Can Apple Keep a Shine on the iPhone?

It needs to focus on hardware and competitive pricing if it plans to stay ahead of rivals introducing their own cheap and feature-rich smartphones

By Olga Kharif

On Mar. 17, Apple (AAPL) unveiled upgrades to the software for its best-selling iPhone. But the consumer electronics maker may need more than software to stay ahead of rivals introducing their own feature-rich smartphones.

Now, Apple needs to home in on hardware and handset pricing. A new version of the iPhone is due to be released at midyear. While Apple is mum on what the new device will look like before its introduction, analysts, consumers, and iPhone enthusiasts have a long list of features they'd like the next iteration to include. "What they ought to be doing is a smaller, lighter, and less expensive iPhone," says Mike Mace, a principal at consumer electronics researcher Rubicon Consulting.

It's important that Apple keep improving hardware quality as rivals introduce their own smartphones amid an economic slump that's forcing consumers to reduce spending. Since the iPhone's introduction, manufacturers have released several comparable devices, some of them at lower prices than the Apple device, which starts at $200. T-Mobile's G1 phone sells for less than $100 on Amazon.com (AMZN). Research In Motion's (RIMM) BlackBerry Storm, which costs $200 through Verizon Wireless, has sold more than 2 million units in the three months through February, according to estimates by Matt Thornton, a senior research analyst at Avian Securities.

Cheaper Rivals Circle

Sprint Nextel (S) will soon introduce the Palm Pre, a smartphone that, like the iPhone, offers a touchscreen. It also includes a physical keyboard that the iPhone lacks. Sprint and Palm (PALM) plan to advertise the device with a comprehensive, expensive campaign. "We'll spend heavily, and we will be aggressive," says Trevor Van Norman, a senior manager at Sprint. "We certainly think the device is a switcher device, we'll go after AT&T (T) and Verizon Wireless." The Pre, whose design was overseen by iPod creator Jon Rubenstein, could sell 3 million units in its first year, both to existing Sprint customers and users who switch from other carriers, Thornton says. Some of these gadgets also include their own online stores, akin to Apple's App Store, that let customers download a host of software applications; others will open their own app sites soon.

The growing list of iPhone alternatives makes it less certain that existing iPhone owners will upgrade to a new iPhone model unless it offers clear hardware improvements or is offered at a better price. In the first few months of 2008, when the new iPhone 3G became available, about 20% of sales came from existing iPhone users who wanted access to AT&T's speedier 3G network, Thornton estimates. People who already had an iPhone were locked into two-year contracts and would have had to pay a penalty if they tried to get out of the deal.

But the first iPhone contracts will be ending by midsummer, and rival providers are certain to try to lure iPhone users who may be looking for an alternative. Instead of upgrading, some 6% of the iPhone users could switch to save cash, Thornton estimates. Sprint's $70-a-month plan for Palm Pre includes text messaging. AT&T's comparably priced plan, its cheapest, doesn't include texts.