Apple and Motorola: A Smart Duet


By Alex Salkever Apple CEO Steve Jobs has earned a reputation as the most intense and controlling CEO in the tech universe, thanks to such tactics as shutting down makers of Mac clones and the fanatical secrecy he maintains around new products. True to form, he has kept a tight handle on Apple's red-hot digital-music business. Apple (AAPL) only allows a handful of file types to play on its iPod music player. And its iTunes Music Store only sells songs encoded with FairPlay, a digital-rights management (DRM) system owned by Apple. FairPlay limits the number of copies that can be made of any song sold by iTMS and prevents them from being played on other digital devices. To date, Apple has refused overtures from other manufacturers of digital-music players to license FairPlay.

So it was a bit of a shock when Apple announced a deal on July 26 to put a special version of iTunes software onto Motorola (MOT) cell phones. Owners of certain high-end handsets will be able to download to their phones songs stored in both Mac and Windows versions of iTunes, including songs purchased from iTMS. Jobs has given the world's second-largest maker of handsets the first license to use FairPlay.

"NO MOORE'S LAW." With cell phones looking and performing more and more like mini-computers, thanks to soaring amounts of memory and enhanced video and e-mail capabilities, Apple fans and analysts are wondering if Jobs isn't letting a fox into the iPod henhouse. They fear the deal could cannibalize the $1 billion or more in annual iPod sales in exchange for less-profitable digital-music sales and customer growth of dubious value. At the July 26 press conference to announce the pact, Jobs stated -- via video cam -- that this wouldn't happen. And he's right. What's more, the potential benefits of this deal easily outweigh possible downsides.

To start with, the fears of cannibalization are clearly out of left field. Most cell phones have been optimized for voice communication. This requires far less power than high-quality music playback. "The biggest issue is power consumption. Anything that changes the way you use your phone and consume your battery [power] is clearly going to cause problems," says Rene Link, vice-president at San Diego mobile-communications consultancy inCode.

Battery life for any music player cell phones made with current technology would be abysmal. What's more, it isn't improving all that quickly. "There's no Moore's Law for battery technology that I'm aware of," says Mike McGuire, a research director for tech consultancy Gartner G2. "That's why, whenever anyone mentions a new, small, fuel-cell breakthrough, the first thing people ask about is whether it could power a laptop or a cell phone." According to Link, the first generation of hard-drive-equipped mobile handsets could come out in a year -- but they'll be clunky and need constant charging, which will likely limit their popularity with consumers.

FIELD TEST. True, more handsets are coming with slots for removable solid-state memory devices such as flash cards, which use less power. But the higher-capacity versions that will be most suitable for digital-music storage still cost at least $50 wholesale, $80 retail. Add that to a cell phone that retails for $250 or more, and you're talking big bucks. And it's unlikely that mobile-communications carriers, which subsidize the majority of handset purchases in the U.S., will suck up the extra costs. This means that for the foreseeable future, cell phones will only carry a few dozen songs. That's hardly enough to rival the iPod.

Meanwhile, the upsides of the deal for Apple are many and varied. Courtesy of Motorola, Apple gets to run a mass field test on how consumers react to high-powered jukebox software running on their phones. "To me, this is an interesting experiment," says Gartner's McGuire. "Apple doesn't have to create another device to test this market, and Motorola gets to find out just how much digital content people want to stick on their mobile phones."

TURN UP THE VOLUME? In fact, the only cost of the deal to Apple will likely come from the extra manhours required to tweak the iTunes code so that it can run well on cell phones, says Michelle Gutierrez, an analyst at Schwab Soundview Capital Markets. That's a fairly trivial cost in the grand scheme of Apple's business expenses. Should the Motorola experiment prove successful, Apple could easily turn around and sell its mobile-phone version of iTunes to other carriers.

And if Apple does end up selling a good number of songs for handset use, it will extend its already huge lead in the legal music-download market, where it claims 70% of total sales. That in turn would raise FairPlay's profile, since more and more music owners would be buying into Apple's DRM system. "The benefit is, as you develop a dominant position in music distribution, people become used to seeing your name, and that drives more traffic through your stores," says Gutierrez. She adds that although margins on Apple's iTMS are very small, in the range of pennies on the dollar, the store is no longer losing money. "It could be a volume play for Apple," she points out.

What's more, the market for music on phones could be much larger than anyone realizes. Hundreds of millions of cell phones are in use around the world, with users forking out $3.2 billion in 2003 just to purchase personalized ringtones from their carriers, according to consultancy The Arc Group. If people are willing to pay $2 or $3 for an 8-second song clip, it's hard to imagine they wouldn't interested in paying less to get the real deal on their handsets.

SWEET HARMONY. Apple would have to sell billions of songs each year to realize significant bottom-line benefits. But with downloads from iTMS and other online music stores representing less than 1% of all music sales, there's plenty of room for growth. Also, eventually battery technology will improve, paving the way for handsets that really are competitive with dedicated digital-music players. By the time that happens, though, chances are Apple's huge iPod advantage will be under attack anyway, as other consumer-electronics companies bring improved digital-music players to market. Competition from handsets will be the least of Apple's worries.

It's clear that Jobs's decision to hook up with Motorola won't threaten the iPod's position in the near term. And the harmonious arrangement could well enhance Apple's position in the digital-music market and cement iTunes as the preferred digital jukebox for handheld devices. What's not to like? Salkever is Technology editor for BusinessWeek Online. Follow his Byte of the Apple column, only on BW Online


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