apple fourth financial quarter of 2008 results are coming out on October 21 of 2008. It seems very likely that the 10 million annual sales level for the iPhone will be announced. I have no inside knowledge of these numbers, but I'm very confident that it is so. I want to give some background and analysis on what those numbers mean, and how they were achieved.

HISTORY

I gave my first opinion of the iPhone announcement only some minutes after it was announced, on 9 January of 2007, saying it was "welcome innovation fusion" to the industry, but warned the industry was not as easy as those of the PC and MP3 player markets; and also expressed my concerns about the lack of a separate keypad.

I followed that with an Open Letter to Apple, still on the 9th of January, warning them that the killer app for a modern smartphone "is not voice nor music" but that the only killer application for our industry currently is SMS text messaging, and that it was not well understood in America, at Apple's home market.

Then, one day later, on Oct 10, 2007, I wrote what many considered the best competitive analysis of the chances of the iPhone in the telecoms industry, in my major analysis entitled Handicapping the Race. I totally stand by that early analysis and made what I think turned out to be very valid early observations, such as "In Europe.. the lack of 3G will be a serious flaw.. by year end (2007) this phone will be almost obsolete in Europe by then." As it turned out to be; only the 3G iPhone would capture Europe's interest this past summer. The response to the original iPhone was quite muted in only a few European countries compared to what it achieved in America in the summer of 2007. I also praised Apple for its powerful marketing, brand loyalty, passionate customers and innovation. I also warned that the first generation (2G) iPhone was not perfect, and that it might well end up, that a later iPhone variant would be the real success, as I wrote one day after the iPhone was announced:

But Apple is not infallible. Sometimes its first step is not enough - remember the Lisa, the predecessor of the Macintosh PC? A great computer at the time, and revolutionary in some ways, but did not take the market by storm. Only the Mac did. Same for the Newton, a great and innovative early PDA but its timing was off and other PDA makers took over what Apple pioneered.

I also was quite correct in guessing how the first iPhone would be received worldwide, writing:

Expect the most glowing reviews and opinions from the American press; and the most critical reviews and opinions from the Northern Asian and Northern European press.

It turned out to be true. The American IT and telecoms press loved the first iPhone, the rest of the world was more mixed and even lukewarm in their reviews. Finally, as to Apple's stated aim of 10 million sales in the first full fiscal year of the iPhone ie Oct 2007 - Sept 2008 - this is what I wrote:

With the launch and aim of 10 million sales comes a certain corporate-wide commitment by Apple to make it happen. I would say they will do it. But it will come at a serious cost to profitability. Note that this expands Apple's portfolio and helps a PC maker move into the mobile internet - the future, so this is also a clever move by Macintosh, to gain a foothold into the mobile computer market of the next decade. Good move by Apple. A lot of worries by major handset makers. An exciting time for the industry. But I want to see a family of iPhones before the end of the year.

So with that, yes, right from the start, I said this phone could well hit 10 million sales. It would not be easy, and it would be costly. It would particularly hit the profitability of this product. I was certainly assuming one of the marketing cost impacts Apple had that it could use - which I mentioned in several comments - was to drop the price of the iPhone in 2008, to help boost sales if the 10 million was turning into a tough target. It was not Apple's only marketing option, naturally; you can boost sales also with advertising, sales support campaigns, new designs, etc. But yes, that the price was slashed to 199 dollars in 2008, tells the story, that yes, Apple had to take a huge cut in its profitability for this product, to be able to reach its stated goal.

I followed that long analysis posting with several more, including the "definitive" blog about the iPhone prior to its launch, that I released a week before the iPhone hit the market, in late June 2008. That article discussed the market strategies for the three main regions, America, Europe and Asia, in my lengthy and detailed posting entitled: Crunching the Numbers for the iPhone. At this point, over five months of analysis of the original 2G iPhone had been prepared by thousands of pundits around the world, but nobody really had used the real product. I ended that analysis with this comment about what I clearly felt would have to be the 3G iPhone in the summer of 2008:

The phone to fear, the ultimate superphone of its age, the one striking fear into the HQ's of Nokia, Motorola, Samsung, SonyEricsson and LG, is the first re-designed iPhone, after feedback from users in Europe and Asia. That truly re-designed "iPhone II", that may be released in the summer or autumn of 2008 at the earliest, that is the must-have smartphone. I can't wait to use that iPhone. This first iPhone is more like the Lisa for Apple PCs, an important step along the way, but the next iPhone is like the Macitosh, a true masterpiece.

