Peter Fader on the New iPhone and Matching Technology to Consumer Demand

We’ve been hearing about technology convergence for quite a while — the blurring of the lines between handheld devices and full-featured personal computers, as well as the merging of PCs and home entertainment systems.

Announcements at the Consumer Electronics Show and Apple’s MacWorld conference, both held earlier this month, heralded the arrival of a number of products at the center of these convergence trends. Apple’s iPhone, introduced at MacWorld, brings together the capabilities of a cell phone and an iPod music player, along with features like web browsing and email that are associated with personal computers. At MacWorld, Apple CEO Steve Jobs also demonstrated Apple TV, formerly known as iTV, which allows users to play the movies and TV shows they download from iTunes on their big-screen TVs.

But are computer companies like Apple hitting the right notes? Wharton marketing professor Peter Fader spoke with Knowledge at Wharton about whether iPhone, Apple TV and other products are delivering features that consumers really want, or if this is simply technology in search of a market.

Knowledge at Wharton: Many are comparing Apple’s entry into the cellular phone business to the introduction of the iPod. But is the situation similar, or is Apple facing a very different market?

Fader: Apple is facing a very different market. It’s a market that’s far more mature than the MP3 Player market was at the time. It’s a far more sophisticated customer base. Apple had the opportunity to go into the MP3 market and basically reshape that market and create the standard for customers’ tastes and preferences.

Those things have already been done by the myriad players in the cell phone market. Apple can do a very limited amount of reshaping. I think that when this phone actually hits the market, some of the grand visions that Steve Jobs has as well as some of the Apple zealots are going to be rather disappointed.

Knowledge at Wharton: The iPhone has a lot of cool features. Are there too many, and is the price — starting at $500 — too high?

Fader: Well it’s not going to be too high for the first few hundred thousand people who just have to have it. You can charge them anything and they’ll pay anything. But for the mass market, if they really want to create something that is anywhere close to what the iPod did, it is very expensive.

And, I think on the feature side, it doesn’t really have that many features. In fact, it’s missing some really, really important features. What it has [going] for it is just a really cool design factor and that’s not enough. It’s going to help them to differentiate themselves from the other phones out there, but it’s not going to be enough to really be a winning entry.

Knowledge at Wharton: What other features [would you imagine] should it include?

Fader: Well, one of the things that it must include is a key pad. I think that it’s very important for people to be able to type or at least text message, and to be able to do that just on the screen instead of having actual keys is going to be very disappointing. There are a lot of people who won’t even give it a try because of the absence of that. And then there’s just some of the lack of the integration with Outlook and other standard bits of software that are becoming quite common with so many phones today.

Knowledge at Wharton: Do you think consumers are tired of juggling multiple devices though? Does the iPhone at least address that problem?

Fader: I don’t think it does. I think about how many people right now are carrying around an iPod and a Blackberry or a Treo, and this kind of falls in between the two. In some sense it’s not as simple; it’s not as small as an iPod. So, it’s a bigger iPod but not necessarily a better one. And, while it does function as a phone, it does lack some features, as we just mentioned. So I think that the large numbers of people who are in that modality are not going to have their needs satisfied here.

Knowledge at Wharton: What do you expect the rest of the cell phone market will do? Will they move up market? Will they add these features and try and leap over the iPhone? Will they try and come in underneath with less expensive phones? What should everybody else do?

Fader: At this point it’s a wait and see. I think at this point people can’t react very quickly to some of the features — like some of the browser features on the new phone seem to be fantastic. And so we’ll see some companies trying to knock those things off. But then you’re going to have to wait and see, once the phone actually comes to market and see what kind of people adopt it and how much price sensitivity there is or isn’t.

I do think though that it does open up the high end, whatever that means. And we will see other [phone] companies trying to stake out that high end, perhaps with a very different phone, but realizing that there are some people willing to pay for things that they might not otherwise have done.

