December 16, 2008, 9:19 AM — Just two years ago, the mobile phone market was pretty ho-hum. You had your candy bar phones and your flip phones. There were BlackBerry devices and Windows Mobile phones. Those phones had calendars and contact lists, and a few other apps that were too annoying to use. Few people ever added any new applications to their phones. Surfing the Web was for emergency use only, since it was slow and ugly.
Fast forward to this year. You've got the must-have iPhone. For open source fans, there's the Android phone. The idea of shopping for, buying and downloading new apps isn't remotely unusual. Browsing online means seeing Web sites that look just like they do on a computer.
It's the ultimate dream of the mobile phone industry, but it wasn't created by the mobile phone industry -- the dream was actualized by outsiders. The result is that today, the traditional phone makers are playing catch-up and some are in such a struggle to do so that their future existence is uncertain.
What the traditional phone makers must view as a double whammy -- competition from the iPhone combined with the economic nose-dive -- end users are finding translates into better phones with more applications.
Apple's introduction of the App Store this year dramatically changed the way the people use their phones. While in the past users rarely downloaded applications to their phones, now the experience is easy enough to go mainstream. That's good news for users of essentially all smart phones, who can expect to see a steady stream of new applications in the future.
In addition to ease-of-use for end users, the App Store also has made it dramatically easier for developers to build applications. As a result there are now 10,000 apps in the store, a figure disproportionately high for the number of iPhones on the market, compared to other phone platforms.
Prior to the App Store, developers had to negotiate with operators to convince them to preload the application on phones, sometimes offering the application to users for free or including the application in a portal where users could buy it.
That's very different than the environment that the App Store has created, said Satoshi Nakajima, president of iPhone application developer Big Canvas and founder of UIEvolution. When he launched UIEvolution, long before the App Store, and released certain applications, "we couldn't even recoup the cost of business development. We're not talking development costs, I'm talking calling AT&T and saying we want to sell this app. Wining and dining and negotiations costs a lot. Then we'd launch and sell 200 copies. What's the point?" he said.
The beauty of the iPhone is that it gets rid of the business development cost, Nakajima said. The 30 percent that developers share with Apple in order to sell the application in the store "is nothing compared to the painful cost of dealing with wireless operators worldwide," he said.
While the Internet bust around the turn of the century sent many wireless application development startups out of business, the effect might not be so dramatic in this market downturn, Nakajima said. That's because while venture capital is drying up at the moment, small developer companies have the potential to earn revenue from their applications in the App Store with relatively little outlay as compared to the old process, he said. "It's not all that difficult to become cash flow positive as long as you keep your company small," he said.
Avi Greengart, analyst at Current Analysis, sees a fundamental shift in the mobile industry that has only just begun. "We've gone from an era of hardware design where all you needed was something pretty to an era of software design where people expect to do more with their phones," said Greengart.
In the near term though, buyers may have fewer phones to choose from.
"Apple set the bar at a different level," said Jack Gold with J. Gold Associates. "When iPhone came along, people looked at it and said, 'maybe this is how phones should work.' So everyone has had to react to the iPhone."
Since the release last year of the iconic iPhone, with its touch screen, lack of a physical keyboard, accelerometer and sleek look, most of the other major mobile phone makers have come out with copycats. They include the BlackBerry Storm, Nokia's N97, Sony Ericsson's Xperia X1, the Samsung Instinct, LG's Voyager and even HTC's G1.
"There's no question the iPhone spurred sales of the BlackBerry Storm and killed off sales of the Razr," said Greengart, referring to Motorola's once-hot Razr phone.
While those devices are improvements over their predecessors, none is exactly a runaway success in the vein of the iPhone. "A lot of people are trying to steal the thunder from Apple," said Nakajima. "But unfortunately they are focusing on touch screen or bigger screens, and those are just pieces. The completeness of the user experience is difficult to steal."
Combined with the economic downturn, the phone makers' difficulties in matching the excitement of the iPhone has raised speculation that some might not weather the storm, ultimately leaving phone buyers with fewer choices.
"In a prolonged recession, consumers are either getting the free phone or they will invest in the winning platform if they decide to invest at all and they won't consider the losers," said Greengart. That means that if consumers have the money to spend on a phone, they will buy the iPhone, which is the known market leader, rather than take a chance on one of the competitors.
Greengart paints a bleak picture for phone makers in the months come. Many economists predict that at the very least the first half of 2009 will be grim. That's the time frame during which Nokia's N97, as well as Android phones from manufacturers such as Motorola, are expected to arrive. In addition, if Apple sticks to its typical 12 month product cycle, it may release a new iPhone around June, Greengart said. Yet they'll all be selling to a market of consumers and businesses that are reluctant or unable to spend money. "Even in the best case scenarios I've been reading about, it doesn't sound like the first half of '09 is going to be a pleasant time to be launching products," he said.
Phone makers that experts say will be in particularly precarious positions include Motorola, Palm and Sony Ericsson, three companies that are already in trouble. Motorola's handset division is struggling badly. Its future depends entirely on whether or not it can produce a hot phone and convince the rest of the company to continue to divert money from other divisions to keep the handset group afloat, said Gold.
Sony Ericsson hasn't been able to make much of a dent in the higher end phone market in the U.S. "I wonder whether Sony Ericsson will have the stomach to plug away in this market rather than focus on Western Europe, their core market, where they're being badly beaten by Nokia," said Greengart. Sony Ericsson could pull out of the U.S., he said. Or, the joint venture could dissolve, with Sony continuing to make phones under its brand and Ericsson getting out of the business all together, he said.
Palm, which recently reported declining revenue and laid off workers, has stagnated since selling off its Palm operating system and working over an extended period on a new OS. "If they don't launch a stupendous hit early in the first half, they probably won't have enough cash," Greengart said. "I'm not a financial analyst but I look at them and say, how will they survive?" Palm is rumored to be introducing its new OS at the CES trade show in January.
In addition, Chinese competitors ZTE and Huawei could decide to pull back on their plans to enter the U.S. market, he said.
The other more established phone makers like Research In Motion, Nokia and Samsung will struggle like the rest but are solid enough to hold their own, the analysts say.
Even the iPhone will not be immune to the economic problems. "Everyone thinks that the iPhone is exempt from all the world economic forces and it's not," said Gold. "It would not surprise me to see iPhone sales come down over the next few quarters as the economy kicks in."
In addition, it's possible that the iPhone will only be attractive to a particular market segment, stunting its potential growth. "The other thing you need to ask is whether or not iPhone will appeal to a much broader audience than it already has. That isn't clear yet," Gold said.
Some reports have recently credited the iPhone with keeping mobile phone sales in the third quarter up over last year. But Gold says that doesn't make sense. "How many people went out and bought an iPhone who wouldn't have gone out and bought some other smartphone?" he asked.