Handsets

Rethinking the iPhone Threat to AT&T


Very soon, maybe by Valentine's Day, Apple (AAPL) will likely host one of its splashy product introductions to announce a new version of the iPhone that works on Verizon's (VZ) network. Customers are expected to stampede to the new pairing, leaving AT&T (T), until now the exclusive U.S. distributor of the iPhone, with an enormous problem.

Like most conventional wisdom, this expectation makes a certain amount of sense. Verizon enjoys a reputation for reliability. AT&T is notorious for dropping calls, especially in densely populated places like New York and San Francisco where iPhones are most common and cell towers get overloaded.

On Dec. 6, Consumer Reports published a survey of 58,000 readers who ranked AT&T as the worst wireless carrier for customer satisfaction—and by an even wider margin than its similarly dismal finish in 2009. The company brought up the rear in quality of calls, access to the Internet, and customer service. "AT&T," noted the Consumer Reports editors, "is now positioned in last place overall and in almost every market we rate."

And yet, while AT&T has reason to worry about losing the lucrative iPhone arrangement it has enjoyed since Apple introduced the device in 2007, the damage may not be as severe as many anticipate. At least initially, Verizon's iPhone may have weaknesses compared to AT&T's. The expense and hassle of changing carriers could also work to AT&T's advantage. "I'm sure some AT&T customers are sufficiently frustrated to switch, but the vast majority are at least happy enough," says Charles S. Golvin, an analyst with Forrester Research in Cambridge, Mass.

Apple's introduction of an iPhone for use on Verizon's network will come sometime after the Consumer Electronics Show in Las Vegas in early January, according to a person familiar with Apple's plans who is not authorized to discuss them publicly. Estimates from industry analysts of the resulting number of defections to Verizon from AT&T range from 1 million to 6 million. John Hodulik, an analyst at UBS Securities (UBS), comes in somewhere in the middle. He predicts that AT&T will sell 8.8 million iPhones in 2011, down from 15.6 million in 2010. Of the 13.3 million Hodulik expects Verizon to sell in 2011, about 2.3 million will be to AT&T refugees, he predicts. An additional 10 million will be current Verizon subscribers who upgrade from other devices, and the rest will come from other carriers.

Still, even if AT&T loses more than twice as many customers as Hodulik projects, the carrier will not suffer a fatal blow. If 6 million of its customers defect, the $6 billion in lost annual revenue would amount to about 10 percent of AT&T's wireless sales in 2011, according to UBS projections. The $6 billion would be 4.8 percent of its total projected sales of $126 billion in 2011. AT&T is expected to try to mitigate the damage by promoting iPhone alternatives, such as cheaper devices that use Google's Android mobile software, says Mark Lowenstein, a former Verizon executive who is managing director of consulting firm Mobile Ecosystem.

Other losers in the unfolding iPhone tale may well be rival carriers Sprint Nextel and T-Mobile. There are no indications that Apple intends to make an iPhone for either of them. Without the Apple magic, their subscriber rolls could fall in 2011 by 650,000 and 950,000, respectively, Hodulik says.

AT&T has been getting ready for the day that Apple shares the iPhone with another carrier. Over the past year it has played a carrot-and-stick game with consumers. In part by easing the cost of upgrading to Apple's new iPhone 4, it enticed 15 million of its 23 million iPhone subscribers to sign new two-year contracts. Meanwhile, last June, AT&T hiked early contract termination fees from $175 to $325, giving users a reason to think twice about switching.

"We are the industry leader in smartphones," says AT&T spokesman Fletcher Cook. Current iPhone users with AT&T service can make a call and use the Internet simultaneously—if, for example, they want to search for a restaurant while continuing a conversation. Verizon's network is based on different technical standards, which do not permit this kind of multitasking. In addition, AT&T's network offers greater speed when sending e-mail, surfing the Web, or playing online games, according to Global Wireless Solutions in Dulles, Va.

"We operate the nation's fastest network, and we plan on making it even faster," says AT&T's Cook. The advantage of greater speed comes into play only when a user has steady cell coverage, of course. When there are too many iPhone users relying on the same tower, some are likely to get dropped. That explains AT&T's bruised reputation for service.

Verizon has largely avoided coverage snafus while handling soaring demand. It has invested heavily in powerful cell tower gear and new fiber-optic lines to connect the towers to the Internet. "Even if Verizon's iPhone customers go wild next year, [the carrier] can easily handle the capacity," says Michael Howard, co-founder of Infonetics Research in Campbell, Calif.

Verizon has also taken the lead in rolling out so-called 4G service, which offers far more speed than today's 3G networks. Verizon recently began selling 4G service in 38 markets across the country, and it owns more of the wireless spectrum than AT&T. (AT&T's $1.9 billion deal announced on Dec. 20 to buy additional spectrum from mobile chip maker Qualcomm (QCOM) will help close the gap.)

Much remains uncertain in this wireless duel. Both AT&T and Verizon have staked their futures on 4G, but neither will have broad-based coverage for the new technology anytime soon. "Right now, it's like we're in a snow globe that's been shaken up," says Roger Entner, an analyst with the research firm Nielsen. "In six months or a year, everything will settle down as these new [4G] networks come on line."

Only then will discerning consumers really be able to compare AT&T's iPhone service to that of Verizon. And only then will the cost of AT&T's loss of its exclusive hold on the iPhone be clear.

The bottom line: The conventional wisdom about the impact of AT&T's loss of exclusive service for the iPhone may require rethinking.

Burrows is a senior writer for Bloomberg Businessweek, based in San Francisco.

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