Tom Krazit of CNET and Eric Savitz of Barrons Deny the Jesus Phone
January 25th, 2008
Daniel Eran Dilger
According to speculation published by pundits, Apple’s iPhone sales have fallen into a mysterious time portal somewhere between Apple selling them and AT&T activating them. The conclusion reached by these wags is that Apple lied about actually selling them and really only pushed them into the channel to fake the appearance of demand, as Microsoft did this year with the Xbox 360. They’re wrong, here’s why.
Tom Krazit of CNET and Eric Savitz, the blogger behind Barrons’ Tech Trader Daily, were both duped, perhaps willingly, by a report published by Bernstein Research analyst Toni Sacconaghi. Based on the same report, John Oats of the Register UK republished the story under the headline “Apple’s iPhone numbers do not add up. Millions being unlocked – or gathering dust at Carphone Warehouse.” The Register also reported that Apple announced plans to sell 10 million units “by the handset’s first birthday, in June,” which was also invented nonsense.
The original report noted that Apple has been selling iPhones significantly faster than AT&T has been activating them on its network, a situation that left “1.4 million iPhones either sitting in inventory or purchased with the intention of unlocking the phone for use with an unauthorized carrier.”
Sacconaghi said that either situation is bad for Apple because it means that demand for the iPhone is lower than its record sales numbers actually suggest, or alternatively that demand is so high that users in foreign markets where the iPhone is not yet officially on sale are buying vast numbers of iPhones in the grey market and unlocking them for use on other networks.
If this reminds you of pundit criticism that Apple’s iTunes is both a collapsing failure and a monstrous monopoly, or the feeble insight that Macs are an insignificant market but will somehow fuel sales of Microsoft’s Windows Home Server, or the warnings that Mac OS X has more vulnerabilities than Vista despite sharing none of its viral malware crises, then you might see where this is going before I actually write it.
Pundits who Contradict Themselves May Be Desperately Delusional.
As with any conspiracy theory, there is plenty of numerology to back up the conclusions that need to be drawn to make the story work. However, the numbers cited by Krazit and Savitz are simply embarrassing to present because they make no sense, much like the Register’s figure skating.
Essentially, they profess to believe that because Apple is selling iPhones faster than AT&T is setting them up with service, the only logical conclusion is that Apple didn’t really sell them, but that they are actually sitting in inventory somewhere. This is the only possible way that one might be able to deny the iPhone, but it still sounds a bit like Thomas needing a bit more convincing after having put his hands through the holes in body of Christ. How much water much gush from Apple’s flinty rock?
The problem with this rejiggering of reality is that Apple can’t announce having sold 4 million iPhones and booking well over $1.4 billion in deferred revenue if it hasn’t in fact sold them. That would be securities fraud and perhaps also involve currency counterfeiting. But that’s not the only hole in the stuffed channel theory.
Apple, the New Microsoft.
This idea also smacks of the “Apple is the new Microsoft” meme, where Windows Enthusiasts in tail-turning full retreat turn back their heads and attempt to belt out a repetition of all the bad news about Microsoft, rephrased to be about Apple. Leopard is the new Vista, Macs may someday be plagued with viruses, Apple might sign up exclusive agreements with every hardware manufacturer to prevent a competitive marketplace, and so on. In this case, the iPhone is the new Xbox.
With the Xbox 360, Microsoft dumped millions of the consoles into the channel and referred to them as having been “shipped to stores,” suggesting that those units made up a huge installed base among users when they really hadn’t made it that far. This was designed to suggest that the 360 had beat Nintendo and Sony to market and had removed any demand for further competition in game consoles.
That strategy backfired after Microsoft ran out of shelf space and couldn’t keep up its channel stuffing. It predicted sales of 15 million units by June 2007, but had to revise that estimate twice, and then actually only shipped less than a couple million units over the first six months of last year. The channel was stuffed, and there wasn’t any demand to unstuff it.
iPhone vs 360 in Channel Inventory.
