Technology

Apple's iPhone Takes a Toll


With the debut of the new iPhone 3G, rival phonemakers and wireless operators—and possibly Apple—will feel the impact

Last year, when Apple (AAPL) unveiled its iPhone and made it available in the U.S. exclusively from AT&T, the debut sent ripples throughout the cell-phone industry. Handset maker Palm suffered as consumers swooned for Apple's phone, according to surveys by consultancy NPD. AT&T benefited by pulling subscribers from rival carriers Alltel (AT) and T-Mobile USA (DT).

So will Apple's new phone, the iPhone 3G, have a similar effect? Early evidence since the new device's July 11 debut suggests it will have even broader impact, in part because the entry-level model sells for $199, compared with $499 for the original version. As a rough measure, take last year's impact and double it. In the first 12 days since the iPhone 3G hit the market, the device sold at twice the rate of its predecessor, according to AT&T (T), which hasn't made more recent data available yet. And analysts expect this quick pace to continue for at least a few months: The iPhone 3G likely sold up to 700,000 units in the few weeks of July alone, estimates Trip Chowdhry, an analyst at Global Equities Research. Apple sold about 1.1 million iPhones in all of the third calendar quarter of last year (BusinessWeek.com, 7/22/08).

Raw sales numbers don't tell the whole story, however. So far, many of the new model's purchasers have been existing AT&T subscribers who already own an iPhone. In a survey of more than 100 iPhone 3G buyers conducted in the past two weeks, Chowdhry found that "most of the users are people who are upgrading." A survey of 328 users that UBS conducted on the iPhone 3G's launch day in the U.S. and Britain revealed that nearly 37% of the new device's buyers were current iPhone users. The fact that users are replacing their phones after holding them for less than a year is testament to Apple's marketing and improvements to the device, including global positioning system (GPS) capabilities and access to software from independent developers. Typically in the U.S. market, users replace their handsets, on average, only once every 17.7 months, according to consultancy J.D. Power & Associates.

Second-Hand iPhone Fallout

As these customers discard their old iPhones by putting them up for sale on eBay (EBAY) or giving them to relatives and friends, the wave of second-hand iPhone users will likely prove to be an equal loss for all device manufacturers, including Apple. And rival carriers can take comfort in the fact that these users won't necessarily go to AT&T. On Aug. 5, of the hundreds of original iPhone listings on eBay, only about 10% were advertised as connected to AT&T's network. Most other used iPhones, offered at $50 to $300, depending on condition, were unlocked—that is, not tied to a particular carrier. People buying them can elect to sign up for service with AT&T or T-Mobile USA, or simply use the device at free Wi-Fi hotspots.

The iPhone doesn't always completely replace other phones, either. A greater chunk of iPhone 3G buyers are carrying the device instead of a notebook computer and keeping a second cell phone for calling (a third of original iPhone users carried a second phone, according to a March survey of 460 U.S. users conducted by Rubicon Consulting). Here's why: Chowdhry's latest survey shows that iPhone 3G users spend 80% of their time browsing the Web and only 20% of their time making calls. That's in sharp contrast to a typical smartphone, whose users spend 60% of the time making calls. "They should change [iPhone's] name to an iTablet," says Chowdhry. "The usage scenario is evolving. People use the iPhone as a PC in your pocket. It's slightly mispositioned in the market."

Rival phonemakers may still be affected, however. Though first-month data are not conclusive, Samsung so far appears to be the worst hit, according to a July 25 survey of 100 carrier store reps conducted by Avian Securities. From June to July, Samsung's "share of responses"—essentially, instances when store reps said a Samsung phone was a best seller in their stores—fell from 18% to 14%. At AT&T stores, Samsung's share of responses fell from 15% to 10%, with the drop directly attributable to the iPhone 3G, says Matt Thornton, an analyst at Avian. While share of responses of Palm (PALM) devices slipped slightly, too, that was due to competition from best-seller Samsung Instinct at Sprint Nextel (S) rather than to competition from Apple, he says.

Clones Making Headway

Many other handset makers are actually riding the iPhone wave. Their iPhone clones are gaining traction, as many subscribers to other carriers' services are loath to pay the high price of breaking their contracts to switch to AT&T. In July, Samsung Instinct actually garnered a higher share of responses than the iPhone, according to Avian. And LG has gained share, thanks to such best-selling devices as Voyager and Dare, which is being heavily promoted by Verizon Wireless. In fact, Apple's share of touch-screen phones in the U.S. could drop to 35% this year, from 40% last year, as the market expands from 7 million to 18.1 million devices, according to consultancy Strategy Analytics.

Exactly how the iPhone 3G's introduction has hurt AT&T's rivals remains difficult to quantify. Much of the data are still being gathered. Just like last year, about 40% of new iPhone buyers are switching from other carriers, according to AT&T. But Ross Rubin, an analyst at NPD Group, which conducts monthly wireless industry studies, says preliminary data indicate "T-Mobile is still quite vulnerable." While Sprint and Verizon Wireless have, in the past year, bulked up their defense by introducing iPhone clones, T-Mobile USA still doesn't offer a product that's competitive enough, Rubin says. T-Mobile USA didn't return a request for comment.

There's another reason for concern: Because the iPhone 3G is so much cheaper than its predecessor, the new device should tap into a new market—youth—says Charles Wolf, an analyst at Needham & Co. who has been observing crowds standing in line at Apple's New York stores. "At Christmas, every teenager in America is going to want one," he says. That's the sort of demographics that, until now, flocked to prepaid services, such as Virgin Mobile (VM), such boutique firms as Helio (recently acquired by Virgin), and lower-cost carriers, such as T-Mobile USA.

Many of these new users are buying the phone to replace their old iPods. The device "will kill off a piece of the iPod market," says Wolf. He points out that with prices comparable for the iPhone and iPod, as much as 30% of the music player's sales will be absorbed by the Apple phone. Wolf believes Apple will dramatically revamp its music player's design this fall to address the issue.


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