Apple iPhone: Successes/Challenges

The Apple iPhone is easily the most publicized new mobile device in recent memory. But despite all the discussion about the product, there’s relatively little hard information available to the public on its impact. How is it being used? What effect is it having on customers and on the technology industry?

To help answer those questions, my company, Rubicon Consulting, conducted a detailed survey of 460 randomly-selected iPhone users in the US. This report summarizes the findings from the survey, and what they mean for users and other companies.
Here are some of the key findings:

• iPhone users are very satisfied. The iPhone users we surveyed report very high levels of satisfaction with the product. They are using its features extensively. (Page 12.)
• E-mail is the #1 function. The most heavily used data function on the iPhone is reading (but not writing) e-mail. (Page 13.)
• The iPhone increases mobile browsing… More than 75% of iPhone users say it has led them to do more mobile browsing. (Page 14.)
• …but it has drawbacks. About 40% of iPhone users say the iPhone has trouble displaying some websites they want to visit. (Page 25.)
• The iPhone is expanding the smartphone market. About 50% of iPhones replaced conventional mobile phones, 40% replaced smartphones, and 10% replaced nothing. Among conventional phones, Motorola Razr was the phone most often replaced. Among smartphones, Windows Mobile and RIM Blackberry were most often replaced. (Page 19.)
• A third of iPhone users carry a second phone. There have been anecdotal reports of iPhone users carrying a second mobile phone, either for basic voice calling, or for other functions like composing e-mail. The survey confirmed those reports. (Page 20.)
• A quarter of iPhone users say it’s displacing a notebook computer. 28% of iPhone users surveyed said strongly that they often carry their iPhone instead of a notebook computer. (Page 22.)
• Users are young. About half of iPhone users are under age 30 (page 29) and about 15% are students (page 31).
• Apple sells to its installed base. At least 75% of US iPhone users are previous Apple customers — they used either iPods or Macintosh computers. (Page 28.)
• The iPhone increases phone bills. The iPhone has increased its users’ monthly mobile phone bills by an average of 24%, or $228 extra per year. (Page 17.)
• The iPhone leads people to change carriers. Almost half of iPhone users changed carriers when they got the iPhone. (Page 18.)
• AT&T’s gamble pays off. The iPhone has probably increased AT&T’s gross service revenue by about $2 billion per year. (Page 4.)

Implications

What do these findings mean for the mobile industry and mobile users, and what will happen next?

Can Apple reach beyond its early adopters?
The survey showed that most iPhone users are relatively youthful technophiles; half are under age 30, and a third of them even carry more than one mobile phone. This group of customers is great for launching a product, but there aren’t enough of them to create sustained growth. The biggest question about the future of the iPhone is whether Apple can reach beyond the early adopters to generate substantial amounts of mainstream demand for the iPhone.
Apple has a history of doing that successfully with products like the iPod, but that was much more narrowly focused on a single usage — it was a mobile appliance rather than a mobile computer. The iPhone’s multiple features make it very appealing to technophiles, but potentially confusing to mainstream customers. The history of the mobile industry is littered with products that sold well at first but then fizzled out. Although the iPhone’s future looks very promising today, its long-term success is not guaranteed.

A good example of how to grow adjacent markets
Apple’s growth in the last ten years is a case study of growing a company through expansion into adjacent markets. Apple leveraged its Macintosh installed base to establish the iTunes music store, and then built the iPod business on top of that. iTunes and the iPod enabled Apple to renew its franchise with young people, and attracted millions of Windows users into becoming Apple customers.

