Price wars beginning?: iPhone now drives subsidy strategies

Last year, of course, the iPhone launch drove hand-wringing over the need to revamp user interfaces, accompanied by a move to large-display touchscreens.
A wave of devices sporting large-display touchscreens followed, with varying results on the user interface. That influence continues to play out with similar launches still slated for the back half of 2008 and beyond.
This year, however, with incremental changes to the iPhone, the subject du jour has refocused on carrier subsidies and consumer-facing prices.
AT&T Mobility’s decision to price 3G iPhones at $200 and $300 – a decision costing in the neighborhood of $1.2 billion that the carrier acknowledged would dampen its earnings-per-share by 10 cents to 12 cents for two years – has already led competitors Verizon Wireless and Sprint Nextel Corp. to cut prices on handsets they deem competitive.
Indeed, Sprint Nextel priced its recently launched Samsung Electronics Co. Ltd. Instinct – touted as its answer-to-the-iPhone with a head-to-head, comparative advertising approach – at $130, notably down from the expected $200.
“That $70 difference comes right out of Sprint’s pocket,” said Roger Entner, analyst at Nielsen/IAG. “Ultimately, that’s a cost to investors.”
“For the time being,” Entner added, “we’ll have a $199 ceiling for devices.”
The analyst said he expected the iPhone’s pricing to cut across the smartphone and feature-phone categories, and that he would be watching mid-third-quarter handset price tags to determine how the carriers’ pricing has influenced unit sales of subsidized phones.
“We’ll see how these devices sell,” the analyst said. “The carriers closely monitor how devices sell and how their subscriber numbers are faring.”
If sales early in the quarter starting July 1 are weak, the analyst said he would expect handset subsidies to appear in the mid-August to September timeframe.
But the handset subsidy game is a tricky one, Entner said.
Anyone who has attempted to follow the carriers’ zigs and zags in pricing their portfolios would likely agree that a) it’s indeed a tricky business, driven by so many factors as to be largely opaque, and b) cause-and-effect are rarely as clear as in the new iPhone pricing and the competitive responses.
However: “The Sprint price drop is unquestionably driven by the iPhone 3G announcement,” said analyst Avi Greengart at Current Analysis.
“Subsidies drive unit sales,” Entner said. “But you have to have inventory to supply the resulting demand. If you over-subsidize, you risk selling out too quickly and dampening demand.”
Handsets that sell out on launch tell the carrier it over-subsidized, Entner said, a form of “subsidy regret” or “seller’s remorse.”
Carriers moderate this risk, in part, by determining the right charge for monthly service, the analyst said.
In European markets such as Germany, for instance, carriers may offer varying levels of device subsidies coupled with monthly tariffs pegged to that subsidy – high-priced handsets with low monthly tariffs, or low-priced handsets with high monthly tariffs, for instance. In the United States, carriers tend to subsidize the handset and recoup that investment over the course of a 24-month service agreement, Entner pointed out.
In AT&T Mobility’s case, it’s clear that the carrier’s first-year results with the original iPhone, both in net subscriber additions and data revenue, convinced it that its current subsidy gamble is worthwhile. How AT&T Mobility’s wager – and the resulting subsidy efforts by its competitors – plays out will be closely watched.
“It’s extremely beneficial for consumers,” Entner said. “Americans have a taste for a good deal.”
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Competing on features
Pricing is an obvious competitive ploy, but the quest to produce an “iPhone killer” is inherently doomed because it defines competition on Apple Inc.’s terms, said analyst Avi Greengart at Current Analysis.
“Everyone is trying to create an ‘iPhone killer,’ which defines the product entirely in Apple’s terms, a game no one but Apple can win,” Greengart wrote in a recent report. “Rather than go head-to-head with Apple, vendors should go where Apple is not … Change the game.”
Areas ripe for exploitation, in Greengart’s view: high-end imaging, touchscreen haptics, QWERTY keypads, stereo Bluetooth, ruggedized casing and multi-carrier SKUs. Sony Ericsson Mobile Communications’ recent announcement of an 8.1 megapixel camera phone in its Cyber-shot line might be a case in point, Greengart said.
“The actual iPhone has changed relatively little … leaving multiple options for competitors to differentiate and compete at the high end,” Greengart wrote.
“All carriers need to offer a touchscreen, entertainment-oriented smartphone or two, because the trend towards more capable touchscreen devices goes well beyond the iPhone,” Greengart wrote. “But the (iPhone) drop to $199 is the biggest change for the U.S. (That) puts tremendous price pressure on feature phones.”
“I expect the iPhone 3G to sell extremely well,” Greengart said, “but that doesn’t mean that it is the only phone that will sell well, and it doesn’t meet everyone’s needs equally well.”
Thus, Greengart advises vendors and carriers to pursue differentiation targeted at various market segments.
His list of “don’ts,” however, is topped by one caveat that Sprint Nextel clearly has ignored.
“Deliberately inviting direct comparisons to the iPhone is stupid,” the analyst wrote.
–Phil Carson