In this issue:

The Kerton Group presents
Kerton Call
28 June 2007


The iPhone – Worthy Of The Hype, And Much More

Apple iPhone comes out tomorrow

The iPhone comes out tomorrow, and the hype bandwagon is running at full steam. Usually, I'm the one to write an opinion counter to the hype, but for once, sign me up. I'll run shotgun on this hype bandwagon. Why do I think the iPhone is worthy of all the hype? I'll explain it, section by section in the following article.

You will benefit from the iPhone.

You are going to be better of because of the iPhone, whether you own one or not. It's like the advent of Local Number Portability - for those customers who changed providers, they were able to access a different phone, feature, or pricing plan that they wanted. But even for customers who did NOT switch carriers, they still benefited greatly from the fact that the carriers needed to compete for existing customers. Prior to that, carriers only really competed for new customers. Customer benefits such as free in-network calling, Cingular's "rollover minutes", Sprint's Fair and Flexible plans, T-Mobile's "Five", and VZW's pro-rated early-exit fees are all competitive responses to WLNP.

In a similar vein, the iPhone is forcing all other phone vendors and carriers to raise their game. Responses have been numerous such as Sony Ericsson W580, W200, or the older K790a (all much cheaper), the Helio Ocean (a great multimedia 3G phone), the HTC Touch. And with AT&T set to have a much more compelling music (and video) service through iTunes, Sprint and Verizon have to completely re-think their mobile music stores. Do you really think their recent drops in prices were made in a vacuum?

So, my point is that even before it's release, other competitors have doubled their efforts, lowered prices, and improved devices in anticipation of the Apple device. That's already done - in the bag. Imagine what happens to the market if the iPhone actually IS successful and other vendors copy the best practices from it.

Shaking the balance of power.

Talk about important. The carriers have had an iron grip on device design, features, and a furiously tenacious grip on the content and services that are available to subscribers. This has been to the great detriment of the wireless Value Added Services (VAS) industry (just ask any developer, off the record, when there isn't a carrier within earshot). By being autocratic and trying to control everything, they have stifled creativity. By taking 50% cuts of all VAS, they have snuffed incentives.

You would think that in a competitive market (which I believe US wireless is), you would have one or more carriers compete customers what they want! (duh) Hutch 3UK did it in Britain because they were desperately competitive. Yet what we have, in most markets including the US, is an oligopolists Prisoner's Dilemma: all carriers are choking the market in a similar way, and none have defected from this de facto pact. Driven by fear, they think the chokehold is best for them. Yet, when one of them defects, the game is over and they will all end up worse off for having played. And AT&T just flinched.

The Apple-driven iTunes model present on iPhone will work around the carriers (somewhat) and we can expect to see more music, video, and content get on the phones through a batch-sync over USB or Wi-Fi. Because of this, AT&T has relinquished significant power to Apple. When customers (including non-iPhone) learn of how easy it can be to get more into and out of their device, they will flock to this model. Other carriers will not be able to compete with AT&T on a VAS basis until they also tear down their walled gardens.

Content providers, SaaS providers, application vendors, all of these will finally get a little bit of power for once. And certainly a new power player, Apple, will have entered the game.

A new channel for content and services.

Content companies will be dancing in the streets on June 29. Finally they've got a channel into the mobile device that isn't bottlenecked by the gatekeeper carriers. They have an easy route to distribute and monetize their content via the iTunes store. Developers are, from their perspective, sick and tired of carriers getting in their way, and then taking a 50% cut. Wow, 50%! Apple makes basically nothing on the iTunes content, charging instead for the hardware. Does that sound appealing for a content company, or what?!

The competitive response.

Other device vendors will need to scramble to catch up with the iPhone's features and slick UI. But Apple will continue to innovate, so they will remain one step behind for a while. They will lose some market share in the consumer and prosumer sectors. But the upside for the other handset makers, and seldom mentioned, is that Apple has broken the grip the Telco had on the device supply chain. Apple has shown that, if you make a compelling enough device that creates demand, you can call some shots.

Some handset vendors are making fun of the iPhone's battery life. I heard a Motorola exec poke fun at it last week on stage, but I think that's a red herring. Battery life is on par with other devices. The only real problem is that it is not user-replaceable. This will manifest itself in a year or so when the cells wear down - as happened with the iPod. Apple should know better on this one.

