Apple's iPod touch Dilemma

Pity the poor iPods. They are the equivalent of yesterday's news. At one time, they were the hottest items in the Apple Store — the MP3 players that destroyed the competition. Ads for the latest generation of these devices were everywhere. Now, not so much. Like a former star quarterback relegated to second string, the iPods' glory days are behind them.

Exactly how bad things are is hard to tell. Apple doesn't break down sales of iPods by individual models. This is especially problematic if you are trying to separate sales of the traditional iPods (classic, nano and shuffle) from the iPod touch (which, as an iOS device, I consider to be more closely aligned with the iPhone and iPad).

Apple does post combined sales of iPods. Most recently, Apple stated that it "sold 6.8 million iPods, a 10 percent unit decline from the year-ago quarter." A year earlier, Apple revealed that they "sold 7.54 million iPods, a 20 percent unit decline from the year-ago quarter."

This year-over-year decline has been evident in all quarterly statements for the past several quarters. Clearly, iPod sales will not be the source of Apple's future growth. I expect iPods to take more and more of a back seat in the years ahead. This shift is already underway. Last year, for what I believe is the first time since the iPod was introduced, there were no hardware upgrades to any of the iPod models. For me, the biggest surprise was the stagnant state of the iPod touch. Apple made no attempt to give the touch feature parity with the latest iPhone model at the time (the 4S).

Still, the iPod news isn't all bad. Apple sold over 30 million iPods during the past 12 months. That's not chump change.

Next week, on September 12, Apple is all but certain to unveil the iPhone 5 (or whatever it will be officially called). A few weeks later, Apple is expected to hold another media event where it will announce a smaller iPad (the iPad mini?). At this second event, Apple is also likely announce any upgrades to iPods. What might be in store for the new iPods?

One possibility is that traditional iPods (especially the iPod nano) will add Wi-Fi support. This makes sense in light of Apple's recent push towards iCloud and iTunes Match. With Wi-Fi support, iPods could access iTunes Match, giving the service a wider user base.

iPod touch

What about the iPod touch? Will the touch get an overhaul to match the new features in the iPhone 5? If I had to guess, I would say no; I expect some changes to the touch, but believe it will still lag behind the new iPhone.

This leads to the critical question: Who is the "iPod touch buyer"? What is the market for this device? It is here that Apple faces a dilemma.

The iPod touch vs. the iPhone

Over the past few years, my assumption has been that the iPod touch primarily appeals to people who want the features of an iPhone (an iPod, a camera and an App Store device) but don't want or need the device to be a phone. Included in this group are kids who are too young to have their own mobile phone (a diminishing subset; I expect to see toddlers with their own smartphones soon). This group also includes people who prefer that their mobile phone not be an iPhone or who don't want a mobile phone at all (perhaps content to rely on services such as Skype). For some, the touch can serve mainly as a game machine, an alternative to portable game devices from Sony and Nintendo.

The problem is that as the iPhone continues to gain in popularity, the market for the iPod touch inevitably declines. If you own an iPhone, it's almost certain that you do not also want an iPod touch. Very few, if any, people have a need for both devices.

If you're deciding between an iPhone vs. an iPod touch, the iPhone is increasingly a more compelling alternative. You can buy an iPhone 3G (probably to be bumped up to an iPhone 4 after next week) for free! True, you have to contend with a two-year carrier contract, but you'll need to do that for any subsidized smartphone. The word "free" is a powerful motivator — especially as the specs of the latest iPod touch are not much different than older iPhone models.

The iPod touch vs. the iPad mini

With the arrival for the iPad mini, the iPod touch will be attacked on a second front. The dilemma here, for Apple, centers on how to differentiate the pricing of the two products.

Apple hasn't yet revealed any pricing for the iPad mini. However, most estimates place the entry price as between $199 and $299. Let's split the difference and assume a base price of $250 for a 16GB model (the current capacity of the entry level $499 iPad).

Currently, iPod touch models range in price from $199 to $399. If price matters above all else (which it does for many consumers) and especially if you don't plan to overload your touch with music and such, you're likely to gravitate to the 8GB $199 model. Otherwise, for just a $100 more, the jump to 32GB is well worth it.

If Apple doesn't change the price of the iPod touch, you will be able to buy an iPad mini for less than a 32GB iPod touch. At this price difference, the only people likely to prefer an iPod touch over an iPad mini are those who require an iOS device that conveniently fits in a pocket and who don't own an iPhone. The size of this market could be vanishingly small.

What could Apple do about this?

One option would be to drop the price of the iPod touch. However, this could lead to a price problem between the touch and the iPod nano. An entry level 8G iPod nano sells for $129. If Apple drops the price of the 8GB iPod touch to $149, that's only a $20 difference! Even so, this might work, as the target audience for the nano and the touch are quite different.

Still, I see a lot of potential nano customers here saying: "For $20 more, I'd rather get the touch." Sales of the nano could plummet. Again, Apple might be okay with this; the company is getting your money whichever device you get. But they would probably prefer a clearer dividing line. Apple could solve this by dropping the price of the nano. However, at some point you have to wonder when all of this price dropping stops making sense.

The other option is to leave the iPod touch price alone, which probably means an even faster and deeper decline in sales. As long as Apple doesn't spend significant resources on upgrading the touch each year, this too might work.

Bottom line: the iPod touch market is being constricted by Apple's own products—the iPhone and the (presumed) iPad mini. And perhaps even by the iPod nano. I'm confident that the situation is not dire enough for Apple to consider abandoning the iPod touch altogether. But Apple does have some price compression and market differentiation quandaries to solve. What will it do? We should know the answers in a few weeks.