As Verizon has reported iPhone sales for one and a half quarters, it's time to try to discern the impact on the product. There were several hypotheses floating around prior to the "big bang" of Verizon.
Some assumed that there would be a large migration away from AT&T and that AT&T iPhone sales would slump. Others that there would be no Verizon iPhones volumes at all because there were so many Android users already converted. There were also suggestions that the iPhone would explode in growth with two major operators carrying it.
What really happened?
The first chart shows historic AT&T activation with Verizon activations added. It also shows sales to "none of the above", namely non-US sales of iPhones[1].
AT&T iPhone activations show no significant impact from Verizon and Verizon itself shows a modest start to sales[2]. What did not happen is an exodus from AT&T. We also did not see a rejection of the iPhone by Verizon customers long exposed to anti-iPhone Droid advertising. We also did not see a considerable impact of Verizon on growth.
Verizon did contribute (4.5 million Verizon iPhone users is nothing to sneeze at) but the contribution was to a degree that was nowhere near a big bang.
That was because the real big bang was from the rest of the world. The same data in the first chart is shown below as a stacked area chart and a share chart. Had Verizon not come on board the business would still have grown year-on-year over 100% (and sequentially).
The US activations have been decreasing as a percent of total iPhones sold. Before Verizon came online, the US share was decreasing (from an average of 45% share in 2008 to 33% in 2010). After Verizon, the US continues to slide to an average of 30% share (two quarters).
After waiting nearly four years, American observers of the iPhone could perhaps be excused for their obsession on the impact of expirated AT&T exclusivity. But the real impact is that by the time it came, it was moot.
It would be a mistake to look upon Q1 and Q2 and say that the explosive growth was due to Verizon or the end of US exclusivity.
The global market is far greater than the US and the iPhone business has simply grown to reflect that.
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Notes
Non-US sales are total iPhones sold minus activations in the US. There is the possibility that some of the unactivated phones were activated on T-Mobile or that there is some delay between purchase, channel inventory and activation, but the time frame shown should smooth out any of the noise.
What we don't know is what was the impact of iPhone sales start on Verizon's other smartphone platforms. Unfortunately, Verizon does not report overall smartphone sales/activations so we can't conclude directly that iPhone has slowed other platforms on Verizon. Some other data (NPD, Changewave, ComScore) do indicate some slowing in Android growth in the US but we have no definitive data to prove it.
AT&T's intent to acquire T-Mobile USA is subject to regulatory approval. Will regulators look at the deal through the lenses of sustaining the traditional industry's profit allocation or through the lenses of device-led disruption?
In theory, regulators are to make a determination on whether the deal will reduce customer choice. But the question is really choice of what? The focus is presumably on the choice of service plans. That's understandable, however coupled to that choice is the choice of devices and even more importantly, the choice of platforms.
The trouble is that US consumers have never had much choice and the US wireless marketplace has been a minefield of incompatibilities and obstacles to market forces.
To begin with, US carriers maintain multiple incompatible network standards. Phones which work on one network do not work on any other. A Sprint phone won't work on AT&T or on Verizon. In fact, some Sprint phones won't work on all of Sprint's network as it still uses the iDen standard legacy from the Nextel acquisition. Even the iPhone which is designed for the AT&T network does not handle T-Mobile's version of 3G. So a consumer cannot make a decision on devices independent of a decision on carrier. This is a phenomenon unique to the US[1].
Secondly, in the US carriers charge for incoming minutes and have shunned pre-paid customers. There was a time when SMS messages were not compatible between networks, which led to the emergence of RIM as the only wireless messaging solution available, though initially not to the average teenager.
Thirdly, because of the multiple incompatible standards, network coverage in the US is still abysmal. Each carrier has had to build out parallel (incompatible) networks at great expense using non-standard equipment over a vast landmass. The result is not only a very expensive network whose capex demands high service fees, but a very poor quality network which is always both spotty and capacity constrained. Operators are therefore keen to lock customers in to post-paid plans to ensure cash flows that drive capital allocations. This is essentially an upmarket flight which does not encourage low end innovation.
These idiosyncrasies are rooted in historical regulatory rulings that led operators to create a uniquely American wireless market. The key regulation was that the US shall have no single wireless standard. In the spirit of laissez-faire this may make sense. But the result has been failure of the common good. This is sharply contrasted with other developed countries which (with notable exceptions) deliver superior service with high efficiency.
