My presupposition of the iPad on the left and Steve Jobs’ actual product on the right.

The iPad’s intuitive user interface will appeal to less tech-savy users. As mentioned in the January 31 podcast of Six Pixels of Separation the device will remove a lot of “metaphors and architecture… inherent to laptops that deter many older users from using those devices.” For similar reasons, as well as its compelling gaming and media apps, the iPad will also attract younger users, even perhaps pre-adolescents. It was probably with this segment in mind the Paint App was demoed during the iPad presentation. The next generation of children will probably be mastering a touchscreen interface long before a keyboard or mouse. With its lower price point and conformability for recreational purposes, I also think that the iPad will become the cool, if not the standard, educational tool for younger users, replacing laptops as the device students tote from classrooms to recess. Therefore it should come as no surprise that a recent AdMob survey indicates that the Pad will be particularly popular with both the young and the old.

I also believe that the iPad will find fans in other segments such as at-home moms or dads, and sales people; as said on the Marketing for Coffee February 3 podcast, “(the iPad) will be a sales machine in a box… a good presentation tool,” echoing my similar prediction in June.

Although these segments will likely provide the initial demand for the iPad, I sincerely believe that it will find a very broad acceptance in the long run, and that it will become the device for consuming media on a personal level, just as a television is the device for group consumption. How often have you seen somebody use a laptop or BlackBerry while watching television? It is pretty much commonplace but neither device is ideal- a laptop is large and sometimes unwieldy, and a BlackBerry or any other “phone” device  is too small and limited. Although the iPhone and iTouch greatly expanded the range of the latter category, they are still a bit too small. The iPad is the “Goldilocks” solution that fits the situation just right.

So if the iPad is so great, how many will Apple sell? Pricing is the critical factor to consider. Apple announced six different initial models, probably to give options for every budget and to increase market penetration. The lowest priced model, a 16GB Wifi iPad, will cost $499 while the high end 64GB 3G model will cost $829. It is worth remembering that the iPod Touch sold over 13 million during its first 15 months, and began at price points of $299 for 8GB and $399 for 16GB, not too far from the low end iPad model. It is also worth noting that the iPod Touch is Apple’s undercover hit- iTouches are estimated to be 40% of the 58 million iPhone OS devices sold worldwide. Given it genuine utility and the market performance of the iTouch , I believe that the iPad will exceed most analysts’ sales predictions, which range from 1.1 to 7 million units for the first year.

I extrapolated the videos sold at December 2008 and 2008 on the speeds implied between official announcements. For example:

(200MM at Oct 16, 08 - 50MM at Jan 10, 07) = 150MM/645 days = 230K sales/day

50MM at Jan 10, 07 + (230K sales/day x 355 days) = 132.6MM sales at December 31, 2007

Utilizing this information I then calculated the average sales per user. Based on my calculations these average sales have dropped since 2007.

The bottom line is that Apple needs to rework its video strategy. The price cut attempts to address the issue. Why should iTunes customers pay $1.99 for a one-hour TV episode when they can spend the same amount for a game that they can play hours with? Apple understands that iTunes customers make this comparison, and that a TV episode, which is watched perhaps twice or three times, especially when repeat viewing require a user to store the video, taking up half a gigabyte of drive space, resulting yet another deterrent.

It’s also possible that Apple’s current roster of video platforms (iMac, MacBook, iPod Classic, iTouch, iPhone, Apple TV etc.) are simply not “fantastically great” enough for video watching due to portability (in the case of the computers) or screen size (in the case of the portable devices). Tomorrow Apple is presenting a new device, which could turn out to be the perfect device for video watching. It might finally convince iTunes customers to buy more TV episodes. It may also persuade Apple’s TV production partners to go along with the new iTunes pricing plan.

