Daniel Eran Dilger
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Kevin Chang, iSuppli and The iPhone Nano Myth

Kevin Chang, iSuppli and The iPhone Nano Myth
Daniel Eran Dilger
Reuters broadly reported JP Morgan’s Kevin Chang forecasting the imminent arrival of a smaller cheaper, version of the iPhone dubbed the ‘iPhone Nano.’ The problem: not only is there is nothing backing up the iPhone Nano prediction, but it makes no sense at all. Even JP Morgan has distanced itself from the initial report.

The Faulty Premise of the iPhone Nano.
Chang originally reported “we believe that iPod Nano will be converted into a phone because it’s probably the only way for Apple to launch a lower end phone without severely cannibalizing iPod Nano.”

How would Apple “convert” the Nano into a phone? It didn’t convert the iPod into a phone, it designed an entirely new device that actually shares little in common with the existing iPod. Did Chang use convert to mean replace? If so, how would a cheaper iPhone replace–or cannibalize–an even cheaper music player?

Even a simple ‘feature phone’ would require a service plan, so the pundits would add up at least a $1200 price tag over two years, just as they love to refer to the iPhone as costing $2000–or $17,670 if they’re really reaching for a headline like Brett Arends.

How would a $1200 nano phone with service compare to a $150 iPod Nano? Clearly, Chang just didn’t give any of this much thought.

[The Street’s Flaccid Campaign Against the iPhone]


iPod Family Values.
The iPhone is already cheap at its $500 – 600 price tag. Similarly featured smartphones all cost more, and even cheapo phones like the Motorola Q cost more after the price of a required service plan is factored in. How could Apple deliver a cheaper phone?

Even if one could imagine a market for an iPhone made cheaper by dropping its full screen WiFi web browsing features, why would Apple confuse the market by adding a marginally cheaper iPhone Nano, priced closer to the Q at around $300? To cheapen the iPhone brand? To lower its margins?

The $600 8 GB iPhone is already a better deal than the $500 version with half as much RAM. Apple only offers the cheaper version to catch price conscious buyers, who can’t get past the idea of the extra cost to discover the value. Considering that you’re paying $60 plus taxes for service every month, the cost premium of the $600 iPhone, which is only an extra $4 and change per month over its two year contract, hardly matters.

The cheaper the iPhone got, the less value it could offer. And again, because a phone requires a service plan the hardware cost that some analysts just can’t get their mind around is really not the problem. I’ve already spotted plenty of fast food workers with iPhones.

It’s only billionaire Steve Ballmer who thinks it’s expensive.

[Apple: iPhone Now Costs Less than Ballmer’s Lame Motorola Q]
[Cingular Apple iPhone vs. Verizon Motorola Q]

Iphone 1-2-1

Patently Absurd.
The patent Chang pointed to as an indication that Apple had an iPhone Nano on the drawing board was of an old fashioned rotary dialing interface idea built upon a variant of the iPod’s clickwheel. Will Apple deliver a rotary phone Nano that takes zero advantage of all the software developed for the iPhone?

The only future for the iPod that makes much sense is a version that shares the iPhone’s multitouch screen but lacks its phone hardware. That omission wouldn’t make the iPod much cheaper than the iPhone though, because the iPhone’s real value isn’t in its hardware, it’s tied up in its software. Apple monetizes that unique software by recouping profits through its revenue sharing plan with AT&T.

Also, the iPhone is already a closer kin to the flash RAM based iPod Nano; it lacks the full size iPod’s hard drive. Cross a hard disk based iPod with iPhone features minus the phone, and you’d end up with a product that costs more than the iPhone, not less.

Apple couldn’t sell such an iPod at a profit anywhere near the iPhone’s, because it wouldn’t be getting an AT&T service revenue share out of the deal.

[How AT&T Picked Up the iPhone: A Brief History of Mobiles]


Inventing Apple Vaporware.
Some FUD pundits like to talk about cheaper versions of the iPhone because they think it might depress sales by inducing potential buyers to wait around for the cheaper version.

A look into the seven year history of the iPod indicates that while iPods did slowly get slightly cheaper, the real change over time was a bump in features. Apple does not deeply discount products, and certainly not a few months after their initial launch. More typically, it boosts features in new models at the same price point.

Without adjusting for inflation, the top iPod only got a $50 price cut after three years of being on the market, despite getting a regular boost in disk capacity. Potential buyers who waited around didn’t save money, they just went without owning a good music player with a higher than usual resale value.

