Is the iPhone Killing the Wireless Industry?

I am almost shocked that I feel this way, but I'm starting to get a little weepy for our country's wireless carriers. In a sense, they are the unsung heroes of our untethered telephony experience, laying out huge sums to build the latest in high-speed mobile networks -- and incurring massive debt in the process.

Yes, I know, when I look at my wireless bill every month, I, too, think that these guys must be making money hand over fist. But consider this: In 2010, the wireless industry spent $24.9 billion investing in infrastructure, according to the CTIA, an industry trade organization. But only two carriers were able to reap more from their network capital expenditures than the cost for that capital, according to Bernstein Research. It's probably no surprise that those companies are AT&T (NYSE: T  ) and Verizon (NYSE: VZ  ) . That leaves Sprint Nextel (NYSE: S  ) , T-Mobile, MetroPCS, Leap (Nasdaq: LEAP  ) , U.S. Cellular, and the rest wondering whether their efforts will ever get rewarded.

The iProblem
But even the profitable carriers are watching their margins getting shaved quarter after quarter, and though they know exactly where the money is going, they are powerless to plug the leak. Why? Because it happens to be caused by their single biggest marketing tool -- the iPhone.

Let's look at Verizon's iProblem. This week, the company announced that it sold 4.2 million iPhones in the fourth quarter, more than twice as many as in the previous quarter. Yet the company's profit margins dropped 5% quarter to quarter.

AT&T is not immune to this phenomenon. According to The Wall Street Journal, analysts predicted that the carrier's wireless profit margins for the fourth quarter would fall to a four-year low, even though AT&T said it would sell a record number of iPhones and other smartphones during that period.

Nomura Securities analyst Michael McCormack told the WSJ that AT&T's relationship with the iPhone has "really been a wealth transfer from AT&T shareholders to Apple shareholders."

But the iPhone is such a draw that carriers are willing to subsidize an estimated $400 of its purchase price each time a subscriber signs a two-year contract, hoping that customer will stick around.

Sprint was so desperate to get into the iPhone club, it agreed to buy $15.5 billion worth of the phones from Apple (Nasdaq: AAPL  ) -- even if it can't sell them all. One could argue that without the iPhone, the No. 3 carrier would never have a chance of competing with the top two carriers. But on the other hand, such a commitment could doom the company anyway.

Data envy
And here's another conundrum that comes with the iPhone, as well as every other smartphone: how to charge for data usage.

Smartphones have created an increased demand on the carriers' networks to provide enough bandwidth for all the downloading and streaming to and from our mobile devices. But the iPhone 4S causes the biggest downdraft out there, and it's only slightly behind the HTC Desire S for gobbling up data, according to a study just published by Arieso.

To add to the carriers' data problem, the Arieso study also pointed out that 50% of all downlinking is done by only 1% of users. So the question is what to do about those little piggies. The Dow Jones Newswires reported that Sprint CEO Dan Hesse told an investor conference that the company deals with overly prolific downloaders by strangling their data bandwidth. So Sprint's solution is to be disingenuous about its advertised unlimited data plans. AT&T and Verizon deal with heavy data users by charging them more through a tiered pricing structure.

Is the tail wagging the dog?
If the iPhone makes it even harder for the wireless carriers to turn a profit, then why have it? T-Mobile may provide that answer. It doesn't carry the iPhone, and it lost 850,000 contract customers through September. Now, some of that may have been caused by other factors, such as theuncertainty over the merger with AT&T, but lack of the iPhone certainly didn't help.

I also can't help wondering what would happen if Sprint can't pay Apple for all those iPhones. Would Apple then take over Sprint and run its own mobile network? I love my iPhone, but I don't think that would be a good idea.

AT&T and Verizon have both been steady income payers for years. It would be a sad day if their profit margins should slip enough to force a decrease in dividend payouts. For some leads on other solid income producing stocks, please help yourself to this special free report from The Motley Fool.

Fool contributor Dan Radovsky owns shares of AT&T. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.


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  • Report this Comment On January 07, 2012, at 9:09 PM, melegross wrote:

    A strange article. Surely, the author understands that these upfront iPhone payments are just for the quarter in which they were sold? When a new iPhone comes out, sales are terrific, so payments for that quarter are higher than for other quarters.

    But the carriers know very well that iPhone customers pay more, on average for their contracts, and they have much less churn. We know that because of the reported figures the carriers give us.