It occurred to me that such a model would be well suited for a digital subscription service, since it could faithfully measure the viewing audience for each channel on its lineup.  I decided to try and create such a model based on the parameters of the new TV subscription service that Apple is rumored to be developing. Supposedly Apple is offering broadcast networks a carriage fee of somewhere between $2 to $4 per subscriber while cable networks are being offered between $1 and $2 per subscriber. These top end of these fees run more than double what cable pays; a necessary compensation since the service will not carry advertising, eliminating a key revenue source for the networks, especially the broadcast nets.

Paying $4 per broadcast network would total $16 in programming costs to Apple. Also paying $2 per cable network with a 10 channel lineup would add on $20 in costs, totalling $36 per subscriber, well past the $30 price tage the service is rumored to have. Therefore, a viable business model for Apple’s service requires lower average carriage fees, but still needs an high upside to convince the networks to join.

An audience-based model that distributes fees according to viewership would allow for:

1. High ceilings for the carriage fees to the networks.
2. Fair compensation to networks for ad-based television viewing audiences cannabilized by Apple’s service
3. A lower total programming cost to Apple.

My proposal is to give each broadcast network a $2 base fee, with an additional $10 distributed among the four networks based on the share of viewing a subscriber gave to each one. Each network could have the possibility of reaching $4 per subscriber if they received 100% of the viewing for a given subscriber. A 25% viewing share would add $0.50. The following two examples demonstrate how it could work.

A similar model could also be implemented for the cable networks by simply substituting lower fees: a $1 flat fee per channel and a smaller distributed fee of $1 among 10 channels.

I realize that this model does not allow for much room in growing the channel lineup since it would incur significant new costs, but this could be planned for depending on Apple’s programming strategy.

In any case I do believe that this type of value-based fee pricing follows the spirit of business models espoused by Google (I am currently reading Googled by Ken Auletta), which efficiently allocate cost to value, and is the approach that will win out in the digital distribution of media.

The iTunes store launched in early 2003 and by the end of the year it had almost 700,000 registered users. With the launches of the iPhone and iPod Touch, iTunes greatly expanded its customer base and they now reach over 100 million users.

The larger user base consequently led to accelerated musics sales. In early September total song sales reached 8.5 billion; they will probably surpass 10 billion in early 2010. (Update: Effectively, Apple reached the 10 billion songs sales point on February 25, 2010)

Looking at the average annual songs sold per registered user, iTunes initially had a very high amount- over 60 songs per user during its first year. This makes sense given that most of iTunes’ initial customers were early adopters of iPods and iTunes and probably hard-core music fans. After 2003 average song sales dropped off, but steadily grew back through 2007, until the user base ballooned (with the introduction of the iPhone and iPod Touch), resulting in another drop in 2008. However, the average has recovered between January and September 2009. Perhaps the latest wave of iTunes customers are becoming music customers.

As I mentioned beforem within video the picture hasn’t been as pretty. Total video units sold has been a fraction of average songs sold per customer. I thought that video sales would’ve picked up once more video-capable Apple devices were in the market (iPhone, iTouch, etc.) but that hasn’t been the case. Average sales per user dropped off in 2008, again, due to the increased user base, but video sales have not recovered like music. Rather there have been two sequential declines in average video units sold per user.

So is there a possibility that Apple will rectify its video position? Since April I have been speculating on the highly rumored iTablet. I believe that the device will be a multimedia marvel, revolutionizing gaming, digital magazines and digital video in particular, much as how the iPod affected the digital music industry. What was missing from my initial analysis was how Apple would need to couple its device launch with an evolution of iTunes, in terms of its video business model.

While iTunes does offer unparalleled access to content from many producers, it is easy to understand how many consumers might be stifled by its pay-to-own business model. An 45 minute standard-definition television episode on iTunes takes up about 450 MB of storage space. That is about 50 times more than a song. A song costs only half as much as the TV episode ($0.99 to $1.99). Therefore the real prohibitive cost to consumers from buying video content is disk space and not the purchasing price.

The logical solution for iTunes would be to implement a video subscription model. This week such a service was reported on at AllThingsDigital and Disney is rumored as being one the service’s early partners. Such an option combined with the “iTablet” would give Apple a much stronger customer offering for video, and would probably propel the company’s position within the market during the next few years.