The US is so unique that it developed its own "Galapagos syndrome". Few global brands can be bothered to invest in it. Vodafone tried to play in the US with Verizon, but its minority position offered no leverage because Verizon spent the better part of a decade avoiding global networking standards. Now T-Mobile is desperate for an exit after trying to leverage the foothold it paid dearly for and failing to offer devices that capture users' imaginations (because they were railroaded into another incompatibility with 3G). Conversely, no US brands have been able to expand internationally. US operators are non-entities abroad, even in what would be natural expansion territories like Latin America or the Caribbean. Those markets belong to European investors today.
Given this background, it's very likely that regulators will look at the deal in terms of balancing what is essentially a deeply flawed, cobbled together industry. Companies can argue that they are rationalizing through consolidation but regulators can argue that "choice" is decreasing. These arguments are mostly moot. The problem is that the US wireless market is balkanized and byzantine.
It's therefore perhaps stunning that the platforms that are currently winning in mobile computing are American: iOS and Android[2]. Note further that none of these winners came from the world of wireless or telecom. These new points of profit condensation in the industry entered from a different industry: computing. But are they now pursuing telecom-compliant strategies? Arguably no. I choose to call them mobile computing and not phone platforms specifically because they will tolerate the cellular regimes as long as they need to, and no longer. Once they will reach the perch of power, the industry will conform to them, not vice versa.
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Notes:
Japan has a similar problem but less pronounced.
Microsoft is still in the running as is Palm, both American.
At the risk of repetition, there are three instances in conference calls that Apple management has stated that the iPhone has a fixed price for all operators and resellers.
The first was in October 20, 2009:
“So when you go from exclusive to multiple, you don’t change the charge to the carrier?”
Cook answered: “Correct.”
The second was a year later, October 18, 2010:
Chris Whitmore – Deutsche Bank: And what is your experience then when you’ve gone non-exclusive from a subsidy and margin standpoint on the phone, have you had to give anything up in the past?
Tim Cook: We don’t give specific information out on the margins. But I think you can look at our ASPs and see that they’ve generally stayed above $600, and that’s despite opening up several markets from an exclusive market to a non-exclusive market.
And the third was a few days ago on January 8, 2011:
Toni Sacconaghi - Bernstein Research: You've said on previous earnings calls that the move to iPhone non-exclusivity in regions of the world has had no impact on your ASPs. Can you comment on whether that is it still the case today and whether we should expect any impact in the migration away from U.S. exclusivity?
Timothy Cook: I don't envision the overall iPhone ASP decreasing from the December quarter that we just completed to the March quarter that we're currently in.
But, as always, we can confirm and validate using the data on pricing we have available.
In this case in the financial reports (take iPhone revenue and divide by units sold):
You can see that after the first iPhone "2G" which had a peculiar pricing that included revenue sharing with the operator and which showed up differently in the accounting, the iPhone has had a steady price slightly above $600 for over two years[1].
This is despite having more than 60% sales outside the US and being non-exclusive multi-operator in many countries. Despite being available locked, unlocked and everything in-between.
We can even confirm what one particular operator paid exactly. In October 2008 AT&T reported that they had paid $900 million for 2.4 million iPhones. That's $375 per phone. Assuming a mix of $199 and $299 3G phones that gives something around $600--below the global ASP for that quarter of about $676. Here exclusivity would imply a discount to average price! The reason for the discount is most likely volume as AT&T was by far the largest buyer of iPhones globally.
Still unconvinced? Try shopping for an unlocked iPhone at any of various retail locations where it's available unlocked. Accounting for VAT or other taxation, the price is always the same and is a slight mark-up to the operator ASP due to retail margins.
Judging from comments on this site, the myth that loss of exclusivity in the US will change profit margins for Apple still persists no matter how many times I repeat this story.
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Notes:
The steadiness of the price should give another huge clue as to the effect of competition on the product.
Although the population of Android users is near in size to the population of iPhone users, the concentration in one carrier shows how distribution agreements hamstring platform choice.
The chart also shows how the iPhone had a huge effect on smartphone adoption at AT&T and how it sucked the oxygen out of the segment for competitors.
It is possible that we'll see more Android at AT&T and a lot more iPhone everywhere else, but on balance, the chart shows how exclusivity distorted the market.
It sounded like Tim Cook was really relieved to announce in the earnings conference call that:
We are not under a contractual exclusivity now in any country in the world. The last one was the United States. We have moved away from those.
...
What I've said before and we have seen this in every case, literally, that we've done, is where we've moved from an exclusive carrier arrangement to a dual- or multi-carrier arrangement, our growth has changed significantly and our market share has increased.
Given new information on subscriber growth and the relationship between Verizon and Apple, it's time to look back and assess how the conclusions are standing up.
