Major Hangups Over The iPod Phone

Cellular carriers are hesitant to sell the Apple-Motorola gizmo. Here's why

It seemed like a sure thing: the iPod mobile phone. What could be more irresistible than a device combining the digital-music prowess of Apple Computer Inc. (AAPL ) with the wireless expertise of Motorola Inc. (MOT )? Motorola sent its buzz machinery into overdrive in January when it leaked word that the product would debut at a cellular-industry conference in New Orleans in mid-March.

Well, hold the phone. At the New Orleans confab, a frustrated Edward J. Zander, Motorola's chief executive, stood before a roomful of analysts and reporters and said the handset's debut would have to wait. Why? Zander said Motorola and Apple want to hold off until the phone is closer to hitting store shelves. But three industry sources say a lack of support from such giant cellular operators as Verizon Wireless and Cingular Wireless was instrumental in delaying the unveiling. So far the wireless companies are reluctant to promote the Motorola-Apple phone.

Behind the clash are two very different views of the future of music on mobile phones. Motorola and Apple would let customers put any digital tune they already own on their phones for free. That would help Motorola sell more phones, and it would help Apple expand its dominance of digital music. Verizon (VZ ), Cingular, and other wireless operators want customers to pay to put music on phones. They think getting a full song should be like getting a ring tone, snippets for which customers now pay from 99 cents to $3. The carriers have no interest in conceding the booming digital-music market to the tech players. "When carriers see this future, Apple is front and center," says Andrew Cole, head of the wireless practice at consultant A.T. Kearney Inc. Apple is "a competitor not to be embraced, but to be rejected."

At issue is whether Apple and Motorola leave room for carriers to benefit. Their phone could be loaded with songs simply by dropping it into a cradle attached to a PC, so that music wouldn't have to travel over carriers' airwaves. There's not a whole lot of profit to share, either. When customers buy songs from Apple's iTunes music store, they pay 99 cents a tune. But Apple only gets about 4 cents of that, after paying the record company and others, says researcher Strategy Analytics. Apple says iTunes is only a breakeven business.

That approach doesn't sit well with the megacarriers -- and they can hamper the sale of any cell phone. Verizon and others typically subsidize the phones they sell to customers, often charging $200 less for handsets at retail than what they pay Motorola and others. Says Jeffrey D. Hallock, Sprint's (FON ) vice-president for strategic marketing: "We need to figure out a way that is economically viable for Sprint."

One way would be for U.S. carriers to follow the model that has been established in Europe. There, carriers such as Vodafone (VOD ), Orange, and O2 have set up their own digital music stores, letting customers download music tracks over the cellular network to their phones. Carriers get a slice of the $2.80 customers pay per song. Wireless players also could offer customers subscription services, with access to thousands of songs for a flat monthly fee of $15 or $20.

U.S. carriers hope to position themselves as major players in digital music and swipe the spotlight from Apple. Their ideal scenario would be for customers to use their mobile phones as digital jukeboxes, plugging in headphones to listen on the go and dropping the phone into a cradle attached to stereo speakers at home. While Apple and Motorola may object, wireless operators can buy music-downloading handsets from phonemakers that are willing to play by their rules -- perhaps aggressive Asian players such as Samsung and LG. "There is a sweet spot in mobility and music," says James P. Ryan, Cingular's vice-president for consumer data services.

Apple and Motorola have options, too. One insider says that even if Cingular and Verizon, the two largest wireless players, won't sell the Motorola-Apple phone, smaller rivals, such as T-Mobile, may peddle it to gain ground on the industry leaders. Motorola says it's working out ways for carriers to profit from digital music and expects to launch the phone with that support this summer. Motorola and Apple could also bypass carriers altogether and sell the phone via retail stores or their own Web sites.

Trouble is, that would mean no carrier subsidy on the handsets. So customers would have to foot the music phone's entire bill, expected to be around $500. "Who wants the $500 iPod phone when you could buy a phone and an iPod for that much?" says analyst Tole J. Hart of researcher Gartner Inc. (IT ) A sure thing? The iPod phone now looks anything but.

By Roger O. Crockett in Chicago, with Peter Burrows in San Mateo

— With assistance by Peter Burrows

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