Why AT&T May Deep-Discount the iPhone

With competitive pressures mounting, the phone company may cut the iPhone's price to boost demandand cement its relationship with Apple

The big thing about the next iPhone was supposed to be high-speed Internet access and tools for business. Instead, it's looking like iPhone 2.0 is all about price and that ever-awkward relationship between Apple and AT&T.

With less than two months to go before Steve Jobs takes the stage at Apple's Worldwide Developers Conference, where he's expected to unveil a new iPhone, it appears that AT&T may not be convinced that new bells and whistles will be enough to get droves of new customers to switch from other wireless carriers. So after a year of charting a new wireless business model by selling the vaunted iPhone at premium prices, the nation's biggest phone company may resort to the oldest trick in the cellular book: big discounts.

Although it has sent millions of new customers AT&T's way, this unique market advantage known as the iPhone will only last so long. With every passing month, rival device makers are introducing new handhelds that attempt to replicate the wide array of innovations—starting with sheer simplicity—that Apple (AAPL) used to rock the wireless world less than a year ago. None of these new phones has duplicated Apple's formula for success yet, but it may be only a matter of time.

Stimulating Demand

Published reports that first appeared on the Web site of Fortune Magazine suggest that AT&T (T), which has an exclusive five-year deal to sell the iPhone in the U.S., is prepared to subsidize the device by as much as $200, slicing the purchase price as low as $199 for customers who sign a two-year service contract. Apple and AT&T declined to comment on the matter.

Such a discount could cause a surge in demand. At last count, Apple had sold some 5.4 million units, the vast majority of them for AT&T's network, even with price tags of $400 to $600—essentially unheard of in the U.S. cellular market. Impressively, AT&T says 40% of its iPhone users are new customers. Yet with rival smartphones like Research In Motion's (RIMM) BlackBerry and a new Palm (PALM) Treo selling for as little at $99 at some carriers, competitive pressures are building.

But a price cut might be about more than nabbing new customers. AT&T's goal may also be to boost monthly revenues from existing subscribers who switch to the iPhone, as the big colorful screen and robust Web browser on the Apple device tends to make iPhone owners heavier users of AT&T's wireless data services. AT&T brings in about $90 a month from each iPhone user, reckons John Hodulik, analyst with UBS Investment Research (UBS). "When Apple cut the price on the iPhone by 33% earlier this year, it stimulated demand," he says. "If this new price turns out to be true, it would do it again. It's like déjà vu all over again."

For AT&T, eager to generate returns on its multibillion-dollar investments in a next-generation data network, a $200 subsidy on a device with a proven success record may be a no-brainer, says Richard Doherty of the Envisioneering Group. "This is not unexpected at all," he says. "The $200 is a small fraction of the revenue that AT&T makes over a two-year contract.

Open Marriage?

There's also been speculation, considered unlikely, that AT&T might be floating the idea of an iPhone subsidy to reinforce its marriage with a partner as notoriously slippery and heavy-handed as Apple.

Some have suggested, for example, that Apple might try to argue that the new iPhone isn't covered by the exclusive rights given AT&T for the first edition, and thus walk away from AT&T. In theory, this would open the door to a version for the technology used by Verizon Wireless and Sprint Nextel (S). The speculation has been fueled in part by comments from Apple's chief operating officer, Tim Cook, in February, when he said that Apple "isn't married" to any particular business model.

Likewise, rumors have emerged in recent weeks that Apple is considering selling an iPhone in Australia that would work with multiple carriers. But most analysts dismiss that possibility as unlikely, at least in the U.S. "As far as anyone knows Apple is married to AT&T for another four years," Hodulik says.

Business Exchange related topics:BlackBerry Vs iPhoneAppleSmartphonesWireless Communication

Before it's here, it's on the Bloomberg Terminal.