Verizon Needs The Apple iPhone More Than Apple Needs Verizon

Verizon Needs The Apple iPhone More Than Apple Needs Verizon 

The Set-Up

Verizon and AT&T are "dogs of the Dow." The two companies are like giant sequoias duking it out for root space, each attempting to grow and spread its roots in the cellular space occupied by the other. Combined the two companies control almost two-thirds of the domestic market for cell phone services (based on subscriber totals) and both companies are attempting to quickly transition from traditional landline service providers to preeminence in wireless products and services. Both companies pay rich dividends, both companies are under performing for shareholders, and only one has the Apple iPhone.  Which one? AT&T. The company that's on the cusp of replacing Verizon as the #1 wireless services provider in the nation.

AT&T ended the June quarter with 90.1 million wireless subscribers, adding 1.6 million net subscribers. Verizon ended the June quarter with 92.1 million subscribers, adding 1.4 million net subscribers.

It's not a coincidence AT&T's emergence as a rival for the top spot (and the company's resurgence as a leading wireless services provider) has occurred while having an exclusive contract for voice and data services for the Apple iPhone.

The Verizon Rumors and Speculation

The rumors and speculation about iPhones for the Verizon network have picked up again. Last November I made the case a deal with Verizon for the iPhone was all but inevitable suggesting the end of 2010 as the ideal target date.

On Friday Philip Elmer-Dewitt in an Apple 2.0 column, referencing John Gruber's argument for a Verizon iPhone by January, has fanned the flames of speculation a Verizon deal will occur by early next year. To his credit PED (the initials by which Philip is commonly referred on the Apple Finance Board) has been consistent in reporting on the persistent iPhone on the Verizon Wireless network rumors since they first began. 

These serial rumors are as old as the iPhone itself due to Apple's early acknowledgment Verizon was provided a first look at the iPhone and passed on the offer to be the exclusive domestic carrier before Apple crafted its relationship with AT&T. Verizon's decision to pass on the iPhone is one the most talked about tech industry blunders of the past several years. 

No matter Verizon's efforts to turn the tables on Apple and force an iPhone deal through the high-profile launch of the Android-based Droid and repeated public attacks on the perceived poor quality of the AT&T cellular network, a deal with Apple for the iPhone has remained elusive. 

Why Verizon Needs The Apple iPhone More Than Apple Needs Verizon

It's common when people speculate on an iPhone deal with Verizon (or Verizon Wireless - the joint venture between Verizon Communications and British-based Vodaphone Group of which Verizon owns a majority stake) to mention how much a Verizon deal would benefit Apple. Few people mention the benefits of an iPhone deal for Verizon. Perhaps it's an implicit understanding Verizon needs the iPhone and I believe Verizon needs the Apple iPhone far more than Apple needs Verizon. 

iPhone 4 supply is constrained on a global scale. Apple, a company I forecast to achieve $65 billion in revenue in the fiscal year ending in September, can not manufacture enough iPhones at this time to meet demand. Verizon deal or no Verizon deal, the iPhone remains an extraordinarily popular product. In the 2nd calendar quarter AT&T activated a record-breaking 3.2 million iPhones on its network. While a Verizon deal is widely expected to increase demand for the iPhone, until there's sufficient supply of iPhones increased demand doesn't sell a single phone. 

In a subsequent column also published on Friday, PED references a ChangeWave Research report that indicates 31% of current US iPhone owners would likely switch to Verizon if an iPhone deal was consummated between the two companies. But it's of little interest to Apple to consummate an iPhone deal with Verizon just so iPhone owners can change carriers for their next contract. Rather, PED's column illustrates how much Verizon needs the iPhone in order to grow and maintain the #1 position among domestic wireless service providers. 

Apple isn't interested in a Verizon deal to pick up more demand. Apple's interest in a Verizon deal is for Verizon to deliver its best Wireless customers to Apple and do so in a way that siphons handset revenue from the Android market and creates post-purchase revenue opportunities from a predominant position in the three-way relationship with the customer. 