(Emphasis was in the original posting.) And compared to the first and quite flawed 2G iPhone, the 3G iPhone is far better, yet still, surprisingly incomplete (as I've blogged many times). But yes, pretty good guesses and insights on the day the iPhone was announced, one day after it was announced, and a week before it was launched.. 

Now, I also promised I'd return to discuss the performance and whether this 10 million level would be reached. I am very confident, from many sources, that Apple was on target to hit and exceed that level of sales. I am very confident that on October 21, Apple will announce it has passed 10 million sales. And that will be greeted by Apple investors with a great sense of relief and satisfaction. And it is quite a great achievement, certainly. But we do need to then put this number in context and dig a bit deeper what it may mean for 2009.

10 MILLION IS ONLY 0.8 PERCENT OF MARKET

Yes. That number is right. If Apple sold 10 million iPhones in the past 12 months, it has captured zero point eight percent, 0.8% or four fifths of one percent, of the total mobile phone market worldwide. Understand that the Macintosh PC has been fighting in the 5% to 12% range of the PC market most of its life for the past twenty years or so. Now, the iPhone has not that. Nowhere even in the "same ballpark". There is a whole order of magnitude between those. The Macintosh series of PCs was a relevant player to the market with high single-digit market share. But the iPhone is totally irrelevant to the big picture of the mobile phone market. Not even one percent. A fraction of one percent. So while Apple celebrates 10 million sales (or whatever actual number it will be, 11 or 12 or even 15 million units), it is tiny. TINY. In the picture of mobile phones.

Please do not misunderstand me. I said from the start, that no matter how well or poorly the iPhone sells, it is an innovative product that will drastically alter the whole industry. The mere launch of the iPhone was a revolution to the industry. That has not changed. BUT the NUMBER of iPhones sold, at 10 million is totally irrelevant because of the size of the industry.

To put it in context, Nokia sells 10 million new phones every single week of the year. So yes, 10 million is a major milestone for a brand new phone-maker that has just entered the market; but it is still small potatoes. Very very very small potatoes.

Yet, the iPhone is not fighting for mass market phones. Its not fair to compare, say a Ferrari sales number to that of Volkswagen or Ford or Toyota. Ferrari is an exclusive premium sports car, in the luxury bracket. So too is the iPhone. It is what we in the industry call a "smartphone". So a far more relevant comparison is to see how it fared in that market.

HOW OF THE SMARTPHONE MARKET

The news is far better. The market size is smaller. Gartner says 190 million smartphones are sold this year 2008. So out of that, 10 million is obviously just over 5%. That is quite impressive indeed, and within this more tightly-defined market, the iPhone is nearing the performance of the Macintosh in the PC market. A far cry from the best that the iPod managed at its peak days in the music player market, but still certainly impressive.

But again, before we get overly excited, we do need to look a bit at the competition there. The American press tends to look at their home market and think that the natural rival of the iPhone is the Blackberry. That is not true. The Blackberry is at almost diametrically the opposite end in the smartphone field, geared at business executive users for their wireless email use that is a magnificent messaging phone; the iPhone is a multimedia and internet -optimised device, far more like the N-Series of Nokia.

But yes, lets look at smartphone market shares. I don't have the numbers for the third quarter of 2008 as of yet, but the second quarter of 2008 have been discussed by Gartner. During that quarter, RIM, ie Blackberry, outsold the iPhone at the rate of 5 to 1. And in the same period, the Nokia smartphones (mostly N-Series like the N-95 and N-82) outsold the iPhone at a rate of... get this.. 15 to 1.  Even in the smartphone market segment, that 10 million level does not get you far. And incidentially, this latest quarter for which we have numbers, worldwide, three other manufacturers sell more smartphones than Apple - they are HTC, Sharp and Fujitsu. Apple is not in the top 5 for smartphones even. For all the hype about the iPhone, how much coverage do these brands get? Did you even know there is a better-selling smartphone from Sharp or Fujitsu, than the iPhone? They do outsell the Apple worldwide...

Of course if we expand the market to look at featurephones, ie musicphones, etc, then we have the giants Samsung, LG and SonyEricsson (and Motorola) joining the game, and all having their "equivalent" models in similar price ranges and of similar specs, outselling the iPhone by factors from 5:1 to 10:1.

I do want to be very clear about this. Yes, 10 million is impressive, but Apple is a tiny spec in the sea of 1,500 models of mobile phones sold worldwide, and they have in the past 15 months taken now less than one percent of market share in the world.

