Ouch! iPhones Pinching Mobile Carriers
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
All reports would seem to indicate that Apple (NASDAQ: AAPL) is slowly taking control of the world. The company has wreaked havoc across the computer, tablet, mobile, app, music, and perhaps even the TV industries. Apple has created a brand so strong that its tribe of consumers has become obsessed with buying the latest and greatest of Apple’s inventions.
The story that often goes under the radar, however, is how companies must deal with Apple in order to distribute its products. Right now wireless carriers are debating how best to handle Apple’s iPhones – and to stay profitable while doing so.
Incredible Subsidies
AT&T (NYSE: T) watched with a smile as its monthly revenue per user rose 14% over the past four years – from $56.88 to $64.93. However, that smile quickly turns to a depressed frown once analysts take a harder look at the data.
An impressive 65% of AT&T customers own smart phones, compared with 50% of Verizon (NYSE: VZ) users. For AT&T, this means that its revenue per customer will inch up slowly, but it is coming much closer to a peak. AT&T should be asking itself: “Of the remaining 1/3 of customers who do not own a smart phone, how many of them can we expect to eventually own a smart phone?”
This problem is further compounded by Apple’s iPhone costs. Apple charges roughly $620 for an iPhone, and phone companies subsidize its purchase for new smart phone customers. So if a company were to charge customers $200 for an iPhone, that sets the phone company back $420 per unit. For comparison sake, Android devices may set firms back approximately $300 per unit.
This is a major problem. For AT&T who sold 15.8 million iPhones last year, a $420 cost per iPhone means that the carrier is subsidizing $6.636 billion worth of iPhone purchases. To put this amount in perspective, AT&T spent roughly $2 billion on wireless advertising last year.
This is a problem.
Fighting the Bully
The three major wireless carriers – Verizon, AT&T, and Sprint (NYSE: S) – have five solutions to this conundrum.
- Raise switching costs. The companies are already beginning to do this. Canceling plans or changing providers before the contract expires costs an expensive fee, and customers also pay a fee to upgrade early. For example, Sprint and AT&T both charge customers $36 for early upgrade to a smart phone while Verizon charges $30.
- Milk profitability from existing wireless customers. Again, the firms are starting to do this as well. Sprint and AT&T are storing up profitability from their low-end customers by raising the upgrade time from 12 to 18 months to 20 months. Under the new rules, subscribers must use the service for 20 months before being eligible for a discounted phone. In this way, the users’ early profitability offsets the later subsidy.
- Pass the costs onto the consumer. Companies could charge an amount like $230 per phone – a trivial difference when buying a $200 iPhone. Assuming 16 million new iPhones, this price change saves a company like AT&T a whopping $480 million in one year.
- Do not offer a subsidy. Verizon is implementing this strategy for users who want unlimited data plans.
- Partner with Apple. This solution is the least likely of the bunch, but carriers could do a joint venture with Apple that lets the carriers pay low subsidies up front in exchange for a percent of ongoing revenue to Apple for a period of time. Apple likely wants its profits upfront, but it may be willing to negotiate with its three major carriers.
Overall, if you have ever wondered why data plans are so expensive – and why you barely use half of your data on the smallest data plan – it is because the phone companies are recouping their costs from subsidizing your sleek new smart phone.
Of course Apple originally starts by pinching the wireless carriers with their expensive phones. But while the carriers originally absorb this cost for new smart phone users, they eventually pass the subsidy on to customers in the form of a huge, unnecessary data plan.
ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
