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Apple iPhone Subsidies: Mobile Companies Called Out on Bogus Complaints

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An industry veteran slams carriers for whining about hugely lucrative deals.

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Predictably, every few months, mobile carriers start rehashing the narrative that wireless carriers are just dying under the weight of unfair smartphone subsidies and purchasing commitments foisted on them by Apple (NASDAQ:AAPL) and its ilk. Some reports claim that Apple's contracts force the carriers to raise prices even on competing phones just to stay in the black. Could it be that the carriers are just whining about nothing?

Recently, The Register, a UK tech news website, published a scathing report claiming that Apple has confidential contracts that force the carriers to commit to a given number of sales for forthcoming handsets even before the new designs are unveiled to the public. This means that the carriers eat the loss if they can't sell the product to customers. This is particularly concerning in light of the less than spectacular sales of the iPhone 5C. The Register article referenced a report by the highly respected Wall Street analyst Craig Moffett, who estimated that Verizon (NYSE:VZ) will miss its $23 billion commitment for iPhone purchases by at least $12 billion. Not only does Apple dictate how much a subsidized phone should cost, but it also prevents carriers from giving deep discounts to competitors. (Samsung (OTCMKTS:SSNLF) is also reportedly trying similar negotiating strategies with limited success.) Apple's demands mean that all US mobile phone customers pay an "Apple tax" when buying a new phone, even if they don't choose to buy an iPhone.

This is alarming, and potentially illegal. But in reality, probably not that shocking. Jean-Louis Gassée, a Silicon Valley venture capitalist and Apple veteran, has some answers to the "Apple tax" arguments.

Gassée, who was head of Apple France in the 1980s, before CEO John Sculley had him take over the Macintosh team (this after Sculley fired Steve Jobs) points out that there is no $12- to $14-billion liability in Verizon's latest 10-Q filing with the SEC. Verizon might be a massive company, but such a detail isn't at all insignificant to its shareholders. Anyone who reads the financial press should know that not everything an analyst says is necessarily true.

He went on to explain that carriers have little to complain about with respect to the subsidies regime. First off, the carriers used to be judge, jury, and executioner when it came to handset subsidies. The arrival of the iPhone, originally available only through AT&T (NYSE:T), gave the company a premium product that forced it to give some power to the handset creator.

"Steve Jobs hypnotized AT&T's management. He convinced them to let Apple set the terms for iPhone distribution in exchange for AT&T's 'running the table.' This meant no AT&T fingerprints on Apple's pristine iPhone, no branding, no independent pricing, no pre-installed crapware - content and software would be downloaded via iTunes, only," Gassée wrote in his blog, Monday Note. "In this arrangement, the iPhone helped AT&T steal customers from its main competitor, Verizon. When Verizon finally signed up with Apple in 2010, it was in a much weaker position than if it had obliged at the very beginning of the Smartphone 2.0 era."

The iPhone acted as a much more powerful "salesman," as Gassée says, paraphrasing Horace Dediu of Asymco. The carriers should be more than willing to deal with subsidizing the iPhone, because the average revenue per user is much higher than for other phones, and the carriers are almost guaranteed to poach customers from competitors that don't have it.

Those in the Anti-Apple tax camp say that without generous subsidies, cheaper phones, especially Google (NASDAQ:GOOG) Android devices, attract much higher sales than Apple's iPhones. This is certainly the case in China and India, where the absence of subsidies put the iPhone out of reach for all but the richest of the rich. In Japan, the number one carrier, NTT DoCoMo (NYSE:DCM) refused to bow to Apple, essentially handing customers to Softbank (OTCMKTS:SFTBF).

Carriers also say that the subsidies are no longer necessary. They were important at first, when customers were unaccustomed to shelling out laptop-level sums on a tiny device. But now that smartphones are so common -- they represent more than 75% of new US phone contracts -- it could be time to say goodbye to old ways, or at least so goes the argument. "When you're growing the business initially, you have to do aggressive device subsidies to get people on the network," said AT&T CEO Randall Stephenson at an investor conference last week. "But as you approach 90% penetration, you move into maintenance mode. That means more device upgrades. And the model has to change. You can't afford to subsidize devices like that."

But even with the subsidy factored into the equation, the iPhone business is still hugely profitable for AT&T. The average revenue per user is notoriously high, in some cases over $60 per month. As Seeking Alpha contributor Ted Barac estimates, even with a $400 subsidy, Sprint's (NYSE:S) return per iPhone sale with a standard two-year contract is 367%.
Carriers make enough from iPhone customers to offset the device subsidy. If they do in fact pass higher costs onto other customers, it's on the carriers, not Apple.
T-Mobile (NYSE:TMUS) has set itself apart with more transparent pricing. You buy your phone, or pay for it in installments, and it's yours. The BYOD (bring your own device) model is starting to catch on with other carriers, too. AT&T is also offering $15 off each month of your plan if you pay full price for your own phone.

See also:

Nintendo Needs Apple and Google for More Than Just Smartphones

Can't Afford Apple's iPad? The $38 Tablet Is Coming Soon

Apple: I Bought an iPhone 5S and I Don't Care How Many Bits It Has

Twitter: @vincent_trivett
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No positions in stocks mentioned.
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