The Impact of Apple's iPhone on the UK Market

| About: Apple Inc. (AAPL)
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Apple's (NASDAQ:AAPL) iPhone has nearly arrived on the UK shores and there are a few twists in the UK flavor compared to the US flavor. Now that we have the pricing and distribution details confirmed it is worthwhile looking at the potential impact on the UK market.

Volumes

Apple's stated aim is 10 million iPhones shipped in the first twelve months. A few weeks ago, Apple announced the first million iPhones, so they have 9m to go in around 9 months.

I am assuming that take-up and targets will be roughly in line with overall country population. My estimation of the total market is around 550m based upon the current population estimations in Wikipedia (USA-302m, Germany-82m, France-61m, UK-61m, Spain-45m). This gives ball park figures for the next nine months sales as Germany-1.3m, France-1.0m, UK-1.0m, Spain-0.7m, USA-4.9m (plus 1m already sold).

It will be extremely hard to track these sales on a country by country basis as inventory at the operators will have to be factored in and I would be surprised if most operators separate out iPhone sales from normal contract sales.

Undoubtedly, Apple will also roll out across the EU during the year and a big notable exclusion from the current list in Italy with a population of 59m. Also, T-Mobile is rumored to have secured the Dutch, Austrian, Hungarian and Croatian markets.

It is interesting that the whole of EU with a population of 494m and far higher mobile penetration is potentially a much bigger market for Apple in volume terms than the USA. Of course, market fragmentation and lower GDP probably mean overall dollar market potential is probably around the same for the EU and USA.

Overall UK Market

According to the OFCOM Q4 2006 market data, there were 21.5m contract SIMs amongst the big four networks compared to 64.4 SIMs in total (including prepay). The growth of contract SIMs throughout 2006 was a quite healthy 1.8m. If we add in 3UK contract base and assume some growth throughout 2007 so far, we have around 25m contract customers in the UK.

Given that the atypical Apple customer more than likely already has a contract mobile phone then a 1m iPhone target will imply around 4% of the total contract market which I believe is an extremely high figure for a top end luxury product to gain in 9 months. This is especially true when we look at contract churn which is around 20% per annum or 5 million contract SIMs. This is an aggressive target for the iPhone given the majority of these contract SIMs will be niches that Apple are not targeting eg business, low use, price sensitive.

Also interesting is that O2 has 28% of the contract market which will imply at a minimum 280k will come from the o2 base. I say at a minimum because the O2 base is more skewed towards the young consumer than the business sectors. It also helps that the iPhone will find it easier to churn an existing o2 customer than a other network customers especially given some of the retention efforts the other networks will put in.

Voice and Text Pricing

The iPhone business model is completely different than the current UK cellular business and deserves more attention but that is for another day and another post. Suffice it is to say that recent attention grabbing headlines of 40% revenue share between the operator and Apple are not the critical factors in any analysis of profitability impact for o2 and apple. It is the profits that matter to shareholders not the headlines.

I am surprised at the low amount of minutes and text in the published iPhone bundles:

  • £35 – 200mins/200texts
  • £45 – 600mins/500texts
  • £55 – 1200mins/500texts
  • If we compare these to the O2 SIM Only (No Lengthy Contract) Deals:

  • £15 – 200mins/400texts
  • £25 - 600mins/1000texts
  • £35 - 1200mins/1000texts
  • The £25 and £35 bundles include either free weekend texts or onnet/fixed line calls so the actual volumes are considerably larger than in the iPhone bundles. If we take into account the volume and the fact that SIM deals do not have an 18-month contract, I would expect non-voice/text elements of the iphone deal amount to a minimum of £25/month.

    Data Element

    The other element in the deal in the deal is the “unlimited” Edge and Wifi data. “Unlimited” is little porky, but the CEO of O2 said the fair use policy equated to 1400 web pages per day. Assuming an average Web Page of 20KB, this equates to a 1GB/month “unlimited” option.

    Unlimited WiFi access on The Cloud network for a single device is priced at £7/month direct from The Cloud. I can’t imagine for a second that O2 is paying anywhere near this given that currently WiFi networks are probably operating at nowhere near capacity and many iPhone users will probably use next to nothing. I would guess that TheCloud would be delirious at a guaranteed £1m/per annum if O2 drove a really hard bargain which only equates to 10p/user/month on a 1m base. But let’s be generous and say the average consumer equates WiFi worth at £5/month.

    Next is the EDGE access which someone told me they would have to paid to downgrade from a HSDPA bearer. I can’t imagine with web ‘n’ walk running a £7.50month/1GB for 3G access with 90% coverage that EDGE access with 30% coverage is worth more than £3/month.

    In other words, at an absolute maximum the data bundle would be worth £8/month leaving an £17/month “iphone” premium after the voice/data calculation.

    It should also be noted that this data provisioning on a third party network is something new to O2 and could lead to some to some support headaches. The auto-sensing of the "optimal" network between EDGE and WiFi also seems to be pushing the boat out as well.

    Achilles Heel

    This premium on the monthly tariffs, the pathetic data service and the upfront handset price is undoubtedly the Achilles heel of the iPhone offering. I would expect the other operators to target this viciously.

    For example, Vodafone (NASDAQ:VOD) has three very functionally rich handsets in its Christmas line-up:

  • Samsung F700 (with a touchscreen and keyboard)
  • Sony Ericsson W910i (with the Music brand and SensMe technology)
  • Nokia (NYSE:NOK) N95 (with WiFi and 5MP camera)
  • These may not have the allure of the iPhone but when heavily subsidised and placed in an attractive bundle could provide stiff competition for the iPhone.

    Voda also has the full MusicStation service which it could put in the bundle for unlimited songs and PC/WiFi downloads for £12.50/month – admittedly this will be low margin for Vodafone with the record companies to pay, but could be a real differentiator compared to the iTune 99p/track option. It could also be a Nokia OVI killer, after all who would use the Nokia service, if the Voda service was bundled?

    At much higher gross margins than reselling content, the other operators have 3G networks with wider coverage and fast bitrates than the weird EDGE/TheCloud WiFi combination. For instance, just look at the T-Mobile web ‘n’ walk £7.50/month offer. On a stand alone basis, this puts the o2 data offer to shame.

    However, the problem for all the other operators is the amount of money current paid to independent retailers for connections - here I feel that Carphone has shot itself in the foot. I don’t know what the Carphone gross margin is on an iPhone, but I suspect they will struggle to match the £100 gross margin /connection that are their published target. Also, I strongly suspect that Carphone will not be able to get up its normal pricing tricks to gain an advantage eg offering cashback or bundling someone’s else product in their offer (eg a PSP) – I am sure that both Orange and T-Mobile will put huge pressure on Carphone for similar terms to the o2 iPhone deal. The potential solution for both Orange and T-Mobile is of course to offer big value in direct deals (or through for example Phones4U on a reduced commission) and cut Carphone out of the equation.

    The biggest surprise for me is that UK launch is so far away with 49 days to go to November 7th – all the other operators have plenty of time to fine tune their plans.

    All told, there are plenty of options and time for the operators to cause chaos to the apple/o2/cpw plans and I suspect this Christmas will be one of most hard fought battles on record, especially when you consider that Christmas is normally all about prepaid handsets.