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How Google's Android Could Finally Crush Apple's iPhone

By Sam Mattera – Nov 16, 2013 at 7:00AM

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Apple's iPhone has benefited from carrier subsidies; Google's new Nexus strategy could undermine that relationship, as T-Mobile's growth is demonstrating.

Google's (GOOGL 1.50%) mobile operating system, Android, is now shipping on more than 80% of smartphones worldwide. As Android has exploded in popularity, Apple's (AAPL 0.97%) share of the market has declined and is now down under 13%. In the U.S., however, Apple continues to dominate, accounting for about 40% of smartphone sales, while Apple's iOS remains the premier platform for Western mobile developers. 

Nevertheless, I think it's inevitable that Google's mobile operating system will eventually overwhelm Apple's iPhone totally, even in the United States. Apple remains entirely dependent on the carriers for its dominance, a relationship Google is beginning to undermine. T-Mobile's (TMUS 0.24%) recent growth is proof of this potential shift.

Why would you ever buy an Android phone?
To be frank, for most consumers in U.S., it simply doesn't make much sense to buy an Android handset. Unless you're a techie or demand a larger display, Apple's iPhone will offer the better experience -- a simpler interface, and a more robust app ecosystem.

Generally, there's no price advantage to be gained by buying an Android handset. Samsung's Galaxy S4 costs the same $200 that Apple's iPhone 5s does on a two-year contract. As long as this heavy reliance on carrier subsidies persists, Apple should be able to continue to own the U.S. handset market -- it might even recapture some subscribers who've strayed if it releases an iPhone phablet next year.

Google is circumventing the carriers
But I don't think this trend will continue. If given the choice, most wireless subscribers would probably prefer not to sign a two-year agreement, and instead go month-to-month. On Verizon Wireless, for example, a month-to-month plan with 2GB of data is just $60 -- the equivalent plan on contract is $100, and getting out of it requires paying early termination fees.

But most subscribers submit to the two-year agreement anyway, because without it, they have to pay their phone's entire cost upfront. That's difficult: An unlocked iPhone 5s is $649, and an unlocked Samsung Galaxy S4 costs roughly the same.

Google has a solution: the Nexus phones. The new Nexus 5 is quite capable, works with all major carriers (except Verizon), and, most importantly, costs just $349 off contract. Most reviewers have been kind to Google's phone; Business Insider's Steve Kovach even went so far as to say it's the only Android phone you should buy.

This is the second time Google has used this strategy. Last year, it released the unlocked Nexus 4 at a similarly low price. But the Nexus 4 wasn't a big seller; according to its manufacturing partner LG, Google wasn't expecting much demand, and the phone worked only with T-Mobile or AT&T's networks. It also lacked LTE, making it a difficult sell as a high-end handset.

Google's Nexus 5 has LTE and works on more carriers, including Sprint. Google appears to be taking the Nexus 5 more seriously, with edgy advertising that has generated some buzz.

T-Mobile's rapid growth
Recent trends at T-Mobile support Google's strategy. Last quarter, the company added roughly 1 million subscribers, outpacing rivals AT&T and Verizon. This is notable, because T-Mobile no longer offers phone subsidies. Instead, T-Mobile encourages subscribers to buy their phones upfront, bring their own phone to the service, or pay for it in monthly installments.

This is not good for the iPhone. On T-Mobile's recent earnings call, CEO John Legere admitted as much, remarking that last quarter, Apple's iPhone accounted for just 21% of the phones T-Mobile sold. In contrast, of Verizon's phone activations, a full 51% of them were iPhones. There could be other reasons to explain the discrepancy -- perhaps Apple fans are just more likely to sign up with Verizon -- but I believe that the different approach to phone subsidies is a major factor.

Unlocked Android handsets would erode Apple's pricing power
No doubt, Apple's iPhone has benefited from carrier subsidies -- they work as a great equalizer, making consumers far less sensitive to price differences. And as long as consumers rely on carrier subsidies to buy their handsets, Apple should be at a great advantage -- its competitors can't undermine it with lower pricing.

But Google could. The trend toward cheap yet powerful unlocked Nexus phones could result in the signing of fewer two-year contracts, particularly if Google continues to emphasize the handset in the coming quarters and can get future Nexus phones to work with more networks (notably Verizon's). T-Mobile's recent growth suggests that consumers are eager to ditch the standard two-year contract.

If Google is effective in undermining consumers' dependence on carrier subsidies, Apple shareholders should be very concerned.

Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple and Google. 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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