IPhone - Why such high ASP?

A Smartphone cost for a consumer over its life is:

1. Upfront cost of buying
2. Data and Voice service
3. Content cost (Apps, could be one time or periodically like in digital media or both)

Today, Apple’s iphone major revenue share is driven through combination of 1 & 2 in post-paid/contract dominant market where it Network uses the iphone as demand generation catalyst which it fulfills by its supply of services reflected in higher ARPU. This has been used twice in rolling out 3G and now LTE services. It is a moot point but going by evidence available before iphone (especially in 3G rollouts in Europe where demand did not increase to meet the supply) that in absence of this new demand the rollouts would have been spread over longer time period.

This is nice virtuous circle as long as it continues to work, since it is demand led hence allowing the Network provider’s to command a premium which would not be the case if it was supply driven i.e. if by infusing new technology Network provider would have hoped for demand of its services.

Smartphone/Iphone  

In US, current wireless ARPU (subscriber based) is $69 for 2012 which is for both feature and smart phone users, if only smart phone users are taken then this would definitely be around $90 which would mean that for the tenure of contract a subscriber is worth $2160 of which $1100 is attributable to smart phone based data usage.  This additional revenue is basically getting shared between Network provider and phone manufacturer (Apple).

The best example for understanding the subsidy cost is the ipad, it has the same appeal /game changing innovation when introduced and has identical content available through the iOS platform but the crucial difference is from Apple perspective is that consumer and the customer are same and no dichotomy like it is there in iphone.

Ipad although having a premium price compared to its competition does not have high operating margin of iphone. This the model that will be prevalent when smart phone reaches maturity, and the same model will work in pre-paid or low ARPU markets. 

Content Services

The third leg of this stool is Content providers (include app developer) who would like to be part of the eco-system and are willing to share revenue with eco-system owners. The content provider the way they have evolved are independent of Network providers i.e. no commercial relationship between them or any cross-subsidies. [This could potentially change in future if some content requires specific network quality/quantity for e.g. an HD movie streaming might involve paying to network provider temporarily sort of on-demand network charges, more in pre-paid rather than in contract market.]

The three eco-systems that are dominant currently are:

1. Apple – comprising of iOS/itune
2. Google – Android
3. Amazon (not in smart phone world currently)

(Windows Mobile is also in reckoning but has not been successful in building a momentum)

Currently, this does not represent a substantial source of revenue for Apple (as content provider are not solely dependent on eco-system but could deliver the services over open Web) but this has important criteria in eco-system’s success which are

• Stickiness: once a consumer setup their digital content which could be around media publications, photo management, music/movie services, social media etc. It makes them reluctant to move out and reduces the churn.
• Demand generation: The more content a user consumes they are likely to increase their network ARPU.
• Additional Revenue: A stream of revenue that that has highest upside potential in future as device and network growth matures
• Eco-system/Cloud services: These are services such as Mail/Calendar/Document Apps (spreadsheets etc)/ Maps which would be provided by Eco-systems owners to distinguish it from others.
• Ad Revenue: through collection of humongous behavioral information many times with implicit consent. Of course, this will be combined with information gathered through non-smart phone based behavioral pattern to provide a complete picture.

Currently, this does not translate directly into a major stream for Apple as its major revenue stream is from upfront purchase and Network provider subsidies. On the other hand Google and Amazon whose business models have relied on Web services revenue stream have unsurprisingly put major emphasis on this stream. (Google keeps its Android platform free and Amazon keeps it device at almost zero operating margin)

High ASP: How long?

As long as the previous virtuous cycle continues where network can continue to move their customers on higher ARPU they would be willing to subsidize. The basic question is for how long and to attempt to predict we need to understand that currently

• USA has smart phone penetration of 56% (May 2013) and saturation may be expected at somewhere in 85% range (9% currently do not own a mobile phone). This would mean USA has still approx. 2 year to reach that stage.
• LTE subscriber amounts to only 20% of total subscriber, this increases the ARPU further and potentially could take 3-4 years for majority of smart phone subscribers to be on LTE
• Currently, there is not any specific “killer application” that could not be sufficed by LTE so once the above two is done smart phone market would be in the mature phase.

The downside specifically for iphone is that it is device primarily owned by educated and moneyed segment which has a higher propensity to consume and majority of them would already be owning one, so that leave the consumers who are not technology faddists and are likely to spent less on their network plan. How much would the network providers be ready to subsidize this group?

This is very difficult to answer but the best case scenario (for Apple) would be for next 2-3 years. The clear signal would be that device life cycle would increase  (Apple is admitting in this year release that the iphone 5 is good enough with plastic covers, only serious gaming and photography enthusiast may pay the 15% premium for 5S).

Another unpredictable is competition as differential in both phone and eco-system is fast reducing and this would provide more negotiation power to network providers to reduce their cost basically phone subsidy.

Apple has consciously taken a decision to ignore or low priortize  pre-paid segment as in their opinion they can always play this game when the growth matures in high ARPU markets. They could have segmented a device for prepaid mkts but that would have probaly affected the halo on the premium tag in USA or developed mkts.