    So the idea that Apple is draining them dry is nonsense. They are making higher profits over the life of the two year contract than from other phones, and that's what matters.

    t-Mobile has stated for several quarters that a major reason for their poor performance was the lack of the iPhone. sprint had stated the same thing. T- mobile has said that even though iPhones can't use their 3G because of the non standard frequency T-Mobile uses, there are a million iPhones on their network. Now, they're getting smarter, and have begun to change that frequency in a few markets. Maybe they will get the iPhone after all.

    Sprint, meanwhile, has stated that iPhone sales were better than expected. Perhaps they will sell all the phones they bought after all.

  • Report this Comment On January 08, 2012, at 1:36 AM, Oldfool103 wrote:

    You could say the same thing about Samsung's Galaxy Nexus (and the by far biggest drains are through the laptop dongle); after all, I keep reading how the Droids are over 50% of the wireless market. Still I guess it is always best to point the finger at Apple. We will get the same report next fall when the LTE i5 comes out. Yet somehow AT&T and Verizon will survive the subsidies and everyone with the 4s will keep paying for another year and the earth will keep spinning.

  • Report this Comment On January 08, 2012, at 2:02 AM, baldheadeddork wrote:

    "But the carriers know very well that iPhone customers pay more, on average for their contracts, and they have much less churn..."

    I'd like to see the data on iPhone customers paying more for their contracts, because I haven't seen any evidence of it. The only way it could be true is if a large number of iPhone customers don't have legacy access to unlimited data and buy higher data plan contracts than Android users. That doesn't pass the smell test.

    About the second part, since the renewal price for a new iPhone is the same as a new customer, the phone cost of churn is irrelevant. A carrier will lose $450 on a new iPhone sale regardless if it's to an existing customer or a capture.

    And about T-Mobile, from personal experience I'd say they've lost those customers because their high speed network blows. My wife and I had T-Mobile voice phones for years and liked their service and pricing. Then we moved my wife to a smart phone and discovered that their data network coverage is awful. When her contract is up we're definitely moving to another carrier.

  • Report this Comment On January 08, 2012, at 8:12 AM, secularinvestor wrote:

    Good points melegross,

    Other than the surge in sales following the release of the iPhone S, (which leads to temporary higher subsidy losses which are then more than made up from the increased revenue generated by the iPhone) much of the surge in carrier Capex is because they are rushing to install 4g networks.

    The carriers are desperate to get Apple to sell 4G enabled iPhones, which would create much needed new customers for the carriers' huge investment in their 4G networks.

    However, so far Apple have refused because the 4G chips use too much power and drain batteries too quickly, a big problem for the Android 4G phones many users are conned into buying.

    When Apple do release a 4G iPhone it will be a godsend for the carriers, resulting in an initial loss with surging iPhone subsidies, followed by high profitable revenue over the 2 year life of most contracts!

    Will the next iPhone be 4G enabled? We'll have to see.

    Meanwhile Sprint's subscribers are soaring with the iPhone while T-mobile's numbers are plummeting.

    T-Mobile shot themselves in the foot when they joined HTC's legal defence case against Apple, which did not make them any friends in Apple HQ! Stupid, stupid, stupid!

  • Report this Comment On January 08, 2012, at 12:40 PM, RudeAwakening wrote:

    This article seems to be a distortion. This past quarter the phone companies have doubled theri iPhone sales so the had to advance a lot of money. The 2 year contract includes that money that was paid for the phones. Naturally with great growth there is a big up fron hit to the companies. Also, there are plenty of expensive non-iphones out there now too so to blame it all on the iphone is a distortion.

  • Report this Comment On January 08, 2012, at 3:58 PM, ETMatyahoo wrote:

    Sorry, RudeAwakening (and also a bit to melegross). Author is on target. The high-data phones are a drain. Dismissing the simple phones as numerous is not the point.

    Let's look at these radio-phones in a utilitarian view. Does everyone need one? No, but it's wanted. The thing is built for "executive/technologist" needs and a great crowd of people do not need one.

    Then, when one of these crowd get one, it's immediately put to use as a video-toy, wasting precious phone resources instead of being productive to society. Down the bit-bucket.

    Other responses and articles also say they prefer to charge data users more fairly. I say price the Executive Function phones well out of reach for nearly everyone - it is a total distraction!

    (Of course, I'll 'Stephen Colbert' here and say that a gift one would not be thrown away! But I'll not pay for too much phone!)

  • Report this Comment On January 08, 2012, at 4:16 PM, endorendil wrote:

    The problem isn't the iPhone particularly - it just happens to be the worst offender of the bunch. The issue is just that the infrastructure costs are too high in the short run, and rapid technological evolution means recuperation times for those costs are short.

