Taking Back the Market

Has Verizon Lost Its iPhone Gamble?

Tim Nash - 2010.04.28

Every quarter, at least one analyst suggests that Apple is about to move to Verizon - and that the great incentive is the additional iPhone sales.

In the March quarter, with a 131% year-over-year increase and a record quarter for iPhone sales, Apple showed that it can do very well without Verizon.

Verizon's Gamble

Verizon's gamble is that its network and customer base is so attractive that Apple would have to agree to terms and make a special CDMA iPhone (the iPhone has always been a GSM device). Instead, Verizon is having to pour money into its next generation LTE network far faster than originally planned while watching AT&T's average revenue per user increase and churn rate decrease because of the iPhone.

In other words, the iPhone effect is more powerful than the network effect, and Verizon is having to fund its network improvements from customers who pay less.

Little Incentive for Apple

With the latest figures from AT&T, it is obvious that there is little incentive for Apple to add Verizon to the list of iPhone carriers until Verizon can support the standard GSM iPhone.

Last quarter, the iPhone attracted more than twice as many net new postpaid contract customers to AT&T as the heavily promoted Droid and all of the other offerings did to Verizon. If Verizon had gone the route of the Canadian CDMA carriers, such as Telus, and installed network wide HSDPA 7.2, it might have had the iPhone when the exclusive period of Apple's contract with AT&T ended.

Although Verizon's standard line now seems to be "it's up to Apple", it would take some strong financial incentives to move Apple fast - like say the 5 million WiFi-free iPhones China Unicom is said to have agreed to buy over three years.

The iPad Factor

As Verizon doesn't yet have a competitive iPad 3G service offering, this seems unlikely. It would be so easy, in marketing terms, to put together an offer like AT&T's, where customers only commit for a month at a time. What a great way to let them experience just how good the Verizon network is!

Or maybe that's the problem, as Verizon has about half the WiFi hotspots of AT&T and needs to have enough of the LTE network in place to be competitive. The earliest this looks likely is the holiday quarter this year, and Verizon is between a rock and a hard place. Either it offers an iPad package by Christmas and risks being shown up in all the areas where there is no LTE coverage, or it gifts to its main competitor all the users of this year's hot Christmas present.

iPhone Optimized for GSM and WiFi

The critical decision for Verizon was Apple taking the iPhone processor design in-house. Apple has recognised that crucial factors for taking over the mobile market are speed, screen (resolution and viewing angle), and battery life. To get the latter as long as possible, the A4 design is optimised for GSM and WiFi.

Then there are the costs of supporting a world phone that works on both CDMA and GSM. Unless Apple chose to go with a GSM model and a worldphone model, which would complicate technical support through Apple Retail, it would end up paying substantial royalties to Qualcomm on every iPhone with CDMA.

Then there is the issue of mutitasking, which will be in iPhone OS 4.0, as CDMA does not allow phone calls and data download at the same time. So, for instance, if you're talking in the car, you still want the iPhone navigation system to keep working and alerts like speed traps to keep coming in. This all makes supporting Verizon and Sprint on CDMA, an old technology standard that both companies are moving away from, a luxury that Apple has chosen not to afford, because of how it impacts the iPhone difference for other markets.

Looking for a Better Network

Although surveys seem to show that users want to move from AT&T, what they want is everything they love about the iPhone on a better network, a network where there are no dropped calls and high speed downloading is always available - the usual nirvana. Comparing the good reports from this year's SXSW in Austin with last year's, when few were able to use their iPhone consistently before the last day, it is clear that AT&T's network investment is working and that the Verizon advantage can be reduced.

Those who want freedom for the iPhone don't want freedom for the carriers to give you what they want. This is the Android problem that Google is struggling against with the Nexus One. When there is little incentive to update you and keep your cellphone working as well as possible, the carriers won't. After all, they have your contract for 18 months or two years, and they have new cellphones to sell.

Unless Google can solve this, Android will become the brand for those who like to control as much as possible of their cellphone, who want to search around the Web for the latest software and mods, while Apple continues to expand its sweetspot - selling to people who want their electronics to just work.

Better Markets than Verizon

Even if Apple suddenly - and against all its history - feels the need to expand the brand so customers look on the iPhone experience as being partly carrier dependent, there are more attractive partners than Verizon. China Mobile has over 500 million users and, according to a Kathryn Huberty (Morgan Stanley) reseach note, there are 50 million Chinese who could buy an iPhone. DoCoMo still dominates the Japanese market and, given KT's fast start with over 500,000 sold, Korea too looks interesting.

