Microsperience

Hysteria and zealotry aside, Darran Clements looks at the real business differential of the iPhone.

In an ever-changing mobile landscape we’re constantly bombarded with the latest, greatest gadget, with the associated promise of a seamless data, voice and internet experience. Without a doubt 2007 was the year of the iPhone, and this summer the second wave hit us when the 3G version was released.

Industry vets may very well have wondered at the column inches across both trade and general media dedicated to Steve Jobs’ latest baby. There are other phones out there that do as much, if not more, we argued. But the iPhone had become more than a communications device – it is a branded, cultural phenomenon that you either love or hate but you cannot ignore.

Under the glitzy skin, however, the commercial raison d’etre of the smartphone is to provide access to, and increase use of, a range of data services which ultimately we hope will drive up ARPUs and shore up the falling revenue from voice calling in mature markets such as the UK and the US. So now that we’re a year down the line, we have an opportunity to ask: what has the business benefit been to O2 in adopting the iPhone?

In the UK, the iPhone is exclusive to the O2 network. So what we would hope to see is that O2’s market share and ARPU has risen. Glancing over the figures (these precede the launch of the iPhone 3G) the picture looks quite rosy:

• iPhone ARPU is 30% higher than average
• 80% of iPhone users use 10 or more services connected to the device
• 60% iPhone users use more than 25Mb of data per month, compared to less than 1% for other contract phone customers.

As usual, however, the devil is in the detail. The average O2 contract subscriber has an ARPU of around GBP43. The average iPhone user has an ARPU that is 30% higher, or around GBP56 – some GBP13 more. However, this is where it gets interesting, as the iPhone incurs costs to O2: the licensing fee paid to Apple as well as the cost of the handset subsidy. The Apply levy is around GBP3 per existing O2 customer upgrading to the iPhone, and around GBP12 for a customer churning to O2. This means that each iPhone customer churning from another network generates around GBP1 per month in extra revenue on average than a typical O2 customer.

However this fails to take account of the handset subsidy paid by the mobile operator. This issue came to a head again in August 2008 when O2 announced that is was going to double the amount of money customers had to spend per month to be entitled to a top-end handset. The average rate in the UK for eligibility has been GBP35 for at least two years, but O2 has hiked this to GBP75 – well out of the reach of many ordinary customers. The move was stimulated by the increasing costs of subsidising smartphones in general, and the iPhone 3G in particular. O2s customer acquisition budget simply couldn’t sustain the level of subsidy it was paying out.

The move gambles on two aspects – that there is enough demand for the phone to overcome the tariff barrier, and secondly that other networks may follow suit. Certainly, demand for the iPhone was brisk in the first few months after release, but thereafter it stagnated. Likewise there is pent up demand for the iPhone 3G, with some users waiting specifically for this version to be released. However, the UK is amidst an economic crisis that is seeing consumers carefully examine their household spending. Is now really the right time to push a large price hike?

Supporting O2’s move is the fact that the iPhone has huge brand penetration. And before the price rise was announced there were strong indications that even die-hard prepaid users might be tempted to a contract because of their desire for the handset. This would be great news for O2 as it would reduce its churn rates and raise its ARPU.

Commercially O2 is indicating by this move that smartphones are not viable at less than GBP75 per month. Or else that its aspirational ARPU is around that level. But consider this. According to Ofcom[1]:

• average mobile ARPU (voice and data) in the UK is GBP17.59 (up 3%), although this is somewhat depressed by prepaid ARPU of GBP9.10. Contract ARPU is GBP33.06
• the increase in ARPU was largely due to increase in average SMS revenue, which rose 17%; ARPU for non-SMS data declined
• households allocate 4.8% of total spending to all telecom services and that’s been at a similar level since 2003
• the peak year for mobile spending was 2004, when households spent GBP33 per month in comparison to GBP32.73 in 2007.

Smartphones account for around 11% of total shipped handsets, and that figure has stalled. In markets like the UK, mobile operators have been inflating the number of smartphones sold artificially by supplying customers subscribing to GBP35+ packages. This has led to many mid-range customers with high-end handsets they can’t use or don’t use. The drivers behind this have been the old telecoms adage: “build it and they will come”. In other words there was a philosophy that once people got used to high-end handsets then ARPUs would rise as they began to consume more data. I’d argue that on the Ofcom figures that isn’t happening (yet!).

Now the question is how long can the networks persevere, and will their carefully laid plans be upset by the economic downturn? The likely effect of the latter being that a proportion of consumers won’t swap out devices at the end of their contracts but will hold onto their perfectly serviceable mid-range handset for another six or 12 months and look to find a cheaper tariff as a result.

While we must also remember that the global figure is being distorted by the high volumes of low-end handsets being bought by developing markets, there is still a question as to how high real consumer demand is for complex data services, and the smartphones that go with these, even in developed markets like the UK. Would operators be better advised to concentrate on improving mid-range and low-end handsets? Is it easier to upsell a low ARPU customer to mid-range than a mid-range customer to a high-end tariff? Would putting effort into sectors that have growth potential yield more sales and higher ARPU?

Take the silver surfer demographic: just as most 70 year olds don’t buy Jimmy Choos, so many will not want, need, be able to afford or be able to use an iPhone. Yet there is potential in this sector for growth, as demonstrated by their relatively low spend on mobile phones, but their increasing adoption of internet technology. Such consumers want handsets that are suited to their needs, not phones designed for 25 year olds. Features that are appealing include bigger buttons, bigger screens, easy to use phones and services that are designed to appeal to them.

I’m also mindful of a conversation I had recently with a tradesman, who told me that his mobile was his business. Yet he had no interest in complex handsets or fancy ringtones. What appealed to him was reliability, coverage, quality of service, a cheap tariff and a robust handset. This demonstrates how important it is from a commercial perspective to remember that the iPhone, sexy as it is, will appeal only to a subset of users. Network operators need to consider whether their budgets are best spent on attracting such users or on better serving other sectors that might cost them less to address but contain hidden growth potential. The iPhone, and other smartphones, may enhance the telesperience for a select few, but putting all your eggs into this basket risks alienating the majority.