ON THE TRAIL OF THE MISSING iPHONES

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INVENTORY ESTIMATES AWAITING THE NEXT MODEL

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About 1.7 million more have been sold than are being used by AT&T customers. The bad and good news for Apple It has been dubbed the Mystery of the Missing iPhones. On Jan. 22, Apple Inc. reported that it sold 3.7 million of its smartphones worldwide in 2007. But AT&T, the only authorized wireless service provider for the iPhone in the U.S., reported that its subscribers activated just fewer than 2 million units last year. The big question on the minds of Apple watchers is: Where have the other 1.7 million iPhonesgone? The uncertainty has helped sink Apple's stock to 132 a share, down 34% since the beginning of the year. That is far worse than the 13% drop for the tech-heavy Nasdaq index. Apple shares were already under pressure because of concerns that weakening consumer spending could affect sales of iPod music players, Mac Books, and other Apple gear. Now worries about iPhone sales have entered the mix. One investor concern is that many of the missing iPhones may be languishing in inventory, on the shelves of Apple's distributors and suppliers. But inventory isn't the only issue. Two sources close to Apple say that far more of the iPhones the company is selling are being "unlocked" than previously expected. Those phones are adapted by customers or gray-market distributors, using unauthorized software and phone cards, to run on the wireless networks of companies with which Apple has no service agreement. Some 800,000 to 1 million iPhones had been unlocked by the end of 2007, the sources say. The high end of that range outpaces most analysts' assumptions of 750,000 unlocked phones. Most of those phones are trickling into nations around the world where Apple has yet to sign up a local carrier--especially China. "In my travels around the world, two out of three iPhones I've seen outside of the U.S. have been unlocked," says Richard Doherty, director at consultancy Envisioneering Group. Unlocked iPhones are bad news for Apple's earnings, at least in the short term. While the company's revenue-sharing agreement with AT&T is kept under wraps, there's no question it's lucrative. Charles R. Wolf, an analyst with Needham & Co., believes the carrier pays Apple $10 per month for every iPhone subscriber over the course of a typical two-year contract, for a total of $240. Toni Sacconaghi, an analyst at Sanford C. Bernstein, thinks each subscriber is worth $300 to $400. Do the math, and for every million iPhones that are unlocked, Apple misses out on $240 million to $400 million, which is pretty much all profit. Although Apple posted sales of $24 billion in 2007, such lost revenues could become more significant as the iPhone becomes a bigger part of Apple's overall business. Piper Jaffray analyst Gene Munster expects Apple to pull in $4.6 billion in iPhone sales in 2008, up from $1.4 billion in 2007. Still, unlocked phones aren't all bad for Apple. The company makes an estimated $120 in gross profit on every phone sold. What's more, in countries where the iPhone isn't yet legally available, the devices may function as part of the Apple's hype machine, revving up awareness of the brand. That, in turn, could make it easier for Apple to strike more carrier distribution deals. Analyst Ingrid Ebeling of JMP Securities says the short-term hit is well worth it. "The No. 1 concern for them should be to selliPhones," she says. How do people get unlocked phones in the first place? Apple's unusual deal with AT&T in the U.S. creates a window of opportunity. Most phones from Nokia, Motorola, and others are sold through the wireless carriers themselves or authorized dealers, and you sign up for a service contract at the same time you buy the phone. Apple cut a different arrangement. Customers buy the iPhone from AT&T or Apple directly, for the same price of $399. The idea was that customers would turn around and activate a service plan with AT&T over the Internet. But they can also choose to install bootleg software, easily available on the Net, and tinker with the guts of the phone so it can be used on other wireless networks. Some customers in the U.S. unlock phones because they don't like AT&T's service, but the vast majority are Apple enthusiasts abroad who can't get authorized service in their home markets. INVENTORY ESTIMATES There's evidence that Apple may have had a change of heart about the unlocking question. Soon after the iPhone was released last June, Apple issued an update to its iTunes software that rendered some unlocked iPhones useless. While the company has continued to add similar code into recent releases of iTunes, it clearly isn't looking too hard for ways to foil the efforts of its million or so unlocked customers. "Almost every iPhone you see on eBay is unlocked, so I don't think Apple is that concerned," says Ebeling. Factoring out the unlocked phones still leaves 700,000 to 900,000 iPhones unaccounted for. About 315,000 of those--and possibly more--were sold through Apple's authorized carriers in France, Britain, and Germany over the holiday season, analysts estimate. An additional 100,000 or more customers may not have activated their phones yet with authorized carriers, either because they haven't gotten around to it or because they're waiting for their current wireless contracts to expire. That leaves 300,000 to 500,000 iPhones in inventory, according to various estimates. Chris Whitmore, an analyst at Deutsche Bank, figures Jobs & Co. typically sell 20,000iPhones a day. That means Apple has 2 to 3 weeks of inventory. Sacconaghi cautions that if sales slow, that same inventory may take eight weeks to move. That's not overly much by AT&T's standards, since it typically carries four to six weeks of cell-phone inventory, but it's sky-high by Apple's lean standards. AWAITING THE NEXT MODEL The real question is what all of this means for overall iPhone demand. Sacconaghi figures Apple's first-quarter iPhone sales could be down as much as 40% compared with sales rates during the holidays, and he thinks the company will struggle to reach its target of 10 million iPhones sold by yearend. The economy is slowing, after all. And with a next-generation iPhone rumored for release this summer, some consumers may delay buying. Perhaps Apple will need to cut prices to boost sales, a painful move if the percentage of unlocked iPhones continues to rise. A cheaper price tag and the loss of Apple's monthly take from carriers would bring the iPhone's lofty profit margins closer to earth. The best resolution for Apple may be to pick up the pace of its overseas expansion. That would give unlocked iPhone owners an opportunity to sign up with the company's chosen wireless partners. And it would help Apple tap into all those other potential customers who haven't wanted to deal with the hassles of unlocking a phone. Indeed, some experts expect the company to announce more carrier deals by the Mobile World Congress 2008 conference in Barcelona in mid-February. GRAPH: FALLING APPLE PHOTO (COLOR): A salesgirl with a bootleg iPhone in Shanghai PHOTO (COLOR)

