Cloud Four Blog

Technical notes, War stories and anecdotes

2011 is not the Year of the iPad 2. It is the Year of the Cheaper iPhone.

Steve Jobs on stage announcing 2011 as the year of the iPad2Yesterday, Apple declared that 2011 is the Year of iPad 2. Calling 2011 the year of anything other than transformation in the Middle East is crazy.

But if we’re going to limit ourselves to Apple products, I think it is more likely to be the Year of the Cheaper iPhone than the iPad 2.

Before the first rumors of a cheaper iPhone surfaced, I’d been talking to friends about demographic and sales information that indicated to me that the tech press was too focused on high-end devices and missing the lower end of the market.

Because of this, I’m bullish on the impact of a cheaper iPhone and what it would mean for Apple’s smartphone market share. Let me explain why.

The Real Reason Why Android is Successful: It’s Good Enough and Cheaper

It seems like I’ve spent most of my life rooting for companies who made products that were superior in design, but lost to products that were good enough and cheaper.

I was flabbergasted that people would buy inferior products that promised headaches instead of joy. I thought people just didn’t understand how these inferior products were going to cost them much more in the long run with the thousand cuts of poor user experience and design.

At some point I realized that I wasn’t giving people enough credit. They knew that Tivo was a better product, but the DVR that the cable company gave them for free was good enough and cheaper. The same has long been true of Windows machines.

The problem for a lot of Apple fans is that they still can’t understand why someone would chose the obviously inferior product. M.G. Siegler of TechCrunch wrote an article entitled, “Is Android Surging Only Because Apple Is Letting It?” His thesis was that Android was only winning because the iPhone wasn’t available on Verizon. In the article, he wrote:

Now, don’t get me wrong, almost all Android phones are a million times better than the phones we had just a few years ago before the iPhone burst onto the scene. And if the iPhone didn’t exist, there is no question that I would use an Android phone and would probably be very happy with it. But the iPhone does exist. And I simply can’t bring myself to use an Android phone when I know a superior device is out there. That’s my only requirement for me to use a product: it has to be the best.

Most people don’t require their phones to be best. They simply want something that’s good enough to get email, text message, and browse the web. Oh and cheaper is better.

BTW, the predictions of big lines to buy the Verizon iPhone hasn’t panned out and sales have thus far been “disappointing.” So much for the theory that carrier exclusivity is why Android passed iPhone in market share.

But Isn’t Android the Same Price as the iPhone?

A common misconception about the smartphone market is that Android phones and iPhones are essentially the same price. Both the Samsung Fascinate (Galaxy S) and the iPhone 4 cost $199 with a two-year contract.

But the Android phones don’t stay at their launch price point. Verizon had a large television campaign last fall that offered a buy one get one free offer for the Fascinate. Verizon’s site currently lists 13 different Android models for under $100.

That’s why the average selling price (ASP) is so important. On average, the iPhone costs twice as much as its nearest rival:

Chart comparing handset ASP

Q2 2007 to Q2 2010 Average Selling Price. Source: Asymco

The lower ASP for Android devices is what allows carriers and retailers to offer steep discounts on these devices. And cheaper phones are important because there is a lot of growth at the lower ends of the market.

Have you heard of the Samsung Freeform?

No? I hadn’t either until I noticed it was the number three phone in terms of impressions in Millennial Media’s March 2010 mobile mix report.

Table of top phones in Dec 2010 on Millennial Media network. Freeform is number six.

Millennial Media’s report tracks the number of ad impressions delivered to a given phone. As you might expect, the top phone is the iPhone and the top ten list contains a mix of Android, Blackberry and iOS devices.

Photo of Samsung Freeform w/ MetroPCS on screen.But amongst those well-known devices is the Samsung Freeform. The Freeform was still the number six phone in the report as late as December of last year.

The inclusion of the Samsung Freeform on this list stood out like a sore thumb. I had to know more about this phone.

It turns out that the Samsung Freeform is one of those feature phones that start to edge into smartphone-like capabilities. It has a keyboard for texting and a reasonably capable browser.

The phone is only available through MetroPCS. Right now, you can get it for $49 unsubsidized.

But more importantly, you can get unlimited voice, text and web on the Samsung Freeform for only $40 per month.

Growth at the Low End of Smartphone Market

Around the same time I learned about the Freeform, a Comscore survey in Europe found that “smartphones are generally seen as luxury devices that come with big price tags and high monthly tariffs, yet the largest segment of the market and the one demonstrating greatest momentum is actually the low to mid tier.”

