iLounge

Looking back at our predictions for 2006, there were certain expectations Apple faced for the year: record-breaking iPod sales, expansion and renaming of the iTunes Music Store to address its increasing video content, greater availability of its Front Row software and Apple Remote-compatible Infrared hardware, and finally, enough iPod hardware to meet ever-improving demand. We also expected more iTunes-compatible phones, new iPod designs, and improvement of the iPod’s international performance.

Most of these predictions turned out to be accurate. Though Apple made only small changes to the iPod lineup prior to late in the year - a low-capacity 1GB nano was introduced - there were more considerable updates in September. At that point, Apple unveiled newly redesigned second-generation iPod nanos and shuffles, each with aluminum enclosures and better price-to-performance ratios than their predecessors. Five colored nano bodies were initially introduced, followed by a sixth, the beautifully rich PRODUCT (RED) Special Edition. The company also enhanced the fifth-generation iPod, delivering superior screen brightness, video battery life, a new library search feature, and a higher-capacity hard disk for the top-end model, all while dropping its price by $50. On the flip side, the company did not introduce two high-end features that had been widely expected - a larger video display or wireless functionality - and Motorola all but killed plans for post-ROKR iTunes Phones, releasing its SLVR L7 and RAZR V3i phones with decreasing enthusiasm, ultimately disappearing as a significant Apple partner by mid-year.

None of the iterative tweaking or Motorola weakness stopped the iPod’s sales momentum. As reported in October, 2006, Apple sold more than 39 million iPods in its 2006 fiscal year, which starts and ends three months before the 2006 calendar year, enough to more than double the iPod’s prior 2005 installed base. Despite increased demand, there were few reports of sell-outs, as the company improved its manufacturing and distribution to handle growing volumes of customers, especially in its own stores. Quarter after quarter, iPod hardware exceeded the prior year’s sales by impressive amounts, and the holiday 2006 quarter is expected to be the iPod’s best ever. However, we saw little evidence that the company was aggressively pursuing international sales to further bolster its numbers, a surprise given the number of countries in which the iPod doesn’t lead, or in which its leadership position is less concrete than in the United States.

Similarly, iTunes went through certain expected and unexpected changes. Its Front Row media interface did appear in more Macintosh computers - all but the Mac Pros - and a next-generation version of the software was previewed for a 2007 release. Now in version 7.0, iTunes’ library management and video playback interfaces were visually overhauled, while a multiple-file download manager and iPod software updater component were added. Its Music Store was rebranded to become the iTunes Store, as Apple rolled out digital sales of both feature-length movies and fifth-generation iPod games, and radically expanded the roster of popular television shows available for purchase. iTunes video downloads were upped in resolution from 320x240 to 640x480 - or 640x272 for 16:9 format films - and a new variable pricing model for films ($9.99 to $14.99), based on date of purchase relative to date of a movie’s release, was added to the Store.

Not all of the iTunes changes were positive. In January, Apple unveiled the iTunes MiniStore, a screen-cluttering iTunes 6 feature designed to recommend Store purchases based on the content of your existing library, which the software would analyze for you. It was a feature no one had asked for, and many people found intrusive; the MiniStore was subsequently downplayed. And in rolling out iTunes 7.0, the company allowed too many bugs to slip through to the big-named release, with users reporting dramatic computer performance slowdowns, problems accessing their libraries, and other issues. Readers howled at the problems, and Apple responded with quick, if not complete fixes.

The company also surprised many people - including us - by demonstrating surprising complacence in the breadth of its international iTunes Stores offerings. Most likely for contractual reasons, legal television and movie downloads never materialized for iPods overseas during 2006, leaving prospective fifth-generation iPod owners outside the U.S. with little reason save capacity to prefer those models over nanos. Similarly, while iTunes Music Stores opened during 2005 in countries such as Japan, Australia, Switzerland, Denmark, Norway, and Sweden, 2006 saw only one such opening - New Zealand - and Apple has suggested that it is content with these markets, and not looking to test the waters in other potential hotspots, such as India, China, or South Korea.