IPhones, iPads to Gain NFC Payment Features

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Apple plans to introduce "Near-Field Communication" services in its next iteration of the iPad 2 and the iPhone for AT&T, enabling the mobile devices to be used in making purchases Technology MOBILE PAYMENTS [Bloomberg] -- Apple Inc. plans to introduce services that would let customers use its iPhone and iPad computer to make purchases, said Richard Doherty, director of consulting firm Envisioneering Group. The services are based on "Near-Field Communication," a technology that can beam and receive information at a distance of up to 4 inches, due to be embedded in the next iteration of the iPhone for AT&T Inc. and the iPad 2, Doherty said. Both products are likely to be introduced this year, he said, citing engineers who are working on hardware for the Apple project. Apple's service may be able to tap into user information already on file, including credit-card numbers, iTunes gift-card balance and bank data, said Richard Crone, who leads financial industry adviser Crone Consulting LLC in San Carlos, California. That could make it an alternative to programs offered by such companies as Visa Inc., MasterCard Inc. and EBay Inc.'s PayPal, said Taylor Hamilton, an analyst at consultant IBISWorld Inc. "It would make a lot of sense for Apple to include NFC functionality in its products," Crone said. The main goal for Apple would be to get a piece of the $6.2 trillion Americans spend each year on goods and services, Crone said. Today, the company pays credit-card processing fees on every purchase from iTunes. By encouraging consumers to use cheaper methods -- such as tapping their bank accounts directly, which is how many purchases are made via PayPal -- Apple could cut its own costs and those of retailers selling Apple products. Natalie Harrison, a spokeswoman for Apple, declined to comment. Adding Features to Phones "NFC is definitely one of the technologies that's getting a lot of attention, but ultimately the consumer is going to choose," said Charlotte Hill, a spokeswoman for PayPal, owned by San Jose, California-based EBay. Elvira Swanson, a spokeswoman for San Francisco-based Visa, said the company is "excited to see NFC mobile devices coming into the market." Ed McLaughlin, chief emerging payments officer at MasterCard, said the company is "running the world's fastest payment network, and that doesn't need to be recreated." MasterCard sees NFC "as an opportunity to partner with organizations" and already has run NFC payment trials around the world. The recently passed Durbin Amendment makes the timing right for a push by Apple, Crone said. The regulation, which will go into effect this summer, may limit debitcard fees paid by retailers and lets them encourage consumers to use one payment method over another. Competing With Android Under Apple Chief Operating Officer Tim Cook, who's handling day-to-day operations as Chief Executive Officer Steve Jobs takes medical leave, the iPhone is adding features that will help it compete with phones that use Google Inc.'s Android software. Samsung Electronics Co.'s Nexus S phone, which runs Android, can read information from NFC tags. Nokia Oyj, the world's largest maker of mobile phones, has pushed NFC adoption for years, though the technology has been slow to take off. "Apple could be the game-changer," Doherty said. Apple, based in Cupertino, California, is considering starting a mobile payment service as early as mid-2011, Doherty said. It would revamp iTunes, a service that lets consumers buy digital movies and music, so it would hold not only users' credit-card account information but also loyalty credits and points, Doherty said. Using the service, customers could walk into a store or restaurant and make payments straight from an iPad or iPhone. They could also receive loyalty rewards and credits for purchases, such as when referring a friend, Doherty said. Targeted Advertising Apple also could use NFC to improve how it delivers mobile ads to customers' handsets and charge higher fees for those ads, Crone said. NFC would let Apple's iAd advertising network personalize ads to the places where a customer is spending money. That could double or triple the ad rates that Apple charges, Crone said. Apple has created a prototype of a payment terminal that small businesses, such as hairdressers and mom-and-pop stores, could use to scan NFC-enabled iPhones and iPads, Doherty said. The company is considering heavily subsidizing the terminal, or even giving it away to retailers, to encourage fast, nationwide adoption of NFC technology and rev up sales of NFC-enabled iPhones and iPads, he said. To help get ready for NFC, Apple last year hired Benjamin Vigier, who worked on the technology at mobile-payment provider MFoundry. It also has applied for a patent on a system that uses NFC to share information between applications running on various Apple devices.

