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I wrote a piece Thursday on Techpinions about Apple’s iPhone Upgrade Program which proved quite popular, hitting Techmeme and being retweeted by some of the bigger names on Twitter, and so I thought I’d do a quick follow-up post with some additional thoughts on the subject, in part based on my additional research and in part based on things that were too detailed to go in that original post.
The impact on carrier revenues
One thing I didn’t really go into in my Techpinions piece was the impact all this could have on carrier revenues. The context here is a bit complex, but I’ll try to keep things simple: in the old days, the carrier charged you the same for service whether or not it was subsidizing a device for you (and no matter how big the subsidy was). Under the new equipment installment and leasing plans, the service fees are substantially lower than they were, but the carrier makes up the difference from your monthly device payment. For example, under the old model for a two year iPhone contract, the carrier charged you around $200 up front and $70 per month in service fees, but under a two-year equipment installment plan it now charges you nothing up front, $50 per month in service fees, and $27 a month in device payments. Its total revenue over the two year period is pretty similar, but of course only if you’re still getting your device through them. The other thing is that certain spending has now moved from the service revenue bucket to the equipment revenue bucket, and as such a long-standing carrier metric – ARPU (average revenue per user) – has become less relevant, because it’s based only on service revenue and doesn’t include those installment payments. As a result, carriers have begun reporting another metric, ABPU (average billings per user), which does capture these device payments. You can see an illustrative example of what’s been happening to these two payments for AT&T over the past few quarters below:What you see with AT&T is that ARPU has fallen pretty steeply over the past couple of years as the shift to installment billing has kicked in, but ABPU is now back where it was two years ago, and rising nicely. The same pattern applies for the other carriers, which are all at slightly different stages in this transition. However, for customers who buy their phones through Apple rather than the carrier, ABPU drops right back down to being the same as ARPU, because there are no device payments. If this happens in large numbers, it will have a significant impact on carrier revenues. The good news is that this will be profit neutral, since the revenue is basically just pass-through revenue anyway and all goes on equipment costs, and as such should actually boost reported margins, but revenues will be hit hard. Interestingly, T-Mobile’s “adjusted EBITDA” metric is already based just on service revenues, so it would be unaffected by this shift.
Competition shifts to iPhone pricing
One of the interesting things we’ve already seen over the last couple of months is a new dimension to the competition between US wireless carriers, especially the two smallest among the big four, Sprint and T-Mobile. Whereas the wireless carriers have in the past only competed on wireless service pricing, and charged virtually identical prices for devices, they’re now falling over themselves to offer the best deal on devices. More precisely, on iPhones specifically. With Apple’s entry to the iPhone financing business, we’re likely to see this competition increase – indeed, T-Mobile announced after Apple’s announcement a more aggressive plan of its own.
What’s fascinating about this is that it comes such a short time after the carriers finally began to abandon the “subsidy” model for phones. In reality, of course, this wasn’t a true subsidy, but merely an obfuscation of the true cost of the device, and a recouping of that true cost through inflated service fees. However, now that they’ve finally abandoned those “subsidies”, the irony is that they’re about to embark on truly subsidizing these devices – the new leasing plans some of the carriers are beginning to offer are going to make it extremely tough to break even on the hardware purchase itself.
Changes in the secondary market
We all know that the secondary market in smartphones (and, once again, in iPhones specifically) has been booming in recent years. Gazelle and others have been buying these devices to sell on in various ways for some time now, but the carriers got in on the act a while back, and Apple has been increasingly getting involved itself. All these players have incentives to recapture devices which can be sold at significantly lower prices even than the older devices Apple keeps in market as new phones, because this expands the addressable market for iPhones without risking general price deflation. The prepaid market in the US is one obvious destination, since the absence of both subsidies and installment plans there means customers pay full price for devices. But there’s always been the risk that the secondary market eventually saturates. There’s an inevitable ceiling in the secondary market – I don’t know how far away it is, but I’m sure all the carriers and Apple are already thinking about this.
However, with increasing numbers of spectrum bands in US devices, these iPhones are potentially sold in other markets too. AT&T is specifically looking at its Mexican wireless operations as a possible destination (something reported in the press and repeated to me by AT&T Mobility CEO Glenn Lurie on Thursday). But Apple, too, could readily repurpose many of the devices it gets back secondhand in the US for other markets, allowing it to address price points it hasn’t been able to so far.
Apple is serious about this business
Lest anyone think Apple is merely dabbling or testing the waters here, it’s clear that it’s actually quite serious about it. It’s bought the top spot in Google’s ad rankings for searches including the obvious one – iPhone Upgrade Program – but also “iPhone upgrade” and “iPhone installment plan”. There may well be others, too – I haven’t had time to check. Apple isn’t just going to wait for people to discover its new plan accidentally – it’s actively out there promoting it in the very places where customers would normally only have found carriers’ service plans or generic Apple pages about the iPhone. The carriers are shrugging all this off – I asked Glenn Lurie about it in a meeting on Thursday and he was blasé about it, while John Legere also nominally welcomed it while somehow seeking to suggest it was simultaneously a real risk for AT&T. But I continue to believe that this may be a far greater risk for the carriers, for all the reasons I outline in this piece and the reasons I gave in my original piece. And I haven’t even begun to talk about where Apple might go next with all this.