Last year’s invite clearly showed a thin iPod, hinting at the return to the “narrow form factor” in the fourth generation Nano, which was indeed presented at this event. The rumored announcements for this year’s event include:

• The Beatles library will be added to iTunes Store. This has been widely speculated since The Beatles remastered catalog is being released the the same day, but the event’s invitation mimics a song from The Rolling Stones; could this be a smokescreen?
• There will be adjustments to the iPod product line including an video camera functionality to the iTouch. Capacity upgrades are expected as always.
• Similarly, there will be price adjustments across the lineup.
• Finally, iTunes version 9.0 will be introduced. It may include new music bundling options and social features. A less likely subscription music service has also been rumored.

Regardless of exact proclamations the event is undoubtedly meant to support Apple’s iPod sales, which are normally strongest in the fourth quarter. This year however expectations are somewhat lower since iPod sales dipped recently in the third quarter, a first on a year-to-year quarterly basis. This is why I consider this year’s September event to be a quick reboot; a moment for Apple to reiterate its lead in the music sector, while buying the company some time to develop in other areas.

The iPod division, or segment, was the strongest contributor at Apple in 2006. Since then Mac sales have grown more briskly. Other segments have also consolidated themselves.

This all demonstrates how Apple, despite the iPod’s success, has not rested on its laurels and has developed its other products while diversifying its business interests. Apple has expanded from computer and software to music, video, mobile and gaming. Moving forward it will be interesting to see which new products and services Apple launches to further expand its stake in each of these sectors.

I personally believe that while a music subscription service would be quite challenging, a video subscription service would be a more natural market fit. Although Apple has done well with iTunes video sales, consumers normally rent access to TV shows or movies, rather than purchasing them outright. I am certain that Apple will eventually present a video subscription option in the iTunes store, perhaps within the next year. Gene Munster, an analyst at Piper Jaffrays, recently predicted that Apple launch an Apple TV set by 2011.

If the company does successfully move into music and video subscription services it could effectively become a media company, competing with the likes of Comcast, Netflix and Hulu. Apple is already leaves its digital music competitors in the dust. It is interesting to speculate how it would fare in the digital video sphere. I am sure the topic will be coming up in the months ahead, if information is finally revealed.

It will also be interesting what happens in the rest of the smartphone market. According to Gartner Research, mobile phones sales dipped 8.6% in 2008, while smartphone sales went up 12.6%. Research In Motion (RIM) has had a strong hold in the smartphone market so far, but last week RIM forecast second quarter sales figures below analysts’ expectations. It’s difficult to say how much this has to do with the new iPhone 3GS but a Piper Jaffray’s analyst Gene Munster did a survey this weekend of new iPhone 3GS customers, indicating that the BlackBerry defectors were 12% of the 3GS customers, double the 6% found last year. All signs point to a tighter race this year between RIM and Apple.

UPDATE (June 23): An interesting article today in MediaPost mentions another smartphone study conducted by the firm CrowdScience, which further illustrates the challenges RIM is facing. The study indicates that 40% of smartphone users would don’t have an iPhone would switch to one, while only 14% of non-BlackBerry users would switch to the RIM device.

This device, let’s call it the iTablet iPad (Microsoft has a hold on the “tablet” category name), will be like a larger version of the iTouch. See below for what I estimated the size and shape to be, and how it would relate to Apple’s existing lineup of small electronic devices; from left to right: Shuffle, Nano, iPod, iTouch and iPhone.

The device can be seen as an extension of the iPod family, but what will it do? The iPad will probably have the following features:

• Multi-touch user interface, similar to the iTouch and iPhone.
• Accelerometer, although the functionality of this will be somewhat different given the larger size of the device.
• Rear or side external audio speakers, similar to iTouch.
• Video and audio output, a first for an Apple small device, but necessary in order to support many of the functions I believe this device will fulfill.
• Wifi for web browsing and connecting to iTunes and the App Store.
• Bluetooth for external devices (headset, keyboard, mouse, game controllers) and for peer-to-peer applications.
• Run on the new iPhone OS 3.0, which offers a variety of new functions including direct App Store movie and TV show downloading, In-App purchasing, Peer-to-Peer connectivity, Voice over Internet functions and Push Notification.

