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Wednesday, March 18, 2009, 07:00 am PT (10:00 am ET)

Apple's iPhone 3.0 expands the 'yawning' competitive gap

While the vast majority of smartphone makers are betting that beefed-up handset hardware alone will attract new feature phone users, Apple demonstrated Tuesday that software stands to be the biggest differentiating factor as the market matures, and is further distancing itself from rivals as a result.

"Yesterday Apple previewed iPhone 3.0, the latest iteration of its mobile computing OS," Oppenheimer analyst Yair Reiner wrote in a report Wednesday. "We believe the update, slated for general release this summer, expands the yawning competitive expanse between Apple's mobile platform and the knock-offs of would-be rivals."

Commonly requested features like Copy & Paste and MMS aside, the analyst added that the iPhone 3.0 software expands and fortifies the Apple handset's most singular competitive differentiator: the ecosystem for third party developers.

"Competitors are scrambling to make hardware that looks like the iPhone," he wrote. "But to our mind, Apple is playing a different game - creating a mobile media platform that in its stickiness and magnetism resembles nothing so much as the Windows operating system that upended it a generation ago."

In his own report on the matter, titled with the catchphrase "it's the software, stupid," Needham & Co.'s Charlie Wolf shared many of the same sentiments as his fellow analyst while drawing attention to the particular challenge facing smartphone makers in maintaining double-digit growth rates during rough economic times.

"The smartphone industry is betting that it can meet this challenge and continue to lure feature phone users through more powerful hardware," he wrote. "While we believe this will work, it will not translate into a sustainable competitive advantage for any individual smartphone manufacturer."

More specifically, Wolf believes the 'misguided' obsession with differentiation through hardware features will leave many smartphone makers treading water because "hardware is essentially a commodity." That is, no manufacturer can achieve a sustainable advantage through hardware because the components in most smartphones are simultaneously available to all competitors.

(See how Apple is also actually working to differentiate the iPhone through proprietary hardware not available to rivals.)

"In our opinion, a more effective differentiator is software — both operating system software and the software applications that run on the device," he wrote. "Apple appears to be the only company that understands this. And that’s why today’s event was significant."

"We could go on," Wolf continued. "But we won’t [...]. Moreover, the significance of today’s event was not about the particular features Apple added in the iPhone 3.0 release. Rather, it signaled that Apple is distancing itself even further from rivals in the operating system software space."

Reiner reiterated his Outperform rating and $120 price target on shares of the Cupertino-based company while Wolf reinforced his Strong Buy rating and $200 price target.