One of the few advantages competitors have over the iPhone is cost. Price is probably the iPhone's greatest weakness. Despite the fact that consumers have indicated a willingness to pay for great Consumer Electronics products, $500-600 will definitely reduce the market for the iPhone, and leave ample opportunity for the other vendors. If they produce a competitive product at 2-3 hundred dollars less, there will be ample market for them. Creative, SanDisk, and others have already proven this in the media player category.

Time to re-write your mobile video business plan.

If you have a business plan in motion that relies on collecting $15 a month from subscribers to your mobile video service of broadcast content, time to go back to the spreadsheet. The acceptable market price for mobile music and mobile video is about to be lowered to the iTunes standard.

Don't think that your broadcast service can sell at a premium. Think of two users side by side, one with Verizon's V-Cast using MediaFLO and one with an iPhone. The V-Cast user has up to 30 channels of broadcast content to choose from, and the other has PVR-style movies and TV shows they got for free, bought on iTunes, or got from Both have good quality images, but the iPhone user has pause-play-skip control, and the V-Cast user has little control. The broadcast model, though great technology, still reminds me of a Bruce Springsteen song, "57 Channels And Nothin On", which you can watch on YouTube via V-Cast or iPhone.

My take is that the user with the V-Cast phone is going to feel sorry that he hasn't got the iPhone. He'll want his video cheaper, with more choice, and more control, and in and out of coverage areas (think 36,000 ft. high). Music…much the same, if not more so because of the important iPod head-start.

It actually steals other carrier's customers.

Carriers often launch apps and content on an exclusive basis. Think Shakira videos and ringtones with VZW, or SMS that was not inter-carrier, or VZW PTT. Each one was launched in the hope of differentiating from competitors, and stealing subscribers from those competitors. Yet we've seen these apps come and go - and NONE have been important enough to churn customers from one carrier to another, and any good apps are quickly matched. The only thing, so far, that actually has driven churn was bad service from a current provider (negative differentiators). Hyped up phone features were supposed to rock our worlds, but in reality, only two non-voice apps have been remotely "killer". That's SMS and email, and no carrier really has any differentiation in these.

But this is different. The iPhone is probably the first positive differentiator that will churn customers. We know this from research, analogical evidence, and the fact that a million people have requested the device from AT&T. Four days before the launch, people are camping in front of AT&T and Apple stores. Has that ever happened before in the telecom space? eBay and Craigslist have "professional waiters" offering to hold a place in line for a fee. Subscribers of other carriers have not renewed their contracts for months so that they can be free to switch carriers for the iPhone. And if you want an iPhone, you'll need to be on AT&T. That's powerful.

And the AT&T benefit goes beyond those who churn to AT&T for an iPhone. The brand cachet gained will be significant. AT&T will be cool again for the first time in an era without horseless carriages. People will enter AT&T stores just to have a look, might even buy something else. Make a sale: minus one subscriber for VZW and plus one sub for AT&T - each churner is a double victory in Wall Street's eyes. I clearly think that the exclusive Apple deal is great for AT&T because of the reasons listed above, and I think it is actually a painless move because of the below...

And there will be ancillary benefits accrued to AT&T. I believe that the carriers historic desire for control has been self-destructive. They have shrunk the pie, and claimed a big piece. Apple is forcing AT&T to open up, and they will be the first carrier to do so, and have a leadership advantage in the new, larger pie. More content, more data services, more activity, more revenue. Hey, I warned you I was on the bandwagon in paragraph 1.

Of course, this is theirs to lose. The phone is unlikely to flop, but if the network flops (as AT&T Wireless did when their new subscriber provisioning system failed just as WLNP was implemented), they will have a lot of egg on their faces.

BTW, I also think the exclusive deal was good for Apple, because they could never have negotiated for as tough terms from carrier without offering exclusivity. Yet without the terms Apple extracted, this whole event would be 'just another device' like the ROKR was.

iPhone actually tries to give the people what they want.

Foreign concept, but that's what Apple does. Well, OK, Apple isn't 100% committed either, as we know they benefit from locking music with DRM that also locks it to iPods, but hey, they are a radical step in the right direction vis-à-vis the telecom industry. The iPhone does, and will continue to innovate in ways the customer wants, with fewer restrictions put in by what the telco wants. The end result is better overall for society - even if it is not better for every individual stakeholder.

The UI was "job one".

Finally - a phone made by a company for whom UI is the leading feature. Motorola, Nokia, et al can say what they want about how important they think UI is. It just isn't to them. Not compared to Apple. And the reality is that UI is the most important thing in any device. Every other feature lurks within the UI. Modern mobile phones start with hardware, features, and functions, and then build a UI wrapper around them. The iPhone is different: eschewing any legacy processes, this device was built from the UI down. This avoids the silos that plague conventional devices.

