AT&T and the iPhone

05-10-10iphoneatt.jpgOn January 9, 2007 Steve Jobs got on stage at Macworld Expo in San Francisco and introduced a product that would revolutionize the mobile wireless device marketplace. The iPhone was poised to do to the smartphone market what the Macintosh did for the PC market. Over the next 3 years, Apple would sell over 42 million iPhones and create a multi-billion dollar ecosystem around iPhone accessories and applications.

In the United States, Apple partnered with wireless provider AT&T (still known as Cingular at the time) to serve as the exclusive wireless carrier for the iPhone. Was AT&T given a “golden ticket” to be a partner in the biggest revolution in wireless since the introduction of the cellular telephone?  Would this be their chance to gain millions of subscribers and cement their position as the #1 wireless provider in the U.S?

Three years later, AT&T now has over 14,000,000 iPhone subscribers, roughly a third are new AT&T subscribers. While the iPhone is ranked #1 in customer satisfaction amongst smartphones, AT&T is ranked dead last in customer satisfaction amongst wireless carriers

The iPhone was and continues to be a huge marketing success for Apple; can the same be said for AT&T? The purpose of this paper is to critically analyze AT&T from a marketing perspective with regards to the iPhone and recently released iPad. I will focus on these two aspects: Whether or not AT&T was able to use the iPhone to improve their brand image amongst consumers and whether or not the iPhone was a success for AT&T in terms of market position and profitability. Before I do that, a little background about why AT&T was chosen as the exclusive U.S. service provider is in order.

When Apple introduced the iPhone in January 2007, AT&T wireless was announced as the exclusive wireless carrier in the U.S. Many wondered why Apple would limit themselves to a single carrier. Speculation at first was that the GSM wireless standard was much more pervasive around the world (vs. CDMA, which is used by Verizon/Sprint) and it would be easier for Apple to launch a single device that they could launch worldwide. When details emerged from the secret negotiations between the wireless carriers and Apple, it was clear that the reason was not technical but about money and control. In 2005, Apple approached Verizon to make a deal on the iPhone. Jim Gerace, a Verizon Wireless vice president, explains Verizon’s reason for rejecting the deal, “Among other things, Apple wanted a percentage of the monthly cellphone fees, say over how and where iPhones could be sold and control of the relationship with iPhone customers.”

AT&T took the deal, which was quite unprecedented; never before had a handset manufacturer (let alone one who never sold a single phone) been able to exert so much control over how a carrier distributed its product. In exchange for lower pricing and exclusivity from Apple, AT&T would give a cut of their monthly service revenue to Apple. Additionally the iPhone could only be sold at Apple or AT&T stores, cutting out AT&T’s vast network of 8000+ independent resellers. They even had the arrogance to send a memo to these resellers on how to help their customers fill out a form on apple.com to order an iPhone, while offering no sales commission in return. AT&T decided to take the risk because while they were the #1 wireless carrier in terms of subscribers (albeit by a slim margin), the storm clouds were looming on the horizon. Their market share of new subscribers plunged from 29.5% in 2006 to 25.8% in 2007. The move was especially risky given Apple’s lack of track record making mobile phones.  On the flip side, Apple’s brand image was stellar and AT&T was hoping some of that image would rub off on them, helping them trade their old, stodgy phone company image for a new, hipper image.  With Apple CEO Steve Jobs predicting that 10 million iPhones would be sold in 2008, AT&T  was looking at adding millions of high-revenue smartphone subscribers. Things seemed to be looking pretty good for AT&T. With cell phone adoption at 82% in the U.S., subscriber growth comes from winning customers over from other carriers. AT&T figured exclusive rights to this revolutionary handset would allow them to do that.

Brand Image

Ask any iPhone user in the U.S. about their iPhone and more often than not the response will be “I love my iPhone, but I hate AT&T.” While the degrees of hate vary, this sentiment shows how AT&T was not able to improve their brand image as a result of partnering with Apple; some may argue their image may be worse as a result. In this section, I will analyze the factors affecting AT&T’s brand image in terms of the initial purchase experience, pricing/terms and ongoing service.

Initial Purchase Experience

With the launch of the original iPhone, Apple and AT&T introduced a new way to buy a cell phone. Instead of having to spend time in a store filling out credit applications and getting their new phones activated, consumers could simply walk in to an Apple or AT&T store, buy the phone and activate it in the comfort of their home when they plugged their new iPhone into their PC. While consumers were greeted at the Apple store with cheering employees and walked out with their new iPhone, their exuberance faded when they went home to activate their new iPhone. AT&T’s activation system was overloaded and some consumers had to wait as long as 43 hours to activate their phone.

