Apple-AT&T: Hints of Strain

I would not want to have been an AT&T employee at Apple's Worldwide Developers Conference. There were at least three moments when comments by Apple (AAPL) executives betrayed thinly veiled criticism of the phone company, leaving me to wonder about the state of the relationship between Apple and the exclusive U.S. iPhone provider.

Both companies say they're plenty happy with the alliance, and people at Apple familiar with the matter say the speakers didn't intend to poke fun at AT&T (T). Nevertheless, comments by Scott Forstall and Phil Schiller underscored potential areas of strain.

The first moment came as Forstall laid out features of the new iPhone operating system, iPhone 3.0. Among them is support for Multimedia Messaging Service, or MMS—the ability to send pictures, videos, contacts, audio recordings, and other content embedded within a phone-to-phone message.

But, Forstall noted, the feature "requires carrier support," meaning it can't work without the cooperation of the wireless service provider. And even though 29 wireless companies in 76 countries will support MMS when iPhone 3.0 launches on June 17, two days before the launch of the new iPhone 3G S, it won't be available in the U.S., through AT&T, until "later this summer," he said before quickly moving on to the next topic. Audience laughter ensued.

Late to the Tethering Game

Another feature the new iPhone is designed to offer is tethering, which lets a wireless phone act like a modem and share its wireless Internet connection with a nearby notebook PC. This handy feature has been available on Palm's (PALM) Treo, Research In Motion's (RIMM) BlackBerry, and scores of other devices for years. Slides presented by Forstall at the conference showed that while 22 carriers in 42 countries will support tethering on the iPhone right away, AT&T will not. More laughter at AT&T's expense.

Later, after introducing the iPhone's video capabilities, Schiller teased at the MMS issue again. "If my carrier supports it, I can send a video clip in an MMS as well," Schiller told the audience, which got the message—that this is one more feature you won't immediately get from AT&T—loud and clear. You can guess what happened next.

AT&T expects to support MMS and video sharing by "late summer," AT&T spokesman Mark Siegel told me. The delay is related to some internal system upgrades to the network. He added that tethering will be offered at some time in the future, but he couldn't give me a date.

The lack of support for MMS and tethering adds to a list of grievances that Apple customers—if not Apple execs—have against AT&T. The largest, for many, is the faulty reliability of AT&T's network. Owners of iPhones are quick to complain about dropped calls, poor call quality, and slow performance of the data network. Many I know carry a second phone primarily for voice calls, and more often than not that voice phone runs on the network of Verizon Wireless, which is owned by Verizon Communications (VZ) and Vodafone (VOD).

It's not easy being a partner with the exacting Apple. Remember the Apple event in September 2005, when Motorola (MOT) released its first Rokr phone supporting iTunes? The device was expected to be the headline product of the day. Then Apple CEO Steve Jobs reached into the coin pocket of his jeans and removed the first iPod Nano, which easily overshadowed the phone. The Rokr became a footnote, while the Nano went on to become the most popular iPod model.

iPhone: Two-Thirds of Mobile Web Browsing

In the case of AT&T and Apple, both sides clearly benefit from the pairing. In AT&T, Apple has the largest wireless service provider and one of the most recognized brands in the U.S. Verizon Wireless initially turned up its nose at partnering with Apple on the iPhone. AT&T has plenty to be happy about, too. During its Apr. 22 earnings conference call with analysts, AT&T Chief Financial Officer Rick Lindner noted the "attractive" average revenue per iPhone user and said that since July 2008 the company has seen some 6 million iPhone activations, 40% of which were new to AT&T.

And while it's true that AT&T's margins get squeezed as it spends money to attract customers and then subsidizes the phone on top of that, iPhone customers pay off in the end. Wireless data service revenue was up 26.3% in the first quarter, while voice revenue was down a little over 7%. You know who's using much of that data? Owners of iPhones. As Apple's Schiller pointed out in his remarks, of all the Web browsing done on a mobile device, about two-thirds of it is done on an iPhone. On Yahoo!'s (YHOO) Flickr photo-sharing site, the number of users who upload pictures from their iPhones is more than three times that of those using a Nokia (NOK) N95.

With all that data usage, it should be pretty clear that AT&T needs to bulk up its network. That would have two important consequences: One, it would benefit all the other data customers on the network—those carrying BlackBerrys, Nokia phones, and other handsets.

At the same time, AT&T would have happier iPhone customers—who might temper their calls for Apple to switch the iPhone to Verizon Wireless. Of course, that switch could still happen, since Apple always likes to keep its options open. As we reported in April, Apple and Verizon have had conversations.

With Verizon starting to build out its next-generation LTE network, it could become a serious contender as an iPhone vendor within a year. Apple may not have intended to make fun of AT&T this week, but the message from the audience in San Francisco should be clear: AT&T needs to give iPhone users one less reason to scoff at it.

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