iPod on long road downhill as iPhone halo effect kicks in

In a new report to investors, Needham Research expert Charlie Wolf turns around his financial institution's predictions for the iPod and now estimates that Apple will sell 95 million iPods in 2017 — just 10 percent more than the 87 million in use today and 30 percent less than Needham had previously believed Apple would sell, hinting at a very slow growth rate compared to the dramatic leaps made in earlier years.

The change partly reflects a saturation of the market but is ultimately about the iPhone, Wolf says. At $200, the iPhone is now thought to almost certainly cannibalize a significant portion of iPod sales, especially for high end users who would otherwise have chosen one of Apple's more expensive stand-alone players.

That drop, in turn, will reportedly have a cascading effect on the iPhone itself. With more users buying the iPhone merely in place of an iPod rather than alongside it, sales of the handset in the long-term should also take a tumble relative to earlier predictions. While still positive, Needham now expects 8.5 million iPhones to be sold in the US this year and 14 million in 2009, leaving international shipments to play a major part in meeting Apple's 10 million-unit goal for 2008.

"Our previous shipment forecast was unrealistically high," Wolf says.

However, even with reduced early shipments and a lower price, Apple isn't expected to have any problem using the iPhone to grow its business. A cost analysis of the 8GB iPhone suggests that the company spends just $175 to produce and sell an iPhone 3G, leaving Apple with a roughly 60 percent margin on each unit that it sells to AT&T at an estimated $400 unsubsidized price.

The margin is twice as much as Apple is believed to have made on the original iPhone and would help soften the blow from the absence of monthly carrier revenue.

Apple's switch in pricing strategy also has the potential to increase share independently of the price. As the phone maker is no longer tied to a particular subscription model, roughly 15.6 million iPhones could sell outside of the US in 2009, including to customers on prepaid services that are more popular in some areas.

American share could also go up as other carriers are given access to the phone through the new model, which specifically detaches Apple from AT&T. "In a world where the iPhone is subsidized just like other smartphones, AT&T no longer brings anything unique to the table," Wolf says.

This also discounts the wildcard of the App Store, which could drive more users to the iPhone but is described as impossible to gauge with the store still under wraps until July.

The presence of the iPhone should also create a second halo effect that Needham analysts hadn't previously anticipated, Wolf explains. While the decline of the iPod will mitigate some of the impact, relatively few iPhone owners outside of the US are likely to already own iPods and will thus be exposed to Apple's products for the first time, filling in where the iPod stopped short.

Such added exposure leads Wolf to boost his very long term estimates for Mac sales, which could now climb to as many as 44 million computers by 2017 and could already create an upside as early as 2009, when the iPhone's effect should first become clear.