Daniel Eran Dilger
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Does the iPhone Shortage Herald an Impending 3G Release? Probably Not

WSJ Andy Jordan Tech Diary
Daniel Eran Dilger
Apple Stores across the US are running out of iPhones, resulting in the rumor that Apple is allowing inventory levels to dry up in advance of the release of a new 3G model. While this commonly does happen prior to the release of a new model, the current iPhone shortage appears to be a artifact of unpredictably high demand from foreign markets rather than an artificial supply shortage, here’s why.

All the King’s Horses.
Writing for the New York Times, Saul Hansell reported the views of various analysts on the subject. Gene Munster of Piper Jaffray was cited as saying the shortages mean there is an “80 percent chance that a new version of the iPhone is coming earlier than anticipated.” While Apple hasn’t officially released a date, most observers’ estimates suggest that the 3G iPhone is likely to arrive no earlier than June. 3G UMTS service is considered an important feature necessary for growth in Europe and is required to bring service to Japan, which lacks GSM service.

A.M. “Toni” Sacconaghi Jr., of Sanford C. Bernstein & Company disagreed, saying “An inventory shortage of Apple products often signals an imminent product refresh, but in this case, the stock-out seems too selective: Apple’s distribution partners would likely be extremely upset if Apple managed the product transition only for its own stores. In addition, the 3G iPhone would arguably be more important for the European market; yet the current-generation phone remains widely in stock in Europe.”

This led Hansell to speculate along the lines of Sacconaghi’s earlier “missing iPhone” analysis, which assumed that Apple was shipping its iPhone supply to AT&T and other European partners in order to stuff the channel with inventory and create the illusion that it was selling more units that it actually was in order to cover up a demand shortage. Hansell wrote that this creative inventory theory might help Apple release better-looking sales figures for the second quarter ending in March, as Apple doesn’t count its own store’s inventory as sold, while units shipped to partners such as AT&T apparently are.

Toni Sacconaghi Alert: Excessive iPhone Demand Reason to Panic

Toni Sacconaghi Alert: Excessive iPhone Demand Reason to Panic
The iPhone Shortage – Bits – Technology – New York Times Blog

The Problem With Channel Stuffing.
Such a strategy wouldn’t work very long however; Microsoft was only able to successfully stuff the channel with Xbox 360s throughout 2006. After that, the plan backfired, resulting in a huge year over year drop in reported sales of 360 consoles in 2007. Fortunately for Microsoft, the media didn’t care about the discrepancy and has instead focused on the limited growth of iPod sales that appears to exist when sales of iPhones are excluded from the sales figures.

The ironic twist is that demand for the 360 actually is waning, while iPod sales are both expanding in unit sales and in profits, and at the same time also branching out into the smartphone market with the iPhone. International demand for both iPods and the iPhone are both strong and growing. In fact, international sales are growing too fast for Apple to manage flawlessly. The inventory hiccups are showing up primarily in Apple’s US retail stores, due to a number of interrelated factors that Apple would rather not talk about.

The iPod Crisis Myth

The iPod Crisis Myth
Video Game Consoles 2007: Wii, PS3 and the Death of Microsoft’s Xbox 360

Nothing to See Here, Please Move Along.
In a prepared statement to the media, Apple representative Steve Dowling told the New York Times, “we are working to replenish iPhone supplies as quickly as we can. Our stores continue to receive shipments almost every day.”

Hansell asked for more clarification on the demand Apple was seeing in its retail stores and on its web site, whether the company was suffering component shortages in manufacturing the iPhone, if the company was preparing to release a new model, and if there were any accounting reasons for shipping supplies to AT&T rather than its own stores. Predictably, Apple didn’t comment further.

Foreign iPhone Demand is Causing Domestic Inventory Supply Problems.
The most reasonable analysis of what’s causing the iPhone inventory problems at Apple’s US stores came from an anonymous source identified as Tantrum, who posted a comment outlining why foreign demand for the iPhone was showing up in Apple’s US stores, forwarded to me by reader Angus Wong.

