The Cupertino company received much admiration and praise when it breached the US$600 stock price and became the most valuable company in the world. However, the device manufacturer lost almost US$100 billion of its market cap when some US operators announced plans to reduce their exposure to the iPhone.
Although the iPhone has helped propel the usage of mobile internet across geographies, most operators have bittersweet feelings about their relationships with Apple, seeing it as more parasitic than symbiotic. And with reason, as Apple’s stock performance has sky-rocketed (it is today 6.7x higher than at the end of 2006) while operators have barely been able to sustain historical levels.
‘Apple of the Eye’ to operators
It all started as a means to an end. Operators realized they had incurred expensive 3G licenses and network roll-outs but were left with underutilised 3G networks. To increase usage, operators began offering all-you-can-eat data plans. However, data service take-up was poor because devices were not user-friendly and lacked a compelling on-the-go proposition. However, all of this changed with the arrival of the iPhone.
The positive correlation between iPhone, mobile internet take-up and usage is today widely accepted. As a result, operators looking to expand their top-line through mobile internet jumped on the smartphone opportunity and tried to upgrade as many users as they could to the iPhone. Notwithstanding data monetization concerns or capacity crunches not discussed here, (see Game Over – Insert Coin: The End of the “Free Handsets For Everyone” Era) several operators mainly in developed markets succeeded in reaching both significant revenues from mobile internet and a ‘tipping point’ in smartphone penetration (e.g. UK and Australia are good examples with 53% and 57% penetration respectively as of May 20121).
The problem for operators is that their exclusive relationship with Apple is not one of equals. Apple knows it is the gateway to the much awaited mobile internet revenues, so leverages its privileged position as the most valuable brand (its brand value is over 3 times that of the highest-ranked operator appearing on the 2012 Brandz report) to impose hard conditions on operators willing to offer the iPhone. Amongst other things, Apple dictates the minimum subsidy level, the minimum units to be procured, the communication messages and style and even the brand association of the operator and that of Apple. In short, Apple rules the relationship and operators have to oblige to it or partner with other smartphone vendors.
Competitive dynamics also need to be considered. Even if an operator is willing to accept a slower rate of mobile internet take-up in exchange for a more moderate subsidy impact, prisoner dilemma situations are not uncommon and competition offering “free” iPhones through 2-year lock-up contracts may force operators to follow suite not to miss out on the opportunity.
Why Apple needs the operators
iPhone’s role in Apple’s recent success is clear as the share evolution vis-à-vis the company’s innovation cycle below illustrates. Apple’s performance reached new heights when the iPhone exclusivity agreements ended and the devices aggressively entered the biggest markets in Asia. The launch and strong growth of the iPad created the second wave of growth in 2011/12.
When trying to estimate how much the mobile industry really participated in this success, our analysis suggests that operators could have contributed as much as 21% to Apple’s total revenues from 2009 to 2011. This figure is derived by multiplying the number of subsidized unit sales by an average unit subsidy of $400, a widely accepted industry average2. On calculating the number of subsidized units sold, we used Apple’s official sales figures per product (see below). It is estimated that only 14% of the iPhones were purchased from Apple stores3 whereas the remaining were through operators. By multiplying these two figures, we arrive at US$45.8 Billion which represents 21% of Apple’s US$216 Billion revenues over the 2009-2011 period. Taking into account of the first half of 2012 (1H12), the figure would rise to 23%. This figure would be much higher as iPad subsidies are excluded (although this is much less relevant than in the case of the iPhone).
A closer look at the device industry and at Apple’s figures in particular illustrates how important subsidies are to Apple’s success. Sales growth of iPhones (+81%) and more recently iPads (+334%) fuelled the company’s growth in the last 2 years and compensated for a decline in iPod sales. Despite this impressive growth, Apple only commands close to 10% share of handset volume. However, the high retail price of the device rewards Apple with 60% of the industry margins4 and an annual growth rate of 143% since 2009.
Without the support from operators through subsidies, Apple’s performance could have been very different. A retail price closer to the US$650 per unit would have made the addressable market for iPhones much smaller. Without subsidies the iPhones would have remained a niche product especially in emerging markets where US$650 represents 8% of the average GDP per capita in China or 18% in India. The impact would be two-fold, not only the top-line results but primarily in the market expectations on growth, reflected in the stock price.
Two additional effects further illustrate what could have been:
- The first effect is the recent shift in share of smartphone sales by operating systems (OS). In the first quarter of 2012, Google’s Android platform has led sales in countries like Spain (72%), Germany (62%), France (55%) and Italy (49%)5. The main reason behind the contraction in iPhone sales in the depressed Western Europe has been attributed to affordability issues, with consumers delaying their devices upgrade6. This effect is further compounded by operators’ move to limit smartphone subsidization in countries like the Netherlands and Spain to compensate shrinking margins. On the other hand, Android phones continue to sell well due to lower entry prices.
- The second effect is the correlation between Apple’s stock performance and operators’ commercial guidelines with regards to smartphone subsidization. As soon as AT&T and Verizon announced their intent to cap the amount of iPhone sales for 2012, Apple’s market capitalization dipped. This effect, combined with a supply constraint in Qualcomm’s chips, caused the stock to lose momentum and dip by as much as 12%, touching the US$500 billion market capitalisation towards the end of May. The stock price only rebounded when bullish comments from Goldman Sachs analysts7 and Piper Jaffray8 tamed the market fears by citing that competitive pressure in the US market will not allow operators to make significant changes in their iPhone upgrade programs and at Apple’s advantage over other device manufacturers in accessing the limited supply of chipsets.
Should Apple be really worried about a reduction in iPhone subsidies?
Given the current levels of smartphone penetration in some countries, operators could consider a break in subsidies or a reduction in the amount subsidised. Instead, the focus should be to monetise the existing smartphone portfolio.
This is particularly important in countries where smartphone penetration is higher than data take-up rates, like in the US, Spain or Taiwan. In these countries, a majority of smartphone users are under-utilising the core functionality of smartphones – the mobile internet. This could be indicative of customers not fully grasping the benefits of their devices and could have been the result of attractive upgrade options or intense competition forcing operators to offer advanced smartphones to unsophisticated customers. In this case, operators could shift their strategy from pushing devices to placing their efforts on increasing mobile internet usage.
At the other end of the spectrum, there are countries where penetration rates have yet to reach the tipping point and where customers are accessing the internet through sub-optimal devices (i.e. feature phones). In these cases, operators will have to continue subsidizing with the hope of reaching a critical mass. Alternatively, low-cost Android smartphones with advanced capabilities are making inroads into highly populated and prepaid-based markets like China, where handset subsidies are riskier. These handsets may be a better solution for operators to avoid subsidies while achieving the same objective.
As a result, we expect operators to become tougher in their negotiation with Apple, as they are now fully aware of their importance to Apple. Operators are encouraged to actively pursue smartphone alternatives in markets where affordability is a key barrier or where smartphone penetration has already reached the tipping point. Nevertheless, the strong positioning that the iPhone has built over time, both from a functional (e.g. features, ecosystem) and emotional (brand) perspective, guarantees Apple to remain at the mainstay of operators’ value proposition in the near future.
1. Source: Kantar Worldpanel Comtech
2. Source: “Apple takes a bigger bite out of carriers margins”, Bank of America Merrill Lynch, Global Telecom Weekly, Jan. 2012
3. Source: “Telco 2020 – How Telcos transform for the “Smartphone Society””, Roland Berger, Competence Center InfoCom, Feb. 2012
4. Apple margins for the iPhone estimated at around 30%
5. Source: Kantar Worldpanel Comtech
6. Source: Reuters