Apple's Ambitious iPhone 3G Plans

It intends to make at least 40 million iPhones in the next year; selling so many will hinge on global success and fixing connection glitches

by Peter Burrows
Forecasting iPhone sales is one of tech's toughest guessing games. Since Apple's iPhone 3G came storming out of the gate with 1 million units sold in the three days after it went on sale July 11, analysts have scrambled to come up with a reliable forecast for how many of the devices the consumer electronics maker will sell in the coming years.

Many analysts expect Apple (AAPL) to sell around 11 million iPhone 3Gs in 2008 and another 25 million in 2009. But perhaps the most optimistic forecast is from Piper Jaffray (PJC) analyst Gene Munster, who expects the company to sell 13 million this year and 45 million next year.

While final sales can't be known until after the fact, clues are emerging as to Apple's production plans. As of mid-August, they were ambitious, BusinessWeek has learned. Apple plans to build 40 million to 45 million iPhone 3Gs in the 12 months through August 2009, according to a person familiar with the company's plans. The low end of that range is 52% more than the 26 million Munster expects the company to sell in that time. Apple boosted its production plans when initial sales proved stronger than the company expected, says the person, who requested anonymity. On launch day, the company expected to build 30 million iPhone 3Gs in 12 months. Apple declined to comment beyond reiterating that it expects to reach a stated goal of selling 10 million iPhone 3Gs in 2008.

The company's ability to reach that 40 million-plus goal will likely hinge on a successful introduction in several countries by the end of next year. Apple will also need to avoid component supply constraints and, maybe most important, address complaints over the performance of the updated version of its popular music-playing mobile phone.

Speeding Things Up

Apple's intention to sell the iPhone 3G in an ever broader circle of countries gives analysts cause for optimism. Analyst Michael Cote of Cote Collaborative recently told Fortune magazine he estimates Apple sold 3 million iPhone 3Gs in the first month, when the product was only available in 22 countries. Even if the sales growth clip slows after the initial burst of sales to gadget lovers, overall iPhone unit sales growth could accelerate given Apple's big international expansion plans. The company expects to begin selling in 20 more countries on Aug. 22. By next year, Apple may also be selling in the vast, swiftly growing Russian and Chinese markets. Also, Apple recently expanded distribution to include 986 Best Buy (BBY) stores.

Until recently, the major problem facing Apple and its partners was how to get enough iPhone 3Gs to market. Daily production has been running at around 150,000, says the person familiar with Apple's plans. If maintained five days a week for 52 weeks, that pace implies an annual production of 39 million devices. Suppliers of iPhone parts are used to handling far greater volumes; cell-phone makers such as Nokia (NOK) sell hundreds of millions of phones a year.

Apple will also need to reduce the time it takes to activate a phone once it's purchased at retail stores, says Needham & Co. analyst Charlie Wolf. "The physical process of activating the phone is the bottleneck," Wolf says. The process can take as long as 30 minutes, though Wolf says he's been told that Apple is working on improvements aimed at reducing the procedure to about 15 minutes.

Addressing Usability Glitches

Another challenge for Apple is a growing chorus of complaints over the phone's performance. Reports of problems began to fill the blogosphere in the second week of August, as owners reported an inability to obtain the fast "3G" wireless access even in places where these advanced networks were in place. Users have also lamented dropped phone calls and frequent switching from 3G to slower 2G networks.

While Apple has never publicly confirmed the problems, BusinessWeek first reported on Aug. 14 that the glitches relate to a communications chip in the device from Germany-based Infineon (BusinessWeek.com, 8/14/08), and that Apple plans to resolve issues with a software upgrade, rather than a product recall. An update came on Aug. 19, but many users and analysts quickly complained that the patch didn't solve the problems. According to reports, some customers say the update created new problems, in some cases rendering their iPhone useless. To now, the glitches haven't dragged down demand, Wolf says. "If the problems linger and the percentage of people being impacted grows, they'll have a problem," he adds.

An Apple spokeswoman won't confirm that there were any problems with the phone, or whether there would be follow-on updates. "We're always working to improve our products for our customers," Apple spokeswoman Jennifer Bowcock says. Apple hasn't made immediate changes to its production timetable in light of the glitches either, says the person familiar with Apple's production plans.

Adapting to Change

Even if Apple's existing production plans prove overly ambitious, Apple is still likely to meet the average estimates for actual iPhone sales. Also, Apple is known for having a supply chain that's efficient enough to adapt quickly to changes in demand. That would help the company avoid a major buildup of unsold products that would need to be sold at a discount or, worse, written off.

Munster says he's optimistic even in the face of the reported glitches. While he says he has not had access to Apple's actual production plans, he based his bullish forecasts for iPhone 3G sales in part on the success of Motorola's (MOT) hit Razr phone, which sold more than 100 million units even though it lacked some of the breakthrough features and brand popularity of the iPhone. Munster also expects Apple to release cheaper models at its annual Macworld show in January. Taken together, the moves could help Apple meet his aggressive targets even sooner than Munster expects it to.

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Burrows is a senior writer for BusinessWeek, based in Silicon Valley .