Carriers Suffer the Subsidy Because They Need the iPhone

By Michelle Maisto  |  Posted 2012-04-29

iPhone and Carriers: How Long Can Apple Keep Its 'Stranglehold'?

Apple sold more smartphones than any other device maker during the first quarter€”35 million to Samsung€™s 32 million and Nokia€™s 12 million, by IHS iSuppli€™s count. With this kind of success comes a unique kind of power.

The iPhone maker charges the carriers more per phone than Samsung and other manufacturers do for their smartphones, and, needing the iPhone, the carriers not only pay but swallow the cost instead of charging customers more for a device they pay more for. The carriers need the iPhone because subscribers want the iPhone. However, should the iPhone be priced higher than a comparable Android device? The fear is that subscribers might want it slightly less, which would be worse for the carriers€™ bottom lines than the current arrangement.

€œMany operators worldwide are stuck on a subsidy treadmill that they find very hard to get off,€ Neil Mawston, executive director of Wireless Device Strategies at Strategy Analytics, told eWEEK. €œEuropean operators reduced subsidies for prepaid phones in the early 2000s, while Japanese operators tweaked subsidies for postpaid phones in the late 2000s, and both changes led to slowdowns in handset volume growth.€

For now, said Mawston, the iPhone €œis a must-have, must-stock and must-subsidize device for operators like Sprint and others.€

Sprint, the latest of the top U.S. carriers to offer the iPhone, struggled in recent years, blaming its lack of an iPhone for the hundreds of thousands of customers that left it each quarter. During its most recent earnings announcement, April 25, Sprint€™s numbers proved its point. With the iPhone in its portfolio, it sold 1.5 million of them during the quarter, 44 percent to customers new to the network. (By contrast, only 21 percent of AT&T€™s first-quarter iPhone sales went to new customers.)

Still, the device raises new issues for Sprint. Bloomberg reported that the carrier is in discussions with equipment suppliers to get up to $3 billion in financing help. Plus, according to the report, €œSprint is coping with rising expenses that include a four-year $15.5 billion contract to sell the iPhone and $10 billion for network expansion over the next two years.€

Carriers Suffer the Subsidy Because They Need the iPhone

The history of the iPhone subsidy, explained Research Analyst Eric Costa, with Technology Business Research (TBR), started in the early days when AT&T stood as the exclusive carrier. €œSince it was obviously not as well known yet [in 2007], so AT&T subsidized the device to make it more competitive with other smartphones.€

A few years later, when the iPhone 3G came out, AT&T lowered the price of the original model, unknowingly (one imagines) cementing a model.

€œThe iPhone became very popular and is now so widely adopted that the operators cannot change the price at this point,€ Costa continued. €œThe price change would have had to come when it was still exclusively at AT&T, but even then, Verizon could have forced the price down once it acquired the iPhone in 1Q11.€

The carriers need the iPhone and so suffer the subsidy, but the big picture is that the iPhone, over its lifetime, benefits the carriers.

Costa explained:

Take AT&T for example. Despite margins tanking each time a new iPhone model is released, AT&T actually increased its OIBDA [or operating income before depreciation and amortization, a slippery accounting term for income] and operating margins since the iPhone€™s introduction to the carrier in [the third quarter of 2008]. This is due to increased iPhone activations and data usage driving data revenue upward, which is helping the operators overcome the impact of the higher equipment subsidies.

Costa charted AT&T€™s iPhone operating and OIBDA margins, and the lines mimicked each other€”whether the margin line dipped or rose, the OIBDA line did the same, though high above it.

Still, the carriers are looking for a way out of this game€”or, more precisely, to lessen their dependence on it. By many accounts, they€™re looking to do so by supporting three solid mobile platforms. With the fate of Research In Motion unsteady, Microsoft€™s Windows Phone is the most likely candidate to join iOS and Android.

€œAt the end of the day, all of the mobile operators would love to reduce their iPhone subsidies, which has a big impact on their expense and the bottom line,€ said Ken Hyers, another analyst with TBR. €œThat€™s why operators like AT&T and Verizon Wireless are so eagerly embracing Windows Phone, which they hope will break Apple€™s stranglehold on their most profitable customers.€

How likely are they to break that hold?

€œCustomers are fickle and fashions change over time,€ said Strategy Analytics€™ Mawston, €œso there will inevitably be new models along to change Apple€™s subsidy dominance at some point in the future€¦ Nokia, Motorola and RIM have all been perceived as over-subsidized by operators at times in the past decade, so the concerns about Apple are part of a broadly familiar cycle.€

Apple CEO Tim Cook, during Apple€™s April 24 earnings call, addressed the issue, to some degree, when asked how Apple would react to carriers around the globe eventually reducing their subsidies.

€œOur focus is on making the very best smartphone in the world€”a phone that delivers €¦ just an off-the-charts user experience that customers want to use every day of their lives. And at the end of the day, I think that carriers, the vast majority of carriers, or maybe even all carriers, want to provide what their customers want to buy,€ Cook said, according to a transcript from Seeking Alpha.

Cook added:

The iPhone has some distinct advantages for the carrier over competing smartphones. For example, many of the carrier executives have told me that churn from iPhone customers is the lowest of any phone they sell €¦ And that has a significant direct financial benefit to the carrier. Also, our engineering teams work extremely hard to be efficient with data €¦ and we believe that as a result of this, the iPhone has far better data efficiency compared to other smartphones that are using sort of an app-rich ecosystem.

Finally, we think that€”and this is the most important€”the iPhone is the best smartphone on the planet to entice a customer who is currently using a traditional mobile phone to upgrade to a smartphone. This is by far the largest opportunity for Apple, for our carrier partners and is a great, fantastic experience to the customer. And so there's a win-win-win there. I think €¦ some of these factors are missed in this general discussion of subsidy.

Historically, any vendor that has risen as Apple has eventually heads back down the hill, as consumers fall for the next big thing, said TBR€™s Hyers.

€œHowever, the next big thing hasn€™t yet arrived, so I think that Apple still has some gas in its tank with iEverything.€ To note, Hyers added: €œAfter the fall, there has never been a successful second act. In the meantime, Apple should grab all the money it can from the operators, because, eventually, its turn will come, too.€


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