Could carriers rebel against the high costs of Apple's iPhone?

Could carriers rebel against the high costs of Apple's iPhone?

If a carrier, like AT&T, wants to improve profitability on iPhone sales, it has to do so by reducing the subsidy. The only way to reduce the subsidy is to get Apple to drop its pricing, or to sell at a higher contract price

Yesterday, on Wall Street, we saw something rare. An Apple analyst downgraded the stock from a “buy” to “neutral” rating. Most analysts who cover Apple are incredibly bullish. So it’s interesting to think about why this analyst, Walter Piecyk from BTIG Research, disagrees.

I haven’t seen his research report with my own eyes, so I’m relying on the good reporting done by AllThingsD here. The crux of the downgrade reasoning seems to come down to subsidies.

Apple sells its latest iPhones for over $600. This is well known by most industry pundits. This is how Apple can make such healthy margins compared to most other players in the market. Analyst speak for this price is ASP, or “average selling price”.

Carriers then subsidize the phone. In the US, typically the sticker price to a consumer is $199 on a two year contract. So the carrier is forking over more than $400 just to bring the customer onto their network.

This wouldn’t be a problem if the $400+ subsidy was a one time thing. But it isn’t. Every two years, customers are eligible to resign a new contract, and grab another subsidized phone. Many carriers, like AT&T, also allow you to upgrade early (before contract expiry), at a higher price. But that higher price still bakes in a huge subsidy on the phone.

Piecyk says, “We expect post-paid wireless operators to remain firm in their plan to stunt the pace of phone upgrades in 2012 and we expect to see some initial evidence of their success in the current quarter.”

He estimates that AT&T will implement stricter upgrade policies, and other carriers may follow suit. This could lead to fiscal Q3 iPhone sales of only $27.5 billion, or about $1 billion less than the average estimates (the Street calls this “consensus”). Remember Q3 is Apple’s June quarter since its fiscal year ends in September.

I don’t think it makes sense for carriers to spend tons of cash to let customers upgrade such an expensive phone one year into a contract. And beyond this, I think the average consumer doesn’t want to upgrade that early. While Piecyk may have a valid argument for a short term weakness in Apple stock, I want to think about this longer term.

I think the real risk to Apple could come from ASP pressure, not a small change in upgrade pricing. The carriers don’t like paying $600+ for iPhones. Most competing high-end smartphones cost less.

If a carrier, like AT&T, wants to improve profitability on iPhone sales, it has to do so by reducing the subsidy. The only way to reduce the subsidy is to get Apple to drop its pricing, or to sell at a higher contract price (say $299 instead of $199).

Both of these will be incredibly hard to execute. Unless there is collusion between carriers, it is hard to imagine that one of them would be willing to raise the iPhone contract price on its own. It would be a sure way to drive all customers to the other carriers. Apple may well have a contract with carriers that defines contract pricing, too.

Apple is also unlikely to respond to requests for better pricing from carriers. Apple sees itself in the position of power, which also happens to be an accurate view. They sell a premium product at a premium price. End of story.

I’m still bullish on Apple. I realize pricing will probably drop over time, but I expect this to occur alongside an expansion into many more markets around the world where customers can’t afford $600 for a phone. The iPod used to be a highly priced product too. As Apple perfected ways of introducing cheaper versions, it did so. The real risk to Apple comes if the company needs to lower prices in response to competition rather than as a way to expand global addressable market.

Another longer term risk is HTML5. I still think it will be a couple of years before iOS developers see a good reason to shift to HTML5. But when it happens, Apple could lose some of its control over customers, and the range (and quality) of apps on the App Store versus competing stores could narrow. As the user experience moves to the web instead of the OS, Apple products could be less “sticky” with those of us who don’t consider ourselves exclusive to the Apple ecosystem.

Obviously Apple stock has risks. Piecyk points out a short term risk. I’ve highlighted a couple of potential longer term risks. There are always risks. But from where I sit, I still think Apple has a lot of growth left.

Have something to say about this story? Share your comments below! Need help with something else? Submit your question!

Chris Umiastowski

Chris was a sell side financial analyst covering the tech sector for over 10 years. He left the industry to enjoy a change in lifestyle as an entrepreneur, consultant, and technology writer.

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Reader comments

Could carriers rebel against the high costs of Apple's iPhone?