The difference between the iPhone and the Xbox 360 is that Microsoft is only a manufacturer. It sells the Xbox through tens of thousands of retail outlets in the US, so stuffing the channel is easy and profitable, up to a point. Apple is both the manufacturer and the primary retailer of the iPhone. Stuffing its own retail channel would be ridiculous, and dumping unsold inventory on AT&T’s several hundred stores wouldn’t be very clever either.
Apple has around 200 retail stores, about 1,900 AT&T partner stores selling the iPhone, and 2,500 storefronts in Europe selling it. Apple also sells the iPhone online through its own site, but it isn’t available from the hundreds of other major retail channel partners Apple sells iPods and Macs through, including Best Buy, Amazon, WalMart and the mail order catalogs. There’s simply not enough channel to stuff with the iPhone, and that’s no accident.
For clear and obvious reasons, Apple is choosing to sell the vast majority of its iPhones through its own retail stores. No only does this earn Apple retail profits as well as manufacturing profits, but it also drives traffic to Apple’s retail stores to get the year’s hottest tech product. Sales are so fast and furious that Apple has set up limitations: you can only buy five, and you have to pay with a credit card.
Unlocked iPhone Sales.
Those limits would make no sense if Apple were facing excess inventories; instead, Apple is trying to slow the sale of iPhones to exporters who unlock them and sell them at a high profit overseas: in the EU outside of the three countries where Apple officially does business, in Canada, the Middle East, India, China, Singapore, Malaysia, Thailand and other parts of Asia with GSM service, and in the Caribbean, Australia, and South America. The iPhone is conspicuously turning up everywhere.
Apple not only makes less revenue on unlocked phones, but at a certain point, the practice also makes it more difficult for Apple to set up partnerships with new mobile operators, because it removes some of the exclusive demand pressure that has enabled the company to set up favorable service pricing and get providers to support and co-market its unique features.
While unlocked iPhones are a risk for Apple, the worldwide interest in the iPhone fueling that demand mitigates the bad news substantially. Pundits have insisted since its unveiling that the iPhone wasn’t good enough for the US, let alone the rest of the world where 3G service is more widely available. They were so wrong it hurts; there’s a huge demand for the existing iPhone, and it commands a premium price even in markets where its exclusive network features such as Visual Voicemail won’t work.
Microsoft has been struggling to make a minor showing with Windows Mobile after more than a half decade of sales, only to be met by yawns outside the US. In its first quarter, the iPhone embarrassed Windows Mobile by grabbing the top spot for smartphones sales of any model and the second largest platform share behind RIM’s BlackBerry.
Denied Thrice As the Cock Crows.
Imagine being cornered into the position of pundits denying the promised phone repeatedly, as I prophesied would happen at its launch, only to realize they are cowardly reviling the savior of technology and fated to be left weeping bitterly for their lack of integrity. These wags have decided that the best course of action to take upon realizing they were wrong and looking foolish for it is to simply insist that reality isn’t happening and that something entirely impossible is going on instead.
Those troubled by the idea of Apple matching or outpacing the collective mobile development efforts of the rest of the world first insisted that the iPhone wouldn’t live up to the hype, then complained that it cost far too much, then announced that nobody would buy it, then sulked about how it might have “vulnerability” problems that other more promiscuous smartphones might somehow lack.
It was fun to point out how ridiculous and transparent all of these attacks were. I first noted that the iPhone would cost only a little more than cheap feature phones like the Windows Mobile Motorola Q. After Apple announced its discounted AT&T service plans, I pointed out that the iPhone would actually cost users a couple hundred dollars less. After Apple dropped the price, I then noted that the iPhone would save users around $400 over the much simpler Q in the long run.
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iPhone Sales vs Activations.