An Apple Shareholder's Perspective: Thank you, Google!

This week Federal regulators cleared Google's purchase of AdMob based in part on Apple's recent acquisition of Quattro Wireless. While much is being made of some kind of Apple vs. Google rivalry in the smartphone market, journalists and the media continue to miss the point.

Apple has a fully integrated iPhone OS economic model. Everything from the handset to the OS to the digital store offering commercial content flows through Apple. The company's emerging iAd service further advances Apple's monetization of the handsets the company makes. The popularity of the iPhone and continuing market share gains was pushing Apple towards a precarious perch. The release of the Apple iPad and the aggressive nature of Apple's iPhone OS monetization model was also bringing Apple's influence in its product markets into public view and under scrutiny. Further, Apple's decision to forego Flash integration raised the ire of regulators and heightened concern over Apple's control of the economics in the digital handset market.

Google's combative approach to Apple in the smartphone market has begun to allay concerns about Apple's economic influence and for all of the bravado and tough talk recently from Google it doesn't in any way impact Apple's success. Rather, Google's approach of positioning the Android as a successful competitor to the iPhone will ultimately work more to Apple's favor than it will enrich Google. The more Google focuses attention on its presence in the smartphone market, the easier Apple can maneuver freely to advance its monetization model.

Google has successfully convinced the public there's a competitive market in smartphones that may not exist to the extent Google would have it appear. For all of the adrenaline pumping persuasion, Google is doing Apple a huge favor.

The Android market is fractured among multiple handset makers each vying for sales and market share. While the Android market is wholly dependent on Google, the company will not be able to deliver the economic goods handset makers need to establish a margin-rich presence in the marketplace. For handset makers it's a matter of picking your poison. 

One of the reasons a Verizon deal for the iPhone did not work is because of Verizon's penchant for controlling the branding presence of the customer relationship. AT&T yielded to Apple. The iPhone is preeminent in the relationship with the carrier and the customer. Google, for all of its hard work, will not be able to position the Android in a way that's preeminent in the relationship with the carrier and the customer. It's impossible to accomplish absent being a handset maker in the market and without greater control of the user experience.

The Android user experience will vary by handset, by software version and to some extent by carrier. There's no way for Google to avoid this trap. Commoditization of the Android handset market is a present danger. Without participation in after-purchase revenue streams handset makers are left in the third position in a three-way contest for revenue with Google and the service providers. It's similar to the plight of Windows PC OEMs seeking acceptable margins in a highly competitive market for unit sales. Hardware differentiation is challenging at best with Google branding its OS, carriers continuing to brand their services and seeking to lock in customers to long-term contracts regardless of the underlying handset being sold. Carriers have choices in the handsets they sell and offering an Android product does little for the manufacturer in an increasingly crowded field.

Google's aggressive attacks on Apple in positioning the Android illustrates the inherent weakness in the platform. If Google's approach is to position the Android OS for what it's not (an iPhone), it leaves unanswered the question of what an Android phone is for potential customers. Realistically it's the only practical approach in an environment in which Google can not wholly control the quality of the user experience and must grapple with a hodgepodge of handset makers each seeking to lower costs in competition with one another. Google will spend lavishly on Android advertising and marketing but several questions are left unaddressed. For example, how does Google plan to challenge Apple and RIM in the enterprise market and how does Google plan to compete with the 800 lb. economic gorilla in the room? Microsoft and Google are locked  in an economic war with points of conflagration in each major market in which the two companies compete.

Android has become a smoke and mirrors campaign to obfuscate one otherwise glaring fact. Android is a stop gap as Google works to deliver Chrome. For all of the bravado and tough talk, a one product strategy can't deliver the revenue solution Google needs. Apple's multi-product iPhone OS monetization model is at least two years ahead of what Google can deliver.

In the meantime with Google convincing the media, the public and even regulators the Android presents real competition to Apple, the folks in Cupertino will continue building the company's multi-product monetization model unfettered by perceptions of competitive concerns. 