24 Comments

I think the biggest short term risk is the phone size. Apple has to solve that problem which in the past, meant doubling the resolution. Apple got themselves in this with the retina marketing. I don't need a bigger phone but it's obviously a huge demand. Still, even with a redesign, reviewers are going to go nuts over a same sized screen on the iphone 5 if it happens.
What's scary is the reaction they got with the new ipad. Doubling the resolution didn't seem to impress many. If that kind of upgrade can be met with yawns and mumbling, then you know you've got problems. Maybe not in sales yet, but clearly you can sense Apple mania may have peaked already. Perhaps more marketing problems or expectation problems than real. This is where Steve Jobs is missed. IMO, he would have sold that retina ipad but it was simply introduced instead.

BTW..i don't think much of the "problems" with subs yet. Apple still has control here. If demand goes down they'll have less power. It's that simple.
The long term worry is ecosystem. Apple needs to focus on it. It's got holes. No maps, siri and icloud need improved, limited airplay, apple tv with hardly any 3rd party apps, an itunes app that needs improved or re imagined, needs better email, calendar, etc.
How many buy itunes media (it costs the same or higher than discs)? How many use me.com emails? How many rely on apple tv? How about facetime? This stuff has be to be assessable and shareable. Where's the android facetime app for example?
If others can catch up or offer better, then look out. The hardware & OS difference among platforms is minor IMO. The app discrepancy (the key iOS advantage) will sort it self out as well over the long run.

If you don't subsidize my phone, that's fine. But then I don't expect to be under a contract with you either.
AT&T and others forget all of us iPhone users who originally left other carriers to come to them when they iPhone was their baby...
Don't give me any incentives to stay and I'll return the favor the next time your network doesn't perform even though my phone now says '4g', you limit my unlimited data or whatever crazy corporate stupidity you cook up next.

I wish carriers would do something like those in europe do where if you bring your own phone your monthly bill would be less. I know many people who would do that to save more money in the long term and also would address the issues with them having to cover the large subsidies of phones.

T-Mobile USA is the only American carrier that does that, the rest leave have no incentives for people to buy unlocked, unsubsidized phones. Verizon and Sprint can't because of the tech they chose and now their LTE bands are different. T-Mobile is planning on making a nationwide HSPA+ network on the 1900 band, and is launching LTE on 1700 so their network will be compatible with AT&T HSPA+ and LTE devices.

hmm... Let me do some math...
Before the iPhone I payed 39-49 on my bill... after the iPhone I pay from 99-109 on my bill.. My bill certainly doubled and in some instances it tripled. Ok... forget about relative numbers... Simple math... Bill went up 60/mo... Carrieras subsidize the phone at a rate of 400/12 which is 16.66/mo. So they ended up earning MORE money from me with the subsidy than without it. 60-16 = $44.00. that means they actually doubled their income from a single customer! Yes subsidies are a good deal. If they eliminate the subsidy as they have eliminated the unlimited data, I expect a DRAMATIC reduction in my bill.

I would suspect your monthly phone bill went up that much with the addition of a data plan, correct? So yes, you are paying more since going from a basic phone to a smartphone but you also have 1) a far more pricey phone, 2)expensive data plan and 3) an expectation to upgrade more often (on AT&T) when each version comes out.
If so then the carrier does have costs associated with deploying and maintaining their data infrastructure so the cost of the subsidy is still eating into their profits.

Carriers cannot "rebel" against anything.
They do not have that option at all.
If they did the iPhone would have come down in price years ago.
But when your a company making a device everyone wants, you can set your own price. People will complain, but they will buy.
This goes for vendors reselling devices on their networks and the retail end user.

The carriers should demand lower costs from Apple since they are carrying the costs associated with the iPhone on their network. Apple built a phone but does not pay for any of the costs associated with maintaining the network.
Don't misunderstand me the carriers are gouging the consumer every month with their bills and that won't change because our current offerings are far from competitive.
The bottom line is if I was the carrier I would charge more, what else are you going to do? Break a contract and go else where have fun its $350-375 to do that and you still have to buy another phone (if going from Verizon/Sprint to AT&T or T-Mo). Are you going to buy your phone at the Apple Store, great pay Retail $600-849 because again if the carrier subsidy is lower Apple can't change the price unless they want to eat it (not going to happen).
Verizon is selling a lot of Android phones and that isn't letting up any time soon. Yes they sell a lot of iPhones but the carrier can push products, coverage, benefits, double data, etc.
Making a profit is not a dirty thing or something to be ashamed of, but the share holders of the wireless carriers I am sure want a bigger profit and may not be happy with how the iPhone/iPad cuts into those profits.
Consider all sides and not just the one side that is pro Apple.