The conclusions I drew were that Verizon had three strikes against them:
The iPhone has stolen their growth
They are facing the prospect of a single OS platform supplier
Android is not competitive vs. iOS
Did iPhone really hurt Verizon?
I pointed out that based on retail sampling data from ITG and what we know from AT&T own sales data, that iPhone at AT&T was outselling Android at Verizon by a ratio of 2.5 to 1.
The latest comScore data closely matches the assumed units of Android shipped by Verizon. Here's why: The comScore data shows the number of active users of each platform. So, for example, as the number of Android users at Verizon grew, it follows that the new users had to buy new Android phones. However, you can also sell more phones than just those for new users. Some phones are going to go to replace those of existing users.
When it comes to Android however, all the Verizon Android devices are pretty new, having been purchased less than a year ago. Replacements would only be sold for damaged or lost devices not covered by warranty.
So from comScore the change in subs at Verizon comes out to about 2.2 million and my original estimate was about 2 million. That's pretty close.
On the other hand, if you look at the chart, you'll notice that the number of iPhone users at AT&T grew by a similar amount (about 2 million). However, AT&T activated over 5 million. That means that about 3 million devices were upgrades. This makes a lot of sense since we know that iPhone is the bulk of AT&T smartphone users.
This is highly supportive evidence that iPhone at AT&T did indeed outsell Verizon Android by at least a factor of 2. Each of those phones came with a 2 year lock-in so indeed AT&T did manage to "steal" growth from Verizon.
Another data point in support of this conclusion was provided by Turley Muller in a comment. AT&T smartphones make up a significantly higher proportion of contract subs at 44% vs Verizon at 23%. Effectively, as a result of their sweetheart deal with Apple, AT&T got double the penetration of smartphones than Verizon since these devices are targeted only to contract subscribers. Those are high ARPU customers that either moved from regular voice plans or switched from other carriers.
So far, the first conclusion seems to be holding up pretty well.
Was Android a strategic constraint to Verizon?
Verizon revealed that they had been negotiating with Apple at least since 2008 and that they were testing the phone for a year. This is not as big a surprise as it may seem. Deals of this kind easily gestate for years. The commitment may not be made until the last minute.
Nevertheless, my point was about the fact that Android was making up to 75% of Verizon's smartphone volume in Q3. This might be a strategic constraint. But "so what?" you may say: AT&T's dependance on iPhone was even greater.
That's precisely my point though. As we've seen with the shift by Apple to multi-carrier distribution, AT&T is now facing serious constraints on growth and the share price is suffering. Although Verizon did not deal with Google as a direct supplier, they were at risk of having much of the IP on their network at least orchestrated by a company that was not always aligned with their strategic goals. Much the same predicament AT&T is facing now.
The tale of AT&T and iPhone does lend support to the premise that Verizon felt a bit too constrained by Android hegemony on its network.
Is Android Competitive with iOS?
This last point was supported by the data showing a widening higher sell-through rate for iOS vs. Android on comparable addressable markets. Although the data has been confirmed with survey data, there are issues with this interpretation. First, because the addressable base for iPhone is higher at AT&T with the post-paid contracts being more popular there, iPhone had an easier time getting sold. Second, because 3/5 of the phones were upgrades.
The jury is still out but the apparent pent-up demand (admittedly anecdotal) for iPhone on Verizon does seem to show that given similar pricing, and a similar demographic/geographic addressable market, people do prefer the iPhone.
The following chart uses comScore data to show the relative consumption of Android vs. iOS by the subscribers of the four major US operators. I modified an original chart published by Silicon Alley Insider.
A few observations:
As of November, the ratio of iOS to Android users was more than 15 to 1 at AT&T.
iOS at AT&T has twice the users as Android at Verizon
Although T-Mobile had the Android franchise to itself for all of 2009, it was overtaken by Verizon within four months
T-Mobile Android consumption has also been nearly matched by Sprint within a year
The rapid eclipse of T-Mobile smartphone penetration makes one wonder how effective Android is as a differentiator for carrier and device vendor alike. It also explains their new pricing model.
The data also gives clues to how iOS at Verizon will grow.
Since Verizon and AT&T have nearly the same number of subscribers, excluding RIM ,which is common to both, AT&T has a far larger penetration of smartphones (16.5 million vs. 7 million.) Is the cause iOS itself or the delay with the timing of Android launch at Verizon?
Other data from comScore shows that much of the gains for Android at Verizon have been at the cost of RIM, so Android has not been entirely additive. Will there be a similar platform switching going on or will iOS be additive to the Android base?
On one hand, the potential exists for a similar number of touch smartphone users at Verizon as at AT&T (15 million as of November). On the other, Verizon is "half-penetrated" with Android. How many will switch (as they did with RIM) and how many will be new users?