Knowledge at Wharton: If it does open up the high end, are there other companies that will benefit from that? I’m thinking of companies like Adobe Systems that makes a development environment for high end phones that’s fairly popular in Japan, but hasn’t caught on as big in places like the U.S.

Fader: I think that that’s fair to say. You’ll see software firms like that. You’ll see on the hardware side, some of the companies that are in some sense trying to compete with the iPod these days like Samsung. They’re already edging around on the high end. I think we’ll see them push up even a little bit higher and that’s great.

I think it’s good to give customers a wide variety. I think that the market is at an interesting point right now — just as it’s maturing you’re going to see just lots of diversity in the high end and the low end. And so it’s important to give people the opportunities up there. But, it’s important to keep in mind that up there is going to be a very small niche and even though they’ll make a lot of money on each one of these phones that they sell, it’s still going to have a very small impact — probably even smaller than the 1% that Steve Jobs and others have been talking about.

Knowledge at Wharton: What about iPhone’s use of Cingular’s EDGE network. Do you think it’s dangerous for Apple to align itself with one network?

Fader: Well, it’s not only unusual for Apple to be so strongly aligned with an outside firm, but it’s a firm that completely lacks the ‘cool factor.’ And if anything, Cingular is being much derided for the slowness of that network, compared to Verizon. I don’t think that that’s a big deal.

I think Cingular is a big credible player. They’re going through a lot of changes; I think a lot of good ones right now. They do have a new network right around the corner. And even though the first iPhone won’t be able to use it, I think that, let’s say, six months after it’s released, that will be something relatively easy to fix.

Knowledge at Wharton: Do you feel that consumers will be apt to switch networks even if they have to pay that $150 penalty to do so?

Fader: There will be some, again that gets back to the price insensitivity. They’re going to pay, let’s say a $1000 for the overall switch and cost of buying a phone and switching and getting a new contract and all of that. They’re doing that largely for social status and at that point price doesn’t really mean anything. So I don’t think the network issue is a big deal at all.

Knowledge at Wharton: At MacWorld, Apple also previewed Apple TV formerly known as iTV, which lets consumers send iTunes video to their large-screen TV sets. Will this be what makes Apple’s iTunes as successful for TV as it has been for downloading audio?

Fader: I don’t think so. I think a lot of the initial reactions to iTV or Apple TV, depending on who you ask have been pretty negative for a couple of reasons. Number one, it gets back to the old problem that Apple doesn’t like to play nicely with others. So it’s a very restrictive format. The other kinds of formats that people like to use like Divx, for instance, just aren’t going to be supported.

Another problem is that one of the great things about watching video on the iPod was the compression that they used — to make it relatively quick, to be able to bring those videos down to a small device. Now you’re going to take those highly compressed videos and try to bring them up to a big device and they’re going to look terrible. And Apple at this point hasn’t done a good job of supporting some of the high definition and say that the 1080 standard that many people are looking at. So there’s going to be a lot of disappointment there. Of course consumers aren’t really aware of that but they’re going to find out the hard way, that things don’t look as good when they are projected.

So there’s an issue of supply and demand. On the supply side, it doesn’t look like the device is going to have all the features and functions that people would like. And on the demand side, people don’t really need this thing. This kind of technology in different forms has been around for a while.

And, there hasn’t been a huge uptake for it. I think it’s a niche kind of thing and some of those niches are being satisfied quite well by the Xbox 360 and Slingbox has done pretty well. So Apple is coming in pretty late with a product that is in many ways inferior to those two.

Knowledge at Wharton: On January 15, Netflix announced plans to deliver streaming video content to their subscribers. This is a different business model than the download-to-own model of iTunes or the YouTube-based free-with-advertising model. Is this a better model for delivering premium films to the home?

Fader: Well, I think in general the subscription model is a better way for people to obtain content, especially digital content. One of the big reasons for success for Netflix, and I’ve said it over and over and over at Knowledge at Wharton, is just that — the subscription model. People pay whatever, $15, $18 a month. They may not be using that much content but they’re very happy to pay for it.