Why would Apple press play, or even pause, after such an extended period of fast forwarding? The answer is probably in two parts: the company wasn’t ready to release the more advanced products believed to be in the pipeline, and perhaps didn’t feel that they were necessary given the popularity of prior iPod models. Business school students and professors believe that the iPod family is now in the “maturity” stage of its growth, where rapid innovation traditionally gives way to incremental change, yet that comparative stability is rewarded with steady sales. We’ll have to see whether this is accurate, or whether the company will re-ignite its fires in 2007 - CEO Steve Jobs has said that 2007 will be “one of the most exciting new product years in Apple’s history.”

While there’s little argument that 2006 was a banner year for iPod accessory makers, it was also a very odd year behind the scenes: despite continued strong sales of iPod hardware, third-party developers began to focus their attention on Apple’s competitors, as Apple took steps to capture more accessory dollars for itself, and the number of far too similar iPod accessories began to grow.

Most positive for the year were impressive expansions of the number and type of accessories being offered. Though official Apple estimates of “over 2,000” and “over 3,000” accessories initially seemed somewhat exaggerated, the market has caught up to those numbers - literally hundreds of different speakers alone are now available, a fact which has led to impressive consumer choice, but also more than a fair amount of confusion. New product genres, such as iPod-specific karaoke devices, portable video displays, security devices, video recorders, and wearable video displays, have emerged, too, expanding the iPod’s capabilities well beyond anything Apple could have initially imagined back in 2001.

Of course, Apple hasn’t stood still. In January, Apple surprised critics and developers alike by releasing the iPod Radio Remote, its first official acknowledgment that some iPod users wanted FM radio tuning functionality. Rather than including its own screen, the Radio Remote relied on a brand-new, proprietary tuning and station-saving interface found on the iPod’s display - a feature that third-party developers were not allowed to use in their own competing radio products. Similarly, Apple’s February release of the iPod Hi-Fi speaker system evoked a new Speakers menu option on the iPod, enabling more convenient access to the iPod’s speaker-specific screen and sound functionality. Again, this new iPod feature was locked to third-party developers - even ones participating in Apple’s Made For iPod licensing program.

These changes and others spooked a number of iPod developers during 2006, leading to a widespread belief that Apple intended to compete more aggressively with third-party companies for the accessory market’s growing revenue, and that it would use anti-competitive practices such as feature lock-outs to enhance its own products. By mid-year, companies such as Sandisk and Microsoft were seeking to replicate the iPod’s hardware and accessory model, and began to approach third-party developers with promises of additional promotion, more attractive business terms, and less contentious development relationships than Apple had offered.

As 2006 comes to a close, the outlook for continued growth of the iPod accessory market is murky. While there is no doubt that both Apple and small third-party developers will continue to focus on creating iPod-specific accessories in 2007, medium- to larger-sized third-party companies appear to be spreading their resources across competing platforms, discussed in greater detail below. There are also whispers of industry consolidation, as certain mid-sized companies are predicted to be on the verge of merging or disappearing entirely from the iPod accessory marketplace. Similarly, given the huge number of “me too” add-ons now out there, particularly in “easy-to-make” categories such as speakers, cases, and car accessories, it’s unclear whether we will continue to see hundreds more of these types of items, whether new players will enter and offer superior innovation, or whether less competitive old players will tire of low sales volumes and disappear.

As incremental and evolutionary as 2006 may have been for Apple, it was clearly a strong year for iPod sales - and generally, a bad year for Apple’s competitors. After several widely-acknowledged failed attempts to compete against the iPod and iTunes with its Network Walkmen and various iterations of its SonicStage music software, Sony’s iTunes Store competitor - Sony Connect - arrived in late 2005 to universally terrible reviews, yet continued to be pushed as the company’s only solution throughout 2006. While Sony attempted to re-direct its marketing and development efforts towards its Walkman phones and PlayStation-branded gaming and entertainment media hub products, fans of its music hardware continued to post workarounds and alternatives to SonicStage, and its proprietary Universal Media Disc portable optical disc format for movies disappeared from stores.