“Demand for iPhones outside the United States, particularly in emerging markets, is out of control and has reached the point where it has started to impact Apple’s normalized supply chain projections,” Tantrum wrote. “It’s okay to have a delta of, say, 100,000 units or so per year between actual and forecast. International demand is driving that delta upwards of 1 million. That’s a whole different ball game for component sourcing, quality control and production ramp-up and some things are starting to come unstuck, even for a finely managed company like Apple.”

Tantrum noted five factors driving iPhone demand outside of the US, resulting in ripples of inventory problems for Apple’s stores in this country. “What’s driving this?

1. Free, out-of-the-box ready, GUI-based network unlock solutions like Ziphone and iLiberty. Confidence in these unlock systems has grown significantly over time as technical expertise required to use them has fallen.

2. A large, very organized procurement mechanism for iPhones, particularly into Russia, Eastern Europe, India and China. There are people who go from store to store buying iPhones and aggregating them for export to ‘resellers’ overseas.

3. Proliferation of Wi-Fi penetration and the recognition that in GSM countries, iPhone works simply and well enough. Wi-Fi hotspot usage is growing significantly around the world and the iPhone’s superior web browser is taking full advantage to maximize customer experience. It’s the right product at the right time for the macro-trend.

4. The iPhone is relatively cheap to emerging market customers used to paying $500 for a BlackBerry and a cheap US Dollar makes it an even better deal. For example in Russia, at $499, a 16GB iPhone translates to around 12,000 Rubles. An 8GB Nokia N95 costs $815 or 20,000 Rubles. The value-for-money perception with iPhone is absolutely huge.

5. Zero or minimal compatibility issues on GSM Networks. I have used my iPhone with SIM cards from 32 different networks in Europe and developing countries. It works seamlessly. The iPhone is a quad-band GSM phone, meaning that it supports all four major GSM frequency bands, 850 and 1900 MHz bands which are used in the Americas, and 900 / 1800 MHz bands used in most other parts of the world, making it compatible with all major GSM networks worldwide. 2 billion people around the world use GSM phones.”

The Scope of iPhone Demand in Emerging Markets.
“To give you an idea of international demand: there are Nigerians shipping more than 500 phones a week from New York to Lagos, and Nigeria is a third world country. The EDGE internet works perfectly, albeit just as slow, there and data is very, very cheap at $5 per 100 MB of usage,” Tantrum said.

There’s big money in emerging markets that American analysts aren’t recognizing, Tantrum says. “’Data-driven’ analysts like Munster and Sacconaghi get misled by the laziness of long-distance US-chauvinist analysis into making market projections based on perfunctory GDP per capita statistics and ‘population living on less than dollar per day’ figures. They look at the wrong data because they think the world works in the same way everywhere. This weak analysis disregards latent middle and upper income demand in developing countries. Income distribution in many emerging markets is extremely lopsided.

”If you define a potential user as someone who can afford (or is used to) paying twice as much for an iPhone and double what an AT&T subscriber pays per month, there are at least 7 million potential iPhone users in Nigeria, 9 Million in South Africa, 80 Million in India, 25 Million in Russia, 25 Million in Brazil, 8 Million in Indonesia and 100 Million in China. Not all of them will be users but just 5% of this number is way more than 10 million. Considering mobile phones are some of the most universally adopted products on the planet, a good GSM phone reaches Iran and Iraq much faster than people on Wall Street can ever imagine. I predict iPhones will be available to elites in Cuba (which has both GSM and TDMA) within the next 30 days.

“From research I’m conducting. we have conservative numbers of grey market as follows:

  • Russia 2000 to 4000 phones/week
  • China 4000 to 6000 phones/week

”Demand from Western Europe is substantially slower but still significant, averaging anything from 2000 to 3000 units/week from New York and other big cities with international airports. Now, not all the phones shipped from New York are bought in NYC but the export pattern is clear and very strong.

“I have completely ignored the cash-flush Middle East where Dubai has always been a world-leading port in grey market clearing and forwarding for consumer electronics. Conservatively speaking, something is sucking 15,000 to 20,000 iPhones per week out of the United States. If this phenomenon is coinciding with steadily growing adoption among US customers, suddenly the slack Apple had is drying up.”