    Imagine that Ford, GM, Buick and the lot would have had to build and maintain all the roads that their cars used. Then imagine that those roads would be obsolete within a couple of years....

    In the case of the carriers, it is hard to argue that most people *really* need more than 1Mbps access speeds when they are out of WiFi range. Those speeds can be delivered fairly cheaply with trailing edge technology that concentrates on big population centra. Would VZW or ATT be missed, if they are replaced by companies that just provide slower data speeds, but reliably and cheaply?

  • Report this Comment On January 08, 2012, at 6:07 PM, XMFDRadovsky wrote:

    I'll chime in here and say that I bet the carriers would love to get hold of another phone that could ignite consumer interest like the iPhone did. That would allow them to not have to except whatever Apple decides to give them without a whimper.

    That's why, if the Windows Phones from Nokia are any good and can get some buzz going in the marketplace, we may be seeing those spring up all over the place this Spring.

    Yes, the Android phones are viable alternatives, but a third solid choice would certainly be better for consumers and the carriers too.

    Dan

  • Report this Comment On January 11, 2012, at 12:17 AM, baldheadeddork wrote:

    "I'll chime in here and say that I bet the carriers would love to get hold of another phone that could ignite consumer interest like the iPhone did."

    I'll bet they don't. Here's why:

    Let's presume the financial people at AT&T, Verizon and Sprint have sufficient data and brain cells to determine their plan costs with a 90% accuracy. If they know their plan costs over the life of a contract, then they can project the overall profit or loss for every combination of plan and handset subsidy. In other words, they know before you walk through the door how much they'll make on whichever phone and plan you choose.

    Actually, we don't have to assume. If anyone was caught by surprise by the overall cost of the iPhone (or its mythical hidden profitability) then we would have seen either revised smartphone earnings estimates or reports that were out of line with guidance. That hasn't happened, not ever that I can recall. Every carrier that gets or has the iPhone issues guidance that smart phone margins will be flat or even shrink even though revenues are up sharply.

    The $400-450 "subsidy" (I prefer the old-fashioned word "loss") carriers take on every iPhone is very close to the total profit they can make on a two-year contract. If it wasn't we'd see a different effect on their bottom line.

    So what reason would a carrier have to sign the most onerous contract in the business? If you're not making money on them, do you really care how much it ignites consumer interest? Let someone else have that fun.

    Which is what Verizon did for four years. If the iPhone mythology were correct, then VZ should have been deeply wounded after T's four-year exclusive hold on The Phone That Changed Everything. Except, they weren't. They were more profitable, they were able to invest more in their network, and they even kept a lead over AT&T in subscriber count. So why did they do it?

    Or go back to 2007. Why did AT&T set the precedent of bending over for Apple when they had a pretty strong hand? They had established themselves as one of the three top carriers in the US (T, VZ and S were all nearly dead equal in subscriber count) and they were making decent profits.

    So why did each company sign on to such a high profile profit killer? Because if you looked beyond consumer interest and earnings, each had a really good tactical reason to take the beating.

    In early 2007, the smartphone market was just beginning to show signs of vitality in the consumer market. Until then, it had been dominated by Blackberry and the business market, where AT&T was the weakest player of the big three. Maybe the iPhone wouldn't work. But not making money on it was worth the potential upside if they could break away from the business market and leave Verizon and Sprint beat each other to death for Blackberry contracts. Which is how it turned out. AT&T made its marketing synonymous with the iPhone and the consumer market while Verizon crushed Sprint first in the business market, then in the consumer market when Verizon got behind the Android platform at the perfect moment. Four years later, AT&T customer base had nearly doubled while Sprint is spiraling towards oblivion. The iPhone let AT&T escape a fight it could have easily lost and allowed it to get huge when size was at least as important as margins.

    For Verizon, the decision to take on the iPhone was a pure ninja move. They didn't need it. They had made themselves as synonymous with Android as AT&T had with the iPhone, they made more money with it, they still had the lead in the corporate market, and they had managed to outgrow AT&T in customer count since 2007 despite not having the iPhone.

    But as long as AT&T had an exclusive on the iPhone, they had a marketing angle that Verizon couldn't touch. Remember, until one year ago the fight between Verizon and AT&T was between "Can you hear me now?" and the "Only place you can get the iPhone."

    Taking the iPhone would pull some disgruntled AT&T customers, but remember VZ isn't making any money on them. The real prize is that it kills AT&T's greatest marketing tool. When Verizon took on the iPhone it changed the fight with AT&T into a battle over who has the best network. That's a fight Verizon wants to have every day of the week. And in the wake of losing their exclusive on the iPhone, AT&T is struggling to find a winning message for consumers.

