Apple’s New Subsidy Model: Back To Square One For Wireless Industry?
Now that it has sunk in that Apple (NSDQ: AAPL) has relented on iPhone subsidies, analysts and pundits are trying to work out what this means. Many are disappointed that Apple has failed to reshape the way the mobile industry works, and instead, has agreed to the same old-same old, a business model Sanford Bernstein analyst Craig Moffett likened to “a drug,”—bringing the industry back to square one, where carriers lure customers with subsidized handsets and take this to justify costlier monthly plans and binding contracts.
To be sure, while the new 3G iPhone carries a lower initial price tag, the overall cost of ownership is actually higher, considering the $30 a month data plan that users must take with it—exploiting the time-honored industry fact that while customers tend to balk at a big initial outlay, they are less fussed if an even greater amount is wrung from them when they are nickel and dimed over a longer period of time. Moffett, reports the NYT, called it a step back, not a step forward, for open networks.
But was it reasonable to expect one company to wean the wireless industry of its longstanding subsidy habit? Going forward, it was clear that the old model of forgoing subsidies for a cut of user revenues wasn’t sustainable, as it limited sales of the device, and thus limited user revenues anyway. For the iPhone to hit the mass market—and to appeal to more users than its typical demographic of 25-35 year old, college educated males, earning $100,000 a year—the price had to come down.
AT&T (NYSE: T) mobile chief Ralph de la Vega has said the “magical price point” for cellphone buying consumers is around $199, a figure AT&T came to based on its experience with Motorola’s Razr, reports the NYT. Once Razr’s price was cut to $199 from its original $500, sales doubled.
AT&T, meanwhile, is happy to subsidize the iPhone given how competitive the US mobile market has become. The company has acknowledged that this move will hit earnings in the $.10-$.12 range, though it says the subsidies will become accretive starting in 2010—which some analysts think is a stretch. According to Stifel Nicholas analyst Christopher King it means rounding up at least 5.5 million incremental gross subscriber additions and more importantly, stealing them from rival carriers. As Om Malik writes on GigaOm, this is unlikely “especially since other handset makers will undoubtedly have some tricks up their sleeves with which to respond to the iPhone.”
There was also the gray market of unlocked iPhones for Apple to consider, which it said in its April earnings call had reached a “significant” number. This was especially true in emerging markets, and even in Europe, where the phone was available through a few select carriers and sold in less-than-expected numbers.
It’s ironic that it was really Apple’s brand cache that was able to fuel the runaway gray market—especially in emerging markets—to such an extent that the only way to really stamp this out was either to break out and sell the models unlocked to a carrier contract, or to tuck in to the “business as usual” cosy model of the carrier subsidy. It’s not what you’d hope for from a game changer, but in a subsidy model where Apple gets its payment up front, it doesn’t have to care about the iPhone once it’s bought, and it doesn’t have to wonder if unlocked iPhone revenues are going missing.
GigaOm does a bit of math and works out that Apple could make $5.98 billion if the low-end model becomes popular, or $6-$7 billion if the high end takes off. Moreover, as volumes start to take off, the cost of materials to build the iPhone will drop from $170 to $100, making it a “profitable enterprise” for Apple.
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