The hard drive based iPod was later delivered in a slimmed down flash RAM version, but only after Apple had conquered the hard disk player market over three generations of standard iPods.

The Mini, later replaced by the Nano, served a very different price and feature niche of the market. Apple then released the Shuffle line, which targeted an even cheaper product category.

[Vaporware: Why Apple Doesn’t Blog]


Feature Phone Distraction.
With all that in mind, why would Apple shatter its goal of selling 10 million iPhones by the end of 2008 by releasing a $300 or less feature phone distraction? What other real differentiation could Apple offer in the phone space, where hardware costs are only a small fraction of the overall cost of owing a phone?

Further, why give up sales of the iPhone to grab ‘market share’ that Apple will have no problem eating up with its existing model? The American mobile phone market is at least five years behind the iPhone, so Apple isn’t exactly in desperate need of moving its competitive game into a cheaper playing field.

The real growth in the mobile industry is in smartphones, not simple feature phones. Despite the clear demand for smarter phones, Microsoft has made little progress in selling its more limited ‘Windows Smartphones’ like the Motorola Q, which has menus of functions but lacks a touchscreen. In this market, less is not more.

The popular phones in the US have been sexy show off phones like the Motorola RAZR or the LG Chocolate, which buyers chased after for their looks. They were both $500 at launch. The iPhone captures the same sexy appeal but throws in an iPod and a real web browser. How and why would Apple move into the cheap seats now?

[Cellphone Envy Lays Motorola Low – New York Times]
[Will LG’s Chocolate phone hit a sweet spot? – BusinessWeek Online]

iSuppli’s Absurd iPhone Profit Reports.
Another reason some have dreamed up cheaper iPhones is the bill of materials reports published by iSuppli that suggest Apple is making enormous hardware profits on the iPhone.

Certainly, if that were the case it would mean lots of room for discounting. However, that’s not the case, and such discounting has no precedent in Apple’s recent history anyway, as noted above.

In January, iSuppli originally estimated a $280.83 bill of materials cost for the 8 GB iPhone; more recently it came up with $265. That isn’t a 55% profit margin however, as it does not include Apple’s other costs, from shipping them from China to staffing iPhone customer support.

Remember when iSuppli reported that manufacturing Windows Vista costs all of $2.50 for the box and DVDs, informed us that Microsoft’s profit margins were 10,000%, and suggested the price of Vista was therefore about to plummet? That didn’t happen of course, but if it had perhaps it would be more obvious how simplistic and silly it is to draw broad conclusions based upon its tear-down estimates.

[More Absurd iPhone Myths: iSuppli, Subsidies, and Pricing]

Iphone 2-2-1

How BOMs Really Work.
Reader Brant Sears wrote, “I was an engineer who worked on the InFocus LiteShow, a wireless projection system that consisted of both hardware and software. We designed hardware that was produced by Asian contract manufacturers. One of these was Foxconn who also has made products for Apple. I got to spend some time looking at bill of materials lists and learning about the economics of producing consumer electronics.

”When I saw the numbers from iSuppli about the iPhone, I was unsurprised. It is quite common for the BOM to be about half of the retail price. There are other per-unit expenses such as shipping, marketing, and estimated support/warranty costs.

“Then there are one time expenses such as tooling: a one time charge that is paid to the contract manufacturer for the purpose of settings up the production line and training the workers to build your product. The 50% markup on the BOM quickly becomes a gross margin in the 20s after these things are factored in.

”The numbers from iSuppli, while they are not the real numbers, are a reasonable guess and not out of line compared to what one would expect. A gross margin in the 20s is not out of line especially for a new product. So, I don’t believe the iPhone is overpriced.

“Another interesting point is that the contracts with these folks usually say that they need to cost reduce the product at a certain rate over time. For example, you might negotiate a 5% reduction in bill of materials cost per quarter. A lot of work in consumer electronics on the hardware side turns out to be shopping and trying to save a penny here or there.

”Somehow I got on their list as an engineer on the product; I was the software architect on it. So, I would occasionally get calls from them wanting me to approve a change from one part to another part to save money. These changes had to be approved by us because they could have the potential that the new products wouldn’t work. Since I knew nothing about whether one resistor was actually similar to another, I couldn’t really answer those, I just had to refer them to the Electrical Engineer on the project.“

My Own iPhone Tear Down.
I’ve been pulling apart iPhone reports myself, but not to make guesses about how much its parts cost. I want to know how they work. The next article will look at what’s known about the iPhone itself.

What do you think? I really like to hear from readers. Comment in the Forum or email me with your ideas.

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