Telco Subsidies Disappearing? No Way

Margie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When a stock is riding high you rarely hear negative columns being written about the equity.  Now that Apple (NASDAQ: AAPL) has dropped fairly precipitously, from a high of $705 a share in September to $529, there have been a proliferation of articles questioning whether or not Apple is actually worth substantially less than its current price.

When the stock was trading near its highs, I remember reading very few columns that were bearish in scope, and it's not that those thoughts weren't out there either. To me this a prime example of how hard it is to “go against the grain.” Much like a politician with tremendous public support is seemingly immune to criticism, this is a case of “kick ‘em while they are down.”

Let’s Talk Subsidies

Yet, this isn’t some ultra-bullish Apple response. I actually want to have a meaningful conversation about some of the bearish arguments being made.

With that said, in Bob Chandler's recent Motley Fool column, he struck upon the theme of the iPhone subsidies: "An iPhone would typically retail around $600 to $800 without carrier subsidy. Given current competitive product and pricing, it is a dubious contention that Apple's market share would be where it is if customers had to pay the unsubsidized price."

He went on to state that carriers had been at a significant disadvantage when forming deals with Apple, and wondered what would happen to Apple profits if the subsidies the cell phone carriers give to their clients ceased.

Apple Puts the Telcos Over a Barrel

You know what's great about having the latest and greatest new gadget that was completely revolutionary? You get to dictate your terms when negotiating with resellers.  And boy did Apple ever do that.

Apple demanded the telcos pay the full amount for the iPhones upfront, and carriers had to commit to a certain volume every year. Sprint (NYSE: S), to get the iPhone, had to commit to sell $15+ billion worth of iPhones over four years.

So it should come as no surprise to anyone that the telcos would love to have competition for the iPhone, which in past years did not exist, perhaps offering better terms than the onerous ones a monopolistic Apple once provided.

Competition Arises

But at last, other technology companies have caught up to Apple.  From the Google (NASDAQ: GOOG) Android phones of Samsung and Motorola, to Nokia's (NYSE: NOK) Lumia 920 Windows 8 based phone, the iPhone finally has serious competition.

Yet Apple products continue to fly off the shelves, as the company rests on its name brand recognition and laurels of past years well deserved. 

Of course, carriers have in fact instructed their employees to attempt to steer customers towards less subsidized phones. (ie, devices they all are able to purchase more cheaply) There were several articles out this summer about AT&T (NYSE: T) doing so.

It's a Free Market

So what would happen if AT&T suddenly decided to eliminate the subsidy for the iPhone?  Duh, the other carriers would be promoting the fact that the newest version would cost $200 with them and $800 at AT&T.

AT&T would lose a lot of really good Apple loyalists, who are generally higher end customers, and the stock would plummet.

Eliminate subsidies for all phones?  For the average consumer in these cash-strapped times, the idea of paying $800 for a phone is rather daunting, even if in the long run the cheaper monthly price on one's cell phone bill would even it out.

According to this Reuters article: "Telefonica and Vodafone had used Spain as a testing ground for scrapping smartphone subsidies and stopped offering customers cut-price or free phones earlier this year.

Vodafone said this week it would bring back subsidies, leaving Telefonica as the only player on the market not offering customers discount handsets on a general basis."

Telefonica has since seen its user base in Spain decline by 7.5%.

Bottom Line

Nevertheless as I have stated before, unless Apple comes out with the new revolutionary product that will WOW the public yet again, thus justifying the snob appeal of having "the best and newest," it is an economic certainty that pricing pressure will start to eat away at its margins.  Maybe not this Christmas, but soon.

Cell phone subsidies came into being for reason -- because people are very hesitant to outlay $800 at once for a device, and would rather pay for it on the back end.  Psychology and economics at work.

Therefore, the idea that subsidies will be eliminated over the next couple of years in a competitive marketplace after seeing what has taken place not only in Spain, but also in Japan, to carriers who tried to eliminate subsidies, to me, simply does not make sense. Competition might bring Apple margins down, but subsidies, in some form, will stay in place because the market demands them.

If you have a thought, or something to calmly offer to the conversation, please enter a comment below.

margiecfl is long long Google, Apple, and Nokia. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple and Google. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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