The great iPod migration by Philip Elmer-DeWitt @FortuneMagazine February 4, 2009, 3:43 PM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons How will Apple AAPL persuade 100 million iPod users to trade up to an iPhone? That’s the problem Bernstein Research’s Toni Sacconaghi tackles in a report to clients Wednesday. His answer: Make an iPhone that comes without a data plan — currently $30 a month in the United States. The opportunity for Apple is so attractive that he puts the odds of such a thing coming to market before the end of the year at better than 50-50. Sacconaghi’s premise is that the market for stand-alone music players is shrinking and will continue to decline over time — eventually going the way of the Palm Pilot — as users trade their iPods in for cell phones that can also play music. For the vast majority of those iPod users, the iPhone is simply too expensive — not because of the $199 starting price, but because of the required voice + data service plan ($70+ per month, or roughly $1,700 over the life of a two-year contract) that Sacconaghi describes as “the biggest gating factor to mass market adoption.” The numbers involved are huge. The worldwide market for smartphones (i.e. phones that require a data plan) is estimated to be about 225 million in 2009. But that’s just 17% of the total 1.35 billion mobile handset market. (See Exhibit 1.) In other words, Apple is effectively not participating in 83% of the mobile handset market place. The irony, Sacconaghi contends, is that Apple is in a unique position to grab a hefty slice of that pie. “Apple’s more than 100 million iPod users give the company a huge opportunity to capture significant market share in the mobile device market, if it can successfully migrate these users to the iPhone. We note that these users would likely be very partial to migrating to an Apple offering, given their familiarity with iTunes and purchases of DRM encoded content.” So what would an iPhone without a data plan look like? Apple, as usual, isn’t talking about future product plans, and “the blogosphere,” says Sacconaghi, “also appears to have little credible insight.” But the two solutions he proposes — an “iPhone nano” and an “iPhone touch” — are not that different from the ideas the rumor sites have been kicking around for months. iPhone nano: A miniature iPhone that plays music and videos, but has a small screen and can’t browse the Net or run iPhone apps. $100, with subsidy. iPhone touch: Today’s iPod touch with a cellular modem. Can make calls and play apps, but may not have 3G or a GPS. $150, with subsidy. Sacconaghi is convinced either one of these approaches would enable Apple to capture 3% of the non-smartphone mobile handset market (compared with its current 12-15% of the smartphone market). Even assuming 100% iPod cannibalization, Apple makes out like a bandit, according to Sacconaghi: “[For] every iPhone nano sale, Apple essentially trades about $125 in revenues (assumed wholesale price) for $250, and $44 in gross profits for $130. For the iPhone Touch, Apple would be trading about $200 in revenues for $350, and $70 in gross profits for $150.” It’s all laid out in the Bernstein Research spreadsheet (Exhibit 3) pasted below the fold.