One option, and definitely not an ideal option, is for the carriers to do what the carriers up here in Canada do, make the contract period three years instead of two. That way Apple still gets their subsidy, the consumer doesn't incur increased contract prices and the carrier can recoup the cost by having a longer contract.
Again, not ideal but it might a lesser-of-all-evils trade-off. With the amount of performance phones are packing these days there's no reason they can't be good for 3 years.

Feel free to raise prices. People won't cancel their current contracts because they won't immediately come into contact with those prices increases, until one day when they're ready to upgrade and you find that they're leaving you because your iPhone is $XX more and it doesn't do anything special.
I would love to see that. The backlash would be amazing to behold.

Wow I don't even know where to begin. Warning this may come off as a rant, but I assure you it is not. It is just an analysis by someone who does not have his head up his you know what (unlike this Wall Street analyst) So here it goes:
1- He estimates that AT&T will implement stricter upgrade policies, and other carriers may follow suit. - Oh I don't doubt that AT&T will try some stupid sh**. But after seeing droves of customers go elsewhere, they will stop. Other carriers won't follow suit, but will gladly take the new customers who abandon AT&T. (stock tip - short AT&T - buy Verizon)
2- "I don’t think it makes sense for carriers to spend tons of cash to let customers upgrade such an expensive phone one year into a contract. And beyond this, I think the average consumer doesn’t want to upgrade that early." - That's right, your average consumer doesn't want to upgrade every year, they want to upgrade every 6 months. Since they keep releasing new phones every couple of weeks, and your average consumer has an attention span of a chipmunk and wants the newest shiny thing they see. Hey I get it. It sucks to eat the $400 subsidy every year, but hey, you can't find cellphone service for under $50 per month and most people pay $100 per month. So they recoup it very quick. And like I mentioned in #1, if they don't want to, another carrier will happily take it. i.e.- my mom wanted to finally upgrade to an iPhone from her dumb phone. She was with Sprint. She was not eligible for an upgrade until Nov. She went in and was willing to pay the full price for it but now she needed a data plan. Sprint tells her that they have to add the data plan to all three lines (it's a family plan). The other two phones are also dumb phones. Why would you need to add data to two dumb phones? So when they wanted to jack her bill up by over $50 per month. She said no. Went to Verizon. Verizon covered all 3 cancellation fees, ported over the numbers, gave her an iPhone for $99 (the 4 8GB model), and she is going to be paying $20 less per month than she would have with Sprint. Much better coverage and much better service for $20 less per month. Sounds like a deal to me. And the kicker was, that when she told Sprint that if they can't do anything for her, she will go elsewhere, their response was, go ahead. LOL I smell bankruptcy in their future. This will happen all day long. That's why Verizon is growing like they are. They understand customer service and the work no is not in their vocabulary. They will keep snagging up pissed off customers as they leave their current carriers. My family now has 10 lines with Verizon and no matter what I ask for, I never get a no. Sometimes we compromise but it's never a flat out no. (stock tip - buy Verizon - short Sprint)
3- "Most competing high-end smartphones cost less." - ??? Really? What competing phones? There is nothing even in the iPhone's rear view mirror. Let's look at this. The iPhone that costs the most money to get, yet blows the other phones out of the water in sales volume, when most of these "competing" phones are free or BOGO. And we are in a cra* economy! What competition?
4- "around the world where customers can’t afford $600 for a phone." - Really? That's why there is ridiculous demand in other countries that it goes on sale, to the point that there are riots over it and they have to shut downs the stores.
5- "The real risk to Apple comes if the company needs to lower prices in response to competition" - Oh that's right, we have seen this happen before. NO! Apple has no competition, they are in a market of their own. When have they lowered prices to compete. NEVER! Like he said, "They sell a premium product at a premium price. End of story." They will never compete on price. NEVER!
6- Another longer term risk is HTML5. - Well at least he didn't say Flash.
Gosh, I guess it doesn't take much to be a Wall Street analyst these days. I suppose that if one day I decided that I don't mind bs, then I could become an analyst too.

Oh FYI - if you are a company that has to compete on price, you better rethink your business plan, or just close your doors now as it will be less costly for you in the long run. Rule #1 in business - NEVER COMPETE ON PRICE! It's always a loosing proposition. Now you can have lower prices, but that better not be your only competitive advantage.