I wasn’t alone in grasping the obvious. On its first day and a half of sales, Apple sold a quarter million iPhones, grabbing a full percentage point of worldwide smartphone sales for the entire quarter. Wags took issue with this number because AT&T announced activations of 146,000 in the first day and a half of sales, which happened to fit into the second calendar quarter of 2007.
Clearly, it’s easier to perform a retail transaction than a service activation. Since no other phone manufacture in the US has boldly sold phones at retail with a secondary activation process that can be done at home, the iPhone’s sales versus activation numbers continued to confuse and irritate wags hoping to nail the iPhone to a stake before it could win too many adherents.
In the final days of June, the activation delay seemed to mainly be a problem on AT&T’s end, as customers with complex existing service plans had to call in and handle some activations manually. At the same time however, there was also a visible presence of foreigners buying iPhones with the intent to use them overseas.
Unlocked Demand for the iPhone.
After sleeping out on the sidewalk to get an iPhone, I had two Australians push ahead of me in line to get iPhones they could take back home with them. I didn’t complain, but only out of a secret shaudenfreude that they might suffer under Telstra for having been so pushy.
That anecdotal observation of overseas interest was later officially sanctioned in warnings Apple released indicating that the company had unmistakably observed that a significant number of iPhones were being purchased with the intent to be unlocked for use overseas or with T-Mobile in the US.
After its first full quarter of iPhone sales, Apple announced that it had sold a total of 1.4 million iPhones since launch, but noted that a whopping 15% had never been activated on AT&T’s network. Clearly, many of those roughly 250,000 iPhones were being used unlocked on other carriers, but there were also other factors that explained the gap. One is that AT&T refused to put iPhones on its business plans. Some users resorted to associating their iPhone with their business plan anyway, with AT&T being none the wiser.
AT&T also reported at the time that 60% of its iPhone users were existing AT&T customers, and 40% had defected from other carriers specifically to get the iPhone. Considering that Apple has long been reporting that 50% of the audience it is selling Macs to in its retail stores are new to the platform, that indicates that the long term subsidy contracts in the US mobile business are even more of a barrier to switching than the Windows monopoly.
If there is so much pressure to overcome in order to switch–or perhaps resistance to switch to AT&T–the proportion of unlocked iPhones being sold is actually relatively small: around 15% are unlocking versus 40% switching their carrier to get the iPhone. Who wouldn’t like those numbers?
The Unlocking Problem in Perspective.
Remember too that for many of those interested in the iPhone, AT&T isn’t even an option because they aren’t in the US. That means this unlocking number, while fun for wags to highlight as a problem for Apple, isn’t really that big of a problem in reality.
While Apple clearly would rather keep iPhone sales tightly managed, both to earn full revenues and in order to have extra bargaining chips with the other providers it is negotiating with worldwide, the problem of too much demand is really not the worst possible issue Apple could be facing with iPhone sales.
Even if it were selling 15 or 20% of its iPhones at a loss, those added sales volumes will help drive down manufacturing costs and make the iPhone more profitable, as well as broadening the reach of Apple’s new WiFi wireless mobile platform.
Imagine if it were instead running into a supply problem like Nintendo’s Wii, where it simply couldn’t build enough units to meet demand. That initially sounds like a nice problem to have, but Nintendo is missing out on significant revenues and the opportunity to sell units now at peak demand. As it catches up, it very likely won’t ever be able to sell as many consoles as it could if it didn’t have the current supply problem.
Apple’s Channel Management.
Apple nearly ran into the same problems in the last quarter with Mac sales, which were so high that Apple depleted its channel inventory to less than ideal levels. The company targets maintaining four to five weeks of channel inventory, but high Mac demand over the last quarter scraped the channel clean down to a bare three weeks of supply.
Tightly managing supply and demand across different models and different channels is both an art and a science, and the reason why Apple recruited its COO Tim Cook from Compaq shortly after the acquisition of NeXT. Apple’s channel management had been a mess, with too many Performas, not enough PowerBooks, and warehouses of parts all growing obsolete. Cook turned Apple around from a disaster to a model of precision planning and operations.