I'm not going to make any predictions yet but I would not be surprised if Android at Verizon will flatline if not drop while iOS at Verizon will jump quickly to make the sum of both equal to AT&T iOS in about twelve months. That would imply about 10 million new Verizon iOS users by 2012.
If Verizon users start to switch from Android to iOS, iOS could add as much as 15 million users. It seems that 10 to 13 is a reasonable estimate.
[ITG sent an explanation of their methodology and there is no indication that the data represents inside information.]
ITG Investment Research analyst Matthew Goodman is forecasting monthly sales record for all of Verizon's devices "based largely on our proprietary daily point-of-sale data from thousands of independent wireless retailers across the US."
Assuming the data is accurate, we are going to dive into it but I will state up-front that without confirmation, the conclusions below should be taken with a grain of salt. All statements should be read with a preceding "if the data is accurate..."
So, if the data is accurate, here is what I conclude [1]:
Verizon Has three strikes against them:
The iPhone has stolen their growth
They are facing the prospect of a single OS platform supplier
Android is not competitive vs. iOS
The iPhone has stolen Verizon's growth
The chart below shows the performance of all of Verizon's smartphones vs. the iPhone at AT&T. The area chart shows how Verizon's volumes grew from 2.7 million in Q1 to 3.3 million in Q3. Not a bad story in itself. However, the iPhone at AT&T went from 2.7 million to 5.3 million in the same time frame. Relative to just the iPhone, Verizon has been underperforming over the last quarter.
Those additional 2.4 million iPhone/AT&T activations in Q3 could be due to replacements but the same could be said for Verizon's volumes. The fact remains that iPhone alone is nearly twice the volume of all of Verizon's smartphone activations.
Just to be clear, this is a direct, apples-to-apples comparison. AT&T and Verizon smartphone performance figures are highly comparable. The two operators are highly representative of the US market. AT&T and Verizon Wireless raked in 75% of all mobile data revenue in Q2 of 2010 and account for 62% of the U.S. wireless customer base.
In addition, Verizon enjoys a larger customer base (has 92.1 million subs vs. AT&T's 90.1 million.) Over the time frame of the data the overall market did not increase dramatically therefore the conclusion that AT&T's win is Verizon's loss is plausible.
I used quarterly data so that iPhone at AT&T could be compared. But if we look at monthly data, the story gets worse:
These are absolute volume figures. You can see how RIM's fade was replaced to some degree by new vendors. However, growth hit a wall in August. Following widespread iPhone 4 availability, sales dropped. Coincidence? Perhaps, but the drop happened even with the addition of Samsung volumes.
That's strike one.
Verizon is facing diminished degrees of strategic freedom
The other notable is that even though Verizon doubled the number of vendors selling smartphones, it seems they are growing their smartphone base slower than the overall market.
Consider each vendor's share is shown below:
From three vendors to six. Shares are roughly evenly split (except for Palm) but none of these vendors are able to drive volume growth.
Consider that Motorola Droid is outselling RIM. This should be rightly noted as amazing. It plainly shows the power of Android. However that power is not something Verizon will benefit from. Quite the opposite.
Consider the share map by units and share of each OS:
Android (and WM, though that's likely to be a very tiny part of the green area) made up 75% of all smartphones sold in October. It's possible that the share could grow to 90% as RIM continues to fade.
For Verizon this would be a serious problem. Although Verizon used to have a disproportionate share of RIM's products, that OS was not enabling an ecosystem like Google's. It was a product narrowly defined around messaging. Verizon is facing the prospect of a single OS supplier who may or may not maintain alignment with Verizon's core profit algorithm. If they diverge, Verizon's bargaining power will be strictly limited.
Strike two against Verizon.
Android is barely enough to keep the battle with AT&T from becoming a rout.
In an apples-to-apples comparison, in Q3 the iPhone at AT&T outsold Android at Verizon (remember, same addressable market) by a factor of 2.5. This is with a variety of devices and vendors thrown in the market. We hardly ever get to see this finely grained a comparison when looking at platforms.
I wrote this up as a lack of competitiveness. It may seem provocative, but I define competitiveness narrowly: the competition is for a purchase decision on equal terms. These purchase decisions are fiendishly complex to predict, but the data speaks: whether it's due to brand, visibility or performance and in spite of "antennagate" the iPhone is cleaning up.
That's strike three.
The devil they know
By 2009, Verizon was probably optimistic that they could head off AT&T (and Apple) at the pass. With the vast array of vendor Android roadmaps laid out in front of them they saw a way to stem the flood of defections. I think that optimism dissipated sometime this year and was replaced by a more dreadful prospect than what iPhone presented in 2007.