Given these features the iPad will transcend all current product categories since it will fill a variety of functions:

• Game Platform: The iPhone and iTouch have clearly demonstrated their ability to compete in the portable gaming market. I believe that Sony’s latest PlayStation Portable (PSP), the 3.8 inch screen PSP Go, revealed last May and releasing in October, is a direct response to Apple’s smaller gaming products. A 10-inch screen will extend Apple’s presence in the gaming market, towards the higher end. Also, since the iPhone OS 3.0 communicates with many accessories, the iPad may probably support Bluetooth gaming controls, which will make the iPad Apple’s first entry into the console game market. There are also rumors of Apple launching a premium game section in the App Store, which might be the direct software component of this strategy.
• E-reader: Clearly the Kindle is a device that has received great reviews and acceptance in the marketplace, but while its black and white digital ink technology facilitates text reading, it is not ideal for color periodicals. Apple is already beginning to cater to this market with iTouch and Iphones Apps like Iceberg Reader which offer both subscription or single pay systems through in-App purchasing. While the Kindle will probably remain the staunch choice for book readers the iPad could take the majority of the color periodical subscription market.
• Multimedia Display: I expect the iPad will become the choice device for multimedia-to-go. It would be much more practical and comfortable for watching movies on trips, instead of carrying around a portable DVD player or a laptop. It could also be shared for viewing between two people unlike an iTouch or iPhone. The new iPhone OS supports direct movie and TV show downloading, signaling where Apple might be going with the iPad.
• Presentation Device: The portable size and touch screen capabilities of this device will make it an innovative device for animated presentations. Just see how much touch screen technology is in vogue now, popping up every day on CNN’s Situation Room and in movies like Quantum of Solace. Salespeople who want show clients some extra pizazz will use the iPad.
• Sporty computer: I also believe that the iPad will be used by many as their ‘second computer.’ I am thinking about businesspeople who already have a company laptop. The iPad will fit that need as their fun computer, for using Facebook, reading Golf Digest online, and watching videos. For all the reasons I listed above, iPad will be the device that they take on vacations. Similar to how some people have two cars; iTablet will be the sporty roadster they use on the weekends.

There are probably a number of other functions I haven’t thought of; I never expected the iPhone to be used a medical device for example. All in all, the new versatile device is sure to overturn many established parameters about electronic device categories, which will appeal to many different consumer segments. If it launches before the Holiday season Apple has another breakout hit on their hands.

The area of the bubbles denotes the storage capacity of the devices. There seems to be three repeated trends here:

1. Maintain existing product lines at lower price points.
2. Introduce new luxury product lines with new features (iPod Video, etc.) at higher-end price points.
3. Introduce new economical product lines with less features (Shuffle) at lower price points.

The iPhone family, although just over two years old, displays similar trends.

I do believe that Apple is being very conservative in their pricing, probably as a result of the economic pressures most consumers are facing. This is clearly indicated by the new prices for an iPhone 3G ($99) and a MacBook Pro ($1,199). Interestingly enough Apple is maintaing the prices for their iTouch family (starting at $229). I believe that these will drop once Apple finally releases the new 10-inch computer tablet that has been catching a lot of press.

New models with premium features have regularly been introduced at higher price points. The fourth generation iPod “Photo” with a 60 GB capacity is the first example of this. A more recent example is the Ipod Touch which offered internet browsing and gaming capabilities, also at a premium price point. While Apple has innovated in its iPod features it has also gradually lowered the prices while increasing the capacity of existing iPod lines. This two pronged approach of continual innovation and increased value has garnered Apple continual sales growth, which will surpass a total of $200 million this year.

It is interesting to speculate how Apple will continue this strategy during the next five years, and which possible new iPod features it will come up with.