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If Apple Cuts Out Carriers, Does It Cut Its Margins? Does That Matter?

Apple (AAPL) may plan to make the iPhone independent of European telecom carriers, according to a report in GigaOM. But even if Apple has an easier time of achieving this than rival Google (GOOG) had with its Nexus One handset, there is still the question of how much the company might hurt its profitability ... and whether taking a serious cut might be necessary to protect its position in the market.

The report suggests that Apple might develop a SIM card, which identifies a customer's carrier subscription under globally popular GSM wireless technology, that would integrate into the iPhone:

Then customers will then be able to choose their carrier at time of purchase at the Apple web site or retail store, or buy the phone and get their handset up and running through a download at the App Store as opposed to visiting a carrier store or calling the carrier. Either way, it reduces the role of the carrier in the iPhone purchase.
Google has tried to create a handset business independent of carriers by selling the Nexus One direct. However, it eventually capitulated to business as usual and, even then, its handset, which Google styled as a "superphone," was a flop. There were three distinct reasons:
  • The phone had significant problems.
  • Google's approach to customer service was so inept and uninformed as to be off-putting to all but the faithful.
  • At a price of about $530, because of the lack of carrier subsidy to consumers, the phone was commercially uncompetitive with anything else on the market.
Apple has little to worry about from either public perception of its product or, given its extensive online and physical retail experience, fundamental customer service issues. However, price could potentially be a killer.

The profitability of the iPhone has helped drive the company's business to dizzying heights. In January, the revenue attributed to each iPhone unit was close to $650. That included not only purchase price, but carrier subsidies and related accessory sales. By the next quarter, that number was down to just under $630.

Clearly there has been downward pressure, which makes sense, given the increasing competition from Android handsets. There is only so long a company can keep premium prices in play. In its last quarter, Apple adjusted how it accounts for iPhone revenue, which will boost significantly how much of the sales price it can claim up front.

The move doesn't technically boost product margins, only when they can be claimed. However, the appearance of larger numbers would likely make investors happier. That will be necessary as Apple has warned that margins in the current quarter could slip by about 3.4 percentage points from what it achieved in the fiscal year that ended in September. More competition, obviously, plus the iPad doesn't seem to enjoy the same degree of margin as the iPhone.

Switching to a carrier-independent model could change this for the worse because it would kill off subsidies and make it difficult to obtain the same amount of revenue per unit. Although some people would pay much higher prices for Apple-branded phones, there are too many competitors to make a multi-hundred-dollar differential sustainable.

And yet, Apple might be wise to move ahead anyway. Its margins are so solid that it could trade off short-term profitability for long-term market position, and the strategic wisdom of acquiring more power in its relationship to carriers is clear.

Such a move would consolidate Apple's ability to control ancillary add-on products and services, and the potential to expand the business. The company would effectively recast the hardware sales model into the one it has created for media and software apps, where everything goes through Apple.


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