Scraping the Channel Dangerously Clean.
In its most recent conference call on first quarter earnings, Apple reported that it seeks to maintain four to five weeks of iPhone inventory, the same as with its Macs. In the winter quarter, the company reported maintaining iPhone inventory within those numbers, but said Mac inventory fell below plan because of unanticipated, record demand. The same thing is now happening to the iPhone due to foreign demand. It is in Apple’s interests to maintain healthy inventory levels, as sold out stores are potentially losing customers just as Nintendo is losing potential sales on the hard to find Wii. Of course, the iPhone actually isn’t nearly as hard to find, and there are ready supplies in alternative outlets, including AT&T stores.

Keeping its own stores stocked is becoming harder because of the increasing demand channeled through organized grey market resellers, who prefer to target Apple’s US stores rather than standing in line at AT&T and dealing with a more complex sale. That dries out the channel at Apple’s flagship stores located in cities such as New York and San Francisco, which serve as easy access hubs to international traffic, while leaving normal inventory levels at Apple’s partner stores, particularly in Europe where a stronger currency offers a less attractive price.

“Many of the millions of visitors coming to the United States every month are going back with a packed iPhone in their luggage,” Tantrum noted. “It’s one of the things people are expected to buy when they come. Foreign nationals are not very likely to buy iPhones at an AT&T store because the requirements are inconsistent (some stores requiring SSNs, existing phone numbers and/or activation), queues are long (non-starter for people with a limited window to get back to the airport), lack of other Apple products (iPods etc) and accessories and simply, AT&T stores are not landmarks.”

Apple’s partner stores in Europe aren’t seeing the same kind of demand for multiple reasons, including the extreme weakness of the US dollar. Tantrum also noted that the organized grey market has become efficient enough to make speculative iPhone profiteering by individuals difficult. “The reason why used iPhones will begin to show up on eBay and other consumer-to-consumer sites in Western Europe is because individuals who speculatively buy an iPhone to resell are up against ‘organized unofficial’ suppliers and 3G is a big deal there. In emerging markets, you’re much more likely to buy a phone from an ‘expert hacker supplier’ if you worry about fixes and other things. And yes, the parallel market is showing budding signs of getting sophisticated at providing some of the support Apple won’t provide.”

A Hot Deal At Any Price.
Tantrum concluded, “Bottom line: Apple has produced a product that is promising but short of the mark in 3G Western Europe, reasonably good for the US but a smash hit in emerging markets.” Underlining that fact are ads by a Singapore outlet run through Google AdSense (pictured below), unabashingly offering unlocked iPhones for just $715.

Pasted Graphic-8

Along similar lines, reader Payman sent in a link to Andy Jordan’s Tech Diary, a video blog published by the Wall Street Journal. In the episode “One Night in Bangkok,” Jordan walks around the tourist markets in Thailand, noting that iPhones sell for around $734 and tourists from various countries are snapping them up for nearly $800. A family from Guinea in West Africa bought four, and an Australian couple are excited to buy two.

In contract, a visitor from the Netherlands was shopping for a new phone that costs 200 Euros there, but would cost 600 Euros back in Holland. Australians are buying DVD movies for $3 each. Yet the iPhone is selling for twice the price as in the US. It’s no wonder why the grey market is funneling units out of the States at a rapid pace that’s throwing Apple’s retail store inventories for a loop

Andy Jordan’s Tech Diary

Immediate 3G iPhone Release Unrealistic.
Echoing the same outlook, Royal Bank analyst Mike Abramsky said in a note to investors that it was “unrealistic” to think that iPhone inventory shortages were sign of the imminent release of a 3G model, and that Apple is more likely to have just underestimated demand.

Rumors have insisted that Apple dialed back production by as much as 50% in the first quarter, fearing that demand would drop sharply after the holiday. In reality, iPhone sales have remained steady, Abramsky said, pointing out that Apple has run into problems estimating iPhone demand at several points, including the surprising number of unlocked devices that appear to be related to sales headed to emerging markets.

In contrast to the pundits worrying that unlocked iPhone sales are a vexing problem for Apple, Abramsky said the company “probably feels like the dog that caught the car.” While Apple doesn’t earn carrier revenue shares on unlocked iPhones, it still earns a manufacturing and retail profit on the hardware sale, and such sales expand the company’s market share and the installed base of iPhone and iPod Touch devices, floating worldwide interest in Apple’s mobile development strategy, and by extension, Cocoa development on the Mac.

