Wireless Carriers See iPhone Profit Problems
September 23, 2012

Wireless Carriers Looking To Offset iPhone 5 Profit Margins

April Flowers for redOrbit.com — Your Universe Online

The launch of a new iPhone from Apple is a cultural phenomenon. Each new launch creates a flurry of excitement, much like the Cabbage Patch Kids in the 1980's or the Furby's in the late 1990's. The iPhone 5 is no exception.

With the launch on September 21, people formed long lines at Apple Stores and phone retailers across the globe, sometimes waiting hours for a chance to buy the newest version.

But what does that actually mean for the cell phone companies, like Verizon, Virgin Mobile or Sprint Nextel?

"We always say an Apple a day keeps the profits away," Neil Montefiore, chief executive of Starhub, said during the Singapore wireless service provider's August earnings conference call.

Getting people to buy the iPhone is easy, but to make a profit companies like AT&T Inc. need folks to pay for all the data services, like mobile video. The reason: wireless companies subsidize the cost of smartphones, offering discounts to consumers to lock them into service contracts. All smartphones cost the wireless companies, but the iPhone subsidy is as much as 60% more than the Android, according to Barclays analyst James Ratcliff.

Most smartphones cost the wireless companies between $250 and $300 dollars each, but the iPhone is closer to $400. That means the iPhone customers only start to be profitable for the wireless carrier around nine months after they purchase the phone. Other smartphones become profitable after only six months.

As a result, even during the selling frenzy of a new launch, wireless companies profit margins are suffering. The phone companies still want to sell the iPhone, though, because it helps them to retain subscribers and attract new ones.

The financial hit is causing some mobile operators to change their policies and their fees. In Australia, some service providers are varying the iPhone's price, making it dependant on how large of a data package the customer purchases.

U.S. carriers have changed their policies so customers have to wait longer for a subsidized upgrade. They have also levied new fees after Verizon, AT&T and Sprint Nextel Corp. suffered dramatic declines in the fourth quarter of 2012, when the iPhone 4S was launched.

These changes are expected to help the companies, but analysts still forecast a drop in earnings before interest, tax, depreciation and amortization (EBITDA) margins. AT&T  profits are expected to fall from 45% in the second quarter to 40.8% in the third. The fourth quarter is even harsher at a projected 35.7%.

Verizon is expected to fair nearly as bad: from 49% in the second quarter to 47.4% in the third and 43.6% in the fourth.

The biggest hope that service providers have is that consumers will spend more money on mobile data with the iPhone 5, saying that services with video should work better on the new phone. The iPhone 5 can support data speeds about 10 times faster than the previous model.

According to analysts, this hypothesis is unproven with no reason to assume iPhone 5 customers will use any more data than people using other devices that support the same high-speed technology.

There is hope, however, as Singapore's biggest mobile operator, SingTel, reports that iPhone 5 orders are already exceeding previous iPhones because of the new phone's higher speeds.

"From a financial standpoint, people who use this device tend to use more of it," said SingTel digital executive Allen Lew.

China Telecom is also banking on iPhone users being willing to spend more money on their services. Telecom had to raise its subsidies by 50% when it started selling an older iPhone in February. Its EBITDA profit margin fell 4 percentage points in the first half of the year to 38.5%, compared to the same period the year before.

Apple hasn't announced launch plans for China yet, but China Telecom expects continued pressure on its bottom line from the iPhone. They hope, however, that the device will help boost revenue, per user, in the long run.

"Our subsidies level will remain pretty high at least for this year," said the executive, who did not have permission to speak to the media and declined to be identified. "We know we'll have to invest more initially."

Wireless operators feel as though they have no choice in offering the iPhone 5 because of its popularity.

"It's kind of like dancing with the devil. It's a blessing and a curse," said Wells Fargo analyst Jennifer Fritzsche.

In a surprising twist, wireless giant Verizon is sending out their version of the iPhone unlocked. Normally Verizon's phones are locked to only operate on their network. The Verizon iPhone 5 will accept an AT&T sim card and can be activated on the AT&T network.

This is the first time a Verizon iPhone has been able to reach another network without complicated hacking procedures. It might not mean much to users early on, but it does mean they have the option of switching carriers without having to buy a new phone.

It isn't known yet if this was intentional or even if the phones will work with other carriers such as T-Mobile USA.