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iPod: A Seed for Growth?

When Steve Jobs unveiled Apple Computer's digital music player, the iPod, in October, 2001, he predicted that the slick, metallic device -- the smallest of its kind on the market -- would be one of the hottest products that holiday season. Little did he know. Over the next few months, Apple sold about 120,000 iPods, priced at $399 each, and grabbed a 2.5% share of the U.S. market for digital music players, according to electronics consultancy NPD Techworld. Not bad for a company that until then had no presence in that business.

In the first six months of this year -- after Apple (AAPL) cut the price and added features -- iPod's market share climbed to 7.1%, estimates NPD analyst Tom Edwards. With typical Apple humility, Stan Ng, iPod's product manager, declares that his baby is becoming "a cultural icon."

While that may be a bit of an overstatement, there's no denying that it's becoming more and more visible. Oscar-winning actress Jennifer Connelly uses an iPod to pass time during filming breaks, according to the September issue of Vanity Fair. And don't be surprised if more people start using an iPod soon. The week of Aug. 26, Apple is rolling out an iPod for Windows-based PCs. Kevin Hunt, an analyst with Thomas Weisel Partners, estimates that iPod sales should jump 25% over the next two quarters.

BROADER STRATEGY. Have Apple and Microsoft suddenly become better friends? Not exactly. Apple sees the new iPod as a way to move the device beyond the $100 million niche of customers who download Net music on a Mac -- and into the broader consumer-electronics business. The operating margins on the iPod are "materially higher" than those Apple gets on its iMac computer, says Brett Miller, an analyst with A.G. Edwards, which could tempt Apple to introduce other higher-margin consumer digital devices. (Apple doesn't disclose its margins by product.)

With a successful iPod to bolster its standing, Apple might roll out, in the next 12 to 18 months, models that sync wirelessly with the computer, says Miller. Analysts say it could also introduce a cell phone with music-playing capabilities or an iPod for storing and displaying photos and music videos. Apple declined to comment on its plans.

That broader strategy could be hard to pull off, however. For one thing, the fickle consumer-electronics business changes at warp speed. Moreover, the industry behemoths aren't about to let Apple muscle in. For example, Toshiba just introduced a new player, the Mobilphile, which could eat away at Apple's market share, predicts Rob Enderle, an analyst with tech consultancy Giga Information Group.

UPGRADABLE EDGE. Mobilphile's most distinctive feature is its 5-gigabyte removable hard drive. While a music fan who wanted an iPod with more capacity would need to buy a new model, a Toshiba Mobilphile user could simply buy a more capacious hard drive and stick it into an old device. That capability could be a major plus for fans with huge music collections.

Retailers would appreciate such flexibility as well, says Enderle. Toshiba (which also makes hard drives for the iPod) could potentially ship its players and drives to stores separately. Merchants could swap in different hard drives based on demand, thus holding down inventory costs. Considering that retailers can make or break a product, that could offer Toshiba huge advantages in both store placement and availability.

True, Apple enjoys good relationships with retailers, too. But the Mobilphile -- which works only with Windows PCs -- is one of the first players on the market to surpass iPod's download speeds. Until recently, Apple's special FireWire data-transfer port allowed users to load songs from the computer and onto the player at speeds about 30 times faster than those of most other devices. That competitive advantage is gone now: Mobilephile transfers songs from computer to the player at 480 megabits per second, vs. iPod's 400 megabits.

"THE CORRECT NERVE." Also, only 10% to 15% of PCs sold come with FireWire. Thus, most buyers of Windows-compatible iPods will have to purchase a FireWire add-in card, which can cost up to $100. That -- and the lack of an upgradable hard drive -- erase much of iPod's price advantage over Mobilphile. A 5-gigabyte iPod sells for $299, while Mobilphile's suggested retail price is $499.

Already, "the response [to Mobilphile] has been incredible," claims Craig Eggeris, director of merchandising for DVD and digital products at Toshiba America Consumer Products in New Jersey. "We seem to have hit the correct nerve."

Not that Apple is worried. The Toshiba device is slightly larger than the iPod as well as more expensive. And the removable hard drive makes its less reliable, scoffs Apple's Ng. However, Toshiba's Eggeris counters that the Mobilphile is highly durable.

SMALLER DRIVES? Apple also has to worry about competition from SONICblue (SBLU), which is likely to come out with new digital music players this fall, says David Huffman, the company's vice-president for audio products. Lips are sealed at the Santa Clara (Calif.), company, but industry insiders suspect that it might unveil a device that uses a much smaller hard drive -- the component that dictates a player's size. Both the iPod and Mobilephile use the smallest now available, a 1.8-inch model. Using a smaller drive would give SONICblue a big advantage.

Also, iPod's easy-to-use interface, which has been one of its main selling points, is being copied and in some cases improved upon, further eroding Apple's advantage. Some competitors' players already offer functions that iPod lacks, such as the ability to compile lists of most-requested songs or allow users to delete songs without having to hook up the device to the computer. "Though iPod is easy to use, it's still missing some things," says analyst Cindy Wolf at Cahners In-Stat.

Rivals are also aping Apple's simplified design. The iPod featured the industry's first scroll navigation wheel. Toshiba's Mobilphile boasts a four-arrow control, which is even simpler and more convenient to use, say experts. While very good, "iPod's interface is not that innovative," says Eric Bergman, senior interaction designer at Sun Microsystems and author of the book Information Appliances and Beyond. Thus, it's relatively easy to duplicate.

Apple contends that it can stay ahead of the competition. "We continue to innovate," says Ng. In response to consumer demand, the company has already added calendar and address book capabilities to the iPod. Photo and video viewing could be coming next, say some analysts.

CD PLUS MP3. Still, Apple has to beware of threats from all sides -- including the nonportable market. If the global economy continues to stagnate, the cheaper -- though not portable -- segments of the digital music-player market will enjoy the most success, says Susan Kevorkian, an analyst at tech consultancy IDC. After all, audio CD players that can also play MP3 files already sell for less than $100.

The market for portable players should nevertheless be healthy. Kevorkian estimates that unit sales of such devices will grow ninefold by 2006, from 1 million this year to 9 million then. And even if iPod hits a rough patch, Apple likely won't turn and run from the market, as it did back in 1998 when it discontinued its Newton personal digital assistant. "We'd love for everybody to own an iPod," says Ng. Only problem is, despite what the song says, love isn't all you need. By Olga Kharif in Portland, Ore.

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