AppleInsider | RBC on shortage; Apple vs. Big Apple; T-Mobile’s 99 Euro iPhones

There are other ways Apple can earn replacement subscription-style revenue on iPhones sold to users in emerging markets outside of its exclusive service partners, as the next article will examine.

I really like to hear from readers. Comment in the Forum or email me with your ideas.

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  • Rich

    I wonder how much profit Apple makes on an unactivated iPhone? Is the extra memory in iPod touch worth roughly the same as the modem, Blueooth, camera, extra buttons and all of licenses needed for the iPhone? I guess we’ll never know for sure.

    I certainly can’t wait for the 2nd gen iPhone though. :)

  • OlivierL

    “There are other ways Apple can earn replacement subscription-style revenue on iPhones sold to users in emerging markets outside of its exclusive service partners”
    30% in AppStore ?

  • NormM

    There’s also the point that, at least when iPhone was announced last year, we were told that the existence of the new phone couldn’t be kept secret during the FCC certification process. Wouldn’t this also apply to a 3G version?

  • Berend Schotanus

    Absolutely GREAT article!

    “I have used my iPhone with SIM cards from 32 different networks in Europe and developing countries.”
    That’s quite a research. Tantrum is proving the strength of the GSM market with an open interface between network and telephone set. I never experienced any flaws on this point either. On the other hand, what I see here in Holland, is that it is hard to almost impossible for phone companies to keep SIM-locks in place. Consequence of the open interface is that GSM units can be shipped and used all over the world, just like iPods.

    An obvious step for Apple on order to keep things in hand might be to offer iPhones in emerging markets at the same price model as iPod touches, which is no subscription payback or any connection to the phone company but let costumers pay for software updates.

    “[…] misled by the laziness of long-distance US-chauvinist analysis […] they look at the wrong data because they think the world works in the same way everywhere.”
    Well noticed!

    Keep on the good work.

  • http://www.thecarbonlesspaper.com johnnyapple

    I saw the Tantrum analysis yesterday and briefly mentioned it in my wildly popular AAPL quarterly financials thread (sometimes more than a reader per week!). Apple confirmed that the shortages are not related to the upcoming 3G, as you point out.

    Most agree that 3G will be in the queue around iPhone’s first anniversary. Adding 3G will be a nice improvement for those of us who use it extensively for web access but more importantly, from a business perspective, expand iPhone usability into several more key markets.

    The large percentage of iPhones ending up in grey markets (not as many as Sacconaghi thinks) leave me to believe that once an approved carrier is available in those areas, many will sign up with the official service. It’s not so simple as to count every grey market phone sale as lost revenue sharing. It will be interesting to watch this play out for another year. iPhone is a giant hit. Is anybody talking about the troublesome grey market for Zune or Kindle? Nope.

  • http://www.hoverboy.com 11thIndian

    I agree. Imminent is unlikely. As Apple’s star performer, it would make no sense to release the iPhone before the late June 1 year anniversary which will see the launch of the 2.0 software and the launch of the AppStore, which is when the gloves come off and the true potential of the iPhone (and it’s lead on all competitors) will become clear.

    AT&T’s CEO Ralph de la Vega said it himself not but a few days ago when he said the 3G iPhone would be available “in a few months”.

  • Netudo

    If you take a look to mexican “Mercado Libre” (It’s a ebay like site):


    You will see a lot of unlocked iPhones for sale. Just for reference, 1 US dollar = 10.55 Mx pesos.

  • chefmitch

    Daniel – thanks for the great article.

    The sales of all of these iPhones all over the world is GREAT for Apple. The benefits include profits for every iPhone sold, strengthening of the iTunes brand + any profits from iTunes Music Store, sales of iPhone accessories (either directly from Apple or from 3rd party), Zero warranty costs, a larger installed base makes the iPhone a more desirable platform for developers and most importantly Apple is able to play a leading role is determining what the mobile web will be (worldwide).

