June 16, 2008

iPhone Has Big Impact on Rivals

It didn't take Apple (AAPL) long to make its mark on the mobile-phone industry. In the first year after the introduction of the iPhone, Apple grabbed handset share from rivals including Research In Motion (RIMM), while AT&T (T), the only authorized U.S. provider of iPhone service, used the device to lure customers from Alltel and T-Mobile USA. Imagine the ripple effect of a cheaper, faster, more feature-packed version of the iPhone.

Not only has Apple whacked as much as $200 from the iPhone price and made it capable of working on a faster wireless network, but the company is also adding a wide range of software features that may make it more appealing to consumers and business users alike. The new iPhone is due in July.

To cope, wireless service providers are likely to increase their own mobile handset subsidies, boost marketing budgets, and reduce prices on some services, analysts and industry insiders say -- all likely to mean slimmer margins. Rivalry from Apple adds to the pressure on an industry already grappling with increased government regulation and competition from new players, including Google (GOOG), that threaten to loosen service providers' control of the market.

In the past year, U.S. wireless carriers had scaled back on the subsidies that resulted in lower handset prices in exchange for long-term wireless service contracts. But now that AT&T is boosting its subsidy of the iPhone, chances are other operators will follow suit -- especially on iPhone copycats. "Most people want the iPhone, just as they want the iPod and not some other MP3 player," says Gloria Barczak, professor of marketing at Northeastern University. "People want the real thing." Consumers will need an incentive to settle for something other than the iPhone, she says. The new iPhone 3G will sell for $199 to $299 with a two-year contract from AT&T.

Retaining Users

To persuade high-end users to stick around, carriers may also need to ramp up spending on wireless plan promotions. Verizon Wireless' ad spending rose 30% in the first quarter, according to ad consultancy TNS Media Intelligence.

Sprint Nextel's (S) ad budget fell 20% in the same period due to the carrier's financial troubles, but it may need to reverse course as the company looks to stem its subscriber losses. "They have to come out with a counter [to the iPhone] and play up their strengths," says Rich Nespola, CEO of consultancy TMNG (TMNG).

Another way to retain users is to offer lower service prices. In fact, here's one way competitors may have a leg up on AT&T, which has raised service prices for iPhone buyers as it tries to recoup the higher subsidy cost. "The operators are going to get very aggressive with pricing in the second half of the year," says Walter Piecyk, an analyst with Pali Research. "We could see 30% to 40% price cuts in the industry, [possibly led by Sprint]. If people are paying more for gas, saving $50 a month for wireless will be compelling." As a result, industrywide margins may slip to closer to 30% from the current 40%, he says.

Handset Headaches

Handset makers, currently benefiting from double-digit growth in the overall smartphone market, could have their share of iPhone-related headaches, too. While carriers are the ones that absorb subsidies, they can also step up pressure on their suppliers to cut prices on bulk orders. What's more, if iPhone sales surge as many analysts expect, market share for rival handset makers will erode. Motorola (MOT), which has failed to release many popular phones in recent years, may suffer more than others, says Ross Rubin, director of industry analysis at NPD Group. But Samsung, LG, and even Nokia (NOK) stand to lose as well. "Higher-end fashion phones will be most vulnerable," Rubin says.

Handset makers' software and development costs are also rising as these companies try to catch up with the iPhone's capabilities and graphics. HTC, whose Touch device has sold 3 million units in the past year globally, has developed special 3D menus, which turn looking through a contact's list into an experience similar to flipping through business cards in a Rolodex. "We want to take the touch experience to a new level," says John Wang, chief marketing officer of HTC.

The world's largest handset maker, Nokia, has been investing in Ovi, a suite of mapping, gaming, and photo-sharing Web services for its smartphones likely to better compete with iPhone's software offerings. "We'll continue to bring [new] service lines into the marketplace," says Bill Plummer, a vice-president at Nokia Americas.

Not "Apples to Apples" How long will the pain last? Hard to tell. It can take years for a blockbuster phone to peak. Motorola's legendary Razr series of phones was introduced in 2004, but didn't reach a crescendo until the first quarter of 2007, when it accounted for 12% of all U.S. cell-phone sales, according to NPD.

Nor will it be easy to determine how well these competing smartphones and iPhone look-alikes will stack up, analysts say. "The thing is, it won't be the iPhone," says Neil Strother, an analyst with JupiterResearch. "You are not comparing apples to apples."


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