Apple fumbles 3G iPhone Launch?

Let me get in my time machine for a second.....

Apple predicts that it will ship 10M iPhones within a year from it's July 2007 launch.

Apple ships about 5.7m iPhones (by multiple analysts conclusions) before supplies mysteriously begin to dry up in late March. By early May, even New York City has no inventory and a line for iPhones starts forming.

April 2nd, Henry Blodget at the Alley speculates that non-authorized international demand is consuming 'buffer inventory' and driving the shortage.

When Apple first introduced the iPhone 1.0, they could ship it 30/60/90 days post-announce because they had no shipping revenue product to stall.  You really don't want to induce a revenue stall in a shipping product if you can avoid it, however Apple learned the hard way that you also don't want to anger your installed base of loyal/feral customers as they discovered with the iPhone price drop.  So, you end up walking a fine line between angering your customers with lack of supply (or over-supply of new models) and angering Wall Street with periodic flatlines in your revenue stream.

The answer is to gracefully manage product transitions.  This is an art form in itself, in the timing of messaging transitions, moving manufacturing lines, selling off inventory, upgrade and price protection programs, and the like.

Apple seems to have been caught in a perfect storm of unanticipated demand (Blodget's article about Europe) that they needed to quickly react to in the form of temporarily increasing the production line of iPhones so they could gracefully trickle out of them about May 30th....just in time to release the iPhone 3G and open up the larger price-sensitive and 3G-hungry market, and a new product introduction when they need to ramp down production of the older model in favor of the newer one.

So, do you ramp up or ramp down?  Do you flatline sales of your iPhone line for 75 days during a key fiscal quarter (Summer/graduate presents) or do you enable your overflow production lines and meet demand at the risk of price-protection/exchange/returns exposure on your bottom line for a percentage of the customers who buy in May?  It reads like a loaded MBA mid-term question from a sadistic professor who enjoys handing out 'C' grades to all students.

It appears Apple chose to flatline.  I don't envy the beating they will take from Wall Street for this fumble, even though every Wall Street Analyst is slobbering over themselves today to say how much of a fait accompli the 3G iPhone is to wrest the title from the Blackberry for #1 in sales.  I wonder how they will balance the stick and carrot of beating them for the quarter stall while praising them for the new product.

And it isn't an inevitability that Apple will more than address the revenue shortfall with the 3G iPhone.  Even if Foxconn can overcome their initial production issues and achieve their 10M unit number, the revenue and profit per unit of the $199/$299 iPhone 3G are abysmal compared to the initial 1.0 iPhone at $499/$399.  We used to have a sarcastic punchline back in the early Cisco IP Phone days..."We'll sell it at a loss but we'll make it up in volume!"

It could be worse, you could be the product manager at eTrade who announced yesterday the new eTrade Mobile Pro trading platform for mobile devices, exclusively for the BlackBerry.

Comments

[Greg Pelton]

It's always fun to see an old-world former product manager from a non-consumer company try and apply his MBA knowledge to a marketplace they really don't understand.

Let's break down your points:

1) Apple angered the loyal fans with the $599 to $399 price drop. Maybe a little bit, but wasn't it a fun experiment to really see how much the Apple fanboys would pay to be the first on their block with the new toy? And don't innovation leaders deserve to command higher profits?

2) Apple mismanaged the product and Wall Street will ding/crush it. Well, the stock is up from $120-180 in the last year (since iPhone 1.0), a 50% increase. It took a beating in Feb/Mar back to $120, but is now back without any significant news about iPhone. Sounds like they not only managed the business & share-price well, but there was a buying opportunity at $120 for the savvy investor.

3) The new revenues and profit margins are worse than before. Since you didn't provide any actual analysis of this, let's dig into the numbers a little bit.

iPhone 1.0 COGS are between $229-$289, depending on your sources and amount of memory. So that puts the Gross Margin at around 50%/phone (call it $200).

iPhone 2.0 COGS are being discussed at $170 (initially) and quickly ramping to $100 at volume. So GM will be anywhere from 33% to 50%, with the bulk being at 50%.

So far...margins will basically be a wash.

For revenues, you're now opening up the market with 3G, and moving from (officially) ~5 countries to 70 countries. Considering the existing demand, it's not a stretch to assume they will easily surpass the 10M phone expectations.

So let's call revenues a wash at this point too (at 10M phones)

Now let's look at the annuity piece of this. AT&T used to kick-back $12-18/month of the data-plan revenue to Apple. So that's $144-216/phone/year. Apple will now be getting $200/phone up front as a subsidy. Basic NPV calculations show us the $200/now is worth more than the monthly annuity. Granted it's a one-time revenue per phone, but I don't think anyone actually believed that Apple was going to get that data-plan annuity in perpituity....did they?

And that brings us to Apps and MobileMe. Apple get 30% of App revenue. They get 100% of MobileMe revenue. Their additional cost to run these services is almost nothing, since it can sit on top of the iTunes and .Mac infrastructure already in place. So that's essentially gravy.

At the end of the day, all of the analysis about product transitions and price protection might hold true in established businesses. But we're not talking about those markets or those products. We're talking about redefining mobile computing and communications. It requires a new type of thinking. It requires a company like Apple to be willing to create some new rules and take chances.

[Randy Sisk]

Wow, Slam!
Hey guys, what's your read on purchase of the 3G. Should I wait for a rev or two or dive in now?

[Christian Renaud]

Greg (well, not actually Greg, because Greg called first thing this morning upset about an imposter, so I will ask nicely in the future that you use your actual name when commenting),

Good points all actually. I stand corrected in a few areas, however want to push back on some of your other analysis.

1) Apple angered loyal fans. Yes, the early adopters knew the risk they were taking however when Apple did the price decrease shortly after launch (either as part of a two-stage pricing strategy or as a reaction to slower than anticipated demand due to price pressure), they also had to bow to popular sentiment and issue credits to early purchasers to stem the ill will they had engendered in their fan base. Consumer or Enterprise or Service Provider, pissing off your most loyal early adopter customer base = bad idea. In fact, pissing off any customers = bad idea generally.

2) Apple's stock price. Yes, it will be interesting to watch how the street reacts to the flat spot in the earnings announcement. As I said, it should be a balancing act between punishing them for the stall and lauding them for the new product which should ship considerable volumes.

3) Your analysis is impressive, and contains some information that I hadn't seen before. All the cross-subsidizing is coming to an end as you had anticipated for the 3G phone, so then it will be a 'long term' plan of subsidizing the GMs on the hardware sale with the app store and the conversion from 'sell high margin phones' to 'sell low margin phones and make it up in software sales'.

This should be a long-term net win for them if the applications don't fail to meet the high expectations of the customer base. It won't, however, address my initial blogpost point of shoring up the shortfall from the revenue stall in time to round off the quarterly numbers for Apple. No argument, it will be a long-term profitable product for them (which legions of consumer-steeped MBAs can tell you) as they will be able to reach a broader installed base for app upsell. So, long term gain, short term loss.

The initial argument of the blogpost is that Apple mis-handled the product transition, which you didn't address with all of your firework analysis (which I recognize as smelling distinctly of a past-employee of mine). Yes, they are revolutionizing the way the mobile app business is done, which is impressive, however that doesn't forgive the inelegant way the transition is/was done.

As to Randy, if you have 3G in your area, I'd do it. It seems solid, and the early hands-on reports say that the reception is much better than the 1.0 iPhone, which is a problem that has plagued me.