The iPad: Apple Turns Back The Hands of Time

I remember 1995 and the rollout of the version of Windows that had a reference to that year in its product name. The demand for the then latest version of Windows was huge. Demand was huge less because of the benefits it brought to the computer user who chose to upgrade to Win 95 or who chose to purchase a new PC with it installed and more because of the economic benefits it brought to software makers, component and peripheral makers and Windows PC OEMs. There was a huge economic effort orchestrated by Microsoft to create demand for the OS upgrade and new PCs. It worked.

In one of the biggest blunders in Apple corporate history, Michael Spindler, Apple's CEO at the time, insisted on releasing premium-priced Macs with 680X0 Motorola processors at the expense of the new line of PowerPC Macs that were in strong demand. In my view Windows 95 was not a particularly good upgrade to Windows. But it was "good enough" to sell Windows PCs while the Mac products consumers wanted were in constrained supply. 

It's now fifteen years later and Apple is releasing the Apple iPad beginning Saturday. There are a variety of lessons that could have been learned from the rollout of Windows 95 and it appears Apple has learned the lessons that matter most. It was the "Performa blunder" that eventually led to the return of Steve Jobs to the company and with his return a renaissance for the company.

Among the first steps taken by Steve Jobs and his new management team at Apple in the one of the greatest turnarounds in US corporate history was the abandoning of projects that sapped resources and the elimination of shipping products that deviated from the desired core product competencies of the Mac maker. Apple made things much more simple. Gone were the three-page foldouts of Apple product choices that only confused consumers and gone were products that competed directly with offerings from potential eco-system partners. 

The Apple iPad is coming to market with consumer awareness of a new hardware device not seen since the release of the original Bondi blue iMac in August 1998. The iPad, though a new product line, is building on the success of the Apple iPhone and iPod touch. Unlike the original iPhone which debuted as a new competitor in an existing smartphone market, Apple is defining the tablet market and is pricing the iPad aggressively to thwart early competition. 

The iPad will leverage not only Apple's retail store infrastructure by increasing foot traffic to the retail stores and resulting increase is sales of Apple products, it will also leverage the developer investment in existing iPhone OS apps. Where the iPad will add new dimensions to the Apple product eco-system is through the expansion of that eco-system to include ebook publishers, magazine and newspaper publishers as well as game developers desiring to create product for the iPad's tablet-sized screen. The iPad is to the handheld device market what the home theatre concept was to the marketers of TVs and related products. The Apple iPad provides an immersive experience that can't be rivaled by today's smartphones or netbooks. The revenue streams the iPad will create for app developers and publishers of content for consumer consumption may eventually dwarf the revenue to Apple from iPad hardware device sales. Further, due to the nature of the iTunes sales environment, Apple will be increasing the flow of dollars to its own coffers from distribution fees.

Through the release of the iPad Apple is turning back the hands of time and delivering a product that is not only the foundation for the next generation of computing devices, it's eviscerating the last vestiges of one of Apple's biggest corporate blunders. In the absence of delivering to consumers the products consumers wanted at the time, the OS that was "good enough" by comparison created an economic empire for Microsoft and the company's OS product dependents. Fifteen years later Apple is positioned to create a dominant eco-system that will supplant the Windows PC and its related products and reign for at least the next few years as the driving force in the delivery of apps, games and content to consumers.

Next week I'll post my estimates of iPad unit sales for the balance of Apple's 2010 fiscal year and look at the expanding eco-system supporting and expanding the markets for iPhone OS-equipped digital devices. 

Acer: Apple's Unintended Ally

Acer Inc., the Taiwanese maker of popular netbooks and other computing products, recently surpassed Dell Inc. as the world's #2 maker of PCs. While Dell has seen continuing weakness in its consumer product sales, Acer has become the world's fastest-growing PC maker in part due to success in the PC market in which Dell is most challenged.