I haven’t found a similar study of growth rates in the United States, but I have found other evidence that seems to support the theory that significant growth in smartphone market is happening at the low price points.

U.S. Minorities Lead Caucasians in Mobile

Over the last year, there have been numerous studies showing that minority adoption and usage of mobile is outpacing caucasians:

Smartphone Penetration by Race/Ethnicity

Pew Internet Research found that African-Americans and Latinos use more mobile data applications. Nielsen found that a higher percentage of minorities both own smartphones and recently acquired smartphones.

It probably goes without saying, but census data shows that minority populations still have lower household incomes than caucasians. Obviously, lower prices will be an important feature for people with less discretionary income.

Android Growth Due to Lower Prices

As I stated above, I believe Android’s skyrocketing growth can be attributed to being good enough and cheaper. The last comparison of income levels for Android and iPhone owners is from Q1 2010. At the time, 36% of Android owners had household incomes of less than $50,000 versus only 22% of iPhone owners. I suspect the difference is more exaggerated now.

Therefore, Android’s success is further proof that growth is happening at the lower end of price spectrum.

The Rational for the Cheaper iPhone in a Single Chart

A couple of weeks ago, I came across a pie chart from Comscore that clearly explains why Apple was rumored to be making a cheaper iPhone:

Comscore pie chart showing household income of iPhone users

If you read the Comscore blog post that this chart comes from, you won’t find anything about the cheaper iPhone. The post focuses on how valuable iPhone subscribers will be to Verizon compared to other smartphone owners because iPhone owners have higher household incomes.

According to Comscore, 81% of iPhone owners have household incomes greater than the U.S. median household income ($44,389).

TNS Global found similar results in a survey noting that “iPhone users are also younger, but the most highly educated, employed as a manager or professional and earning more than $100K per year.”

Does Apple care about the low end of the market?

When I tweeted about the above chart, I got a lot of feedback from people who were confused about what I thought the chart meant. My friend Jonathan Stark jokingly asked if BMW was going to announce a car for under $10k? The implication being that Apple stakes out the high end and doesn’t care about the low end of the market.

@grigs I think we're in agreement... Apple don't give a crap about the low end of the market (other than perhaps to block competitors) --@jonathanstark

I have always thought that Apple cared about market share, but that it wasn’t the top goal for Apple. Apple seems to value:

  1. Building the best product they can
  2. Selling products with a high profit margin
  3. Gaining market share

In that order. They won’t compromise their design ideals, brand or margins to chase the low end.

But if they can create an cheaper iPhone that lives up to Apple’s brand promise and sustains their margins, I see no reason why they wouldn’t pursue the low end of the market given the growth opportunities there.

iPod Nanos

Until recently when people brought up the idea of Apple pursuing an iPod Nano and iPod Shuffle like approach to the smartphone market, I didn’t think Apple could do it. It didn’t seem like there was enough room to differentiate the iPod Touch from a low end iPhone.

I also had my doubts they could build a product at the low price point without compromising. They can’t decrease the screen size like they did for the iPod Nano or remove it entirely like they did for the iPod Shuffle.

However, I now believe there is a lot of room for Apple to explore the low end market. There are a lot of premium features on the iPhone 4, like the retina display, that could be removed on a low end phone without compromising the quality of the design.

But no matter what I think, we should listen to what Apple COO Tim Cook said about the low end market. Cook recently told an analyst that “Apple did not want its products to be ‘just for the rich,’ and that the company is ‘not ceding any market.'”

Will a Cheaper iPhone Make a Difference? The Biggest Cost of a Phone is the Carrier Subscription

When rumors of the cheaper iPhone first surfaced, many people commented on the fact that reducing the cost of the phone won’t help Apple unless they do something to reduce the monthly subscription cost. I disagree.

The success of Android indicates that even if the monthly costs are the same, that many people will chose the slightly less expensive phone. While consumers in carrier subsidized markets never see the full average selling price of phones, it does seem to make an impact in market share.

Second, if Apple is able create an iPhone that is relatively inexpensive without a carrier subsidy, then people can choose to buy it without a contract or go prepaid. In fact, a cheaper iPhone may be the best way to force lower prices by increasing competition between carriers.

There are nuggets that hint at this strategy in quotes from the recent analyst briefing:

A cheaper iPhone available without a contract and with a soft SIM allowing people to switch networks would force carriers to compete on price. If Apple also expands into the prepaid market and signs up lower priced carriers like MetroPCS and Virgin Mobile, the impact on carriers could be as large as the impact of the original iPhone.

