The wireless carriers are learning the old adage “be careful what you wish for, you just might get it.” Scoring the iPhone may mean a rush of customers, but don’t expect an immediate payoff.
The reality of this scenario came shortly after Sprint announced its quarterly earnings and noted a significant drop in its profit margin, from 16% to 9.5% in the course of a year. The difference, it noted, was the iPhone. Granted, it brought in a lot of new customers; 1.8 million new customers, 40% of them new customers to Sprint, something the number three carrier certainly needs.
But that still led to hyperbole and hyperventilating in the tech press. The iPhone is a nightmare for carriers declared CNN. The iPhone Is Killing Mobile Carriers declared Atlantic Wired. Skyrocketing iPhone Sales Are Killing U.S. Carriers intoned Slate.
It’s true that the carriers are taking a hit in their profit margins. Verizon’s EBITDA (earnings before interest, taxes, depreciation and amortization) service margin went from an average of 46.4% per quarter to 42.2% when it picked up the iPhone. AT&T saw profit margin go from 37.6% one year ago to 28.7% last quarter because it sold twice as many iPhones as in the same quarter the year prior.
That’s because the carriers take a loss initially. Carriers pay around $450 for the device but then sell it for $200. Obviously this is not a problem that can be solved through volume. Their hope is to make up the difference over time. That’s why smartphones have pricey data rate plans and very hefty early termination fees compared to feature phones.
Carriers typically allocate $20 a month out of the monthly revenue for capital recovery. Over a two-year contract, that’s $480, which makes up the difference between the sell price and purchase price, said Gerry Purdy, principal analyst with MobileTrax LLC.
“They figure people will use data plans and network services, so they will make it up over time with revenues. So you take a hit in the short term to give you the opportunity for a longer term gross margin growth of over time. Sprint warned the financial impact would hurt but the long-term prospects were significant,” said Purdy.
So the carriers aren’t about to give up on the phone that brings in customers, even if there is an initial hit on profits. Verizon and AT&T both declined to comment. A Sprint spokesperson had the following comment: “While Sprint has acknowledged that the iPhone will not be profitable in the short term, over time we expect iPhone customers to be among our most profitable due to lower churn and higher customer lifetime value. Last quarter Sprint sold 1.8 million iPhones, 40% to new customers which exceeded expectations and is the best early indicator of future profitability.”
It doesn’t take the full two years to get to a net positive on the phones, said Purdy. “For every subscriber getting into an iPhone, or Android for that matter, if [customers] increase their use of software and services, then the carrier revenue is higher and allows a net positive to occur in less than two years,” he said.