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June 10, 2008

With its dramatically lower price, Apple's new 3G iPhone is a tantalizing jewel to other wireless phone service providers such as Sprint, Verizon and T-Mobile.

AT&T's decision to literally subsidize an estimated $300 to $400 of each customer's iPhone purchase is a bold move to increase its market share.

As the wireless carrier pointed out yesterday, its a very expensive bet that may not pay off for a few years to come.

AT&T's decision is the clearest sign yet that the slowdown in wireless growth has forced telcos to try and poach the other players' high-paying subscribers. The sharper tactics underscore the pressures some phone companies feel from a cut-throat triple-play battle with cable companies.

Huge network upgrade costs and new video technologies have created a churning customer cauldron with no clear winners. And this heightened competition comes during a cooling economy and a consumer spending slowdown.

Citigroup analyst Mike Rollins says "we believe AT&T is looking to acquire a larger marketshare with the new 3G iPhone with significantly larger subsidies."

"It certainly raises the bar in this already cut-throat industry," says UBS analyst John Hodulik.

AT&T said it will increase the price of the iPhone data plan by $10 a month, but even with that hike the company expects the big subsidy to take 11 cents off each year's bottom line for the next two years.

As could be expected, not everyone thinks this is a sign of good health for the industry. One long-time telco analyst points out that in 2010, which is when AT&T expects its big-subsidy bet to start paying off, is exactly when the iPhone contracts expire and users are free to go to the next cool thing.

"It's probably a smart move by AT&T, but the question is: What will it do to the rest of the industry?" asks UBS' Hodulik.

With subscriber growth slowing down a lot recently, telcos are trying to squeeze more out of each existing customer. One measure of this is average revenue per user. AT&T got about $95 a month from each user of the original iPhone, nearly twice the average wireless bill, adding up over two years to a take of about $1,700 after kickbacks to Apple.

Subsidies certainly aren't anything new. They are standard practice among telcos who split the costs of the phone with their customers. But what AT&T plans to do to help lower the customers' iPhone cost to $199 is bring a once-expensive phone down to a relatively affordable level.

In other words, rack up higher costs to win more high-spending customers in the long run, at least that's what is hoped.

With its $300-plus subsidy, AT&T sets a new standard for wireless companies trying to win over high-end customers. "We will probably see an increase in subsidies on expensive phones," says Hodulik.

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Source: Fortune.