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Analyst addresses unanswered questions on Apple

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By LC Angell

Contributing Editor
Published: Thursday, May 4, 2006
News Categories: Apple

Piper Jaffray senior analyst Gene Munster has released a research report in which he addresses more than 20 unanswered questions on Apple, the majority of which are iPod and iTunes related. In the report, Munster gives his views on several topics, including the possibility of a built-in iPod FM tuner, an Apple iPhone, how the iPod will keep its competitive advantage, and whether or not the iPod shuffle will be cut from the iPod lineup. The analyst also digs into the average number of iPods each iPod owner has, advertisements in iTunes, the downtick in last quarter’s iPod sales, Sony’s hopes of creating an iPod competitor, and when we’ll see full-length movies on the iTunes Music Store. You can read Munster’s answers to the iPod and iTunes questions in their entirety after the jump.

Will Apple Offer A Built-In FM Tuner In The iPod?
While innovation on the iPod will no doubt continue, we do not expect Apple will integrate an FM tuner, at least in the near term. We believe the company does not feel there is a strong desire from customers to have an integrated FM tuner; Apple has said that it thinks customers want to be their own DJs. Also, Apple only has an interest in adding features to an iPod that are very high quality; the quality of reception on FM tuners in existing MP3 players has been weak.
 
Why Did We See A Seasonal Downtick In iPods In The March Quarter For The First Time In 3 Years?
iPod sales were down in the Mar-06 quarter for the first time in 3 years. While this is the first sequential downtick we have seen for the iPod in some time, it is important to keep in mind that in prior March quarters major iPod launches occurred resulting in abnormal sequential March quarter growth. There would have been downward seasonality in the previous two March quarters, but in the Mar-04 quarter the iPod mini was introduced and in the Mar-05 quarter we saw the launch of the iPod shuffle. Backing out those two March quarter product launches, we would see that there always has been March quarter iPod seasonality; it was just less evident in prior years because of the new product releases.
 
How Is Apple Attacking The International iPod Opportunity?
2006 will be a year in which Apple puts more focus on European markets. In February 2005 the company estimated that iPod market share in Germany was 5%; today it’s 21%. Market share in France is currently 11%. We believe the company will look to grow iPod market share in Europe through marketing, not by competing on price.
 
How Many iPods Does Each iPod Owner Have?
We had originally thought that the number of iPods/iPod owner was 1.5 or greater. After looking at the growth of iPods in the last two quarters, we now believe that the number of iPods/iPod owner is between 1.0 and 1.5. Assuming 80% of iPods have been sold in the US, and assuming 1.2 iPods per iPod owner, equates to 29.3m iPod users in the US; about 10% of the US population has an iPod. We consider 10% a low penetration of iPods.

Is Apple Going To Make An iPhone?
We continue to believe there is a 75% chance that Apple will launch an iPhone (iPod/cell phone) within the next 12 months. In conversations with Apple, however, we have found that the company continues to say the primary focus will be on a standalone music device. The company has said it is possible that a music enabled phone could cannibalize the demand for a lower priced iPods. For example, the inclusion of a digital camera in cell phones did not impact demand for higher end cameras, but low priced cameras came under attack. Essentially, the low end of the camera market was taken away. The company has indicated that it does not want to see the low end of the iPod market get cannibalized by music enabled phones. While we continue to believe there is a high chance that Apple will launch an iPhone in the next 12 months, the company says that the right path for Apple is to continue to pursue devices with one primary feature and not focus on multiple functions in one device.
 
How Can Apple Keep The iPod Competitive?
We believe the economies of scale with Apple’s iPod provide the company with a significant competitive advantage, as competitors are unable to significantly undercut iPod pricing. Conversations with Apple show that it believes the key to staying competitive is to create the best experience possible, continually innovating in the product pipeline, and trying not to invent new product categories where no problem exists, but inventing new products to solve an existing problem. Apple management focuses on the problems consumers are facing and tries to focus product development on ways to solve those problems within the constraints of the supply chain. In addition to innovating and bringing new products to market, the existing iPod eco-system keeps the product competitive. There are more than 2,000 iPod accessories in the market: iPods work in users’ homes, cars, or anywhere they take it. iPod owners have invested in community and, in general, it appears people feel the iPod eco-system and quality outweigh potential limitations of being tied to a proprietary file format.
 
