Is the iPod Touch cannibalizing iPhone sales?

In the critical Christmas quarter, Apple's iPod sales broke records, while iPhone sales were down slightly. My bet: AT&T's mediocre service and high contract price are driving some potential iPhone users to the iPod Touch.

It looks like the iPod's still got a bit of life left. It may no longer be the main driver of innovation at Apple, but the company sold 22.7 million iPods during its fiscal first quarter. That's up 3 percent from the same period last year, although a much slower rate of growth than in previous years . Still, it's growth nonetheless. Not only did Apple beat expectations but the results reported Wednesday also marked an all-time quarterly sales record for its iconic MP3 player.

The iPod Touch: everything great about the iPhone, minus AT&T. CNET Networks

Meanwhile, iPhone sales actually fell from the previous quarter, from 6.9 million to 4.4 million, coming in slightly shy of Wall Street's consensus expectations of 5 million. That's a definite reversal of the "hockey stick" sales trend we saw beginning last quarter.

What's going on here? My theory is that the iPod Touch is cannibalizing some potential iPhone sales. Plenty of users are satisfied with their current cell phone provider, but have read reviews indicting AT&T's cellular network. I've found this to be true in my own case--AT&T's 3G network has spotty coverage around Seattle, and my iPhone drops calls more frequently than my last phone, a RAZR from Verizon, although it's not as bad as the phone I had with T-Mobile until 2006. (I literally threw that one into a garbage can at the hospital, when I couldn't use it to call my family about the birth of my daughter.)

But most of the best things about the iPhone--the touch screen, the App Store, the music interface--are available on the iPod Touch, plus you get full Web access and e-mail when you're within range of an open Wi-Fi network. Better yet, you get more capacity for your music--I'm constantly having to delete apps and albums from my 8GB iPhone, but a 32GB iPod Touch would be enough for my entire digital music collection. Except the darn thing would have cost $200 more than my iPhone.

Actually, scratch that--once you add in the cost of the required AT&T data plan, any iPhone is far more expensive than the $399 32GB iPod Touch.

I reckon a lot of potential iPhone buyers are doing the same calculations and buying an iPod Touch instead. If so, offering a $99 iPhone--as I'm willing to bet Apple will do before the end of 2009--probably won't help sales all that much. Rather, Apple might have to consider changing from AT&T to another partner carrier--Verizon seems to be the least-bad of the big U.S. cellular networks, based on anecdotes I hear from its customers.

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