    The tactical reasoning behind the iPhone goes for Sprint, too. The iPhone is Dan Hesse 90-yard hail mary. The company would likely have died within a couple years (being generous) without it, so why not sign on to a $15 billion guaranteed contract with Apple? If it doesn't work it's just another claim for the bankruptcy lawyers to deal with.

    None of this has been about iPhone sales. It's always been about using the iPhone and taking the costs that come with it for different motives but a similar goal: Get or stay strong enough to take advantage of those phones where you can make money, and survive long enough to raise the prices on everything.

    Carriers do not look at phones the same way consumers do. Never have, never will. Their favorite phone is probably a feature phone - it's dirt cheap to buy and the required plan is pure profit. Their favorite smart phone is the second or third tier Android or WP7 they can buy for less than $100 and give to you for free. It's $300 more profitable than the iPhone on the same plan.

    If you take consumer sentiment out of it and just look at the customer relationship between the carriers and phone providers, it's a fascinating life or death battle. Is Apple's holy war on Google about ego and pride? Or about weakening the platform carriers would prefer to sell? With neither Verizon or AT&T investing anything in marketing the iPhone now that both of them have it, Apple has to find a way to keep the iPhone vital for carriers without sacrificing their margins. Now comes Microsoft with subsidies (f'real, this time) to keep the carrier's cost of WP7 handsets low. Are they repeating the move AT&T made back in 2007, giving their customers an appealing alternative while the competition beats each other senseless?

    It's been fun to watch, it's going to get even more entertaining, and we'll still be only an afterthought.

  • Report this Comment On January 14, 2012, at 10:06 AM, XMFDRadovsky wrote:

    bhd,

    If I am reading your comments correctly, I believe your points reinforce my assertion that the carriers would love to have a third smartphone ecosystem to give both the iPhone and the Android phones a run for the money.

    If a phone and operating system duo comes along that can compete head-to-head with the iPhone in features and quality, and that also has the app development and marketing structure behind it that ensures continuing growth of that ecosystem, then that could take away what some see as Apple's ability to hold the carriers hostage to its pricing demands.

    If that can happen, then that increased competition should either be beneficial to consumers who could see the carriers' cost savings passed on to the consumer, or more likely, to the stock holders as a benefit of increased profit margins.

    A lot of 'ifs', 'shoulds', and 'coulds' here though ...

    Dan

  • Report this Comment On January 15, 2012, at 1:33 AM, baldheadeddork wrote:

    Dan - Not really.

    Carriers want multiple phone platforms to compete against one another, they'd really prefer that each platform has multiple phone manufacturers to add further competition, and they don't want any carrier to have a monopoly on any major platform. But I think the last thing they want is another combination of phone and platform that has the same following as the iPhone.

    Play out what you're saying. Let's say the new Nokia Lumina 900 WP7 phone becomes an iPhone-esque hit. If people are lining up to get one two days before the launch and that one phone accounts for ~20% of AT&T's smart phone sales, what do you think Nokia is going to do with the pricing? Maybe it's just my cynical nature, but I bet that Nokia would push their prices up to match the iPhone long before Apple felt a need to lower theirs.

    This is why I think there is such a fundamental misunderstanding of the market. Another iPhone would change a thing for Apple. If the Nokia 900 and the iPhone 4S each have 20% of the market, what pressure exists for either Apple or Nokia to lower their prices to carriers? Or, even say there are three phones with the iPhone's following. Why would any phone manufacturer sell any of these phones for the same price as the phones that aren't as popular?

    For carrier and consumer prices to fall, you wouldn't need one or two phones as good and popular as the iPhone - you'd need several or even a dozen of them. The carriers only get the upper hand in negotiating prices for these phones when they can afford to live without some of them. As long as any one phone can deliver a large percentage of all the smartphone sales that carrier will make, the carriers are at the mercy of the manufacturers.

    Carriers don't want a phone to compete with the iPhone, they want platforms with phones by several manufacturers that can swarm the iPhone without giving any one manufacturer too much leverage. They want Android and WP7 as a whole to pull the iPhone down to a point where Apple needs to stay with the carrier more than the carrier needs to sell the iPhone.

    But even if this happens, it doesn't mean that prices will fall for consumers. Remember, in the US we're buying the contract, not the phone. If the price of the phone comes down that isn't a saving that has to be passed along to consumers unless the carrier is feeling competitive pressure on contract prices. If you want consumer prices to drop you don't need a strong competitor for Apple, you need a strong competitor for Verizon.

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