Why Can’t Sony Figure Out The MP3 Player Market And Compete With The iPod?
We believe Sony has done a poor job of marketing its MP3 players, starting with naming the products (ex: should I buy the “NW-E505” or the “NW-E307”?). In general, from Apple’s perspective, the company believes that Sony has not gotten a strong grasp of the recipe required to create a strong customer experience with both hardware and software. Sony’s historical strength has been in its hardware; most of the company’s engineers are hardware focused. Sony, therefore, has been unable to create a customer experience similar to what exists with the iPod/iTunes integration.
 
Will The iPod shuffle Stay In The Lineup And When Will It Be Updated?
The inclusion of the shuffle in iPod family was originally about protecting the low end of the market. At the time the shuffle was released, Apple did not have anything below $249 and competitors’ products (Creative, iriver, Sony, etc.) were seeing some success in the low end. The iPod shuffle took the low end of the market away from competitors and, most notably, negatively impacted Creative’s market share. While there has been some speculation that Apple will either discontinue or add new features to the shuffle, we believe the company wants to continue to provide a very low end player with few features. Adding features could impact the iPod nano market and removing the product from the lineup would be giving away the very low end market to other players.

Is iTunes Headed For A Tiered Pricing Model?
Apple’s recent renegotiations with 4 of the major record labels show that the $0.99 song is here to stay for a while. Although iTunes Japan does have some tiered pricing (about 10% of the iTunes Japan library has tiered pricing), Apple does not intend or desire to have tiered pricing on iTunes in any other geography. We see this as another indication of Apple’s continuous strive to make its products and services simple to use.
 
How Many Videos Are Sold On iTunes Per Week And Are iTunes Videos Any More Or Less Profitable Than iTunes Songs?
We believe approximately 1 million videos are sold on iTunes each week, compared to around 21 million songs sold per week. In other words, about 4% of iTunes downloads are video based. Regarding profitability of iTunes videos, the company recently indicated to us that iTunes videos and iTunes songs have very similar profitability levels. Overall, the iTunes store is run at a level that is slightly better than breakeven.
 
Will We See Full Length Movies On iTunes Anytime Soon?
We see a chicken and egg scenario forming with full length movie downloads. What will come first?: 1) full length feature film on iTunes, or 2) a larger screen video iPod. It is difficult to say how this scenario will play out. It is also important to look at what value would be gained from having full length movies on iTunes. Right now, a consumer can easily find any full length movie on DVD or on-demand. Apple has focused on TV shows because unlike full length movies, there is a clear value proposition to the consumer and the networks in offering TV shows. For a consumer, if you miss an episode (or entire season) of a show, iTunes is the only way to see it unless you want to wait until the episode comes out on DVD. The benefit to the networks is that this is a new way to monetize original TV content. Ultimately, we expect that iTunes will offer feature length movies on iTunes, but we do not believe this is a top priority for the company at this time.
 
Will Apple Start Selling Advertising In The iTunes Music Store?
Napster.com was recently launched as an ad based business model and there has recently been some chatter in the trade press suggesting that Apple will sell ad space on iTunes. We do not believe that it will sell ad space on iTunes. In addition, conversations with the company have pointed to a continuation of an ad-free iTunes. There are some podcasts that sell ads, but we believe Apple knows the value of an ad free experience and will not sacrifice long-term customer satisfaction for a near term pop in ad revenue.

 

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Comments

1

somehow i’m willing to bet the rollout of an iTMS movie download site will coincide with the release of the much talked about full-screen ipod. there is no chicken or egg first consideration here.

Posted by bryking in Texas, USA on May 4, 2006 at 4:20 PM (PDT)

2

I wish I had fm on my iPod for baseball and football games I can’t think I’m the only one…..

=:-{))

Posted by Xtoast in midwest usa on May 5, 2006 at 1:45 PM (PDT)

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