But even if they cannot lower the carrier costs, making a cheaper iPhone is the only thing they have full control over if they want to expand the iPhone and reach people with lower household incomes.

A Cheaper iPhone Will Be a Smash Hit

Those who have followed me on twitter or seen me speak at conferences knows that despite the fact I love Apple products, I haven’t been bullish on its prospects of Apple dominating mobile market share. The main reason for my pessimism had been based on other platforms being good enough and cheaper.

Horace Dediu of Asymco recently wrote that he still holds “that 20% smartphone share is possible for the iPhone.” This was my best guess for where Apple would end up as well.

The news that Apple will be releasing a cheaper iPhone changes my view substantially. If Apple is aggressive about the low end of the market, and it sounds like they may be, then the limitation on their market share will likely be their ability to keep up with demand. My off-the-cuff guess is a cheaper iPhone puts Apple at 30 to 40% of the market when the dust settles.

But we don’t need to look that far into the future to know that a cheaper iPhone is going to be a big hit. It is going to be huge this year.

12 Comments on “2011 is not the Year of the iPad 2. It is the Year of the Cheaper iPhone.”

  1. John Keith says:

    Hi Jason,

    I believe we are heading toward a convergence in which “good enough” phones are really pretty awesome, and are cheap enough for carriers to offer, with (or hey, at some point, without) subscription, as entirely free to end consumers. Your example of a $40/month consumer cost represents just under $1,000 USD for a two year contract. To make that work, the carriers need to account for all the COGS, which could conceivably cover the costs of lower-end smartphones. Free to me!

    There will definitely be pressure on Apple as all those HW manufacturers on the low cost treadmill compete and reduce costs – partly by including no-cost operating software such as Android. I think Apple needs to be in this low cost market to preserve it’s high end market, for sure. And I think they’ll need to make a pretty decent phone to do it.

    On a related note, there’s all this talk about the Amazon Kindle going 100% free by the end of the year. Makes fabulous sense to give away the reader and charge for books which need replacing so often!

    http://www.kk.org/thetechnium/archives/2011/02/free_kindle_thi.php

  2. Michael says:

    Great article, well except for the use of bold :) I think you are 90% dead on, but skirt around the issue a little. Android is a classic disruptive technology. Actually, it is really a textbook disruptive technology. Apple so far has acted exactly as an incumbent reacts. It really is textbook.

    Now think about the speculation of lower priced iPhones in the above context. The problem with them is that Apple would have to introduce products that compete with the incredible cash-cow that is the current iPhone. Look at Apple’s product strategies over the years and you can see how hard they try to avoid this situation. They usually try to create very distinct product lines (iPod Nano vs. iPod Touch, or MacBook Air vs. MacBook Pro) or they say “we’ll sell you last year’s model at a discount.” You seem to agree that the first approach really is viable in the iPhone market. If they did introduce a smaller, cheaper iPhone, there will be huge challenges in getting current apps to work on it. Not to mention that it will inevitably be significantly inferior to Android phones selling at the same price. This is also why the “last year’s model” approach has failed. Why buy an iPhone 3GS for $50 when you could get a Galaxy S for the same price?

    I’m skeptical that Apple would be able to use carrier competition to their advantage in order to drive down costs. RIM’s never been able to do that. Apple (1st iPhone) and Google (Nexus One) both made an effort on this too. You’ll always have a hard time convincing people to spend hundreds of dollars extra to avoid a contract, at least in the US. Most people I know have the attitude that they are going to have service anyways, so the contract has zero cost to them making its subsidy very attractive.

    Back to disruptive technology … Apple would have to invest in or embrace/adopt the disruptive technology (Android). It is very hard to imagine Apple doing anything like that (license iOS? Open source it?). Instead with the iPhone4, they employed classic incumbent responses. They innovated with the high end features (Retina Display, thinner phone, FaceTime), where few consumers could actually benefit from the innovation. I think they conceded the low end right then. A look at their market share since then confirms this. Meanwhile Android continues its classic disruptive technology track, providing less and less reasons to pay the iPhone premium. I’m not smart enough to come up with a strategy for Apple where they don’t continue their current trajectory of being reduced to a niche player. They already saw their peak in fall of 2009. 3-5 years from now where will they be? 10% maybe?

  3. Jason Grigsby says:

    @michael I disagree that a cheaper iPhone would make it difficult to get existing apps to work on it.