Sadly, AT&T did not learn their lesson and made things worse when Apple released the 2nd generation iPhone, the 3G. They decided to go back to the old model of in-store activation. The reason given by Mark Siegel at AT&T: “We want everyone to go home with their iPhone up and running and this gives you the opportunity in person to resolve any questions or issues.” However, speculation was that 20% of the original iPhones were never activated and ended up on the grey market resulting in lost revenue for both Apple and AT&T. The in-store activation mandate was an attempt to prevent the phones from being activated with AT&T on a cheaper non –iPhone rate plan or hacked and activated carriers other than AT&T. While having to activate in-store was a mild inconvenience for the consumer, once again, the activation system was overloaded and people waited in long lines at Apple and AT&T’s stores. Frustrated store employees ended up sending customers home to activate their phones. It turned out the glitch was due to Apple’s system, but due to the halo effect, Apple emerged unscathed and AT&T’s image took another hit.

While the in-store activation issues were ironed out for the launch of the 3rd generation iPhone, the 3GS, the launch of the iPhone 4 a year later introduced a whole new set of issues. Demand for the iPhone 4 was unprecedented; it would become Apple’s biggest product launch ever. AT&T’s pre-order system had a security glitch exposing customer’s personal data to each other and causing the system to charge the wrong credit cards. This and the sheer number of orders caused AT&T’s site to crumble under the load and AT&T shut the site down after one day. Rumors even surfaced that AT&T did not even bother to test the site before launching.

These initial purchase glitches set a negative tone from the get-go from a customer relationship perspective. While AT&T is responsible for a few of the technical glitches, Apple deserves some of the blame as well.  So why did AT&T bear the brunt of consumer wrath? Through the unprecedented marketing agreement AT&T and Apple signed, Apple got to own the buying experience for the most part, providing an in-store experience and providing their usual friendly customer service thereby relegating AT&T to a faceless utility provider adding zero value other than providing radio waves. AT&T had no way of generating positive press for themselves. Even if they executed 100% perfectly, the press would be non-existent or neutral. When they didn’t execute perfectly, the press lambasted them.

From the buying experience point of view, there is nothing AT&T could have done to improve their image to the consumer. They got what they bargained for when they agreed to Apple’s terms. This very issue was one of the main reasons Verizon rejected Apple. Clearly Verizon cared more about staying in control of their image. Someone at AT&T got too excited when Apple came knocking. What if AT&T and Verizon both rejected Apple’s terms? Apple would be forced to change their terms or severely limit their market potential by going to Sprint or T-Mobile. While Verizon was thinking long term with regards to maintaining their brand integrity, AT&T, thinking short term, just saw dollar signs. They thought they had their exclusive Apple cash cow that they could milk for the next 4-5 years without regard to what would happen should they lose exclusive access to it.

Pricing and Terms

Traditionally, a wireless consumer in the U.S. would get a heavily discounted or free phone in exchange for signing a 2-year contract. For example, a carrier might buy a phone from Samsung or Motorola for $200 and give it away to the consumer for free. The carrier would recoup the cost of subsidizing the phone over the life of the 2 year contract. If the consumer chose to terminate the contract early, the carrier would charge them an early termination fee (ETF) to recoup the costs of the handset subsidy.

The pricing for 1st generation iPhone was a departure from the traditional wireless pricing model.  Apple sold the phone to consumers at a modest discount and recouped their lost profit through kickbacks from AT&T in the form of a cut of the monthly service revenue. This was a great deal for Apple and AT&T but terrible for consumers. Consumers had to pay almost full price ($500-600) for an iPhone AND had to sign a 2-year contract. AT&T offered only 3 rate plans, which fortunately were price competitive with other carriers. These plans included an allocation of voice minutes, 200 text messages and unlimited data. However the original iPhone did not support 3G data or picture/video messaging, like a lot of the other phones on the market. Goldman Sachs predicted AT&T would activate 700,000 iPhones on launch weekend, they only activated 146,000.

While sales of the original iPhone were growing steadily, they were missing out on mass appeal because of the iPhone’s high initial cost. For the iPhone 3G, AT&T re-negotiated the revenue sharing deal and went back to a traditional handset subsidy model. Consumers would pay $200 less for the iPhone 3G.  While $199 for an iPhone looked great, AT&T made some changes to the rate plans. The net result was that to get the same thing as you got with the original iPhone, (voice, unlimited data and 200 texts), you would pay $15 more per month ($10 for 3G data and $5 for 200 texts). The only consolation to the consumer is that the data was 3G as opposed to the very slow EDGE data service. If you happened to live outside of a major metropolitan area where AT&T did not have 3G coverage, you still had to pay for the more expensive data plan. AT&T eliminated the sticker shock on the handset but managed to gain it back (and more) on the back end. The consumer would pay $360 more over the 2 year contract, negating the cost savings on the handset purchase. Though there were some consumer complaints about the new rate plans, most were OK with it as they felt they were getting better data speeds and a much more robust phone. AT&T stuck to this pricing plan when the iPhone 3GS was launched a year later.

