Apple's Phone Isn't Ringing Any Chimes

It certainly doesn't threaten the iPod -- and that may be just what Jobs wants

Apple Computer Inc. (AAPL ) has made more than its share of epic moves. It kick-started the modern PC era with the Mac in 1984. It offered a vision of the handheld future with its ill-fated Newton in 1993. And in recent years it cracked the code on how to sell music in digital form via its iPod music player. So expectations were high when Apple, on Sept. 7, took the wraps off its first offering for one of tech's hottest markets: cell phones.

But the first iTunes phone, in many ways, is underwhelming. Officially called the Rokr and made by Motorola Inc. (MOT ), it's a silver-and-pearl-white device modeled on an existing Motorola phone. Press a button, and the familiar Apple interface appears on the screen. The unit -- available exclusively from Cingular Wireless for $249, with a two-year contract -- holds just 100 songs. That compares with more than 1,000 for phones from Nokia Corp. (NOK ) and Samsung. And while other phones can download the latest White Stripes or Beyoncé tune over the airwaves from anywhere, the iTunes phone has to be synched to a PC to get fresh music, just like the iPod.

Even CEO Steven P. Jobs seems less than enthusiastic. At a star-studded press conference in San Francisco, he spent more time raving about Apple's new Nano, a pencil-thin addition to the iPod line that can hold 1,000 songs. He called it "the biggest revolution since the original iPod," while he deemed the Motorola phone "pretty cool."

Did Apple's designers suffer a rare brain cramp? Not likely. Rather, it looks like Jobs is making a careful gamble. He doesn't want the music-phone market to soar, at least not right away. That could cut into his iPod franchise, the source of almost all his revenue and profit growth. At the same time, he knows the mobile-phone market could be tremendously important for digital music in the future. So he's positioning Apple to be ready for a sales boom without leading the charge himself. "They don't want to cannibalize their business," says analyst Gene Munster of Piper Jaffray Cos. (PJC ). They just want "to give people a little taste."

Jobs, in other words, seems to be trying to define the music phone to his advantage. Phones such as those from Nokia and Samsung will rival the iPod as the device to carry all your music. But the iTunes phone is designed to be an accessory to the iPod rather than a replacement. It will use the same iTunes software the iPod does but will carry only a fraction of the number of songs. "They have to be asking themselves: 'How can we stem or stop the erosion [to mobile phones]?"' says David Frerichs, U.S. general manager for Coding Technologies, a Swedish company that develops music-compression technology. "They could try to set a standard of expectations in everyone's minds that phones can only get a small number of songs, so they aren't your music archive."

Jobs's hesitance is understandable since anything that messes with the iPod formula is bad for Apple. Sales of its various iPod models are expected to hit $4.8 billion this year, up from $2.3 billion in 2004. A rush to music phones could hurt future growth.

But Jobs's approach comes with steep risks. While he dabbles, he takes the chance that a rival could come up with a blockbuster hit, undercutting Apple's ability to make iTunes a dominant standard in this growing market. And there's no doubt the competition is coming. "Samsung, Sony, Nokia -- they all have significant plans," says Alan R. McGlade, chief executive of MusicNet, a provider of digital music technology.

Wireless carriers, which control the phones that get to market through their subsidies, aren't falling into line, either. Mighty Verizon Wireless (VZ ) chose Sept. 6, the day before Jobs's keynote, to clarify its own digital-music plans, including several new music phones and an over-the-air service that will debut later this year. Sprint Nextel Corp. (S ) plans new phones and an over-the-air service that will let customers buy music at a moment's notice. "The capability [of the iTunes phone] is not that new," says Paul S. Reddick, vice-president of business development and product innovation at Sprint. "What we're talking about launching this year is new."


The mobile-music market may well take off despite Jobs's measured support. Still, he has plenty of cards to play. Most intriguing are the licensing possibilities. With the iTunes phone, Apple provided its iTunes software and FairPlay digital-rights management software to Motorola, although how Apple is compensated was not disclosed. If the new phone becomes a hit, Jobs could pursue other deals, including licensing software to Motorola or another manufacturer for a phone that could store thousands of songs.

Another path Jobs could take? He could come out with his own cell phone, leaving current partner Motorola behind. Piper Jaffray's Munster thinks there's a 50% chance Apple will introduce its own phone in the next year. In a survey of 200 people, 18% were interested in buying an "iPhone" from Apple, Munster found. "People don't want a Motorola-Apple phone. They want an Apple phone," he says. "That's what our surveys show, and [Apple is] probably doing the same research we're doing."

Getting into the cell-phone business these days is quite simple: There's no need to master radio technology or build a manufacturing plant since contract manufacturers such as Flextronics International Ltd. (FLEX ) or BenQ Corp. can handle all that. So Apple could keep all the profits -- and the control to make a phone the way it wants. A long shot? Perhaps. But it's one sure way Apple could make a real splash in the wireless industry.

By Peter Burrows in San Francisco, with Roger O. Crockett in Chicago and Heather Green in New York

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