Apple Must Rethink iPhone Strategy in Europe Now

In a research note I wrote a couple of weeks ago I made the observation that Apple’s strategy in Europe was faltering. Growing evidence suggests that unless the company overhauls its approach to the European market it risks killing the initial momentum it secured for the iPhone.

Apple’s COO, Tim Cook, stated on an earnings call last night that “carriers are free to price the iPhone as low as they wish”. Perhaps this is the first time Apple realises it’s time to change tack.

Apple’s made no secret of the fact that significant numbers of iPhones are being unlocked. I think the weak dollar has contributed to the exodus of iPhones from the US market. I reckon most of them leave the US to be unlocked for resale around the world, and this undermines Apple’s strategy of exclusive deals with chosen operators.

Any change in strategy is risky and Apple needs to be careful. The European sales channel for mobile phones has no qualms about discounting devices to zero if that’s what it takes to close a deal. Heavy discounting on iPhones would be dangerous for Apple, as it could undermine the pricing of iPods.

I’d advise Apple to consider the following options:

1. Abandon exclusive agreements with mobile network operators and reduce Apple’s cut of ongoing revenue. I think the net result will be more valuable to Apple as it’ll gain revenue it’s now losing because people unlock iPhones to use on a network of their choice.

2. Offer a prepaid iPhone. Europeans already understand they have to pay for a phone if they want to use it on a prepaid tariff. There’s a proliferation of higher-tier prepaid phones in Europe and people are becoming wary of signing 18- or 24-month contracts, so this is a significant opportunity. This approach might also lead to fewer unlocked iPhones. More people would resist the temptation to unlock their iPhone and would use it on the network it was locked to. Apple would benefit, as it would derive income from its revenue-sharing agreements. This approach would be ideally suited to an “iPhone Nano” — a cut-down version of the iPhone — or perhaps an older model with, say, 8GB of memory.

3. Abandon the iPod touch and create a single “connected” flagship iPod (the iPhone touch, if you like). This radical approach would see Apple discontinuing the current generations of the iPhone and iPod touch and replacing them with a range of products that all included mobile phone capability. Users could choose whether they want to sign up for cellular service or just use the device with Wi-Fi. People signing up for cellular service might be given a rebate or an accessories pack in place of a subsidy, or they could be tempted to “upgrade” to cellular service by a special tariff. This approach would not affect the headline price of the iPhone and would protect Apple’s iPod business. This tactic is already happening in the PC market. More and more manufacturers are producing notebooks with embedded cellular technology that in some cases will never be activated.

If Apple were to change tack, it would have to overcome some hurdles. At the very least it would have to unravel some of its exclusive distribution deals with O2, T-Mobile and Orange, but this is unlikely to be an insurmountable problem, and some cracks seem to be appearing already.

The bottom line is that Apple’s secretive and US-centric approach to conceiving the iPhone has resulted in some missteps in its marketing strategy. It’s still in the early stages of entering the mobile phone market, so there’s still time to adjust its approach. By tweaking its distribution strategy Apple may gain a meaningful foothold in the market. If not, I think the iPhone’s destined to remain a niche product.