Things got very interesting in the 1st half of 2010. In the beginning of the year, Apple announced its next revolutionary product, the iPad. The iPad came in 2 versions: WiFi and Wifi+3G. AT&T was announced as the provider for the 3G service. Steve Jobs said that he made a “breakthrough” deal with AT&T. Consumers would be able to buy 3G service for ($29.99/mo unlimited and 250MB for $14.99/mo) for the iPad on a pay-as-you-go basis. No contract, cancel and re-start whenever you need it. Consumer reaction to these plans was overwhelmingly positive. AT&T had finally come out with a consumer-friendly rate plan.

This exuberance was short lived. Less than 1 month after the iPad 3G started shipping, AT&T pulled the plug on the unlimited data plan. The plan changed to $25/mo for 2GB of data transfer. AT&T tried to spin it as a price reduction saying that 98% of users use less than 2GB/month and now they can save $5 per month. iPad owners went nuts feeling that they bought an iPad 3G based on the availability of unlimited data only to have AT&T pull the rug out from under them. They felt as if they were victims of bait and switch. AT&T capitulated and allowed consumers who purchased an iPad 3G before June 7, 2010 to be “grandfathered in” to the unlimited plan. They could keep the plan for as long as they paid for it, the stipulation was that if a consumer decided to suspend service or if their auto-renew failed because their credit card did not go through, they would no longer be grandfathered in. These users are essentially locked into a de-facto contract. So much for Steve Jobs’ “Breakthrough.”

The era of unlimited cellular data was coming to an end. It is a reality all carriers are facing.  So given that their competitors were beginning to cap data usage, why did AT&T announce an unlimited plan for the iPad only to change course a month later? Were they that short-sighted that they had no clue how much data the iPad would use? Did they look at the first couple weeks of data usage from the iPad 3G on their network and say, “My goodness, this iPad uses a LOT of data, quick! We need to change the plan ASAP” ? Or did AT&T know full well what they were doing and pull a classic bait and switch? A class-action alleging the latter has been filed against Apple and AT&T.  While I am sure the lawyers will make tons of money either way, my position is that the culprit is short-sightedness and a lack of planning.

With the launch of the iPhone 4, AT&T eliminated unlimited data as they did with the iPad, and introduced new lower data plans based off the same tiered data plans on the new iPad. AT&T spun this as saving the customers money, instead of paying $30/month for unlimited data, they could pay $15 or $25 depending on their needs. They again cited studies that 95% of their users don’t go over 2GB/month. While historically that may be true, it won’t be in the future as the iPhone 4 can record and upload HD video, place video calls, etc.  More and more users will hit the 2GB cap and will be getting big bills at the end of the month for overages.  If for some reason consumers don’t like it, too bad; AT&T quietly raised their early termination fee from $175 to $375. Joel Kelsey, Consumer’s Union policy analyst, called the new plans “a rate hike dressed up as clever public relations.”

AT&T

Verizon

Sprint

T-Mobile

Rate Plan*

$115

$123

$99

$99

Data Limit

2GB

Unlimited

Unlimited

Unlimited

Activation Fee /ETF

$36/ $325

$35/

$350

$0/

$200

$35/

$200

*2-yr contract, Unlimited Voice, Data Plan, Unlimited Text, Visual Voicemail

From a competitive pricing standpoint, the table below compares smartphone service plans from the four major U.S. Carriers. AT&T is only slightly less expensive than #1 carrier Verizon, but 15% higher than #3 Sprint and #4 T-Mobile. AT&T is the only carrier that has a limit on their data plans (for now). If you go over your data limit, AT&T charges you $10 for an additional 1GB. AT&T and Verizon are charging a premium, both for the service and ETF whereas Sprint and T-Mobile are using an aggressive $99 price point for unlimited voice/data and a lower ETF.

When you look at the 3G coverage maps below, you begin to wonder why AT&T can charge a premium over Sprint, who has much more extensive 3G coverage.

Verizonhttp://www.cellularmaps.com/image/vzw_3g_compare10.jpg

http://www.cellularmaps.com/image/vzw_3g_compare_x3.gif

Comparison of the four major wireless providers’ 3G data coverage

One can only speculate it is because they have the iPhone and others don’t, though AT&T will say that their 3G network is faster (which is true if you have good data coverage where you are).

With the iPhone, AT&T had a chance to revolutionize wireless service the same way Apple revolutionized the wireless handset. Instead, they stuck to their existing paradigm. Since the iPhone was locked to AT&T making it very difficult to activate it on another carrier anyway, AT&T could have eliminated contracts and subsidies. An alternative business model could be to sell the phone at full price and offer interest-free financing for 24 months. The customer pays nothing up front, feels like they are getting a good deal due to the interest-free financing. Sure the financing deal is a contract, but not in the traditional cell-phone contract sense. Imagine the marketing spin that AT&T could put on the elimination of contracts/ETFs and nothing-down, interest free financing on handsets!

To mitigate the elimination of unlimited data, AT&T could introduce “rollover” data. One of the few points of praise AT&T gets is their “rollover” minutes scheme whereby unused minutes in one month are rolled over into the next month. AT&T implementing this scheme for unused data would be very well received.