It is perhaps coincidental that the rumors of a Verizon deal with Apple seem to have started in earnest right after August. It's thin, circumstantial evidence, but the only evidence we have to corroborate the data above is that Verizon has been signaling more desperation.
Reading further into the data, I would say Verizon faced these problems and decided that they had to throw in the towel. Apple may be the devil, but so could be Google. Apple was predictably evil. But Google? The devil you know is perhaps better than the one you can't predict.
What's more, the devil Apple seems to be helping your worst enemy way too much and the unpredictable one does not seem to help all that much.
Final question: how many iPhones will Verizon sell
I think this data shows that Verizon has another reason to sell the iPhone. The underperformance of their smartphone franchise is not the only determinant, but it is perhaps another straw on the camel's back.
What would happen if (or more likely when) Verizon sells the iPhone? I believe they will sell them at the same rate as AT&T does.
The data shows that Verizon sold, on average, about 3 million smartphones per quarter during the first nine months. That's about 1 million a month. That was based on three platforms, six vendors and widespread promotion.
The iPhone sold almost 4 million a quarter over the same time period.
Verizon users bought smartphones at a lower rate than AT&T users bought iPhones. This is even though the two carriers have approximately the same subs base which churns very slowly. Since a mass-market product will appeal equally to statistically equivalent populations the product should be taken-up with similar vigor.
So the question is not whether Verizon can sell iPhones at the rate of 4 million a quarter. The question is only whether these 4 million will be in addition to the 3 million that are currently buying non-iPhones.
My guess is that the 3 million run rate for non-iPhones will drop, but not to zero.
The impact on the other vendors supplying Verizon may be strongly negative depending on the level of promotion Verizon puts on the product. That promotion budget is usually fixed as a percent of sales. What Verizon applies to iPhone will be taken out of what is spends on Droid. I have always said that operators will be motivated to balance their supplier power. The promotion budget is the primary instrument to meet that end.
On the other hand, the overall market will grow so 2010's 3 million/Q will be 2011's 6 million/Q. There is plenty of room for multiple platforms.
So my conclusion remains that iPhone will find at least 8 million new users with Verizon. The analysis above give me confidence to increase the upper bound to possibly 12 million.
Verizon striking out means they need to change the way they play. The iPhone is a new ball game.
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[1] To assemble this discussion I used only the data provided in the article linked above and the officially published iPhone activation numbers from AT&T. Obtaining specific smartphone vendor volumes is a matter of reverse engineering the share chart and cross-referencing it to the table of vendor sales.
This means 63% of iPhones sold outside the US last quarter. This is down from about 70% earlier this year. As it was a launch quarter and distribution was much more constrained outside the US, the lower figure is not surprising.
It's still important to note however that sales outside the US are far larger than in the US but penetration and share is far less.
In last year's third calendar quarter earnings call (October 20, 2009) Tim Cook was asked:
“So when you go from exclusive to multiple, you don’t change the charge to the carrier?”
Cook answered: “Correct.”
In this year's third calendar quarter earnings call (October 18, 2010) Tim Cook was asked again whether the future iPhone non-exclusive subsidy will affect the iPhone revenues and again Tim Cook repeated that it won't.
Chris Whitmore - Deutsche Bank
And what is your experience then when you've gone non-exclusive from a subsidy and margin standpoint on the phone, have you had to give anything up in the past?
Tim Cook
We don't give specific information out on the margins. But I think you can look at our ASPs and see that they've generally stayed above $600, and that's despite opening up several markets from an exclusive market to a non-exclusive market.
The recurring assumption that the loss of AT&T exclusivity will cause iPhone price erosion is wrong and has been evident in the sales data for over a year now. Not only did Cook state clearly that there is one price for iPhone to the channel regardless of exclusivity but the price data shows that as Apple moved to non-exclusives in many regions of the world, the ASP remained fairly constant:
Over the period when the blue line has been flat, Apple moved a number of markets from exclusive to non-exclusive. There are three main countries where iPhones have a contractual exclusive relationship. That is the United States, Germany and Spain. (China and Japan are exclusive due to network technologies). All these markets will go to non-exclusive next year. I don't expect any change in the ASP as a result.
The final data point comes from AT&T themselves when they revealed the price they paid for the iPhone was roughly the same as the ASP shown above.
As of two weeks ago, AT&T was to be the launch partner for Windows Phone. AT&T had been expected to unveil phones from HTC, Samsung and LG, according The Wall Street Journal.
