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Steve Jobs's Tiny but Sure Bet

By Peter Burrows Time and again, Apple (AAPL) CEO Steve Jobs gets grilled when he introduces digital-music products. When the iPod came out in October, 2001, critics complained the $400 unit was hopelessly overpriced. Many said the same thing when Apple unveiled the iPod Mini in early 2004, arguing that consumers would never fork over $250 for just a few gigabytes of storage. And a year later, some naysayers called the iPod Shuffle plain silly, given its lack of a screen to navigate through songs.

Obviously, Jobs has had the last laugh -- as some 22 million units sold altogether will attest. And now comes a product, the 1.5-ounce iPod Nano, that's so smartly conceived and well-engineered, the skeptics are hard pressed to find anything to complain about.

Sure, consumers will have to pay $50 more to get the same song capacity as with the now-discontinued iPod Mini line. But get one of these gizmos in your hand, and such complaints will fade.

WHAT GUMPTION. Design guru Donald A. Norman, co-founder of Norman-Nielsen Group, says the product sounds like the perfect compromise between the iPod Mini, which he finds to be slightly too large to be comfortable on his morning jogs, and that screenless iPod Shuffle. "This product overcomes all the deficits," he says.

Apple's introduction of this product has many remarkable aspects -- in particular, the decision to create it in the first place. After all, the iPod Mini is less than two years old and was Apple's best-selling gadget.

Few companies would have had the gumption to stack a bet on a new device to replace such a hit product before any sign of a slowdown. And besides the strategic risk is the daunting operational task of winding down production of iPod Minis without leaving too much business on the table -- or too much inventory in stores.

"WE PULLED IT OFF." Jobs says the even bigger challenge was cranking up production of the iPod Nano from nada to the huge volumes needed to take the Mini's place. "It was a very big bet for us, but we pulled it off," Jobs said in an interview on the day of the announcement. "This has been the largest manufacturing ramp of any product in Apple's history."

There's little doubt the device will sell briskly. In fact, given that Apple has discontinued the iPod Mini, Jobs's prediction that the Nano will become the world's best-selling MP3 player is hardly going out on a limb.

With no iPod Mini to dilute its impact, the Nano is almost sure to a hot seller -- but it will be impossible to tell how many people are buying it because they love its diminutive size or simply because no iPod Mini is available as an alternative.

TOO COOL TO LOSE. Indeed, Harvard professor Clayton Christenson, author of the book, The Innovators' Dilemma, worries that Apple might have done more to distance itself from the competition by adding new capabilities -- say, software that could help the iPod discover a user's mood once he or she has selected or skipped a few songs -- rather than by just making it razor-thin.

"I hope it works for them," he says. "But if you improve a product in a dimension of performance that really doesn't matter to the customer, you just end up spending a lot of money -- and in a sense cannibalize a beautiful product in a way that doesn't get you much more traction."

Still, most analysts think the product is just too cool to lose. Certainly, the Nano is bound to appeal to the "collect-the-whole-set" portion of the iPod-owning public. Count singer Madonna in that crew. "Every time I buy [an iPod], Apple comes out with a new one," she joked in a video chat with Jobs during his keynote address. "Steve, you've got to stop being so prolific."

FLASH ELEMENT. Even if the Nano doesn't lure hordes of consumers who have yet to buy a digital-music player, Apple could benefit anyway. The Nano could help dispel the one small storm cloud on the near-term horizon for Apple: The decline in average selling prices.

Thanks to the debut of the Mini and the Shuffle, the average price has dropped in recent years. But by creating what is essentially a souped-up iPod Shuffle with a screen for $200, Apple will be under less pressure to cannibalize itself with an improved version of the $99 Shuffle.

What's more, the Nano could potentially reduce Apple's warranty and support costs, since it uses solid-state flash memory to store songs, rather than more fragile, crash-prone hard drives.

LESS THAN EIGHT QUARTERS. And Nano will clearly create problems for competitors, many of which are already reeling. iSupply analyst Nam Kim says the number of MP3 player manufacturers in China has plunged to 300 from 500 in 2004, and some brand-name makers are crying uncle as well. On Aug. 26, Rio -- the company that pioneered the portable digital music player in the late 1990s -- closed its doors.

Indeed, Apple may well have the market for this newly defined form factor to itself for a while. For one thing, its industrial designers had to do some stellar work to figure out how to pack a full-featured iPod into an enclosure that's thinner than a pencil and weighs less than eight quarters, as Jobs pointed out in his speech.

And to the extent that suppliers such as PortalPlayer and Samsung did custom work on its chips, chances are those advances will be exclusively Apple's for some time.

PRICEY MEMORY. "This is the biggest leap forward since the original iPod," says Jobs. "It's dramatically ahead of where any competitive product is." That's sure to make rivals recall the original iPod, which built up a huge lead during its first 18 months on the market thanks to Apple's exclusive contract on the 1.8-inch hard drives it used.

But while Apple may choose to emphasize its designers' genius, raw economics may be the biggest problem for rivals. Having purchased 40% of Samsung's flash memory capacity (see BW Online, 8/26/05, "A Memorable Deal for Apple and Samsung?"), analysts figure Apple got discounts that rivals won't come close to matching.

That's critical, because memory makes up by far the biggest portion of the bill of materials for a digital music player. David H. Carey, president of Portelligent, says four gigabytes of memory -- that's what's in the $250 version of the Nano -- would cost $144 on the spot market, with all the remaining components costing just $30 or so.

ANOTHER AGENDA. How big a discount could Apple be getting from Samsung? Carey doesn't know, but his detailed analysis of the iPod Mini revealed a bill-of-materials of $130 -- roughly 45% of the retail price of the unit.

Assuming Apple wanted to maintain a similar ratio, it would need to get its memory cost down to about $100, a 44% discount from spot-market prices. That jibes with an estimate from another memory chip analyst, who figures Apple may have gotten a 40% break.

Why so much? Carey thinks it has less to do with near-term profits and more to do with both Samsung's and Apple's long-term plans. "I suspect there's another agenda going on," he says. "It could help Samsung solidify its lock on the memory market and help Apple solidify its lock on the iPod market." As far as Apple's concerned, that plan is well under way.

With Arik Hesseldahl in New York

Burrows is Computer editor in BusinessWeek's Silicon Valley bureau

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