Ongoing Service: Network Problems

When it comes to consumer dissatisfaction with AT&T, the purchase experience and rate plans pale in comparison to the network problems. iPhone users complain about dropped calls, spotty coverage, slow data, etc.  This is a very complex issue and the best way to understand it is to break it down into a few different areas.

The first area of focus is coverage. There are two distinct facets to coverage: voice coverage and 3G data coverage. To effectively understand the difference, take a look at the following coverage maps:

AT&T Voice (orange shading)

AT&T 3G (Blue Shading)

http://www.cellularmaps.com/image/nat_gsm08.gif

AT&T 3G

Verizon Voice (Red Shading)

Verizon 3G (Red Shading)

http://www.cellularmaps.com/image/vzw_voiceandmessaging_0809.jpg

http://www.cellularmaps.com/image/vzw_3g_compare10.jpg

Comparison of Voice and 3G footprint

These maps paint a picture of coverage from a macro perspective, keep in mind that within a covered area there may be localized dead spots. Putting that aside for now, we can see that both AT&T and Verizon have similar coverage footprints from a voice perspective, but when you compare the 3G maps, the difference in coverage footprint is staggering. Verizon constantly uses AT&T’s 3G map against them in their advertising campaigns. AT&T’s response is that their 3G coverage covers 75% of the U.S. population, they have all the popular smartphones (read as “we have the iPhone”) and they have the fastest 3G network.  All of which are true, but the visual of the Verizon vs. AT&T 3G maps is much easier to burn in people’s minds than the facts and figures AT&T puts out.

So, from a high level, AT&T’s coverage looks good. They claim to cover 97% of the U.S. population for voice and 75% of the population for 3G data. Unless you are in a rural area, you should have no problem getting a good voice and data connection, right? If one were to look at Consumer Reports and the anecdotal information on the Internet, the answer would seem to be “not really.” AT&T has borne the brunt of a lot of consumer wrath and been the butt of jokes. When the iPad was announced, comedian Steven Colbert remarked on his show:  “The iPad has the same touchscreen technology as the iPhone, and the same apps, and just like an iPhone, you can’t make phone calls with it.”

The aim here is not to go in to technical issues about AT&T’s network, but to understand the iPhone’s impact on AT&T’s brand perception.

In Consumer Reports January 2007 (pre-iPhone) cell service survey AT&T scored 62.6, ranking it #3 amongst the four major carriers. The mean across all four carriers was 66. Fast forward to January 2010, they scored 66, ranked #4, mean was 70. While the industry improved their score 6% as an aggregate, AT&T improved 5%. Despite spending billions to upgrade their network, their customer satisfaction fell very slightly relative to their competitors. The bottom line is that this data shows no appreciable drop in consumer satisfaction with AT&T since the iPhone was released.

If AT&T’s overall customer satisfaction has not changed since the iPhone was released, why has AT&T taken so much heat since the iPhone was released? The reason is what I will call the ‘iPhone effect.’  While iPhone users represent less than 15% of AT&T’s customer base, they are more sophisticated, spend more money and are more vocal than the average AT&T customer. They are savvy, passionate, early adopter thought leaders that can generate disproportionate word of mouth and radiate influence accordingly. Social media ad network BuzzLogic found in 2009 that AT&T’s data plan for the iPhone was discussed in 23% of the influential online conversations, much more than those of any other smartphone,

though negative tones hang over more than half of those conversations. The iPhone Generates 2-4x the network traffic of other smartphones, so if you do the math, this 15% of AT&T’s customer base represents about half of AT&T’s overall wireless data traffic.

The consensus among analysts is that AT&T took the iPhone deal but vastly underestimated the impact the iPhone would have on its network and was not prepared for the ‘iPhone effect.’  The iPhone represented a paradigm shift in the wireless device market. AT&T was either unwilling or unable to adjust the market research methods they used to estimate network usage. A recent article in the Wall Street Journal put it best:

Before the iPhone, [AT&T} used to be able to accurately forecast to the minute the type of phone usage each new customer would add to its network based on basic demographics such as age and income levels. The forecast always held true across cities and towns.

But with the iPhone, such bets are off, AT&T executives painfully learned. It now looks at a broader set of customer profiles to forecast behaviors. For example, in a metro area with a large proportion of students, the phone operator schedules network upgrades to occur outside of colleges' nine-month academic terms.

"I'm as interested now in what you're doing when you're not on the network," said John Stankey, head of AT&T's operations arm.

To illustrate the ‘iPhone effect’ on AT&T’s image, consider the following: According to AdWeek, the YouGov Brand Index rating for AT&T slipped from 18.3 in June 2009 to 14.6 in September 2009. As a point of reference, Verizon held steady at 21.2. This is significant because this represents the launch period for the iPhone 3GS. The day the 3GS went on sale was a record-breaking sales day for AT&T.  During this period, they added millions of iPhones to their network; millions of gobbling up 2-4x the resources of other phones.