Creative Labs, maker of the Zen family of digital media players, went down but not out during 2006. Despite a highly publicized $100 million payday over a patent dispute with Apple - one which saw the companies cross-license certain of their media player technologies - Creative’s promotion of Zen-related products declined following the agreement, and the company happily announced its intention to develop accessories for the iPod. A widescreen version of its Zen Vision video player quietly appeared mid-year, and was barely noticed. Formerly seen as a legitimate, if much smaller, Apple rival, iRiver has essentially ceased marketing efforts in the United States, and the once-threatening Dell has exited the MP3 player market entirely. Similarly, competing MP3 player maker Philips announced a lineup of iPod-ready speaker systems, proving the value of the old maxim, “if you can’t beat ‘em, join ‘em.”

The failure of any of these companies to successfully challenge the iPod has left the second, third, fourth, and fifth-place spots open to surprising new entrants. Absolutely unknown for music-related products only three years ago, memory chip maker SanDisk has become a second-place challenger to the iPod in sales, gaining market share with smart pricing of iPod nano and shuffle-alikes, plus some obnoxious marketing efforts. Companies such as Memorex, Walt Disney Company, and Creative Labs have been rounding out the top five, until the recent introduction of Microsoft’s Zune.

Based upon an existing media player developed by Toshiba, Zune aimed to challenge the full-sized iPod with a design that promised comparable storage space, battery life, and pricing, but also included a larger screen, wireless functionality, and a somewhat novel user interface. Over-hyped by various media outlets and paid viral marketers, Zune debuted in November, 2006 to mostly negative reviews, each praising certain individual elements of the product’s design, but ultimately concluding that neither the device nor its supporting software were up to par with Apple’s offerings. Thanks to an aggressive advertising campaign, the unit saw reasonable first-week sales - second-place 9% share to Apple’s 63% share - but immediately fell to 2.1% in the following week, as Apple wrestled off new price cuts from Sandisk.

The emergence of Microsoft and Sandisk as Apple’s primary competitors was perhaps the iPod’s biggest surprise in 2006, and a suggestion of the risks Apple engenders by failing to keep up with its past pace of innovation. Had a more capable video iPod - one with a larger screen and/or wireless functionality - emerged at the company’s September event, everyone might have been spared months of discussion over the impending battle between iPods and Zunes; the point would have been moot. And had Apple released a more significantly updated iPod nano - or been more aggressive in pricing - it might have already dispatched SanDisk, which continues to win over cost-conscious consumers despite its lack of so many of Apple’s widely-acknowledged advantages.

From a consumer’s perspective, the presence of iPod competitors is a good thing: these alternatives force Apple to innovate, reasonably price products, and advertise in a way that will grow and cement the business for future generations of iPod owners. These competitors may even improve the market for iPod accessories, by providing developers with alternative revenue streams and other options for products Apple may reject, as well as favorable business terms that could lead Apple to improve its own practices when they get out of hand. That said, it’s most likely not in Apple’s best interest to inspire the Microsofts of the world to stay in the marketplace: beyond the fact that such companies are willing to resort to shady tactics to buy their way into markets, they can create VHS-versus-Betamax-style trouble for consumers as well, offering bad deals to certain partners, and thereby needlessly fracturing the availability of content for an otherwise popular platform. It’s our hope that Apple acts quickly, and wisely, to put stakes in the hearts of its few remaining vampires this coming year.

Though the “What’s Next” portion of these Year in Review articles is always our favorite part to write, it’s also the one most fraught with landmines: Apple’s next moves are never certain, and even when something seems either impossible or inevitable, there are no guarantees. For that reason, take our predictions with the requisite grain of salt.

iTV: If Apple can be taken at its word on one product, which we strongly believe it can be, its next major move into the home will be the renamed iTV, which we’ve previewed already based on its unusual advance introduction this past September. From what’s widely known at this point, iTV will wirelessly stream iTunes audio, video, and synchronized photo content from your home computer for enjoyment through a home TV/AV system, and will be able to access movie trailers and possibly other content through a home’s wireless Internet connection. iTV is believed to contain enough memory or hard disk space to store at least a small amount of content without continued connection to a computer, but the specifics of this feature are unclear, as are the other justifications for its announced $299 price point. It is our sincere hope that Apple intends iTV to be a component of a larger networked storage and playback solution, offering wireless hard disks, remote controls, and other features that will eliminate the system’s dependence on a powered-on home computer.

