Ever since Apple (NasdaqGS: AAPL) introduced the iPhone in June 2007, it has only been available on the AT&T wireless network. AT&T (NYSE: T) is estimated to pay Apple $600 per activated iPhone for the privilege of this exclusivity arrangement. Since AT&T offers the phones to the public for $199 (or even less with a two-year contract), Apple is receiving a huge subsidy of $400 or more per phone. Since there are about 11 million active iPhone users in the U.S., that subsidy represents a lot of moola to Apple. AT&T is doing well also.
Apple iPhone Has Been Very, Very Good to AT&T
The iPhone has helped AT&T grow its wireless subscriber base to 85 million in the U.S., second only to Verizon Wireless’ 91 million. But in the highly lucrative smartphone” market (e.g., high-speed Internet, email, video games), AT&T is number one with at 43% market share compared to Verizon’s lowly 23% share. Furthermore, AT&T outgrew Verizon last year, adding 7.3 million new mobile subscribers versus only 5.7 million for Verizon.
Apple is Scared of Google’s Android
Given the benefits the exclusivity arrangement has provided to both participants, I was shocked to read numerous press reports that Apple plans to cancel the arrangement with AT&T starting in 2011. Why is Apple trying to fix something that ain’t broke? One word comes to mind: Google. Google has developed the Android wireless operating system (OS) that is taking the cell phone market by storm. The OS is what’s important to mobile users, not the hardware, and Android is a better OS than the iPhone hands down. Let me (actually ZDNet) count the ways
Google’s Nexus One is Better Than the iPhone
Last November 5th, Motorola introduced the Droid phone, which is based on the Android OS and operates on the Verizon Wireless network. It was initially quite popular, but got upstaged on January 5th by Google’s own Android smartphone called Nexus One. The Nexus One was initially available only on the mediocre T-Mobile third-generation (3G) network and AT&T’s low-speed 2G network, but on March 16th Google announced that Nexus One would soon be available on both AT&T’s and Sprint’s high-speed 3G networks. In other words, AT&T agreed to allow Nexus One to be available on the same 3G network that the iPhone operates on.
Is Google Going to Acquire T-Mobile?
A second bombshell hit Apple earlier in February: rumors of Google acquiring T-Mobile and providing all 33 million T-Mobile subscribers with Nexus One phones for free! Although mere unconfirmed speculation, analysts have given it some credence because T-Mobile’s parent – Germany’s Deutsche Telekom – has indicated an interest in selling T-Mobile to the public in an IPO. How much do you think Apple could charge for its iPhone if customers had the choice of obtaining a Nexus One phone for free? Answer: Not much
The iPhone Killer
While this is bad enough, it understates the Android threat faced by the iPhone. Meet iPhone’s worst nightmare that will launch this summer: the HTC EVO 4G. One analyst calls it the Android-powered knight in superphone armor.” PC World says the HTC EVO has killer features” that will absolutely crush the iPhone. Although the HTC EVO will initially be available only on Sprint’s spotty network, Sprint has a 4G network with speeds up to 10 times faster than the AT&T 3G network iPhone currently operates on or on the Verizon 3G network it may soon be operating on.
WIMAX vs LTE in 4G
Sprint’s 4G network is based on the WIMAX technical standard, whereas Verizon is building a 4G network based on the Long-Term Evolution (LTE) technical standard (launch date sometime late in 2011). Some analysts think LTE is superior to WIMAX, but LTE won’t be ready for another 18 months whereas WIMAX is ready now. Furthermore, LTE currently suffers from a lack of radio spectrum whereas WIMAX has more than enough. I don’t care how good a radio technology is; if you don’t have enough radio real estate, you can’t have a viable service.
Bottom line: I’m betting that iPhone users, who are sophisticated first-adopters when it comes to technology, will switch to HTC EVO in order to get 4G now, rather than suffer on AT&T and Verizon’s relatively slow 3G networks for another 18 months. Sprint (and Google) obviously hopes that I am right.
Apple is Between a Rock and a Hard Place
Apple is in a pickle with no perfect solution. On the one hand, eliminating AT&T exclusivity will allow millions of subscribers on other U.S. wireless networks such as Verizon to use the iPhone, which will spur iPhone sales. Some analysts predict that Apple could almost double the 11 million iPhones currently in service.
But there is a downside. Without exclusivity, no wireless carrier is going to subsidize the sale of the iPhone. The only reason AT&T was willing to subsidize is because it knew that each customer had no choice but stay with AT&T if it wanted to use the iPhone. Consequently, there was a high likelihood that AT&T would recoup the cost of the subsidy through two years of monthly cellular service payments. But once exclusivity is gone, customers can buy the iPhone from AT&T and immediately switch to another network, leaving AT&T holding the bag with no chance to recoup the cost of the subsidy. No carrier will take that risk.
iPhone Subsidies are History
Gone will be the days when a customer can buy an iPhone for only $99 with a two-year contract. Customers will have to pay close to the full cost of an iPhone. I’m not sure how much that is, since currently you can’t buy an iPhone without an AT&T service contract, but prices on eBay run as high as $600 for a 32 gigabyte model. Without AT&T’s massive phone subsidy, far fewer people will buy the iPhone, and I predict Apple will get nowhere near a double in iPhone sales. Sure, sales will increase somewhat as they did in France after a similar exclusivity arrangement ended, and that’s a plus for Apple. But it won’t be enough to stop Android smartphones – which already are available on a multitude of wireless networks – from outselling Apple within a year. To sum up: Apple is desperate to accrue as much income now as possible, since its sees the future and the future is Android.
AT&T Doesn’t Need iPhone Exclusivity
An equally interesting question is what impact a loss of exclusivity will have on AT&T. I’ve heard doom and gloom predictions, but I don’t buy it. In fact – and this may surprise some people -- I think AT&T is in a much better position than Apple going forward. The benefits to AT&T from a loss of iPhone exclusivity are numerous:
- End of expensive $400-$450 subsidy per iPhone
- Fewer system overloads by iPhone users that caused AT&T network service quality to suffer, which hurt its reputation
- More cash available to spend on system upgrades. In fact, AT&T plans to spend $2 billion more on network upgrades in 2010 than it did in 2009. AT&T already has the fastest 3G network and recently announced the completion of a high-speed packet access (HSPA) 7.2 software upgrade to all of its 3G cell sites nationwide, which promises to make its 3G network even faster (7.2 Mbps fast compared to the current 3.6 Mbps theoretical limit).
- Low probability of losing many iPhone customers. Almost 70% of AT&T’s iPhone customers were AT&T Mobility customers prior to upgrading to the iPhone, so they should stick around even after exclusivity ends. Furthermore, many of AT&T’s iPhone customers are still in the early stages of two-year service contracts and they are likely to stick around so that they don’t have to pay a $175 early termination penalty