Now Apple is leveraging both the Macintosh and iPod customer bases to kick-start the iPhone. More than half of the iPhone customers we surveyed are iPod owners, and another 25% use Macintosh computers. Apple’s large and very loyal installed base makes it much easier for the company to branch into a related market.
The lesson for other companies is that satisfying customers is about a lot more than just selling them upgrades of what they have today. Managed properly, a loyal user base is also a springboard for creating new businesses.
AT&T made a good choice
When AT&T decided to offer the iPhone, some people in the mobile industry criticized it for making too many concessions to Apple. The terms of the Apple-AT&T deal have not been released to the public, so it is impossible to judge its precise effect on AT&T. But based on the findings of our study, it looks very likely that AT&T made a good decision.
AT&T gains services revenue from the iPhone in two ways. First, the iPhone increases the average monthly phone bills of existing AT&T customers who switch to the iPhone. Second, because AT&T is the exclusive carrier for the iPhone in the US, it causes some people to switch from other carriers to AT&T.
Based on the findings of the study, AT&T is probably getting about $2 billion in incremental yearly service revenue due to the iPhone deal, and that figure will increase as more iPhones are sold.

Here’s how the $2 billion figure was calculated:

An unannounced part of that revenue gets shared with Apple, so not all of it goes to the bottom line for AT&T. But it is still a substantial source of growth in a US mobile phone market that is saturating, and doesn’t have many new users available.
These numbers mean the iPhone probably accounted for a substantial proportion of AT&T Wireless’ total new subscriber growth in the second half of 2007.

A shift in power
Traditionally, mobile operators have controlled the decisions about which phones will be offered to users. The success of the iPhone in getting people to switch operators in the US shifts power away from the operators and toward handset companies that can demonstrate the ability to generate demand. A company with that power has enormous leverage over the operators, because it can play them off against each other.

However, Apple’s type of product design is incredibly difficult for most other companies to imitate, because they don’t have expertise in tying together OS, user interface, online services, and hardware design. The path to success in smartphones is clear, but it’s not clear how many companies have the skills to walk it.

The resurrection of the notebook replacement
In the early days of the PDA market, many people predicted that PDAs would replace notebook computers. By and large, it didn’t happen; a PDA was not a good enough substitute for the core things that people did with notebooks. So we didn’t expect to hear that iPhone users were replacing notebooks. But to our surprise, about a quarter of iPhone users strongly said that they often carry the iPhone instead of a notebook computer.

This statistic deserves watching. As the iPhone attracts mainstream users, will they be less willing to replace a notebook with something else? Or will the availability of third party software for the iPhone make it an even more attractive notebook replacement?

The iPhone has been viewed as a way for Apple to attack the mobile phone market, but it and its sister device, the iPod Touch, might also turn out to be a back door opportunity to take a chunk out of the PC notebook market. The PC companies should take notice.

A glass that’s half full for software developers
About 40% of the iPhone users surveyed said strongly that they want to add new software applications to their iPhones. This is both encouraging and a caution for software developers. The good news is that there’s a lot of demand for add-on applications, even before the iPhone software store opens this summer. That demand will only increase as store begins operation. The caution for developers is that current iPhone owners are tech-loving early adopters, the most likely people to demand new software. Even among those users, a third showed at best lukewarm interest in adding new application. That percentage will probably increase as Apple reaches out to more mainstream customers. Developers should absolutely not assume that the whole iPhone user base will be on the market for third party apps. Unlike PCs, many iPhones will never get a third party application added to them.

What the iPhone means to competitors
To Microsoft: Severe challenges. Microsoft’s Windows Mobile is sandwiched between two big competitors, Google and Apple. Apple is crafting hardware-software systems that deliver a great user experience, while Google is giving away an operating system to the very companies that license Windows Mobile today. It’s possible for Microsoft to try to compete on both fronts, but creating a proprietary device and at the same time selling an operating system to others is extraordinarily difficult (Palm tried to do it and ended up splitting the company in two).

We think Microsoft should probably decide whether it wants to compete in devices (in which case it will need to create its own phones, as it did for music players with the Zune) or compete in operating systems (in which case it will probably have to give away Windows Mobile for free).

Both alternatives are very high-risk, and require business models that are outside Microsoft’s core competencies. The company’s recent purchase of Danger, which designed the TMobile Sidekick, may indicate that it intends to go the device route.