Acer sells PC products under four brand names: Acer, Gateway, Packard Bell and eMachines. The Gateway and eMachines brands up were picked-up when Acer purchased what remained of Gateway in 2007 and the company acquired Packard Bell in early 2008. Through these acquisitions Acer picked-up the remnants of failing PC makers and took possession of brand names with perceived value in various global markets.

Acer operates on razor-thin margins. Gross margins on products sold are around 10%, less than 1/3 the margin Apple commands on its products. To maintain success the company must grow unit volume. Acer may soon become the world's leader in laptop sales and eventually challenge HP for the global top spot in total PC shipments. At low margins unit shipments become all the more important.

How does Acer's success benefit Apple?

Acer has become the successor to three defunct computer makers: Gateway, eMachines and Packard Bell. These brands have become nameplates for Acer's inexpensive PC products. The different nameplates are used in the regions in which the respective brands maintain the greatest strength. By creating one central enterprise (including Acer's own branded product) the company continues to push PC prices lower and is essentially clearing the field of competitors in the PC market.  

In 2008 Acer recorded revenue of $16.65 billion and net income of $358 million. The company is targeting $30 billion in annual revenue as the company's goal. To achieve this ambitious goal the company is moving into smartphones in a more substantial way and is moving away from Windows Mobile in favor of Android-based phones. In the PC market the company will continue to drive down costs to protect its 10% margin while gaining as much unit volume as possible.

Acer's aggressive growth plans will make it challenging at best for Dell to remain in the consumer market. The company's successful focus on netbooks is also redefining the way people choose and use laptop PCs and is unwittingly eroding the market for more expensive portable Windows PCs. 

Acer has become Apple's unintended ally in furthering Apple's effort to undermine the PC-centric model. This is not good news for Microsoft but it is good news for Apple. Acer is clearing the way for the much-rumored Apple tablet which is expected to arrive in a small form factor with constant connectivity. It will also feature access to over 100,000 low-cost/no-cost iPhone OS apps. 

Acer will continue to devour competitors in the PC market with low-cost, low-margin netbooks and laptops leaving a gaping hole for an Apple-designed tablet with unique functionality to fill the middle ground between the limits of a netbook and Apple's higher priced laptop line. 

The Droid

Accompanied by an expensive ad campaign, the Droid has hit the market. It's a step up in the continuing market migration to smartphones and products available for consumer purchase. But it's not an "iPhone killer" and any effort to position it that way will lead to disappointment and may actually be a disservice to the product and works against its consumer adoption.

In my view Verizon is miffed. The company's primary competitor, AT&T, is taking market share via of the iPhone. The problem Verizon has created for itself is positioning the Droid in its ads to compete directly with the iPhone. A better approach would be to release the Droid based on its merits as another smartphone option for consumers.

Verizon does not have a lock on the Android smartphone market and will be competing with other smartphone service providers offering similar fare. The loser in the market isn't Apple and the iPhone, it's first Microsoft and the Windows Mobile platform and to a lesser extent RIM and the BlackBerry line of products. Apple is gaining ground on RIM and Windows Mobile is losing share by the minute.

Android 2.0 offers a compelling list of features. For consumers choosing to remain tethered to Verizon as a primary determiner in choosing a new smartphone, the Droid with Android 2.0 may be an attractive choice. But I don't think it will materially slow defections from Verizon to AT&T this quarter by consumers interested in the iPhone.

I think Verizon has made a huge marketing mistake in choosing to position the Droid in direct competition to the iPhone. It would be more effective in my view to position the Droid for everything it is, not what it isn't. The direct comparison has done little more than alert consumers the iPhone isn't coming to Verizon anytime soon. The ad campaign is as apt to sell more iPhones for AT&T as it is to sell Droids to existing Verizon customers.

Android 2.0 will be available on a number of handsets offered by multiple service providers. Price competition is inevitable. Verizon at this point is doing nothing to position the Droid effectively in what will be a highly competitive environment between carriers offering similarly featured phones. There's less wrong with all of the coming Android-based phones than there is in the way Verizon is positioning the Droid.