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iTune Phones: Finally, Some Noise

By Olga Kharif and Peter Burrows, with Roger Crockett Are Apple Computer (AAPL) and Motorola (MOT) finally getting ready to launch an iTunes cell phone? The phone was set to be announced in March, but at the last minute both companies decided to delay the introduction.

Now it appears they're ready -- and they may even have signed up a service provider. In a June 23 research note, RBC Capital Markets analyst Mark Sue said Cingular, a joint venture between telcos SBC (SBC) and BellSouth (BLS), will announce the phone within a month.

PROMISING NEW MARKET. The mobile phone -- or rather, a family of iTune phones, ranging from low end to high end -- will become available to consumers before Christmas, Sue says. That seems to jibe with Motorola's previous assurances that the gadget will hit stores in the third quarter.

Analysts have been expecting an iTunes phone for months. Back in March, Apple and Motorola decided to postpone the announcement the day before Motorola was expected to unveil the new handset. Analysts say it was because Cingular bailed out. Cingular, Motorola, and Apple declined to comment.

Now, it looks like the deal will happen sooner, rather than later. All parties involved -- Motorola, Cingular, and, perhaps most of all, Apple -- have much to gain from the hookup. The move could help them take the pole position in a promising new market -- delivering digital music to cell phones, a device that has become the center of the digital lifestyle for millions of people around the world.

RIVALS MULTIPLY. Currently, the three companies are seen as laggards in this market. Other online music services, wireless service providers like Verizon Wireless, and consumer-electronics makers are readying their own mobile music services to debut within 12 months. They're all aiming for a market that in two years will include 2 million U.S. wireless subscribers listening to music on their handsets, estimates SG Cowen analyst Thomas Watts.

The longer Cingular, Motorola, and Apple wait to get into the market, the more they risk a rival catching fire. On June 15, Napster (NAPS) and telecom-gear maker Ericsson (ERICY) announced that they would offer a wireless music service for operators to use.

Meanwhile, startup Mercora, headed by a cofounder of antivirus-software maker McAfee (MFE), already allows cell-phone users to listen to songs for free. And satellite radio operators XM Satellite Radio (XMSR) and Sirius (SIRI) are looking to offer music radio for cell phones. These are just some of the services that could roll out within a year.

DEFENDING AN EMPIRE. If Apple doesn't nail down a deal with Cingular now, the carrier will soon have other options to choose from. Cingular is in negotiations with Southern California software company SingleTouch, whose 1-2-3 technology would allow music downloads with the press of a few keystrokes.

Clearly, Apple has the most to lose, given the runaway success of its family of iPod players and iTunes Music Store. With around 75% of the digital music player market (more than 15 million sold) and more than 80% of song downloads (more than 400 million), Apple dominates the digital market today.

Still, the average iPod owner has purchased only a few dozen songs via iTunes, so selling music downloads is still only in its infancy. If consumers -- particularly younger ones who tend to buy more music and be more cell-phone-centric -- move quickly to buying songs wirelessly via their handsets, that could put Apple's music empire at risk.

OLD WAY, AT FIRST. Music phones offer a huge opportunity. Many analysts believe they could easily outstrip portable audio players like Apple's iPod in popularity within a few years. But if Jobs & Co. manage to jump into cell phones, they could bring iTunes into the mainstream.

Cingular, with its more than 50 million subscribers, may be Apple's only option for a service provider in the U.S. Afraid that Apple would take a potentially new source of revenue (music downloads) for itself, all other major U.S. wireless carriers have refused Jobs's overtures outright, says Andrew Cole, an analyst with consultancy A.T. Kearney (see BW Online, 4/15/05, "Wireless Outfits Will Face the Music").

What would Apple's deal with Cingular look like? The latter could get a short-term exclusive right to Apple's iTunes service, says Cole. The carrier also will likely get a share of revenues from music downloads, which will, at least at first, be done the old way: Users will download a song onto their computers and then move it onto their iTunes phones. Eventually, should Cingular unveil a service for wireless downloads direct to a cell phone, it might get a larger share of the revenues or keep any premium charged for the on-the-go service.

Of course, even if Apple, Motorola, and Cingular come to a direct-to-handset arrangement, the service might not take off. "It has to be priced right, and it has to be easy enough to download music," says Jeff Kagan, a telecom industry analyst. The phone should also have to have enough capacity and battery power to handle songs and be intuitive to use.

PRICE EDGE. How would the Cingular offering fare -- and what would it mean for Apple and Motorola? Most carriers pooh-pooh the idea because the iTunes phone won't work with any service that lets consumers buy songs directly over the airwaves.

Still, jumping on Apple's coattails might have more appeal given consumer behavior today. For starters, most avid digital music fans now own an iPod and have purchased at least a few songs from iTunes -- so they have an investment in Apple's proprietary approach. As such, Cingular would be able to tap into the biggest digital player user base.

What's more, one insider hints that Apple hopes to let people get songs onto their cell phones for the same price, 99 cents, and at the same sound quality as they now get by downloading tunes to their computers. Other carriers would have to charge more to help pay for the costs of developing their own services and would likely have to compress the music to a greater degree, resulting in lower sound quality.

PROJECT BENEFITS. For Cingular, the iTunes deal may be its best option -- especially since it hasn't done much to develop its own music service. On the surface, Cingular might seem to be better served by creating its own service, enabling it to keep all the revenue from the songs it sells. But since even Apple only barely makes a profit selling at 99 cents, it's unlikely Cingular could make much -- unless it could somehow convince customers to pay far more than that to get the same song.

By hooking up with Apple, the carrier might take a far lower share of the revenue of each song -- but make more money. That's because it wouldn't incur its own costs to run a service -- and it would benefit from Apple's marketing might to drive demand. Indeed, Watts estimates Cingular could see its average revenue per user rise 1% to 2% through such a deal. And many iPod owners could decide to switch to Cingular for their cellular needs.

Motorola also is banking on the iTunes phone. Motorola realizes it has to move fast, since music cell phones from rivals are multiplying rapidly. Later this year, Sony Ericsson will release two new phones, the W800 and W600, specifically designed for downloading and storing music. Mobile-phone leader Nokia (NOK) has several music cell phones out already, and it will launch more in the coming months. That's likely an extra incentive for Motorola to push the Cingular deal.

NEED FOR SPEED. Most analysts have already incorporated the phone's shipments into their financial forecasts for Motorola. Sue, of RBC Capital Markets, believes that sales will exceed investors' expectations thanks, in part, to the iTunes connection.

And for all three companies, speed is of the essence.

Kharif is a BusinessWeek Online reporter in Portland, Ore., and Burrows is a correspondent in BusinessWeek's San Mateo bureau

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