    First, the NYT confirmed that the cheaper iPhone will not mean a smaller iPhone (http://www.nytimes.com/2011/02/18/technology/18apple.html) so we don’t have to worry about incompatibility from that respect.

    I think they can use different materials in the case to distinguish the product lines. And they can cut costs by removing the retina display, front-facing camera, gyroscope, etc.

    The key to battling the carriers which none of the previous attempts have been able to do is the software SIM and a low enough price. Can they accomplish both? I don’t know. Until the analyst report this week, I wouldn’t have expected that.

    But we know Apple has been working on software SIMs since at least early of 2010. In fact, they have a patent for “a wireless selection system that would require carriers to compete for service on an iPhone.” http://www.tuaw.com/2011/02/10/apple-patent-would-require-carriers-to-bid-for-iphone-service.

    Last fall, the rumors were strong that Apple was going to push this technology into either the Verizon iPhone or the iPad 2. It still hasn’t materialized.

    Regarding the overall market share, I guess we’ll see. Up until this point, I’ve pegged them at 20 to 25% of the market–bigger than their mac share, but still a minority. WIth a cheaper phone, I think they can do better than that. But I still think they end up less than 50% of the market and probably are not the leader in market share.

  4. Joel Hooper says:

    Interesting article, thanks Jason. As I saw your reply to Michael’s interesting comment I thought, “oh great, I can’t wait to see what he says about Michael’s point about cannibalization by a cheaper phone of their existing high-end high-margin iPhone sales”. But then I was to disappointed to see that you didn’t tackle the issue head on.

    Your view seems to be that even without reducing the size of the phone (to avoid the apps problems) that using “different materials in the case to distinguish the product lines” and “removing the retina display, front-facing camera, gyroscope” will make the models different enough to avoid cannibalization. That seems to me unlikely: with the combination of the iPhone brand with the cheaper price point Apple would have to reckon with substantial cannibalization, especially within the approx 20% of buyers earning <50K. Perhaps this is not enough buyers to cause concern given the high additional sales expected of the cheaper iPhone but it certainly is something to think very carefully about.

  5. Jason Grigsby says:

    @joel Sorry for skipping the cannibalization argument.

    I left it alone because if the on-the-record comments by Apple COO Tim Cook to a financial analyst that they are going to create a less expensive iPhone doesn’t convince people that it is happening, then nothing I say will.

    A less expensive iPhone is about as certain as any Apple rumor could be. So whatever they are planning on doing, they’re either not worried about cannibalizing their sales, or they’re looking at it like the iPod Nano where they intentionally cannibalized their own high end product to reach a broader market.

  6. I don’t want to seem like a fanboy, but in my mind, and a lot of people would agree with me, Android is far better than the iPhone in almost any aspect. I give Apple the retina display and the high quality build, but (to me) when comparing both software platforms Android stands a clear winner there.

    My point is: It all comes down to personal preference. and while a lot of people like Apple’s simplicity and ease of use, a lot of us prefer configurability, freedom and interoperability.

  7. Jason Grigsby says:

    @ivan I like Android phones as well. The Nexus S we own is awesome. It’s a growing market. Apple can have a huge hit and Android will still be doing well.

  8. Jake says:

    The iPhone is a gateway product for Apple, specifically for developers. So, even if they don’t normally compete in low margin markets, expanding the App Store’s addressable customer base is of paramount importance to keep the platform competitive with Android.

    Selling another unit matters less than adding a new app consumer.

    The lurkwarm market reaction to a CDMA iPhone will reenforce the need to move down in the market.

  9. Good article, Jason. Are you thinking US market share or worldwide? We discussed this in Dec based on my own article where I pegged Appke at 30-40% worldwide. At the time you thought I was nuts. Glad you came around :-)

    One comment: rumor is Apple sold one million devices in the opening weekend on Verizon. I wish I could be disappointed like that!

  10. Jason Grigsby says:

    @elia Worldwide share. I needed to see Apple start selling at lower price points to believe they could expand share. I wasn’t sure they would do so because the premium spot with a dominate share of the industry profits is a nice comfortable spot to be in.

  11. Jake says:

    One more thing :) If Apple produces a nano iPhone, carrier network quality may be a limiting factor.

    Roughly equating sales to activations, one million devices is a slightly above average weekend for Android. I think Apple (and definitely the media) expected a much bigger bump.

  12. @Jake: I didn’t say it was or was not disappointing. Verizon’s comments are that it wasn’t as they announced it as the largest opening weekend for a new device (to them) ever. All I said is that I would love to be disappointed like that :-)