  • tundraboy

    Analysts in the U.S. don’t realize how aspirational Apple products are in the developing world. Yes it’s a P.C. dominated world but everyone I know back home looks to Apple as the ultimate, I-can-die-now consumer electronics product. The price of Macs are still beyond the justifiable range of most computer buyers in the third world but a Mac (or near-Mac) in your pocket for $500? That’s an easy sell any time.

  • Rich87

    I think there’s a much simpler explanation here: positive reaction to the iPhone 2.0 software. One the June realease and details of the software were made public, a lot more people decided the iPhone will be right for them and just a simple software upgrade from what they can purchase today. Just look at the current Apple Store bestseller list. The 16GB and 8GB iPhones hold the number 1 and number 2 positions, ouitselling even the iPod nano!

  • Jim F.

    I think this is on target as usual and a great new source of info for johnnyapple on the financial side.

    I do believe the 3G is over hyped. I have not seen where there has been a breakthrough on 3G chip sets that do not suck down batteries like no tomorrow. Additionally we have Apple’s contract with at&t for 5 years of iPhone on their networks. Has anyone seen the 3G installed networks on the at&t web site? Yes there are large metro areas, but there is a lot of blank space out there that only EDGE supports. So to have full coverage we need EDGE and 3G… and a car battery sized pack to keep the phone active. T-mobiles is even less.

  • beanie

    Pixar has a movie called WALL-E which is going to hit theaters around June 28, 2008. Last year iPhone was released on the same day as Pixar movie “Cars.” If Steve Jobs is unimaginative, he will announce 3G iPhone at WWDC and release it on the day WALL-E hits theaters.

    iPhone “traffic” Market Share measured by NetApplications
    200803 = 0.15%
    200802 = 0.14%
    200801 = 0.13%
    200712 = 0.12% 4.0 million iphones sold total
    200711 = 0.09%
    200710 = 0.07%
    200709 = 0.07% 1.2 million iphones sold total
    200708 = 0.05%
    200707 = 0.04%

    No surge in iPhone traffic in first three months of 2008 like that between Oct 2007 to Dec 2007. My guess is iPhone follows iPod pattern and has dropped back down to 1-1.5 million iPhones a quarter. Apple probably is doing a little “channel stuffing” to prop up numbers.

  • http://www.roughlydrafted.com danieleran

    @ beanie: again, the percentages of web traffic you are trying to compare are not static. Each month’s “percentage” is not equal.

    It’s no different than comparing iPod unit market share month over month. The individual percentages can’t really be compared because the overall market is changing every month.

    In the case of web stats, it has even less to do with units sold, and far more to do with how much each of the users in the entire installed base of web browsers are using the Internet.

    Comparing web stat percentages between platforms gives a rough guide of how much each device is actually being used, and whether that use it trending up (like the iPhone) or static (like Windows Mobile).

    It does not provide a very good metric for estimating iPhone sales, because if everyone in Dec is on vacation, and everyone in Jan-Mar is hammering the web at work, even the same number of mobile devices would appear to drop as a percentage of overall web traffic.

    iPhones are outnumbering WM by more than 2x, but Apple has only sold three full quarters of iPhones, at roughly the same or slightly more volume as all the WM phone makers in the US put together. However, Microsoft has been marketing WM phones since 2003, so Apple isn’t just beating the new WM phones, but whipping the entire installed base of Pocket IE devices.

  • gus2000

    “Channel stuffing” is a method to fool investors by using inflated quarterly sales figures. It is unethical, detrimental to the company, and illegal.

    There is no evidence that Apple has become obsessed with quarterly figures, nor has lied to investors for the purpose of artificially lifting the stock price. They do not need to stuff the channel with iPhones, because only the Apple naysayers care if the 10M iPhone sales target is met or not. Apple would happily announce that they sold 9.9M phones in 2008 rather than stuffing an additional 100,000 into the channel.

    Microsoft stuffed the channel with XBoxes, but not with the intent of fooling investors; it was the customers they were trying to fool. Nothing succeeds like success, and they hoped that inflated sales figures would create additional demand, thereby nullifying the stuffiness of the channel. It was sensible of them to try, since the Self-Fulfilling Prophesy has been a Microsoft staple for the last decade. Frankly, I’m surprised it didn’t work.