The iPhone proved to be very taxing on AT&T’s network, causing a strain on their network resulting in dropped calls and slow data service. To invoke the ire of iPhone http://cr4.globalspec.com/PostImages/200903/iphone_att_chain_ECD9AFF9-A164-A9BE-E4E0DB289C49EDAF.jpgcustomers even more, AT&T crippled some of the features on the iPhone; features that other phones have had on AT&T’s network for years. With the 3.0 release of the iPhone software, Apple introduced MMS (picture/voice messaging) and tethering (the ability to connect your phone to your PC and use it as a modem). While iPhone customers in other countries gained access to this feature right away, these features were disabled by AT&T and the company did not give a timeframe as to when they might enable the feature. You could imagine how irate a customer who spent $300-500 on an iPhone would have been when they found out they could not have a feature that you could get on a $49 Blackberry.  AT&T was so afraid of the effect enabling these features would have had on their network, they were willing to discriminate against their highest –paying customers. AT&T did not enable MMS for 4 months. AT&T enabled tethering over a year later for a $20/month additional charge with the caveat that you must switch to one of the new, limited data plans. Given that a PC can eat up 2GB of data pretty fast, AT&T’s tethering scheme does not seem like a very good deal.

AT&T has never come out and acknowledged the problem directly, but if you were to look at the PR section of their web site, there is a constant stream of press releases detailing how much money they are spending adding capacity in various markets. The problem is, in addition to the expense, adding capacity takes time. On top of the regulatory issues, it takes a long time to secure real estate (exacerbated by NIMBYism), run fiber optic cable to the cell site and build the tower.  Add to this the fact that AT&T just completed a huge transition from TDMA cell technology to GSM in 2004, so their network was new to begin with.

According to AT&T’s CTO, John Donovan, between 2006-2009, AT&T experienced a 5000% growth in data traffic. As a veteran of the data networking industry, I have personal knowledge of how difficult and costly building out a wireless network is. The fact that AT&T was able handle this 50 fold increase in demand at all is astonishing. Throw in recent additions like video conferencing and HD video streaming and this growth rate may even increase in the next few years. While 4G technology may alleviate this problem, mass roll-out of 4G is a few years away.  AT&T had no choice but to implement a 2GB cap on their data plans. It gives them a chance to play catch-up while they beef up their network.  If Verizon had gotten the iPhone, they would have had the same problem, perhaps secretly Verizon was savvy enough to know this and factored this into their decision not to carry the iPhone.

With my technical background and an understanding of the network issues, I am willing to cut AT&T some slack. However the average consumer does not understand this. All they see is their phone not working properly. What has AT&T done in response to customer sentiment?

1. Issued press releases about how they are adding capacity.  A company can release all the PR they want, but when they fail to deliver, it can upset customers even more. Case in point: AT&T issued a huge press release stating how they massively beefed up capacity for the 2010 Super Bowl in Miami. I attended the Super Bowl and I watched as my iPhone became completely unusable as more and more fans arrived at the stadium. The fans around me who had Verizon or Sprint phones had no problems.

2. Released an iPhone application called “Mark the Spot.” When a user encounters a dead spot, they launch the app which sends GPS coordinates of the dead spot back to AT&T. It was an ingenious way to collect data, but it was not very well received. One blogger titled a blog entry about the release of the app ‘Mark the Spot: Tell AT&T where the iPhone sucks.’ Another big complaint was that if you are in a dead zone, how are you going to be able to upload the data to AT&T. On the bright side there are reports that AT&T is sending some users who, months ago, reported dead spots text messages thanking them for their feedback and reporting that AT&T has addressed the dead spot.

3. AT&T has begun rolling out femotocells. A femtocell is a mini “cell-site” that users can plug into their high-speed internet connection will provide 5000 square feet of coverage for users who have low or no signal in their homes or offices. While this is a great way to alleviate traffic on their cell towers and address in-building coverage, AT&T charges $149 for the device and any minutes or data used through the femotocell count against your service plan. Consumers resented having to pay $149 and give AT&T a chunk of their home Internet connection to address what they perceive to be a shortfall in AT&T’s network. As of July 2010, AT&T reportedly began handing out free femotocells in a couple of test markets. A few customers reported receiving a letter in the mail that reads, “As one of AT&T's most valuable customers, you are eligible for a special gift, It's just our way of saying thank you for your continued loyalty." The letter contained a coupon for a free femotocell redeemable at any AT&T store.

As much as AT&T has taken heat for all of the iPhone’s problems, there is ample evidence that Apple may be as much to blame. Remember Apple is relatively new to the wireless handset business. Traditional manufacturers like Motorola and Nokia have had 20+ years of trial and error under their belts, Apple has had less than 4. While there reports of cosmetic defects, software bugs and overheating batteries,  here is a brief rundown of some of the reported issues related to bad reception:

· In 2008, a report from the Swedish engineering publication Ny Teknik said Apple's handsets aren't sensitive enough to adequately receive the 3G signal.

