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Here is a lesson from Apple in its foray in mobile phone industry.

Jonathan Kennedy wrote on the 11th Aug:

With its initial foray into the mobile phone industry, Apple chose to adopt a unique business model. The traditional model for handset vendors is to sell their devices to carriers at a wholesale price, and the carrier would then subsidize the retail price for consumers. This gave the carriers control over end-market pricing, and most important, it allowed the carriers to adjust their customer acquisition costs based on the level of contractual commitment to the carrier. Apple’s model, however, was different. The company chose to replace the traditional subsidy model with a revenue sharing model. This gave Apple more control over end-user pricing, and it also provided the company with a recurring, high-margin revenue stream for each iPhone user.

At first, the new model was greeted with intense enthusiasm. The problem was that many customers (more than Apple expected) simply unlocked their iPhones:

While Apple clearly assumed that some of the purchased phones would never be activated, the actual numbers of these non-activated phones was surprising for management, Wall Street, and the industry. Within a few short months after the iPhone’s release, hackers had produced and distributed software that “unlocked” the iPhone and enabled it to work on non-supported carrier networks. Shortly thereafter, a gray market for unlocked iPhones developed… of the six million 2.5G iPhones Apple sold through June 9, 2008, we believe nearly 50% were unlocked.

With that many phones being unlocked, Apple was losing millions on revenue sharing deals, weakening the non-subsidized model. Additionally, according to Shope, adoption was weakened by high prices and uncooperative international carriers who were reluctant to agree to Apple’s stringent terms.

So Apple had to make a change. With the launch of the 3G iPhone, Apple adopted the traditional subsidized-handset business model. In doing so, Apple simultaneously eliminated the unlocking problem and opened up the iPhone to previously untapped markets. By eliminating exclusive revenue sharing deals with international partners, AAPL expands the number of carriers, and therefore its customer base:

We believe this business model change provides three immediate benefits to Apple’s longterm iPhone prospects. First, with freedom to subsidize the iPhone, carriers can now price the iPhone at or below competitive handset prices and some will even offer the device for free with selected service contracts. In a marketplace that is clearly elastic, we estimate that this will provide a substantial boost to Apple’s installed base growth. We currently forecast units of 13.3 million for calendar 2008, easily surpassing Apple’s original 10 million unit target. For calendar 2009, we forecast units of 26.4 million, representing 99.4% annual growth.

Second, by abandoning revenue sharing, it is now much easier for Apple to build a wide array of carrier partnerships. Only a handful of carriers were willing to abandon the traditional industry model for revenue sharing. With its new model, however, Apple has signed agreements with more than 70 carriers around the world, with many more to come.

And finally, Apple’s move towards a traditional contract-based subsidy model has enabled it to shift the economic burden of unlocked phones to the carriers. In the previous model, an unlocked phone meant that Apple was not going to share in the highly profitable monthly carrier revenues. Now, a carrier may choose to sell a phone without a contract, but Apple still gets the same wholesale price for the phone (with the subsidy baked in). We believe this provides a higher degree of certainty to Apple’s earnings and cash flow stream.

Apple tried to change the business model by introducing revenue sharing with the telephone carriers. Theoretically, it was a smart move. The market and the hackers out smarted the move with a 50%rate of unlocked phone. Let us hope that 3G iPhone will bring better yields to Apple.

(The base of the Apple story is from Clusterstock, a blog from Jonathan Kennedy.)


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