    They did the reverse with Zune 2.0. By shipping a limited number initially, it created the illusion of great demand. I don’t know if that had the desired effect, but I don’t really care, since it has no impact on Apple sales.

    It still bugs me slightly that 95% of the inventory of an Apple store is in the back stockroom. I’m so accustomed to seeing piles of boxes everywhere I shop that I keep thinking they must be out of everything. Pity…Apple packaging is actually quite attractive.

  • Bill

    You guys are killing me. I really wanted to see the 2nd gen iPhone and have it 3G technology. I may just buy a Centro since they are so cheap, hen upgrade to the 2nd gen iPhone when it arrives and has the features that I require. Even my wife herd about the speculation, so I thought that it may be real. It’s disappointing news. Oh well, the old Treo 650 has a few miles on it. I will still wait a few months before getting the new Centro, just in case.

  • David Stevenson

    One other possible factor of the discrepancy between Apple store supplies and partner store supplies: Apple has a history of selling iPods and may have figured the iPhone sales would show the same or similar drop as iPods after the holidays, whereas the partners only had sales data on cell phone seasonal sales rates.

  • francini

    So the question I have is this: what can Apple effectively do, that they’re not already doing, to prevent the product drain of iPhones out of the US?

    I’ll probably get roundly criticized for this, but perhaps there should be some sort of proof-of-residence required to purchase one — that would perhaps take care of the casual tourists buying iPhones and shipping them to countries without deals in place between Apple and an in-country service provider.

  • addicted44

    I think it was interesting that I saw almost as many iphones in Bombay, India in my 3 weeks there over the holiday season as I did in Atlanta in the 3 months since!

    The emerging markets absolutely love the iphone (and ipod). Apple better wake up to this fact and strike deals with providers in China, India and Russia.

  • http://stainedglasspoet.com stainedglasspoet

    @francini – Preventative measures by companies are no fun. Why create artificial scarcity? Hopefully, Apple will divorce their carrier deals and bring ‘legit’ iPhones to where the demand is.

    @johnny apple – “Is anybody talking about the troublesome grey market for Zune or Kindle? Nope.” :trophy:

    @beaner – it was Ratatouille, not Cars, that hit theaters June 29, 2007.

  • mihomeagent

    Lemme just laugh at Beanie for his “Apple is probably channel-stuffing.” Hahahaha. Is “we’re out of stock” how a channel is stuffed?

  • geeeze

    I think part of what is happening is we are seeing the transition from the early adopter to mass market penetration much sooner than many other technology products have in the past. The iPhone is still the must have gadget. How many of us know someone who is not technical who had to have an iPhone because someone showed them how easy it is to use. You simply hand anyone the phone and tell them if they feel lost hit the home button. They discover features they wouldn’t even try in the unfriendly interface on their current cell phone. The more people who get to the end of their contract “lock” the more mass market adoption we will see.

    Switching to an iPhone is a lot easier than switching from Windows to the Mac OS. It’s not a complex product. Cell phones prior to the iPhone have been very difficult to use and challenging to enable even basic features. The iPhone changes that. How many of us have had 5 or more cell phones since our first phone? Can you recall one that you thought, “wow, this has an intuitive interface.” Imagine if you weren’t technical and had to use these devices.

    TV vs. Internet trends suggest Americans are spending more time on the Internet than we are watching TV. Having access to that new “pastime,” wherever you are, 24/7 is addicting. How many times do you say to yourself, “I wish I could look that up right now.” Try that on any other portable device. Then try it on the iPhone. Our internet habits are advertising the iPhone to the masses. The supposed $400 million in free advertising Apple received when the iPhone was announced following 2 years of secrecy, pales by comparison to the power of the human mind to need that device. There are millions of people every day saying to themselves, I wish I had an iPhone so I could look that up. I predict 10 million phones will be sold before June 29th 2008.

  • Scott

    Man when did you say this sh!t: “The iPhone is simply the most incredible piece of consumer hardware I’ve ever touched. … The iPhone simply embarrasses my own expertise, which I am usually loath to admit.”

    No wonder I’m hooked. Yo are a genius!!!

    May you elaborate on this!

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