· In June 2010, users reported that holding the iPhone 4 a certain way caused a large drop in signal strength. Bloggers dubbed this the “grip of death.” This was due to a new antenna design. The irony is that this new antenna design was conceived to dramatically improve reception. Consumer Reports published their initial findings on July 12: Consumer Reports' engineers have just completed testing the iPhone 4, and have confirmed that there is a problem with its reception. When your finger or hand touches a spot on the phone's lower left side—an easy thing, especially for lefties—the signal can significantly degrade enough to cause you to lose your connection altogether if you're in an area with a weak signal. Due to this problem, we can't recommend the iPhone 4…Apple needs to come up with a permanent—and free—fix for the antenna problem before we can recommend the iPhone 4.”

· In July 2010, Apple admitted that there was a software bug affecting all iPhone models that miscalculates signal strength and reports 2 more bars than it should.

An article by Randall Stross published in the New York Times in December 2009, put forth some data that practically vindicates AT&T and implicates Apple for the iPhone’s woes. Below are some key quotes from the article:

· “Roger Entner, senior vice president for telecommunications research at Nielsen, said the iPhone’s “air interface,” the electronics in the phone that connect it to the cell towers, had shortcomings that “affect both voice and data.” He said that in the eyes of the consumer, “the iPhone has the nimbus of infallibility, ergo, it’s AT&T’s fault.” AT&T does not publicly defend itself because it will not criticize Apple under any circumstances, he said.[emphasis added]

· “Global Wireless Solutions, one of the third-party services that run network tests for the major carriers, shared some of its current findings. The service dispatches drivers across the country with phones and laptops equipped with data cards. They have covered more than three million miles of roads this year, while running almost two million wireless data sessions and placing more than three million voice calls. The results place AT&T’s data network not just on top, but well ahead of everyone else. “AT&T’s data throughput is 40 to 50 percent higher than the competition, including Verizon,”

· “Root Wireless ran 4.7 million tests on smartphones for each of the four major carriers, in every market, AT&T had faster average download speeds and had signal strength of 75 percent or better more frequently than did Verizon. I asked Ron Dicklin, chief technology officer at Root Wireless, how these results, showing AT&T as the clear leader, could be reconciled with the negative appraisal of Consumer Reports’ respondents. He explained that his company’s tests of AT&T’s data network were done with handsets other than the iPhone.” [emphasis added]

· “AT&T and Apple could both gain by swapping talent. Apple, send your marketing wizards to lend your partner a hand. It sorely needs help. AT&T, send some engineers to redesign the iPhone to make better use of the country’s fastest wireless network.”

So why has Apple not garnered nearly the amount of consumer wrath AT&T has? The halo effect gave Apple a “nimbus of infallibility.” It is a testament to the tremendous value of a well-managed brand image. If the roles were reversed and AT&T had the stellar brand image, Apple might no longer be making iPhones; they probably would no longer be in business. Apple’s image is vital to their survival, AT&T on the other hand is so established and entrenched, that up until recently their image was not as vital to them. As their near monopoly on telecom services has come to an end over the past 10 years and speculation that their exclusivity on the iPhone is coming to an end, they are going to have to do something about their brand image. AT&T is attempting to do just that. They have recently begun a re-branding campaign where they will position themselves as a “lifestyle company.” Under the tagline “rethink possible” AT&T’s goal is to re-shape consumer perception of AT&T from a telecommunications company to an innovation company.

If AT&T expects to re-brand themselves and shed their “phone company” image, they need to have the courage to drop the typical big corporation mentality of denying problems while secretly fixing them. They should be forthcoming about the problems and detail their exact plan of action. They should attempt to make consumers understand how hard it was to anticipate the unprecedented demand for data and how even with 5000% growth, they still managed to do a decent job keeping up. They should outline where they plan to build more cell sites and provide timelines for network upgrades. They need to show consumers how hard it is working to deliver the best smartphone experience and how much they value their customers. It is too bad they can’t use Stross’s NY times article as a marketing tool, doing so would evoke the ire of Apple.

Impact on AT&T’s bottom line

Was the iPhone a good deal for AT&T from a profit and market share perspective? From a profit perspective, it is difficult to know some of the capital expenditures AT&T has had to make to accommodate the iPhone. This may not be a factor anyway as AT&T would have had to make those expenditures to accommodate other devices like Blackberries and data cards anyway. There is enough data out there for us to do a rough NPV calculation. NPV is a tried and true method businesses use to calculate the value of a project today based on future cash flows. We can use it to calculate the value to AT&T of acquiring a new wireless customer. To calculate NPV, we need to know the associated cash inflows and outflows as well as their weighted average cost of capital (WACC). We can estimate the subsidy (cash outflow) AT&T pays for each phone by sampling the no-contract price of various phones and subtracting the 2-year contract price.  AT&T reportedly has a profit margin (cash inflow) on wireless service of approximately 40%. We can multiply that by monthly revenue of $100 per smartphone subscriber and $62.50 per non-smartphone subscriber.  AT&T’s WACC is estimated at 8.35%. The following is a calculation of NPV of a subscriber that completes their 2 year contract and a subscriber that terminates their contract after 1 year and pays the prorated ETF:

