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Brace Yourself for the iPhone Effect
By Michael Comeau
Research Analyst
1/10/2007 9:40 AM EST

The mobile-phone supply chain is a highly complex machine with countless moving parts, including phone makers, component suppliers, telecom carriers, government agencies and infinitely fickle consumers. Well, Apple (AAPL) just blew the whole damn thing up with its new iPhone.

In terms of style, the iPhone is the most impressive consumer electronics product I've seen in some time. With its big touch screen, innovative keyless interface, decent storage capabilities and OS X operating system, there is simply nothing like it on the market. I mean, just take a look at this thing.

Plus, like many of Apple's products, it is a marvel of design dictated by common sense. It has a two-megapixel camera so users can take decent pictures, WiFi capabilities, four or eight gigabytes of storage and, unlike other phones with audio/video capabilities, a standard 3.5-millimeter headphone jack so you don't have to buy some ridiculously expensive proprietary adapter.

Plus, it features the ability to deactivate the screen when you bring the phone to your ear, to save on battery life and prevent you from unintentionally activating anything that may be on it at that time. I expected the phone to be something simpler, but from what I've seen, it handles its complexity fairly well and should in no way be overwhelming to the average user. If there is anything to complain about, it appears that the phone does not have 3G Internet capabilities.

It isn't cheap at $499 or more for a two-year contract with Cingular, but that doesn't matter now because of the huge pent-up demand. Let's not forget, Palm (PALM) has introduced past Treo smartphone models in the same price range, so it's not a stretch for Apple to do so, especially considering the rich feature set.

The iPhone is a fantastic strategic move by Apple. When everyone targeted the original iPod and the iPod Mini, Apple killed them and put out the Nano and the video iPod. Then everyone targeted the Nano and the video iPod, and phonemakers such as Sony-Ericcson and LG cranked out music-enabled phones to benefit from the digital-music boom driven by Apple. So Apple drops the iPhone on them.

And let's not forget that Microsoft (MSFT) , which tried to kill the iPod with the ill-fated Zune, now has a new mark in the iPhone. Apple is a moving target of the deadliest kind.

And now Apple has catapulted itself into the roughly one-billion-units-per-year mobile-phone market, which is a heck of a lot bigger than the MP3-player market the iPod dominated. Plus, one would think that Apple likely secured favorable pricing terms with Cingular for the iPhone, and that is certainly going to draw subscribers. Plus, this phone will stand out in any phone store, and there is now yet another reason for countless consumers to wander into an Apple store, where they just might also walk out with a Mac.

The timing also looks great, with the iPhone being available in June. Like it did with the Nano and iPod Mini, Apple isn't sitting around waiting for people to get tired of their products. It is proactively changing the game on its own terms on a regular basis, while competitors such as Microsoft focus on playing catch-up rather than actually innovating.

As I implied above, the major phone makers are now in even more serious trouble. Motorola's recent guidance cut was the result of weak pricing, as unit growth is being driven by low-cost models favored by emerging markets. However, now Motorola and the other phone makers have a major new competitor in the higher-priced developing markets, one that is poised to take market share as quickly as it can produce its models.

The smartphone market is not very big, and Apple expects to sell 10 million units in 2008, a conservative estimate (in my view anyway) that will certainly affect the pricing power of competing models that simply don't stand out next to it. And since Cingular has a multiyear exclusive on the iPhone, that carrier is likely to see an acceleration in subscriber growth as consumers defect for the iPhone, reducing phone demand at other carriers. Additionally, other phone providers on Cingular's network are likely to feel some pain as subscribers wait for the iPhone to come in stock.

Another factor is that Apple almost definitely has another phone up its sleeve, possibly something simpler in a lower price range that can appeal to those who are not willing to pony up big bucks for a phone, as it eventually did with the iPod Shuffle.

The phone maker best positioned to withstand the iPhone assault is Research In Motion (RIMM) because of its entrenched position with BlackBerry-wielding corporate soldiers across the universe. But I would definitely think twice about holding the stock of any other mobile-phone company.

As for Apple's stock, expect 2007 to be a roller coaster, even more so than 2006 was. The effect of the iPhone on the current iPod models is unclear as of now, and the news and rumor flow will be cranked up to an extreme level, turning Apple into the ultimate "buy the dips" stock. But over the long term, I believe that the success of Apple's phone initiatives has the potential to dwarf that of the iPod and represents an annual revenue opportunity literally in the tens of billions of dollars.

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