Unlike the Mac, the iPhone didn’t risk running out of inventory in the last quarter, but it also didn’t back up into the channel. Apple similarly planned for four to five weeks of iPhone channel inventory and maintained those targets. That works out to about a half million iPhones in the channel, which lines up with the number of Macs that Apple has maintained in inventory over the last several years.
That means the invented panic that Apple has been slashing orders as iPhone inventory piles up is simply not true. Conversely, it also highlights the genius of pricing the iPhone high at first, then dropping the price as Apple took notes on production and demand for an entirely new category of product launch.
Frothy self-important pundits described the price cut as a disastrous mistake, but only because they were not qualified to write about economics or operations and could only manage to arrogantly naysay from a comfortable position as myopic hindsight observers.
Tim Cook on Apple’s iPhone Inventory.
In Apple’s latest quarterly conference call, Cook noted that the company was still seeing “significant” sales of unlocked iPhones, but noted that it was impossible to accurately target how many of the units sold were intentionally being used outside of Apple’s partner networks, and how many were simply gifts awaiting activation at a later date, or otherwise held up due to the prevalence of long term mobile contracts.
Cook also noted that the demand for unlocked iPhones was an “expression of strong interest in iPhone globally,” a silver lining that must be painfully blinding to the Saul of Tarsus pundits who have been persecuting the iPhone for so long.
With significant numbers of iPhones being whisked out of the US, UK, Germany, and France to be sold at an unlocked premium while lacking some advertised features and despite the availability of many competing models, it really makes it hard to profess a lack of faith in Apple’s success.
The Inflated Channel Inventory Myth.
Sacconaghi worked hard to postulate the idea that Apple was building inventory levels in partner stores, risking a collapse of sales following saturated demand. If Apple is working so hard to fake sales in the face of weak demand, why would it also set up limits on the number of phones customers can buy and force them to pay with trackable credit cards?
Apple’s retail partner stores are all savvy mobile operators that have experience in buying and selling a variety of different phone sets. Apple isn’t pushing iPhones out into tens of thousands of general purpose retailers who haven’t ever sold smartphones before. Are the several hundred stores in the UK’s Carphone Warehouse chain really gullible enough to take significant shipments of iPhones if they aren’t actually selling them?
And why did Apple threaten to sue grey market retailers of the iPhone in Singapore if there really was no demand for the iPhone? It is simply absurd to suggest that Apple can’t sell the iPhone due to a lack of interest in the sense that Microsoft can’t sell its Xbox 360s, or Windows Vista, or Windows Mobile phones, or the Zune, or Windows Media songs, or Xbox Live videos, or Windows Home Server, and so on.
Apple isn’t trying to dump the iPhone on channel partners or it would be making promiscuous partnerships with 80,000 retailers for the hottest product of the year. It’s also not just content with selling iPhone units, or it would be selling $900 iPhones unlocked worldwide. The company is working to build a new business model for smartphones, where the value of the iPhone is used to attract new subscribers to specific operators and therefore become more valuable than a commodity phone available anywhere.
The company also isn’t just restricting sales to weasel out high prices; Apple actually dropped the iPhone’s price to position it alongside the iPod Touch and give it high volume popularity. If it wanted to blow out some short term profits, a higher priced unlocked version would be the way to do that. Instead, Apple is working to develop a sustainable model that not only surpasses sales of other smartphones, but does so while maintaining value both for Apple and for its mobile partners, something rivals such as Motorola have failed to do.
That particular mission should be received as good news for an industry languishing in cheap, low quality, low innovation phones and which desperately needs leadership under a messiah that can elevate values and usher in a new era of enlightenment. It’s too bad CNET and the rest of the fearful doubting pundits are so dead set against it that they’ll say anything they can to try to stop something that clearly isn’t showing any signs of weakness.
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