Phone Type

Average Subsidy

Monthly

GP

NPV

(2 –year)

NPV

(1-year)

Standard

$150

$25

$401

$230

Smartphone

$250

$40

$631

$419

iPhone

$400

$40

$481

$269

A lot of the financial press warns that AT&T’s profit takes a huge hit due to the large subsidy they pay for the iPhone. While the cash outlays do cause a near-term hit, the acquisition of the customer is NPV positive. While this alone looks good, there is something else unique to the iPhone that makes it an even better deal for AT&T. With every other phone on the market, a consumer can un-lock their phone and activate it with another carrier. The iPhone is unique in that it is locked to AT&T and cannot be unlocked. If a subscriber’s contract ends, even if they sell/give away their old iPhone to someone else, their old iPhone will more likely than not be re-activated on AT&T’s network.  When that happens, it is pure profit for AT&T as the subsidy on that used phone has already been paid. This means that as AT&T’s iPhone user base matures, the iPhone becomes more and more profitable.

What about market share? When AT&T first started selling the iPhone, they were the #1 carrier and in 2010, they are #2. On the surface, it looks like Verizon did better over the past few years, but these rankings based on pure number of subscribers don’t tell the whole story. First, Verizon acquired Alltell wireless and their 13 million subscribers in 2009. Second, and most important, is that AT&T has the highest market share of smartphone subscribers, 43% vs. Verizon’s 23%. This market segment is highly desirable as they bring in 1.5-2 times the revenue of a standard phone subscriber.

Another huge effect the iPhone has had on AT&T is the reduction of the percentage of customers who defect to other providers, known in the industry as “churn-rate.” Carriers go to great lengths to keep this churn rate down because as evidenced by the subsidies alone, the cost to acquire a new customer is quite high.

The chart on the right plots AT&T’s and Verizon’s monthly churn rate. Since the iPhone was released in Mid-2007, AT&T’s churn rate has dropped from 1.3% to 1.05%. Verizon went from 0.95% to 1.05%. This is despite the fact that Verizon’s customer satisfaction rating was significantly higher than AT&T’s. The incongruity between AT&T’s churn rate and customer satisfaction is a testament to how much consumers are willing to put up with what they perceive to be bad service to have what they perceive to be a great phone.

Rob Frankel, a consultant and author of numerous branding books commented to Advertising Age: ”This is as much of a branding issue as anything. Think of AT&T

as the Microsoft of telecom: People use it because they have to, not because they’ve

chosen to.”

20090526cell1.gifThe chart to the right is even more telling. It plots the percentage of Verizon customers who plan to switch to AT&T and vice versa. You can see the huge shift right around the time the iPhone was announced. Clearly AT&T gained a huge advantage when they got exclusive rights to the iPhone. The big question is what would happen should this exclusivity come to an end.

End of exclusivity – the impact of a Verizon iPhone

Rumors continue to swirl about the iPhone going to Verizon. Apple would benefit tremendously by allowing multiple carriers to carry the iPhone. When French regulators forced Apple to end its exclusive deal with France Telecom and open it up to all three French providers, Apple’s market share doubled in 6 months.  Given this, it almost seems inevitable that AT&T’s exclusivity is coming to an end.

According to one analyst, AT&T could lose as many as 1 million subscribers to Verizon.  AT&T’s wireless revenue is approaching $16 billion a year. If AT&T loses 1 million subscribers that pay an average of $100/month, their revenue drops by 1.2 billion, or 7.5%. Another analyst predicts the loss of 8 million customers and over $6 billion in revenue.

Those are some pretty dire numbers. If AT&T loses the iPhone exclusivity, they will take a hit initially, but there are several reasons why things for AT&T may not be nearly as bad as these analysts predict.

1. As I mentioned earlier, without some serious hacking which voids the warranty, the current iPhone is locked to AT&T. Say 8 million people ditch AT&T for Verizon. That means there will be a huge glut of second hand iPhones on the market. Bargain hunters will snap up these phones and activate them on AT&T. AT&T will be able to activate these phones without a subsidy, therefore making these customers profitable from day 1.

2. 70% of AT&T’s iPhone customers were AT&T customers before they had an iPhone. If they were AT&T customers all along, would many of them switch?

