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The release of the 3G iPhone has Apple (Nasdaq: AAPL) 
enthusiasts pumped up, but it left AT&T (NYSE: T) investors feeling deflated over the carrier's decision to heavily subsidize the new, cheaper device in the hopes of reaping longer-term gains.
While Apple shares were up about 2 percent Tuesday, AT&T's stock was down, losing just under 1 percent to close at $37.22.
The drop came a day after AT&T acknowledged that the new generation of iPhone -- which will run on a faster network and feature GPS (Global Positioning System) technology -- will cut into profit margins and earnings for the rest of this year and for all of 2009.
High Costs
The subsidies AT&T is paying to Apple will cost the carrier 10 to 12 US cents per share off the top of its earnings for 2008 and 2009 and threaten its bid for double-digit earnings growth in those years, it said.
The carrier remains upbeat, however, that over time, the lower price point -- the 8 gigabyte version of the 3G iPhone will retail for $199 while the 16 GB model will sell for $299 -- will drive increased subscriber volumes.
The 3G iPhone partnership will begin adding to profits by 2010, AT&T said.
"We expect this will spur demand, boost adoption of data services, and attract high-value customers," said AT&T Chief Financial Officer Rick Lindner.
Looking Ahead
The theory appears to be at least in part that the 3G iPhone -- which promises faster Web-surfing speeds -- will encourage users to significantly increase their data consumption and also lock them into the carrier beyond the two years they are required to commit to in order to activate the phone.
Another key element of the AT&T strategy involves the end of the revenue-sharing arrangement. As part of the deal to win the exclusive right to carry the iPhone, AT&T agreed to give Apple a share of monthly revenue from the first generation of the device.
Consumers will be the winners in the short term, as the price of the feature-rich iPhone is cut in half. However, AT&T is raising the prices for service plans to start at $39.99 per month, plus $30 for unlimited data. That works out to a $10 increase from the cheapest plan for the first-generation iPhone.
AT&T has already said that iPhone subscribers are among its biggest spenders, generating on average twice the monthly subscription fees as users on traditional mobile phones.
Bargaining Positions
The fact that AT&T is still facing an earnings hit despite not having to pay Apple for each customer each month demonstrates how steep the subsidies are and how strong Apple's bargaining position was, Gartner (NYSE: IT) analyst Ken Dulaney told MacNewsWorld.
"The first device created as much buzz as anything in the wireless world in recent years," he said. The fact that several competitors have built look-alike products -- devices that will now face the added competitive headache of a lower-priced iPhone -- shows that Apple produced something that appeals to a broad range of consumers. "AT&T is thinking long term, and probably hoping to get as many customers through the door as it can as quickly as it can."
That may be especially important if the exclusivity of the Apple-AT&T arrangement is severed at some point, Dulaney added.
AT&T is also eager to have traffic on its 3G network, which it says it spend $20 billion constructing during the past four years. Exhibiting to users the rapid speed -- peak downloads may be 10 times as fast as the traditional cell network the first-generation iPhone used -- may help convince them to stay as newer options, such as Sprint's (NYSE: S) WiMax network or Verizon's 70 megahertz network, hit the marketplace.
The Cutting Edge
AT&T's subsidies follow a well-worn path in the mobile phone industry, Gloria Barczak, a professor of marketing at Northeastern University in Boston, told MacNewsWorld.
AT&T's move falls in line with the industry standard to subsidize most cell phones, she said. "It also lowers the phone price to buyers, thereby expanding the base of users. Although customers are tied into a two-year contract, chances are that they will add services over time, increasing the revenues and profits to AT&T. The services are where the carriers make money, so it makes sense to lower the price of the phone to increase the number of users and the services they utilize."
The strategy is not unique to the cell phone world. In fact, it's a virtual version of the razor and razor blade model that was also adopted for printers -- with companies such as HP (NYSE: HPQ) selling printers for little or no profit and then making money on the ink cartridges, Barczak added.
She believes the addition of the faster network capabilities and the GPS technology in the 3G iPhone will also help AT&T gain business customers, who typically spend more each month than consumers. "Faster download speed, in particular, was a notable deficiency in the iPhone 1.0 and inhibited enterprise adoption of the product," she said.
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