iphone is cheap?

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The iPhone Is Too Cheap

Posted by Eric Zeman, Oct 12, 2009 11:33 AM



The $99 iPhone is turning the wireless industry on its head, and not in a good way. It's having an obvious negative affect on AT&T (NYSE: T)'s bottom line, and it's causing some serious pain for other makers of mobile devices.

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Last week, analyst firm Yankee Group fired off a report begging mobile network operators to stop subsidizing devices so heavily. The report details how device subsidies are bad for the industry, and I am inclined to agree.

Yankee's Andy Castonguay notes, "AT&T's iPhone model is a prime example of the negative effects of the subsidization model. It shows that an AT&T iPhone account with high data usage doesn't break even until month 17 of a 24-month contract."

Consider. The full retail price of the iPhone 3GS 32GB is about $700. Consumers, however, pay only $300 if they buy it new. AT&T is eating $400 of the price of the phone upfront in order to convince customers to sign up for two-year contracts. The low price has convinced millions of new customers to join AT&T's network, but they are killing the company's profits.

Castonguay said, "The danger of this early success is that operators, OEMs and other companies can quickly become enamored with the titillating burst of media attention and begin to lose sight of the longer-term ramifications of their decisions -- namely, shrinking profitability. Assuming that an iPhone user maintains voice usage comparable to AT&T's average customer and data usage of 5GB per month, Yankee Group estimates that AT&T would achieve an operating margin per account of approximately 47%, leading to a total profit margin of 16.1% per user."

If AT&T were to drop the iPhone subsidy, it would get its money back in eight months, and see 33.4% profits per user -- double what it's currently seeing.

AT&T isn't the only company seeing the negative affects of subsidies. Even the free or sub-$50 phones that are sold by network operators cost $100 or more at full retail value. Each and every carrier is losing out on profit and margins by making devices more affordable for the end user to purchase up front.

The problem with AT&T's heavy subsidies of the iPhone are that it puts amazing pressure on devices priced in the $99 to $199 segment. There are a huge number of devices that would (and should) be priced in that range were it not for the $99 iPhone. Instead, some carriers and manufacturers are dropping the price of devices that would otherwise be $150, $130 or $120 down to the $99 price point -- or even lower -- to compete with the iPhone. It puts pressure on the entire system and drags down the industry's ability to make money.

Castonguay said, "Rising customer acquisition costs, exclusivity fees and flat-rate pricing are squeezing margins for coveted smartphone users. To reverse this trend, operators must spread the control and risks across OEMs and retailers to offer more affordable options and establish greater levels of clarity and trust with consumers."

As a consumer do I really want to pay $700 out of pocket for a mobile phone? Heck no, but that doesn't mean that the companies involved in the wireless industry don't deserve to make a profit. I don't want to spend more money on my devices, but I also don't want to see the companies making and selling them go out of business because the system is broken.

So, yeah, I'm going to say it: The iPhone is too cheap.

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