ITS STILL VERY IMPRESSIVE FOR THE NOVICE PHONE MAKER

With all that negative "anti-Apple propaganda", lets then turn to the sunny side. Many said it was an aggressive and ambitious target. There were plenty of pundits in 2007 who said Apple would fail to reach 10 million in one year, especially considering how expensive the iPhone was.

Big giants of the industry were struggling, we've seen Motorola lose massively in the game over the past few years. So yes, going from zero to 10 million is very impressive. I then also want to point out this number. The big five makers - Nokia, Samsung, LG, Motorola and SonyEricsson - capture about 80% of the worldwide phone market. But there is a huge drop to the next "biggest" player who fight for that sixth largest supplier slot. And here it gets interesting.

We have to see the final numbers, as these fluctuate among a dozen players all selling in the 8 million to 25 million range, but Apple is very possibly in the top 10 of global handset makers (already). Bearing in mind, there are about 30 makers who are in that group, including HTC, RIM, Sharp and Fujitsu, but also such unfamiliar brands as Kyocera, Huawei, TT and ZTE. In this race, behind the big five giants, RIM is the sixth-largest handset maker in the world, and Apple is barely at the fringe of being in the Top 10. In the fourth Quarter of 2007 they were the tenth-largest maker, but fell out of the Top 10 in the first half of 2008. Now with the 3G iPhone and more aggressive pricing, its very likely that Apple is once again in the top 10.

THAT is a big achievement indeed, whether they are ranked 9th or 11th or 13th. It means that in their first year, Apple has fought ahead of about 25 handset makers in the world, and are certainly one of the makers to watch. And obviously they are growing their modest share, so expect this ranking to improve over the next year, as the iPhone 3G (and its successor phone sometime next year) will be available in far more markets than the original 2G iPhone.

HOW FAST TO TEN MILLION

Now, a contrast. Canadian Research in Motion (RIM) makes the Blackberry. They got into the phone business in 2001 and have grown a steady and fiercely loyal user base with wireless email on their iconic phones. In seven years, they have achieved a global subscriber base of 19 million who use both their phone and the Blackberry wireless email service (as of mid-2007, three quarters of that subscriber base was in North America). There is a difference between a "Blackberry subscriber" who uses the phone and their service, and the total user base of Blackberry phones. RIM sell more phones than only to that subscriber base; in fact in Europe the biggest Blackberry user base is teenagers and young adults who are addicted to SMS text messaging, and love the BB's keypad for texting, but who never even use the email function of the Blackberry. RIM reported that they sold 6 million handsets in the second quarter of 2008, so they sell about 24 million devices per year. This in seven years from launch.

Taiwan based HTC made PDAs and other electronic gadgets. It moved into the mobile phone space in 2002. It was the first phone maker to use Microsoft's Windows for Mobile operating system and has grown its market steadily in the smartphone space, and currently sells about 12 million phones per year. This level of sales achieved in six years.

12 million in six years, 24 million in seven years? But Apple does 10+ million in one year. Certainly achieving 10 million sales in one year is a considerable achievement.

AT EXPENSE OF PROFITABILITY

When Steve Jobs announced the aggressive 10 million sales target in 2007, I am certain it was made with a lot of analysis and understanding of the market, as well as Apple's internal strengths and abilities. I am also certain, that since Apple announced a strategy of an exclusive partner network programme, and attempted to pursue that in 2007, but abandoned that in 2008; there must have been a drastic change in facing the reality of the mobile telecoms market, compared to the assumptions made when the iPhone launch was still being planned and the original strategy made.

The original network deals included a revenue-sharing element - where Apple would gain a revenue-share out of the data traffic of iPhone users - something no other major handset maker has been able to achieve. This requirement by Apple was also its big hurdle in 2007, with many fruitful network negotiations crashing on this one Apple requirement. They had only a handful networks under contract at the end of 2007 with this arrangement.

Apple finally abandoned this requirement in 2008 and now have a vast range of countries where the iPhone will be sold; and indeed in many countries like Italy and Australia, there are several network operators who will offer the iPhone. It is no secret, that Apple has radically altered its strategy.

The original strategy did include the requirement of selling the iPhone at an "unsubsidised" cost of 499 or 599 dollars depending on the model. In all of its early markets, like the USA and the UK, the rival smartphones are all heavily subsidised. So rival phones, say like the Nokia N-95, in many markets sell for zero dollars (to qualified buyers willing to sign two year contracts). The argument was that since Apple would be gaining from the revenue-sharing, then the mobile operator partner would not be willing to subsidise the phone.

