A lot of this rumor is counter to Apple's strategy at least as it relates to their bottom line now.
First, a large part of iPhones revenue is not just the phone but also the App store revenue. This phone eliminates that source of income for Apple.
Strike one.
Another big part of the iPhone's success is that it acts like an iPod you can listen to your music or watch videos on the go (in an airplane, on the road, etc.).
By moving to cloud based, you eliminate that as well because now you can only stream music via Wi-Fi at home (when you have your computer and audio system available to play music on anyway), or use limited bandwidth to stream where you get good reception only.
If anyone here has taken a road trip, you know that reception is not very good even on major highways once you leave the big city. And of course, in Airplane mode your iPhone Nano is just a phone, can't listen to music there either.
So that's 2 strikes.
Then comes the size factor. If the size is made smaller, it will have a smaller battery. Combined with the fact that now you must use battery-intense 3G or WiFi just to even play music, your battery will drain VERY quickly. This would probably give the device no more than 3-4 hours of Mp3 playing (even with screen off) - that's assuming you started with a full battery - which is not acceptable.
Strike 3!
A more likely scenario: The screen size is the same with just smaller bezels, or the screen size is slightly reduced but not so much that it impacts usability and compatibility with current apps.
Storage is reduced to 8GB to keep things cheap (even the iPod nano has at least that much and it's cheap).
Alternatively, if storage is removed, then some sort of removable storage medium could be used. Perhaps a proprietary storage chip or even straight up Micro SD would be used.
That way users buy the $199 phone, then have to spend another $49+ to get adequate storage for it.
There is just no way that Apple will forgo the extra revenue from the App store (which they will need especially if they make this really cheap) AND effectively cripple the device from being used as an iPod.
Think about it guys, every device Apple makes has some revenue on the backend for Apple.
- Apple TV - iTunes Movies and Rentals
- iPods - Music & Movies from iTunes
- iPhone/iPad - App store purchases, Music & Movies from iTunes
What people are describing with this latest rumor is that Apple is going to make a device that they cannot make money from on the backend AND they will sell it for less than devices that they DO make money on the backend from (cannibalizing some sales while making less money). It just sounds wrong.
..... unless the new Free MobileMe/iTunes Streaming is THAT great that Apple is willing to bank on people putting up with 3 hours of Mp3 Playing time while paying for streaming over [unreliable, expensive, and highly limited] 3G connection.
I don't see it, I just don't see it.