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Will Apple's iPhone connect?

The tech innovator will face a steep learning curve and powerful rivals as it enters a promising new market.

June 25, 2007|Michelle Quinn | Times Staff Writer

SAN FRANCISCO — Apple Inc.'s two most lucrative products are a study in contrasts. Its iPod dominates the digital-music device market with more than 70% of players sold in the U.S., while after decades the Macintosh has secured barely 5% of the personal computer market.

So which one is the iPhone, which hits stores Friday at 6 p.m., destined to emulate?

That depends on whether early buyers like it enough to match the hype, whether Apple lowers the price soon and whether the company can quickly learn the ropes of the complicated cellphone industry.

"When people first have it in their hands, they will be thinking more with their hearts than their heads," said Michael Gartenberg, research director at Jupiter Research. "But quickly, everything about the iPhone has to meet consumer expectations."

The stakes are high for Cupertino, Calif.-based Apple, which is counting on the iPhone to join the iPod and Mac as its third major business. So is Wall Street. Apple's shares have soared more than 40% since the day in January when the company announced the product, which combines a cellphone, music player and Web-browsing computer into a touch-screen device.

"We are looking forward to shipping iPhone on June 29, and we can't wait for customers to get their hands on it," Apple spokesman Steve Dowling said, declining to comment further.

The importance of Apple's first phone is magnified by the slowing growth of iPod sales. Analysts say music-playing cellphones, often subsidized by mobile carriers, pose the biggest threat to the iPod's dominance. The iPhone will probably accelerate that trend as some consumers in the market for an iPod choose to buy the iPhone instead.

But if the iPhone becomes a hit, it could do another thing the iPod does: bring people into Apple stores, where they might buy other products. The iPod's popularity has led to more sales of Macintosh computers, something of a forgotten stepsister to the glamorous music players. Apple's computer sales grew 36% in the fiscal second quarter compared with the same period in the previous year.

The Mac business is expected to continue to grow, though not explosively, in the future. Apple has traditionally focused on the high end of the personal computer market, unwilling to battle PC kings such as Hewlett-Packard Co. and Dell Inc.

Apple needs another mass-market sensation as an insurance policy against the ups and downs of its current businesses. The iPod has eclipsed the computing business as Apple's big moneymaker. It generated 40% of the company's revenue of $19 billion during the 2006 fiscal year, which ended in September, compared with 39% for the Mac unit.

Apple Chief Executive Steve Jobs signaled the company's broader ambitions in January, when he dropped "Computer" from its name. The iPhone TV commercials appeal to more than just the Mac faithful who sustained the company for so many years. The ads show an iPhone user e-mailing holiday photos, watching YouTube videos and ordering food from a restaurant.

"This is a company that's shifting," Gartenberg said. "It wants to be at the core of people's digital lifestyle."

Jobs says he aims to sell 10 million iPhones in the next 18 months, which would represent about 1% of the global cellphone market. Analysts say he is sure to get that, generating billions of dollars in sales in the process.

As it enters a new market, Apple has a lot going for it. Its brand sizzles. Many consumers are frustrated with their cellphones. And having sold more than 100 million iPods, the company has a customer base that it hopes will prove willing to try something new.

But if Apple wants the iPhone to be more than a niche player in telecom, a few things have to go right.

A lot rides on execution. The first iPhone owners, particularly reviewers and bloggers, will wield enormous power. They will either stoke demand or damp it.

"This product is going to be loved or hated," said Trip Chowdhry, a software analyst with Global Equities Research in San Francisco. "There may not be a second chance if it's terrible."

Price is another issue. The iPhone costs $499 for a 4-gigabyte model and $599 for an 8-gigabyte one. That's a lot to pay, considering that many carriers give phones away with signed service contracts.

Analysts predict that Apple will gauge demand, eventually introduce a family of iPhones for as little as $299 and beef up the capabilities of its most expensive model to appeal to business users.

That's what the company did to boost the popularity of the iPod. The less expensive shuffle, mini and nano are credited with making the iPod ubiquitous today.

Perhaps the biggest barrier to the iPhone is how well Apple learns the mobile phone industry.

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