Wednesday, August 13, 2008

iPhone Stalled En Route to China

Apple, once criticized for not being able to satisfy demand for the product, will on September 7 expand iPhone 3G sales to include Best Buy Mobile, a U.S. joint venture between Best Buy and UK-based Carphone Warehouse (Apple's UK iPhone reseller partner). Apple's production rate on iPhones is reported to have reached 800,000 per week [1], a volume to crush Apple's initial calendar 2008 sales goal of ten million units. Apple's list of countries in which the product is sold with carrier support for all its features (e.g., visual voicemail) is set to more than double, if the "Coming Soon" list is to be taken seriously. Apple's announced schedule calls for another twenty nations to move from "Coming Soon" to "Now Available" on August 22.

Between opening new stores, expanding sales outlets with third parties, and opening whole new jurisdictions to supported sales and service, one would not be embarrassed to conclude that iPhone sales represent a huge growth story for Apple, which barely over a year ago first entered the mobile phone market. Is iPhone 3G an unstoppabble train?

Alas, no.

Part of Apple's success with iPhone 3G is its price. The price, ironically, is also a barrier to Apple's access to the Chinese market.

iPhone 3G: Smaller Price Tag Than Prior iPhone
iPhone 3G sales now benefit from lower sticker price due to carrier price subsidies. Prior to the subsidy, buyers who took phones overseas for resale or use on unapproved carriers could make a business in phone resale, creating demand in official markets based on demand in non-target markets. In theory, this meant more handset sales; in practice, it meant also that Apple lost potential phone service revenue in its pre-subsidy carrier contracts. With service revenue sharing agreements a substantial part of Apple's expected revenues, post-sale use of handsets can impact Apple's profit from the devices. Under the subsidy arrangement, Apple received revenues up-front and bears no apparent risk of post-sale disappointment.

Apple must greatly prefer the security and predictability of the subsidy arrangement. However, it's prevented iPhone sales in China.

Why Can't Apple Sell iPhones in China?
With revenue sharing off the table, Chinese carriers can talk turkey with Apple about phone distribution agreements. It shouldn't require a degree in rocket science to figure out that the real sticking point in these negotiations is the money Apple must be paid by carriers for each phone it wants to put in a customer's hand.

So, why can't Apple sell an unsubsidized phone in China in the meantime? In the US, folks bought v1.0 phones to the point of sellout before Apple's $200 price drop. But, the price drop wasn't what you call a success. The price drop ... the infuriated customers indignant with a sense of betrayal ... the apology and $100 coupon ... not pretty. Apple came off looking like it had no idea how to price its products, and it was seen as punishing early adopters while doing so.

This may explain why Apple doesn't itself sell an unsubsidized 3G phone in China while awaiting carrier agreements.

Eventual carrier subsidy agreements would have the effect of dropping the phone's price. Unsubsidized self-paid buyers will not receive a discount on paid minutes merely because they didn't buy the phone with their service, and Apple will have no leverage to negotiate a subsidy with its carriers over phones sold prior to the agreement, and independently of the carriers' services. Chinese carriers can't be expected as a class to be less greedy than carriers elsewhere, can they? So when the subsidy agreements begin in China, the effect on customers will be a price drop, and Apple will face the anger without having the benefit of subsequent recoupment from carrier revenues.

Apple's addition of countries -- in some cases, more than one carrier per country -- to its list of places Apple's phones can be bought with vendor support is likely to continue. However, as appealing as some of those places might be, the big-footprint growth that is not on the list is pretty significant: China and Russia. While Apple doesn't reach an arrangement with carriers serving either country, Apple will be unable to make ideal revenues from either. So long as Apple imagines a subsidy arrangement being worked out, it will hesitate to try selling unsubsidized phones due to the price-drop backlash. So long as no supported phone sales exist, demand will be met by gray market efforts to bring phones into those jurisdictions.

While Apple stands willing to offer unlocked, unsubsidized phones in jurisdictions requiring separation of phone sales from service contracts, it would seem Apple might want to make hay while the sun shines by selling phones under the same terms in jurisdictions where carriers seeking to out-deal Apple are not getting with the program.

Particularly if Apple is already opening stores there.

On the other hand, if Apple is looking for the high-volume sales and doesn't imagine satisfying them through a small handful of new retail stores, perhaps the decision to sell from such stores would be insignificant. Apple's sales of all products through all channels to China and Russia are pretty slim as a fraction of all Apple product sales, suggesting that the existing channels -- Apple does have some official resellers in China -- are just not up to the task of such a high-volume business. Given the training apparently required to be able to oversee phone activation, dropping iPhones on computer resellers isn't a plausible option.

So, what's Apple to do?

[1] Present production volume may represent pre-launch stock-up volumes in advance of new jurisdiction roll-outs, and may not represent anything like normal sales volume. Remember, numerous countries launch later this month.

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