These are all markets where the carriers want to work with Apple if the iPhone economics works for them. These are all markets where the carriers haven't spent much time and money trying to trash the iPhone and then promoting their in-house premium brand Droid against it.

iPhone vs. Droid

How would Verizon promote the iPhone, now that it has Droid? Having all those outlets available for the iPhone is a lot less interesting if the iPhone is buried at the back of the store. It would be a return to the old days of shopping for a Mac among racks of PCs and dealing with staff who are motivated to sell you something else.

Further, Verizon won't want to drop Droid after investing over $100 million in advertising when it can use the Droid brand to sell millions of handsets and has the opportunity of being this quarter's vendor to play the various Android manufacturers (members of the Open Handset Alliance include Acer, ASUSTek, Ericsson, Garmin, HTC, Huawei, LG, Motorola, Samsung, Sony Ericsson, Toshiba, and ZTE) against each other. Unless it fails, Android is likely to become the Verizon house brand sold by preference in all of its outlets.

A Change of Management at Verizon?

It may take a change of management at Verizon for there to be an iPhone future, in the same way that it took a change of management at Disney for Pixar to stay there.

Vodaphone, which already owns 45% of Verizon, has talked about buying the rest. Like Verizon, it initially missed out on the iPhone. Realising this was a mistake, it became the third iPhone carrier in the UK. Vodaphone launched the iPhone in January and sold 100,000 to its customer base of around 19 million in the first week - sales figures Google would have loved for the Nexus One on T-Mobile.

Vodaphone knows the benefits of having the iPhone and has a good idea of how badly not having it is affecting Verizon's business.

Verizon as a Negative Example

In any case, Apple gains from having Verizon as an example of what happens if you don't seize the Apple opportunity when Steve Jobs offers it to you. Since the launch of the iPhone, AT&T has outgrown Verizon quarter by quarter. Verizon had to buy another carrier (Alltel) to get out in front with subscriber numbers. Last quarter, AT&T took another half-million subscribers off that lead after 900,000 new customers came for the iPhone.

Verizon vs. AT&T 3G coverage mapIf Apple sells around 2 million iPads this quarter, that alone could cut another 1 million from Verizon's shrinking lead. Every time a new iPad user tries out AT&T and gets good service for a month, he will think all the negative noise about size of the network is just noise and be ready to move when the cellphone contract is over. This could boost subscriber numbers quickly.

By the time Verizon's LTE is truly ready, AT&T could be ahead again.

Verizon Gives AT&T Incentive to Improve

Verizon is still useful to Apple though - it gives AT&T an incentive to improve its network, and the better AT&T's network, the more iPhones Apple sells. It stops Apple from being subjected to the monopolist slowdown when it wants to take over another company - who knows if and when Google will be allowed to buy AdMob - and it forces competitors' costs up, as they need to launch and support their phones on CDMA and GSM to stand a chance of getting traction in the market.

If Apple wants to continue its exclusive arrangement with AT&T in the US, we can expect Apple to put forward the arguments on costs and lack of monopoly in the smartphone market to the FCC or the Senate subcommittee looking at handsets. It will be difficult for either body to demand that Apple suffer damages so Verizon can regain ground lost from making poor decisions, and since the FCC lost the case on net neutrality, it will have problems convincing Apple and AT&T that it has the right to regulate this area without a new telecom bill.

The Obama administration currently has other priorities.

Growing the Market with the Next iPhone

We should see the new iPhone in June. The anticipated two-thirds increase in processor speed alone, with a 1 GHz A4 processor (vs. 600 MHz in the iPhone 3G), will fill the lines outside the Apple Stores on Day 1. Adding in the better battery life and better resolution, it should be another record iPhone quarter, if Apple can launch early enough and ramp up the production fast enough. LEM

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Tim Nash is a Director of WattWenn which has a new approach to scheduling the production of TV and movies to make the most of budgets. The views in this article are his own and are prejudiced from spending more years working for computer companies than he cares to remember.

Tim lives with his wife, her website on the area ariege.com, two daughters, a cat, and a dog in the French Pyrenees. He lapsed for a while after the Apple II, but became a Mac fan when his wife introduced him to the Macintosh IIsi. If you find his articles helpful, please consider making a donation to his tip jar.

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