iPhone: Rumors have continued all throughout 2006 that Apple would release a self-branded mobile phone without the involvement of Motorola, either coupling phone, messaging, and iPod music functionality into a device with iPod nano-like dimensions, or blending those, video playback, and more sophisticated PDA-like features in a larger, iPod-sized enclosure. Nothing happened. But we strongly believe that one or both of these devices will appear in 2007, and if Apple opts to sidestep formal, subsidized partnerships with Cingular, T-Mobile, or other companies, and rather sells them directly to customers as unlocked replacements for their existing phones - at reasonable prices - the success of these products will be nothing short of staggering. Conversely, if Apple prices the phones too high, misses one of several obvious features, or again attempts to cripple their music functionality relative to today’s iPods, the experience will be far less impressive.

New iPods: Our feeling is that the wireless and video innovations expected in 2006 iPods were delayed by technical and other considerations, and that Apple plans to introduce such features - particularly enhanced video - in 2007 models. Wireless functionality continues to be a major battery drainer, one reason it has not yet appeared in any iPod, and our impression is that larger-scale, graphical interface improvements are on tap for the coming year as well.

Updates to iTunes: In 2007, Apple doesn’t need to radically expand the breadth of offerings from the iTunes Store - it already sells most types of digital content people might want. Instead, we think that Apple will focus on improving the depth and international availability of its newer video offerings - TV shows and movies - putting most of its effort on building the Store’s movie catalog, while continuing to add new shows, music, and games on an as-released basis. It’s conceivable that the company will also make downloadable books and magazines available through the Store, but a much better - and larger - screened device would be needed to display them. Look for this to happen if the company gets into miniature notebooks, tablet computers, or tablet/iPod hybrids, any one of which we’d be excited to buy.

Accessories: Three things seem to be certain going into the coming year. First, Apple is committed to using accessories to make the iPod more ubiquitous for travelers. As its 2006 deals with leading auto manufacturers and several air transportation providers - ones that promised iPod integration kits for cars and planes - have illustrated, the company views vehicle integration as a major priority, and wants to see iPod-ready car speakers and in-flight monitors become the norm rather than the exception. We look forward to more of these sorts of deals, though we are convinced that a new iPod on-TV interface is desperately needed to make everything from home TVs to in-vehicle monitors easier to use with iPods, and Apple - not a third-party company - should be the one to make this happen.

Second, though there are lots of obvious accessories that will continue to appear in the marketplace no matter what, Apple is committed to working with unique partners to develop “outside the box” accessories that might not otherwise see the light of day. Its partnership with Nike for the pedometer and voice feedback nano add-on Nike + iPod Sport Kit - one of the best, and reportedly one of the fastest-selling iPod accessories in 2006 - suggests that the company’s resources are going to go towards work with players who can bring significant promotional resources and novel development input to the table. For this reason, there’s no way to know for sure what sort of collaborative accessories might be coming next, but if they’re being developed in a similar partnership, there’s a good chance that they’ll be huge.

Third, Apple claims to be more interested in growing the accessory market than participating as a me-too player: the $349 iPod Hi-Fi and $99 leather iPod cases could be seen as tests of whether the speaker and case markets could do better, rather than attempts to displace the myriad $150 and $35 players already there. In keeping with that philosophy, though Apple released a few obvious accessories for the new nano and shuffle, its lineups were much smaller than with the comparable 2005 products, and after the release of iPod Hi-Fi, the company appears to be less interested in fighting with potential partners than seeing them succeed and generate licensing revenues. Whether this continues to be the case is not clear, but our feeling is that Apple will concentrate on making “truly new” types of accessories, and may regrettably try to use proprietary iPod menus or hardware lock-out chips to stifle competitors.