Apple, Verizon Took Years to Overcome Their IPhone Differences

Verizon Communications Inc. President Lowell McAdam works a few miles from the New York auditorium where he announced yesterday’s deal to offer Apple Inc.’s iPhone. It took him four years to get there.

The press conference at Lincoln Center marked the end of haggling over branding and revenue sharing between the two companies, as well as efforts to ensure reliability. McAdam and Apple Chief Operating Officer Tim Cook came to terms last year, setting the stage for Verizon to offer the iPhone on Feb. 10.

The companies’ detente underscores Verizon’s desire to offer one of the best-selling smartphones, even if it means ceding more control than usual. Apple, meanwhile, gains access to the largest U.S. wireless carrier. That may help maintain its ballooning sales growth and stave off competition from Motorola Mobility Holdings Inc. and Samsung Electronics Co., which use Google Inc.’s Android operating system.

“We said over the last three or four years that the business interests would come together -- and they did,” McAdam, who is in line to be Verizon’s chief executive officer, said in an interview.

Since reaching their agreement last year, the companies have been testing a version of the handset that will work with Verizon’s code division multiple access, or CDMA, technology, McAdam said. AT&T Inc., the iPhone’s exclusive U.S. carrier since the device debuted in 2007, uses a different system.

Cell Towers

The companies erected Verizon cellular towers at Apple’s Cupertino, California, headquarters to check the phone’s signal and avoid the reliability troubles of the iPhone at AT&T. The two sides also had to agree to swap inside information about future products.

“We had to share with them where we were going with our network and they had to share with us what they were planning for devices,” said McAdam, 56. “That’s when we said, ‘Yes, this should work.’”

One of Verizon Wireless’s top engineers -- David McCarley, its executive director of technology -- worked on Apple’s campus for more than a year. He helped Apple understand its CDMA technology, McAdam said. Apple was given “their own laboratory to play with,” he said.

McAdam, who has worked at Verizon since it was formed in 2000, also personally used the iPhone ahead of yesterday’s announcement.

Technical Concerns

McAdam and Cook inked the final deal after negotiations that also involved Apple CEO Steve Jobs and Verizon CEO Ivan Seidenberg, McAdam said.

“We probably worked six or nine months on the technical side of this and saw we could make this work,” he said. “Then we did the commercial side. The commercial deal took us a day.”

The agreement bridges a gulf between Apple and Verizon that predates the iPhone’s deal with AT&T. When Apple first began working on its smartphone in 2005, it decided to base it on a format called the global system for mobile communications, or GSM, rather than Verizon’s CDMA standard. While CDMA is more popular in the U.S., the AT&T-favored GSM technology predominates globally.

Confident that the device would be a megahit that would upend industry commercial norms, Apple also decided it wanted a stake in any carriers’ monthly service fees. That ran counter to Verizon’s approach to manufacturers.

Instead, Apple struck a deal with AT&T, which agreed to share wireless-service revenue and let Apple manage its iTunes software on the phone. The companies later dropped the revenue- sharing deal in favor of having AT&T buy phones outright from Apple and resell them at subsidized rates. AT&T has paid Apple an estimated $600 for each handset, according to John Hodulik, an analyst at UBS AG in New York.

Top Seller

The partnership transformed the wireless industry, helping inspire a new stable of smartphones from Motorola, Samsung and HTC Corp., which all formed partnerships with Google. At Apple, the iPhone fueled sales and profit, with the device becoming the company’s biggest-selling product. It accounted for 39 percent of Apple’s $65.2 billion in revenue last year.

At AT&T, the iPhone has been plagued by network congestion and complaints about dropped calls, especially in big cities. AT&T was ranked the worst U.S. carrier in a Consumer Reports survey published last month. The design of Apple’s latest model, the iPhone 4, drew complaints as well, because it could lose signal strength when held a certain way. Verizon’s network was ranked second-best by Consumer Reports, behind U.S. Cellular.

Even so, AT&T’s network offers faster speeds and broader global coverage for the iPhone, said Mark Siegel, a spokesman for that company.

Branding Issue

To reach a deal, Apple and Verizon had to reconcile different approaches to branding. Verizon puts its stamp on other manufacturers’ devices, including phones from Research In Motion Ltd. and Motorola. By contrast, only Apple’s name appears on the iPhone.

“They don’t put a lot of logos on their phones,” McAdam said in the interview. “So that wasn’t a major issue for us.”

Watching the success of the AT&T-Apple partnership may have led Verizon to accept a similar deal, said Jean-Louis Gassee, a former Apple executive who is now a venture capitalist at Allegis Capital in Palo Alto, California.

“As my grandmother used to say, ‘If you can’t get what you like, you have to like what you can get,’” he said.

Share Price

Apple shares have more than tripled in value since the iPhone was introduced in January 2007. They climbed $1.16 to $342.80 at 9:44 a.m. New York time on the Nasdaq Stock Market. The company is now the world’s second-most-valuable, behind Exxon Mobil Corp.

Verizon Communications, which co-owns its wireless business with Vodafone Group Plc, rose 11 cents to $35.47 in New York Stock Exchange composite trading. AT&T gained 9 cents to $28.

Apple can help Verizon increase the number of customers using smartphones, which typically require separate data plans, said Carl Howe, an analyst at Boston-based Yankee Group. IPhone customers have bills of about $120 a month, versus $40 to $80 for users of regular phones, he said.

An iPhone on the Verizon network will cost the same as on AT&T. With a two-year contract, the handset costs $199.99 for a 16-gigabyte model and $299.99 for a 32-gigabyte version.

The move will take a toll on Verizon in increased subsidies. The carrier may sell 13 million iPhones this year with an estimated subsidy of $400 each, UBS’s Hodulik said. That would add up to $5.2 billion.

He estimates that 2.1 million net new customers will join Verizon in 2011. That compares with 650,000 for AT&T, which ranks second to Verizon in total U.S. customers. Apple also will get access to 93.2 million existing Verizon customers.

“It expands the overall footprint that the iPhone can serve and the number of consumers who can use it,” said Matt Murphy, a partner at venture capital firm Kleiner Perkins Caufield & Byers in Menlo Park, California. He oversees a fund dedicated to smartphone applications. “We’re going to see extreme growth.”

To contact the reporters on this story: Adam Satariano in San Francisco at asatariano1@bloomberg.net; Peter Burrows in San Francisco at pburrows@bloomberg.net

To contact the editors responsible for this story: Tom Giles at tgiles5@bloomberg.net; Peter Elstrom at pelstrom@bloomberg.net

Bloomberg reserves the right to edit or remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.