How Apple's iPhone Reshaped the Industry
A few years ago, if someone asked what sort of cell phone you had, your response would probably be to name a network, like Sprint (S) or Cingular (T). Wireless carriers so completely controlled the business, especially in the U.S., that many manufacturers weren't even allowed to put their brand names on handsets. Now this relationship is changing in ways that will reduce the power of carriers and, with luck, increase consumers' choices.
The relationship started to shift when people began using phones for more than voice calls and text messages. As browsers and e-mail systems became important, it mattered more whether you had a Palm (PALM) Treo or a BlackBerry (RIMM) than whether your phone ran on the Verizon Wireless or AT&T (T) network. Then along came Apple's (AAPL) iPhone to rewrite the rules completely.
The conventional wisdom holds that AT&T scored a coup when it signed on as the exclusive U.S. iPhone carrier, and on one level this is true. The company reported that it activated 2.4 million of the new 3G iPhones in the third quarter, that 40% of those customers came to AT&T from rival operators, and that their average monthly bill was 1.6 times that of other subscribers. But the impact on AT&T's bottom line is another story. Mostly because of the fat subsidy it pays Apple for each iPhone, AT&T's third-quarter earnings of $3.2 billion were $900 million less than they would otherwise have been.
AT&T should eventually recoup the subsidy from monthly fees, especially if subscribers don't come in for a new subsidized phone the minute their two-year contract is up. But what the carrier has probably lost forever is ownership of the customer, a process economists call "disintermediation."
Before the iPhone, relatively few owners of any phones—smart or dumb—downloaded applications. The carriers had a nice business selling ringtones and the odd game. But with iTunes and the App Store, Apple became the exclusive supplier of applications as well as music and videos. The content suppliers got about two-thirds of the revenue, Apple kept about a third, and the carriers were frozen out.
"It's remarkable the impact [Apple] has had," says Jim Balsillie, co-CEO of BlackBerry maker Research In Motion (RIMM). "They exposed a lot of disintermediation risk in the industry." Balsillie says when RIM proposed application stores a couple of years ago, the carriers were hostile. But Apple's success is forcing the carriers to play. "Now everyone wants [an app store]," Balsillie says, and RIM will oblige next year, offering terms that will give carriers some of the action. Google (GOOG) has the Android Market, and Microsoft (MSFT) is considering an app store for Windows Mobile.
A key test of the new relationship between handset makers and smartphone software publishers, carriers, and customers will arrive when turn-by-turn driving instructions come to the iPhone. Apple seems to have created the phone with navigation in mind, yet the App Store prohibits programs that offer real-time driving instructions. Such services are available for other smartphones, typically for $10 a month, with revenues split between the carrier and a service provider such as TeleNav or Networks in Motion. Apple is mum about its intentions, but rumors are flying that it plans a navigation offering that leaves carriers in the cold.
I wish Apple were less controlling and less opaque about what may be sold at the App Store, but on the whole, I think the development of a robust market for third-party smartphone applications is a great thing for consumers. It's a huge improvement from the days when stodgy, innovation-averse carriers ran the show.
This shift in power is a bad thing for wireless carriers, whose nightmares of being turned into commodity sellers of bandwidth are coming true. But it's a win for everyone else.