When Apple was willing to abandon the revenue-share requirement, then the mobile operators were also willing to handle the iPhone as they would other similar smartphones, and depending on the market, offer severe subsidies to iPhone buyers. (Note that in some countries subsidies are illegal, like in Italy; and in other markets the subsidies have been extinguished by all telecoms operators as harmful to the industry, such as in South Korea)

Nonetheless, the net result is that firstly, Apple was unable to secure the network deals to get any chance of 10 million unit sales with the original strategy. Part of that strategy, that was told to Apple investors, was that Apple would gain out of the revenue-sharing of the telecoms traffic. Note that in the big picture of the Trillion Dollar industry of mobile telecoms, 85% of the money is in telecoms traffic (voice calls, SMS text messages, and various wireless data services), and only 15% in the hardware (mobile phones, data cards, USB dongles etc). Even a small share of the far larger pie, could have been a remarkably lucrative benefit to Apple. Mobile telecoms as industry maintains EBITDA margins ("profitability") of 35%. The IT sector has profitability rates in bad times in the single digits and in good times barely in the teens. This was a major goal for Apple and now it seems clear, that this avenue for profit generation by the iPhone has been abandoned (the current contracts probably continue for a few years, so for example AT&T in the USA and O2 in the UK will probably continue to deliver some revenue-share to Apple until those contracts are renegotiated).

The other element is the lower payment to Apple per phone sold, obviously. So much like I predicted, Apple was able to achieve its goal of 10 million sales, but that goal would be achieved by cutting seriously into the profits of the iPhone.

Still, all in all, a great first year by Apple. It did truly shake up the industry. The iPhone has helped Apple move from a stagnant PC industry and a stalling MP3 player business, into the still strongly growing mobile phone industry. Now Apple is a legitimate and very desirable premium handset maker with a very strong brand. They have enormous potential and opportunity here.

WHERE NEXT?

I would hope someone at Apple HQ bothers to read my Open Letter and release an iPhone with a real (slider) keypad/keyboard; that would greatly enhance the phone. And for the next model, yes a better camera and adding the flash. But video recording has to be there now, out of the box; and the iPhone has to support MMS picture messaging - MMS is poised to become bigger by user base than total worldwide email users, near the end of this year or early next year. The iPhone is the only smartphone that is not compliant with the global standard for MMS picture messaging (shame!). These little improvements will make the next iPhone far better and it could start to aim to double its market share, and start to battle RIM for the position of the 6th largest handset maker if Apple really wanted to succeed in this space..

But now, the iPhone is an established model in the smartphone category. Now Apple has to conform to the industry game rules, and no matter how much they hate it, they have to start to increase their range of models, speed up the product introduction cycle - one new model per year will not get them from 10 million to 20 million. Look at RIM, they release a new Blackberry at least every quarter. Nokia releases a new phone model every week. And while its impressive to add fantastic features to the iPhone, the easiest way to add satisfaction and customer acceptance, is to remove the glaring deficiencies in the current model.. But Apple is hearing all that from all of their "real" customers (the network mobile telecoms operators/carriers, who buy the iPhones and sell to their subscribers ie end-users). They want to win. They will adjust. I wish they'd just do this sooner rather than later, so that we can get to the real advantages of Apple's innovation and leadership. Perhaps the next phone (next summer?) is finally the superphone that everybody truly loves...

(And for anyone who is interested in understanding the mobile market, I've got the primer for you. Send me an email to tomi (at) tomiahonen (dot) com, and I'll send you my 2-page Thought Piece crammed with stats and facts about the mobile telecoms industry)

Comments

[Drew McManus]

I totally agree with you on MMS. Apple and AT&T need to improve this terrible user experience. I go into more detail here: http://blog.mcmanus-family.com/2008/09/the-case-for-mms-on-the-iphone.html

[Dominic Byrnes]

I just don't think MMS is a priority for Apple - I think not including it is a deliberate move on their part. Most operators charge users a heft fee for MMS. The more that phones become email-capable, the better it will be for a user to email a pic from phone to phone - the cost will move from a per-usage transaction to being part of the data-usage.

[db]

I understand why a roman-character-set user would want a separate keyboard/keypad, but in terms of margins you have to realise that the lack of a physical keypad makes it much easier to reach different language groups with the same physical device. I believe this is a key reason why Apple are going with a touchscreen keypad.

[Tomi T Ahonen]

Hi Drew, Dominic and db

Thanks for the comments. I'll reply to each individually

Drew - good point, and I'm sad to say it is a rather universal matter, that MMS is often very clumsily deployed by the networks (and handsets) but its getting better. I think all services need to be as easy to use as SMS, and MMS is slowly approaching that level on better networks and handsets in parts of the world. Here in Asia, almost half of local phone subscribers use picture messaging so it is clearly a lot better here. But many of my European colleagues still complain its not easy there. So you're not alone, ha-ha. Good posting at your blog, BTW.