Dude. Remove pickle from nether region. And perhaps use paragraph breaks if you want to publish a novel.
The author said he'd worry about Apple if they had to price reduce due to competition. Sounds pretty reasonable. He didn't say it was actually happening. Hence the pickle removal advice.
There are rich people everywhere. Every country has people willing to spend $600 on a phone. Duh. But the absolute vast majority of the population in lower income countries can't afford it.
Oh, and newsflash ... there are crazy numbers of Android phone uses who would argue with your over-enthusiastic use of question marks when challenging the idea that Apple has 'no competition'.
Grip pickle. Pull. Hard.

So, the only way that works is if people actually stop wanting iPhones. Otherwise, that's an effective strategy to loose customers to your competition. Just ask T-Mobile or, until recently, Sprint.

Those prices apply to the newest model, but Apple has sold the previous generation as a 'budget' phone the last 2 cycles (with AT&T going so far as to give the 3GS away on contract when the 4S came out). I think the carriers already have what this analyst is asking for, just not with the most recent generation of hardware.

First, obviously carriers don't pay $600 for the iPhone. They surely get it for way less, as resellers do. Second, do you think carriers pay for what exceeds $199? Don't be naive. Consumers do. It's in the price, they just don't label it. Believe me, you're paying!

Mr. Piecky failed to mention that AT&T had an outstanding CY Q1. This is from AT&T's January 26 2012 quarterly report:
"12th consecutive quarter with a year-over-year increase in postpaid wireless subscriber ARPU (average monthly revenues per subscriber), up 1.4 percent to $63.76 — more than $6 higher than nearest competitor’s ARPU"
Note: "ARPU" is "Average Revenue Per User." It's what the carriers want to maximize.
So yeah, everything could always be better. But AT&T seems to be doing quite well selling iPhone, thank you very much.

Re: 'As the user experience moves to the web instead of the OS, Apple products could be less “sticky” with those of us who don’t consider ourselves exclusive to the Apple ecosystem.'
Web designers tend to overestimate the effect of HTML5. Yes, it will eliminate many legacy technologies (Adobe Flash among others.) But no, the average consumer won't really care if the apps on their iPhone are native ARM- or HTML5-based. There is zero "pull" in the consumer space toward web-based apps in general. No pent-up demand for HTML5-based apps.
Also, as the user experience moves to voice-based interfaces like Siri, the need for fussy over-designed "chrome" in apps will decrease. There will be less need for users to navigate through and to control apps by tapping those oh-so-expertly sized, placed, and colored tap targets.

You miss the point. There is obviously no consumer demand for HTML5 apps. There is, however, some producer demand. Well, to clarify, producers don't really care either if the underlying tech is Objective C, HTML, or smoke signals. What they care about, in some order, is:
a) Making the best possible app
b) Reaching the most possible people
c) Minimizing development costs.
HTML-based apps win in b) and c), but native apps crush HTML apps for a) in virtually all application categories.
If, as you state, the consumer truly does not care if the app is native or HTML-baed, the theory goes that as HTML5 improves, more and more application categories will reach a tipping point for a) where HTML results are either as good as native apps, or close enough that HTML's advantages in b) and c) make it the better choice.
Chris cites that as a long-term danger to iOS (or, really, any platform); when coding for the lowest common denominator (HTML) is not much of a penalty, producers will choose the LCD, reducing the number of killer apps unique to a single platform. It will be Apple's job to keep advancing iOS and iOS developer tools so that native apps are always superior, much like Microsoft advanced DirectX past OpenGL (for developer tools, yes, it was) to keep game developers locked into Windows-first.

It's all greed on Apples part. I feel like they view themselves as Gods gift. I don't see why they can't sell the iPhone for slightly less or the amount it costs to make it to the carriers. (it surely isn't $600 to make.)
Apple makes more than anyone could ever want in just the 30% they take from developers in the App Store. I wish they would actually care enough about us average joes and help a brother out. But all they care about is exploiting China and charging us way too much.
On a side note, Sony and Microsoft sold their consoles for less than they cost to make because they knew they would make up for it in software sales. If only Apple could put ego and greed aside...

Apple usually stiicks to prices. Look at QVC, or HSN. The basic 32 gig WiFi is almost $900.00 not $600.00 it cost you to buy it out right. The shopping newworks add a bunch of junk for $300.00, that they only paid $90.00 for, because they do not get a deal from Apple. My concern, if Apple keeps doing these little upgrades, and does not really come up with a new iPhone, why up grade. Is the iPhone starting to loose it's luster? Is it worth paying $600.00?

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