Nipping at iPhone's Heels

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Liste n MP3 Help Section: OPINION TECH & YOU Competition is spawning innovative mobile phones from Google, RIM, and others In the 15 months since it introduced the iPhone, Apple has radically changed our expectations for mobile phones. But the rest of the industry isn't standing still. We're likely to see a fresh round of innovation as T-Mobile rolls out the first handset based on Google's Android operating system. And Research In Motion is fiercely defending its mobile e-mail turf with very good new products. Of the two, outsider Google faces the tougher challenge. But based on a preliminary look at the T-Mobile G1, announced on Sept. 23, launching in the U.S. and Europe in late October, I'd say it has a shot. Apple set this whole competition in motion by building a single, excellent smartphone within an ecosystem that it controls totally, including the right to approve all thirdparty software. In contrast, Google is pushing an open platform, meaning any handset manufacturer can design hardware that runs Android. The closest relative to Android is Windows Mobile, which remains awkward to use after a decade of tweaking by Microsoft. I spent only about an hour with the G1, which is co-branded by Google and handset maker HTC ($180 with two-year contract; unlimited data plans start at $25).Disappointingly, the phone is a bit thick and heavy. The screen slides up to reveal a keyboard, but the way the keys are recessed between raised areas on either side makes for slightly uncomfortable typing. And while the big touchscreen is nice, you can't resize objects simply by pinching or stretching them with your fingers. Once you get used to this trick on the iPhone, you expect it on every handset. The Android software is far more interesting than the G1 hardware, in part because the developers tried to tear down the walls that divide applications. Other mobilephone operating systems get you only some of the way to this goal. On a Windows Mobile handset or an iPhone, if you click on a Web address in an e-mail message, the phone opens a Web page in a browser. Click on a phone number in a Web page, and the phone usually dials it. But a task as simple as copying text from a Web page and pasting it into an e-mail is difficult to impossible on handsets. Android tries to fix this by organizing activities around users' needs and desires rather than predetermined programs. In a sense you are always in a browser, even when it doesn't look like it. Not surprisingly for a product designed by Google, search is central: If you start typing while browsing the Web or looking at a picture, Android will search the phone's memory and the Web based on the text. This instant search could prove to be either extremely helpful or really annoying. I will explore it in a more Download

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detailed review of the G1 closer to its launch. One problem with the initial Android release is its Google-centricity. The search, of course, is Google search, and e-mail is optimized for Google's gmail. The phone pulls contacts from Google Contacts, so you'll need to jump through hoops to keep the phone's contact list in sync with Outlook or the Mac Address Book. Another problem: The G1 is data-hungry and will mostly be stuck on slow networks. T-Mobile is just starting up its fast 3G data service, and it will be available in only 21 cities. If Android is a work in progress, BlackBerry is a mature product that knows what it wants to be and keeps getting better. RIM has expanded its consumer line with the TMobile Pearl Flip and will soon announce its first touchscreen product, the Storm, with Verizon. And it has strengthened its appeal to BlackBerry's core corporate market with the Bold. For reasons that are unclear, AT&T is holding the Bold off the U.S. market, but I was able to test an unlocked Canadian version ($759), courtesy of online retailer PureMobile, on the AT&T network. It is quite simply the best BlackBerry ever. It's bigger than a Curve and feels a bit bulky after the mini-phones I've been using, but it exploits its scale to great advantage with a big, sharp display, an excellent keyboard, and plenty of battery power to get through a long day. RIM has redesigned the user interface to take advantage of the larger screen, but not so drastically that it will feel alien to BlackBerry users. With an improved Web browser, the phone moves seamlessly between AT&T's 3G service and Wi-Fi. It's expected to cost about $400 with a contract, and I hope AT&T offers it soon. If e-mail is your thing, the Bold is worth waiting for. Turmoil created by the iPhone is spurring innovations such as Android and evolutionary products like the Bold. Consumers can reap the benefits. For past columns and online-only reviews, go to businessweek.com/go/techmaven. PHOTO (COLOR): T-Mobile G1 with Android: Good first try, but not quite there yet PHOTO (COLOR): The Bold is the best BlackBerry ever. So why is AT&T keeping it out of the U.S.?

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