So it fits in very well with that. This is not a big deal; this is more or less a bit of PR. It’s a competitive necessity for Netflix to have a toe in that space and to try and compete a little bit more with what’s been going on at Blockbuster. But at least it’s consistent with their strategy so far. As I’ve said, this by itself isn’t going to create huge profits but it might stem defections from the Netflix customer base.

Knowledge at Wharton: Since this content is being streamed to the PC, you’ve got this problem again of you can’t watch on your home theatre system. Would Netflix have been smart to partner with someone like Apple TV or Microsoft to bring the content to consumer’s large screens?

Fader: I don’t think that’s out of the question right now. I think that Netflix has worked well with other firms and I honestly don’t know what kind of business development conversations are going on right now. But it wouldn’t surprise me if something like that happened.

It wouldn’t surprise me if it happened in the same way it worked with Wal-Mart, where someone who was a competitor ends up endorsing and working with them. So I could see firms coming to Netflix to say, “Let’s do this together.” Again it might not happen today or tomorrow. It doesn’t really matter if it does. I think by the time consumers really want to and really expect to be able to bring movies on a TV, I think the market will change between now and then. It’s going to be a while.

Knowledge at Wharton: Let’s come back to Apple now. If you were Steve Jobs, what would you do next?

Fader: That’s very hard to say. He’s a brilliant man but he’s of course very mercurial, he’s unpredictable and he’s very private. I think for instance the name change caught some people as a surprise. I don’t think that — it’s not a huge move but I don’t think it was a good move at all. So he has all kinds of things up his sleeve.

If you go back to the subscription model, I absolutely believe that at one point he will eat his words from five, six years ago and move to a subscription model. I think the iPhone would have been a good opportunity to do that. But it’s not just a matter of business models for him. It’s devices, it’s coolness, and it’s keeping that factor that right away people pay attention to Apple, whatever they announce, no matter how good or bad it really is.

Knowledge at Wharton: Why do you think the name change was not a good idea?

Fader: Well for one thing it’s an admission of defeat. One of the ideas of the iPod was to eventually port people over to the Macintosh. It would show people that “Hey I can work with one of these Apple devices; maybe I’ll take the bigger bite”. And that hasn’t worked. It’s made no difference at all.

It’s very important to realize that the Mac is still a huge piece of Apple’s business. And, it’s quite surprising what wasn’t announced at Macworld, which was anything about the Mac. As far as I know there were no announcements about the Mac. That really is the bread and butter of the company. And it’s a signal that they’re not going to be developing or supporting it as much as they used to.

That would be a big mistake. I mean draw a contrast with IBM. They’re not making or selling business machines anymore, but they’re still very deeply committed to that business and to finding other ways to help customers meet needs when they’re dealing with so called business machines. Apple seems to be moving away from that and they’re becoming kind of a cute, cool gadget company. And, oh by the way they have a few computers over there as well.

Knowledge at Wharton: But if the name change indicates the move into the consumer products space, isn’t that market much larger than the PC market?

Fader: They’re both very competitive markets and so it’s hard to say whether they’re better off in one versus another. If you look, there are plenty of firms in the consumer electronics space that are struggling. So I don’t really know if it’s a move to or a move away from. And again it’s not a huge important big deal. But the signal or lack of a signal, about what’s going on with the Mac by itself [I think] matters quite a bit.

Knowledge at Wharton: Do you have any final advice for Apple or any other PC company that’s trying to transition into the home entertainment business?

Fader: Absolutely. Make customers happy; give them what they want. And that means to Apple, open up the systems to try to accommodate other formats and try to work with other firms. That’s really, really important. When you constrain people — when you tell people, “We can give you anything that you want but here are the limitations on it” — that’s going to be a real limit to a firm’s growth and success.