iPhone too pricey? Then think smartphone-lite

Smartphones, such as Apple's iPhone, are all the rage these days. But as the economy worsens, these sophisticated devices and the expensive data plans that are required to be purchased along with them, are out of reach for most cell phone users.

A new handset maker based in the U.K. says it is developing phones that will offer similar functionality at a fraction of the cost. INQ U.K., which is owned by Hong Kong-based telecom giant Hutchison Whampoa, is developing a set of souped-up feature phones that will be loaded with all kinds of Internet and social networking functionality for half the cost of a traditional smartphone.

Frank Meehan, INQ's CEO, believes that there is a large number of mobile consumers with iPhone-envy who don't want to spend the money on the device or the expensive data service. He thinks there is a huge opportunity in making a less expensive, less complex device tailored for a few Internet-based applications to address this segment of the cell phone market.

"Most manufacturers are spending billions of dollars going after the iPhone with limited success," said Frank Meehan, INQ's CEO. "But 80 percent of the market can't afford an iPhone and the corresponding service plan."

This notion of creating more affordable, higher functioning phones is likely to be a hot topic at the GSMA's Mobile World Congress next week. MWC is the largest gathering of cellphone makers in the world and is considered the premiere event of the year for the worldwide mobile phone market.

Several phone makers including LG and Samsung have already tried to address this market with newly designed devices that offer email functionality and Web surfing. But these devices, which do not run full smartphone operating systems, are priced about the same as smartphones. The LG Dare hit the market at about $250. The LG Voyager sells for $199. And the Samsung Instinct was originally priced at $129. Each of these phones also require expensive data plans with a total cost of about $70 or $80 a month.

INQ's value proposition is that it will not only offer consumers a much better mobile Internet and social networking experience, but it will be much cheaper than what's currently on the market. Because the devices are less expensive than smartphones or other advanced feature phones, Meehan also believes that mobile operators could be more flexible in how they price their data services to attract even more consumers.

"The phones are so inexpensive that carriers could create lower-cost data tiers of service," Meehan said. "And they could still maintain their margins."

Economic realities
There's no question the global recession is hitting the cell phone market hard. Worldwide sales of cell phones in the fourth quarter were down about 12.6 percent compared to the fourth quarter of 2007, according to IDC. Even the mighty market leader Nokia is getting hit. The company said sales dropped 19 percent in the fourth quarter of 2008 compared with the same period a year earlier. And its profit fell about 69 percent. Other manufacturers, such as Motorola and Sony Ericsson, have also reported heavy losses

The one bright spot in the mobile handset market are smartphones. Device makers grew sales of these advanced phones by 22.5 percent compared to the fourth quarter of 2007, IDC reported. Strong smartphone sales has also helped boost profits for wireless operators. Verizon Wireless said its average revenue per user for data services was up 27.9 percent for the fourth quarter, compared to the same quarter a year ago. AT&T, which activated 1.9 million iPhones during the quarter, saw its wireless-data revenue grow 51.2 percent during the quarter.

This is good news for device makers and mobile operators, who are trying to push smartphones into the mass market.

But there's just one tiny problem. Smartphones are not cheap to manufacture. Market research firm iSuppli recently took apart the BlackBerry Storm and priced its hardware components at about $203. Verizon sells the device for $199 with a two-year contract. Another iSuppli report says the Blackberry Bold's hardware cost is about $158. Meanwhile, the iPhone costs $174.

The $200 retail price tag seems to be the sweet spot that most smartphone early adopters in the U.S. market are willing to pay. This means that operators must subsidize the cost of the device to get to this price tag. AT&T's iPhone, T-Mobile's G1 and Verizon's Storm all debuted at $200 with a two-year service contract.

But as competition heats up, experts like Ryan Reith of IDC, expect carriers to further subsidize these devices to compete with other carriers. The iPhone has been holding its value very well. But carriers are already starting to cut prices and offer special deals on other smart phones.

Only a month after it hit the market, the G1 started selling for $148 from Wal-Mart. And three months after it launched the Storm, Verizon Wireless is now offering a special buy-one-get-one free promotion that allows customers who buy any BlackBerry device, including the Storm, to get another one free.

While these subsidies could attract new customers, they will also cut into mobile operators' profits.

Even with increased subsidies, most consumers will still find the steep monthly data fees too much to stomach, leaving a large portion of the cell phone market untapped. Toni Sacconaghi, an analyst with Bernstein Research, recently wrote in a research note that because of these hefty data plan costs that iPhone maker Apple is missing out on 83 percent of the handset market today.

"To more effectively address this part of the market, we believe Apple should offer an iPhone that does not require the user to sign up for a data plan," Sacconaghi's report reads. "Note that we do not necessarily believe that a non-data plan iPhone needs to be priced significantly lower at retail than the current 3G iPhone ($199 in the US, with service contract), but waiving the data plan requirement alone would save users on the order of $30 per month, or $720 over two years-making it accessible to a much larger base of users."

The inside track for INQ
This is where INQ sees opportunity. Meehan says the company can build a phone specifically designed to access a slew of Web-based applications for less than $100.

The company's first phone called the INQ1 is already available in the U.K. and Australia on 3's network. The slider phone has Facebook, Skype, Yahoo, Google, eBay and Windows Messenger built-in. And those Web-based services are tightly integrated into the phone, so users can take a picture with the 3.2-megapixel camera and immediately upload it to Facebook, MySpace or any other site they want. The phone also has a music player that can connect to Last.fm (a unit of CBS Interactive, as is CNET Networks, the publisher of CNET News and CNET Reviews) for streaming music right out of the box. In Australia, the phone sells for about $117 on a prepaid plan or for as low as $25 with a service plan.

Because the phones are so cheap, Meehan believes that mobile operators could afford to create special data plans that cost much less than the all-you-can-eat plans available for the iPhone of the BlackBerry.

"With a lower cost device, carriers can put together more aggressive data plans for these social networking phones," he said. "Every time you drop the price on a smartphone, you lose that margin. If you have a social networking phone that costs less money to begin with, you have more to play with."

Meehan added that social networking, above any other mobile data service, appears to be what people are willing to spend money on.

"People may not be willing to pay extra for mobile TV or music, but they'll pay a bit more for email and Facebook, so long as it's not too high," he said.

Indeed, INQ isn't the only company that sees social networking applications as the key to increased data usage. RIM partnered with Facebook in 2007 to create a BlackBerry Facebook application. The Facebook application designed for the iPhone is one of the most popular downloaded from Apple's App Store.

And just this week The Wall Street Journal reported that Nokia is supposedly partnering with Facebook to embed some social networking functionality into its phones. Facebook is also working with Palm. And Motorola is also rumored to be working with Facebook on integrating the application into future phones, the newspaper reported.

But the biggest challenge INQ likely faces is creating a device that consumers love. Not only does the Web and social networking experience have to be on par or better than today's smartphones, but the hardware design and software interface must be slick and easy to use.

And as components for smartphones decline in price, INQ is also fighting against economic forces. Once smartphones become as cheap to manufacture as an INQ phone, the company could lose its value proposition.