Now, I have some issues with the iPhone UI, don't get me wrong. I prefer devices that have more hardware buttons. There are some functions that I want one click away, with tactile feedback. I want to be able to move a few switches with the device in my pocket. But that's a relatively small gripe, especially given the UI improvements that overcome the limitation.

The right sacrifices were made.

A lot has been made of the fact that this phone only has an EDGE modem. But space/power/cost trade-offs always must be made. And those complaining about this have just bought-in too much of the 3G hype. Don't get me wrong, 3G is delightful when needed, like a laptop modem. But Blackberry, for example, works perfectly well on the 19,800kbps Mobitex network. The key is to managing the need for fast data, and deploying a slick UI that hides the latency. RIM figured it out, and got a 7-year head-start in the mobile email space.

So why doesn't the iPhone NEED 3G? Well, the notion is not that users will be actively using data-traffic-intensive applications while mobile. The notion is that they will sideload a variety of content and apps from their desktop into the device. How stupid is that? Let me see...using a 480Mbps connection that is free for data traffic (a.k.a. USB) vs. using a 600Kbps 3G connection that uses battery, increases hardware costs, and is billed by the carrier. If that's stupid, then call me Gump. Not to mention the Wi-Fi radio that can get access at home, office, or some Hotspots. 3G will come in later devices, as the market determines, but I think we will find the lack of 3G a small peccadillo.

No Keyboard. Well, this one hurts the device in the eye of the most active email users. But there is a clever text input touch-screen keypad, so for SMS messages and short emails, it works fine. And even though email push functionality and security are not enterprise-grade, this device isn't targeting the Blackberry set anyway. RIM can relax and sit this one out, for now. This is clearly a consumer device, and hardware thumb-boards are mostly an enterprise feature.

Phones are officially CE.

The other cool thing about this is that phones have historically been a utilitarian part of the network. The industry name we use for them is "terminals". We see them as the end point on the network, linked to the network provider and provisioned by them. But with the iPhone, the mobile phone is becoming Consumer Electronics for real. Phones will start to be devices bought by consumers, and simply connected to a network. Call the network a pipe, if you must…Steve Jobs does. From there, what's next? Gameboys connected to the network, cameras? What other CE will follow this leader? In this new world, many devices will connect to a neutral-host carrier that provides the simple service of connectivity.

The deciding factor.

That said, iPhone is not for me. I find that phone choice is made mostly by the Second Feature Rule. You haven't heard of that rule because I just made it up. But basically almost everyone's first priority for a mobile phone is voice connectivity. But every phone delivers that commoditized feature. So people end up choosing the kind of phone they carry by their second feature priority. These range from (followed by an example):

  • gaming (BREW phones)
  • size
  • design (the RAZR, Vertu)
  • price (developing world)
  • email (um..Blackberry)
  • enterprise apps (Windows mobile or RIM)
  • camera (Nokia N95)
  • SMS text (Danger Hiptop)
  • music (Sony Ericsson, iPhone)
  • UI (the iPhone, Helio Ocean)
  • WiFi
  • Data speed
  • video (MediaFlo phones, DVB-H in the EU)

But a phone today, being the size it is, cannot be great at ALL these things. Even if money is no object, compromises have to be made. So some devices are better at one thing, and others at another thing. For me, my second priority is email, and I don't consider the iPhone a strong contender. But if your second priority is media…you just might be an iPhone customer.

by Derek Kerton
Principal Analyst, The Kerton Group

Stage Notes

Did you catch Derek on Bloomberg Radio this morning? He was interviewed on the earnings annoucements from PALM and RIMM.

The Kerton Group is running a few events for the Telecom Council of Silicon Valley this fall. If you are interested in getting involved, drop us a line.

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The Kerton Group provides insightful, expert consulting in wireless telecommunications to companies across the entire value chain and around the world. Our analysts' deep, vertical knowledge of the wireless industry delivers a complete understanding of the technology, market, and business issues our clients face today and in the future. The Kerton Group's expertise is internationally recognized in widely distributed industry reports, articles, newsletters, and frequent quotes in national press and industry publications. Our services include strategy, business development, research, marketing, product development, due diligence and technology transfer services. We also run the SPIF, a private investment forum for telecom investors. Our projects, clients and publications are detailed online:

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