3. The iPhone’s market share is being challenged by new competitors running Google’s Android operating system. Verizon’s “Droid” marketing campaign around their Android based phones has been quite successful. In the first 75 days, Verizon sold 1.05 million Android phones. Apple sold 1 million phones in their first 75 days. While Apple’s market share remained essentially flat to slightly down from Nov 2009 to May 2010 (24.8% to 24.4%), Google’s went from 2.8% to 13%.  These numbers do not take the recent launch of the iPhone 4 into account, but it is safe to say competitors are now offering viable alternatives to the iPhone. AT&T’s reliance on the iPhone to drive smartphone subscriber growth will fade as a result of all the alternatives in the marketplace. The carriers will become more profitable as competition drives down prices thereby reducing the subsidy providers have to pay or perhaps even eliminating them completely.

4. If AT&T does lose some iPhone subscribers, their system will be less overloaded. AT&T has earned through trial and error how to handle the iPhone on their network and has spent considerable resources to beef up their network. AT&T’s current HSPA 7.2 based 3G network is technically superior to Verizon’s EVDO based 3G network. If suddenly millions of data-hungry iPhone users jump onto Verizon’s network, they may end up with more complaints than AT&T ever had.

AT&T is not taking the looming loss of iPhone exclusivity lying down. First, AT&T is positioning itself as THE provider of smartphone service. AT&T started a marketing campaign in May 2009 around this theme. It is interesting to note that there was no iPhone product placement in any of the ads in this campaign. Second, AT&T let nearly all of its current iPhone customer upgrade to the new iPhone 4 for the fully subsidized price regardless of how long they had left on their contract. All they had to do was sign a new 2-year contract (with the new, doubled ETF). This was ingenious as these existing iPhone subscribers’ contracts would have ended in the next 6-18 months, there will be a flood of new alternatives to the iPhone and likely a choice of providers offering the iPhone. This buys AT&T enough time to continue beefing up their network and hopefully show them how much better the iPhone experience is on AT&T vs. the competition, before they have a chance to defect.

The real winner in any of these scenarios is the consumer. Competition will offer them more choices of phones and providers, lower phone prices and lower service prices.  To maintain their leadership in the smartphone market, AT&T must focus on the customer and not how much better their network is than the competition. Rob Frankel said it best in the Advertising Age article: “FedEx never did any chest-pounding about

how many trucks and planes it had. The delivery company’s message was consistently about knowing how important the package is to the customer’s business and that’s why FedEx works hard to get it there.”

Conclusion

If anything can be learned from the Apple/AT&T iPhone partnership, it is the power and value of a brand image. It shows how Apple, a $51 billion company with 34,000 employees and only 5 years of telecommunications experience, can, through its stellar image and the associated halo effect, force AT&T, a $123 billion company with 276,000 and literally 100 years of telecom experience, to take the blame for all of the problems associated with the iPhone no matter where the actual fault lied. Despite the image problems AT&T suffered from due to the iPhone, the iPhone allowed them to dramatically grow their share of the most lucrative wireless market segment and taught them valuable lessons on how to build a wireless network that can handle demand for data that is growing exponentially every year. As the famous quote from Friedrich Nietzsche goes, “That which does not kill us makes us stronger.” With regards to their technical engineering capability, AT&T is much stronger from the hard lessons they learned over the past few years.

z.png The stock chart of Apple vs. AT&T below is quite telling. Despite the bad economic conditions, the iPhone has generated a lot of value for Apple shareholders. The iPhone so far has failed to generate anywhere near the value for AT&T’s share holders.  AT&T has proved their superior technical engineering capabilities, but has failed to translate that into the marketing success that drives up stock price.  To do so, AT&T must shift their network engineering focus to a customer-centric focus, the way Apple did when Steve Jobs returned as CEO of Apple. AT&T is moving in the right direction by re-branding themselves as an “experience” company. Changing the image of a 100+ year old phone company is a monumental task, then again so was building a network that could keep up with a 5000% increase in demand.


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(Cauley, 2007)

(Burrows, 2007)

(Richtel, 2007)

(Reardon, Is the iPhone hurting AT&T’s brand?, 2009)

(Baig E. , 2007)

(Winter, 2008)

(Markoff, 2008)

(Diaz, 2010)

(Evans, 2010)

(Oswald, 2010)

(TECHWEB, 2007)

(Bilton, 2010)

(Reynolds, 2010)

(Consumer Reports, 2007)

(Consumer Reports, 2010)

(Chang, 2009)

(Peers, 2009)

(Sheth, 2010)

(Hein, 2009)

(Paczkowski, 2009)

(Reardon, Why is AT&T delaying rollout of iPhone tethering, MMS?, 2009)

(Paczkowski, Time to Cut AT&T Some Slack, iPhone Users?, 2009)

(Biggs, 2009)

(Hachman, 2010)

(Techweb, 2009)

(Consumer Reports, 2010)

(Pegoraro, 2010)

(Stross, 2009)

(Patel, 2010)

(Peers, 2009)

(Kimble, 2009)

(Fink, 2010)

(Chang, 2009)

(Lagorce, 2009)

(Bensinger, 2010)

(Kelleher, 2010)

(Baig, RIM tops U.S. smartphone market; Android surging, 2010)

(Chang, 2009)

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