Dominic - very true, MMS was not a high priority at Apple and yes, they thought that if they include mobile email, that would cover this need. How wrong they are. This year there will be more total MMS users, than all email users on any platform worldwide.. This is just that Apple got bad advice (not their fault) by the America-based consultants who advised them when originally designing the iPhone. It is a view anymore only held in America, that email might become the predominant messaging platform on mobile. They were fooled by those who looked at the Blackberry in isolation... But the Blackberry in any mobile messaging competitive market - typical European or Asian market - and users quickly stop preferring email on the BB, they shift their traffic to SMS.. email will go the way of the fax this next decade while SMS, MMS and IM (Instant Messaging) will flourish.

db - good point, it is easier to deploy different language characgter sets on a touch screen than a physical keyboard. However, in both cases, the software of the phone has to cover all major languages intended for the phone, ie western and kanji and arabic and russian and thai and korean and chinese etc.. So they already had to "map out" all those to the screen keypad, regardless.

And the relative cost of doing the rubber mat for the keypad, into the major language groups, is modest cost, but you are right, it is an additional cost to the keypad structure, and any slider mechanism, that might be involved.

I do think, however, you didn't get my main point about this (and I was not clear about it, obviously, in this posting. I believe I've explained it before such asin my Open Letter). The reason you have to have a separate keypad, is to allow text entry blind, and one-handed. Why?

Because only SMS text messaging is proven to be addictive, the only addictive mobile service in the industry today. It is as addictive as cigarette smoking. 76% of the mobile phone subscriber base worldwide already uses SMS, which will be 3 billion people at the end of this year. Thats well over twice the amount of total email users on all PCs, laptops, desktops, web browser tablets, Blackberries, smartphones, etc.

And SMS is typically used in hurried situations, while standing or walking, and often with something heavy or expensive in your other hand, such as your briefcase, or your car's steering wheel (yes yes, we should not send SMS while driving, but we all do it, until it is made illegal, and even then people will do it only less frequently), or your child's hand, etc. And you have to be able to send SMS while blind, ie with the phone in your pocket or under the table or behind your back. etc. 48% of British teenagers admit to sending texts secretly while talking to someone else.

That is why they have to have a text entry system that can be used blind and one-handed. Now, it is possible to make a keyboard onto a touch screen, that gives tactile feedback (I've tested two prototypes doing this) with the kinds of tiny electric impulses that the skin detects as if you actually depressed a key. So Apple could well accomplish this by sticking to the touch screen format. That is quite possible. But they need to get past the two-handed operation, with the iPhone on a table or on your knee. Else it will not grow nearly enough with the target group of heavily addicted young adults who in the rest of the world, already are fully addicted to SMS, and in America, are becoming addicted to SMS.

Ten percent of British teenagers send 100 SMS per day. That number jumps to 30% among South Korean teenagers. The Philippine population as a whole - averages 20 SMS sent per day. The world average is already at 3 SMS sent per day, even Americans average 2 SMS sent per day across the whole cellphone subscriber base. This is the biggest data application on the planet and the tsunami is only growing bigger.

Oh, one more thing - SMS is worth 130 billion dollars - yes, you read that right - 130 billion dollars (or as much as the global music industry plus the global movie (box office) industry plus the global videogaming industry plus the global DVD sales industry, combined..)

And that service, SMS text messaging, delivers 43% of the total PROFITS of the mobile telecoms operator/carrier business worldwide. They love SMS, they hate phones that are not good at SMS. They are pressuring Apple to boost the SMS ability of the iPhone.

Because what happens? Today if you own an iPhone and are addicted to SMS, you get a second phone that is excellent at SMS, ie a Blackberry or the Nokia E-90 Communicator or whatever. Then you put all your SMS traffic on that other phone, not the iPhone. The iPhone carrier/operator gets the heavy data loads of the iPhone (usually on an all-you-can-eat data package, so there is no added profit from more traffic). The profits of voice calls are dwindling. But the most profitable service, SMS, for that customer goes to the other phone - which in most cases, is on a rival network. Getting a customer of yours, to adopt the iPhone, will REDUCE your profits, and increase the profits of your competitor..

Not good business. Apple is hearing this all over the world and trust me, they will improve the SMS ability of the phone. My suggestion keeps continuing that they need to incorporate a keypad as a slider. I have not changed my mind on it since Jan 9, 2007...

Thank you all for writing

Tomi Ahonen :-)