The partial collision of Apple and RIM.
Apple and RIM approach the smartphone marketplace from very different perspectives. Apple’s device is entertainment-centric and, as this survey showed, it sells to young people. RIM’s devices are communication-centric and have traditionally sold to businesspeople in a higher age bracket. There has been a lot of media speculation of a smartphone war between RIM and Apple, but actually they occupy very distinct territories in a highly segmented market.

But each company wants to grow into the other’s space. RIM has been adding entertainment features and consumer-friendly designs to its product line, while Apple has promised to add Microsoft Exchange compatibility to the iPhone. This will create more competition between the companies.

If Apple really wants to target RIM, though, it will need to create an iPhone with a thumb keyboard, something that Steve Jobs has spoken against in the past. We don’t think RIM would be wise to try to enter the entertainment market against Apple; the infrastructure investment would be too large, and besides RIM’s brand image is all wrong for that. RIM would be much better served to defend and grow its business market by adding more types of business communication to the Blackberry, such as videoconferencing, whiteboarding, and business travel functions.

Will Apple and Nokia compete, or just divide the world?
The iPhone is very strong in the US, but its sales in Europe have been less effervescent. Nokia is very strong in most of the world’s mobile phone markets, but is just another phone company in the US.

Although Apple clearly hopes to sell the iPhone outside the US, and Nokia definitely covets the youth market that Apple dominates, the real battle between them has yet to happen. Each company faces significant challenges when playing on the other’s turf. The iPhone doesn’t yet take advantage of the 3G data networks in Europe and elsewhere, the company doesn’t own an extensive chain of retail stores outside the US, and the strength of the Macintosh business varies from country to country. That makes it much harder for Apple to duplicate the intense buzz that the iPhone generated in the US.

Nokia’s challenges are more about process. The company’s habits and business practices are all optimized around producing hundreds of millions of mobile phones a year quickly and at low cost. The sort of hand-crafted hardware-software integration that Apple does has no place in Nokia’s system. But without it, Nokia will be very hard-pressed to match the iPhone’s user experience.

Changes to watch for
New form factors. The market for mobile data devices has always been heavily segmented, so it’s impossible for a single hardware design to please everyone. The iPhone users we surveyed confirmed that — 43% of them strongly supported making at least one major physical change to the iPhone: making it larger or smaller, adding a keyboard, or adding a keypad.

Undoubtedly there are also other customers who want those features so badly that they haven’t bought an iPhone at all. This is an opportunity for Apple to increase its sales by serving those customers, or it’s an opportunity for competitors to steal share by addressing segments that Apple’s not serving.

Better browsers. The improved, more PC-like browsing experience of the iPhone is clearly one of its major draws. But as the survey respondents pointed out, the iPhone browser fails to properly display a lot of websites, most notably those using Adobe Flash. About 40% of iPhone users said the browser has trouble displaying some web pages they want to visit.

Apple and Adobe are feuding in public over whether and how Flash can be made available on the iPhone. The dispute punishes users and is damaging to both companies. It’s also an opportunity for Apple’s competitors. Until and unless Flash becomes available on the iPhone, another mobile company might be able to steal away iPhone customers by creating a better browsing device. Apple needs to continue improving the iPhone browser, and that means settling its dispute with Adobe.

For other mobile companies, we think there will be intense pressure to ship more PC-like browsers, especially in devices that have larger screens. Although many very smart observers of the industry have pointed out that the mobile web would work better if it were reformulated for small screens, that process will take years, and in the meantime a lot of mobile users appear to be willing to pay extra for mobile access to the PC web, even if it’s a little awkward. Smartphone companies that fail to deliver good browsing risk being ignored by mobile operators and users.

You can download the full research in this whitepaper: iPhone survey whitepaper v2.

(This post was originally posted on my company’s website, Rubicon Consulting, and co-authored with Micheal Mace, a principal who worked for me at Rubicon.)